Reg VV Final Rule

Vol. 79

Friday,

No. 21

January 31, 2014

Book 2 of 2 Books
Pages 5535–6076
Part II

Department of the Treasury
Office of the Comptroller of the Currency

Board of Governors of the Federal Reserve
System
Federal Deposit Insurance Corporation
Securities and Exchange Commission

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12 CFR Parts 44, 248, and 351
17 CFR Part 255
Prohibitions and Restrictions on Proprietary Trading and Certain Interests
in, and Relationships With, Hedge Funds and Private Equity Funds; Final
Rule

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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 AD82

FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 351
RIN 3064–AD85

SECURITIES AND EXCHANGE
COMMISSION
17 CFR Part 255
[Release No. BHCA–1; 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: Final rule.
AGENCY:

The OCC, Board, FDIC, and
SEC (individually, an ‘‘Agency,’’ and
collectively, ‘‘the Agencies’’) are
adopting a rule that would implement
section 13 of the BHC Act, which was
added by section 619 of the Dodd-Frank
Wall Street Reform and Consumer
Protection Act (‘‘Dodd-Frank Act’’).
Section 13 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.

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SUMMARY:

The final rule is effective April
1, 2014.
FOR FURTHER INFORMATION CONTACT:
OCC: Ursula Pfeil, Counsel, or
Deborah Katz, Assistant Director,
Legislative and Regulatory Activities
DATES:

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Division, (202) 649–5490; Ted Dowd,
Assistant Director, or Roman Goldstein,
Senior Attorney, Securities and
Corporate Practices Division, (202) 649–
5510; Kurt Wilhelm, Director for
Financial Markets Group, (202) 649–
6360; Stephanie Boccio, Technical
Expert for Credit and Market Risk
Group, (202) 649–6360, Office of the
Comptroller of the Currency, 250 E
Street SW., Washington, DC 20219.
Board: Christopher M. Paridon,
Counsel, (202) 452–3274, or Anna M.
Harrington, Senior Attorney, Legal
Division, (202) 452–6406; Mark E. Van
Der Weide, Deputy Director, Division of
Bank Supervision and Regulation, (202)
452–2263; or Sean D. Campbell, Deputy
Associate Director, Division of Research
and Statistics, (202) 452–3760, Board of
Governors of the Federal Reserve
System, 20th and C Streets NW.,
Washington, DC 20551.
FDIC: Bobby R. Bean, Associate
Director, [email protected], or Karl R.
Reitz, Chief, Capital Markets Strategies
Section, [email protected], Capital
Markets Branch, Division of Risk
Management Supervision, (202) 898–
6888; Michael B. Phillips, Counsel,
[email protected], or Gregory S. Feder,
Counsel, [email protected], Legal
Division, Federal Deposit Insurance
Corporation, 550 17th Street NW.,
Washington, DC 20429.
SEC: Josephine J. Tao, Assistant
Director, Angela R. Moudy, Branch
Chief, John Guidroz, Branch Chief,
Jennifer Palmer or Lisa Skrzycki,
Attorney Advisors, Office of Trading
Practices, Catherine McGuire, Counsel,
Division of Trading and Markets, (202)
551–5777; W. Danforth Townley,
Attorney Fellow, Jane H. Kim, Brian
McLaughlin Johnson or Marian Fowler,
Senior Counsels, Division of Investment
Management, (202) 551–6787; David
Beaning, Special Counsel, Office of
Structured Finance, Division of
Corporation Finance, (202) 551–3850;
John Cross, Office of Municipal
Securities, (202) 551–5680; or Adam
Yonce, Assistant Director, or Matthew
Kozora, Financial Economist, Division
of Economic and Risk Analysis, (202)
551–6600, U.S. Securities and Exchange
Commission, 100 F Street NE.,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
II. Notice of Proposed Rulemaking
III. Overview of Final Rule
A. General Approach and Summary of
Final Rule
B. Proprietary Trading Restrictions
C. Restrictions on Covered Fund Activities
and Investments

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D. Metrics Reporting Requirement
E. Compliance Program Requirement
IV. Final Rule
A. Subpart B—Proprietary Trading
Restrictions
1. Section ll.3: Prohibition on
Proprietary Trading and Related
Definitions
a. Definition of ‘‘Trading Account’’
b. Rebuttable Presumption for the ShortTerm Trading Account
c. Definition of ‘‘Financial Instrument’’
d. Proprietary Trading Exclusions
1. Repurchase and Reverse Repurchase
Arrangements and Securities Lending
2. Liquidity Management Activities
3. Transactions of Derivatives Clearing
Organizations and Clearing Agencies
4. Excluded Clearing-Related Activities of
Clearinghouse Members
5. Satisfying an Existing Delivery
Obligation
6. Satisfying an Obligation in Connection
With a Judicial, Administrative, SelfRegulatory Organization, or Arbitration
Proceeding
7. Acting Solely as Agent, Broker, or
Custodian
8. Purchases or Sales Through a Deferred
Compensation or Similar Plan
9. Collecting a Debt Previously Contracted
10. Other Requested Exclusions
2. Section ll.4(a): Underwriting
Exemption
a. Introduction
b. Overview
1. Proposed Underwriting Exemption
2. Comments on Proposed Underwriting
Exemption
3. Final Underwriting Exemption
c. Detailed Explanation of the
Underwriting Exemption
1. Acting as an Underwriter for a
Distribution of Securities
a. Proposed Requirements That the
Purchase or Sale Be Effected Solely in
Connection With a Distribution of
Securities for Which the Banking Entity
Acts as an Underwriter and That the
Covered Financial Position be a Security
i. Proposed Definition of ‘‘Distribution’’
ii. Proposed Definition of ‘‘Underwriter’’
iii. Proposed Requirement That the
Covered Financial Position Be a Security
b. Comments on the Proposed
Requirements That the Trade Be Effected
Solely in Connection With a Distribution
for Which the Banking Entity Is Acting
as an Underwriter and That the Covered
Financial Position Be a Security
i. Definition of ‘‘Distribution’’
ii. Definition of ‘‘Underwriter’’
iii. ‘‘Solely in Connection With’’ Standard
c. Final Requirement That the Banking
Entity Act as an Underwriter for a
Distribution of Securities and the
Trading Desk’s Underwriting Position Be
Related to Such Distribution
i. Definition of ‘‘Underwriting Position’’
ii. Definition of ‘‘Trading Desk’’
iii. Definition of ‘‘Distribution’’
iv. Definition of ‘‘Underwriter’’
v. Activities Conducted ‘‘in Connection
With’’ a Distribution
2. Near Term Customer Demand
Requirement

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a. Proposed Near Term Customer Demand
Requirement
b. Comments Regarding the Proposed Near
Term Customer Demand Requirement
c. Final Near Term Customer Demand
Requirement
3. Compliance Program Requirement
a. Proposed Compliance Program
Requirement
b. Comments on the Proposed Compliance
Program Requirement
c. Final Compliance Program Requirement
4. Compensation Requirement
a. Proposed Compensation Requirement
b. Comments on the Proposed
Compensation Requirement
c. Final Compensation Requirement
5. Registration Requirement
a. Proposed Registration Requirement
b. Comments on Proposed Registration
Requirement
c. Final Registration Requirement
6. Source of Revenue Requirement
a. Proposed Source of Revenue
Requirement
b. Comments on the Proposed Source of
Revenue Requirement
c. Final Rule’s Approach to Assessing
Source of Revenue
3. Section ll.4(b): Market-Making
Exemption
a. Introduction
b. Overview
1. Proposed Market-Making Exemption
2. Comments on the Proposed MarketMaking Exemption
a. Comments on the Overall Scope of the
Proposed Exemption
b. Comments Regarding the Potential
Market Impact of the Proposed
Exemption
3. Final Market-Making Exemption
c. Detailed Explanation of the MarketMaking Exemption
1. Requirement to Routinely Stand Ready
To Purchase And Sell
a. Proposed Requirement To Hold Self Out
b. Comments on the Proposed Requirement
To Hold Self Out
i. The Proposed Indicia
ii. Treatment of Block Positioning Activity
iii. Treatment of Anticipatory Market
Making
iv. High-Frequency Trading
c. Final Requirement To Routinely Stand
Ready To Purchase And Sell
i. Definition of ‘‘Trading Desk’’
ii. Definitions of ‘‘Financial Exposure’’ and
‘‘Market-Maker Inventory’’
iii. Routinely Standing Ready To Buy and
Sell
2. Near Term Customer Demand
Requirement
a. Proposed Near Term Customer Demand
Requirement
b. Comments Regarding the Proposed Near
Term Customer Demand Requirement
i. The Proposed Guidance for Determining
Compliance With the Near Term
Customer Demand Requirement
ii. Potential Inventory Restrictions and
Differences Across Asset Classes
iii. Predicting Near Term Customer
Demand
iv. Potential Definitions of ‘‘Client,’’
‘‘Customer,’’ or ‘‘Counterparty’’

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v. Interdealer Trading and Trading for
Price Discovery or To Test Market Depth
vi. Inventory Management
vii. Acting as an Authorized Participant or
Market Maker in Exchange-Traded
Funds
viii. Arbitrage or Other Activities That
Promote Price Transparency and
Liquidity
ix. Primary Dealer Activities
x. New or Bespoke Products or Customized
Hedging Contracts
c. Final Near Term Customer Demand
Requirement
i. Definition of ‘‘Client,’’ ‘‘Customer,’’ and
‘‘Counterparty’’
ii. Impact of the Liquidity, Maturity, and
Depth of the Market on the Analysis
iii. Demonstrable Analysis of Certain
Factors
iv. Relationship to Required Limits
3. Compliance Program Requirement
a. Proposed Compliance Program
Requirement
b. Comments on the Proposed Compliance
Program Requirement
c. Final Compliance Program Requirement
4. Market Making-Related Hedging
a. Proposed Treatment of Market MakingRelated Hedging
b. Comments on the Proposed Treatment of
Market Making-Related Hedging
c. Treatment of Market Making-Related
Hedging in the Final Rule
5. Compensation Requirement
a. Proposed Compensation Requirement
b. Comments Regarding the Proposed
Compensation Requirement
c. Final Compensation Requirement
6. Registration Requirement
a. Proposed Registration Requirement
b. Comments on the Proposed Registration
Requirement
c. Final Registration Requirement
7. Source of Revenue Analysis
a. Proposed Source of Revenue
Requirement
b. Comments Regarding the Proposed
Source of Revenue Requirement
i. Potential Restrictions on Inventory,
Increased Costs for customers, and Other
Changes To Market-Making Services
ii. Certain Price Appreciation-Related
Profits Are an Inevitable or Important
Component of Market Making
iii. Concerns Regarding the Workability of
the Proposed Standard in Certain
Markets or Asset Classes
iv. Suggested Modifications to the
Proposed Requirement
v. General Support for the Proposed
Requirement or for Placing Greater
Restrictions on a Market Maker’s Sources
of Revenue
c. Final Rule’s Approach To Assessing
Revenues
8. Appendix B of the Proposed Rule
a. Proposed Appendix B Requirement
b. Comments on Proposed Appendix B
c. Determination To Not Adopt Proposed
Appendix B
9. Use of Quantitative Measurements
4. Section ll.5: Permitted RiskMitigating Hedging Activities
a. Summary of Proposal’s Approach to
Implementing the Hedging Exemption

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b. Manner of Evaluating Compliance With
the Hedging Exemption
c. Comments on the Proposed Rule and
Approach to Implementing the Hedging
Exemption
d. Final Rule
1. Compliance Program Requirement
2. Hedging of Specific Risks and
Demonstrable Reduction Of Risk
3. Compensation
4. Documentation Requirement
5. Section ll.6(a)–(b): Permitted Trading
in Certain Government and Municipal
Obligations
a. Permitted Trading in U.S. Government
Obligations
b. Permitted Trading in Foreign
Government Obligations
c. Permitted Trading in Municipal
Securities
d. Determination To Not Exempt
Proprietary Trading in Multilateral
Development Bank Obligations
6. Section ll.6(c): Permitted Trading on
Behalf of Customers
a. Proposed Exemption for Trading on
Behalf of Customers
b. Comments on the Proposed Rule
c. Final Exemption for Trading on Behalf
of Customers
7. Section ll.6(d): Permitted Trading by
a Regulated Insurance Company
8. Section ll.6(e): Permitted Trading
Activities of a Foreign Banking Entity
a. Foreign Banking Entities Eligible for the
Exemption
b. Permitted Trading Activities of a Foreign
Banking Entity
9. Section ll.7: Limitations on Permitted
Trading Activities
a. Scope of ‘‘Material Conflict of Interest’’
1. Proposed Rule
2. Comments on the Proposed Limitation
on Material Conflicts of Interest
a. Disclosure
b. Information Barriers
3. Final Rule
b. Definition of ‘‘High-Risk Asset’’ and
‘‘High-Risk Trading Strategy’’
1. Proposed Rule
2. Comments on Proposed Limitations on
High-Risk Assets and Trading Strategies
3. Final Rule
c. Limitations on Permitted Activities That
Pose a Threat to Safety and Soundness
of the Banking Entity or the Financial
Stability of the United States
B. Subpart C—Covered Fund Activities and
Investments
1. Section ll.10: Prohibition on
Acquisition or Retention of Ownership
Interests in, and Certain Relationships
With, a Covered Fund
a. Prohibition Regarding Covered Fund
Activities and Investments
b. ‘‘Covered Fund’’ Definition
1. Foreign Covered Funds
2. Commodity Pools
3. Entities Regulated Under the Investment
Company Act
c. Entities Excluded From Definition of
Covered Fund
1. Foreign Public Funds
2. Wholly-Owned Subsidiaries
3. Joint Ventures
4. Acquisition Vehicles

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5. Foreign Pension or Retirement Funds
6. Insurance Company Separate Accounts
7. Bank Owned Life Insurance Separate
Accounts
8. Exclusion for Loan Securitizations and
Definition of Loan
a. Definition of Loan
b. Loan Securitizations
i. Loans
ii. Contractual Rights Or Assets
iii. Derivatives
iv. SUBIs and Collateral Certificates
v. Impermissible Assets
9. Asset-Backed Commercial Paper
Conduits
10. Covered Bonds
11. Certain Permissible Public Welfare and
Similar Funds
12. Registered Investment Companies and
Excluded Entities
13. Other Excluded Entities
d. Entities Not Specifically Excluded From
the Definition of Covered Fund
1. Financial Market Utilities
2. Cash Collateral Pools
3. Pass-Through REITS
4. Municipal Securities Tender Option
Bond Transactions
5. Venture Capital Funds
6. Credit Funds
7. Employee Securities Companies
e. Definition of ‘‘Ownership Interest’’
f. Definition of ‘‘Resident of the United
States’’
g. Definition of ‘‘Sponsor’’
2. Section ll.11: Activities Permitted in
Connection With Organizing and
Offering a Covered Fund
a. Scope of Exemption
1. Fiduciary Services
2. Compliance With Investment
Limitations
3. Compliance With Section 13(f) of the
BHC Act
4. No Guarantees or Insurance of Fund
Performance
5. Limitation on Name Sharing With a
Covered Fund
6. Limitation on Ownership By Directors
and Employees
7. Disclosure Requirements
b. Organizing and Offering an Issuing
Entity of Asset-Backed Securities
c. Underwriting and Market Making for a
Covered Fund
3. Section ll.12: Permitted Investment in
a Covered Fund
a. Proposed Rule
b. Duration of Seeding Period for New
Covered Funds
c. Limitations on Investments in a Single
Covered Fund (‘‘Per-Fund Limitation’’)
d. Limitation on Aggregate Permitted
Investments in All Covered funds
(‘‘Aggregate Funds Limitation’’)
e. Capital Treatment of an Investment in a
Covered Fund
f. Attribution of Ownership Interests to a
Banking Entity
g. Calculation of Tier 1 Capital
h. Extension of Time to Divest Ownership
Interest in a Single Fund
4. Section ll.13: Other Permitted
Covered Fund Activities
a. Permitted Risk-Mitigating Hedging
Activities

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b. Permitted Covered Fund Activities and
Investments Outside of the United States
1. Foreign Banking Entities Eligible for the
Exemption
2. Activities or Investments Solely Outside
of the United States
3. Offered for Sale or Sold to a Resident of
the United States
4. Definition of ‘‘Resident of the United
States’’
c. Permitted Covered Fund Interests and
Activities by a Regulated Insurance
Company
5. Section ll.14: Limitations on
Relationships With a Covered Fund
a. Scope of Application
b. Transactions That Would Be a ‘‘Covered
Transaction’’
c. Certain Transactions and Relationships
Permitted
1. Permitted Investments and Ownerships
Interests
2. Prime Brokerage Transactions
d. Restrictions on Transactions With Any
Permitted Covered Fund
6. Section ll.15: Other Limitations on
Permitted Covered Fund Activities
C. Subpart D and Appendices A and B—
Compliance Program, Reporting, and
Violations
1. Section ll.20: Compliance Program
Mandate
a. Program Requirement
b. Compliance Program Elements
c. Simplified Programs for Less Active
Banking Entities
d. Threshold for Application of Enhanced
Minimum Standards
2. Appendix B: Enhanced Minimum
Standards for Compliance Programs
a. Proprietary Trading Activities
b. Covered Fund Activities or Investments
c. Enterprise-Wide Programs
d. Responsibility and Accountability
e. Independent Testing
f. Training
g. Recordkeeping
3. Section ll.20(d) and Appendix A:
Reporting and Recordkeeping
Requirements Applicable to Trading
Activities
a. Approach to Reporting and
Recordkeeping Requirements Under the
Proposal
b. General Comments on the Proposed
Metrics
c. Approach of the Final Rule
d. Proposed Quantitative Measurements
and Comments on Specific Metrics
4. Section ll.21: Termination of
Activities or Investments; Authorities for
Violations
V. Administrative Law Matters
A. Use of Plain Language
B. Paperwork Reduction Act Analysis
C. Regulatory Flexibility Act Analysis
D. OCC Unfunded Mandates Reform Act of
1995 Determination

I. Background
The Dodd-Frank Act was enacted on
July 21, 2010.1 Section 619 of the Dodd1 Dodd-Frank Wall Street Reform and Consumer
Protection Act, Public Law 111–203, 124 Stat. 1376
(2010).

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Frank Act added a new section 13 to the
Bank Holding Company Act of 1956
(‘‘BHC Act’’) (codified at 12 U.S.C. 1851)
that generally prohibits any banking
entity from engaging in proprietary
trading or from acquiring or retaining an
ownership interest in, sponsoring, or
having certain relationships with a
hedge fund or private equity fund
(‘‘covered fund’’), subject to certain
exemptions.2 New section 13 of the BHC
Act also provides that a nonbank
financial company designated by the
Financial Stability Oversight Council
(‘‘FSOC’’) for supervision by the Board
(while not a banking entity under
section 13 of the BHC Act) would be
subject to additional capital
requirements, quantitative limits, or
other restrictions if the company
engages in certain proprietary trading or
covered fund activities.3
Section 13 of the BHC Act generally
prohibits banking entities from engaging
as principal in proprietary trading for
the purpose of selling financial
instruments in the near term or
otherwise with the intent to resell in
order to profit from short-term price
movements.4 Section 13(d)(1) expressly
exempts from this prohibition, subject
to conditions, certain activities,
including:
• Trading in U.S. government, agency
and municipal obligations;
• Underwriting and market makingrelated activities;
• Risk-mitigating hedging activities;
• Trading on behalf of customers;
• Trading for the general account of
insurance companies; and
• Foreign trading by non-U.S.
banking entities.5
Section 13 of the BHC Act also
generally prohibits banking entities
from acquiring or retaining an
ownership interest in, or sponsoring, a
hedge fund or private equity fund.
Section 13 contains several exemptions
that permit banking entities to make
limited investments in hedge funds and
private equity funds, subject to a
number of restrictions designed to
ensure that banking entities do not
rescue investors in these funds from loss
and are not themselves exposed to
2 See

12 U.S.C. 1851.
12 U.S.C. 1851(a)(2) and (f)(4). The Agencies
note that two of the three companies currently
designated by FSOC for supervision by the Board
are affiliated with insured depository institutions,
and are therefore currently banking entities for
purposes of section 13 of the BHC Act. The
Agencies are continuing to review whether the
remaining company engages in any activity subject
to section 13 of the BHC Act and what, if any,
requirements apply under section 13.
4 See 12 U.S.C. 1851(a)(1)(A) and (B).
5 See id. at 1851(d)(1).
3 See

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significant losses from investments or
other relationships with these funds.
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 that these activities
be subject to additional capital charges,
quantitative limits, or other
restrictions.6
II. Notice of Proposed Rulemaking:
Summary of General Comments
Authority for developing and
adopting regulations to implement the
prohibitions and restrictions of section
13 of the BHC Act is divided among the
Board, the Federal Deposit Insurance
Corporation (‘‘FDIC’’), the Office of the
Comptroller of the Currency (‘‘OCC’’),
the Securities and Exchange
Commission (‘‘SEC’’), and the
Commodity Futures Trading
Commission (‘‘CFTC’’).7 As required by
section 13(b)(2) of the BHC Act, the
Board, OCC, FDIC, and SEC in October
2011 invited the public to comment on
proposed rules implementing that
section’s requirements.8 The period for
filing public comments on this proposal
was extended for an additional 30 days,
until February 13, 2012.9 In January
2012, the CFTC requested comment on
a proposal for the same common rule to
implement section 13 with respect to
those entities for which it is the primary
financial regulatory agency and invited
public comment on its proposed
implementing rule through April 16,
6 See

12 U.S.C. 1851(a)(2) and (d)(4).
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.
8 See 76 FR 68846 (Nov. 7, 2011) (‘‘Joint
Proposal’’).
9 See 77 FR 23 (Jan. 23, 2012) (extending the
comment period to February 13, 2012).

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7 See

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2012.10 The statute 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.11
The proposed rules invited comment
on a multi-faceted regulatory framework
to implement section 13 consistent with
the statutory language. In addition, the
Agencies invited comments on the
potential economic impacts of the
proposed rule and posed a number of
questions seeking information on the
costs and benefits associated with each
aspect of the proposal, as well as on any
significant alternatives that would
minimize the burdens or amplify the
benefits of the proposal in a manner
consistent with the statute. The
Agencies also encouraged commenters
to provide quantitative information and
data about the impact of the proposal on
entities subject to section 13, as well as
on their clients, customers, and
counterparties, specific markets or asset
classes, and any other entities
potentially affected by the proposed
rule, including non-financial small and
mid-size businesses.
The Agencies received over 18,000
comments addressing a wide variety of
aspects of the proposal, including
definitions used by the proposal and the
exemptions for market making-related
activities, risk-mitigating hedging
activities, covered fund activities and
investments, the use of quantitative
metrics, and the reporting proposals.
The vast majority of these comments
were from individuals using a version of
a short form letter to express support for
the proposed rule. More than 600
comment letters were unique comment
letters, including from members of
Congress, domestic and foreign banking
entities and other financial services
firms, trade groups representing
banking, insurance, and the broader
financial services industry, U.S. state
and foreign governments, consumer and
public interest groups, and individuals.
To improve understanding of the issues
raised by commenters, the Agencies met
with a number of these commenters to
discuss issues relating to the proposed
rule, and summaries of these meetings
10 See 77 FR 8332 (Feb. 14, 2012) (‘‘CFTC
Proposal’’).
11 See 12 U.S.C. 1851(b)(2)(B)(ii). The Secretary of
the Treasury, as Chairperson of the FSOC, is
responsible for coordinating the Agencies’
rulemakings under section 13 of the BHC Act. See
id.

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are available on each of the Agency’s
public Web sites.12 The CFTC staff also
hosted a public roundtable on the
proposed rule.13 Many of the
commenters generally expressed
support for the broader goals of the
proposed rule. At the same time, many
commenters expressed concerns about
various aspects of the proposed rule.
Many of these commenters requested
that one or more aspects of the proposed
rule be modified in some manner in
order to reflect their viewpoints and to
better accommodate the scope of
activities that they argued were
encompassed within section 13 of the
BHC Act. The comments addressed all
major sections of the proposed rule.
Section 13 of the BHC Act also
required the FSOC to conduct a study
(‘‘FSOC study’’) and make
recommendations to the Agencies by
January 21, 2011 on the implementation
of section 13 of the BHC Act. The FSOC
study was issued on January 18, 2011.
The FSOC study 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.14 The FSOC 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
12 See http://www.regulations.gov/#!docketDetail;
D=OCC-2011-0014 (OCC); http://www.federal
reserve.gov/newsevents/reform_systemic.htm
(Board); http://www.fdic.gov/regulations/laws/
federal/2011/11comAD85.html (FDIC); http://
www.sec.gov/comments/s7-41-11/s74111.shtml
(SEC); and http://www.cftc.gov/LawRegulation/
DoddFrankAct/Rulemakings/DF_28_VolckerRule/
index.htm (CFTC).
13 See Commodity Futures Trading Commission,
CFTC Staff to Host a Public Roundtable to Discuss
the Proposed Volcker Rule (May 24, 2012),
available at http://www.cftc.gov/PressRoom/
PressReleases/pr6263-12; transcript available at
http://www.cftc.gov/ucm/groups/public/@
newsroom/documents/file/transcript053112.pdf.
14 See Financial Stability Oversight Counsel,
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.
(‘‘FSOC study’’). See 12 U.S.C. 1851(b)(1). Prior to
publishing its study, FSOC requested public
comment on a number of issues to assist 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.

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enforcement procedures for violations.15
The Agencies carefully considered the
FSOC study and its recommendations.
In formulating this final rule, the
Agencies carefully reviewed all
comments submitted in connection with
the rulemaking and considered the
suggestions and issues they raise in light
of the statutory restrictions and
provisions as well as the FSOC study.
The Agencies have sought to reasonably
respond to all of the significant issues
commenters raised. The Agencies
believe they have succeeded in doing so
notwithstanding the complexities
involved. The Agencies also carefully
considered different options suggested
by commenters in light of potential
costs and benefits in order to effectively
implement section 13 of the BHC Act.
The Agencies made numerous changes
to the final rule in response to the issues
and information provided by
commenters. These modifications to the
rule and explanations that address
comments are described in more detail
in the section-by-section description of
the final rule. To enhance uniformity in
both rules that implement section 13
and administration of the requirements
of that section, the Agencies have been
regularly consulting with each other in
the development of this final rule.
Some commenters requested that the
Agencies repropose the rule and/or
delay adoption pending the collection of
additional information.16 As described
in part above, the Agencies have
provided many and various types of
opportunities for commenters to provide
input on implementation of section 13
of the BHC Act and have collected
substantial information in the process.
In addition to the official comment
process described above, members of
the public submitted comment letters in
advance of the official comment period
for the proposed rules and met with
staff of the Agencies to explain issues of
concern; the public also provided
substantial comment in response to a
request for comment from the FSOC
regarding its findings and
recommendations for implementing
section 13.17 The Agencies provided a
detailed proposal and posed numerous
15 See

FSOC study at 5–6.
e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); ABA (Keating); Chamber (Nov. 2011);
Chamber (Nov. 2013); Members of Congress (Dec.
2011); IIAC; Real Estate Roundtable; Ass’n. of
German Banks; Allen & Overy (Clearing); JPMC;
Goldman (Prop. Trading); BNY Mellon et al.; State
Street (Feb. 2012); ICI Global; Chamber (Feb. 2012);
Socie´te´ Ge´ne´rale; HSBC; Western Asset Mgmt.;
Abbott Labs et al. (Feb. 2012); PUC Texas; Columbia
Mgmt.; ICI (Feb. 2012); IIB/EBF; British Bankers’
Ass’n.; ISDA (Feb. 2012); Comm. on Capital Markets
Regulation; Ralph Saul (Apr. 2012); BPC.
17 See 75 FR 61,758 (Oct. 6, 2010).

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16 See,

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questions in the preamble to the
proposal to solicit and explore
alternative approaches in many areas. In
addition, the Agencies have continued
to receive comment letters after the
extended comment period deadline,
which the Agencies have considered.
Thus, the Agencies believe interested
parties have had ample opportunity to
review the proposed rules, as well as the
comments made by others, and to
provide views on the proposal, other
comment letters, and data to inform our
consideration of the final rules.
In addition, the Agencies have been
mindful of the importance of providing
certainty to banking entities and
financial markets and of providing
sufficient time for banking entities to
understand the requirements of the final
rule and to design, test, and implement
compliance and reporting systems. The
further substantial delay that would
necessarily be entailed by reproposing
the rule would extend the uncertainty
that banking entities would face, which
could prove disruptive to banking
entities and the financial markets.
The Agencies note, as discussed more
fully below, that the final rule
incorporates a number of modifications
designed to address the issues raised by
commenters in a manner consistent
with the statute. The preamble below
also discusses many of the issues raised
by commenters and explains the
Agencies’ response to those comments.
To achieve the purpose of the statute,
without imposing unnecessary costs, the
final rule builds on the multi-faceted
approach in the proposal, which
includes development and
implementation of a compliance
program at each banking entity engaged
in trading activities or that makes
investments subject to section 13 of the
BHC Act; the collection and evaluation
of data regarding these activities as an
indicator of areas meriting additional
attention by the banking entity and the
relevant agency; appropriate limits on
trading, hedging, investment and other
activities; and supervision by the
Agencies. To allow banking entities
sufficient time to develop appropriate
systems, the Agencies have provided for
a phased-in schedule for the collection
of data, limited data reporting
requirements only to banking entities
that engage in significant trading
activity, and agreed to review the merits
of the data collected and revise the data
collection as appropriate over the next
21 months. Importantly, as explained in
detail below, the Agencies have also
reduced the compliance burden for
banking entities with total assets of less
than $10 billion. The final rule also
eliminates compliance burden for firms

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that do not engage in covered activities
or investments beyond investing in U.S.
government obligations, agency
guaranteed obligations, or municipal
obligations.
Moreover, the Agencies believe the
data that will be collected in connection
with the final rule, as well as the
compliance efforts made by banking
entities and the supervisory experience
that will be gained by the Agencies in
reviewing trading and investment
activity under the final rule, will
provide valuable insights into the
effectiveness of the final rule in
achieving the purpose of section 13 of
the BHC Act. The Agencies remain
committed to implementing the final
rule, and revisiting and revising the rule
as appropriate, in a manner designed to
ensure that the final rule faithfully
implements the requirements and
purposes of the statute.18
Finally, the Board has determined, in
accordance with section 13 of the BHC
Act, to provide banking entities with
additional time to conform their
activities and investments to the statute
and the final rule. The restrictions and
prohibitions of section 13 of the BHC
Act became effective on July 21, 2012.19
The statute provided banking entities a
period of two years to conform their
activities and investments to the
requirement of the statute, until July 21,
2014. Section 13 also permits the Board
to extend this conformance period, one
year at a time, for a total of no more than
three additional years.20 Pursuant to this
authority and in connection with this
rulemaking, the Board has in a separate
action extended the conformance period
for an additional year until July 21,
2015.21 The Board will continue to
monitor developments to determine
whether additional extensions of the
conformance period are in the public
interest, consistent with the statute.
Accordingly, the Agencies do not
believe that a reproposal or further
delay is necessary or appropriate.
Commenters have differing views on
the overall economic impacts of section
13 of the BHC Act.
18 If any provision of this rule, or the application
thereof to any person or circumstance, is held to be
invalid, such invalidity shall not affect other
provisions or application of such provisions to
other persons or circumstances that can be given
effect without the invalid provision or application.
19 See 12 U.S.C. 1851(c)(1).
20 See 12 U.S.C. 1851(c)(2); See also, A
Conformance Period for Entities Engaged in
Prohibited Proprietary Trading or Private Equity
Fund or Hedge Fund Activities, 76 FR 8265 (Feb.
14, 2011) (citing 156 Cong. Rec. S5898 (daily ed.
July 15, 2010) (statement of Sen. Merkley)).
21 See, Board Order Approving Extension of
Conformance Period, available at http://
www.federalreserve.gov/newsevents/press/bcreg/
bcreg20131210b1.pdf.

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Some commenters remarked that
proprietary trading restrictions will
have detrimental impacts on the
economy such as: reduction in
efficiency of markets, economic growth,
and in employment due to a loss in
liquidity.22 In particular, a commenter
expressed concern that there may be
high transition costs as non-banking
entities replace some of the trading
activities currently performed by
banking entities.23 Another commenter
focused on commodity markets
remarked about the potential reduction
in commercial output and curtailed
resource exploration due to a lack of
hedging counterparties.24 Several
commenters stated that section 13 of the
BHC Act will reduce access to debt
markets—especially for smaller
companies—raising the costs of capital
for firms and lowering the returns on
certain investments.25 Further, some
commenters mentioned that U.S. banks
may be competitively disadvantaged
relative to foreign banks due to
proprietary trading restrictions and
compliance costs.26
On the other hand, other commenters
stated that restricting proprietary
trading activity by banking entities may
reduce systemic risk emanating from the
financial system and help to lower the
probability of the occurrence of another
financial crisis.27 One commenter
contended that large banking entities
may have a moral hazard incentive to
engage in risky activities without
allocating sufficient capital to them,
especially if market participants believe
these institutions will not be allowed to
fail.28 Commenters argued that large
banking entities may engage in activities
that increase the upside return at the
expense of downside loss exposure
which may ultimately be borne by
Federal taxpayers 29 and that subsidies
associated with bank funding may
create distorted economic outcomes.30
Furthermore, some commenters
remarked that non-banking entities may
fill much of the void in liquidity
22 See, e.g., Oliver Wyman (Dec. 2011); Chamber
(Dec. 2011); Thakor Study; Prof. Duffie; IHS.
23 See Prof. Duffie.
24 See IHS.
25 See, e.g., Chamber (Dec. 2011); Thakor Study;
Oliver Wyman (Dec. 2011); IHS.
26 See, e.g., RBC; Citigroup (Feb. 2012); Goldman
(Covered Funds).
27 See, e.g., Profs. Admati & Pfleiderer; AFR (Nov.
2012); Better Markets (Dec. 2011); Better Markets
(Feb. 2012); Occupy; Johnson & Prof. Stiglitz; Paul
Volcker.
28 See Occupy.
29 See Profs. Admati & Pfleiderer; Better Markets
(Feb. 2012); Occupy; Johnson & Prof. Stiglitz; Paul
Volcker.
30 See Profs. Admati & Pfleiderer; Johnson & Prof.
Stiglitz.

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provision left by banking entities if
banking entities reduce their current
trading activities.31 Finally, some
commenters mentioned that hyperliquidity that arises from, for instance,
speculative bubbles, may harm the
efficiency and price discovery function
of markets.32
The Agencies have taken these
concerns into account in the final rule.
As described below with respect to
particular aspects of the final rule, the
Agencies have addressed these issues by
reducing burdens where appropriate,
while at the same time ensuring that the
final rule serves its purpose of
promoting healthy economic activity. In
that regard, the Agencies have sought to
achieve the balance intended by
Congress under section 13 of the BHC
Act. Several comments suggested that a
costs and benefits analysis be performed
by the Agencies.33 On the other hand,
some commenters 34 correctly stated
that a costs and benefits analysis is not
legally required.35 However, the
Agencies find certain of the information
submitted by commenters concerning
costs and benefits and economic effects
to be relevant to consideration of the
rule, and so have considered this
information as appropriate, and, on the
basis of these and other considerations,
sought to achieve the balance intended
by Congress in section 619 of the DoddFrank Act. The relevant comments are
addressed therein.
III. Overview of Final Rule
The Agencies are adopting this final
rule to implement section 13 of the BHC
Act with a number of changes to the
proposal, as described further below.
The final rule adopts a risk-based
approach to implementation that relies
on a set of clearly articulated
characteristics of both prohibited and
permitted activities and investments
and is designed to effectively
accomplish the statutory purpose of
reducing risks posed to banking entities
by proprietary trading activities and
investments in or relationships with
covered funds. As explained more fully
31 See AFR et al. (Feb. 2012); Better Markets (Apr.
16, 2012); David McClean; Public Citizen; Occupy.
32 See Johnson & Prof. Stiglitz (citing Thomas
Phillipon (2011)); AFR et al. (Feb. 2012); Occupy.
33 See SIFMA et al. (Covered Funds) (Feb. 2012);
BoA; ABA (Keating); Chamber (Feb. 2012); Socie´te´
Ge´ne´rale; FTN; SVB; ISDA (Feb. 2012); Comm. on
Capital Market Regulation; Real Estate Roundtable.
34 See, e.g., Better Markets (Feb. 2012); Randel
Pilo.
35 For example, with respect to the CFTC, Section
15(a) of the CEA requires such consideration only
when ‘‘promulgating a regulation under this
[Commodity Exchange] Act.’’ This final rule is not
promulgated under the CEA, but under the BHC
Act. CEA section 15(a), therefore, does not apply.

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below in the section-by-section analysis,
the final rule has been designed to
ensure that banking entities do not
engage in prohibited activities or
investments and to ensure that banking
entities engage in permitted trading and
investment activities in a manner
designed to identify, monitor and limit
the risks posed by these activities and
investments. For instance, the final rule
requires that any banking entity that is
engaged in activity subject to section 13
develop and administer a compliance
program that is appropriate to the size,
scope and risk of its activities and
investments. The rule requires the
largest firms engaged in these activities
to develop and implement enhanced
compliance programs and regularly
report data on trading activities to the
Agencies. The Agencies believe this will
permit banking entities to effectively
engage in permitted activities, and the
Agencies to enforce compliance with
section 13 of the BHC Act. In addition,
the enhanced compliance programs will
help both the banking entities and the
Agencies identify, monitor, and limit
risks of activities permitted under
section 13, particularly involving
banking entities posing the greatest risk
to financial stability.
A. General Approach and Summary of
Final Rule
The Agencies have designed the final
rule to achieve the purposes of section
13 of the BHC Act, which include
prohibiting banking entities from
engaging in proprietary trading or
acquiring or retaining an ownership
interest in, or having certain
relationships with, a covered fund,
while permitting banking entities to
continue to provide, and to manage and
limit the risks associated with
providing, client-oriented financial
services that are critical to capital
generation for businesses of all sizes,
households and individuals, and that
facilitate liquid markets. These clientoriented financial services, which
include underwriting, market making,
and asset management services, are
important to the U.S. financial markets
and the participants in those markets.
At the same time, providing appropriate
latitude to banking entities to provide
such client-oriented services need not
and should not conflict with clear,
robust, and effective implementation of
the statute’s prohibitions and
restrictions.
As noted above, the final rule takes a
multi-faceted approach to implementing
section 13 of the BHC Act. In particular,
the final rule includes a framework that
clearly describes the key characteristics
of both prohibited and permitted

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activities. The final rule also requires
banking entities to establish a
comprehensive compliance program
designed to ensure compliance with the
requirements of the statute and rule in
a way that takes into account and
reflects the banking entity’s activities,
size, scope and complexity. With
respect to proprietary trading, the final
rule also requires the large firms that are
active participants in trading activities
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.
As a matter of structure, the final rule
is generally divided into four subparts
and contains two appendices, as
follows:
• Subpart A of the final 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 final rule prohibits
proprietary trading, defines terms
relevant to covered trading activity,
establishes exemptions from 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 final 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 final rule generally
requires banking entities to establish a
compliance program regarding
compliance with section 13 of the BHC
Act and the final rule, including written
policies and procedures, internal
controls, a management framework,
independent testing of the compliance
program, training, and recordkeeping;
• Appendix A of the final rule details
the quantitative measurements that
certain banking entities may be required
to compute and report with respect to
certain trading activities;
• Appendix B of the final rule details
the enhanced minimum standards for
programmatic compliance that certain
banking entities must meet with respect
to their compliance program, as
required under subpart D.

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B. Proprietary Trading Restrictions
Subpart B of the final rule implements
the statutory prohibition on proprietary
trading and the various exemptions to
this prohibition included in the statute.
Section ll.3 of the final rule contains
the core prohibition on proprietary
trading and defines a number of related
terms, including ‘‘proprietary trading’’
and ‘‘trading account.’’ The final rule’s
definition of proprietary trading
generally parallels the statutory
definition and covers engaging as
principal for the trading account of a
banking entity in any transaction to
purchase or sell specified types of
financial instruments.36
The final rule’s definition of trading
account also is consistent with the
statutory definition.37 In particular, the
definition of trading account in the final
rule includes three classes of positions.
First, the definition includes the
purchase or sale of one or more
financial instruments 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.38 For purposes
of this part of the definition, the final
rule also contains a rebuttable
presumption that the purchase or sale of
a financial instrument by a banking
entity is for the trading account of the
banking entity if the banking entity
holds the financial instrument for fewer
than 60 days or substantially transfers
the risk of the financial instrument
within 60 days of purchase (or sale).39
Second, with respect to a banking entity
subject to the Federal banking agencies’
Market Risk Capital Rules, the
definition includes the purchase or sale
of one or more financial instruments
subject to the prohibition on proprietary
trading that are treated as ‘‘covered
positions and trading positions’’ (or
hedges of other market risk capital rule
covered positions) under those capital
rules, other than certain foreign
exchange and commodities positions.40
Third, the definition includes the
purchase or sale of one or more
financial instruments by a banking
entity that is licensed or registered or
required to be licensed or registered to
engage in the business of a dealer, swap
dealer, or security-based swap dealer to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such or is
final rule § ll.3(a).
final rule § ll.3(b).
38 See final rule § ll.3(b)(1)(i).
39 See final rule § ll.3(b)(2).
40 See final rule § ll.3(b)(1)(ii).
36 See

engaged in those businesses outside of
the United States, to the extent the
instrument is purchased or sold in
connection with the activities of such
business.41
The definition of proprietary trading
also contains clarifying exclusions for
certain purchases and sales of financial
instruments that generally do not
involve the requisite short-term trading
intent, such as the purchase and sale of
financial instruments arising under
certain repurchase and reverse
repurchase arrangements or securities
lending transactions and securities
acquired or taken for bona fide liquidity
management purposes.42
In Section ll.3, the final rule also
defines a number of other relevant
terms, including the term ‘‘financial
instrument.’’ This term is used to define
the scope of financial instruments
subject to the prohibition on proprietary
trading. Consistent with the statutory
language, such financial instruments
include securities, derivatives,
commodity futures, and options on such
instruments, but do not include loans,
spot foreign exchange or spot physical
commodities.43
In Section ll.4, the final rule
implements the statutory exemptions for
underwriting and market making-related
activities. For each of these permitted
activities, the final rule defines the
exempt activity and provides a number
of requirements that must be met in
order for a banking entity to rely on the
applicable exemption. As more fully
discussed below, these include
establishment and enforcement of a
compliance program targeted to the
activity; limits on positions, inventory
and risk exposure addressing the
requirement that activities be designed
not to exceed the reasonably expected
near term demands of clients,
customers, or counterparties; limits on
the duration of holdings and positions;
defined escalation procedures to change
or exceed limits; analysis justifying
established limits; internal controls and
independent testing of compliance with
limits; senior management
accountability and limits on incentive
compensation. In addition, the final rule
requires firms with significant marketmaking or underwriting activities to
report data involving several metrics
that may be used by the banking entity
and the Agencies to identify trading
activity that may warrant more detailed
compliance review.
These requirements are generally
designed to ensure that the banking

37 See

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final rule § ll.3(b)(1)(iii).
final rule § ll.3(d).
43 See final rule § ll.3(c).
41 See
42 See

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entity’s trading activity is limited to
underwriting and market making-related
activities and does not include
prohibited proprietary trading.44 These
requirements are also intended to work
together to ensure that banking entities
identify, monitor and limit the risks
associated with these activities.
In Section ll.5, the final rule
implements the statutory exemption for
risk-mitigating hedging. As with the
underwriting and market-making
exemptions, § ll.5 of the final rule
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 hedging
activity is limited to risk-mitigating
hedging in purpose and effect.45 Section
ll.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.46 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.
In Section ll.6, the final 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
of the United States. Section ll.6(a) of
the final rule describes the government
obligations in which a banking entity
may trade, which include U.S.
government and agency obligations,
obligations and other instruments of
specified government sponsored
entities, and State and municipal
obligations.47 Section ll.6(b) of the
final rule permits trading in certain
foreign government obligations by
affiliates of foreign banking entities in
the United State and foreign affiliates of
a U.S. banking entity abroad.48 Section
ll.6(c) of the final rule describes
permitted trading on behalf of
customers and identifies the types of
transactions that would qualify for the
exemption.49 Section ll.6(d) of the
final rule describes permitted trading by
a regulated insurance company or an
affiliate thereof for the general account
of the insurance company, and also
final rule § ll.4(a), (b).
final rule § ll.5.
46 See final rule § ll.5(c).
47 See final rule § ll.6(a).
48 See final rule § ll.6(b).
49 See final rule § ll.6(c).
44 See

permits those entities to trade for a
separate account of the insurance
company.50 Finally, § ll.6(e) of the
final rule describes trading permitted
outside of the United States by a foreign
banking entity.51 The exemption in the
final rule clarifies when a foreign
banking entity will qualify 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 the BHC Act. As explained in
detail below, the exemption also
provides that the risk as principal, the
decision-making, and the accounting for
this activity must occur solely outside of
the United States, consistent with the
statute.
In Section ll.7, the final 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.52 This
section also describes the terms material
conflict of interest, high-risk asset, and
high-risk trading strategy for these
purposes.
C. Restrictions on Covered Fund
Activities and Investments
Subpart C of the final rule implements
the statutory prohibition on, directly or
indirectly, acquiring and retaining an
ownership interest in, or having certain
relationships with, a covered fund, as
well as the various exemptions to this
prohibition included in the statute.
Section ll.10 of the final rule contains
the core prohibition on covered fund
activities and investments and defines a
number of related terms, including
‘‘covered fund’’ and ‘‘ownership
interest.’’ 53 The definition of covered
fund contains a number of exclusions
for entities that may rely on exclusions
from the Investment Company Act of
1940 contained in section 3(c)(1) or
3(c)(7) of that Act but that are not
engaged in investment activities of the
type contemplated by section 13 of the
BHC Act. These include, for example,
exclusions for wholly owned
subsidiaries, joint ventures, foreign
pension or retirement funds, insurance
company separate accounts, and public
welfare investment funds. The final rule
also implements the statutory rule of

45 See

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final rule § ll.6(d).
final rule § ll.6(e).
52 See final rule § ll.7.
53 See final rule § ll.10(b).
50 See
51 See

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construction in section 13(g)(2) and
provides that a securitization of loans,
which would include loan
securitization, qualifying asset backed
commercial paper conduit, and
qualifying covered bonds, is not covered
by section 13 or the final rule.54
The definition of ‘‘ownership
interest’’ in the final rule provides
further guidance regarding the types of
interests that would be considered to be
an ownership interest in a covered
fund.55 As described in this
Supplementary Information, these
interests may take various forms. The
definition of ownership interest also
explicitly excludes from the definition
‘‘restricted profit interest’’ that is solely
performance compensation for services
provided to the covered fund by the
banking entity (or an employee or
former employee thereof), under certain
circumstances.56 Section ll.10 of the
final rule also defines a number of other
relevant terms, including the terms
‘‘prime brokerage transaction,’’
‘‘sponsor,’’ and ‘‘trustee.’’
Section ll.11 of the final rule
implements the exemption for
organizing and offering a covered fund
provided for under section 13(d)(1)(G)
of the BHC Act. Section ll.11(a) of the
final 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, subject to certain
limits contained in section 13 of the
BHC Act.57 The requirements are
discussed in detail in Part IV.B.2. of this
SUPPLEMENTARY INFORMATION. Section
ll.11 also explains how these
requirements apply to covered funds
that are issuing entities of asset-backed
securities, as well as implements the
statutory exemption for underwriting
and market-making ownership interests
of a covered fund, including explaining
the limitations imposed on such
activities under the final rule.
In Section ll.12, the final rule
permits a banking entity to acquire and
54 The Agencies believe that most securitization
transactions are currently structured so that the
issuing entity with respect to the securitization is
not an affiliate of a banking entity under the BHC
Act. However, with respect to any securitization
that is an affiliate of a banking entity and that does
not meet the requirements of the loan securitization
exclusion, the related banking entity will need to
determine how to bring the securitization into
compliance with this rule.
55 See final rule § ll.10(d)(6).
56 See final rule § ll.10(b)(6)(ii).
57 See 156 Cong. Rec. S5889 (daily ed. July 15,
2010) (statement of Sen. Hagan).

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retain, as an investment in a covered
fund, an ownership interest in a covered
fund that the banking entity organizes
and offers or holds pursuant to other
authority under § ll.11.58 This section
implements section 13(d)(4) of the BHC
Act and related provisions. Section
13(d)(4)(A) of the BHC Act permits a
banking entity to make an investment in
a covered fund that the banking entity
organizes and offers, 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 ll
.12 of the final 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. In
addition, § ll.12 requires that the
aggregate value of all investments in
covered funds, plus any earnings on
these investments, be deducted from the
capital of the banking entity for
purposes of the regulatory capital
requirements, and explains how that
deduction must occur. Section ll.12
of the final rule also clarifies how a
banking entity must calculate its
compliance with these investment
limitations (including by deducting
such investments from applicable
capital, as relevant), and 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. This section also
explains how a banking entity must
apply the covered fund investment
limits to a covered fund that is an
issuing entity of asset backed securities
or a covered fund that is part of a
master-feeder or fund-of-funds
structure.
In Section ll.13, the final rule
implements the statutory exemptions
described in sections 13(d)(1)(C), (D),
(F), and (I) of the BHC Act that permit
a banking entity: (i) to acquire and
retain an ownership interest in a
covered fund as a risk-mitigating
hedging activity related to employee
compensation; (ii) in the case of a nonU.S. banking entity, to acquire and
retain an ownership interest in, or act as
sponsor to, a covered fund solely
outside the United States; and (iii) to
acquire and retain an ownership interest
in, or act as sponsor to, a covered fund
58 See

final rule § ll.12.

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by an insurance company for its general
or separate accounts.59
In Section ll.14, the final 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 Federal Reserve
Act.60 Section ll.14(a)(2) of the final
rule describes the transactions between
a banking entity and a covered fund that
remain permissible under the statute
and the final rule. Section ll.14(b) of
the final 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 Federal Reserve Act,61 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.
In Section ll.15, the final 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.62 This
section also describes material conflict
of interest, high-risk asset, and high-risk
trading strategy for these purposes.
D. Metrics Reporting Requirement
Under the final rule, a banking entity
that meets relevant thresholds specified
in the rule must furnish the following
quantitative measurements for each of
its trading desks engaged in covered
trading activity calculated in accordance
with Appendix A:
• Risk and Position Limits and Usage;
• Risk Factor Sensitivities;
• Value-at-Risk and Stress VaR;
• Comprehensive Profit and Loss
Attribution;
• Inventory Turnover;
• Inventory Aging; and
• Customer Facing Trade Ratio.
The final rule raises the threshold for
metrics reporting from the proposal to
capture only firms that engage in
final rule § ll.13(a)–(c).
60 See 12 U.S.C. 371c; see also final rule
§ ll.14.
61 12 U.S.C. 371c–1.
62 See final rule § ll.15.
59 See

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significant trading activity, identified at
specified aggregate trading asset and
liability thresholds, and delays the dates
for reporting metrics through a phasedin approach based on the size of trading
assets and liabilities. Specifically, the
Agencies have delayed the reporting of
metrics until June 30, 2014 for the
largest banking entities that, together
with their affiliates and subsidiaries,
have trading assets and liabilities the
average gross sum of which equal or
exceed $50 billion on a worldwide
consolidated basis over the previous
four calendar quarters (excluding
trading assets and liabilities involving
obligations of or guaranteed by the
United States or any agency of the
United States). Banking entities with
$25 billion or more in trading assets and
liabilities and banking entities with $10
billion or more in trading assets and
liabilities would also be required to
report these metrics beginning on April
30, 2016, and December 31, 2016,
respectively.
Under the final rule, a banking entity
required to report metrics must
calculate any applicable quantitative
measurement for each trading day. Each
banking entity required to report must
report each applicable quantitative
measurement to its primary supervisory
Agency on the reporting schedule
established in the final rule unless
otherwise requested by the primary
supervisory Agency for the entity. The
largest banking entities with $50 billion
in consolidated trading assets and
liabilities must report the metrics on a
monthly basis. Other banking entities
required to report metrics must do so on
a quarterly basis. All quantitative
measurements for any calendar month
must be reported no later than 10 days
after the end of the calendar month
required by the final rule unless another
time is requested by the primary
supervisory Agency for the entity except
for a transitional six month period
during which reporting will be required
no later than 30 days after the end of the
calendar month. Banking entities
subject to quarterly reporting will be
required to report quantitative
measurements within 30 days of the end
of the quarter, unless another time is
requested by the primary supervisory
Agency for the entity in writing.63
63 See final rule § ll.20(d)(3). The final rule
includes a shorter period of time for reporting
quantitative measurements than was proposed for
the largest banking entities. Like the monthly
reporting requirement for these firms, this is
intended to allow for more effective supervision of
their large-scale trading operations.

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
E. Compliance Program Requirement
Subpart D of the final 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 final
rule.64 To reduce the overall burden of
the rule, the final rule provides that a
banking entity that does not engage in
covered trading activities (other than
trading in U.S. government or agency
obligations, obligations of specified
government sponsored entities, and
state and municipal obligations) or
covered fund activities and investments
need only establish a compliance
program prior to becoming engaged in
such activities or making such
investments.65 In addition, to reduce the
burden on smaller banking entities, a
banking entity with total consolidated
assets of $10 billion or less that engages
in covered trading activities and/or
covered fund activities or investments
may satisfy the requirements of the final
rule by including in its existing
compliance policies and procedures
appropriate references to the
requirements of section 13 and the final
rule and adjustments as appropriate
given the activities, size, scope and
complexity of the banking entity.66
For banking entities with total assets
greater than $10 billion and less than
$50 billion, the final rule specifies six
elements that each compliance program
established under subpart D must, at a
minimum, include. These requirements
focus on written policies and
procedures reasonably designed to
ensure compliance with the final rules,
including limits on underwriting and
market-making; a system of internal
controls; clear accountability for
compliance and review of limits,
hedging, incentive compensation, and
other matters; independent testing and
audits; additional documentation for
covered funds; training; and
recordkeeping requirements.
A banking entity with $50 billion or
more total consolidated assets (or a
foreign banking entity that has total U.S.
assets of $50 billion or more) or that is
required to report metrics under
Appendix A is required to adopt an
enhanced compliance program with
more detailed policies, limits,
governance processes, independent
testing and reporting. In addition, the
final rule § ll.20.
final rule § ll.20(f)(1).
66 See final rule § ll.20(f)(2).
64 See
65 See

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Chief Executive Officer of these larger
banking entities must attest that the
banking entity has in place a program
reasonably designed to achieve
compliance with the requirements of
section 13 of the BHC Act and the final
rule.
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 final rule.
IV. Final Rule
A. Subpart B—Proprietary Trading
Restrictions
1. Section ll.3: Prohibition on
Proprietary Trading and Related
Definitions
Section 13(a)(1)(A) of the BHC Act
prohibits a banking entity from engaging
in proprietary trading unless otherwise
permitted in section 13.67 Section
13(h)(4) of the BHC Act defines
proprietary trading, in relevant part, as
engaging as principal for the trading
account of the banking entity in any
transaction to purchase or sell, or
otherwise acquire or dispose of, a
security, derivative, contract of sale of a
commodity for future delivery, or other
financial instrument that the Agencies
include by rule.68
Section ll.3(a) of the proposed rule
implemented section 13(a)(1)(A) of the
BHC Act by prohibiting a banking entity
from engaging in proprietary trading
unless otherwise permitted under
§§ ll.4 through ll.6 of the proposed
rule. Section ll.3(b)(1) of the
proposed rule defined proprietary
trading in accordance with section
13(h)(4) of the BHC Act and clarified
that proprietary trading does not
include acting solely as agent, broker, or
custodian for an unaffiliated third party.
The preamble to the proposed rule
explained that acting in these types of
capacities does not involve trading as
principal.69
Several commenters expressed
concern about the breadth of the ban on
proprietary trading.70 Some of these
commenters stated that proprietary
trading must be carefully and narrowly
defined to avoid prohibiting activities
67 12

U.S.C. 1851(a)(1)(A).
U.S.C. 1851(h)(4).
69 See Joint Proposal, 76 FR 68,857.
70 See, e.g., Ass’n. of Institutional Investors (Feb.
2012); Capital Group; Comm. on Capital Markets
Regulation; IAA; SIFMA et al. (Prop. Trading) (Feb.
2012); SVB; Chamber (Feb. 2012); Wellington.
68 12

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5545

that Congress did not intend to limit
and to preclude significant, unintended
consequences for capital markets,
capital formation, and the broader
economy.71 Some commenters asserted
that the proposed definition could result
in banking entities being unwilling to
take principal risk to provide liquidity
for institutional investors; could
unnecessarily constrain liquidity in
secondary markets, forcing asset
managers to service client needs
through alternative non-U.S. markets;
could impose substantial costs for all
institutions, especially smaller and midsize institutions; and could drive risktaking to the shadow banking system.72
Others urged the Agencies to determine
that trading as agent, broker, or
custodian for an affiliate was not
proprietary trading.73
Commenters also suggested
alternative approaches for defining
proprietary trading. In general, these
approaches sought to provide a brightline definition to provide increased
certainty to banking entities74 or make
the prohibition easier to apply in
practice.75 One commenter stated the
Agencies should focus on the economics
of banking entities’ transactions and ban
trading if the banking entity is exposed
to market risk for a significant period of
time or is profiting from changes in the
value of the asset.76 Several
commenters, including individual
members of the public, urged the
Agencies to prohibit banking entities
from engaging in any kind of proprietary
trading and require separation of trading
from traditional banking activities.77
After carefully considering comments,
the Agencies are defining proprietary
trading as engaging as principal for the
trading account of the banking entity in
any purchase or sale of one or more
71 See Ass’n. of Institutional Investors (Feb. 2012);
GE (Feb. 2012); Invesco; Sen. Corker; Chamber (Feb.
2012).
72 See Chamber (Feb. 2012).
73 See Japanese Bankers Ass’n.
74 See, e.g., ABA (Keating); Ass’n. of Institutional
Investors (Feb. 2012); BOK; George Bollenbacher;
Credit Suisse (Seidel); NAIB et al.; SSgA (Feb.
2012); JPMC.
75 See Public Citizen.
76 See Sens. Merkley & Levin (Feb. 2012).
77 See generally Occupy; Public Citizen; AFR et
al. (Feb. 2012). The Agencies received over fifteen
thousand form letters in support of a rule with few
exemptions, many of which expressed a desire to
return to the regulatory scheme as governed by the
Glass-Steagall affiliation provisions of the U.S.
Banking Act of 1933, as repealed through the
Graham-Leach-Bliley Act of 1999. See generally
Sarah McGee; Christopher Wilson; Michael Itlis;
Barry Rein; Edward Bright. Congress rejected such
an approach, however, opting instead for the more
narrowly tailored regulatory approach embodied in
section 13 of the BHC Act.

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financial instruments.78 The Agencies
believe this effectively restates the
statutory definition. The Agencies are
not adopting commenters’ suggested
modifications to the proposed definition
of proprietary trading or the general
prohibition on proprietary trading
because they generally appear to be
inconsistent with Congressional intent.
For instance, some commenters
appeared to suggest an approach to
defining proprietary trading that would
capture only bright-line, speculative
proprietary trading and treat the
activities covered by the statutory
exemptions as completely outside the
rule.79 However, such an approach
would appear to be inconsistent with
Congressional intent because, for
instance, it would not give effect to the
limitations on permitted activities in
section 13(d) of the BHC Act.80 For
similar reasons, the Agencies are not
adopting a bright-line definition of
proprietary trading.81
A number of commenters expressed
concern that, as a whole, the proposed
rule may result in certain negative
economic impacts, including: (i)
Reduced market liquidity; 82 (ii) wider
spreads or otherwise increased trading
costs; 83 (iii) higher borrowing costs for
78 See final rule § ll.3(a). The final rule also
replaces all references to the proposed term
‘‘covered financial position’’ with the term
‘‘financial instrument.’’ This change has no
substantive impact because the definition of
‘‘financial instrument’’ is substantially identical to
the proposed definition of ‘‘covered financial
position.’’ Consistent with this change, the final
rule replaces the undefined verbs ‘‘acquire’’ or
‘‘take’’ with the defined terms ‘‘purchase’’ or ‘‘sale’’
and ‘‘sell.’’ See final rule §§ ll.3(c), ll.2(u), (x).
79 See, e.g., Ass’n. of Institutional Investors (Feb.
2012); GE (Feb. 2012); Invesco; Sen. Corker;
Chamber (Feb. 2012); JPMC.
80 See 156 Cong. Rec. S5895–96 (daily ed. July 15,
2010) (statement of Sen. Merkley) (stating the
statute ‘‘permits underwriting and market-makingrelated transactions that are technically trading for
the account of the firm but, in fact, facilitate the
provision of near-term client-oriented financial
services.’’).
81 See ABA (Keating); Ass’n. of Institutional
Investors (Feb. 2012); BOK; George Bollenbacher;
Credit Suisse (Seidel); NAIB et al.; SSgA (Feb.
2012); JPMC.
82 See, e.g., AllianceBernstein; Obaid Syed; Rep.
Bachus et al.; EMTA; NASP; Sen. Hagan; Investure;
Lord Abbett; Sumitomo Trust; EFAMA; Morgan
Stanley; Barclays; BoA; Citigroup (Feb. 2012);
STANY; ABA (Keating); ICE; ICSA; SIFMA (Asset
Mgmt.) (Feb. 2012); Putnam; ACLI (Feb. 2012);
Wells Fargo (Prop. Trading); Capital Group; RBC;
Columbia Mgmt.; SSgA (Feb. 2012); Fidelity; ICI
(Feb. 2012); ISDA (Feb. 2012); Comm. on Capital
Markets Regulation; Clearing House Ass’n.; Thakor
Study. See also CalPERS (acknowledging that the
systemic protections afforded by the Volcker Rule
come at a price, including reduced liquidity to all
markets).
83 See, e.g., AllianceBernstein; Obaid Syed;
NASP; Investure; Lord Abbett; CalPERS; Credit
Suisse (Seidel); Citigroup (Feb. 2012); ABA
(Keating); SIFMA (Asset Mgmt.) (Feb. 2012);

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businesses or increased cost of
capital; 84 and/or (iv) greater market
volatility.85 The Agencies have carefully
considered commenters’ concerns about
the proposed rule’s potential impact on
overall market liquidity and quality. As
discussed in more detail in Parts IV.A.2.
and IV.A.3., the final rule will permit
banking entities to continue to provide
beneficial market-making and
underwriting services to customers, and
therefore provide liquidity to customers
and facilitate capital-raising. However,
the statute upon which the final rule is
based prohibits proprietary trading
activity that is not exempted. As such,
the termination of non-exempt
proprietary trading activities of banking
entities may lead to some general
reductions in liquidity of certain asset
classes. Although the Agencies cannot
say with any certainty, there is good
reason to believe that to a significant
extent the liquidity reductions of this
type may be temporary since the statute
does not restrict proprietary trading
activities of other market participants.86
Thus, over time, non-banking entities
may provide much of the liquidity that
is lost by restrictions on banking
entities’ trading activities. If so,
eventually, the detrimental effects of
increased trading costs, higher costs of
capital, and greater market volatility
should be mitigated.
To respond to concerns raised by
commenters while remaining consistent
with Congressional intent, the final rule
has been modified to provide that
certain purchases and sales are not
Putnam; Wells Fargo (Prop. Trading); Comm. on
Capital Markets Regulation.
84 See, e.g., Rep. Bachus et al.; Members of
Congress (Dec. 2011); Lord Abbett; Morgan Stanley;
Barclays; BoA; Citigroup (Feb. 2012); ABA
(Abernathy); ICSA; SIFMA (Asset Mgmt.) (Feb.
2012); Chamber (Feb. 2012); Putnam; ACLI (Feb.
2012); UBS; Wells Fargo (Prop. Trading); Capital
Group; Sen. Carper et al.; Fidelity; Invesco; Clearing
House Ass’n.; Thakor Study.
85 See, e.g., CalPERS (expressing the belief that a
decline in banking entity proprietary trading will
increase the volatility of the corporate bond market,
especially during times of economic weakness or
periods where risk taking declines, but noting that
portfolio managers have experienced many different
periods of market illiquidity and stating that the
market will adapt post-implementation (e.g.,
portfolio managers will increase their use of CDS
to reduce economic risk to specific bond positions
as the liquidation process of cash bonds takes more
time, alternative market matching networks will be
developed)); Morgan Stanley; Capital Group;
Fidelity; British Bankers’ Ass’n.; Invesco.
86 See David McClean; Public Citizen; Occupy. In
response to commenters who expressed concern
about risks associated with proprietary trading
activities moving to non-banking entities, the
Agencies note that section 13’s prohibition on
proprietary trading and related exemptions apply
only to banking entities. See, e.g., Chamber (Feb.
2012).

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proprietary trading as described in more
detail below.87
a. Definition of ‘‘Trading Account’’
As explained above, section 13
defines proprietary trading as engaging
as principal ‘‘for the trading account of
the banking entity’’ in certain types of
transactions. Section 13(h)(6) of the
BHC Act defines trading account as any
account used for acquiring or taking
positions in financial instruments
principally for the purpose of selling in
the near-term (or otherwise with the
intent to resell in order to profit from
short-term price movements), and any
such other accounts as the Agencies
may, by rule, determine.88
The proposed rule defined trading
account to include three separate
accounts. First, the proposed definition
of trading account included, consistent
with the statute, any account that is
used by a banking entity to acquire or
take one or more covered financial
positions for short-term trading
purposes (the ‘‘short-term trading
account’’).89 The proposed rule
identified four purposes that would
indicate short-term trading intent: (i)
Short-term resale; (ii) benefitting from
actual or expected short-term price
movements; (iii) realizing short-term
arbitrage profits; or (iv) hedging one or
more positions described in (i), (ii) or
(iii). The proposed rule presumed that
an account is a trading account if it is
used to acquire or take a covered
financial position (other than a position
in the market risk rule trading account
or the dealer trading account) that the
banking entity holds for 60 days or
less.90
Second, the proposed definition of
trading account included, for certain
entities, any account that contains
positions that qualify for trading book
capital treatment under the banking
agencies’ market risk capital rules other
than positions that are foreign exchange
derivatives, commodity derivatives or
contracts of sale of a commodity for
delivery (the ‘‘market risk rule trading
account’’).91 ‘‘Covered positions’’ under
the banking agencies’ market-risk
capital rules are positions that are
generally held with the intent of sale in
the short-term.
Third, the proposed definition of
trading account included any account
used by a banking entity that is a
securities dealer, swap dealer, or
final rule § ll.3(d).
12 U.S.C. 1851(h)(6).
89 See proposed rule § ll.3(b)(2)(i)(A).
90 See proposed rule § ll.3(b)(2)(ii).
91 See proposed rule §§ ll.3(b)(2)(i)(B); ll
.3(b)(3).
87 See
88 See

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security-based swap dealer to acquire or
take positions in connection with its
dealing activities (the ‘‘dealer trading
account’’).92 The proposed rule also
included as a trading account any
account used to acquire or take any
covered financial position by a banking
entity in connection with the activities
of a dealer, swap dealer, or securitybased swap dealer outside of the United
States.93 Covered financial positions
held by banking entities that register or
file notice as securities or derivatives
dealers as part of their dealing activity
were included because such positions
are generally held for sale to customers
upon request or otherwise support the
firm’s trading activities (e.g., by hedging
its dealing positions).94
The proposed rule also set forth four
clarifying exclusions from the definition
of trading account. The proposed rule
provided that no account is a trading
account to the extent that it is used to
acquire or take certain positions under
repurchase or reverse repurchase
arrangements, positions under securities
lending transactions, positions for bona
fide liquidity management purposes, or
positions held by derivatives clearing
organizations or clearing agencies.95
Overall, commenters did not raise
significant concerns with or objections
to the short-term trading account.
Several commenters argued that the
definition of trading account should be
limited to only this portion of the
proposed definition of trading
account.96 However, a few commenters
raised concerns regarding the treatment
of arbitrage trading under the proposed
rule.97 Several commenters asserted that
the proposed definition of trading
account was too broad and covered
trading not intended to be covered by
the statute.98 Some of these commenters
maintained that the Agencies exceeded
their statutory authority under section
13 of the BHC Act in defining trading
account to include the market risk rule
trading account and dealer trading
account, and argued that the definition
should be limited to the short-term
trading account definition.99
Commenters argued, for example, that
proposed rule § ll.3(b)(2)(i)(C).
proposed rule § ll.3(b)(2)(i)(C)(5).
94 See Joint Proposal, 76 FR 68,860.
95 See proposed rule § ll.3(b)(2)(iii).
96 See ABA (Keating); JPMC.
97 See AFR et al. (Feb. 2012); Paul Volcker; Credit
Suisse (Seidel); ISDA (Feb. 2012); Japanese Bankers
Ass’n.
98 See ABA (Keating); Allen & Overy (on behalf
of Large Int’l Banks with U.S. Operations); Am.
Express; BoA; Goldman (Prop. Trading); ISDA (Feb.
2012); Japanese Bankers Ass’n.; JPMC; SIFMA et al.
(Prop.Trading) (Feb. 2012); State Street (Feb. 2012).
99 See ABA (Keating); JPMC; SIFMA et al.
(Prop.Trading) (Feb. 2012); State Street (Feb. 2012).
92 See

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an overly broad definition of trading
account may cause traditional bank
activities important to safety and
soundness of a banking entity to fall
within the prohibition on proprietary
trading to the detriment of banking
organizations, customers, and financial
markets.100 A number of commenters
suggested modifying and narrowing the
trading account definition to remove the
implicit negative presumption that any
position creates a trading account, or
that all principal trading constitutes
prohibited proprietary trading unless it
qualifies for a narrowly tailored
exemption, and to clearly exempt
activities important to safety and
soundness.101 For example, one
commenter recommended that a
covered financial position be considered
a trading account position only if it
qualifies as a GAAP trading position.102
A few commenters requested the
Agencies define the phrase ‘‘short term’’
in the rule.103
Several commenters argued that the
market risk rule should not be
referenced as part of the definition of
trading account.104 A few of these
commenters argued instead that the
capital treatment of a position be used
only as an indicative factor rather than
a dispositive test.105 One commenter
thought that the market risk rule trading
account was redundant because it
includes only positions that have shortterm trading intent.106 Commenters also
contended that it was difficult to
consider and comment on this aspect of
the proposal because the market risk
capital rules had not been finalized.107
A number of commenters objected to
the dealer trading account prong of the
definition.108 Commenters asserted that
this prong was an unnecessary and
100 See

ABA (Keating); Credit Suisse (Seidel).
ABA (Keating); Ass’n. of Institutional
Investors (Feb. 2012); BoA; Capital Group; IAA;
Credit Suisse (Seidel); ICI (Feb. 2012); ISDA (Feb.
2012); NAIB et al.; SIFMA et al. (Prop.Trading)
(Feb. 2012); SVB; Wellington.
102 See ABA (Keating).
103 See NAIB et al.; Occupy; but See Alfred Brock.
104 See ABA; BoA; Goldman (Prop. Trading);
ISDA (Feb. 2012); JPMC; SIFMA et al.
(Prop.Trading) (Feb. 2012).
105 See BoA; SIFMA et al. (Prop.Trading) (Feb.
2012).
106 See ISDA (Feb. 2012).
107 See ABA (Keating); BoA; Goldman (Prop.
Trading); ISDA (Feb. 2012); JPMC. The banking
agencies adopted a final rule that amends their
respective market risk capital rules on August 30,
2012. See 77 FR 53,060 (Aug. 30, 2012). The
Agencies continued to receive and consider
comments on the proposed rule to implement
section 13 of the BHC Act after that time.
108 See ABA (Keating); Allen & Overy (on behalf
of Large Int’l Banks with U.S. Operations); Am.
Express; Goldman (Prop. Trading); ISDA (Feb.
2012); Japanese Bankers Ass’n.; JPMC; SIFMA et al.
(Prop.Trading) (Feb. 2012).
101 See

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unhelpful addition that went beyond
the requirements of section 13 of the
BHC Act, and that it made the trading
account determination more complex
and difficult.109 In particular,
commenters argued that the dealer
trading account was too broad and
introduced uncertainty because it
presumed that dealers always enter into
positions with short-term intent.110
Commenters also expressed concern
about the difficulty of applying this test
outside the United States and requested
that, if this account is retained, the final
rule be explicit about how it applies to
a swap dealer outside the United States
and treat U.S. swap dealers
consistently.111
In contrast, other commenters
contended that the proposed rule’s
definition of trading account was too
narrow, particularly in its focus on
short-term positions,112 or should be
simplified.113 One commenter argued
that the breadth of the trading account
definition was critical because positions
excluded from the trading account
definition would not be subject to the
proposed rule.114 One commenter
supported the proposed definition of
trading account.115 Other commenters
believed that reference to the marketrisk rule was an important addition to
the definition of trading account. Some
expressed the view that it should
include all market risk capital rule
covered positions and not just those
requiring short-term trading intent.116
Certain commenters proposed
alternate definitions. Several
commenters argued against using the
term ‘‘account’’ and instead advocated
applying the prohibition on proprietary
trading to trading positions.117 Foreign
banks recommended applying the
definition of trading account applicable
to such banks in their home country, if
the home country provided a clear
definition of this term.118 These
commenters argued that new definitions
in the proposed rule, like trading
account, would require foreign banking
109 See ABA (Keating); Allen & Overy (on behalf
of Large Int’l Banks with U.S. Operations); JPMC;
State Street (Feb. 2012); ISDA (Feb. 2012); SIFMA
et al. (Prop.Trading) (Feb. 2012).
110 See ABA (Keating); Am. Express; Goldman
(Prop. Trading); ISDA (Feb. 2012); JPMC.
111 See Allen & Overy (on behalf of Large Int’l
Banks with U.S. Operations); Am. Express; JPMC.
112 See Sens. Merkley & Levin (Feb. 2012);
Occupy.
113 See, e.g., Public Citizen.
114 See AFR et al. (Feb. 2012).
115 See Alfred Brock.
116 See AFR et al. (Feb. 2012).
117 See ABA (Keating); Goldman (Prop. Trading);
NAIB et al.
118 See Japanese Bankers Ass’n.; Norinchukin.

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entities to develop new and complex
procedures and expensive systems.119
Commenters also argued that various
types of trading activities should be
excluded from the trading account
definition. For example, one commenter
asserted that arbitrage trading should
not be considered trading account
activity,120 while other commenters
argued that arbitrage positions and
strategies are proprietary trading and
should be included in the definition of
trading account and prohibited by the
final rule.121 Another commenter argued
that the trading account should include
only positions primarily intended, when
the position is entered into, to profit
from short-term changes in the value of
the assets, and that liquidity
investments that do not have price
changes and that can be sold whenever
the banking entity needs cash should be
excluded from the trading account
definition.122
After carefully reviewing the
comments, the Agencies have
determined to retain in the final rule the
proposed approach for defining trading
account that includes the short-term,
market risk rule, and dealer trading
accounts with modifications to address
issues raised by commenters. The
Agencies believe that this multi-prong
approach is consistent with both the
language and intent of section 13 of the
BHC Act, including the express
statutory authority to include ‘‘any such
other account’’ as determined by the
Agencies.123 The final definition
effectuates Congress’s purpose to
generally focus on short-term trading
while addressing commenters’ desire for
greater certainty regarding the definition
of the trading account.124 In addition,
the Agencies believe commenters’
concerns about the scope of the
proposed definition of trading account
are substantially addressed by the
refined exemptions in the final rule for
customer-oriented activities, such as
market making-related activities, and
the exclusions from proprietary
trading.125 Moreover, the Agencies
119 See

Japanese Bankers Ass’n.
Alfred Brock.
121 See AFR et al. (Feb. 2012); Paul Volcker.
122 See NAIB et al. See infra Part IV.A.1.d.2.
(discussing the liquidity management exclusion).
123 12 U.S.C. 1851(h)(6).
124 In response to commenters’ concerns about the
meaning of account, the Agencies note the term
‘‘trading account’’ is a statutory concept and does
not necessarily refer to an actual account. Trading
account is simply nomenclature for the set of
transactions that are subject to the final rule’s
restrictions on proprietary trading. See ABA
(Keating); Goldman (Prop. Trading); NAIB et al.
125 For example, several commenters’ concerns
about the potential impact of the proposed
definition of trading account were tied to the

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believe that it is appropriate to focus on
the economics of a banking entity’s
trading activity to help determine
whether it is engaged in proprietary
trading, as discussed further below.126
As explained above, the short-term
trading prong of the definition largely
incorporates the statutory provisions.
This prong covers trading involving
short-term resale, price movements, and
arbitrage profits, and hedging positions
that result from these activities.
Specifically, the reference to short-term
resale is taken from the statute’s
definition of trading account. The
Agencies continue to believe it is also
appropriate to include in the short-term
trading prong an account that is used by
a banking entity to purchase or sell one
or more financial instruments
principally for the purpose of
benefitting from actual or expected
short-term price movements, realizing
short-term arbitrage profits, or hedging
one or more positions captured by the
short-term trading prong. The
provisions regarding price movements
and arbitrage focus on the intent to
engage in transactions to benefit from
short-term price movements (e.g.,
entering into a subsequent transaction
in the near term to offset or close out,
rather than sell, the risks of a position
held by the banking entity to benefit
from a price movement occurring
between the acquisition of the
underlying position and the subsequent
offsetting transaction) or to benefit from
differences in multiple market prices,
including scenarios where movement in
those prices is not necessary to realize
the intended profit.127 These types of
transactions are economically
equivalent to transactions that are
principally for the purpose of selling in
the near term or with the intent to resell
to profit from short-term price
movements, which are expressly
covered by the statute’s definition of
trading account. Thus, the Agencies
believe it is necessary to include these
provisions in the final rule’s short-term
trading prong to provide clarity about
the scope of the definition and to
prevent evasion of the statute and final
perceived narrowness of the proposed exemptions.
See ABA (Keating); Ass’n. of Institutional Investors
(Feb. 2012); BoA; Capital Group; IAA; Credit Suisse
(Seidel); ICI (Feb. 2012); ISDA (Feb. 2012); NAIB et
al.; SIFMA et al. (Prop. Trading) (Feb. 2012); SVB;
Wellington.
126 See Sens. Merkley & Levin (Feb. 2012).
However, as discussed in this SUPPLEMENTARY
INFORMATION, the Agencies are not prohibiting any
trading that involves profiting from changes in the
value of the asset, as suggested by this commenter,
because permitted activities, such as market
making, can involve price appreciation-related
revenues. See infra Part IV.A.3. (discussing the final
market-making exemption).
127 See Joint Proposal, 76 FR 68,857–68,858.

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rule.128 In addition, like the proposed
rule, the final rule’s short-term trading
prong includes hedging one or more of
the positions captured by this prong
because the Agencies assume that a
banking entity generally intends to hold
the hedging position for only so long as
the underlying position is held.
The remaining two prongs to the
trading account definition apply to
types of entities that engage actively in
trading activities. Each prong focuses on
analogous or parallel short-term trading
activities. A few commenters stated
these prongs were duplicative of the
short-term trading prong, and argued the
Agencies should not include these
prongs in the definition of trading
account, or should only consider them
as non-determinative factors.129 To the
extent that an overlap exists between
the prongs of this definition, the
Agencies believe they are mutually
reinforcing, strengthen the rule’s
effectiveness, and may help simplify the
analysis of whether a purchase or sale
is conducted for the trading account.130
The market risk capital prong covers
trading positions that are covered
positions for purposes of the banking
agency market-risk capital rules, as well
as hedges of those positions. Trading
positions under those rules are positions
held by the covered entity ‘‘for the
purpose of short-term resale or with the
intent of benefitting from actual or
expected short-term price movements,
or to lock-in arbitrage profits.’’ 131 This
definition largely parallels the
provisions of section 13(h)(4) of the
BHC Act and mirrors the short-term
trading account prong of both the
proposed and final rules. Covered
positions are trading positions under the
rule that subject the covered entity to
risks and exposures that must be
actively managed and limited—a
requirement consistent with the
purposes of the section 13 of the BHC
Act.
Incorporating this prong into the
trading account definition reinforces the
consistency between governance of the
types of positions that banking entities
identify as ‘‘trading’’ for purposes of the
market risk capital rules and those that
are trading for purposes of the final rule
under section 13 of the BHC Act.
Moreover, this aspect of the final rule
reduces the compliance burden on
banking entities with substantial trading
128 As a result, the Agencies are not excluding
arbitrage trading from the trading account
definition, as suggested by at least one commenter.
See, e.g., Alfred Brock.
129 See ISDA (Feb. 2012); JPMC; ABA (Keating);
BoA; SIFMA et al. (Prop. Trading) (Feb. 2012).
130 See Occupy.
131 12 CFR part 225, Appendix E.

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activities by establishing a clear, brightline rule for determining that a trade is
within the trading account.132
After reviewing comments, the
Agencies also continue to believe that
financial instruments purchased or sold
by registered dealers in connection with
their dealing activity are generally held
with short-term intent and should be
captured within the trading account.
The Agencies believe the scope of the
dealer prong is appropriate because, as
noted in the proposal, positions held by
a registered dealer in connection with
its dealing activity are generally held for
sale to customers upon request or
otherwise support the firm’s trading
activities (e.g., by hedging its dealing
positions), which is indicative of shortterm intent.133 Moreover, the final rule
includes a number of exemptions for the
activities in which securities dealers,
swap dealers, and security-based swap
dealers typically engage, such as market
making, hedging, and underwriting.
Thus, the Agencies believe the broad
scope of the dealer trading account is
balanced by the exemptions that are
designed to permit dealer entities to
continue to engage in customer-oriented
trading activities, consistent with the
statute. This approach is designed to
ensure that registered dealer entities are
engaged in permitted trading activities,
rather than prohibited proprietary
trading.
The final rule adopts the dealer
trading account substantially as
proposed,134 with streamlining that
eliminates the specific references to
different types of securities and
derivatives dealers. The final rule
adopts the proposed approach to
covering trading accounts of banking
entities that regularly engage in the
business of a dealer, swap dealer, or
security-based swap dealer outside of
the United States. In the case of both
domestic and foreign entities, this
provision applies only to financial
instruments purchased or sold in
connection with the activities that
require the banking entity to be licensed
or registered to engage in the business
of dealing, which is not necessarily all
of the activities of that banking
entity.135 Activities of a banking entity
132 Accordingly, the Agencies are not using a
position’s capital treatment as merely an indicative
factor, as suggested by a few commenters.
133 See Joint Proposal, 76 FR 68,860.
134 See final rule § ll.3(b)(1)(iii).
135 An insured depository institution may be
registered as a swap dealer, but only the swap
dealing activities that require it to be so registered
are covered by the dealer trading account. If an
insured depository institution purchases or sells a
financial instrument in connection with activities of
the insured depository institution that do not trigger
registration as a swap dealer, such as lending,

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that are not covered by the dealer prong
may, however, be covered by the shortterm or market risk rule trading
accounts if the purchase or sale satisfies
the requirements of §§ ll.3(b)(1)(i) or
(ii).136
A few commenters stated that they do
not currently analyze whether a
particular activity would require dealer
registration, so the dealer prong of the
trading account definition would
require banking entities to engage in a
new type of analysis.137 The Agencies
recognize that banking entities that are
registered dealers may not currently
engage in such an analysis with respect
to their current trading activities and,
thus, this may represent a new
regulatory requirement for these
entities. If the regulatory analysis
otherwise engaged in by banking
entities is substantially similar to the
dealer prong analysis required under the
trading account definition, then any
increased compliance burden could be
small or insubstantial.138
In response to commenters’ concerns
regarding the application of this prong
to banking entities acting as dealers in
jurisdictions outside the United
States,139 the Agencies continue to
believe including the activities of a
banking entity engaged in the business
of a dealer, swap dealer, or securitybased swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business, is
appropriate. As noted above, dealer
activity generally involves short-term
trading. Further, the Agencies are
concerned that differing requirements
for U.S. and foreign dealers may lead to
regulatory arbitrage. For foreign banking
entities acting as dealers outside of the
United States that are eligible for the
exemption for trading conducted by
foreign banking entities, the Agencies
believe the risk-based approach to this
exemption in the final rule should help
deposit-taking, the hedging of business risks, or
other end-user activity, the financial instrument is
included in the trading account only if the
instrument falls within the statutory trading
account under § ll.3(b)(1)(i) or the market risk
rule trading account under § ll.3(b)(1)(ii) of the
final rule.
136 See final rule §§ ll.3(b)(1)(i) and (ii).
137 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Goldman (Prop. Trading).
138 See, e.g., Goldman (Prop. Trading) (‘‘For
instance, a banking entity’s market making-related
activities with respect to credit trading may involve
making a market in bonds (traded in a brokerdealer), single-name CDSs (in a security-based swap
dealer) and CDS indexes (in a swap dealer). For
regulatory or other reasons, these transactions could
take place in different legal entities. . .’’).
139 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC; Allen & Overy (on behalf of Large Int’l Banks
with U.S. Operations).

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5549

address the concerns about the scope of
this prong of the definition.140
In response to one commenter’s
suggestion that the Agencies define the
term trading account to allow a foreign
banking entity to use of the relevant
foreign regulator’s definition of this
term, where available, the Agencies are
concerned such an approach could lead
to regulatory arbitrage and otherwise
inconsistent applications of the rule.141
The Agencies believe this commenter’s
general concern about the impact of the
statute and rule on foreign banking
entities’ activities outside the United
States should be substantially addressed
by the exemption for trading conducted
by foreign banking entities under
§ ll.6(e) of the final rule.
Finally, the Agencies have declined to
adopt one commenter’s
recommendation that a position in a
financial instrument be considered a
trading account position only if it
qualifies as a GAAP trading position.142
The Agencies continue to believe that
formally incorporating accounting
standards governing trading securities is
not appropriate because: (i) The
statutory proprietary trading provisions
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
securities; and (iii) these accounting
standards could change in the future
without consideration of the potential
impact on section 13 of the BHC Act
and these rules.143
b. Rebuttable Presumption for the ShortTerm Trading Account
The proposed rule included a
rebuttable presumption clarifying when
a covered financial position, by reason
of its holding period, is traded with
short-term intent for purposes of the
short-term trading account. The
Agencies proposed this presumption
primarily to provide guidance to
banking entities that are not subject to
the market risk capital rules or are not
covered dealers or swap entities and
accordingly may not have experience
evaluating short-term trading intent. In
particular, § __.3(b)(2)(ii) of the
proposed rule provided that an account
would be presumed to be a short-term
trading account if it was used to acquire
final rule § ll.6(e).
Japanese Bankers Ass’n.
142 See ABA (Keating).
143 See Joint Proposal, 76 FR 68,859.
140 See
141 See

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or take a covered financial position that
the banking entity held for a period of
60 days or less.
Several commenters supported the
rebuttable presumption, but suggested
either shortening the holding period to
30 days or less,144 or extending the
period to 90 days,145 to several
months,146 or to one year.147 Some of
these commenters argued that
specifying an overly short holding
period would be contrary to the statute,
invite gamesmanship,148 and miss
speculative positions held for longer
than the specified period.149
Commenters also suggested turning the
presumption into a safe harbor 150 or
into guidance.151
Other commenters opposed the
inclusion of the rebuttable presumption
for a number of reasons and requested
that it be removed.152 For example,
these commenters argued that the
presumption had no statutory basis; 153
was arbitrary; 154 was not supported by
data, facts, or analysis; 155 would
dampen market-making and
underwriting activity; 156 or did not take
into account the nature of trading in
different types of securities.157 Some
commenters also questioned whether
the Agencies would interpret rebuttals
of the presumption consistently,158 and
stressed the difficulty and costliness of
144 See

Japanese Bankers Ass’n.
Capital Group.
146 See AFR et al. (Feb. 2012).
147 See Sens. Merkley & Levin (Feb. 2012); Public
Citizen (arguing that one-year demarks tax law
covering short term capital gains).
148 See Sens. Merkley & Levin (Feb. 2012).
149 See Occupy.
150 See Capital Group.
151 See SIFMA et al. (Prop. Trading) (Feb. 2012).
152 See ABA (Keating); Am. Express; Business
Roundtable; Capital Group; ICI (Feb. 2012);
Investure; JPMC; Liberty Global; STANY; Chamber
(Feb. 2012).
153 See ABA (Keating); JPMC; Chamber (Feb.
2012).
154 See Am. Express; ICI (Feb. 2012).
155 See ABA (Keating); Chamber (Feb. 2012).
156 See AllianceBernstein; Business Roundtable;
ICI (Feb. 2012); Investure; Liberty Global; STANY.
Because the rebuttable presumption does not
impact the availability of the exemptions for
underwriting, market making, and other permitted
activities, the Agencies do not believe this
provision creates any additional burdens on
permissible activities.
157 See Am. Express (noting that most foreign
exchange forward transactions settle in less than
one week and are used as commercial payment
instruments, and not speculative trades); Capital
Group.
158 See ABA (Keating). As discussed below in Part
IV.C., the Agencies expect to continue to coordinate
their supervisory efforts related to section 13 of the
BHC Act and to share information as appropriate in
order to effectively implement the requirements of
that section and the final rule.

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rebutting the presumption,159 such as
enhanced documentation or other
administrative burdens.160 One foreign
banking association also argued that
requiring foreign banking entities to
rebut a U.S. regulatory requirement
would be costly and inappropriate given
that the trading activities of the banking
entity are already reviewed by home
country supervisors.161 This commenter
also contended that the presumption
could be problematic for financial
instruments purchased for long-term
investment purposes that are closed
within 60 days due to market
fluctuations or other changed
circumstances.162
After carefully considering the
comments received, the Agencies
continue to believe the rebuttable
presumption is appropriate to generally
define the meaning of ‘‘short-term’’ for
purposes of the short-term trading
account, especially for small and
regional banking entities that are not
subject to the market risk capital rules
and are not registered dealers or swap
entities. The range of comments the
Agencies received on what ‘‘short-term’’
should mean—from 30 days to one
year—suggests that a clear presumption
would ensure consistency in
interpretation and create a level playing
field for all banking entities with
covered trading activities subject to the
short-term trading account. Based on
their supervisory experience, the
Agencies find that 60 days is an
appropriate cut off for a regulatory
presumption.163 Further, because the
purpose of the rebuttable presumption
is to simplify the process of evaluating
whether individual positions are
included in the trading account, the
Agencies believe that implementing
different holding periods based on the
type of financial instrument would
insert unnecessary complexity into the
presumption.164 The Agencies are not
providing a safe harbor or a reverse
presumption (i.e., a presumption for
positions that are outside of the trading
account), as suggested by some
159 See ABA (Keating); AllianceBernstein; Capital
Group; Japanese Bankers Ass’n.; Liberty Global;
JPMC.
160 See NAIB et al.; Capital Group.
161 See Japanese Bankers Ass’n. As noted above,
the Agencies believe concerns about the impacts of
the definition of trading account on foreign banking
entity trading activity outside of the United States
are substantially addressed by the final rule’s
exemption for proprietary trading conducted by
foreign banking entities in final rule § .6(e).
162 Id.
163 See final rule § .3(b)(2). Commenters did not
provide persuasive evidence of the benefits
associated with a rebuttable presumption for
positions held for greater or fewer than 60 days.
164 See, e.g., Am. Express; Capital Group; Sens.
Merkley & Levin (Feb. 2012).

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commenters, in recognition that some
proprietary trading could occur outside
of the 60 day period.165
Adopting a presumption allows the
Agencies and affected banking entities
to evaluate all the facts and
circumstances surrounding trading
activity in determining whether the
activity implicates the purpose of the
statute. For example, trading in a
financial instrument for long-term
investment that is disposed of within 60
days because of unexpected
developments (e.g., an unexpected
increase in the financial instrument’s
volatility or a need to liquidate the
instrument to meet unexpected liquidity
demands) may not be trading activity
covered by the statute. To reduce the
costs and burdens of rebutting the
presumption, the Agencies will allow a
banking entity to rebut the presumption
for a group of related positions.166
The final rule provides three
clarifying changes to the proposed
rebuttable presumption. First, in
response to comments, the final rule
replaces the reference to an ‘‘account’’
that is presumed to be a trading account
with the purchase or sale of a ‘‘financial
instrument.’’ 167 This change clarifies
that the presumption only applies to the
purchase or sale of a financial
instrument that is held for fewer than 60
days, and not the entire account that is
used to make the purchase or sale.
Second, the final rule clarifies that basis
trades, in which a banking entity buys
one instrument and sells a substantially
similar instrument (or otherwise
transfers the first instrument’s risk), are
subject to the rebuttable
presumption.168 Third, in order to
maintain consistency with definitions
used throughout the final rule, the
references to ‘‘acquire’’ or ‘‘take’’ a
financial position have been replaced
with references to ‘‘purchase’’ or ‘‘sell’’
a financial instrument.169
165 See Capital Group; AFR et al. (Feb. 2012);
Sens. Merkley & Levin (Feb. 2012); Public Citizen;
Occupy.
166 The Agencies believe this should help address
commenters’ concerns about the burdens associated
with rebutting the presumption. See ABA (Keating);
AllianceBernstein; Capital Group; Japanese Bankers
Ass’n.; Liberty Global; JPMC; NAIB et al.; Capital
Group.
167 See, e.g., ABA (Keating); Clearing House
Ass’n.; JPMC.
168 The rebuttable presumption covered these
trades in the proposal, but the final rule’s use of
‘‘financial instrument’’ rather than ‘‘covered
financial position’’ necessitated clarifying this point
in the rule text. See final rule § .3(b)(2). See also
Public Citizen.
169 The Agencies do not believe these revisions
have a substantive effect on the operation or scope
of the final rule in comparison to the statute or
proposed rule.

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c. Definition of ‘‘Financial Instrument’’
Section 13 of the BHC Act generally
prohibits proprietary trading, which is
defined in section 13(h)(4) to mean
engaging as principal for the trading
account in any purchase or sale of any
security, any derivative, any contract of
sale of a commodity for future delivery,
any option on any such security,
derivative, or contract, or any other
security or financial instruments that
the Agencies may, by rule, determine.170
The proposed rule defined the term
‘‘covered financial position’’ to
reference the instruments listed in
section 13(h)(4), including: (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.171 To provide additional
clarity, the proposed rule also provided
that, consistent with the statute, any
position that is itself a loan, a
commodity, or foreign exchange or
currency was not a covered financial
position.172
The proposal also defined a number
of other terms used in the definition of
covered financial position, including
commodity, derivative, loan, and
security.173 These terms were generally
defined by reference to the federal
securities laws or the Commodity
Exchange Act because these existing
definitions are generally wellunderstood by market participants and
have been subject to extensive
interpretation in the context of
securities, commodities, and derivatives
trading.
As noted above, the proposed rule
included derivatives within the
definition of covered financial position.
Derivative was defined to include any
swap (as that term is defined in the
Commodity Exchange Act) and securitybased 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.174
The proposed rule also included 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,
12 U.S.C. 1851(h)(4).
proposed rule § .3(c)(3)(i).
172 See proposed rule § .3(c)(3)(ii).
173 See proposed rule § .2(l), (q), (w); § .3(c)(1) and
(2).
174 See 7 U.S.C. 1a(47) (defining ‘‘swap’’); 15
U.S.C. 78c(a)(68) (defining ‘‘security-based swap’’).

derivatives, and which if not included
could permit banking entities to engage
in proprietary trading that is
inconsistent with the purpose of section
13 of the BHC Act. Specifically, the
proposed definition also included: (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); 175 (iii) any
agreement, contract, or transaction in
foreign currency described in section
2(c)(2)(C)(i) of the Commodity Exchange
Act; 176 (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; 177 and (v) any transactions
authorized under section 19 of the
Commodity Exchange Act.178 In
addition, the proposed rule excluded
from the definition of derivative (i) any
consumer, commercial, or other
agreement, contract, or transaction that
the CFTC and SEC have further defined
by joint regulation, interpretation,
guidance, or other action as not within
the definition of swap or security-based
swap, and (ii) any identified banking
product, as defined in section 402(b) of
the Legal Certainty for Bank Products
Act of 2000 (7 U.S.C. 27(b)), that is
subject to section 403(a) of that Act (7
U.S.C. 27a(a)).
Commenters expressed a variety of
views regarding the definition of
covered financial position, as well as
other defined terms used in that
definition. For instance, some
commenters argued that the definition
should be expanded to include
transactions in spot commodities or
foreign currency, even though those
instruments are not included by the
statute.179 Other commenters strongly
supported the exclusion of spot
commodity and foreign currency
transactions as consistent with the
statute, arguing that these instruments
are part of the traditional business of
banking and do not represent the types
of instruments that Congress designed
section 13 to address. These
commenters argued that including spot
commodities and foreign exchange
within the definition of covered
financial position in the final rule
would put U.S. banking entities at a
competitive disadvantage and prevent

170 See
171 See

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175 7

U.S.C. 1a(24), (25).
U.S.C. 2(c)(2)(C)(i).
177 7 U.S.C. 2(c)(2)(D)(i).
178 7 U.S.C. 23.
179 See Sens. Merkley & Levin (Feb. 2012); Public
Citizen; Occupy.
176 7

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them from conducting routine banking
operations.180 One commenter argued
that the proposed definition of covered
financial position was effective and
recommended that the definition should
not be expanded.181 Another commenter
argued that an instrument be considered
to be a spot foreign exchange
transaction, and thus not a covered
financial position, if it settles within 5
days of purchase.182 Another
commenter argued that covered
financial positions used in interaffiliate
transactions should expressly be
excluded because they are used for
internal risk management purposes and
not for proprietary trading.183
Some commenters requested that the
final rule exclude additional
instruments from the definition of
covered financial position. For instance,
some commenters requested that the
Agencies exclude commodity and
foreign exchange futures, forwards, and
swaps, arguing that these instruments
typically have a commercial and not
financial purpose and that making them
subject to the prohibitions of section 13
would negatively affect the spot market
for these instruments.184 A few
commenters also argued that foreign
exchange swaps and forwards are used
in many jurisdictions to provide U.S.
dollar-funding for foreign banking
entities and that these instruments
should be excluded since they
contribute to the stability and liquidity
of the market for spot foreign
exchange.185 Other commenters
contended that foreign exchange swaps
and forwards should be excluded
because they are an integral part of
banking entities’ ability to provide trust
and custody services to customers and
are necessary to enable banking entities
to deal in the exchange of currencies for
customers.186
One commenter argued that the
inclusion of certain instruments within
the definition of derivative, such as
purchases or sales of nonfinancial
commodities for deferred shipment or
delivery that are intended to be
physically settled, was inappropriate.187
This commenter alleged that these
instruments are not derivatives but
180 See Northern Trust; Morgan Stanley; JPMC;
Credit Suisse (Seidel); Am. Express; See also AFR
et al. (Feb. 2012) (arguing that the final rule should
explicitly exclude ‘‘spot’’ commodities and foreign
exchange).
181 See Alfred Brock.
182 See Credit Suisse (Seidel).
183 See GE (Feb. 2012).
184 See JPMC; BoA; Citigroup (Feb. 2012).
185 See Govt. of Japan/Bank of Japan; Japanese
Bankers Ass’n.; See also Norinchukin.
186 See Northern Trust; Citigroup (Feb. 2012).
187 See SIFMA et al. (Prop. Trading) (Feb. 2012).

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should instead be viewed as contracts
for purchase of specific commodities to
be delivered at a future date. This
commenter also argued that the
Agencies do not have authority under
section 13 to include these instruments
as ‘‘other securities or financial
instruments’’ subject to the prohibition
on proprietary trading.188
Some commenters also argued that,
because the CFTC and SEC had not yet
finalized their definitions of swap and
security-based swap, it was
inappropriate to use those definitions as
part of the proposed definition of
derivative.189 One commenter argued
that the definition of derivative was
effective, although this commenter
argued that the final rule should not
cross-reference the definition of swap
and security-based swap under the
federal commodities and securities
laws.190
After carefully considering the
comments received on the proposal, the
final rule continues to apply the
prohibition on proprietary trading to the
same types of instruments as listed in
the statute and the proposal, which the
final rule defines as ‘‘financial
instrument.’’ Under the final rule, a
financial instrument is defined as: (i) A
security, including an option on a
security; 191 (ii) a derivative, including
an option on a derivative; or (iii) a
contract of sale of a commodity for
future delivery, or option on a contract
of sale of a commodity for future
delivery.192 The final rule excludes from
the definition of financial instrument: (i)
A loan; 193 (ii) a commodity that is not
an excluded commodity (other than
foreign exchange or currency), a
derivative, a contract of sale of a
commodity for future delivery, or an
option on a contract of sale of a
commodity for future delivery; or (iii)
foreign exchange or currency.194 An
excluded commodity is defined to have
the same meaning as in section 1a(19)
of the Commodity Exchange Act.
The Agencies continue to believe that
these instruments and transactions,
which are consistent with those
referenced in section 13(h)(4) of the
BHC Act as part of the statutory
definition of proprietary trading,
188 See

id.
SIFMA et al. (Prop.Trading) (Feb. 2012);
ISDA (Feb. 2012).
190 See Alfred Brock.
191 The definition of security under the final rule
is the same as under the proposal. See final rule § l
l.2(y).
192 See final rule § .3(c)(1).
193 The definition of loan, as well as comments
received regarding that definition, is discussed in
detail below in Part IV.B.1.c.8.a.
194 See final rule § .3(c)(2).

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189 See

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represent the type of financial
instruments which the proprietary
trading prohibition of section 13 was
designed to cover. While some
commenters requested that this
definition be expanded to include spot
transactions 195 or loans,196 the
Agencies do not believe that it is
appropriate at this time to expand the
scope of instruments subject to the ban
on proprietary trading.197 Similarly,
while some commenters requested that
certain other instruments, such as
foreign exchange swaps and forwards,
be excluded from the definition of
financial instrument,198 the Agencies
believe that these instruments appear to
be, or operate in economic substance as,
derivatives (which are by statute
included within the scope of
instruments subject to the prohibitions
of section 13). If these instruments were
not included within the definition of
financial instrument, banking entities
could use them to engage in proprietary
trading that is inconsistent with the
purpose and design of section 13 of the
BHC Act.
As under the proposal, loans,
commodities, and foreign exchange or
currency are not included within the
scope of instruments subject to section
13. The exclusion of these types of
instruments is intended to eliminate
potential confusion by making clear that
the purchase and sale of loans,
commodities, and foreign exchange or
currency—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. 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 qualify for
the exclusion.
The final rule also adopts the
definitions of security and derivative as
proposed.199 These definitions, which
195 See Sens. Merkley & Levin (Feb. 2012); Public
Citizen; Occupy.
196 See Occupy.
197 Several commenters supported the exclusion
of spot commodity and foreign currency
transactions as consistent with the statute. See
Northern Trust; Morgan Stanley; State Street (Feb.
2012); JPMC; Credit Suisse (Seidel); Am. Express;
See also AFR et al. (Feb. 2012) (arguing that the
final rule should explicitly exclude ‘‘spot’’
commodities and foreign exchange). One
commenter stated that the proposed definition
should not be expanded. See Alfred Brock. With
respect to the exclusion for loans, the Agencies note
this is generally consistent with the rule of statutory
construction regarding the sale and securitization of
loans. See 12 U.S.C. 1851(g)(2).
198 See JPMC; BAC; Citigroup (Feb. 2012); Govt.
of Japan/Bank of Japan; Japanese Bankers Ass’n.;
Northern Trust; See also Norinchukin.
199 See final rule §§ __.2(h), (y).

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reference existing definitions under the
federal securities and commodities
laws, are generally well-understood by
market participants and have been
subject to extensive interpretation in the
context of securities and commodities
trading activities. While some
commenters argued that it would be
inappropriate to use the definition of
swap and security-based swap because
those terms had not yet been finalized
pursuant to public notice and
comment,200 the CFTC and SEC have
subsequently finalized those definitions
after receiving extensive public
comment on the rulemakings.201 The
Agencies believe that this notice and
comment process provided adequate
opportunity for market participants to
comment on and understand those
terms, and as such they are incorporated
in the definition of derivative under this
final rule.
While some commenters requested
that foreign exchange swaps and
forwards be excluded from the
definition of derivative or financial
instrument, the Agencies have not done
so for the reasons discussed above.
However, as explained below in Part
IV.A.1.d., the Agencies note that to the
extent a banking entity purchases or
sells a foreign exchange forward or
swap, or any other financial instrument,
in a manner that meets an exclusion
from proprietary trading, that
transaction would not be considered to
be proprietary trading and thus would
not be subject to the requirements of
section 13 of the BHC Act and the final
rule. This includes, for instance, the
purchase or sale of a financial
instrument by a banking entity acting
solely as agent, broker, or custodian, or
the purchase or sale of a security as part
of a bona fide liquidity management
plan.
d. Proprietary Trading Exclusions
The proposed rule contained four
exclusions from the definition of trading
account for categories of transactions
that do not fall within the scope of
section 13 of the BHC Act because they
do not involve short-term trading
activities subject to the statutory
prohibition on proprietary trading.
These exclusions covered the purchase
or sale of a financial instrument under
certain repurchase and reverse
repurchase agreements and securities
lending arrangements, for bona fide
200 See SIFMA et al. (Prop. Trading) (Feb. 2012);
ISDA (Feb. 2012).
201 See CFTC and SEC, Further Definition of
‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘SecurityBased Swap Agreement’’; Mixed swaps; Security
Based Swap Agreement Recordkeeping, 78 FR
48,208 (Aug. 13, 2012).

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liquidity management purposes, and by
a clearing agency or derivatives clearing
organization in connection with clearing
activities.
As discussed below, the final rule
provides exclusions for the purchase or
sale of a financial instrument under
certain repurchase and reverse
repurchase agreements and securities
lending agreements; for bona fide
liquidity management purposes; by
certain clearing agencies, derivatives
clearing organizations in connection
with clearing activities; by a member of
a clearing agency, derivatives clearing
organization, or designated financial
market utility engaged in excluded
clearing activities; to satisfy existing
delivery obligations; to satisfy an
obligation of the banking entity in
connection with a judicial,
administrative, self-regulatory
organization, or arbitration proceeding;
solely as broker, agent, or custodian;
through a deferred compensation or
similar plan; and to satisfy a debt
previously contracted. After considering
comments on these issues, which are
discussed in more detail below, the
Agencies believe that providing
clarifying exclusions for these nonproprietary activities will likely
promote more cost-effective financial
intermediation and robust capital
formation. Overly narrow exclusions for
these activities would potentially
increase the cost of core banking
services, while overly broad exclusions
would increase the risk of allowing the
types of trades the statute was designed
to prohibit. The Agencies considered
these issues in determining the
appropriate scope of these exclusions.
Because the Agencies do not believe
these excluded activities involve
proprietary trading, as defined by the
statute and the final rule, the Agencies
do not believe it is necessary to use our
exemptive authority in section
13(d)(1)(J) of the BHC Act to deem these
activities a form of permitted
proprietary trading.
1. Repurchase and Reverse Repurchase
Arrangements and Securities Lending
The proposed rule’s definition of
trading account excluded an account
used to acquire or take one or more
covered financial positions that arise
under (i) a repurchase or reverse
repurchase agreement pursuant to
which the banking entity had
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,202 or (ii) a
202 See

proposed rule § ll.3(b)(2)(iii)(A).

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transaction in which the banking entity
lends or borrows a security temporarily
to or from another party pursuant to a
written securities lending agreement
under which the lender retains the
economic interests of an owner of such
security and has the right to terminate
the transaction and to recall the loaned
security on terms agreed to by the
parties.203 Positions held under these
agreements operate in economic
substance as a secured loan and are not
based on expected or anticipated
movements in asset prices. Accordingly,
these types of transactions do not
appear to be of the type the statutory
definition of trading account was
designed to cover.204
Several commenters expressed
support for these exclusions and
requested that the Agencies expand
them.205 For example, one commenter
requested clarification that all types of
repurchase transactions qualify for the
exclusion.206 Some commenters
requested expanding this exclusion to
cover all positions financed by, or
transactions related to, repurchase and
reverse repurchase agreements.207 Other
commenters requested that the
exclusion apply to all transactions that
are analogous to extensions of credit
and are not based on expected or
anticipated movements in asset prices,
arguing that the exclusion would be too
limited in scope to achieve its objective
if it is based on the legal form of the
underlying contract.208 Additionally,
some commenters suggested expanding
the exclusion to cover transactions that
are for funding purposes, including
prime brokerage transactions, or for the
purpose of asset-liability
management.209 Commenters also
recommended expanding the exclusion
to include re-hypothecation of customer
203 See proposed rule § __.3(b)(2)(iii)(B). The
language that described securities lending
transactions in the proposed rule generally mirrored
that contained in Rule 3a5–3 under the Exchange
Act. See 17 CFR 240.3a5–3.
204 See Joint Proposal, 76 FR 68,862.
205 See generally ABA (Keating); Alfred Brock;
Citigroup (Feb. 2012); GE (Feb. 2012); Goldman
(Prop. Trading); ICBA; Japanese Bankers Ass’n.;
JPMC; Norinchukin; RBC; RMA; SIFMA et al. (Prop.
Trading) (Feb. 2012); State Street (Feb. 2012); T.
Rowe Price; UBS; Wells Fargo (Prop. Trading). See
infra Part IV.A.d.10. for the discussion of
commenters’ requests for additional exclusions
from the trading account.
206 See SIFMA et al. (Prop.Trading) (Feb. 2012).
207 See FIA; SIFMA et al. (Prop. Trading) (Feb.
2012).
208 See Goldman (Prop. Trading); JPMC; UBS.
209 See Goldman (Prop. Trading); UBS. For
example, one commenter suggested that fully
collateralized swap transactions should be
exempted from the definition of trading account
because they serve as funding transactions and are
economically similar to repurchase agreements. See
SIFMA et al. (Prop. Trading) (Feb. 2012).

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securities, which can produce financing
structures that, like a repurchase
agreement, are functionally loans.210
In contrast, other commenters argued
that there was no statutory or policy
justification for excluding repurchase
and reverse repurchase agreements from
the trading account, and requested that
this exclusion be removed from the final
rule.211 Some of these commenters
argued that repurchase agreements
could be used for prohibited proprietary
trading 212 and suggested that, if
repurchase agreements are excluded
from the trading account,
documentation detailing the use of
liquidity derived from repurchase
agreements should be required.213 These
commenters suggested that unless the
liquidity is used to secure a position for
a willing customer, repurchase
agreements should be regarded as a
strong indicator of proprietary
trading.214 As an alternative,
commenters suggested that the Agencies
instead use their exemptive authority
pursuant to section 13(d)(1)(J) of the
BHC Act to permit repurchase and
reverse repurchase transactions so that
such transactions must comply with the
statutory limits on material conflicts of
interests and high-risks assets and
trading strategies, and compliance
requirements under the final rule.215
These commenters urged the Agencies
to specify permissible collateral types,
haircuts, and contract terms for
securities lending agreements and
require that the investment of proceeds
from securities lending transactions be
limited to high-quality liquid assets in
order to limit potential risks of these
activities.216
After considering the comments
received, the Agencies have determined
to exclude repurchase and reverse
repurchase agreements and securities
lending agreements from the definition
of proprietary trading under the final
rule. The final rule defines these terms
subject to the same conditions as were
in the proposal. This determination
recognizes that repurchase and reverse
repurchase agreements and securities
lending agreements excluded from the
definition operate in economic
substance as secured loans and do not
in normal practice represent proprietary
210 See

Goldman (Prop. Trading).
AFR et al. (Feb. 2012); Occupy; Public
Citizen; Sens. Merkley & Levin (Feb. 2012).
212 See AFR et al. (Feb. 2012).
213 See Public Citizen.
214 See Public Citizen.
215 See AFR et al. (Feb. 2012); Occupy.
216 See AFR et al. (Feb. 2012); Occupy.
211 See

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trading.217 The Agencies will, however,
monitor these transactions to ensure this
exclusion is not used to engage in
prohibited proprietary trading activities.
To avoid evasion of the rule, the
Agencies note that, in contrast to certain
commenters’ requests,218 only the
transactions pursuant to the repurchase
agreement, reverse repurchase
agreement, or securities lending
agreement are excluded. For example,
the collateral or position that is being
financed by the repurchase or reverse
repurchase agreement is not excluded
and may involve proprietary trading.
The Agencies further note that if a
banking entity uses a repurchase or
reverse repurchase agreement to finance
a purchase of a financial instrument,
other transactions involving that
financial instrument may not qualify for
this exclusion.219 Similarly, short
positions resulting from securities
lending agreements cannot rely upon
this exclusion and may involve
proprietary trading.
Additionally, the Agencies have
determined not to exclude all
transactions, in whatever legal form that
may be construed to be an extension of
credit, as suggested by commenters,
because such a broad exclusion would
be too difficult to assess for compliance
and would provide significant
opportunity for evasion of the
prohibitions in section 13 of the BHC
Act.
2. Liquidity Management Activities

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The proposed definition of trading
account excluded an account used to
acquire or take a position for the
purpose of bona fide liquidity
management, subject to certain
requirements.220 The preamble to the
proposed rule explained that bona fide
liquidity management seeks to ensure
that the banking entity has sufficient,
readily-marketable assets available to
meet its expected near-term liquidity
needs, not to realize short-term profit or
benefit from short-term price
movements.221
217 Congress recognized that repurchase
agreements and securities lending agreements are
loans or extensions of credit by including them in
the legal lending limit. See Dodd–Frank Act section
610 (amending 12 U.S.C. 84b). The Agencies believe
the conditions of the final rule’s exclusions for
repurchase agreements and securities lending
agreements identify those activities that do not in
normal practice represent proprietary trading and,
thus, the Agencies decline to provide additional
requirements for these activities, as suggested by
some commenters. See Public Citizen; AFR et al.
(Feb. 2012); Occupy.
218 See Goldman (Prop. Trading); JPMC; UBS.
219 See CFTC Proposal, 77 FR 8348.
220 See proposed rule § ll.3(b)(2)(iii)(C).
221 Id.

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To curb abuse, the proposed rule
required that a banking entity acquire or
take a position for liquidity management
in accordance with a documented
liquidity management plan that meets
five criteria.222 Moreover, the Agencies
stated in the preamble that liquidity
management positions that give rise to
appreciable profits or losses as a result
of short-term price movements would be
subject to significant Agency scrutiny
and, absent compelling explanatory
facts and circumstances, would be
considered proprietary trading.223
The Agencies received a number of
comments regarding the exclusion.
Many commenters supported the
exclusion of liquidity management
activities from the definition of trading
account as appropriate and necessary.
At the same time, some commenters
expressed the view that the exclusion
was too narrow and should be replaced
with a broader exclusion permitting
trading activity for asset-liability
management (‘‘ALM’’). Commenters
argued that two aspects of the proposed
rule’s definition of ‘‘trading account’’
would cause ALM transactions to fall
within the prohibition on proprietary
trading—the 60-day rebuttable
presumption and the reference to the
market risk rule trading account.224 For
example, commenters expressed
concern that hedging transactions
associated with a banking entity’s
residential mortgage pipeline and
mortgage servicing rights, and managing
credit risk, earnings at risk, capital,
asset-liability mismatches, and foreign
exchange risks would be among
positions that may be held for 60 days
or less.225 These commenters contended
that the exclusion for liquidity
management and the activity
exemptions for risk-mitigating hedging
and trading in U.S. government
obligations would not be sufficient to
permit a wide variety of ALM
activities.226 These commenters
contended that prohibiting trading for
ALM purposes would be contrary to the
goals of enhancing sound risk
management, the safety and soundness
of banking entities, and U.S. financial
proposed rule § ll.3(b)(2)(iii)(C)(1)–(5).
Joint Proposal, 76 FR 68,862.
224 See ABA (Keating); BoA; CH/ABASA; JPMC.
See supra Part IV.A.1.b. (discussing the rebuttable
presumption under § ll3.(b)(2) of the final rule);
See also supra Part IV.A.1.a. (discussing the market
risk rule trading account under § ll3.(b)(1)(ii) of
the final rule).
225 See CH/ABASA; Wells Fargo (Prop. Trading).
226 See CH/ABASA; JPMC; State Street (Feb.
2012); Wells Fargo (Prop. Trading). See also BaFin/
Deutsche Bundesbank.
222 See
223 See

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stability,227 and would limit banking
entities’ ability to manage liquidity.228
Some commenters argued that the
requirements of the exclusion would not
provide a banking entity with sufficient
flexibility to respond to liquidity needs
arising from changing economic
conditions.229 Some commenters argued
the requirement that any position taken
for liquidity management purposes be
limited to the banking entity’s near-term
funding needs failed to account for
longer-term liquidity management
requirements.230 These commenters
further argued that the requirements of
the liquidity management exclusion
might not be synchronized with the
Basel III framework, particularly with
respect to the liquidity coverage ratio if
‘‘near-term’’ is considered less than 30
days.231
Commenters also requested
clarification on a number of other issues
regarding the exclusion. For example,
one commenter requested clarification
that purchases and sales of U.S.
registered mutual funds sponsored by a
banking entity would be permissible.232
Another commenter requested
clarification that the deposits resulting
from providing custodial services that
are invested largely in high-quality
securities in conformance with the
banking entity’s ALM policy would not
be presumed to be ‘‘short-term trading’’
under the final rule.233 Commenters also
urged that the final rule not prohibit
interaffiliate transactions essential to the
ALM function.234
In contrast, other commenters
supported the liquidity management
exclusion criteria 235 and suggested
tightening these requirements. For
example, one commenter recommended
that the rule require that investments
made under the liquidity management
exclusion consist only of high-quality
liquid assets.236 Other commenters
argued that the exclusion for liquidity
management should be eliminated.237
One commenter argued that there was
no need to provide a special exemption
for liquidity management or ALM
activities given the exemptions for
227 See

BoA; JPMC; RBC.
ABA (Keating); Allen & Overy (on behalf
of Canadian Banks); JPMC; NAIB et al.; State Street
(Feb. 2012); T. Rowe Price.
229 See ABA (Keating); CH/ABASA; JPMC.
230 See ABA (Keating); BoA; CH/ABASA; JPMC.
231 See ABA (Keating); Allen & Overy (on behalf
of Canadian Banks); BoA; CH/ABASA
232 See T. Rowe Price.
233 See State Street (Feb. 2012).
234 See State Street (Feb. 2012); JPMC. See also
Part IV.A.1.d.10. (discussing commenter requests to
exclude inter-affiliate transactions).
235 See AFR et al. (Feb. 2012); Occupy.
236 See Occupy.
237 See Sens. Merkley & Levin (Feb. 2012).
228 See

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trading in government obligations and
risk-mitigating hedging activities.238
After carefully reviewing the
comments received, the Agencies have
adopted the proposed exclusion for
liquidity management with several
important modifications. As limited
below, liquidity management activity
serves the important prudential
purpose, recognized in other provisions
of the Dodd-Frank Act and in rules and
guidance of the Agencies, of ensuring
banking entities have sufficient liquidity
to manage their short-term liquidity
needs.239
To ensure that this exclusion is not
misused for the purpose of proprietary
trading, the final rule imposes a number
of requirements. First, the liquidity
management plan of the banking entity
must be limited to securities (in keeping
with the liquidity management
requirements proposed by the Federal
banking agencies) and specifically
contemplate and authorize the
particular securities to be used for
liquidity management purposes;
describe the amount, types, and risks of
securities that are consistent with the
entity’s liquidity management; and the
liquidity circumstances in which the
particular securities may or must be
used.240 Second, any purchase or sale of
securities contemplated and authorized
by the plan must be principally for the
purpose of managing the liquidity of the
banking entity, and not for the purpose
of short-term resale, benefitting from
actual or expected short-term price
movements, realizing short-term
arbitrage profits, or hedging a position
taken for such short-term purposes.
Third, the plan must require that any
securities purchased or sold for
liquidity management purposes be
highly liquid and limited to instruments
the market, credit and other risks of
which the banking entity does not
reasonably expect to give rise to
appreciable profits or losses as a result
of short-term price movements.241
238 See

Sens. Merkley & Levin (Feb. 2012).
section 165(b)(1)(A)(ii) of the Dodd-Frank
Act; Enhanced Prudential Standards, 77 FR 644 at
645 (Jan. 5, 2012), available at http://www.gpo.gov/
fdsys/pkg/FR-2012-01-05/pdf/2011-33364.pdf; See
also Enhanced Prudential Standards, 77 FR 76,678
at 76,682 (Dec. 28, 2012), available at http://
www.gpo.gov/fdsys/pkg/FR-2012-12-28/pdf/201230734.pdf.
240 To ensure sufficient flexibility to respond to
liquidity needs arising from changing economic
times, a banking entity should envision and address
a range of liquidity circumstances in its liquidity
management plan, and provide a mechanism for
periodically reviewing and revising the liquidity
management plan.
241 The requirement to use highly liquid
instruments is consistent with the focus of the
clarifying exclusion on a banking entity’s near-term
liquidity needs. Thus, the final rules do not include

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Fourth, the plan must limit any
securities purchased or sold for
liquidity management purposes to an
amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan.242 Fifth, the
banking entity must incorporate into its
compliance program internal controls,
analysis and independent testing
designed to ensure that activities
undertaken for liquidity management
purposes are conducted in accordance
with the requirements of the final rule
and the entity’s liquidity management
plan. Finally, the plan must be
consistent with the supervisory
requirements, guidance and
expectations regarding liquidity
management of the Agency responsible
for regulating the banking entity.
The final rule retains the provision
that the financial instruments purchased
and sold as part of a liquidity
management plan be highly liquid and
not reasonably expected to give rise to
appreciable profits or losses as a result
of short-term price movements. This
requirement is consistent with the
Agencies’ expectation for liquidity
management plans in the supervisory
context. It is not intended to prevent
firms from recognizing profits (or losses)
on instruments purchased and sold for
liquidity management purposes.
Instead, this requirement is intended to
underscore that the purpose of these
transactions must be liquidity
management. Thus, the timing of
purchases and sales, the types and
duration of positions taken and the
incentives provided to managers of
these purchases and sales must all
indicate that managing liquidity, and

not taking short-term profits (or limiting
short-term losses), is the purpose of
these activities.
The exclusion as adopted does not
apply to activities undertaken with the
stated purpose or effect of hedging
aggregate risks incurred by the banking
entity or its affiliates related to assetliability mismatches or other general
market risks to which the entity or
affiliates may be exposed. Further, the
exclusion does not apply to any trading
activities that expose banking entities to
substantial risk from fluctuations in
market values, unrelated to the
management of near-term funding
needs, regardless of the stated purpose
of the activities.243
Overall, the Agencies do not believe
that the final rule will stand as an
obstacle to or otherwise impair the
ability of banking entities to manage the
risks of their businesses and operate in
a safe and sound manner. Banking
entities engaging in bona fide liquidity
management activities generally do not
purchase or sell financial instruments
for the purpose of short-term resale or
to benefit from actual or expected shortterm price movements. The Agencies
have determined, in contrast to certain
commenters’ requests, not to expand
this liquidity management provision to
broadly allow asset-liability
management, earnings management, or
scenario hedging.244 To the extent these
activities are for the purpose of profiting
from short-term price movements or to
hedge risks not related to short-term
funding needs, they represent
proprietary trading subject to section 13
of the BHC Act and the final rule; the
activity would then be permissible only
if it meets all of the requirements for an
exemption, such as the risk-mitigating
hedging exemption, the exemption for
trading in U.S. government securities, or
another exemption.

commenters’ suggested revisions to this
requirement. See Clearing House Ass’n.; See also
Occupy; Sens. Merkley & Levin (Feb. 2012). The
Agencies decline to identify particular types of
securities that will be considered highly liquid for
purposes of the exclusion, as requested by some
commenters, in recognition that such a
determination will depend on the facts and
circumstances. See T. Rowe Price; State Street (Feb.
2012).
242 The Agencies plan to construe ‘‘near-term
funding needs’’ in a manner that is consistent with
the laws, regulations, and issuances related to
liquidity risk management. See, e.g., Liquidity
Coverage Ratio: Liquidity Risk Measurement,
Standards, and Monitoring, 78 FR 71,818 (Nov. 29,
2013); Basel Committee on Bank Supervision, Basel
III: The Liquidity Coverage Ratio and Liquidity Risk
Management Tools (January 2013) available at
http://www.bis.org/publ/bcbs238.htm. The
Agencies believe this should help address
commenters’ concerns about the proposed
requirement. See, e.g., ABA (Keating); Allen &
Overy (on behalf of Canadian Banks); CH/ABASA;
BoA; JPMC.

3. Transactions of Derivatives Clearing
Organizations and Clearing Agencies
A banking entity that is a central
counterparty for clearing and settlement
activities engages in the purchase and
sale of financial instruments as an
integral part of clearing and settling
those instruments. The proposed
definition of trading account excluded
an account used to acquire or take one
or more covered financial positions by

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243 See, e.g., Staff of S. Comm. on Homeland Sec.
& Governmental Affairs Permanent Subcomm. on
Investigations, 113th Cong., Report: JPMorgan
Chase Whale Trades: A Case History of Derivatives
Risks and Abuses (Apr. 11, 2013), available at
http://www.hsgac.senate.gov/download/reportjpmorgan-chase-whale-trades-a-case-history-ofderivatives-risks-and-abuses-march-15–2013.
244 See, e.g., ABA (Keating); BoA; CH/ABASA;
JPMC.

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a derivatives clearing organization
registered under the Commodity
Exchange Act or a clearing agency
registered under the Securities
Exchange Act of 1934 in connection
with clearing derivatives or securities
transactions.245 The preamble to the
proposed rule noted that the purpose of
these transactions is to provide a
clearing service to third parties, not to
profit from short-term resale or shortterm price movements.246
Several commenters supported the
proposed exclusion for derivatives
clearing organizations and urged the
Agencies to expand the exclusion to
cover a banking entity’s clearing-related
activities, such as clearing a trade for a
customer, trading with a clearinghouse,
or accepting positions of a defaulting
member, on grounds that these activities
are not proprietary trades and reduce
systemic risk.247 One commenter
recommended expanding the exclusion
to non-U.S. central counterparties 248 In
contrast, one commenter argued that the
exclusion for derivatives clearing
organizations and clearing agencies had
no statutory basis and should instead be
a permitted activity under section
13(d)(1)(J).249
After considering the comments
received, the final rule retains the
exclusion for purchases and sales of
financial instruments by a banking
entity that is a clearing agency or
derivatives clearing organization in
connection with its clearing
activities.250 In response to
comments,251 the Agencies have also
incorporated two changes to the rule.
First, the final rule applies the exclusion
to the purchase and sale of financial
instruments by a banking entity that is
a clearing agency or derivatives clearing
organization in connection with clearing
financial instrument transactions.
proposed rule § ll.3(b)(2)(iii)(D).
Joint Proposal, 76 FR 68,863.
247 See Allen & Overy (Clearing); Goldman (Prop.
Trading); SIFMA et al. (Prop. Trading) (Feb. 2012);
State Street (Feb. 2012).
248 See IIB/EBF.
249 See Sens. Merkley & Levin (Feb. 2012).
250 ‘‘Clearing agency’’ is defined in the final rule
with reference to the definition of this term in the
Exchange Act. See final rule § ll.3(e)(2).
‘‘Derivatives clearing organization’’ is defined in the
final rule as (i) a derivatives clearing organization
registered under section 5b of the Commodity
Exchange Act; (ii) a derivatives clearing
organization that, pursuant to CFTC regulation, is
exempt from the registration requirements under
section 5b of the Commodity Exchange Act; or (iii)
a foreign derivatives clearing organization that,
pursuant to CFTC regulation, is permitted to clear
for a foreign board of trade that is registered with
the CFTC.
251 See IIB/EBF; BNY Mellon et al.; SIFMA et al.
(Prop.Trading) (Feb. 2012); Allen & Overy
(Clearing); Goldman (Prop. Trading).
245 See

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Second, in response to comments,252 the
exclusion in the final rule is not limited
to clearing agencies or derivatives
clearing organizations that are subject to
SEC or CFTC registration requirements
and, instead, certain foreign clearing
agencies and foreign derivatives clearing
organizations will be permitted to rely
on the exclusion if they are banking
entities.
The Agencies believe that clearing
and settlement activity is not designed
to create short-term trading profits.
Moreover, excluding clearing and
settlement activities prevents the final
rule from inadvertently hindering the
Dodd–Frank Act’s goal of promoting
central clearing of financial
transactions. The Agencies have
narrowly tailored this exclusion by
allowing only central counterparties to
use it and only with respect to their
clearing and settlement activity.
4. Excluded Clearing-Related Activities
of Clearinghouse Members
In addition to the exclusion for
trading activities of a derivatives
clearing organization or clearing agency,
some commenters requested an
additional exclusion from the definition
of ‘‘trading account’’ for clearing-related
activities of members of these
entities.253 These commenters noted
that the proposed definition of ‘‘trading
account’’ provides an exclusion for
positions taken by registered derivatives
clearing organizations and registered
clearing agencies 254 and requested a
corresponding exclusion for certain
clearing-related activities of banking
entities that are members of a clearing
agency or members of a derivatives
clearing organization (collectively,
‘‘clearing members’’).255
Several commenters argued that
certain aspects of the clearing process
may require a clearing member to
engage in principal transactions. For
example, some commenters argued that
a clearinghouse’s default management
process may require clearing members
to take positions in financial
instruments upon default of another
clearing member.256 According to
commenters, default management
processes can involve: (i) Collection of
initial and variation margin from
252 See

IIB/EBF; Allen & Overy (Clearing).
SIFMA et al. (Prop. Trading) (Feb. 2012);
Allen & Overy (Clearing); Goldman (Prop. Trading);
State Street (Feb. 2012).
254 See proposed rule § ll.3(b)(2)(iii)(D).
255 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Allen & Overy (Clearing); Goldman (Prop. Trading);
State Street (Feb. 2012).
256 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Allen & Overy (Clearing); State Street (Feb. 2012).
See also ISDA (Feb. 2012).
253 See

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customers under an ‘‘agency model’’ of
clearing; (ii) porting, where a defaulting
clearing member’s customer positions
and margin are transferred to another
non-defaulting clearing member; 257 (iii)
hedging, where the clearing house looks
to clearing members and third parties to
enter into risk-reducing transactions and
to flatten the market risk associated with
the defaulting clearing member’s house
positions and non-ported customer
positions; (iv) unwinding, where the
defaulting member’s open positions may
be allocated to other clearing members,
affiliates, or third parties pursuant to a
mandatory auction process or forced
allocation; 258 and (v) imposing certain
obligations on clearing members upon
exhaustion of a guaranty fund.259
Commenters argued that, absent an
exclusion from the definition of
‘‘trading account,’’ some of these
clearing-related activities could be
considered prohibited proprietary
trading under the proposal. Two
commenters specifically contended that
the dealer prong of the definition of
‘‘trading account’’ may cause certain of
these activities to be considered
proprietary trading.260 Some
commenters suggested alternative
avenues for permitting such clearingrelated activity under the rules.261
Commenters argued that such clearingrelated activities of banking entities
should not be subject to the rule because
they are risk-reducing, beneficial for the
financial system, required by law under
certain circumstances (e.g., central
clearing requirements for swaps and
security-based swaps under Title VII of
the Dodd-Frank Act), and not used by
banking entities to engage in proprietary
trading.262
Commenters further argued that
certain activities undertaken as part of
a clearing house’s daily risk
management process may be impacted
by the rule, including unwinding selfreferencing transactions through a
mandatory auction (e.g., where a firm
acquired credit default swap (‘‘CDS’’)
protection on itself as a result of a
merger with another firm) 263 and trade
crossing, a mechanism employed by
257 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Allen & Overy (Clearing).
258 See Allen & Overy (Clearing).
259 See SIFMA et al. (Prop. Trading) (Feb. 2012).
260 See SIFMA et al. (Prop. Trading) (Feb. 2012)
(arguing that the SEC has suggested that entities
that collect margins from customers for cleared
swaps may be required to be registered as brokerdealers); State Street (Feb. 2012).
261 See Goldman (Prop. Trading); SIFMA et al.
(Prop.Trading) (Feb. 2012); ISDA (Feb. 2012).
262 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); State Street (Feb. 2012);
Allen & Overy (Clearing).
263 See Allen & Overy (Clearing).

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certain clearing houses to ensure the
accuracy of the price discovery process
in the course of, among other things,
calculating settlement prices and margin
requirements.264
The Agencies do not believe that
certain core clearing-related activities
conducted by a clearing member, often
as required by regulation or the rules
and procedures of a clearing agency,
derivatives clearing organization, or
designated financial market utility,
represent proprietary trading as
contemplated by the statute. For
example, the clearing and settlement
activities discussed above are not
conducted for the purpose of profiting
from short-term price movements. The
Agencies believe that these clearingrelated activities provide important
benefits to the financial system.265 In
particular, central clearing reduces
counterparty credit risk,266 which can
lead to a host of other benefits,
including lower hedging costs,
increased market participation, greater
liquidity, more efficient risk sharing that
promotes capital formation, and
reduced operational risk.267
Accordingly, in response to
comments, the final rule provides that
proprietary trading does not include
specified excluded clearing activities by
a banking entity that is a member of a
264 See Allen & Overy (Clearing); SIFMA et al.
(Prop.Trading) (Feb. 2012). These commenters
stated that, in order to ensure that a clearing
member is providing accurate end-of-day prices for
its open positions, a clearing house may require the
member to provide firm bids for such positions,
which may be tested through a ‘‘forced trade’’ with
another member. See id.; See also ISDA (Feb. 2012).
265 For example, Title VII of the Dodd-Frank Act
mandates the central clearing of swaps and
security-based swaps, and requires that banking
entities that are swap dealers, security-based swap
dealers, major swap participants or major securitybased swap participants collect variation margin
from many counterparties on a daily basis for their
swap or security-based swap activity. See 7 U.S.C.
2(h); 15 U.S.C. 78c–3; 7 U.S.C. 6s(e); 15 U.S.C. 78o–
10(e); Margin Requirements for Uncleared Swaps
for Swap Dealers and Major Swap Participants, 76
FR 23,732 (Apr. 28, 2011). Additionally, the SEC’s
Rule 17Ad–22(d)(11) requires that each registered
clearing agency establish, implement, maintain and
enforce policies and procedures that set forth the
clearing agency’s default management procedures.
See 17 CFR 240.17Ad–22(d)(11). See also Exchange
Act Release No. 68,080 (Oct. 12, 2012), 77 FR
66,220, 66,283 (Nov. 2, 2012).
266 Centralized clearing affects counterparty risk
in three basic ways. First, it redistributes
counterparty risk among members through
mutualization of losses, reducing the likelihood of
sequential counterparty failure and contagion.
Second, margin requirements and monitoring
reduce moral hazard, reducing counterparty risk.
Finally, clearing may reallocate counterparty risk
outside of the clearing agency because netting may
implicitly subordinate outside creditors’ claims
relative to other clearing member claims.
267 See Proposed Rule, Cross-Border SecurityBased Swap Activities, Exchange Act Release No.
69490 (May 1, 2013), 78 FR 30,968, 31,162–31,163
(May 23, 2013).

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clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility.268 ‘‘Excluded clearing activities’’
is defined in the rule to identify
particular core clearing-related
activities, many of which were raised by
commenters.269 Specifically, the final
rule will exclude the following activities
by clearing members: (i) Any purchase
or sale necessary to correct error trades
made by or on behalf of customers with
respect to customer transactions that are
cleared, provided the purchase or sale is
conducted in accordance with certain
regulations, rules, or procedures; (ii) any
purchase or sale related to the
management of a default or threatened
imminent default of a customer, subject
to certain conditions, another clearing
member, or the clearing agency,
derivatives clearing organization, or
designated financial market utility
itself; 270 and (iii) any purchase or sale
required by the rules or procedures of a
clearing agency, derivatives clearing
organization, or designated financial
market utility that mitigates risk to such
agency, organization, or utility that
would result from the clearing by a
clearing member of security-based
swaps that references the member or an
affiliate of the member.271
The Agencies are identifying specific
activities in the rule to limit the
potential for evasion that may arise from
a more generalized approach. However,
the relevant supervisory Agencies will
be prepared to provide further guidance
or relief, if appropriate, to ensure that
the terms of the exclusion do not limit
the ability of clearing agencies,
derivatives clearing organizations, or
designated financial market utilities to
effectively manage their risks in
accordance with their rules and
procedures. In response to commenters
requesting that the exclusion be
available when a clearing member is
required by rules of a clearing agency,
derivatives clearing organization, or
designated financial market utility to
purchase or sell a financial instrument
as part of establishing accurate prices to
be used by the clearing agency,
derivatives clearing organization, or
designated financial market utility in its
final rule § ll.3(d)(5).
final rule § ll.3(e)(7).
270 A number of commenters discussed the
default management process and requested an
exclusion for such activities. See SIFMA et al.
(Prop. Trading) (Feb. 2012); Allen & Overy
(Clearing); State Street (Feb. 2012). See also ISDA
(Feb. 2012).
271 See Allen & Overy (Clearing) (discussing rules
that require unwinding self-referencing transactions
through a mandatory auction (e.g., where a firm
acquired CDS protection on itself as a result of a
merger with another firm)).
268 See
269 See

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end of day settlement process,272 the
Agencies note that whether this is an
excluded clearing activity depends on
the facts and circumstances. Similarly,
the availability of other exemptions to
the rule, such as the market-making
exemption, depend on the facts and
circumstances. This exclusion applies
only to excluded clearing activities of
clearing members. It does not permit a
banking entity to engage in proprietary
trading and claim protection for that
activity because trades are cleared or
settled through a central counterparty.
5. Satisfying an Existing Delivery
Obligation
A few commenters requested
additional or expanded exclusions from
the definition of ‘‘trading account’’ for
covering short sales or failures to
deliver.273 These commenters alleged
that a banking entity engages in this
activity for purposes other than to
benefit from short term price
movements and that it is not proprietary
trading as defined in the statute. In
response to these comments, the final
rule provides that a purchase or sale by
a banking entity that satisfies an existing
delivery obligation of the banking entity
or its customers, including to prevent or
close out a failure to deliver, in
connection with delivery, clearing, or
settlement activity is not proprietary
trading.
Among other things, this exclusion
will allow a banking entity that is an
SEC-registered broker-dealer to take
action to address failures to deliver
arising from its own trading activity or
the trading activity of its customers.274
In certain circumstances, SEC-registered
broker-dealers are required to take such
action under SEC rules.275 In addition,
buy-in procedures of a clearing agency,
securities exchange, or national
securities association may require a
272 See Allen & Overy (Clearing); SIFMA et al.
(Prop. Trading) (Feb. 2012); See also ISDA (Feb.
2012).
273 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading).
274 In order to qualify for this exclusion, a
banking entity’s principal trading activity that
results in its own failure to deliver must have been
conducted in compliance with these rules.
275 See, e.g., 17 CFR 242.204 (requiring, among
other things, that a participant of a registered
clearing agency or, upon reasonable allocation, a
broker-dealer for which the participant clears trades
or from which the participant receives trades for
settlement, take action to close out a fail to deliver
position in any equity security by borrowing or
purchasing securities of like kind and quantity); 17
CFR 240.15c3–3(m) (providing that, if a brokerdealer executes a sell order of a customer and does
not obtain possession of the securities from the
customer within 10 business days after settlement,
the broker-dealer must immediately close the
transaction with the customer by purchasing
securities of like kind and quantity).

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banking entity to deliver securities if a
party with a fail to receive position
takes certain action.276 When a banking
entity purchases securities to meet an
existing delivery obligation, it is
engaging in activity that facilitates
timely settlement of securities
transactions and helps provide a
purchaser of the securities with the
benefits of ownership (e.g., voting and
lending rights). In addition, a banking
entity has limited discretion to
determine when and how to take action
to meet an existing delivery
obligation.277 Providing a limited
exclusion for this activity will avoid the
potential for SEC-registered brokerdealers being subject to conflicting or
inconsistent regulatory requirements
with respect to activity required to meet
the broker-dealer’s existing delivery
obligations.

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6. Satisfying an Obligation in
Connection With a Judicial,
Administrative, Self-Regulatory
Organization, or Arbitration Proceeding
The Agencies recognize that, under
certain circumstances, a banking entity
may be required to purchase or sell a
financial instrument at the direction of
a judicial or regulatory body. For
example, an administrative agency or
self-regulatory organization (‘‘SRO’’)
may require a banking entity to
purchase or sell a financial instrument
in the course of disciplinary
proceedings against that banking
entity.278 A banking entity may also be
obligated to purchase or sell a financial
instrument in connection with a judicial
or arbitration proceeding.279 Such
transactions do not represent trading for
276 See, e.g., NSCC Rule 11, NASDAQ Rule 11810,
FINRA Rule 11810.
277 See, e.g., 17 CFR 242.204 (requiring action to
close out a fail to deliver position in an equity
security within certain specified timeframes); 17
CFR 240.15c3–3(m) (requiring a broker-dealer to
‘‘immediately’’ close a transaction under certain
circumstances).
278 For example, an administrative agency or SRO
may require a broker-dealer to offer to buy
securities back from customers where the agency or
SRO finds the broker-dealer fraudulently sold
securities to those customers. See, e.g., In re
Raymond James & Assocs., Exchange Act Release
No. 64767, 101 S.E.C. Docket 1749 (June 29, 2011);
FINRA Dep’t of Enforcement v. Pinnacle Partners
Fin. Corp., Disciplinary Proceeding No.
2010021324501 (Apr. 25, 2012); FINRA Dep’t of
Enforcement v. Fifth Third Sec., Inc., No.
2005002244101 (Press Rel. Apr. 14, 2009).
279 For instance, section 29 of the Exchange Act
may require a broker-dealer to rescind a contract
with a customer that was made in violation of the
Exchange Act. Such rescission relief may involve
the broker-dealer’s repurchase of a financial
instrument from a customer. See 15 U.S.C. 78cc;
Reg’l Props., Inc. v. Fin. & Real Estate Consulting
Co., 678 F.2d 552 (5th Cir. 1982); Freeman v.
Marine Midland Bank N.Y., 419 F.Supp. 440
(E.D.N.Y. 1976).

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short-term profit or gain and do not
constitute proprietary trading under the
statute.
Accordingly, the Agencies have
determined to adopt a provision
clarifying that a purchase or sale of one
or more financial instruments that
satisfies an obligation of the banking
entity in connection with a judicial,
administrative, self-regulatory
organization, or arbitration proceeding
is not proprietary trading for purposes
of these rules. This clarification will
avoid the potential for conflicting or
inconsistent legal requirements for
banking entities.
7. Acting Solely as Agent, Broker, or
Custodian
The proposal clarified that proprietary
trading did not include acting solely as
agent, broker, or custodian for an
unaffiliated third party.280 Commenters
generally supported this aspect of the
proposal. One commenter suggested that
acting as agent, broker, or custodian for
affiliates should be explicitly excluded
from the definition of proprietary
trading in the same manner as acting as
agent, broker, or custodian for
unaffiliated third parties.281
Like the proposal, the final rule
expressly provides that the purchase or
sale of one or more financial
instruments by a banking entity acting
solely as agent, broker, or custodian is
not proprietary trading because acting in
these types of capacities does not
involve trading as principal, which is
one of the requisite aspects of the
statutory definition of proprietary
trading.282 The final rule has been
modified to include acting solely as
agent, broker, or custodian on behalf of
an affiliate. However, the affiliate must
comply with section 13 of the BHC Act
and the final implementing rule; and
may not itself engage in prohibited
proprietary trading. To the extent a
banking entity acts in both a principal
and agency capacity for a purchase or
sale, it may only use this exclusion for
the portion of the purchase or sale for
which it is acting as agent. The banking
entity must use a separate exemption or
proposed rule § ll.3(b)(1).
Japanese Bankers Ass’n.
282 See 12 U.S.C. 1851(h)(4). A common or
collective investment fund that is an investment
company under section 3(c)(3) or 3(c)(11) will not
be deemed to be acting as principal within the
meaning of § ll.3(a) because the fund is
performing a traditional trust activity and purchases
and sells financial instruments solely on behalf of
customers as trustee or in a similar fiduciary
capacity, as evidenced by its regulation under 12
CFR part 9 (Fiduciary Activities of National Banks)
or similar state laws.
280 See
281 See

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exclusion, if applicable, to the extent it
is acting in a principal capacity.
8. Purchases or Sales Through a
Deferred Compensation or Similar Plan
While the proposed rule provided that
the prohibition on covered fund
activities and investments did not apply
to certain instances where the banking
entity acted through or on behalf of a
pension or similar deferred
compensation plan, no such similar
treatment was given for proprietary
trading. One commenter argued that the
proposal restricted a banking entity’s
ability to engage in principal-based
trading as an asset manager that serves
the needs of the institutional investors,
such as through ERISA pension and
401(k) plans.283
To address these concerns, the final
rule provides that proprietary trading
does not include the purchase or sale of
one or more financial instruments
through a deferred compensation, stockbonus, profit-sharing, or pension plan of
the banking entity that is established
and administered in accordance with
the laws of the United States or a foreign
sovereign, if the purchase or sale is
made directly or indirectly by the
banking entity as trustee for the benefit
of the employees of the banking entity
or members of their immediate family.
Banking entities often establish and act
as trustee to pension or similar deferred
compensation plans for their employees
and, as part of managing these plans,
may engage in trading activity. The
Agencies believe that purchases or sales
by a banking entity when acting through
pension and similar deferred
compensation plans generally occur on
behalf of beneficiaries of the plan and
consequently do not constitute the type
of principal trading that is covered by
the statute.
The Agencies note that if a banking
entity engages in trading activity for an
unaffiliated pension or similar deferred
compensation plan, the trading activity
of the banking entity would not be
proprietary trading under the final rule
to the extent the banking entity was
acting solely as agent, broker, or
custodian.
9. Collecting a Debt Previously
Contracted
Several commenters argued that the
final rule should exclude collecting and
disposing of collateral in satisfaction of
debts previously contracted from the
definition of proprietary trading.284
Commenters argued that acquiring and
283 See Ass’n. of Institutional Investors (Nov.
2012).
284 See LSTA (Feb. 2012); JPMC; Goldman (Prop.
Trading); SIFMA et al. (Prop.Trading) (Feb. 2012).

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disposing of collateral in satisfaction of
debt previously contracted does not
involve trading with the intent of
profiting from short-term price
movements and, thus, should not be
proprietary trading for purposes of this
rule. Rather, this activity is a prudent
and desirable part of lending and debt
collection activities.
The Agencies believe that the
purchase and sale of a financial
instrument in satisfaction of a debt
previously contracted does not
constitute proprietary trading. The
Agencies believe an exclusion for
purchases and sales in satisfaction of
debts previously contracted is necessary
for banking entities to continue to lend
to customers, because it allows banking
entities to continue lending activity
with the knowledge that they will not be
penalized for recouping losses should a
customer default. Accordingly, the final
rule provides that proprietary trading
does not include the purchase or sale of
one or more financial instruments in the
ordinary course of collecting a debt
previously contracted in good faith,
provided that the banking entity divests
the financial instrument as soon as
practicable within the time period
permitted or required by the appropriate
financial supervisory agency.285
As a result of this exclusion, banking
entities, including SEC-registered
broker-dealers, will be able to continue
providing margin loans to their
customers and may take possession of
margined collateral following a
customer’s default or failure to meet a
margin call under applicable regulatory
requirements.286 Similarly, a banking
entity that is a CFTC-registered swap
dealer or SEC-registered security-based
swap dealer may take, hold, and
exchange any margin collateral as
counterparty to a cleared or uncleared
swap or security-based swap
transaction, in accordance with the
rules of the Agencies.287 This exclusion
will allow banking entities to comply
with existing regulatory requirements
final rule § ll.3(d)(9).
example, if any margin call is not met in
full within the time required by Regulation T, then
Regulation T requires a broker-dealer to liquidate
securities sufficient to meet the margin call or to
eliminate any margin deficiency existing on the day
such liquidation is required, whichever is less. See
12 CFR 220.4(d).
287 See SEC Proposed Rule, Capital, Margin,
Segregation, Reporting and Recordkeeping
Requirements for Security-Based Swap Dealers,
Exchange Act Release No. 68071, 77 FR 70,214
(Nov. 23, 2012); CFTC Proposed Rule, Margin
Requirements for Uncleared Swaps for Swap
Dealers and Major Swap Participants, 76 FR 23,732
(Apr. 28, 2011); Banking Agencies’ Proposed Rule,
Margin and Capital Requirements for Covered Swap
Entities, 76 FR 27,564 (May 11, 2011).
285 See

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286 For

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regarding the divestiture of collateral
taken in satisfaction of a debt.
10. Other Requested Exclusions
Commenters requested a number of
additional exclusions from the trading
account and, in turn, the prohibition on
proprietary trading. In order to avoid
potential evasion of the final rule, the
Agencies decline to adopt any
exclusions from the trading account
other than the exclusions described
above.288 The Agencies believe that
various modifications to the final rule,
including in particular to the exemption
for market-making related activities,
address many of commenters’ concerns
regarding unintended consequences of
the prohibition on proprietary trading.
2. Section ll.4(a): Underwriting
Exemption
a. Introduction
After carefully considering comments
on the proposed underwriting
exemption, the Agencies are adopting
the proposed underwriting exemption
substantially as proposed, but with
certain refinements and clarifications to
the proposed approach to better reflect
the range of securities offerings that an
underwriter may help facilitate on
behalf of an issuer or selling security
holder and the types of activities an
underwriter may undertake in
connection with a distribution of
securities to facilitate the distribution
process and provide important benefits
to issuers, selling security holders, or
purchasers in the distribution. The
Agencies are adopting such an approach
because the statute specifically permits
banking entities to continue providing
these beneficial services to clients,
customers, and counterparties. At the
same time, to reduce the potential for
evasion of the general prohibition on
proprietary trading, the Agencies are
requiring, among other things, that the
trading desk make reasonable efforts to
sell or otherwise reduce its
288 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012) (transactions that are not based on expected
or anticipated movements in asset prices, such as
fully collateralized swap transactions that serve
funding purposes); Norinchukin and Wells Fargo
(Prop. Trading) (derivatives that qualify for hedge
accounting); GE (Feb. 2012) (transactions related to
commercial contracts); Citigroup (Feb. 2012) (FX
swaps and FX forwards); SIFMA et al. (Prop.
Trading) (Feb. 2012) (interaffiliate transactions); T.
Rowe Price (purchase and sale of shares in
sponsored mutual funds); RMA (cash collateral
pools); Alfred Brock (arbitrage trading); ICBA
(securities traded pursuant to 12 U.S.C. 1831a(f)).
The Agencies are concerned that these exclusions
could be used to conduct impermissible proprietary
trading, and the Agencies believe some of these
exclusions are more appropriately addressed by
other provisions of the rule. For example,
derivatives qualifying for hedge accounting may be
permitted under the hedging exemption.

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5559

underwriting position (accounting for
the liquidity, maturity, and depth of the
market for the relevant type of security)
and be subject to a robust risk limit
structure that is designed to prevent a
trading desk from having an
underwriting position that exceeds the
reasonably expected near term demands
of clients, customers, or counterparties.
b. Overview
1. Proposed Underwriting Exemption
Section 13(d)(1)(B) of the BHC Act
provides an exemption from the
prohibition on proprietary trading for
the purchase, sale, acquisition, or
disposition of securities and certain
other instruments in connection with
underwriting activities, to the extent
that such activities are designed not to
exceed the reasonably expected near
term demands of clients, customers, or
counterparties.289
Section ll.4(a) of the proposed rule
would have implemented this
exemption by requiring that a banking
entity’s underwriting activities comply
with seven requirements. As discussed
in more detail below, the proposed
underwriting exemption required that:
(i) A banking entity establish a
compliance program under § ll.20;
(ii) the covered financial position be a
security; (iii) the purchase or sale be
effected solely in connection with a
distribution of securities for which the
banking entity is acting as underwriter;
(iv) the banking entity meet certain
dealer registration requirements, where
applicable; (v) the underwriting
activities be designed not to exceed the
reasonably expected near term demands
of clients, customers, or counterparties;
(vi) the underwriting activities be
designed to generate revenues primarily
from fees, commissions, underwriting
spreads, or other income not attributable
to appreciation in the value of covered
financial positions or to hedging of
covered financial positions; and (vii) the
compensation arrangements of persons
performing underwriting activities be
designed not to reward proprietary risktaking.290 The proposal explained that
these seven criteria were proposed so
that any banking entity relying on the
underwriting exemption would be
engaged in bona fide underwriting
activities and would conduct those
activities in a way that would not be
susceptible to abuse through the taking
of speculative, proprietary positions as
289 12

U.S.C. 1851(d)(1)(B).
proposed rule § ll.4(a).

290 See

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part of, or mischaracterized as,
underwriting activity.291

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2. Comments on Proposed Underwriting
Exemption
As a general matter, a few
commenters expressed overall support
for the proposed underwriting
exemption.292 Some commenters
indicated that the proposed exemption
is too narrow and may negatively
impact capital markets.293 As discussed
in more detail below, many commenters
expressed views on the effectiveness of
specific requirements of the proposed
exemption. Further, some commenters
requested clarification or expansion of
the proposed exemption for certain
activities that may be conducted in the
course of underwriting.
Several commenters suggested
alternative approaches to implementing
the statutory exemption for
underwriting activities.294 More
specifically, commenters recommended
that the Agencies: (i) Provide a safe
harbor for low risk, standard
underwritings; 295 (ii) better incorporate
the statutory limitations on high-risk
activity or conflicts of interest; 296 (iii)
prohibit banking entities from
underwriting illiquid securities; 297 (iv)
prohibit banking entities from
participating in private placements; 298
(v) place greater emphasis on adequate
291 See Joint Proposal, 76 FR 68,866; CFTC
Proposal, 77 FR 8352.
292 See Barclays (stating that the proposed
exemption generally effectuates the aims of the
statute while largely avoiding undue interference,
although the commenter also requested certain
technical changes to the rule text); Alfred Brock.
293 See, e.g., Lord Abbett; BoA; Fidelity; Chamber
(Feb. 2012).
294 See Sens. Merkley & Levin (Feb. 2012); BoA;
Fidelity; Occupy; AFR et al. (Feb. 2012).
295 See Sens. Merkley & Levin (Feb. 2012)
(suggesting a safe harbor for underwriting efforts
that meet certain low-risk criteria, including that:
The underwriting be in plain vanilla stock or bond
offerings, including commercial paper, for
established business and governments; and the
distribution be completed within relevant time
periods, as determined by asset classes, with
relevant factors being the size of the issuer and the
market served); Johnson & Prof. Stiglitz (expressing
support for a narrow safe harbor for underwriting
of basic stocks and bonds that raise capital for real
economy firms).
296 See Sens. Merkley & Levin (Feb. 2012)
(suggesting that, for example, the exemption plainly
prevent high-risk, conflict ridden underwritings of
securitizations and structured products and crossreference Section 621 of the Dodd-Frank Act, which
prohibits certain material conflicts of interest in
connection with asset-backed securities).
297 See AFR et al. (Feb. 2012) (recommending that
the Agencies prohibit banking entities from acting
as underwriter for assets classified as Level 3 under
FAS 157, which would prohibit underwriting of
illiquid and opaque securities without a genuine
external market, and representing that such a
restriction would be consistent with the statutory
limitation on exposures to high-risk assets).
298 See Occupy.

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internal compliance and risk
management procedures; 299 or (vi)
make the exemption as broad as
possible.300
3. Final Underwriting Exemption
After considering the comments
received, the Agencies are adopting the
underwriting exemption substantially as
proposed, but with important
modifications to clarify provisions or to
address commenters’ concerns. As
discussed above, some commenters
were generally supportive of the
proposed approach to implementing the
underwriting exemption, but noted
certain areas of concern or uncertainty.
The underwriting exemption the
Agencies are adopting addresses these
issues by further clarifying the scope of
activities that qualify for the exemption.
In particular, the Agencies are refining
the proposed exemption to better
capture the broad range of capitalraising activities facilitated by banking
entities acting as underwriters on behalf
of issuers and selling security holders.
The final underwriting exemption
includes the following components:
• A framework that recognizes the
differences in underwriting activities
across markets and asset classes by
establishing criteria that will be applied
flexibly based on the liquidity, maturity,
and depth of the market for the
particular type of security.
• A general focus on the
‘‘underwriting position’’ held by a
banking entity or its affiliate, and
managed by a particular trading desk, in
connection with the distribution of
securities for which such banking entity
or affiliate is acting as an
underwriter.301
• A definition of the term ‘‘trading
desk’’ that focuses on the functionality
of the desk rather than its legal status,
and requirements that apply at the
trading desk level of organization within
a banking entity or across two or more
affiliates.302
• Five standards for determining
whether a banking entity is engaged in
permitted underwriting activities. Many
299 See BoA (recommending that the Agencies
establish a strong presumption that all of a banking
entity’s activities related to underwriting are
permitted under the rules as long as the banking
entity has adequate compliance and risk
management procedures).
300 See Fidelity (suggested that the rules be
revised to ‘‘provide the broadest exemptions
possible under the statute’’ for underwriting and
certain other permitted activities).
301 See infra Part IV.A.2.c.1.c.
302 See infra Part IV.A.2.c.1.c. The term ‘‘trading
desk’’ is defined in final rule § ll.3(e)(13) as ‘‘the
smallest discrete unit of organization of a banking
entity that purchases or sells financial instruments
for the trading account of the banking entity or an
affiliate thereof.’’

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of these criteria have similarities to
those included in the proposed rule, but
with important modifications in
response to comments. These standards
require that:
Æ The banking entity act as an
‘‘underwriter’’ for a ‘‘distribution’’ of
securities and the trading desk’s
underwriting position be related to such
distribution. The final rule includes
refined definitions of ‘‘distribution’’ and
‘‘underwriter’’ to better capture the
broad scope of securities offerings used
by issuers and selling security holders
and the range of roles that a banking
entity may play as intermediary in such
offerings.303
Æ The amount and types of securities
in the trading desk’s underwriting
position be designed not to exceed the
reasonably expected near term demands
of clients, customers, or counterparties,
and reasonable efforts be made to sell or
otherwise reduce the underwriting
position within a reasonable period,
taking into account the liquidity,
maturity, and depth of the market for
the relevant type of security.304
Æ The banking entity establish,
implement, maintain, and enforce an
internal compliance program that is
reasonably designed to ensure the
banking entity’s compliance with the
requirements of the underwriting
exemption, including reasonably
designed written policies and
procedures, internal controls, analysis,
and independent testing identifying and
addressing:
D The products, instruments, or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
D Limits for each trading desk, based
on the nature and amount of the trading
desk’s underwriting activities, including
the reasonably expected near term
demands of clients, customers, or
counterparties, on the amount, types,
and risk of the trading desk’s
underwriting position, level of
exposures to relevant risk factors arising
from the trading desk’s underwriting
position, and period of time a security
may be held;
D Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
D Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
303 See final rule §§ ll.4(a)(2)(i), ll.4(a)(3),
ll.4(a)(4); See also infra Part IV.A.2.c.1.c.
304 See final rule § ll.4(a)(2)(ii); See also infra
Part IV.A.2.c.2.c.

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increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval.305
Æ The compensation arrangements of
persons performing the banking entity’s
underwriting activities are designed not
to reward or incentivize prohibited
proprietary trading.306
Æ The banking entity is licensed or
registered to engage in the activity
described in the underwriting
exemption in accordance with
applicable law.307
After considering commenters’
suggested alternative approaches to
implementing the statute’s underwriting
exemption, the Agencies have
determined to retain the general
structure of the proposed underwriting
exemption. For instance, two
commenters suggested providing a safe
harbor for ‘‘plain vanilla’’ or ‘‘basic’’
underwritings of stocks and bonds.308
The Agencies do not believe that a safe
harbor is necessary to provide certainty
that a banking entity may act as an
underwriter in these particular types of
offerings. This is because ‘‘plain
vanilla’’ or ‘‘basic’’ underwriting
activity should be able to meet the
requirements of the final rule. For
example, the final definition of
‘‘distribution’’ includes any offering of
securities made pursuant to an effective
registration statement under the
Securities Act.309
Further, in response to one
commenter’s request that the final rule
prohibit a banking entity from acting as
an underwriter in illiquid assets that are
determined to not have observable price
inputs under accounting standards,310
the Agencies continue to believe that it
would be inappropriate to incorporate
accounting standards in the rule
because accounting standards could
change in the future without
consideration of the potential impact on
the final rule.311 Moreover, the Agencies
305 See final rule § ll.4(a)(2)(iii); See also infra
Part IV.A.2.c.3.c.
306 See final rule § ll.4(a)(2)(iv); See also infra
Part IV.A.2.c.4.c.
307 See final rule § ll.4(a)(2)(v); See also infra
Part IV.A.2.c.5.c.
308 See Sens. Merkley & Levin (Feb. 2012);
Johnson & Prof. Stiglitz. One of these commenters
also suggested that the Agencies better incorporate
the statutory limitations on material conflicts of
interest and high-risk activities in the underwriting
exemption by including additional provisions in
the exemption to refer to these limitations. See
Sens. Merkley & Levin (Feb. 2012). The Agencies
note that these limitations are adopted in § ll.7
of the final rules, and this provision will apply to
underwriting activities, as well as all other
exempted activities.
309 See final rule § ll.4(a)(3).
310 See AFR et al. (Feb. 2012).
311 See Joint Proposal, 76 FR 68,859 n.101
(explaining why the Agencies declined to

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do not believe it is necessary to
differentiate between liquid and less
liquid securities for purposes of
determining whether a banking entity
may underwrite a distribution of
securities because, in either case, a
banking entity must have a reasonable
expectation of purchaser demand for the
securities and must make reasonable
efforts to sell or otherwise reduce its
underwriting position within a
reasonable period under the final
rule.312
Another commenter suggested that
the Agencies establish a strong
presumption that all of a banking
entity’s activities related to
underwriting are permitted under the
rule as long as the banking entity has
adequate compliance and risk
management procedures.313 While
strong compliance and risk management
procedures are important for banking
entities’ permitted activities, the
Agencies believe that an approach
focused solely on the establishment of a
compliance program would likely
increase the potential for evasion of the
general prohibition on proprietary
trading. Similarly, the Agencies are not
adopting an exemption that is
unlimited, as requested by one
commenter, because the Agencies
believe controls are necessary to prevent
potential evasion of the statute through,
among other things, retaining an unsold
allotment when there is sufficient
customer interest for the securities and
to limit the risks associated with these
activities.314
Underwriters play an important role
in facilitating issuers’ access to funding,
and thus underwriters are important to
the capital formation process and
economic growth.315 Obtaining new
financing can be expensive for an issuer
because of the natural information
advantage that less well-known issuers
have over investors about the quality of
their future investment opportunities.
An underwriter can help reduce these
costs by mitigating the information
asymmetry between an issuer and its
potential investors. The underwriter
does this based in part on its familiarity
with the issuer and other similar issuers
as well as by collecting information
about the issuer. This allows investors
to look to the reputation and experience

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of the underwriter as well as its ability
to provide information about the issuer
and the underwriting. For these and
other reasons, most U.S. issuers rely on
the services of an underwriter when
raising funds through public offerings.
As recognized in the statute, the
exemption is intended to permit
banking entities to continue to perform
the underwriting function, which
contributes to capital formation and its
positive economic effects.
c. Detailed Explanation of the
Underwriting Exemption
1. Acting as an Underwriter for a
Distribution of Securities
a. Proposed Requirements That the
Purchase or Sale be Effected Solely in
Connection With a Distribution of
Securities for Which the Banking Entity
Acts as an Underwriter and That the
Covered Financial Position be a Security
Section ll.4(a)(2)(iii) of the
proposed rule required that the
purchase or sale be effected solely in
connection with a distribution of
securities for which a banking entity is
acting as underwriter.316 As discussed
below, the Agencies proposed to define
the terms ‘‘distribution’’ and
‘‘underwriter’’ in the proposed rule. The
proposed rule also required that the
covered financial position being
purchased or sold by the banking entity
be a security.317
i. Proposed Definition of ‘‘Distribution’’
The proposed definition of
‘‘distribution’’ mirrored the definition of
this term used in the SEC’s Regulation
M under the Exchange Act.318 More
specifically, the proposed rule defined
‘‘distribution’’ as ‘‘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.’’319
The Agencies did not propose to define
the terms ‘‘magnitude’’ and ‘‘special
selling efforts and selling methods,’’ but
stated that the Agencies would expect to
rely on the same factors considered in
Regulation M for assessing these
elements.320 The Agencies noted that
proposed rule § ll.4(a)(2)(iii).
proposed rule § ll.4(a)(2)(ii).
318 See Joint Proposal, 76 FR 68,866–68,867;
CFTC Proposal, 77 FR 8352; 17 CFR 242.101;
proposed rule § ll.4(a)(3).
319 See proposed rule § ll.4(a)(3).
320 See Joint Proposal, 76 FR 68,867 (‘‘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. In
316 See
317 See

incorporate certain accounting standards in the
proposed rule); CFTC Proposal, 77 FR 8344 n.107.
312 See infra Part IV.A.2.c.2.c.
313 See BoA.
314 See Fidelity.
315 See, e.g., BoA (‘‘The underwriting activities of
U.S. banking entities are essential to capital
formation and, therefore, economic growth and job
creation.’’); Goldman (Prop. Trading); Sens. Merkley
& Levin (Feb. 2012).

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‘‘magnitude’’ does not imply that a
distribution must be large and,
therefore, this factor would not preclude
small offerings or private placements
from qualifying for the proposed
underwriting exemption.321
ii. Proposed Definition of ‘‘Underwriter’’
Like the proposed definition of
‘‘distribution,’’ the Agencies proposed
to define ‘‘underwriter’’ in a manner
similar to the definition of this term in
the SEC’s Regulation M.322 The
definition of ‘‘underwriter’’ in the
proposed rule was: (i) Any person who
has agreed with an issuer or selling
security holder to: (a) Purchase
securities for distribution; (b) engage in
a distribution of securities for or on
behalf of such issuer or selling security
holder; or (c) 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 the
preceding provisions to engage in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.323
In connection with this proposed
requirement, the Agencies noted 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. To
determine whether a banking entity is
acting as an underwriter as part of a
distribution of securities, the Agencies
proposed to take into consideration the
extent to which a banking entity is
engaged in the following activities:
• Assisting an issuer in capitalraising;
• Performing due diligence;
• Advising the issuer on market
conditions and assisting in the

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addition, delivering a sales document, such as a
prospectus, and conducting road shows are
generally indicative of special selling efforts and
selling methods. Another indicator of special
selling efforts and selling methods is compensation
that is greater than that for secondary trades but
consistent with underwriting compensation for an
offering.’’); CFTC Proposal, 77 FR 8352; Review of
Antimanipulation Regulation of Securities Offering,
Exchange Act Release No. 33924 (Apr. 19, 1994), 59
FR 21,681, 21,684–21,685 (Apr. 26, 1994).
321 See Joint Proposal, 76 FR 68,867; CFTC
Proposal, 77 FR 8352.
322 See Joint Proposal, 76 FR 68,866–68,867;
CFTC Proposal, 77 FR 8352; 17 CFR 242.101;
proposed rule § ll.4(a)(4).
323 See proposed rule § ll.4(a)(4). As noted in
the proposal, the proposed rule’s definition differed
from the definition in Regulation M because the
proposed rule’s definition would also include 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. See Joint Proposal, 76 FR 68,867; CFTC
Proposal, 77 FR 8352.

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preparation of a registration statement
or other offering document;
• 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.324
The proposal recognized that there may
be circumstances in which an
underwriter would hold securities that
it could not sell in the distribution for
investment purposes. The Agencies
stated that if the unsold securities were
acquired in connection with
underwriting under the proposed
exemption, then the underwriter would
be able to dispose of such securities at
a later time.325
iii. Proposed Requirement That the
Covered Financial Position Be a
Security
Pursuant to § ll.4(a)(2)(ii) of the
proposed exemption, a banking entity
would be permitted to purchase or sell
a covered financial position that is a
security only in connection with its
underwriting activities.326 The proposal
stated that this requirement was meant
to reflect the common usage and
understanding of the term
‘‘underwriting.’’ 327 It was noted,
however, that a derivative or commodity
future transaction may be otherwise
permitted under another exemption
(e.g., the exemptions for market makingrelated or risk-mitigating hedging
activities).328
b. Comments on the Proposed
Requirements That the Trade Be
Effected Solely in Connection With a
Distribution for Which the Banking
Entity Is Acting as an Underwriter and
That the Covered Financial Position Be
a Security
In response to the proposed
requirement that a purchase or sale be
‘‘effected solely in connection with a
distribution of securities’’ for which the
‘‘banking entity is acting as
underwriter,’’ commenters generally
focused on the proposed definitions of
‘‘distribution’’ and ‘‘underwriter’’ and
the types of activities that should be
permitted under the ‘‘in connection
with’’ standard. Commenters did not
324 See Joint Proposal, 76 FR 68,867; CFTC
Proposal, 77 FR 8352.
325 See id.
326 See proposed rule § ll.4(a)(2)(ii).
327 See Joint Proposal, 76 FR 68,866; CFTC
Proposal, 77 FR 8352.
328 See Joint Proposal, 76 FR 68,866 n.132; CFTC
Proposal, 77 FR 8352 n.138.

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directly address the requirement in
§ ll.4(a)(2)(ii) of the proposed rule,
which provided that the covered
financial position purchased or sold
under the exemption must be a security.
A number of commenters expressed
general concern that the proposed
underwriting exemption’s references to
a ‘‘purchase or sale of a covered
financial position’’ could be interpreted
to require compliance with the
proposed rule on a transaction-bytransaction basis. These commenters
indicated that such an approach would
be overly burdensome.329
i. Definition of ‘‘Distribution’’
Several commenters stated that the
proposed definition of ‘‘distribution’’ is
too narrow,330 while one commenter
stated that the proposed definition is too
broad.331 Commenters who viewed the
proposed definition as too narrow stated
that it may exclude important capitalraising and financing transactions that
do not appear to involve ‘‘special selling
efforts and selling methods’’ or
‘‘magnitude.’’ 332 In particular, these
commenters stated that the proposed
definition of ‘‘distribution’’ may
preclude a banking entity from
participating in commercial paper
issuances,333 bridge loans,334 ‘‘at-themarket’’ offerings or ‘‘dribble out’’
programs conducted off issuer shelf
registrations,335 offerings in response to
reverse inquiries,336 offerings through
an automated execution system,337
small private offerings,338 or selling
security holders’ sales of securities of
issuers with large market capitalizations
that are executed as underwriting
transactions in the normal course.339
Several commenters suggested that
the proposed definition be modified to
329 See, e.g., Goldman (Prop. Trading); SIFMA et
al. (Prop. Trading) (Feb. 2012).
330 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); Wells Fargo (Prop.
Trading); RBC.
331 See Occupy.
332 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); Wells Fargo (Prop.
Trading); RBC.
333 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); Wells Fargo (Prop.
Trading). In addition, one commenter expressed
general concern that the proposed rule would cause
a reduction in underwriting services with respect to
commercial paper, which would reduce liquidity in
commercial paper markets and raise the costs of
capital in already tight credit markets. See Chamber
(Feb. 2012).
334 See Goldman (Prop. Trading); Wells Fargo
(Prop. Trading); RBC; LSTA (Feb. 2012).
335 See Goldman (Prop. Trading).
336 See SIFMA et al. (Prop. Trading) (Feb. 2012).
337 See SIFMA et al. (Prop. Trading) (Feb. 2012).
338 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); Wells Fargo (Prop.
Trading).
339 See RBC.

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include some or all of these types of
offerings.340 For example, two
commenters requested that the
definition explicitly include all
offerings of securities by an issuer.341
One of these commenters further
requested a broader definition that
would include any offering by a selling
security holder that is registered under
the Securities Act or that involves an
offering document prepared by the
issuer.342 Another commenter suggested
that the rule explicitly authorize certain
forms of offerings, such as offerings
under Rule 144A, Regulation S, Rule
101(b)(10) of Regulation M, or the socalled ‘‘section 4(11⁄2)’’ of the Securities
Act, as well as transactions on behalf of
selling security holders.343 Two
commenters proposed approaches that
would include the resale of notes or
other debt securities received by a
banking entity from a borrower to
replace or refinance a bridge loan.344
One of these commenters stated that
permitting a banking entity to receive
and resell notes or other debt securities
from a borrower to replace or refinance
a bridge loan would preserve the ability
of a banking entity to extend credit and
offer customers a range of financing
options. This commenter further
represented that such an approach
would be consistent with the exclusion
of loans from the proposed definition of
‘‘covered financial position’’ and the
commenter’s recommended exclusion
from the definition of ‘‘trading account’’
for collecting debts previously
contracted.345
340 See Goldman (Prop. Trading); SIFMA et al.
(Prop. Trading) (Feb. 2012); RBC.
341 See Goldman (Prop. Trading) (stating that this
would capture, among other things, commercial
paper issuances, issuer ‘‘dribble out’’ programs, and
small private offerings, which involve the purchase
of securities directly from an issuer with a view
toward resale, but may not always be clearly
distinguished by ‘‘special selling efforts and selling
methods’’ or by ‘‘magnitude’’); SIFMA et al. (Prop.
Trading) (Feb. 2012).
342 See SIFMA et al. (Prop. Trading) (Feb. 2012).
This commenter indicated that expanding the
definition of ‘‘distribution’’ to include both
offerings of securities by an issuer and offerings by
a selling security holder that are registered under
the Securities Act or that involve an offering
document prepared by the issuer would ‘‘include,
for example, an offering of securities by an issuer
or a selling security holder where securities are sold
through an automated order execution system,
offerings in response to reverse inquiries and
commercial paper issuances.’’ Id.
343 See RBC.
344 See Goldman (Prop. Trading); RBC. In
addition, one commenter requested the Agencies
clarify that permitted underwriting activities
include the acquisition and resale of securities
issued in lieu of or to refinance bridge loan
facilities, irrespective of whether such activities
qualify as ‘‘distributions’’ under the proposal. See
LSTA (Feb. 2012).
345 See Goldman (Prop. Trading).

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One commenter, however, stated that
the proposed definition of
‘‘distribution’’ is too broad. This
commenter suggested that the
underwriting exemption should only be
available for registered offerings, and
the rule should preclude a banking
entity from participating in a private
placement. According to the
commenter, permitting a banking entity
to participate in a private placement
may facilitate evasion of the prohibition
on proprietary trading.346
ii. Definition of ‘‘Underwriter’’
Several commenters stated that the
proposed definition of ‘‘underwriter’’ is
too narrow.347 Other commenters,
however, stated that the proposed
definition is too broad, particularly due
to the proposed inclusion of selling
group members.348
Commenters requesting a broader
definition generally stated that the
Agencies should instead use the
Regulation M definition of ‘‘distribution
participant’’ or otherwise revise the
definition of ‘‘underwriter’’ to
incorporate the concept of a
‘‘distribution participant,’’ as defined
under Regulation M.349 According to
these commenters, using the term
‘‘distribution participant’’ would better
reflect current market practice and
would include dealers that participate
in an offering but that do not deal
directly with the issuer or selling
security holder and do not have a
written agreement with the
underwriter.350 One commenter further
represented that the proposed provision
for selling group members may be less
inclusive than the Agencies intended
because individual selling dealers or
dealer groups may or may not have
written agreements with an underwriter
in privity of contract with the issuer.351
Another commenter requested that, if
the ‘‘distribution participant’’ concept is
not incorporated into the rule, the
346 See

Occupy.
SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); Wells Fargo (Prop.
Trading).
348 See AFR et al. (Feb. 2012); Public Citizen;
Occupy (suggesting that the Agencies exceeded
their statutory authority by incorporating the
Regulation M definition of ‘‘underwriter,’’ rather
than the Securities Act definition of ‘‘underwriter’’).
349 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); Wells Fargo (Prop.
Trading). The term ‘‘distribution participant’’ is
defined in Rule 100 of Regulation M as ‘‘an
underwriter, prospective underwriter, broker,
dealer, or other person who has agreed to
participate or is participating in a distribution.’’ 17
CFR 242.100.
350 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); Wells Fargo (Prop.
Trading).
351 See Goldman (Prop. Trading).
347 See

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5563

proposed definition of ‘‘underwriter’’ be
modified to include a person who has
an agreement with an affiliate of an
issuer or selling security holder (e.g., an
agreement with a parent company to
distribute the issuer’s securities).352
Other commenters opposed the
inclusion of selling group members in
the proposed definition of
‘‘underwriter.’’ These commenters
stated that because selling group
members do not provide a price
guarantee to an issuer, they do not
provide services to a customer and their
activities should not qualify for the
underwriting exemption.353
A number of commenters stated that
it is unclear whether the proposed
underwriting exemption would permit a
banking entity to act as an authorized
participant (‘‘AP’’) to an ETF issuer,
particularly with respect to the creation
and redemption of ETF shares or
‘‘seeding’’ an ETF for a short period of
time when it is initially launched.354
For example, a few commenters noted
that APs typically do not perform some
or all of the activities that the Agencies
proposed to consider to help determine
whether a banking entity is acting as an
underwriter in connection with a
distribution of securities, including due
diligence, advising an issuer on market
conditions and assisting in preparation
of a registration statement or offering
documents, and participating in or
organizing a syndicate of investment
banks.355
However, one commenter appeared to
oppose applying the underwriting
exemption to certain AP activities.
According to this commenter, APs are
generally reluctant to concede that they
are statutory underwriters because they
do not perform all the activities
associated with the underwriting of an
operating company’s securities. Further,
this commenter expressed concern that,
if an AP had to rely on the proposed
underwriting exemption, the AP could
be subject to heightened risk of
incurring underwriting liability on the
issuance of ETF shares traded by the
AP. As a result of these considerations,
352 See SIFMA et al. (Prop. Trading) (Feb. 2012).
This commenter also requested a technical
amendment to proposed rule § ll.4(a)(4)(ii) to
clarify that the person is ‘‘participating’’ in a
distribution, not ‘‘engaging’’ in a distribution. See
id.
353 See AFR et al. (Feb. 2012); Public Citizen.
354 See BoA; ICI Global; Vanguard; ICI (Feb.
2012); SSgA (Feb. 2012). As one commenter
explained, an AP may ‘‘seed’’ an ETF for a short
period of time at its inception by entering into
several initial creation transactions with the ETF
issuer and refraining from selling those shares to
investors or redeeming them for a period of time to
facilitate the ETF achieving its liquidity launch
goals. See BoA.
355 See ICI Global; ICI (Feb. 2012); Vanguard.

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the commenter believed that a banking
entity may be less willing to act as an
AP for an ETF issuer if it were required
to rely on the underwriting
exemption.356
iii. ‘‘Solely in Connection With’’
Standard
To qualify for the underwriting
exemption, the proposed rule required a
purchase or sale of a covered financial
position to be effected ‘‘solely in
connection with’’ a distribution of
securities for which the banking entity
is acting as underwriter. Several
commenters expressed concern that the
word ‘‘solely’’ in this provision may
result in an overly narrow interpretation
of permissible activities. In particular,
these commenters indicated that the
‘‘solely in connection with’’ standard
creates uncertainty about certain
activities that are currently conducted
in the course of an underwriting, such
as customary underwriting syndicate
activities.357 One commenter
represented that such activities are
traditionally undertaken to: Support the
success of a distribution; mitigate risk to
issuers, investors, and underwriters; and
facilitate an orderly aftermarket.358 A
few commenters further stated that
requiring a trade to be ‘‘solely’’ in
connection with a distribution by an
underwriter would be inconsistent with
the statute,359 may reduce future
innovation in the capital-raising
process,360 and could create market
disruptions.361
A number of commenters stated that
it is unclear whether certain activities
would qualify for the proposed
underwriting exemption and requested
that the Agencies adopt an exemption
that is broad enough to permit such
activities.362 Commenters stated that
there are a number of activities that
should be permitted under the
underwriting exemption, including: (i)
Creating a naked or covered syndicate
short position in connection with an
offering; 363 (ii) creating a stabilizing
356 See

SSgA (Feb. 2012).
SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); BoA; Wells Fargo (Prop.
Trading); Comm. on Capital Markets Regulation.
358 See Goldman (Prop. Trading).
359 See Goldman (Prop. Trading); Wells Fargo
(Prop. Trading); SIFMA et al. (Prop. Trading) (Feb.
2012).
360 See Goldman (Prop. Trading).
361 See SIFMA et al. (Prop. Trading) (Feb. 2012).
362 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); Wells Fargo (Prop.
Trading); RBC.
363 See SIFMA et al. (Prop. Trading) (Feb. 2012)
(‘‘The reason for creating the short positions
(covered and naked) is to facilitate an orderly
aftermarket and to reduce price volatility of newly
offered securities. This provides significant value to
issuers and selling security holders, as well as to

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bid; 364 (iii) acquiring positions via
overallotments 365 or trading in the
market to close out short positions in
connection with an overallotment
option or in connection with other
stabilization activities; 366 (iv) using call
spread options in a convertible debt
offering to mitigate dilution of existing
shareholders; 367 (v) repurchasing
existing debt securities of an issuer in
the course of underwriting a new series
of debt securities in order to stimulate
demand for the new issuance; 368 (vi)
purchasing debt securities of
comparable issuers as a price discovery
mechanism in connection with
underwriting a new debt security; 369
(vii) hedging the underwriter’s exposure
to a derivative strategy engaged in with
an issuer; 370 (viii) organizing and
assembling a resecuritized product,
including, for example, sourcing bond
collateral over a period of time in
anticipation of issuing new
securities; 371 and (ix) selling a security
to an intermediate entity as part of the
creation of certain structured
products.372
investors, by giving the syndicate buying power that
helps protect against immediate volatility in the
aftermarket.’’); RBC; Goldman (Prop. Trading).
364 See SIFMA et al. (Prop. Trading) (Feb. 2012)
(‘‘Underwriters may also engage in stabilization
activities under Regulation M by creating a
stabilizing bid to prevent or slow a decline in the
market price of a security. These activities should
be encouraged rather than restricted by the Volcker
Rule because they reduce price volatility and
facilitate the orderly pricing and aftermarket trading
of underwritten securities, thereby contributing to
capital formation.’’).
365 See RBC.
366 See Goldman (Prop. Trading).
367 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading) (stating that the call
spread arrangement ‘‘may make a wider range of
financing options feasible for the issuer of the
convertible debt’’ and ‘‘can help it to raise more
capital at more attractive prices’’).
368 See Wells Fargo (Prop. Trading). The
commenter further stated that the need to purchase
the issuer’s other debt securities from investors may
arise if an investor has limited risk tolerance to the
issuer’s credit or has portfolio restrictions.
According to the commenter, the underwriter
would typically sell the debt securities it purchased
from existing investors to new investors. See id.
369 See Wells Fargo (Prop. Trading).
370 See Goldman (Prop. Trading).
371 See ASF (Feb. 2012) (stating that, for example,
a banking entity may respond to customer or
general market demand for highly-rated mortgage
paper by accumulating residential mortgage-backed
securities over time and holding such securities in
inventory until the transaction can be organized
and assembled).
372 See ICI (Feb. 2012) (stating that the sale of
assets to an intermediate asset-backed commercial
paper or tender option bond program should be
permitted under the underwriting exemption if the
sale is part of the creation of a structured security).
See also AFR et al. (Feb. 2012) (stating that the
treatment of a sale to an intermediate entity should
depend on whether the banking entity or an
external client is the driver of the demand and, if
the banking entity is the driver of the demand, then

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c. Final Requirement That the Banking
Entity Act as an Underwriter for a
Distribution of Securities and the
Trading Desk’s Underwriting Position
Be Related to Such Distribution
The final rule requires that the
banking entity act as an underwriter for
a distribution of securities and the
trading desk’s underwriting position be
related to such distribution.373 This
requirement is substantially similar to
the proposed rule,374 but with five key
refinements. First, to address
commenters’ confusion about whether
the underwriting exemption applies on
a transaction-by-transaction basis, the
phrase ‘‘purchase or sale’’ has been
modified to instead refer to the trading
desk’s ‘‘underwriting position.’’ Second,
to balance this more aggregated
position-based approach, the final rule
specifies that the trading desk is the
organizational level of a banking entity
(or across one or more affiliated banking
entities) at which the requirements of
the underwriting exemption will be
assessed. Third, the Agencies have
made important modifications to the
definition of ‘‘distribution’’ to better
capture the various types of private and
registered offerings a banking entity may
be asked to underwrite by an issuer or
selling security holder. Fourth, the
definition of ‘‘underwriter’’ has been
refined to clarify that both members of
the underwriting syndicate and selling
group members may qualify as
underwriters for purposes of this
exemption. Finally, the word ‘‘solely’’
has been removed to clarify that a
broader scope of activities conducted in
connection with underwriting (e.g.,
stabilization activities) are permitted
under this exemption. These issues are
discussed in turn below.
i. Definition of ‘‘Underwriting Position’’
In response to commenters’ concerns
about transaction-by-transaction
analyses,375 the Agencies are modifying
the near term demand requirement should not be
met). Two commenters stated that the underwriting
exemption should not permit a banking entity to
sell a security to an intermediate entity in the
course of creating a structured product. See
Occupy; Alfred Brock. These commenters were
generally responding to a question on this issue in
the proposal. See Joint Proposal, 76 FR 68,868–
68,869 (question 78); CFTC Proposal, 77 FR 8354
(question 78).
373 Final rule § ll.4(a)(2)(i). The terms
‘‘distribution’’ and ‘‘underwriter’’ are defined in
final rule § ll.4(a)(3) and § ll.4(a)(4),
respectively.
374 Proposed rule § ll.4(a)(2)(iii) required that
‘‘[t]he purchase or sale is effected solely in
connection with a distribution of securities for
which the covered banking entity is acting as
underwriter.’’
375 See, e.g., Goldman (Prop. Trading); SIFMA et
al. (Prop. Trading) (Feb. 2012).

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
the exemption to clarify the level at
which compliance with certain
provisions will be assessed. The
proposal was not intended to impose a
transaction-by-transaction approach,
and the final rule’s requirements
generally focus on the long or short
positions in one or more securities held
by a banking entity or its affiliate, and
managed by a particular trading desk, in
connection with a particular
distribution of securities for which such
banking entity or its affiliate is acting as
an underwriter. Like § ll.4(a)(2)(ii) of
the proposed rule, the definition of
‘‘underwriting position’’ is limited to
positions in securities because the
common usage and understanding of the
term ‘‘underwriting’’ is limited to
activities in securities.
A trading desk’s underwriting
position constitutes the securities
positions that are acquired in
connection with a single distribution for
which the relevant banking entity is
acting as an underwriter. A trading desk
may not aggregate securities positions
acquired in connection with two or
more distributions to determine its
‘‘underwriting position.’’ A trading desk
may, however, have more than one
‘‘underwriting position’’ at a particular
point in time if the banking entity is
acting as an underwriter for more than
one distribution. As a result, the
underwriting exemption’s requirements
pertaining to a trading desk’s
underwriting position will apply on a
distribution-by-distribution basis.
A trading desk’s underwriting
position can include positions in
securities held at different affiliated
legal entities, provided the banking
entity is able to provide supervisors or
examiners of any Agency that has
regulatory authority over the banking
entity pursuant to section 13(b)(2)(B) of
the BHC Act with records, promptly
upon request, that identify any related
positions held at an affiliated entity that
are being included in the trading desk’s
underwriting position for purposes of
the underwriting exemption. Banking
entities should be prepared to provide
all records that identify all of the
positions included in a trading desk’s
underwriting position and where such
positions are held.
The Agencies believe that a
distribution-by-distribution approach is
appropriate due to the relatively distinct
nature of underwriting activities for a
single distribution on behalf of an issuer
or selling security holder. The Agencies
do not believe that a narrower
transaction-by-transaction analysis is
necessary to determine whether a
banking entity is engaged in permitted
underwriting activities. The Agencies

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also decline to take a broader approach,
which would allow a banking entity to
aggregate positions from multiple
distributions for which it is acting as an
underwriter, because it would be more
difficult for the banking entity’s internal
compliance personnel and Agency
supervisors and examiners to review the
trading desk’s positions to assess the
desk’s compliance with the
underwriting exemption. A more
aggregated approach would increase the
number of positions in different types of
securities that could be included in the
underwriting position, which would
make it more difficult to determine that
an individual position is related to a
particular distribution of securities for
which the banking entity is acting as an
underwriter and, in turn, increase the
potential for evasion of the general
prohibition on proprietary trading.
ii. Definition of ‘‘Trading Desk’’
The proposed underwriting
exemption would have applied certain
requirements across an entire banking
entity. To promote consistency with the
market-making exemption and address
potential evasion concerns, the final
rule applies the requirements of the
underwriting exemption at the trading
desk level of organization.376 This
approach will result in the requirements
of the underwriting exemption applying
to the aggregate trading activities of a
relatively limited group of employees on
a single desk. Applying requirements at
the trading desk level should facilitate
banking entity and Agency monitoring
and review of compliance with the
exemption by limiting the location
where underwriting activity may occur
and allowing better identification of the
aggregate trading volume that must be
reviewed to determine whether the
desk’s activities are being conducted in
a manner that is consistent with the
underwriting exemption, while also
allowing adequate consideration of the
particular facts and circumstances of the
desk’s trading activities.
The trading desk should be managed
and operated as an individual unit and
should reflect the level at which the
profit and loss of employees engaged in
underwriting activities is attributed. The
term ‘‘trading desk’’ in the underwriting
context is intended to encompass what
is commonly thought of as an
underwriting desk. A trading desk
engaged in underwriting activities
would not necessarily be an active
market participant that engages in
frequent trading activities.
376 See infra Part IV.A.3.c. (discussing the final
market-making exemption).

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A trading desk may manage an
underwriting position that includes
positions held by different affiliated
legal entities.377 Similarly, a trading
desk may include employees working
on behalf of multiple affiliated legal
entities or booking trades in multiple
affiliated entities. The geographic
location of individual traders is not
dispositive for purposes of determining
whether the employees are engaged in
activities for a single trading desk.
iii. Definition of ‘‘Distribution’’
The term ‘‘distribution’’ is defined in
the final rule as: (i) An offering of
securities, whether or not subject to
registration under the Securities Act,
that is distinguished from ordinary
trading transactions by the presence of
special selling efforts and selling
methods; or (ii) an offering of securities
made pursuant to an effective
registration statement under the
Securities Act.378 In response to
comments, the proposed definition has
been revised to eliminate the need to
consider the ‘‘magnitude’’ of an offering
and instead supplements the definition
with an alternative prong for registered
offerings under the Securities Act.379
The proposed definition’s reference to
magnitude caused some commenter
concern with respect to whether it could
be interpreted to preclude a banking
entity from intermediating a small
private placement. After considering
comments, the Agencies have
determined that the requirement to have
special selling efforts and selling
methods is sufficient to distinguish
between permissible securities offerings
and prohibited proprietary trading, and
the additional magnitude factor is not
needed to further this objective.380 As
proposed, the Agencies will rely on the
same factors considered under
Regulation M to analyze the presence of
special selling efforts and selling
377 See

supra note 302 and accompanying text.
rule § ll.4(a)(3).
379 Proposed rule § ll.4(a)(3) defined
‘‘distribution’’ as ‘‘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.’’
380 The policy goals of this rule differ from those
of the SEC’s Regulation M, which is an antimanipulation rule. The focus on magnitude is
appropriate for that regulation because it helps
identify offerings that can give rise to an incentive
to condition the market for the offered security. To
the contrary, this rule is intended to allow banking
entities to continue to provide client-oriented
financial services, including underwriting services.
The SEC emphasizes that this rule does not have
any impact on Regulation M.
378 Final

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methods.381 Indicators of special selling
efforts and selling methods include
delivering a sales document (e.g., a
prospectus), conducting road shows,
and receiving compensation that is
greater than that for secondary trades
but consistent with underwriting
compensation.382 For purposes of the
final rule, each of these factors need not
be present under all circumstances.
Offerings that qualify as distributions
under this prong of the definition
include, among others, private
placements in which resales may be
made in reliance on the SEC’s Rule
144A or other available exemptions 383
and, to the extent the commercial paper
being offered is a security, commercial
paper offerings that involve the
underwriter receiving special
compensation.384
The Agencies are also adopting a
second prong to this definition, which
will independently capture all offerings
of securities that are made pursuant to
an effective registration statement under
the Securities Act.385 The registration
prong of the definition is intended to
provide another avenue by which an
offering of securities may be conducted
under the exemption, absent other
special selling efforts and selling
methods or a determination of whether
such efforts and methods are being
conducted. The Agencies believe this
prong reduces potential administrative
burdens by providing a bright-line test
for what constitutes a distribution for
purposes of the final rule. In addition,
this prong is consistent with the
purpose and goals of the statute because
it reflects a common type of securities
offering and does not raise evasion
concerns as it is unlikely that an entity
would go through the registration
process solely to facilitate or engage in
381 See Joint Proposal, 76 FR 68,867; CFTC
Proposal, 77 FR 8352.
382 See Joint Proposal, 76 FR 68,867; CFTC
Proposal, 77 FR 8352; Review of Antimanipulation
Regulation of Securities Offering, Exchange Act
Release No. 33924 (Apr. 19, 1994), 59 FR 21,681,
21,684–21,685 (Apr. 26, 1994).
383 The final rule does not provide safe harbors
for particular distribution techniques. A safe
harbor-based approach would provide certainty for
specific types of offerings, but may not account for
evolving market practices and distribution
techniques that could technically satisfy a safe
harbor but that might implicate the concerns that
led Congress to enact section 13 of the BHC Act.
See RBC.
384 This clarification is intended to address
commenters’ concern regarding potential
limitations on banking entities’ ability to facilitate
commercial paper offerings under the proposed
underwriting exemption. See supra Part
IV.A.2.c.1.b.i.
385 See, e.g., Form S–1 (17 CFR 239.11); Form S–
3 (17 CFR 239.13); Form S–8 (17 CFR 239.16b);
Form F–1 (17 CFR 239.31); Form F–3 (17 CFR
239.33).

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speculative proprietary trading.386 This
prong would include, among other
things, the following types of registered
securities offerings: Offerings made
pursuant to a shelf registration
statement (whether on a continuous or
delayed basis),387 bought deals,388 at the
market offerings,389 debt offerings, assetbacked security offerings, initial public
offerings, and other registered offerings.
An offering can be a distribution for
purposes of either § ll.4(a)(3)(i) or
§ ll.4(a)(3)(ii) of the final rule
regardless of whether the offering is
issuer driven, selling security holder
driven, or arises as a result of a reverse
inquiry.390 Provided the definition of
386 Although the Agencies are providing an
additional prong to the definition of ‘‘distribution’’
for registered offerings, the final rule does not limit
the availability of the underwriting exemption to
registered offerings, as suggested by one
commenter. The statute does not include such an
express limitation, and the Agencies decline to
construe the statute to require such an approach. In
response to the commenter stating that permitting
a banking entity to participate in a private
placement may facilitate evasion of the prohibition
on proprietary trading, the Agencies believe this
concern is addressed by the provision in the final
rule requiring that a trading desk have a reasonable
expectation of demand from other market
participants for the amount and type of securities
to be acquired from an issuer or selling security
holder for distribution and make reasonable efforts
to sell its underwriting position within a reasonable
period. As discussed below, the Agencies believe
this requirement in the final rule appropriately
addresses evasion concerns that a banking entity
may retain an unsold allotment for purely
speculative purposes. Further, the Agencies believe
that preventing a banking entity from facilitating a
private offering could unnecessarily hinder capitalraising without providing commensurate benefits
because issuers use private offerings to raise capital
in a variety of situations and the underwriting
exemption’s requirements limit the potential for
evasion for both registered and private offerings, as
noted above.
387 See Securities Offering Reform, Securities Act
Release No. 8591 (July 19, 2005), 70 FR 44,722
(Aug. 3, 2005); 17 CFR 230.405 (defining
‘‘automatic shelf registration statement’’ as a
registration statement filed on Form S–3 (17 CFR
239.13) or Form F–3 (17 CFR 239.33) by a wellknown seasoned issuer pursuant to General
Instruction I.D. or I.C. of such forms, respectively);
17 CFR 230.415.
388 A bought deal is a distribution technique
whereby an underwriter makes a bid for securities
without engaging in a preselling effort, such as book
building or distribution of a preliminary
prospectus. See, e.g., Delayed or Continuous
Offering and Sale of Securities, Securities Act
Release No. 6470 (June 9, 1983), n.5.
389 See, e.g., 17 CFR 230.415(a)(4) (defining ‘‘at
the market offering’’ as ‘‘an offering of equity
securities into an existing trading market for
outstanding shares of the same class at other than
a fixed price’’). At the market offerings may also be
referred to as ‘‘dribble out’’ programs.
390 Under the ‘‘reverse inquiry’’ process, an
investor may be allowed to purchase securities from
the issuer through an underwriter that is not
designated in the prospectus as the issuer’s agent
by having such underwriter approach the issuer
with an interest from the investor. See Joseph
McLaughlin and Charles J. Johnson, Jr., ‘‘Corporate
Finance and the Securities Laws’’ (4th ed. 2006,
supplemented 2012).

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distribution is met, an offering can be a
distribution for purposes of this rule
regardless of how it is conducted,
whether by direct communication,
exchange transactions, or automated
execution system.391
As discussed above, some
commenters expressed concern that the
proposed definition of ‘‘distribution’’
would prevent a banking entity from
acquiring and reselling securities issued
in lieu of or to refinance bridge loan
facilities in reliance on the underwriting
exemption. Bridge financing
arrangements can be structured in many
different ways, depending on the
context and the specific objectives of the
parties involved. As a result, the
treatment of securities acquired in lieu
of or to refinance a bridge loan and the
subsequent sale of such securities under
the final rule depends on the facts and
circumstances. A banking entity may
meet the terms of the underwriting
exemption for its bridge loan activity, or
it may be able to rely on the marketmaking exemption. If the banking
entity’s bridge loan activity does not
qualify for an exemption under the rule,
then it would not be permitted to engage
in such activity.
iv. Definition of ‘‘Underwriter’’
In response to comments, the
Agencies are adopting certain
modifications to the proposed definition
of ‘‘underwriter’’ to better capture
selling group members and to more
closely resemble the definition of
‘‘distribution participant’’ in Regulation
M. In particular, the Agencies are
defining ‘‘underwriter’’ as: (i) A person
who has agreed with an issuer or selling
security holder to: (A) Purchase
securities from the issuer or selling
security holder for distribution; (B)
engage in a distribution of securities for
or on behalf of the issuer or selling
security holder; or (C) manage a
distribution of securities for or on behalf
of the issuer or selling security holder;
or (ii) a person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.392
A number of commenters requested
that the Agencies broaden the
underwriting exemption to permit
activities in connection with a
distribution of securities by any
distribution participant. A few of these
commenters interpreted the proposed
definition of ‘‘underwriter’’ as requiring
a selling group member to have a
written agreement with the underwriter
391 See
392 See

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to participate in the distribution.393
These commenters noted that such a
written agreement may not exist under
all circumstances. The Agencies did not
intend to require that members of the
underwriting syndicate or the lead
underwriter have a written agreement
with all selling group members for each
offering or that they be in privity of
contract with the issuer or selling
security holder. To provide clarity on
this issue, the Agencies have modified
the language of subparagraph (ii) of the
definition to include firms that, while
not members of the underwriting
syndicate, have agreed to participate or
are participating in a distribution of
securities for or on behalf of the issuer
or selling security holder.
The final rule does not adopt a
narrower definition of ‘‘underwriter,’’ as
suggested by two commenters.394
Although selling group members do not
have a direct relationship with the
issuer or selling security holder, they do
help facilitate the successful
distribution of securities to a wider
variety of purchasers, such as regional
or retail purchasers that members of the
underwriting syndicate may not be able
to access as easily. Thus, the Agencies
believe it is consistent with the purpose
of the statutory underwriting exemption
and beneficial to recognize and allow
the current market practice of an
underwriting syndicate and selling
group members collectively facilitating
a distribution of securities. The
Agencies note that because banking
entities that are selling group members
will be underwriters under the final
rule, they will be subject to all the
requirements of the underwriting
exemption.
As provided in the preamble to the
proposed rule, engaging in the following
activities may indicate that a banking
entity is acting as an underwriter under
393 The basic documents in firm commitment
underwritten securities offerings generally are: (i)
The agreement among underwriters, which
establishes the relationship among the managing
underwriter, any co-managers, and the other
members of the underwriting syndicate; (ii) the
underwriting (or ‘‘purchase’’) agreement, in which
the underwriters commit to purchase the securities
from the issuer or selling security holder; and (iii)
the selected dealers agreement, in which selling
group members agree to certain provisions relating
to the distribution. See Joseph McLaughlin and
Charles J. Johnson, Jr., ‘‘Corporate Finance and the
Securities Laws’’ (4th ed. 2006, supplemented
2012), Ch. 2. The Agencies understand that two
firms may enter into a master agreement that
governs all offerings in which both firms participate
as members of the underwriting syndicate or as a
member of the syndicate and a selling group
member. See, e.g., SIFMA Master Selected Dealers
Agreement (June 10, 2011), available at
www.sifma.org.
394 See AFR et al. (Feb. 2012); Public Citizen.

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§ ll.4(a)(4) as part of a distribution of
securities:
• Assisting an issuer in capitalraising;
• Performing due diligence;
• Advising the issuer on market
conditions and assisting in the
preparation of a registration statement
or other offering document;
• 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.395
The Agencies continue to take the view
that the precise activities performed by
an underwriter will vary depending on
the liquidity of the securities being
underwritten and the type of
distribution being conducted. A banking
entity is not required to engage in each
of the above-noted activities to be
considered an underwriter for purposes
of this rule. In addition, the Agencies
note that, to the extent a banking entity
does not meet the definition of
‘‘underwriter’’ in the final rule, it may
be able to rely on the market-making
exemption in the final rule for its
trading activity. In response to
comments noting that APs for ETFs do
not engage in certain of these activities
and inquiring whether an AP would be
able to qualify for the underwriting
exemption for certain of its activities,
the Agencies believe that many AP
activities, such as conducting general
creations and redemptions of ETF
shares, are better suited for analysis
under the market-making exemption
because they are driven by the demands
of other market participants rather than
the issuer, the ETF.396 Whether an AP
may rely on the underwriting exemption
for its activities in an ETF will depend
on the facts and circumstances,
including, among other things, whether
the AP meets the definition of
‘‘underwriter’’ and the offering of ETF
shares qualifies as a ‘‘distribution.’’
To provide further clarity about the
scope of the definition of ‘‘underwriter,’’
the Agencies are defining the terms
‘‘selling security holder’’ and ‘‘issuer’’
in the final rule. The Agencies are using
the definition of ‘‘issuer’’ from the
Securities Act because this definition is
commonly used in the context of
securities offerings and is well
395 See Joint Proposal, 76 FR 68,867; CFTC
Proposal, 77 FR 8352. Post-issuance secondary
market activity is expected to be conducted in
accordance with the market-making exemption.
396 See infra Part IV.A.3.

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understood by market participants.397 A
‘‘selling security holder’’ is defined as
‘‘any person, other than an issuer, on
whose behalf a distribution is made.’’ 398
This definition is consistent with the
definition of ‘‘selling security holder’’
found in the SEC’s Regulation M.399
v. Activities Conducted ‘‘in Connection
With’’ a Distribution
As discussed above, several
commenters expressed concern that the
proposed underwriting exemption
would not allow a banking entity to
engage in certain auxiliary activities that
may be conducted in connection with
acting as an underwriter for a
distribution of securities in the normal
course. These commenters’ concerns
generally arose from the use of the word
‘‘solely’’ in § ll.4(a)(2)(iii) of the
proposed rule, which commenters noted
was not included in the statute’s
underwriting exemption.400 In addition,
a number of commenters discussed
particular activities they believed
should be permitted under the
underwriting exemption and indicated
the term ‘‘solely’’ created uncertainty
about whether such activities would be
permitted.401
To reduce uncertainty in response to
comments, the final rule requires a
trading desk’s underwriting position to
be ‘‘held . . . and managed . . . in
connection with’’ a single distribution
397 See final rule § ll.3(e)(9) (defining the term
‘‘issuer’’ for purposes of the proprietary trading
provisions in subpart B of the final rule). Under
section 2(a)(4) of the Securities Act, ‘‘issuer’’ is
defined as ‘‘every person who issues or proposes to
issue any security; except that with respect to
certificates of deposit, voting-trust certificates, or
collateral-trust certificates, or with respect to
certificates of interest or shares in an
unincorporated investment trust not having a board
of directors (or persons performing similar
functions) or of the fixed, restricted management, or
unit type, the term ‘issuer’ means the person or
persons performing the acts and assuming the
duties of depositor or manager pursuant to the
provisions of the trust or other agreement or
instrument under which such securities are issued;
except that in the case of an unincorporated
association which provides by its articles for
limited liability of any or all of its members, or in
the case of a trust, committee, or other legal entity,
the trustees or members thereof shall not be
individually liable as issuers of any security issued
by the association, trust, committee, or other legal
entity; except that with respect to equipment-trust
certificates or like securities, the term ‘issuer’
means the person by whom the equipment or
property is or is to be used; and except that with
respect to fractional undivided interests in oil, gas,
or other mineral rights, the term ‘issuer’ means the
owner of any such right or of any interest in such
right (whether whole or fractional) who creates
fractional interests therein for the purpose of public
offering.’’ 15 U.S.C. 77b(a)(4).
398 Final rule § ll.4(a)(5).
399 See 17 CFR 242.100(b).
400 See supra Part IV.A.2.c.1.b.iii.
401 See supra notes 357, 358, 363–372 and
accompanying text.

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for which the relevant banking entity is
acting as an underwriter, rather than
requiring that a purchase or sale be
‘‘effected solely in connection with’’
such a distribution. Importantly, for
purposes of establishing an
underwriting position in reliance on the
underwriting exemption, a trading desk
may only engage in activities that are
related to a particular distribution of
securities for which the banking entity
is acting as an underwriter. Activities
that may be permitted under the
underwriting exemption include
stabilization activities,402 syndicate
shorting and aftermarket short
covering,403 holding an unsold
allotment when market conditions may
make it impracticable to sell the entire
allotment at a reasonable price at the
time of the distribution and selling such
position when it is reasonable to do
so,404 and helping the issuer mitigate its
risk exposure arising from the
distribution of its securities (e.g.,
entering into a call-spread option with
an issuer as part of a convertible debt
offering to mitigate dilution to existing
shareholders).405 Such activities should
be intended to effectuate the
distribution process and provide
benefits to issuers, selling security
holders, or purchasers in the
distribution. Existing laws, regulations,
and self-regulatory organization rules
limit or place certain requirements
around many of these activities. For
example, an underwriter’s subsequent
402 See SIFMA et al. (Prop. Trading) (Feb. 2012).
See Anti-Manipulation Rules Concerning Securities
Offerings, Exchange Act Release No. 38067 (Dec. 20,
1996), 62 FR 520, 535 (Jan. 3, 1997) (‘‘Although
stabilization is price-influencing activity intended
to induce others to purchase the offered security,
when appropriately regulated it is an effective
mechanism for fostering an orderly distribution of
securities and promotes the interests of
shareholders, underwriters, and issuers.’’).
403 See SIFMA et al. (Prop. Trading) (Feb. 2012);
RBC; Goldman (Prop. Trading). See Proposed
Amendments to Regulation M: Anti-Manipulation
Rules Concerning Securities Offerings, Exchange
Act Release No. 50831 (Dec. 9, 2004), 69 FR 75,774,
75,780 (Dec. 17, 2004) (‘‘In the typical offering, the
syndicate agreement allows the managing
underwriter to ‘oversell’ the offering, i.e., establish
a short position beyond the number of shares to
which the underwriting commitment relates. The
underwriting agreement with the issuer often
provides for an ‘overallotment option’ whereby the
syndicate can purchase additional shares from the
issuer or selling shareholders in order to cover its
short position. To the extent that the syndicate
short position is in excess of the overallotment
option, the syndicate is said to have taken an
‘uncovered’ short position. The syndicate short
position, up to the amount of the overallotment
option, may be covered by exercising the option or
by purchasing shares in the market once secondary
trading begins.’’).
404 See SIFMA et al. (Prop. Trading) (Feb. 2012);
RBC; BoA; BDA (Feb. 2012).
405 See SIFMA et al. (Prop. Trading) (Feb. 2012);
RBC; Goldman (Prop. Trading).

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sale of an unsold allotment must
comply with applicable provisions of
the federal securities laws and the rules
thereunder. Moreover, any position
resulting from these activities must be
included in the trading desk’s
underwriting position, which is subject
to a number of restrictions in the final
rule. Specifically, as discussed in more
detail below, the trading desk must
make reasonable efforts to sell or
otherwise reduce its underwriting
position within a reasonable period,406
and each trading desk must have robust
limits on, among other things, the
amount, types, and risks of its
underwriting position and the period of
time a security may be held.407 Thus, in
general, the underwriting exemption
would not permit a trading desk, for
example, to acquire a position as part of
its stabilization activities and hold that
position for an extended period.
This approach does not mean that any
activity that is arguably connected to a
distribution of securities is permitted
under the underwriting exemption.
Certain activities noted by commenters
are not core to the underwriting
function and, thus, are not permitted
under the final underwriting exemption.
However, a banking entity may be able
to rely on another exemption for such
activities (e.g., the market-making or
hedging exemptions), if applicable. For
example, a trading desk would not be
able to use the underwriting exemption
to purchase a financial instrument from
a customer to facilitate the customer’s
ability to buy securities in the
distribution.408 Further, purchasing
another financial instrument to help
determine how to price the securities
that are subject to a distribution would
not be permitted under the underwriting
exemption.409 These two activities may
final rule § ll.4(a)(2)(ii); infra Part
IV.A.2.c.2.c. (discussing the requirement to make
reasonable efforts to sell or otherwise reduce the
underwriting position).
407 See final rule § ll.4(a)(2)(iii)(B); infra Part
IV.A.2.c.3.c. (discussing the required limits for
trading desks engaged in underwriting activity).
408 See Wells Fargo (Prop. Trading). The Agencies
do not believe this activity is consistent with
underwriting activity because it could result in an
underwriting desk holding a variety of positions
over time that are not directly related to a
distribution of securities the desk is conducting on
behalf of an issuer or selling security holder.
Further, the Agencies believe this activity may be
more appropriately analyzed under the marketmaking exemption because market makers generally
purchase or sell a financial instrument at the
request of customers and otherwise routinely stand
ready to purchase and sell a variety of related
financial instruments.
409 See id. The Agencies view this activity as
inconsistent with underwriting because
underwriters typically engage in other activities,
such as book-building and other marketing efforts,
to determine the appropriate price for a security
406 See

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be permitted under the market-making
exemption, depending on the facts and
circumstances. In response to one
commenter’s suggestion that hedging
the underwriter’s risk exposure be
permissible under this exemption, the
Agencies emphasize that hedging the
underwriter’s risk exposure is not
permitted under the underwriting
exemption.410 A banking entity must
comply with the hedging exemption for
such activity.
In response to comments about the
sale of a security to an intermediate
entity in connection with a structured
finance product,411 the Agencies have
not modified the underwriting
exemption. Underwriting is distinct
from product development. Thus,
parties must adjust activities associated
with developing structured finance
products or meet the terms of other
available exemptions. Similarly, the
accumulation of securities or other
assets in anticipation of a securitization
or resecuritization is not an activity
conducted ‘‘in connection with’’
underwriting for purposes of the
exemption.412 This activity is typically
engaged in by an issuer or sponsor of a
securitized product in that capacity,
rather than in the capacity of an
underwriter. The underwriting
exemption only permits a banking
entity’s activities when it is acting as an
underwriter.
2. Near Term Customer Demand
Requirement
a. Proposed Near Term Customer
Demand Requirement
Like the statute, § ll.4(a)(2)(v) of the
proposed rule required that the
underwriting activities of the banking
entity with respect to the covered
and these activities do not involve taking positions
that are unrelated to the securities subject to
distribution. See infra IV.A.2.c.2.
410 Although one commenter suggested that an
underwriter’s hedging activity be permitted under
the underwriting exemption, we do not believe the
requirements in the proposed hedging exemption
would be unworkable or overly burdensome in the
context of an underwriter’s hedging activity. See
Goldman (Prop. Trading). As noted above,
underwriting activity is of a relatively distinct
nature, which is substantially different from
market-making activity, which is more dynamic and
involves more frequent trading activity giving rise
to a variety of positions that may naturally hedge
the risks of certain other positions. The Agencies
believe it is appropriate to require that a trading
desk comply with the requirements of the hedging
exemption when it is hedging the risks of its
underwriting position, while allowing a trading
desk’s market making-related hedging under the
market-making exemption.
411 See ICI (Feb. 2012); AFR et al. (Feb. 2012);
Occupy; Alfred Brock.
412 A banking entity may accumulate loans in
anticipation of securitization because loans are not
financial instruments under the final rule. See
supra Part IV.A.1.c.

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
financial position be designed not to
exceed the reasonably expected near
term demands of clients, customers, or
counterparties.413
b. Comments Regarding the Proposed
Near Term Customer Demand
Requirement

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Both the statute and the proposed rule
require a banking entity’s underwriting
activity to be ‘‘designed not to exceed
the reasonably expected near term
demands of clients, customers, or
counterparties.’’ 414 Several commenters
requested that this standard be
interpreted in a flexible manner to allow
a banking entity to participate in an
offering that may require it to retain an
unsold allotment for a period of time.415
In addition, one commenter stated that
the final rule should provide flexibility
in this standard by recognizing that the
concept of ‘‘near term’’ differs between
asset classes and depends on the
liquidity of the market.416 Two
commenters expressed views on how
the near term customer demand
requirement should work in the context
of a securitization or creating what the
commenters characterized as
‘‘structured products’’ or ‘‘structured
instruments.’’ 417
Many commenters expressed concern
that the proposed requirement, if
narrowly interpreted, could prevent an
underwriter from holding a residual
position for which there is no
immediate demand from clients,
customers, or counterparties.418
Commenters noted that there are a
variety of offerings that present some
risk of an underwriter having to hold a
residual position that cannot be sold in
the initial distribution, including

413 See proposed rule § ll.4(a)(2)(v); Joint
Proposal, 76 FR 68,867; CFTC Proposal, 77 FR 8353.
414 See supra Part IV.A.2.c.2.a.
415 See SIFMA et al. (Prop. Trading) (Feb. 2012);
BoA; BDA (Feb. 2012); RBC. Another commenter
requested that this requirement be eliminated or
changed to ‘‘underwriting activities of the banking
entity with respect to the covered financial position
must be designed to meet the near-term demands
of clients, customers, or counterparties.’’ See
Japanese Bankers Ass’n.
416 See RBC (stating that the Board has found
acceptable the retention of assets acquired in
connection with underwriting activities for a period
of 90 to 180 days and has further permitted holding
periods of up to a year in certain circumstances,
such as for less liquid securities).
417 See AFR et al. (Feb. 2012); Sens. Merkley &
Levin (Feb. 2012).
418 See SIFMA et al. (Prop. Trading) (Feb. 2012);
BoA; BDA (Feb. 2012); RBC.

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‘‘bought deals,’’ 419 rights offerings,420
and fixed-income offerings.421 A few
commenters noted that similar scenarios
can arise in the case of an AP creating
more shares of an ETF than it can
sell 422 and bridge loans.423 Two
commenters indicated that if the rule
does not provide greater clarity and
flexibility with respect to the near term
customer demand requirement, a
banking entity may be less inclined to
participate in a distribution where there
is the potential risk of an unsold
allotment, may price such risk into the
fees charged to underwriting clients, or
may be forced into a ‘‘fire sale’’ of the
unsold allotment.424
Several other commenters provided
views on whether a banking entity
should be able to hold a residual
position from an offering pursuant to
the underwriting exemption, although
they did not generally link their
comments to the proposed near term
demand requirement.425 Many of these
commenters expressed concern about
permitting a banking entity to retain a
portion of an underwriting and noted
potential risks that may arise from such
419 See SIFMA et al. (Prop. Trading) (Feb. 2012);
BoA; RBC. These commenters generally stated that
an underwriter for a ‘‘bought deal’’ may end up
with an unsold allotment because, pursuant to this
type of offering, an underwriter makes a
commitment to purchase securities from an issuer
or selling security holder, without pre-commitment
marketing to gauge customer interest, in order to
provide greater speed and certainty of execution.
See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC.
420 See SIFMA et al. (Prop. Trading) (Feb. 2012)
(representing that because an underwriter generally
backstops a rights offering by committing to
exercise any rights not exercised by shareholders,
the underwriter may end up holding a residual
portion of the offering if investors do not exercise
all of the rights).
421 See BDA (Feb. 2012). This commenter stated
that underwriters frequently underwrite bonds in
the fixed-income market knowing that they may
need to retain unsold allotments in their inventory.
The commenter indicated that this scenario arises
because the fixed-income market is not as deep as
other markets, so underwriters frequently cannot
sell bonds when they go to market; instead, the
underwriters will retain the bonds until a sufficient
amount of liquidity is available in the market. See
id.
422 See SIFMA et al. (Prop. Trading) (Feb. 2012);
BoA.
423 See BoA; RBC; LSTA (Feb. 2012). One of these
commenters stated that, in the case of securities
issued in lieu of or to refinance bridge loan
facilities, market conditions or investor demand
may change during the period of time between
extension of the bridge commitment and when the
bridge loan is required to be funded or such
securities are required to be issued. As a result, this
commenter requested that the near term demands
of clients, customers, or counterparties be measured
at the time of the initial extension of the bridge
commitment. See LSTA (Feb. 2012).
424 See SIFMA et al. (Prop. Trading) (Feb. 2012);
RBC.
425 See AFR et al. (Feb. 2012); CalPERS; Occupy;
Public Citizen; Goldman (Prop. Trading); Fidelity;
Japanese Bankers Ass’n.; Sens. Merkley & Levin
(Feb. 2012); Alfred Brock.

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5569

activity.426 For example, some of these
commenters stated that retention or
warehousing of underwritten securities
can be an indication of impermissible
proprietary trading intent (particularly if
systematic), or may otherwise result in
high-risk exposures or conflicts of
interests.427 One of these commenters
recommended the Agencies use a metric
to monitor the size of residual positions
retained by an underwriter,428 while
another commenter suggested adding a
requirement to the proposed exemption
to provide that a ‘‘substantial’’ unsold or
retained allotment would be an
indication of prohibited proprietary
trading.429 Similarly, one commenter
recommended that the Agencies
consider whether there are sufficient
provisions in the proposed rule to
reduce the risks posed by banking
entities retaining or warehousing
underwritten instruments, such as
subprime mortgages, collateralized debt
obligation tranches, and high yield debt
of leveraged buyout issuers, which
poses heightened financial risk at the
top of economic cycles.430
Other commenters indicated that
undue restrictions on an underwriter’s
ability to retain a portion of an offering
may result in certain harms to the
capital-raising process. These
commenters represented that unclear or
negative treatment of residual positions
will make banking entities averse to the
risk of an unsold allotment, which may
result in banking entities underwriting
smaller offerings, less capital generation
for issuers, or higher underwriting
discounts, which would increase the
cost of raising capital for businesses.431
One of these commenters suggested that
a banking entity be permitted to hold a
residual position under the
underwriting exemption as long as it
continues to take reasonable steps to
attempt to dispose of the residual
position in light of existing market
conditions.432
In addition, in response to a question
in the proposal, one commenter
426 See AFR et al. (Feb. 2012); CalPERS; Occupy;
Public Citizen; Alfred Brock.
427 See AFR et al. (Feb. 2012) (recognizing,
however, that a small portion of an underwriting
may occasionally be ‘‘hung’’); CalPERS; Occupy
(stating that a banking entity’s retention of unsold
allotments may result in potential conflicts of
interest).
428 See AFR et al. (Feb. 2012).
429 See Occupy (stating that the meaning of the
term ‘‘substantial’’ would depend on the
circumstances of the particular offering).
430 See CalPERS.
431 See Goldman (Prop. Trading); Fidelity
(expressing concern that this may result in a more
concentrated supply of securities and, thus,
decrease the opportunity for diversification in the
portfolios of shareholders’ funds).
432 See Goldman (Prop. Trading).

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expressed the view that the rule should
not require documentation with respect
to residual positions held by an
underwriter.433 In the case of
securitizations, one commenter stated
that if the underwriter wishes to retain
some of the securities or bonds in its
longer-term investment book, such
decisions should be made by a separate
officer, subject to different standards
and compensation.434
Two commenters discussed how the
near term customer demand
requirement should apply in the context
of a banking entity acting as an
underwriter for a securitization or
structured product.435 One of these
commenters indicated that the near term
demand requirement should be
interpreted to require that a distribution
of securities facilitate pre-existing client
demand. This commenter stated that a
banking entity should not be considered
to meet the terms of the proposed
requirement if, on the firm’s own
initiative, it designs and structures a
complex, novel instrument and then
seeks customers for the instrument,
while retaining part of the issuance on
its own book. The commenter further
emphasized that underwriting should
involve two-way demand—clients who
want assistance in marketing their
securities and customers who may wish
to purchase the securities—with the
banking entity serving as an
intermediary.436 Another commenter
indicated that an underwriting should
likely be seen as a distribution of all, or
nearly all, of the securities related to a
securitization (excluding any amount
required for credit risk retention
purposes) along a time line designed not
to exceed reasonably expected near term
demands of clients, customers, or
counterparties. According to the
commenter, this approach would serve
to minimize the arbitrage and risk
concentration possibilities that can arise
through the securitization and sale of
some tranches and the retention of other
tranches.437
One commenter expressed concern
that the proposed near term customer
demand requirement may impact a
banking entity’s ability to act as primary
dealer because some primary dealers are
obligated to bid on each issuance of a
government’s sovereign debt, without
regard to expected customer demand.438
Two other commenters expressed
433 See

Japanese Bankers Ass’n.
Sens. Merkley & Levin (Feb. 2012).
435 See AFR et al. (Feb. 2012); Sens. Merkley &
Levin (Feb. 2012).
436 See AFR et al. (Feb. 2012)
437 See Sens. Merkley & Levin (Feb. 2012).
438 See Banco de Me
´ xico.
434 See

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general concern that the proposed
underwriting exemption may be too
narrow to permit banking entities that
act as primary dealers in or for foreign
jurisdictions to continue to meet the
relevant jurisdiction’s primary dealer
requirements.439
c. Final Near Term Customer Demand
Requirement
The final rule requires that the
amount and types of the securities in
the trading desk’s underwriting position
be designed not to exceed the
reasonably expected near term demands
of clients, customers, or counterparties,
and reasonable efforts be made to sell or
otherwise reduce the underwriting
position within a reasonable period,
taking into account the liquidity,
maturity, and depth of the market for
the relevant type of security.440 As
noted above, the near term demand
standard originates from section
13(d)(1)(B) of the BHC Act, and a similar
requirement was included in the
proposed rule.441 The Agencies are
making certain modifications to the
proposed approach in response to
comments.
In particular, the Agencies are
clarifying the operation of this
requirement, particularly with respect to
unsold allotments.442 Under this
requirement, a trading desk must have
a reasonable expectation of demand
from other market participants for the
amount and type of securities to be
acquired from an issuer or selling
security holder for distribution.443 Such
439 See SIFMA et al. (Prop. Trading) (Feb. 2012);
IIB/EBF. One of these commenters represented that
many banking entities serve as primary dealers in
jurisdictions in which they operate, and primary
dealers often: (i) Are subject to minimum purchase
and other obligations in the jurisdiction’s foreign
sovereign debt; (ii) play important roles in
underwriting and market making in State,
provincial, and municipal debt issuances; and (iii)
act as intermediaries through which a government’s
financial and monetary policies operate. This
commenter stated that, due to these considerations,
restrictions on the ability of banking entities to act
as primary dealer are likely to harm the
governments they serve. See IIB/EBF.
440 Final rule § ll.4(a)(2)(ii).
441 The proposed rule required the underwriting
activities of the banking entity with respect to the
covered financial position to be designed not to
exceed the reasonably expected near term demands
of clients, customers, or counterparties. See
proposed rule § ll.4(a)(2)(v).
442 See supra Part IV.A.2.c.2.b. (discussing
commenters’ concerns that the proposed near term
customer demand requirement may limit a banking
entity’s ability to retain an unsold allotment).
443 A banking entity may not structure a complex
instrument on its own initiative using the
underwriting exemption. It may use the
underwriting exemption only with respect to
distributions of securities that comply with the final
rule. The Agencies believe this requirement
addresses one commenter’s concern that a banking
entity could rely on the underwriting exemption

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reasonable expectation may be based on
factors such as current market
conditions and prior experience with
similar offerings of securities. A banking
entity is not required to engage in bookbuilding or similar marketing efforts to
determine investor demand for the
securities pursuant to this requirement,
although such efforts may form the basis
for the trading desk’s reasonable
expectation of demand. While an issuer
or selling security holder can be
considered to be a client, customer, or
counterparty of a banking entity acting
as an underwriter for its distribution of
securities, this requirement cannot be
met by accounting solely for the issuer’s
or selling security holder’s desire to sell
the securities.444 However, the
expectation of demand does not require
a belief that the securities will be placed
immediately. The time it takes to carry
out a distribution may differ based on
the liquidity, maturity, and depth of the
market for the type of security.445
without regard to anticipated customer demand.
See AFR et al. (Feb. 2012) In addition, a trading
desk hedging the risks of an underwriting position
in a complex, novel instrument must comply with
the hedging exemption in the final rule.
444 An issuer or selling security holder for
purposes of this rule may include, among others,
corporate issuers, sovereign issuers for which the
banking entity acts as primary dealer (or functional
equivalent), or any other person that is an issuer,
as defined in final rule § ll.3(e)(9), or a selling
security holder, as defined in final rule § ll
.4(a)(5). The Agencies believe that the underwriting
exemption in the final rule should generally allow
a primary dealer (or functional equivalent) to act as
an underwriter for a sovereign government’s
issuance of its debt because, similar to other
underwriting activities, this involves a banking
entity agreeing to distribute securities for an issuer
(in this case, the foreign sovereign) and engaging in
a distribution of such securities. See SIFMA et al.
(Prop. Trading) (Feb. 2012); IIB/EBF; Banco de
Me´xico. A banking entity acting as primary dealer
(or functional equivalent) may also be able to rely
on the market-making exemption or other
exemptions for some of its activities. See infra Part
IV.A.3.c.2.c. The final rule defines ‘‘client,
customer, or counterparty’’ for purposes of the
underwriting exemption as ‘‘market participants
that may transact with the banking entity in
connection with a particular distribution for which
the banking entity is acting as underwriter.’’ Final
rule § ll.4(a)(7).
445 One commenter stated that, in the case of a
securitization, an underwriting should be seen as a
distribution of all, or nearly all, of the securities
related to a securitization (excluding the amount
required for credit risk retention purposes) along a
time line designed not to exceed the reasonably
expected near term demands of clients, customers,
or counterparties. See Sens. Merkley & Levin (Feb.
2012). The final rule’s near term customer demand
requirement considers the liquidity, maturity, and
depth of the market for the type of security and
recognizes that the amount of time a trading desk
may need to hold an underwriting position may
vary based on these factors. The final rule does not,
however, adopt a standard that applies differently
based solely on the particular type of security being
distributed (e.g., an asset-backed security versus an
equity security) or that precludes certain types of
securities from being distributed by a banking entity
acting as an underwriter in accordance with the

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This requirement is not intended to
prevent a trading desk from distributing
an offering over a reasonable time
consistent with market conditions or
from retaining an unsold allotment of
the securities acquired from an issuer or
selling security holder where holding
such securities is necessary due to
circumstances such as less-thanexpected purchaser demand at a given
price.446 An unsold allotment is,
however, subject to the requirement to
make reasonable efforts to sell or
otherwise reduce the underwriting
position.447 The definition of
requirements of this exemption because the
Agencies believe the statute is best read to permit
a banking entity to engage in underwriting activity
to facilitate distributions of securities by issuers and
selling security holders, regardless of type, to
provide client-oriented financial services. That
reading is consistent with the statute’s language and
finds support in the legislative history. See 156
Cong. Rec. S5895–S5896 (daily ed. July 15, 2010)
(statement of Sen. Merkley) (stating that the
underwriting exemption permits ‘‘transactions that
are technically trading for the account of the firm
but, in fact, facilitate the provision of near-term
client-oriented financial services’’). In addition,
with respect to this commenter’s statement
regarding credit risk retention requirements, the
Agencies note that compliance with the credit risk
retention requirements of Section 15G of the
Exchange Act would not impact the availability of
the underwriting exemption in the final rule.
446 This approach should help address
commenters’ concerns that an inflexible
interpretation of the near term demand requirement
could result in fire sales, higher fees for
underwriting services, or reluctance to act as an
underwriter for certain types of distributions that
present a greater risk of unsold allotments. See
SIFMA et al. (Prop. Trading) (Feb. 2012); RBC.
Further, the Agencies believe this should reduce
commenters’ concerns that, to the extent a delayed
distribution of securities, which are acquired as a
result of an outstanding bridge loan, is able to
qualify for the underwriting exemption, a stringent
interpretation of the near term demand requirement
could prevent a banking entity from retaining such
securities if market conditions are suboptimal or
marketing efforts are not entirely successful. See
RBC; BoA; LSTA (Feb. 2012). In response to one
commenter’s request that the Agencies allow a
banking entity to assess near term demand at the
time of the initial extension of the bridge
commitment, the Agencies believe it could be
appropriate to determine whether the banking
entity has a reasonable expectation of demand from
other market participants for the amount and type
of securities to be acquired at that time, but note
that the trading desk would continue to be subject
to the requirement to make reasonable efforts to sell
the resulting underwriting position at the time of
the initial distribution and for the remaining time
the securities are in its inventory. See LSTA (Feb.
2012).
447 The Agencies believe that requiring a trading
desk to make reasonable efforts to sell or otherwise
reduce its underwriting position addresses
commenters’ concerns about the risks associated
with unsold allotments or the retention of
underwritten instruments because this requirement
is designed to prevent a trading desk from retaining
an unsold allotment for speculative purposes when
there is customer buying interest for the relevant
security at commercially reasonable prices. Thus,
the Agencies believe this obviates the need for
certain additional requirements suggested by
commenters. See, e.g., Occupy; AFR et al. (Feb.

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‘‘underwriting position’’ includes,
among other things, any residual
position from the distribution that is
managed by the trading desk. The final
rule includes the requirement to make
reasonable efforts to sell or otherwise
reduce the trading desk’s underwriting
position in order to respond to
comments on the issue of when a
banking entity may retain an unsold
allotment when it is acting as an
underwriter, as discussed in more detail
below, and ensure that the exemption is
available only for activities that involve
underwriting activities, and not
prohibited proprietary trading.448
As a general matter, commenters
expressed differing views on whether an
underwriter should be permitted to hold
an unsold allotment for a certain period
of time after the initial distribution. For
example, a few commenters suggested
that limitations on retaining an unsold
allotment would increase the cost of
raising capital 449 or would negatively
impact certain types of securities
offerings (e.g., bought deals, rights
offerings, and fixed-income
offerings).450 Other commenters,
however, expressed concern that the
2012); CalPERS. The final rule strikes an
appropriate balance between the concerns raised by
these commenters and those noted by other
commenters regarding the potential market impacts
of strict requirements against holding an unsold
allotment, such as higher fees to underwriting
clients, fire sales of unsold allotments, or general
reluctance to participate in any distribution that
presents a risk of an unsold allotment. The
requirement to make reasonable efforts to sell or
otherwise reduce the underwriting position should
not cause the market impacts predicted by these
commenters because it does not prevent an
underwriter from retaining an unsold allotment for
a reasonable period or impose strict holding period
limits on unsold allotments. See SIFMA et al. (Prop.
Trading) (Feb. 2012); RBC; Goldman (Prop.
Trading); Fidelity.
448 This approach is generally consistent with one
commenter’s suggested approach to addressing the
issue of unsold allotments. See, e.g., Goldman
(Prop. Trading) (suggesting that a banking entity be
permitted to hold a residual position under the
underwriting exemption as long as it continues to
take reasonable steps to attempt to dispose of the
residual position in light of existing market
conditions). In addition, allowing an underwriter to
retain an unsold allotment under certain
circumstances is consistent with the proposal. See
Joint Proposal, 76 FR 68,867 (‘‘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.’’); CFTC Proposal, 77 FR 8352. A
number of commenters raised questions about
whether the rule would permit retaining an unsold
allotment. See Goldman (Prop. Trading); Fidelity;
SIFMA et al. (Prop. Trading) (Feb. 2012); BoA; RBC;
AFR et al. (Feb. 2012); CalPERS; Occupy; Public
Citizen; Alfred Brock.
449 See Goldman (Prop. Trading); Fidelity.
450 See SIFMA et al. (Prop. Trading) (Feb. 2012);
BoA; RBC.

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proposed exemption would allow a
banking entity to retain a portion of a
distribution for speculative purposes.451
The Agencies believe the requirement
to make reasonable efforts to sell or
otherwise reduce the underwriting
position appropriately addresses both
sets of comments. More specifically, this
standard clarifies that an underwriter
generally may retain an unsold
allotment that it was unable to sell to
purchasers as part of the initial
distribution of securities, provided it
had a reasonable expectation of buying
interest and engaged in reasonable
selling efforts.452 This should reduce the
potential for the negative impacts of a
more stringent approach predicted by
commenters, such as increased fees for
underwriting, greater costs to businesses
for raising capital, and potential fire
sales of unsold allotments.453 However,
to address concerns that a banking
entity may retain an unsold allotment
for purely speculative purposes, the
Agencies are requiring that reasonable
efforts be made to sell or otherwise
reduce the underwriting position, which
includes any unsold allotment, within a
reasonable period. The Agencies agree
with these commenters that systematic
retention of an underwriting position,
without engaging in efforts to sell the
position and without regard to whether
the trading desk is able to sell the
securities at a commercially reasonable
price, would be indicative of
impermissible proprietary trading
intent.454 The Agencies recognize that
the meaning of ‘‘reasonable period’’ may
differ based on the liquidity, maturity,
and depth of the market for the relevant
type of securities. For example, an
underwriter may be more likely to retain
an unsold allotment in a bond offering
because liquidity in the fixed-income
market is generally not as deep as that
in the equity market. If a trading desk
retains an underwriting position for a
period of time after the distribution, the
trading desk must manage the risk of its
underwriting position in accordance
with its inventory and risk limits and
authorization procedures. As discussed
above, hedging transactions undertaken
in connection with such risk
management activities must be
conducted in compliance with the
451 See AFR et al. (Feb. 2012); CalPERS; Occupy;
Public Citizen; Alfred Brock.
452 To the extent that an AP for an ETF is able
to meet the terms of the underwriting exemption for
its activity, it may be able to retain ETF shares that
it created if it had a reasonable expectation of
buying interest in the ETF shares and engages in
reasonable efforts to sell the ETF shares. See SIFMA
et al. (Prop. Trading) (Feb. 2012); BoA.
453 See Goldman (Prop. Trading); Fidelity; SIFMA
et al. (Prop. Trading) (Feb. 2012); RBC.
454 See AFR et al. (Feb. 2012); CalPERS; Occupy.

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hedging exemption in § ll.5 of the
final rule.
The Agencies emphasize that the
requirement to make reasonable efforts
to sell or otherwise reduce the
underwriting position applies to the
entirety of the trading desk’s
underwriting position. As a result, this
requirement applies to a number of
different scenarios in which an
underwriter may hold a long or short
position in the securities that are the
subject of a distribution for a period of
time. For example, if an underwriter is
facilitating a distribution of securities
for which there is sufficient investor
demand to purchase the securities at the
offering price, this requirement would
prevent the underwriter from retaining
a portion of the allotment for its own
account instead of selling the securities
to interested investors. If instead there
was insufficient investor demand at the
time of the initial offering, this
requirement would recognize that it
may be appropriate for the underwriter
to hold an unsold allotment for a
reasonable period of time. Under these
circumstances, the underwriter would
need to make reasonable efforts to sell
the unsold allotment when there is
sufficient market demand for the
securities.455 This requirement would
also apply in situations where the
underwriters sell securities in excess of
the number of securities to which the
underwriting commitment relates,
resulting in a syndicate short position in
the same class of securities that were the
subject of the distribution.456 This
provision of the final exemption would
require reasonable efforts to reduce any
portion of the syndicate short position
attributable to the banking entity that is
acting as an underwriter. Such
reduction could be accomplished if, for
example, the managing underwriter
exercises an overallotment option or
shares are purchased in the secondary
market to cover the short position.
The near term demand requirement,
including the requirement to make
reasonable efforts to reduce the
underwriting position, represents a new
regulatory requirement for banking
entities engaged in underwriting. At the
margins, this requirement could alter
the participation decision for some
banking entities with respect to certain
types of distributions, such as
distributions that are more likely to
result in the banking entity retaining an
underwriting position for a period of
455 The trading desk’s retention and sale of the
unsold allotment must comply with the federal
securities laws and regulations, but is otherwise
permitted under the underwriting exemption.
456 See supra note 403.

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time.457 However, the Agencies
recognize that liquidity, maturity, and
depth of the market vary across types of
securities, and the Agencies expect that
the express recognition of these
differences in the rule should help
mitigate any incentive to exit the
underwriting business for certain types
of securities or types of distributions.
3. Compliance Program Requirement
a. Proposed Compliance Program
Requirement
Section ll.4(a)(2)(i) of the proposed
exemption required a banking entity to
establish an internal compliance
program, as required by § ll.20 of the
proposed rule, that is designed to ensure
the banking entity’s compliance with
the requirements of the underwriting
exemption, including reasonably
designed written policies and
procedures, internal controls, and
independent testing.458 This
requirement was proposed so that any
banking entity relying on the
underwriting exemption would have
reasonably designed written policies
and procedures, internal controls, and
independent testing in place to support
its compliance with the terms of the
exemption.459
b. Comments on the Proposed
Compliance Program Requirement
Commenters did not directly address
the proposed compliance program
requirement in the underwriting
exemption. Comments on the proposed
compliance program requirement of
§ ll.20 of the proposed rule are
discussed in Part IV.C., below.
c. Final Compliance Program
Requirement
The final rule includes a compliance
program requirement that is similar to
the proposed requirement, but the
Agencies are making certain
enhancements to emphasize the
importance of a strong internal
compliance program. More specifically,
the final rule requires that a banking
entity’s compliance program specifically
include reasonably designed written
policies and procedures, internal
457 For example, some commenters suggested that
the proposed underwriting exemption could have a
chilling effect on banking entities’ willingness to
engage in underwriting activities. See, e.g., Lord
Abbett; Fidelity. Further, some commenters
expressed concern that the proposed near term
customer demand requirement might negatively
impact certain forms of capital-raising if the
requirement is interpreted narrowly or inflexibly.
See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA;
BDA (Feb. 2012); RBC.
458 See proposed rule § ll.4(a)(2)(i).
459 See Joint Proposal, 76 FR 68,866; CFTC
Proposal, 77 FR 8352.

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controls, analysis and independent
testing 460 identifying and addressing: (i)
The products, instruments or exposures
each trading desk may purchase, sell, or
manage as part of its underwriting
activities; 461 (ii) limits for each trading
desk, based on the nature and amount
of the trading desk’s underwriting
activities, including the reasonably
expected near term demands of clients,
customers, or counterparties; 462 (iii)
internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; 463
and (iv) authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed one or more of
a trading desk’s limits, demonstrable
analysis of the basis for any temporary
or permanent increase to one or more of
a trading desk’s limits, and independent
review (i.e., by risk managers and
compliance officers at the appropriate
level independent of the trading desk) of
such demonstrable analysis and
approval.464
As noted above, the proposed
compliance program requirement did
not include the four specific elements
listed above in the proposed
underwriting exemption, although each
of these provisions was included in
some form in the detailed compliance
program requirement under Appendix C
of the proposed rule.465 The Agencies
are moving these particular
requirements, with certain
enhancements, into the underwriting
exemption because the Agencies believe
these are core elements of a program to
ensure compliance with the
underwriting exemption. These
compliance procedures must be
established, implemented, maintained,
and enforced for each trading desk
engaged in underwriting activity under
§ ll.4(a) of the final rule. Each of the
460 The independent testing standard is discussed
in more detail in Part IV.C., which discusses the
compliance program requirement in § ll.20 of the
final rule.
461 See final rule § ll.4(a)(2)(iii)(A).
462 See final rule § ll.4(a)(2)(iii)(B). A trading
desk must have limits on the amount, types, and
risk of the securities in its underwriting position,
level of exposures to relevant risk factors arising
from its underwriting position, and period of time
a security may be held. See id.
463 See final rule § ll.4(a)(2)(iii)(C).
464 See final rule § ll.4(a)(2)(iii)(D).
465 See Joint Proposal, 76 FR 68,963–68,967
(requiring certain banking entities to establish,
maintain, and enforce compliance programs with,
among other things: (i) Written policies and
procedures that describe a trading unit’s authorized
instruments and products; (ii) internal controls for
each trading unit, including risk limits for each
trading unit and surveillance procedures; and (iii)
a management framework, including management
procedures for overseeing compliance with the
proposed rule).

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requirements in paragraphs (a)(2)(iii)(A)
through (D) must be appropriately
tailored to the individual trading
activities and strategies of each trading
desk.
The compliance program requirement
in the underwriting exemption is
substantially similar to the compliance
program requirement in the marketmaking exemption, except that the
Agencies are requiring more detailed
risk management procedures in the
market-making exemption due to the
nature of that activity.466 The Agencies
believe including similar compliance
program requirements in the
underwriting and market-making
exemptions may reduce burdens
associated with building and
maintaining compliance programs for
each trading desk.
Identifying in the compliance
program the relevant products,
instruments, and exposures in which a
trading desk is permitted to trade will
facilitate monitoring and oversight of
compliance with the underwriting
exemption. For example, this
requirement should prevent an
individual trader on an underwriting
desk from establishing positions in
instruments that are unrelated to the
desk’s underwriting function. Further,
the identification of permissible
products, instruments, and exposures
will help form the basis for the specific
types of position and risk limits that the
banking entity must establish and is
relevant to considerations throughout
the exemption regarding the liquidity,
maturity, and depth of the market for
the relevant type of security.
A trading desk must have limits on
the amount, types, and risk of the
securities in its underwriting position,
level of exposures to relevant risk
factors arising from its underwriting
position, and period of time a security
may be held. Limits established under
this provision, and any modifications to
these limits made through the required
escalation procedures, must account for
the nature and amount of the trading
desk’s underwriting activities, including
the reasonably expected near term
demands of clients, customers, or
counterparties. Among other things,
these limits should be designed to
prevent a trading desk from
systematically retaining unsold
allotments even when there is customer
demand for the positions that remain in
the trading desk’s inventory. The
Agencies recognize that trading desks’
limits may differ across types of
securities and acknowledge that trading
466 See final rule §§ ll.4(a)(2)(iii),
ll.4(b)(2)(iii).

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desks engaged in underwriting activities
in less liquid securities, such as
corporate bonds, may require different
inventory, risk exposure, and holding
period limits than trading desks engaged
in underwriting activities in more liquid
securities, such as certain equity
securities. A trading desk hedging the
risks of an underwriting position must
comply with the hedging exemption,
which provides for compliance
procedures regarding risk
management.467
Furthermore, a banking entity must
establish internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits,
including the frequency, nature, and
extent of a trading desk exceeding its
limits.468 This may include the use of
management and exception reports.
Moreover, the compliance program must
set forth a process for determining the
circumstances under which a trading
desk’s limits may be modified on a
temporary or permanent basis (e.g., due
to market changes).
As noted above, a banking entity’s
compliance program for trading desks
engaged in underwriting activity must
also include escalation procedures that
require review and approval of any
trade that would exceed one or more of
a trading desk’s limits, demonstrable
analysis that the basis for any temporary
or permanent increase to one or more of
a trading desk’s limits is consistent with
the near term customer demand
requirement, and independent review of
such demonstrable analysis and
approval.469 Thus, to increase a limit of
a trading desk, there must be an analysis
of why such increase would be
appropriate based on the reasonably
expected near term demands of clients,
customers, or counterparties, which
must be independently reviewed. A
banking entity also must maintain
documentation and records with respect
to these elements, consistent with the
requirement of § ll.20(b)(6).
As discussed in more detail in Part
IV.C., the Agencies recognize that the
compliance program requirements in
the final rule will impose certain costs
on banking entities but, on balance, the
Agencies believe such requirements are
necessary to facilitate compliance with
the statute and the final rule and to
reduce the risk of evasion.470
final rule § ll.5.
final rule § ll.4(a)(2)(iii)(C).
469 See final rule § ll.4(a)(2)(iii)(D).
470 See Part IV.C. (discussing the compliance
program requirement in § ll.20 of the final rule).
467 See
468 See

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4. Compensation Requirement
a. Proposed Compensation Requirement
Another provision of the proposed
underwriting exemption required that
the compensation arrangements of
persons performing underwriting
activities at the banking entity must be
designed not to encourage proprietary
risk-taking.471 In connection with this
requirement, the proposal clarified that
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 risk-taking.472
b. Comments on the Proposed
Compensation Requirement
A few commenters expressed general
support for the proposed requirement,
but suggested certain modifications that
they believed would enhance the
requirement and make it more
effective.473 Specifically, one
commenter suggested tailoring the
requirement to underwriting activity by,
for example, ensuring that personnel
involved in underwriting are given
compensation incentives for the
successful distribution of securities off
the firm’s balance sheet and are not
rewarded for profits associated with
securities that are not successfully
distributed (although losses from such
positions should be taken into
consideration in determining the
employee’s compensation). This
commenter further recommended that
bonus compensation for a deal be
withheld until all or a high percentage
of the relevant securities are
distributed.474 Finally, one commenter
suggested that the term ‘‘designed’’
should be removed from this
provision.475
c. Final Compensation Requirement
Similar to the proposed rule, the
underwriting exemption in the final rule
requires that the compensation
arrangements of persons performing the
banking entity’s underwriting activities,
as described in the exemption, be
471 See proposed rule § ll.4(a)(2)(vii); Joint
Proposal, 76 FR 68,868; CFTC Proposal, 77 FR 8353.
472 See id.
473 See Occupy; AFR et al. (Feb. 2012); Better
Markets (Feb. 2012).
474 See AFR et al. (Feb. 2012).
475 See Occupy.

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designed not to reward or incentivize
prohibited proprietary trading.476 The
Agencies do not intend to preclude an
employee of an underwriting desk from
being compensated for successful
underwriting, which involves some risktaking.
Consistent with the proposal,
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 by the banking
entity are inconsistent with the
underwriting exemption. A banking
entity may, however, 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 services,
not prohibited proprietary trading. For
example, a compensation plan based
purely on net profit and loss with no
consideration for inventory control or
risk undertaken to achieve those profits
would not be consistent with the
underwriting exemption.
The Agencies are not adopting an
approach that prevents an employee
from receiving any compensation
related to profits arising from an unsold
allotment, as suggested by one
commenter, because the Agencies
believe the final rule already includes
sufficient controls to prevent a trading
desk from intentionally retaining an
unsold allotment to make a speculative
profit when such allotment could be
sold to customers.477 The Agencies also
are not requiring compensation to be
vested for a period of time, as
recommended by one commenter to
reduce traders’ incentives for undue
risk-taking. The Agencies believe the
final rule includes sufficient controls
around risk-taking activity without a
compensation vesting requirement
because a banking entity must establish
limits for a trading desk’s underwriting
position and the trading desk must
make reasonable efforts to sell or
otherwise reduce the underwriting
position within a reasonable period.478
The Agencies continue to believe it is
476 See final rule § ll.4(a)(2)(iv); proposed rule
§ ll.4(a)(2)(vii). This is consistent with the final
compensation requirements in the market-making
and hedging exemptions. See final rule § ll
.4(b)(2)(v); final rule § ll.5(b)(3).
477 See AFR et al. (Feb. 2012); supra Part
IV.A.2.c.2.c. (discussing the requirement to make
reasonable efforts to sell or otherwise reduce the
underwriting position).
478 See AFR et al. (Feb. 2012).

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appropriate to focus on the design of a
banking entity’s compensation
structure, so the Agencies are not
removing the term ‘‘designed’’ from this
provision.479 This retains an objective
focus on actions that the banking entity
can control—the design of its incentive
compensation program—and avoids a
subjective focus on whether an
employee feels incentivized by
compensation, which may be more
difficult to assess. In addition, the
framework of the final compensation
requirement will allow banking entities
to better plan and control the design of
their compensation arrangements,
which should reduce costs and
uncertainty and enhance monitoring,
than an approach focused solely on
individual outcomes.
5. Registration Requirement
a. Proposed Registration Requirement
Section ll.4(a)(2)(iv) of the
proposed rule would have required that
a banking entity have the appropriate
dealer registration or be exempt from
registration or excluded from regulation
as a dealer to the extent that, in order
to underwrite the security at issue, a
person must generally be a registered
securities dealer, municipal securities
dealer, or government securities
dealer.480 Further, if the banking entity
was engaged in the business of a dealer
outside the United States in a manner
for which no U.S. registration is
required, the proposed rule would have
required the banking entity to be subject
to substantive regulation of its dealing
business in the jurisdiction in which the
business is located.
b. Comments on Proposed Registration
Requirement
Commenters generally did not address
the proposed dealer requirement in the
underwriting exemption. However, as
discussed below in Part IV.A.3.c.2.b., a
number of commenters addressed a
similar requirement in the proposed
market-making exemption.
c. Final Registration Requirement
The requirement in § ll.4(a)(2)(vi)
of the underwriting exemption, which
provides that the banking entity must be
licensed or registered to engage in
underwriting activity in accordance
with applicable law, is substantively
479 See

Occupy.
480 See proposed rule § ll.4(a)(2)(iv); Joint
Proposal, 76 FR 68,867; CFTC Proposal, 77 FR 8353.
The proposal clarified that, in the case of a financial
institution that is a government securities dealer,
such institution must have filed notice of that status
as required by section 15C(a)(1)(B) of the Exchange
Act. See Joint Proposal, 76 FR 68,867; CFTC
Proposal, 77 FR 8353.

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similar to the proposed dealer
registration requirement in § ll
.4(a)(2)(iv) of the proposed rule. The
primary difference between the
proposed requirement and the final
requirement is that the Agencies have
simplified the language of the rule. The
Agencies have also made conforming
changes to the corresponding
requirement in the market-making
exemption to promote consistency
across the exemptions, where
appropriate.481
As was proposed, this provision will
require a U.S. banking entity to be an
SEC-registered dealer in order to rely on
the underwriting exemption in
connection with a distribution of
securities—other than exempted
securities, security-based swaps,
commercial paper, bankers acceptances
or commercial bills—unless the banking
entity is exempt from registration or
excluded from regulation as a dealer.482
To the extent that a banking entity relies
on the underwriting exemption in
connection with a distribution of
municipal securities or government
securities, rather than the exemption in
§ ll.6(a) of the final rule, this
provision may require the banking
entity to be registered or licensed as a
municipal securities dealer or
government securities dealer, if required
by applicable law. However, this
provision does not require a banking
entity to register in order to qualify for
the underwriting exemption if the
banking entity is not otherwise required
to register by applicable law.
The Agencies have determined that,
for purposes of the underwriting
exemption, rather than require a
banking entity engaged in the business
of a securities dealer outside the United
States to be subject to substantive
regulation of its dealing business in the
jurisdiction in which the business is
located, a banking entity’s dealing
activity outside the U.S. should only be
subject to licensing or registration
provisions if required under applicable
foreign law (provided no U.S.
registration or licensing requirements
apply to the banking entity’s activities).
In response to comments, the final rule
recognizes that certain foreign
jurisdictions may not provide for
substantive regulation of dealing
481 See Part IV.A.3.c.6. (discussing the registration
requirement in the market-making exemption).
482 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 final
rule would not require the banking entity to be a
registered securities dealer to underwrite the assetbacked securities. See 15 U.S.C. 78c(a)(5)(C)(iii).

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businesses.483 The Agencies do not
believe it is necessary to preclude
banking entities from engaging in
underwriting activities in such foreign
jurisdictions to achieve the goals of
section 13 of the BHC Act because these
banking entities would continue to be
subject to the other requirements of the
underwriting exemption.
6. Source of Revenue Requirement
a. Proposed Source of Revenue
Requirement
Under § ll.4(a)(2)(vi) of the
proposed rule, the underwriting
activities of a banking entity would have
been required to be designed to generate
revenues primarily from fees,
commissions, underwriting spreads, or
other income not attributable to
appreciation in the value of covered
financial positions or hedging of
covered financial positions.484 The
proposal clarified that underwriting
spreads would include any ‘‘gross
spread’’ (i.e., the 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.485 This requirement provided
that activities conducted in reliance on
the underwriting exemption should
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
underwritten securities.486
b. Comments on the Proposed Source of
Revenue Requirement

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A few commenters requested certain
modifications to the proposed source of
revenue requirement. These
commenters’ suggested revisions were
generally intended either to refine the
standard to better account for certain
activities or to make it more
stringent.487 Three commenters
expressed concern that the proposed
source of revenue requirement would
negatively impact a banking entity’s
483 See infra Part IV.A.3.c.6.c. (discussing
comments on this issue with respect to the
proposed dealer registration requirement in the
market-making exemption).
484 See proposed rule § ll.4(a)(2)(vi); Joint
Proposal, 76 FR 68,867–68,868; CFTC Proposal, 77
FR 8353.
485 See Joint Proposal, 76 FR 68,867–68,868
n.142; CFTC Proposal, 77 FR 8353 n.148.
486 See Joint Proposal, 76 FR 68,867–68,868;
CFTC Proposal, 77 FR 8353.
487 See Goldman (Prop. Trading); Occupy; Sens.
Merkley & Levin (Feb. 2012).

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ability to act as a primary dealer or in
a similar capacity.488
With respect to suggested
modifications, one commenter
recommended that ‘‘customer revenue’’
include revenues attributable to
syndicate activities, hedging activities,
and profits and losses from sales of
residual positions, as long as the
underwriter makes a reasonable effort to
dispose of any residual position in light
of existing market conditions.489
Another commenter indicated that the
rule would better address securitization
if it required compensation to be linked
in part to risk minimization for the
securitizer and in part to serving
customers. This commenter suggested
that such a framework would be
preferable because, in the context of
securitizations, fee-based compensation
structures did not previously prevent
banking entities from accumulating
large and risky positions with
significant market exposure.490
To strengthen the proposed
requirement, one commenter requested
that the terms ‘‘designed’’ and
‘‘primarily’’ be removed and replaced by
the word ‘‘solely.’’ 491 Two other
commenters requested that this
requirement be interpreted to prevent a
banking entity from acting as an
underwriter for a distribution of
securities if such securities lack a
discernible and sufficiently liquid preexisting market and a foreseeable market
price.492
c. Final Rule’s Approach To Assessing
Source of Revenue
The Agencies believe the final rule
includes sufficient controls around an
underwriter’s source of revenue and
have determined not to adopt the
additional requirement included in
proposed rule § ll.4(a)(2)(vi). The
Agencies believe that removing this
requirement addresses commenters’
concerns that the proposed requirement
488 See Banco de Me
´ xico (stating that primary
dealers need to profit from resulting proprietary
positions in foreign sovereign debt, including by
holding significant positions in anticipation of
future price movements, in order to make the
primary dealer business financially attractive); IIB/
EBF (noting that primary dealers may actively seek
to profit from price and interest rate movements of
their holdings, which the relevant sovereign entity
supports because such activity provides muchneeded liquidity for securities that are otherwise
largely purchased pursuant to buy-and-hold
strategies by institutional investors and other
entities seeking safe returns and liquidity buffers);
Japanese Bankers Ass’n.
489 See Goldman (Prop. Trading).
490 See Sens. Merkley & Levin (Feb. 2012).
491 See Occupy (requesting that the rule require
automatic disgorgement of any profits arising from
appreciation in the value of positions in connection
with underwriting activities).
492 See AFR et al. (Feb. 2012); Public Citizen.

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did not appropriately reflect certain
revenue sources from underwriting
activity 493 or may impact primary
dealer activities.494 At the same time,
the final rule continues to include
provisions that focus on whether an
underwriter is generating underwritingrelated revenue and that should limit an
underwriter’s ability to generate
revenues purely from price
appreciation. In particular, the
requirement to make reasonable efforts
to sell or otherwise reduce the
underwriting position within a
reasonable period, which was not
included in the proposed rule, should
limit an underwriter’s ability to gain
revenues purely from price appreciation
related to its underwriter position.
Similarly, the determination of whether
an underwriter receives special
compensation for purposes of the
definition of ‘‘distribution’’ takes into
account whether a banking entity is
generating underwriting-related
revenue.
The final rule does not adopt a
requirement that prevents an
underwriter from generating any
revenue from price appreciation out of
concern that such a requirement could
prevent an underwriter from retaining
an unsold allotment under any
circumstances, which would be
inconsistent with other provisions of the
exemption.495 Similarly, the Agencies
are not adopting a source of revenue
requirement that would prevent a
banking entity from acting as
underwriter for a distribution of
securities if such securities lack a
discernible and sufficiently liquid preexisting market and a foreseeable market
price, as suggested by two
commenters.496 The Agencies believe
these commenters’ concern is mitigated
by the near term demand requirement,
which requires a trading desk to have a
reasonable expectation of demand from
other market participants for the amount
and type of securities to be acquired
from an issuer or selling security holder
for distribution.497 Further, one
commenter recommended a revenue
requirement directed at securitization
activities to prevent banking entities
from accumulating large and risky
positions with significant market
493 See

Goldman (Prop. Trading).
Banco de Me´xico; IIB/EBF; Japanese
Bankers Ass’n.
495 See Occupy; supra Part IV.A.2.c.2. (discussing
comments on unsold allotments and the
requirement in the final rule to make reasonable
efforts to sell or otherwise reduce the underwriting
position).
496 See AFR et al. (Feb. 2012); Public Citizen.
497 See supra Part IV.A.2.c.2.
494 See

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exposure.498 The Agencies believe the
requirement to make reasonable efforts
to sell or otherwise reduce the
underwriting position should achieve
this stated goal and, thus, the Agencies
do not believe an additional revenue
requirement for securitization activity is
needed.499
3. Section ll.4(b): Market-Making
Exemption
a. Introduction
In adopting the final rule, the
Agencies are striving to balance two
goals of section 13 of the BHC Act: To
allow market making, which is
important to well-functioning markets
as well as to the economy, and
simultaneously to prohibit proprietary
trading, unrelated to market making or
other permitted activities, that poses
significant risks to banking entities and
the financial system. In response to
comments on the proposed marketmaking exemption, the Agencies are
adopting certain modifications to the
proposed exemption to better account
for the varying characteristics of market
making-related activities across markets
and asset classes, while requiring that
banking entities maintain a robust set of
risk controls for their market makingrelated activities. A flexible approach to
this exemption is appropriate because
the activities a market maker undertakes
to provide important intermediation and
liquidity services will differ based on
the liquidity, maturity, and depth of the
market for a given type of financial
instrument. The statute specifically
permits banking entities to continue to
provide these beneficial services to their
clients, customers, and
counterparties.500 Thus, the Agencies
are adopting an approach that
recognizes the full scope of market
making-related activities banking
entities currently undertake and
requires that these activities be subject
to clearly defined, verifiable, and
monitored risk parameters.
b. Overview
1. Proposed Market-Making Exemption
Section 13(d)(1)(B) of the BHC Act
provides an exemption from the
498 See

Sens. Merkley & Levin (Feb. 2012).
final rule § ll.4(a)(2)(ii). Further, as
noted above, this exemption does not permit the
accumulation of assets for securitization. See supra
Part IV.A.2.c.1.c.v.
500 As discussed in Part IV.A.3.c.2.c.i., infra, the
terms ‘‘client,’’ ‘‘customer,’’ and ‘‘counterparty’’ are
defined in the same manner in the final rule. Thus,
the Agencies use these terms synonymously
throughout this discussion and sometimes use the
term ‘‘customer’’ to refer to all entities that meet the
definition of ‘‘client, customer, and counterparty’’
in the final rule’s market-making exemption.

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prohibition on proprietary trading for
the purchase, sale, acquisition, or
disposition of securities, derivatives,
contracts of sale of a commodity for
future delivery, and options on any of
the foregoing in connection with 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.501
Section ll.4(b) of the proposed rule
would have implemented this statutory
exemption by requiring that a banking
entity’s market making-related activities
comply with seven standards. As
discussed in the proposal, these
standards were designed to ensure that
any banking entity relying on the
exemption would be engaged in bona
fide market making-related activities
and, further, would conduct such
activities in a way that was not
susceptible to abuse through the taking
of speculative, proprietary positions as
a part of, or mischaracterized as, market
making-related activities. The Agencies
proposed to use additional regulatory
and supervisory tools in conjunction
with the proposed market-making
exemption, including quantitative
measurements for banking entities
engaged in significant covered trading
activity in proposed Appendix A,
commentary on how the Agencies
proposed to distinguish between
permitted market making-related
activity and prohibited proprietary
trading in proposed Appendix B, and a
compliance regime in proposed § ll
.20 and, where applicable, Appendix C
of the proposal. This multi-faceted
approach was intended to address the
complexities of differentiating permitted
market making-related activities from
prohibited proprietary trading.502
2. Comments on the Proposed MarketMaking Exemption
The Agencies received significant
comment regarding the proposed
market-making exemption. In this Part,
the Agencies highlight the main issues,
concerns, and suggestions raised by
commenters with respect to the
proposed market-making exemption. As
discussed in greater detail below,
commenters’ views on the effectiveness
of the proposed exemption varied.
Commenters discussed a broad range of
topics related to the proposed marketmaking exemption including, among
others: The overall scope of the
proposed exemption and potential
restrictions on market making in certain
501 12

U.S.C. 1851(d)(1)(B).
Joint Proposal, 76 FR 68,869; CFTC
Proposal, 77 FR 8354–8355.
502 See

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markets or asset classes; the potential
market impact of the proposed marketmaking exemption; the appropriate level
of analysis for compliance with the
proposed exemption; the effectiveness
of the individual requirements of the
proposed exemption; and specific
activities that should or should not be
considered permitted market makingrelated activity under the rule.
a. Comments on the Overall Scope of
the Proposed Exemption
With respect to the general scope of
the exemption, a number of commenters
expressed concern that the proposed
approach to implementing the marketmaking exemption is too narrow or
restrictive, particularly with respect to
less liquid markets. These commenters
expressed concern that the proposed
exemption would not be workable in
many markets and asset classes and
does not take into account how marketmaking services are provided in those
markets and asset classes.503 Some
commenters expressed particular
concern that the proposed exemption
may restrict or limit certain activities
currently conducted by market makers
(e.g., holding inventory or interdealer
trading).504 Several commenters stated
503 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012) (stating that the proposed exemption ‘‘seems
to view market making based on a liquid, exchangetraded equity model in which market makers are
simple intermediaries akin to agents’’ and that
‘‘[t]his view does not fit market making even in
equity markets and widely misses the mark for the
vast majority of markets and asset classes’’); SIFMA
(Asset Mgmt.) (Feb. 2012); Credit Suisse (Seidel);
ICI (Feb. 2012); BoA; Columbia Mgmt.; Comm. on
Capital Markets Regulation; Invesco; ASF (Feb.
2012) (‘‘The seven criteria in the proposed rule, and
the related criterion for identifying permitted
hedging, are overly restrictive and will make it
impractical for dealers to continue making markets
in most securitized products.’’); Chamber (Feb.
2012) (expressing particular concern about the
commercial paper market).
504 Several commenters stated that the proposed
rule would limit a market maker’s ability to
maintain inventory. See, e.g., NASP; Oliver Wyman
(Dec. 2011); Wellington; Prof. Duffie; Standish
Mellon; MetLife; Lord Abbett; NYSE Euronext;
CIEBA; British Columbia; SIFMA et al. (Prop.
Trading) (Feb. 2012); Shadow Fin. Regulatory
Comm.; Credit Suisse (Seidel); Morgan Stanley;
Goldman (Prop. Trading); BoA; STANY; SIFMA
(Asset Mgmt.) (Feb. 2012); Chamber (Feb. 2012);
IRSG; Abbott Labs et al. (Feb. 14, 2012); Abbott Labs
et al. (Feb. 21, 2012); Australian Bankers Ass’n.
(Feb. 2012); FEI; ASF (Feb. 2012); RBC; PUC Texas;
Columbia Mgmt.; SSgA (Feb. 2012); PNC et al.;
Fidelity; ICI (Feb. 2012); British Bankers’ Ass’n.;
Comm. on Capital Markets Regulation; IHS; Oliver
Wyman (Feb. 2012); Thakor Study (stating that by
artificially constraining the security holdings that a
banking entity can have in its inventory for market
making or proprietary trading purposes, section 13
of the BHC Act will make bank risk management
less efficient and may adversely impact the
diversified financial services business model of
banks). However, some commenters stated that
market makers should seek to minimize their
inventory or should not need large inventories. See,

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that the proposed exemption would
create too much uncertainty regarding
compliance 505 and, further, may have a
chilling effect on banking entities’
market making-related activities.506 Due
to the perceived restrictions and
burdens of the proposed exemption,
many commenters indicated that the
rule may change the way in which
market-making services are provided.507
A number of commenters expressed the
view that the proposed exemption is
inconsistent with Congressional intent
because it would restrict and reduce
banking entities’ current market makingrelated activities.508
Other commenters, however, stated
that the proposed exemption was too
broad and recommended that the rule
place greater restrictions on market
making, particularly in illiquid,
nontransparent markets.509 Many of
these commenters suggested that the
exemption should only be available for
traditional market-making activity in
relatively safe, ‘‘plain vanilla’’
e.g., AFR et al. (Feb. 2012); Public Citizen; Johnson
& Prof. Stiglitz. Other commenters expressed
concern that the proposed rule could limit
interdealer trading. See, e.g., Prof. Duffie; Credit
Suisse (Seidel); JPMC; Morgan Stanley; Goldman
(Prop. Trading); Chamber (Feb. 2012); Oliver
Wyman (Dec. 2011).
505 See, e.g., BlackRock; Putnam; Fixed Income
Forum/Credit Roundtable; ACLI (Feb. 2012);
MetLife; IAA; Wells Fargo (Prop. Trading); T. Rowe
Price; Sen. Bennet; Sen. Corker; PUC Texas;
Fidelity; ICI (Feb. 2012); Invesco.
506 See, e.g., Wellington; Prof. Duffie; Standish
Mellon; Commissioner Barnier; NYSE Euronext;
BoA; Citigroup (Feb. 2012); STANY; ICE; Chamber
(Feb. 2012); BDA (Feb. 2012); Putnam; FTN; Fixed
Income Forum/Credit Roundtable; ACLI (Feb.
2012); IAA; CME Group; Capital Group; PUC Texas;
Columbia Mgmt.; SSgA (Feb. 2012); Eaton Vance;
ICI (Feb. 2012); Invesco; Comm. on Capital Markets
Regulation; Oliver Wyman (Feb. 2012); SIFMA
(Asset Mgmt.) (Feb. 2012); Thakor Study.
507 For example, some commenters stated that
market makers may revert to an agency or ‘‘special
order’’ model. See, e.g., Barclays; Goldman (Prop.
Trading); ACLI (Feb. 2012); Vanguard; RBC. In
addition, some commenters stated that new systems
will be developed, such as alternative market
matching networks, but these commenters
disagreed about whether such changes would
happen in the near term. See, e.g., CalPERS;
BlackRock; Stuyvesant; Comm. on Capital Markets
Regulation. Other commenters stated that it is
unlikely that new systems will be developed. See,
e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Oliver
Wyman (Feb. 2012). One commenter stated that the
proposed rule may cause a banking organization
that engages in significant market-making activity to
give up its banking charter or spin off its marketmaking operations to avoid compliance with the
proposed exemption. See Prof. Duffie.
508 See, e.g., NASP; Wellington; JPMC; Morgan
Stanley; Credit Suisse (Seidel); BoA; Goldman
(Prop. Trading); Citigroup (Feb. 2012); STANY;
SIFMA (Asset Mgmt.) (Feb. 2012); Chamber (Feb.
2012); Putnam; ICI (Feb. 2012); Wells Fargo (Prop.
Trading); NYSE Euronext; Sen. Corker; Invesco.
509 See, e.g., Better Markets (Feb. 2012); Sens.
Merkley & Levin (Feb. 2012); Occupy; AFR et al.
(Feb. 2012); Public Citizen; Johnson & Prof. Stiglitz.

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instruments.510 Two commenters
represented that the proposed
exemption would have little to no
impact on banking entities’ current
market making-related services.511
Commenters expressed differing
views regarding the ease or difficulty of
distinguishing permitted market
making-related activity from prohibited
proprietary trading. A number of
commenters represented that it is
difficult or impossible to distinguish
prohibited proprietary trading from
permitted market making-related
activity.512 With regard to this issue,
several commenters recommended that
the Agencies not try to remove all
aspects of proprietary trading from
market making-related activity because
doing so would likely restrict certain
legitimate market-making activity.513
Other commenters were of the view
that it is possible to differentiate
between prohibited proprietary trading
and permitted market making-related
activity.514 For example, one commenter
stated that, while the analysis may
involve subtle distinctions, the
fundamental difference between a
banking entity’s market-making
activities and proprietary trading
activities is the emphasis in market
making on seeking to meet customer
needs on a consistent and reliable basis
throughout a market cycle.515 According
to another commenter, holding
substantial securities in a trading book
for an extended period of time assumes
the character of a proprietary position
and, while there may be occasions when
510 See, e.g., Johnson & Prof. Stiglitz; Sens.
Merkley & Levin (Feb. 2012); Occupy; AFR et al.
(Feb. 2012); Public Citizen.
511 See Occupy (‘‘[I]t is unclear that this rule, as
written, will markedly alter the current customerserving business. Indeed, this rule has gone to
excessive lengths to protect the covered banking
entities’ ability to maintain responsible customerfacing business.’’); Alfred Brock.
512 See, e.g., Rep. Bachus et al.; IIF; Morgan
Stanley (stating that beyond walled-off proprietary
trading, the line is hard to draw, particularly
because both require principal risk-taking and the
features of market making vary across markets and
asset classes and become more pronounced in times
of market stress); CFA Inst. (representing that the
distinction is particularly difficult in the fixedincome market); ICFR; Prof. Duffie; WR Hambrecht.
513 See, e.g., Chamber (Feb. 2012) (citing an article
by Stephen Breyer stating that society should not
expend disproportionate resources trying to reduce
or eliminate ‘‘the last 10 percent’’ of the risks of a
certain problem); JPMC; RBC; ICFR; Sen. Hagan.
One of these commenters indicated that any
concerns that banking entities would engage in
speculative trading as a result of an expansive
market-making exemption would be addressed by
other reform initiatives (e.g., Basel III
implementation will provide laddered disincentives
to holding positions as principal as a result of
capital and liquidity requirements). See RBC.
514 See Wellington; Paul Volcker; Better Markets
(Feb. 2012); Occupy.
515 See Wellington.

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5577

a customer-oriented purchase and
subsequent sale extend over days and
cannot be more quickly executed or
hedged, substantial holdings of this
character should be relatively rare and
limited to less liquid markets.516
Several commenters expressed
general concern that the proposed
exemption may be applied on a
transaction-by-transaction basis and
explained the burdens that may result
from such an approach.517 Commenters
appeared to attribute these concerns to
language in the proposed exemption
referring to a ‘‘purchase or sale of a
[financial instrument]’’ 518 or to
language in Appendix B indicating that
the Agencies may assess certain factors
and criteria at different levels, including
a ‘‘single significant transaction.’’ 519
With respect to the burdens of a
transaction-by-transaction analysis,
some commenters noted that banking
entities can engage in a large volume of
market-making transactions daily,
which would make it burdensome to
apply the exemption to each trade.520 A
few commenters indicated that, even if
the Agencies did not intend to require
transaction-by-transaction analysis, the
proposed rule’s language can be read to
imply such a requirement. These
commenters indicated that ambiguity on
this issue could have a chilling effect on
market making or could allow some
examiners to rigidly apply the
requirements of the exemption on a
trade-by-trade basis.521 Other
commenters indicated that it would be
difficult to determine whether a
particular trade was or was not a
market-making trade without
consideration of the relevant unit’s
overall activities.522 One commenter
elaborated on this point by stating that
516 See

Paul Volcker.
Wellington; SIFMA et al. (Prop. Trading)
(Feb. 2012); Barclays; Goldman (Prop. Trading);
HSBC; Fixed Income Forum/Credit Roundtable;
ACLI (Feb. 2012); PUC Texas; ERCOT; Invesco. See
also IAA (stating that it is unclear whether the
requirements must be applied on a transaction-bytransaction basis or if compliance with the
requirements is based on overall activities). This
issue is addressed in Part IV.A.3.c.1.c., infra.
518 See, e.g., Barclays; SIFMA et al. (Prop.
Trading) (Feb. 2012). As explained above, the term
‘‘covered financial position’’ from the proposal has
been replaced by the term ‘‘financial instrument’’ in
the final rule. Because the types of instruments
included in both definitions are identical, the term
‘‘financial instrument’’ is used throughout this Part.
519 See, e.g., Goldman (Prop. Trading);
Wellington.
520 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Barclays (stating that ‘‘hundreds or
thousands of trades can occur in a single day in a
single trading unit’’).
521 See, e.g., ICI (Feb. 2012); Barclays; Goldman
(Prop. Trading).
522 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Goldman (Prop. Trading).
517 See

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‘‘an analysis that seeks to characterize
specific transactions as either market
making. . . or prohibited activity does
not accord with the way in which
modern trading units operate, which
generally view individual positions as a
bundle of characteristics that contribute
to their complete portfolio.’’ 523 This
commenter noted that a position entered
into as part of market making-related
activities may serve multiple functions
at one time, such as responding to
customer demand, hedging a risk, and
building inventory. The commenter also
expressed concern that individual
transactions or positions may not be
severable or separately identifiable as
serving a market-making purpose.524
Two commenters suggested that the
requirements in the market-making
exemption be applied at the portfolio
level rather than the trade level.525
Moreover, commenters also set forth
their views on the organizational level
at which the requirements of the
proposed market-making exemption
should apply.526 The proposed
exemption generally applied
requirements to a ‘‘trading desk or other
organizational unit’’ of a banking entity.
In response to this proposed approach,
commenters stated that compliance
should be assessed at each trading desk
or aggregation unit 527 or at each trading
unit.528
523 SIFMA

et al. (Prop. Trading) (Feb. 2012).
id. (suggesting that the Agencies ‘‘give full
effect to the statutory intent to allow market making
by viewing the permitted activity on a holistic
basis’’).
525 See ACLI (Feb. 2012); Fixed Income Forum/
Credit Roundtable.
526 See Wellington; Morgan Stanley; SIFMA et al.
(Prop. Trading) (Feb. 2012); ACLI (Feb. 2012); Fixed
Income Forum/Credit Roundtable. The Agencies
address this topic in Part IV.A.3.c.1.c., infra.
527 See Wellington. This commenter did not
provide greater specificity about how it would
define ‘‘trading desk’’ or ‘‘aggregation unit.’’ See id.
528 See Morgan Stanley (stating that ‘‘trading
unit’’ should be defined as ‘‘each organizational
unit that is used to structure and control the
aggregate risk-taking activities and employees that
are engaged in the coordinated implementation of
a customer-facing revenue generation strategy and
that participate in the execution of any covered
trading activity’’); SIFMA et al. (Prop. Trading)
(Feb. 2012). One of these commenters discussed its
suggested definition of ‘‘trading unit’’ in the context
of the proposed requirement to record and report
certain quantitative measurements, but it is unclear
that the commenter was also suggesting that this
definition be used for purposes of the marketmaking exemption. For example, this commenter
expressed support for a multi-level approach to
defining ‘‘trading unit,’’ and it is not clear how a
definition that captures multiple organizational
levels across a banking organization would work in
the context of the market-making exemption. See
SIFMA et al. (Prop. Trading) (Feb. 2012) (suggested
that ‘‘trading unit’’ be defined ‘‘at a level that
presents its activities in the context of the whole’’
and noting that the appropriate level may differ
depending on the structure of the banking entity).

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Several commenters suggested
alternative or additive means of
implementing the statutory exemption
for market making-related activity.529
Commenters’ recommended approaches
varied, but a number of commenters
requested approaches involving one or
more of the following elements: (i) Safe
harbors,530 bright lines,531 or
presumptions of compliance with the
exemption based on the existence of
certain factors (e.g., compliance
program, metrics, general customer
focus or orientation, providing liquidity,
and/or exchange registration as a market
maker); 532 (ii) a focus on metrics or
other objective factors; 533 (iii) guidance
on permitted market making-related
activity, rather than rule
requirements; 534 (iv) risk management
structures and/or risk limits; 535 (v)
adding a new customer-facing criterion
or focusing on client-related
activities; 536 (vi) capital and liquidity
529 See, e.g., Wellington; Japanese Bankers Ass’n.;
Prof. Duffie; IR&M; G2 FinTech; MetLife; NYSE
Euronext; Anthony Flynn and Koral Fusselman; IIF;
CalPERS; SIFMA et al. (Prop. Trading) (Feb. 2012);
Sens. Merkley & Levin (Feb. 2012); Shadow Fin.
Regulatory Comm.; John Reed; Prof. Richardson;
Credit Suisse (Seidel); JPMC; Morgan Stanley;
Barclays; Goldman (Prop. Trading); BoA; Citigroup
(Feb. 2012); STANY; ICE; BlackRock; Johnson &
Prof. Stiglitz; Fixed Income Forum/Credit
Roundtable; ACLI (Feb. 2012); Wells Fargo (Prop.
Trading); WR Hambrecht; Vanguard; Capital Group;
PUC Texas; SSgA (Feb. 2012); PNC et al.; Fidelity;
Occupy; AFR et al. (Feb. 2012); Invesco; ISDA (Feb.
2012); Stephen Roach; Oliver Wyman (Feb. 2012).
The Agencies respond to these comments in Part
IV.A.3.b.3., infra.
530 See, e.g., Sens. Merkley & Levin (Feb. 2012);
John Reed; Prof. Richardson; Johnson & Prof.
Stiglitz; Capital Group; Invesco; BDA (Feb. 2012)
(Oct. 2012) (suggesting a safe harbor for any trading
desk that effects more than 50 percent of its
transactions through sales representatives).
531 See, e.g., Flynn & Fusselman; Prof. Colesanti
et al.
532 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); IIF; NYSE Euronext; Credit Suisse (Seidel);
JPMC; Barclays; BoA; Wells Fargo (Prop. Trading)
(suggesting that the rule: (i) Provide a general grant
of authority to engage in any transactions entered
into as part of a banking entity’s market-making
business, where ‘‘market making’’ is defined as ‘‘the
business of being willing to facilitate customer
purchases and sales of [financial instruments] as an
intermediary over time and in size, including by
holding positions in inventory;’’ and (ii) allow
banking entities to monitor compliance with this
exemption internally through their compliance and
risk management infrastructure); PNC et al.; Oliver
Wyman (Feb. 2012).
533 See, e.g., Goldman (Prop. Trading); Morgan
Stanley; Barclays; Wellington; CalPERS; BlackRock;
SSgA (Feb. 2012); Invesco.
534 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012) (suggesting that this guidance could be
incorporated in banking entities’ policies and
procedures for purposes of complying with the rule,
in addition to the establishment of risk limits,
controls, and metrics); JPMC; BoA; PUC Texas;
SSgA (Feb. 2012); PNC et al.; Wells Fargo (Prop.
Trading).
535 See, e.g., Japanese Bankers Ass’n.; Citigroup
(Feb. 2012).
536 See, e.g., Morgan Stanley; Stephen Roach.

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requirements; 537 (vii) development of
individualized plans for each banking
entity, in coordination with
regulators; 538 (viii) ring fencing
affiliates engaged in market makingrelated activity; 539 (ix) margin
requirements; 540 (x) a compensationfocused approach; 541 (xi) permitting all
swap dealing activity; 542 (xii) additional
provisions regarding material conflicts
of interest and high-risk assets and
trading strategies; 543 and/or (xiii)
making the exemption as broad as
possible under the statute.544
b. Comments Regarding the Potential
Market Impact of the Proposed
Exemption
As discussed above, several
commenters stated that the proposed
rule would impact a banking entity’s
ability to engage in market makingrelated activity. Many of these
commenters represented that, as a
result, the proposed exemption would
likely result in reduced liquidity,545
537 See, e.g., Prof. Duffie; CalPERS; STANY; ICE;
Vanguard; Capital Group.
538 See MetLife; Fixed Income Forum/Credit
Roundtable; ACLI (Feb. 2012).
539 See, e.g., Prof. Duffie; Shadow Fin. Regulatory
Comm. See also Wedbush.
540 See WR Hambrecht.
541 See G2 FinTech.
542 See ISDA (Feb. 2012); ISDA (Apr. 2012).
543 See Sens. Merkley & Levin (Feb. 2012) (stating
that the exemption should expressly mention the
conflicts provision and provide examples to warn
against particular conflicts, such as recommending
clients buy poorly performing assets in order to
remove them from the banking entity’s book or
attempting to move market prices in favor of trading
positions a banking entity has built up in order to
make a profit); Stephen Roach (suggesting that the
exemption integrate the limitations on permitted
activities).
544 See Fidelity (stating that the exemption needs
to be as broad as possible to account for customerfacing principal trades, block trades, and market
making in OTC derivatives). See also STANY
(stating that it is better to make the exemption too
broad than too narrow).
545 See, e.g., AllianceBernstein; Rep. Bachus et al.
(Dec. 2011); EMTA; NASP; Wellington; Japanese
Bankers Ass’n.; Sen. Hagan; Prof. Duffie; Investure;
Standish Mellon; IR&M; MetLife; Lord Abbett;
Commissioner Barnier; Quebec; IIF; Sumitomo
Trust; Liberty Global; NYSE Euronext; CIEBA;
EFAMA; SIFMA et al. (Prop. Trading) (Feb. 2012);
Credit Suisse (Seidel); JPMC; Morgan Stanley;
Barclays; Goldman (Prop. Trading); BoA; Citigroup
(Feb. 2012); STANY; ICE; BlackRock; SIFMA (Asset
Mgmt.) (Feb. 2012); BDA (Feb. 2012); Putnam;
Fixed Income Forum/Credit Roundtable; Western
Asset Mgmt.; ACLI (Feb. 2012); IAA; CME Group;
Wells Fargo (Prop. Trading); Abbott Labs et al. (Feb.
14, 2012); Abbott Labs et al. (Feb. 21, 2012); T.
Rowe Price; Australian Bankers Ass’n. (Feb. 2012);
FEI; AFMA; Sen. Carper et al.; PUC Texas; ERCOT;
IHS; Columbia Mgmt.; SSgA (Feb. 2012); PNC et al.;
Eaton Vance; Fidelity; ICI (Feb. 2012); British
Bankers’ Ass’n.; Comm. on Capital Markets
Regulation; Union Asset; Sen. Casey; Oliver Wyman
(Dec. 2011); Oliver Wyman (Feb. 2012) (providing
estimated impacts on asset valuation, borrowing
costs, and transaction costs in the corporate bond
market based on hypothetical liquidity reduction

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wider bid-ask spreads,546 increased
market volatility,547 reduced price
discovery or price transparency,548
increased costs of raising capital or
higher financing costs,549 greater costs
for investors or consumers,550 and
scenarios); Thakor Study. The Agencies respond to
comments regarding the potential market impact of
the rule in Part IV.A.3.b.3., infra.
546 See, e.g., AllianceBernstein; Wellington;
Investure; Standish Mellon; MetLife; Lord Abbett;
Barclays; Goldman (Prop. Trading); Citigroup (Feb.
2012); BlackRock; Putnam; ACLI (Feb. 2012);
Abbott Labs et al. (Feb. 14, 2012); Abbott Labs et
al. (Feb. 21, 2012); T. Rowe Price; Sen. Carper et
al.; IHS; Columbia Mgmt.; ICI (Feb. 2012) British
Bankers’ Ass’n.; Comm. on Capital Markets
Regulation; Thakor Study (stating that section 13 of
the BHC Act will likely result in higher bid-ask
spreads by causing at least some retrenchment of
banks from market making, resulting in fewer
market makers and less competition).
547 See, e.g., Wellington; Prof. Duffie; Standish
Mellon; Lord Abbett; IIF; SIFMA et al. (Prop.
Trading) (Feb. 2012); Barclays; Goldman (Prop.
Trading); BDA (Feb. 2012); IHS; FTN; IAA; Wells
Fargo (Prop. Trading); T. Rowe Price; Columbia
Mgmt.; SSgA (Feb. 2012); Eaton Vance; British
Bankers’ Ass’n.; Comm. on Capital Markets
Regulation.
548 See, e.g., Prof. Duffie (arguing that, for
example, ‘‘during the financial crisis of 2007–2009,
the reduced market making capacity of major dealer
banks caused by their insufficient capital levels
resulted in dramatic downward distortions in
corporate bond prices’’); IIF; Barclays; IAA;
Vanguard; Wellington; FTN.
549 See, e.g., AllianceBernstein; Chamber (Dec.
2011); Members of Congress (Dec. 2011);
Wellington; Sen. Hagan; Prof. Duffie; IR&M;
MetLife; Lord Abbett; Liberty Global; NYSE
Euronext; SIFMA et al. (Prop. Trading) (Feb. 2012);
NCSHA; ASF (Feb. 2012) (stating that ‘‘[f]ailure to
permit the activities necessary for banking entities
to act in [a] market-making capacity [in assetbacked securities] would have a dramatic adverse
effect on the ability of securitizers to access the
asset-backed securities markets and thus to obtain
the debt financing necessary to ensure a vibrant
U.S. economy’’); Credit Suisse (Seidel); JPMC;
Morgan Stanley; Barclays; Goldman (Prop. Trading);
BoA; Citigroup (Feb. 2012); STANY; BlackRock;
Chamber (Feb. 2012); IHS; BDA (Feb. 2012); Fixed
Income Forum/Credit Roundtable; ACLI (Feb.
2012); Wells Fargo (Prop. Trading); Abbott Labs et
al. (Feb. 14, 2012); Abbott Labs et al. (Feb. 21,
2012); T. Rowe Price; FEI; AFMA; SSgA (Feb. 2012);
PNC et al.; ICI (Feb. 2012); British Bankers’ Ass’n.;
Oliver Wyman (Dec. 2011); Oliver Wyman (Feb.
2012); GE (Feb. 2012); Thakor Study (stating that
when a firm’s cost of capital goes up, it invests
less—resulting in lower economic growth and lower
employment—and citing supporting data indicating
that a 1 percent increase in the cost of capital would
lead to a $55 to $82.5 billion decline in aggregate
annual capital spending by U.S. nonfarm firms and
job losses between 550,000 and 1.1 million per year
in the nonfarm sector). One commenter further
noted that a higher cost of capital can lead a firm
to make riskier, short-term investments. See Thakor
Study.
550 See, e.g., Wellington; Standish Mellon; IR&M;
MetLife; Lord Abbett; NYSE Euronext; CIEBA;
Barclays; Goldman (Prop. Trading); BoA; Citigroup
(Feb. 2012); STANY; ICE; BlackRock; Fixed Income
Forum/Credit Roundtable; ACLI (Feb. 2012); IAA;
Abbott Labs et al. (Feb. 14, 2012); Abbott Labs et
al. (Feb. 21, 2012); T. Rowe Price; Vanguard;
Australian Bankers Ass’n. (Feb. 2012); FEI; Sen.
Carper et al.; Columbia Mgmt.; SSgA (Feb. 2012);
ICI (Feb. 2012); Comm. on Capital Markets
Regulation; TMA Hong Kong; Sen. Casey; IHS;

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slower execution times.551 Some
commenters expressed particular
concern about potential impacts on
institutional investors (e.g., mutual
funds and pension funds) 552 or on small
or midsized companies.553 A number of
commenters discussed the
interrelationship between primary and
secondary market activity and indicated
that restrictions on market making
would impact the underwriting
process.554
A few commenters expressed the view
that reduced liquidity would not
Oliver Wyman (Dec. 2011); Oliver Wyman (Feb.
2012); Thakor Study.
551 See, e.g., Barclays; FTN; Abbott Labs et al.
(Feb. 14, 2012); Abbott Labs et al. (Feb. 21, 2012).
552 See, e.g., AllianceBernstein (stating that, to the
extent the rule reduces liquidity provided by
market makers, open end mutual funds that are
largely driven by the need to respond to both
redemptions and subscriptions will be immediately
impacted in terms of higher trading costs);
Wellington (indicating that periods of extreme
market stress are likely to exacerbate costs and
challenges, which could force investors such as
mutual funds and pension funds to accept
distressed prices to fund redemptions or pay
current benefits); Lord Abbett (stating that certain
factors, such as reduced bank capital to support
market-making businesses and economic
uncertainty, have already reduced liquidity and
caused asset managers to have an increased
preference for highly liquid credits and expressing
concern that, if section 13 of the BHC Act further
reduces liquidity, then: (i) Asset managers’
increased preference for highly liquid credit could
lead to unhealthy portfolio concentrations, and (ii)
asset managers will maintain a larger cash cushion
in portfolios that may be subject to redemption,
which will likely result in investors getting poorer
returns); EFAMA; BlackRock (stating that
investment decisions are heavily dependent on a
liquidity factor input, so as liquidity dissipates,
investment strategies become more limited and
returns to investors are diminished by wider
spreads and higher transaction costs); CFA Inst.
(noting that a mutual fund that tries to liquidate
holdings to meet redemptions may have difficulty
selling at acceptable prices, thus impairing the
fund’s NAV for both redeeming investors and for
those that remain in the fund); Putnam; Fixed
Income Forum/Credit Roundtable; ACLI; T. Rowe
Price; Vanguard; IAA; FEI; Sen. Carper et al.;
Columbia Mgmt.; ICI (Feb. 2012); Invesco; Union
Asset; Standish Mellon; Morgan Stanley; SIFMA
(Asset Mgmt.) (Feb. 2012).
553 See, e.g., CIEBA (stating that for smaller
issuers in particular, market makers need to have
incentives to make markets, and the proposal
removes important incentives); ACLI (indicating
that lower liquidity will most likely result in higher
costs for issuers of debt and, for lesser known or
lower quality issuers, this cost may be significant
and in some cases prohibitive because the cost will
vary depending on the credit quality of the issuer,
the amount of debt it has in the market, and the
maturity of the security); PNC et al. (expressing
concern that a regional bank’s market-making
activity for small and middle market customers is
more likely to be inappropriately characterized as
impermissible proprietary trading due to lower
trading volume involving less liquid securities);
Morgan Stanley; Chamber (Feb. 2012); Abbott Labs
et al. (Feb. 14, 2012); Abbott Labs et al. (Feb. 21,
2012); FEI; ICI (Feb. 2012); TMA Hong Kong; Sen.
Casey.
554 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC; RBC; NYSE Euronext; Credit Suisse (Seidel).

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necessarily be a negative result.555 For
example, two commenters noted that
liquidity is vulnerable to liquidity
spirals, in which a high level of market
liquidity during one period feeds a
sharp decline in liquidity during the
next period by initially driving asset
prices upward and supporting increased
leverage. The commenters explained
that liquidity spirals lead to ‘‘fire sales’’
by market speculators when events
reveal that assets are overpriced and
speculators must sell their assets to
reduce their leverage.556 According to
another commenter, banking entities’
access to the safety net allows them to
distort market prices and, arguably,
produce excess liquidity. The
commenter further represented that it
would be preferable to allow the
discipline of the market to choose the
pricing of securities and the amount of
liquidity.557 Some commenters cited an
economic study indicating that the U.S.
financial system has become less
efficient in generating economic growth
in recent years, despite increased
trading volumes.558
Some commenters stated that it is
unlikely the proposed rule would result
in the negative market impacts
identified above, such as reduced
market liquidity.559 For example, a few
commenters stated that other market
participants, who are not subject to
section 13 of the BHC Act, may enter the
market or increase their trading
activities to make up for any reduction
in banking entities’ market-making
555 See, e.g., Paul Volcker; AFR et al. (Feb. 2012);
Public Citizen; Prof. Richardson; Johnson & Prof.
Stiglitz; Better Markets (Feb. 2012); Prof. Johnson.
556 See AFR et al. (Feb. 2012); Public Citizen. See
also Paul Volcker (stating that at some point, greater
liquidity, or the perception of greater liquidity, may
encourage more speculative trading).
557 See Prof. Richardson.
558 See, e.g., Johnson & Prof. Stiglitz (citing
Thomas Phillippon, Has the U.S. Finance Industry
Become Less Efficient?, NYU Working Paper, Nov.
2011); AFR et al. (Feb. 2012); Public Citizen; Better
Markets (Feb. 2012); Prof. Johnson.
559 See, e.g., Sens. Merkley & Levin (Feb. 2012)
(stating that there is no convincing, independent
evidence that the rule would increase trading costs
or reduce liquidity, and the best evidence available
suggests that the buy-side firms would greatly
benefit from the competitive pressures that
transparency can bring); Better Markets (Feb. 2012)
(‘‘Industry’s claim that [section 13 of the BHC Act]
will ‘reduce market liquidity, capital formation, and
credit availability, and thereby hamper economic
growth and job creation’ disregard the fact that the
financial crisis did more damage to those concerns
than any rule or reform possibly could.’’); Profs.
Stout & Hastings; Prof. Johnson; Occupy; Public
Citizen; Profs. Admati & Pfleiderer; Better Markets
(June 2012); AFR et al. (Feb. 2012). One commenter
stated that the proposed rule would improve market
liquidity, efficiency, and price transparency. See
Alfred Brock.

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activity or other trading activity.560 For
instance, one of these commenters
suggested that the revenue and profits
from market making will be sufficient to
attract capital and competition to that
activity.561 In addition, one commenter
expressed the view that prohibiting
proprietary trading may support more
liquid markets by ensuring that banking
entities focus on providing liquidity as
market makers, rather than taking
liquidity from the market in the course
of ‘‘trading to beat’’ institutional buyers
like pension funds, university
endowments, and mutual funds.562
Another commenter stated that, while
section 13 of the BHC Act may
temporarily reduce trading volume and
excessive liquidity at the peak of market
bubbles, it should increase the long-run
stability of the financial system and
render genuine liquidity and credit
availability more reliable over the long
term.563
Other commenters, however,
indicated that it is uncertain or unlikely
that non-banking entities will enter the
market or increase their trading
activities, particularly in the short
term.564 For example, one commenter
noted the investment that banking
entities have made in infrastructure for
trading and compliance would take
smaller or new firms years and billions
of dollars to replicate.565 Another
commenter questioned whether other
market participants, such as hedge
funds, would be willing to dedicate
capital to fully serving customer needs,
which is required to provide ongoing
liquidity.566 One commenter stated that
even if non-banking entities move in to
560 See, e.g., Sens. Merkley & Levin (Feb. 2012);
Prof. Richardson; Better Markets (Feb. 2012); Profs.
Stout & Hastings; Prof. Johnson; Occupy; Public
Citizen; Profs. Admati & Pfleiderer; Better Markets
(June 2012). Similarly, one commenter indicated
that non-banking entity market participants could
fill the current role of banking entities in the market
if implementation of the rule is phased in. See ACLI
(Feb. 2012).
561 See Better Markets (Feb. 2012).
562 See Prof. Johnson.
563 See AFR et al. (Feb. 2012).
564 See, e.g., Wellington; Prof. Duffie; Investure;
IIF; Liberty Global; SIFMA et al. (Prop. Trading)
(Feb. 2012); Credit Suisse (Seidel); JPMC; Morgan
Stanley; Barclays; BoA; STANY; SIFMA (Asset
Mgmt.) (Feb. 2012); FTN; Western Asset Mgmt.;
IAA; PUC Texas; ICI (Feb. 2012); IIB/EBF; Invesco.
In addition, some commenters recognized that other
market participants are likely to fill banking
entities’ roles in the long term, but not in the short
term. See, e.g., ICFR; Comm. on Capital Markets
Regulation; Oliver Wyman (Feb. 2012).
565 See Oliver Wyman (Feb. 2012) (‘‘Major bankaffiliated market makers have large capital bases,
balance sheets, technology platforms, global
operations, relationships with clients, sales forces,
risk infrastructure, and management processes that
would take smaller or new dealers years and
billions of dollars to replicate.’’).
566 See SIFMA et al. (Prop. Trading) (Feb. 2012).

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replace lost trading activity from
banking entities, the value of the current
interdealer network among market
makers will be reduced due to the exit
of banking entities.567 Several
commenters expressed the view that
migration of market making-related
activities to firms outside the banking
system would be inconsistent with
Congressional intent and would have
potentially adverse consequences for the
safety and soundness of the U.S.
financial system.568
Many commenters requested
additional clarification on how the
proposed market-making exemption
would apply to certain asset classes and
markets or to particular types of market
making-related activities. In particular,
commenters requested greater clarity
regarding the permissibility of: (i)
interdealer trading,569 including trading
for price discovery purposes or to test
market depth; 570 (ii) inventory
management; 571 (iii) block positioning
activity; 572 (iv) acting as an authorized
participant or market maker in ETFs; 573
(v) arbitrage or other activities that
promote price transparency and
liquidity; 574 (vi) primary dealer
activity; 575 (vii) market making in
futures and options; 576 (viii) market
567 See

Thakor Study.
e.g., Prof. Duffie; Oliver Wyman (Feb.

making in new or bespoke products or
customized hedging contracts; 577 and
(ix) inter-affiliate transactions.578 As
discussed in more detail in Part
IV.B.2.c., a number of commenters
requested that the market-making
exemption apply to the restrictions on
acquiring or retaining an ownership
interest in a covered fund.579 Some
commenters stated that no other
activities should be considered
permitted market making-related
activity under the rule.580 In addition, a
few commenters requested clarification
that high-frequency trading would not
qualify for the market-making
exemption.581
3. Final Market-Making Exemption
After carefully considering comment
letters, the Agencies are adopting
certain refinements to the proposed
market-making exemption. The
Agencies are adopting a market-making
exemption that is consistent with the
statutory exemption for this activity and
designed to permit banking entities to
continue providing intermediation and
liquidity services. The Agencies note
that, while all market-making activity
should ultimately be related to the
intermediation of trading, whether
directly to individual customers through
bilateral transactions or more broadly to

568 See,

2012).
569 See, e.g., MetLife; SIFMA et al. (Prop. Trading)
(Feb. 2012); RBC; Credit Suisse (Seidel); JPMC;
BoA; ACLI (Feb. 2012); AFR et al. (Feb. 2012); ISDA
(Feb. 2012); Goldman (Prop. Trading); Oliver
Wyman (Feb. 2012).
570 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Chamber (Feb. 2012); Goldman (Prop. Trading).
571 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Credit Suisse (Seidel); Goldman (Prop.
Trading); MFA; RBC.
572 See infra Part IV.A.3.c.1.b.ii. (discussing
commenters’ requests for greater clarity regarding
the permissibility of block positioning activity).
573 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Credit Suisse (Seidel); JPMC; Goldman (Prop.
Trading); BoA; ICI (Feb. 2012); ICI Global;
Vanguard; SSgA (Feb. 2012).
574 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Credit Suisse (Seidel); JPMC; Goldman (Prop.
Trading); FTN; RBC; ISDA (Feb. 2012).
575 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); JPMC; Goldman (Prop. Trading); Banco de
Me´xico; IIB/EBF.
576 See CME Group (requesting clarification that
the market-making exemption permits a banking
entity to engage in market making in exchangetraded futures and options because the dealer
registration requirement in § ll.4(b)(2)(iv) of the
proposed rule did not refer to such instruments and
stating that lack of an explicit exemption would
reduce market-making activities in these
instruments, which would decrease liquidity). But
See Johnson & Prof. Stiglitz (stating that the
Agencies should pay special attention to options
trading and other derivatives because they are
highly volatile assets that are difficult if not
impossible to effectively hedge, except through a
completely matched position, and suggesting that
options and similar derivatives may need to be
required to be sold only as riskless principal under

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§ ll.6(b)(1)(ii) of the proposed rule or
significantly limited through capital charges); Sens.
Merkley & Levin (Feb. 2012) (stating that asset
classes that are particularly hard to hedge, such as
options, should be given special attention under the
hedging exemption).
577 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Credit Suisse (Seidel); JPMC; Goldman (Prop.
Trading); SIFMA (Asset Mgmt.) (Feb. 2012). Other
commenters, however, stated that banking entities
should be limited in their ability to rely on the
market-making exemption to conduct transactions
in bespoke or customized derivatives. See, e.g., AFR
et al. (Feb. 2012); Public Citizen.
578 See, e.g., Japanese Bankers Ass’n. (stating that
transactions with affiliates and subsidiaries and
related to hedging activities are a type of market
making-related activity or risk-mitigating hedging
activity that should be exempted by the rule);
SIFMA et al. (Prop. Trading) (Feb. 2012). According
to one of these commenters, inter-affiliate
transactions should be viewed as part of a
coordinated activity for purposes of determining
whether a banking entity qualifies for an
exemption. This commenter stated that, for
example, if a market maker shifts positions held in
inventory to an affiliate that is better able to manage
the risk of such positions, both the market maker
and its affiliate would be engaged in permitted
market making-related activity. This commenter
further represented that fitting the inter-affiliate
swap into the exemption may be difficult (e.g., one
of the affiliates entering into the swap may not be
holding itself out as a willing counterparty). See
SIFMA et al. (Prop. Trading) (Feb. 2012).
579 See, e.g., Cleary Gottlieb; JPMC; BoA; Credit
Suisse (Williams).
580 See, e.g., Occupy; Alfred Brock.
581 See, e.g., Occupy; AFR et al. (Feb. 2012);
Public Citizen; Johnson & Prof. Stiglitz; Sens.
Merkley & Levin (Feb. 2012); John Reed.

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a given marketplace, certain
characteristics of a market-making
business may differ among markets and
asset classes.582 The final rule is
intended to account for these
differences to allow banking entities to
continue to engage in market makingrelated activities by providing customer
intermediation and liquidity services
across markets and asset classes, if such
activities do not violate the statutory
limitations on permitted activities (e.g.,
by involving or resulting in a material
conflict of interest with a client,
customer, or counterparty) and are
conducted in conformance with the
exemption.
At the same time, the final rule
requires development and
implementation of trading, risk and
inventory limits, risk management
strategies, analyses of how the specific
market making-related activities are
designed not to exceed the reasonably
expected near term demands of
customers, compensation standards, and
monitoring and review requirements
that are consistent with market-making
activities.583 These requirements are
designed to distinguish exempt market
making-related activities from
impermissible proprietary trading. In
addition, these requirements are
designed to ensure that a banking entity
is aware of, monitors, and limits the
risks of its exempt activities consistent
with the prudent conduct of market
making-related activities.
As described in detail below, the final
market-making exemption consists of
the following elements:
• A framework that recognizes the
differences in market making-related
activities across markets and asset
582 Consistent with the FSOC study and the
proposal, the final rule recognizes that 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
type of financial instrument. See Joint Proposal, 76
FR 68,870; CFTC Proposal, 77 FR 8356; FSOC study
(stating that ‘‘characteristics of permitted activities
in one market or asset class may not be the same
in another market (e.g., permitted activities in a
liquid equity securities market may vary
significantly from an illiquid over-the-counter
derivatives market)’’).
583 Certain of these requirements, like the
requirements to have risk and inventory limits, risk
management strategies, and monitoring and review
requirements were included in the enhanced
compliance program requirement in proposed
Appendix C, but were not separately included in
the proposed market-making exemption. Like the
statute, the proposed rule would have required that
market making-related activities be designed not to
exceed the reasonably expected near term demand
of clients, customers, or counterparties. The
Agencies are adding an explicit requirement in the
final rule that a trading desk conduct analyses of
customer demand for purposes of complying with
this statutory requirement.

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classes by establishing criteria that can
be applied based on the liquidity,
maturity, and depth of the market for
the particular type of financial
instrument.
• A general focus on analyzing the
overall ‘‘financial exposure’’ and
‘‘market-maker inventory’’ held by any
given trading desk rather than a
transaction-by-transaction analysis. The
‘‘financial exposure’’ reflects the
aggregate risks of the financial
instruments, and any associated loans,
commodities, or foreign exchange or
currency, held by a banking entity or its
affiliate and managed by a particular
trading desk as part of its market
making-related activities. The ‘‘marketmaker inventory’’ means all of the
positions, in the financial instruments
for which the trading desk stands ready
to make a market that are managed by
the trading desk, including the trading
desk’s open positions or exposures
arising from open transactions.584
• A definition of the term ‘‘trading
desk’’ that focuses on the operational
functionality of the desk rather than its
legal status, and requirements that apply
at the trading desk level of organization
within a single banking entity or across
two or more affiliates.585
• Five requirements for determining
whether a banking entity is engaged in
permitted market making-related
activities. Many of these criteria have
similarities to the factors included in
the proposed rule, but with important
modifications in response to comments.
These standards require that:
Æ The trading desk that establishes
and manages a financial exposure
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure and is willing and available to
quote, buy and sell, or otherwise enter
into long and short positions in those
types of financial instruments for its
own account, in commercially
reasonable amounts and throughout
market cycles, on a basis appropriate for
the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments; 586
Æ The amount, types, and risks of the
financial instruments in the trading
desk’s market-maker inventory are
designed not to exceed, on an ongoing
584 See infra Part IV.A.3.c.1.c.ii. See also final rule
§§ ll.4(b)(4), (5).
585 See infra Part IV.A.3.c.1.c.i. The term ‘‘trading
desk’’ is defined as ‘‘the smallest discrete unit of
organization of a banking entity that buys or sells
financial instruments for the trading account of the
banking entity or an affiliate thereof.’’ Final rule
§ ll.3(e)(13).
586 See final rule § ll.4(b)(2)(i); infra Part
IV.A.3.c.1.c.iii.

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5581

basis, the reasonably expected near term
demands of clients, customers, or
counterparties, as required by the
statute and based on certain factors and
analysis; 587
Æ The banking entity has established
and implements, maintains, and
enforces an internal compliance
program that is reasonably designed to
ensure its compliance with the marketmaking exemption, including
reasonably designed written policies
and procedures, internal controls,
analysis, and independent testing
identifying and addressing:
D The financial instruments each
trading desk stands ready to purchase
and sell in accordance with § ll
.4(b)(2)(i) of the final rule;
D The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with its established
limits; the products, instruments, and
exposures each trading desk may use for
risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
inventory; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective; 588
D Limits for each trading desk, based
on the nature and amount of the trading
desk’s market making-related activities,
including factors used to determine the
reasonably expected near term demands
of clients, customers, or counterparties,
on: the amount, types, and risks of its
market-maker inventory; the amount,
types, and risks of the products,
instruments, and exposures the trading
desk uses for risk management
purposes; the level of exposures to
relevant risk factors arising from its
financial exposure; and the period of
time a financial instrument may be held;
D Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
D Authorization procedures,
including escalation procedures that
587 See final rule § ll.4(b)(2)(ii); infra Part
IV.A.3.c.2.c. In addition, the Agencies are adopting
a definition of the terms ‘‘client,’’ ‘‘customer,’’ and
‘‘counterparty’’ in § ll.4(b)(3) of the final rule.
588 Routine market making-related risk
management activity by a trading desk is permitted
under the market-making exemption and, provided
the standards of the exemption are met, is not
required to separately meet the requirements of the
hedging exemption. The circumstances under
which risk management activity relating to the
trading desk’s financial exposure is permitted under
the market-making exemption or must separately
comply with the hedging exemption are discussed
in more detail in Parts IV.A.3.c.1.c.ii. and
IV.A.3.c.4., infra.

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require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis that the
basis for any temporary or permanent
increase to a trading desk’s limit(s) is
consistent with the requirements of the
market-making exemption, and
independent review of such
demonstrable analysis and approval; 589
Æ To the extent that any limit
identified above is exceeded, the trading
desk takes action to bring the trading
desk into compliance with the limits as
promptly as possible after the limit is
exceeded; 590
Æ The compensation arrangements of
persons performing market makingrelated activities are designed not to
reward or incentivize prohibited
proprietary trading; 591 and
Æ The banking entity is licensed or
registered to engage in market makingrelated activities in accordance with
applicable law.592
• The use of quantitative
measurements to highlight activities
that warrant further review for
compliance with the exemption.593 As
discussed further in Part IV.C.3., the
Agencies have reduced some of the
compliance burdens by adopting a more
tailored subset of metrics than was
proposed to better focus on those
metrics that the Agencies believe are
most germane to the evaluation of the
activities that firms conduct under the
market-making exemption.
In refining the proposed approach to
implementing the statute’s marketmaking exemption, the Agencies closely
considered the various alternative
approaches suggested by
commenters.594 However, like the
proposed approach, the final marketmaking exemption continues to adhere
to the statutory mandate that provides
for an exemption to the prohibition on
proprietary trading for market makingrelated activities. Therefore, the final
rule focuses on providing a framework
for assessing whether trading activities
are consistent with market making. The
Agencies believe this approach is
589 See final rule § ll.4(b)(2)(iii); infra Part
IV.A.3.c.3.
590 See final rule § ll.4(b)(2)(iv).
591 See final rule § ll.4(b)(2)(v); infra Part
IV.A.3.c.5.
592 See final rule § ll.4(b)(2)(vi); infra Part
IV.A.3.c.6. As discussed further below, this
provision pertains to legal registration or licensing
requirements that may apply to an entity engaged
in market making-related activities, depending on
the facts and circumstances. This provision would
not require a banking entity to comply with
registration requirements that are not required by
law, such as discretionary registration with a
national securities exchange as a market maker on
that exchange.
593 See infra Part IV.C.3.
594 See supra Part IV.A.3.b.2.

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consistent with the statute 595 and
strikes an appropriate balance between
commenters’ desire for both clarity and
flexibility. For example, while a brightline or safe harbor based approach
would generally provide a high degree
of certainty about whether an activity
qualifies for the market-making
exemption, it would also provide less
flexibility to recognize the differences in
market-making activities across markets
and asset classes.596 In addition, any
bright-line approach would be more
likely to be subject to gaming and
avoidance as new products and types of
trading activities are developed than
other approaches to implementing the
market-making exemption.597 Although
a purely guidance-based approach
would provide greater flexibility, it
would also provide less clarity, which
could make it difficult for trading
personnel, internal compliance
personnel, and Agency supervisors and
examiners to determine whether an
activity complies with the rule and
would lead to an increased risk of
evasion of the statutory requirements.598
595 Certain approaches suggested by commenters,
such as relying solely on capital requirements,
requiring ring fencing, permitting all swap dealing
activity, or focusing solely on how traders are
compensated do not appear to be consistent with
the statutory language because they do not appear
to limit market making-related activity to that
which is designed not to exceed the reasonably
expected near term demands of clients, customers,
or counterparties, as required by the statute. See
Prof. Duffie; STANY; ICE; Shadow Fin. Regulatory
Comm.; ISDA (Feb. 2012); ISDA (Apr. 2012); G2
FinTech.
596 While an approach establishing a number of
safe harbors that are each tailored to a specific asset
class would address the need to recognize
differences across asset classes, such an approach
may also increase the complexity of the final rule.
Further, commenters did not provide sufficient
information to determine the appropriate
parameters of a safe harbor-based approach.
597 As noted above, a number of commenters
suggested the Agencies adopt a bright-line rule,
provide a safe harbor for certain types of activities,
or establish a presumption of compliance based on
certain factors. See, e.g., Sens. Merkley & Levin
(Feb. 2012); John Reed; Prof. Richardson; Johnson
& Prof. Stiglitz; Capital Group; Invesco; BDA (Oct.
2012); Flynn & Fusselman; Prof. Colesanti et al.;
SIFMA et al. (Prop. Trading) (Feb. 2012); IIF; NYSE
Euronext; Credit Suisse (Seidel); JPMC; Barclays;
BoA; Wells Fargo (Prop. Trading); PNC et al.; Oliver
Wyman (Feb. 2012). Many of these commenters
expressed general concern that the proposed
market-making exemption may create uncertainty
for individual traders engaged in market makingrelated activity and suggested that their proposed
approach would alleviate such concern. The
Agencies believe that the enhanced focus on risk
and inventory limits for each trading desk (which
must be tied to the near term customer demand
requirement) and the clarification that the final
market-making exemption does not require a tradeby-trade analysis should address concerns about
individual traders having to assess whether they are
complying with the market-making exemption on a
trade-by-trade basis.
598 Several commenters suggested a guidancebased approach, rather than requirements in the

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Some commenters suggested an
approach to implementing the marketmaking exemption that would focus on
metrics or other objective factors.599 As
discussed below, a number of
commenters expressed support for using
the metrics as a tool to monitor trading
activity and not to determine
compliance with the rule.600 While the
Agencies agree that quantitative
measurements are useful for purposes of
monitoring a trading desk’s activities
and are requiring certain banking
entities to calculate, record, and report
quantitative measurements to the
Agencies in the final rule, the Agencies
do not believe that quantitative
measurements should be used as a
dispositive tool for determining
compliance with the market-making
exemption.601
In response to two commenters’
request that the final rule focus on a
banking entity’s risk management
structures or risk limits and not on
attempting to define market-making
activities,602 the Agencies do not believe
that management of risk, on its own, is
sufficient to differentiate permitted
market making-related activities from
impermissible proprietary trading. For
example, the existence of a risk
management framework or risk limits,
while important, would not ensure that
a trading desk is acting as a market
maker by engaging in customer-facing
activity and providing intermediation
and liquidity services.603 The Agencies
also decline to take an approach to
implementing the market-making
exemption that would require the
development of individualized plans for
each banking entity in coordination
with the Agencies, as suggested by a few
final rule. See, e.g., SIFMA et al. (Prop. Trading)
(Feb. 2012) (suggesting that this guidance could
then be incorporated in banking entities’ policies
and procedures for purposes of complying with the
rule, in addition to the establishment of risk limits,
controls, and metrics); JPMC; BoA; PUC Texas;
SSgA (Feb. 2012); PNC et al.; Wells Fargo (Prop.
Trading).
599 See, e.g., Goldman (Prop. Trading); Morgan
Stanley; Barclays; Wellington; CalPERS; BlackRock;
SSgA (Feb. 2012); Invesco.
600 See infra Part IV.C.3. (discussing the final
rule’s metrics requirement). See SIFMA et al. (Prop.
Trading) (Feb. 2012); Wells Fargo (Prop. Trading);
RBC; ICI (Feb. 2012); Occupy (stating that there are
serious limits to the capabilities of the metrics and
the potential for abuse and manipulation of the
input data is significant); Alfred Brock.
601 See infra Part IV.C.3. (discussing the final
metrics requirement).
602 See, e.g., Japanese Bankers Ass’n.; Citigroup
(Feb. 2012).
603 However, as discussed below, the Agencies
believe risk limits can be a useful tool when they
must account for the nature and amount of a
particular trading desk’s market making-related
activities, including the reasonably expected near
term demands of clients, customers, or
counterparties.

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commenters.604 The Agencies believe it
is useful to establish a consistent
framework that will apply to all banking
entities to reduce the potential for
unintended competitive impacts that
could arise if each banking entity is
subject to an individualized plan that is
tailored to its specific organizational
structure and trading activities and
strategies.
Although the Agencies are not in the
final rule modifying the basic structure
of the proposed market-making
exemption, certain general items
suggested by commenters, such as
enhanced compliance program elements
and risk limits, have been incorporated
in the final rule text for the marketmaking exemption, instead of a separate
appendix.605 Moreover, as described
below, the final market-making
exemption includes specific substantive
changes in response to a wide variety of
commenter concerns.
The Agencies understand that the
economics of market making—and
financial intermediation in general—
require a market maker to be active in
markets. In determining the appropriate
scope of the market-making exemption,
the Agencies have been mindful of
commenters’ views on market making
and liquidity. Several commenters
stated that the proposed rule would
impact a banking entity’s ability to
engage in market making-related
activity, with corresponding reductions
in market liquidity.606 However,
604 See MetLife; Fixed Income Forum/Credit
Roundtable; ACLI (Feb. 2012).
605 The Agencies are not, however, adding certain
additional requirements suggested by commenters,
such as a new customer-facing criterion, margin
requirements, or additional provisions regarding
material conflicts of interest or high-risk assets or
trading strategies. See, e.g., Morgan Stanley;
Stephen Roach; WR Hambrecht; Sens. Merkley &
Levin (Feb. 2012). The Agencies believe that the
final rule includes sufficient requirements to ensure
that a trading desk relying on the market-making
exemption is engaged in customer-facing activity
(for example, the final rule requires the trading desk
to stand ready to buy and sell a type of financial
instrument as market maker and that the trading
desk’s market-maker inventory is designed not to
exceed the reasonably expected near term demands
of clients, customers, or counterparties). The
Agencies decline to include margin requirements in
the final exemption because banking entities are
currently subject to a number of different margin
requirements, including those applicable to, among
others: SEC-registered broker-dealers; CFTCregistered swap dealers; SEC-registered securitybased swap dealers: And foreign dealer entities.
Further, the Agencies are not providing new
requirements regarding material conflicts of interest
and high-risk assets and trading strategies in the
market-making exemption because the Agencies
believe these issues are adequately addressed in
§ ll.7 of the final rule. The limitations in § ll
.7 will apply to market making-related activities
and all other exempted activities.
606 See supra note 545 and accompanying text.
The Agencies acknowledge that reduced liquidity
can be costly. One commenter provided estimated

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commenters disagreed about whether
reduced liquidity would be beneficial or
detrimental to the market, or if any such
reductions would even materialize.607
Many commenters stated that reduced
liquidity could lead to other negative
market impacts, such as wider spreads,
higher transaction costs, greater market
volatility, diminished price discovery,
and increased cost of capital.
The Agencies understand that market
makers play an important role in
providing and maintaining liquidity
throughout market cycles and that
restricting market-making activity may
result in reduced liquidity, with
corresponding negative market impacts.
For instance, absent a market maker
who stands ready to buy and sell,
investors may have to make large price
concessions or otherwise expend
resources searching for counterparties.
By stepping in to intermediate trades
and provide liquidity, market makers
thus add value to the financial system
by, for example, absorbing supply and
demand imbalances. This often means
taking on financial exposures, in a
principal capacity, to satisfy reasonably
expected near term customer demand,
as well as to manage the risks associated
with meeting such demand.
The Agencies recognize that, as noted
by commenters, liquidity can be
associated with narrower spreads, lower
transaction costs, reduced volatility,
greater price discovery, and lower costs
of capital.608 The Agencies agree with
these commenters that liquidity
provides important benefits to the
financial system, as more liquid markets
are characterized by competitive market
makers, narrow bid-ask spreads, and
frequent trading, and that a narrowly
tailored market-making exemption
could negatively impact the market by,
as described above, forcing investors to
make price concessions or unnecessarily
expend resources searching for
impacts on asset valuation, borrowing costs, and
transaction costs in the corporate bond market
based on certain hypothetical scenarios of reduced
market liquidity. This commenter noted that its
hypothetical liquidity shifts of 5, 10, and 15
percentile points were ‘‘necessarily arbitrary’’ but
judged ‘‘to be realistic potential outcomes of the
proposed rule.’’ Oliver Wyman (Feb. 2012). Because
the Agencies have made significant modifications to
the proposed rule in response to comments, the
Agencies believe this commenter’s concerns about
the market impacts of the proposed rule have been
substantially addressed.
607 As noted above, a few commenters stated that
reduced liquidity may provide certain benefits. See,
e.g., Paul Volcker; AFR et al. (Feb. 2012); Public
Citizen; Prof. Richardson; Johnson & Prof. Stiglitz;
Better Markets (Feb. 2012); Prof. Johnson. However,
a number of commenters stated that reduced
liquidity would have negative market impacts. See
supra note 545 and accompanying text.
608 See supra Part IV.A.3.b.2.b.

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5583

counterparties.609 For example, while
bid-ask spreads compensate market
makers for providing liquidity when
asset values are uncertain, under
competitive forces, dealers compete
with respect to spreads, thus lowering
their profit margins on a per trade basis
and benefitting investors.610 Volatility is
driven by both uncertainty about
fundamental value and the liquidity
needs of investors. When markets are
illiquid, participants may have to make
large price concessions to find a
counterparty willing to trade, increasing
the importance of the liquidity channel
for addressing volatility. If liquiditybased volatility is not diversifiable,
investors will require a risk premium for
holding liquidity risk, increasing the
cost of capital.611 Commenters
additionally suggested that the effects of
diminished liquidity could be
concentrated in securities markets for
small or midsize companies or for
lesser-known issuers, where trading is
already infrequent.612 Volume in these
609 See supra Part IV.A.3.b.2.b. As discussed
above, a few other commenters suggested that to the
extent liquidity is vulnerable to destabilizing
liquidity spirals, any reduced liquidity stemming
from section 13 of the BHC Act and its
implementing rules would not necessarily be a
negative result. See AFR et al. (Feb. 2012); Public
Citizen. See also Paul Volcker. These commenters
also suggested that the Agencies adopt stricter
conditions in the market-making exemption, as
discussed throughout this Part IV.A.3. However,
liquidity—essentially, the ease with which assets
can be converted into cash—is not destabilizing in
and of itself. Rather, liquidity spirals are a function
of how firms are funded. During market downturns,
when margin requirements tend to increase, firms
that fund their operations with leverage face higher
costs of providing liquidity; firms that run up
against their maximum leverage ratios may be
forced to retreat from market making, contributing
to the liquidity spiral. Viewed in this light, it is
institutional features of financial markets—in
particular, leverage—rather than liquidity itself that
contributes to liquidity spirals.
610 Wider spreads can be costly for investors. For
example, one commenter estimated that a 10 basis
point increase in spreads in the corporate bond
market would cost investors $29 billion per year.
See Wellington. Wider spreads can also be
particularly costly for open-end mutual funds,
which must trade in and out of the fund’s portfolio
holdings on a daily basis in order to satisfy
redemptions and subscriptions. See Wellington;
AllianceBernstein.
611 A higher cost of capital increases financing
costs and translates into reduced capital
investment. While one commenter estimated that a
one percent increase in the cost of capital would
lead to a $55 to $82.5 billion decline in capital
investments by U.S. nonfarm firms, the Agencies
cannot independently verify these potential costs.
Further, this commenter did not indicate what
aspect of the proposed rule could cause a one
percent increase in the cost of capital. See Thakor
Study. In any event, the Agencies have made
significant changes to the proposed approach to
implementing the market-making exemption that
should help address this commenter’s concern.
612 See, e.g., CIEBA; ACLI; PNC et al.; Morgan
Stanley; Chamber (Feb. 2012); Abbott Labs et al.

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markets can be low, increasing the
inventory risk of market makers. The
Agencies recognize that, if the final rule
creates disincentives for banking
entities to provide liquidity, these low
volume markets may be impacted first.
As discussed above, the Agencies
received several comments suggesting
that the negative consequences
associated with reduced liquidity would
be unlikely to materialize under the
proposed rule. For example, a few
commenters stated that non-bank
financial intermediaries, who are not
subject to section 13 of the BHC Act,
may increase their market-making
activities in response to any reduction
in market making by banking entities, a
topic the Agencies discuss in more
detail below.613 In addition, some
commenters suggested that the
restrictions on proprietary trading
would support liquid markets by
encouraging banking entities to focus on
financial intermediation activities that
supply liquidity, rather than proprietary
trades that demand liquidity, such as
speculative trades or trades that frontrun institutional investors.614 The
statute prohibits proprietary trading
activity that is not exempted. As such,
the termination of nonexempt
proprietary trading activities of banking
entities may lead to some general
reductions in liquidity of certain asset
classes. Although the Agencies cannot
say with any certainty, there is good
reason to believe that to a significant
extent the liquidity reductions of this
type may be temporary since the statute
does not restrict proprietary trading
activities of other market participants.
Thus, over time, non-banking entities
may provide much of the liquidity that
is lost by restrictions on banking
entities’ trading activities. If so,
eventually, the detrimental effects of
increased trading costs, higher costs of
capital, and greater market volatility
should be mitigated.
Based on the many detailed
comments provided, the Agencies have
made substantive refinements to the
market-making exemption that the
Agencies believe will reduce the
likelihood that the rule, as
implemented, will negatively impact the
ability of banking entities to engage in
the types of market making-related
activities permitted under the statute
and, therefore, will continue to promote
(Feb. 14, 2012); FEI; ICI (Feb. 2012); TMA Hong
Kong; Sen. Casey.
613 See, e.g., Sens. Merkley & Levin (Feb. 2012);
Prof. Richardson; Better Markets (Feb. 2012); Profs.
Stout & Hastings; Prof. Johnson; Occupy; Public
Citizen; Profs. Admati & Pfleiderer; Better Markets
(June 2012).
614 See, e.g., Prof. Johnson.

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the benefits to investors and other
market participants described above,
including greater market liquidity,
narrower bid-ask spreads, reduced price
concessions and price impact, lower
volatility, and reduced counterparty
search costs, thus reducing the cost of
capital. For instance, the final marketmaking exemption does not require a
trade-by-trade analysis, which was a
significant source of concern from
commenters who represented, among
other things, that a trade-by-trade
analysis could have a chilling effect on
individual traders’ willingness to engage
in market-making activities.615 Rather,
the final rule has been crafted around
the overall market making-related
activities of individual trading desks,
with various requirements that these
activities be demonstrably related to
satisfying reasonably expected near term
customer demands and other marketmaking activities. The Agencies believe
that applying certain requirements to
the aggregate risk exposure of a trading
desk, along with the requirement to
establish risk and inventory limits to
routinize a trading desk’s compliance
with the near term customer demand
requirement, will reduce negative
potential impacts on individual traders’
decision-making process in the normal
course of market making.616 In addition,
in response to a large number of
comments expressing concern that the
proposed market-making exemption
would restrict or prohibit market
making-related activities in less liquid
markets, the Agencies are clarifying that
the application of certain requirements
in the final rule, such as the frequency
of required quoting and the near term
demand requirement, will account for
the liquidity, maturity, and depth of the
market for a given type of financial
instrument. Thus, banking entities will
be able to continue to engage in market
making-related activities across markets
and asset classes.
At the same time, the Agencies
recognize that an overly broad marketmaking exemption may allow banking
entities to mask speculative positions as
liquidity provision or related hedges.
The Agencies believe the requirements
included in the final rule are necessary
to prevent such evasion of the marketmaking exemption, ensure compliance
615 See supra note 517 (discussing commenters’
concerns regarding a trade-by-trade analysis).
616 For example, by clarifying that individual
trades will not be viewed in isolation and requiring
strong compliance procedures, this approach will
generally allow an individual trader to operate
within the compliance framework established for
his or her trading desk without having to assess
whether each individual transaction complies with
all requirements of the market-making exemption.

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with the statute, and facilitate internal
banking entity and external Agency
reviews of compliance with the final
rule. Nevertheless, the Agencies
acknowledge that these additional costs
may have an impact on banking entities’
willingness to engage in market makingrelated activities. Banking entities will
incur certain compliance costs in
connection with their market makingrelated activities under the final rule.
For example, banking entities may not
currently limit their trading desks’
market-maker inventory to that which is
designed not to exceed reasonably
expected near term customer demand,
as required by the statute.
As discussed above, commenters
presented diverging views on whether
non-banking entities are likely to enter
the market or increase their marketmaking activities if the final rule should
cause banking entities to reduce their
market-making activities.617 The
Agencies note that prior to the GrammLeach-Bliley Act of 1999, marketmaking services were more commonly
provided by non-bank-affiliated brokerdealers than by banking entities. As
discussed above, by intermediating and
facilitating trading, market makers
provide value to the markets and profit
from providing liquidity. Should
banking entities retreat from making
markets, the profit opportunities
available from providing liquidity will
provide an incentive for non-bankaffiliated broker-dealers to enter the
market and intermediate trades. The
Agencies are unable to assess the likely
effect with any certainty, but the
Agencies recognize that a marketmaking operation requires certain
infrastructure and capital, which will
impact the ability of non-banking
entities to enter the market-making
business or to increase their presence.
Therefore, should banking entities
retreat from making markets, there
could be a transition period with
reduced liquidity as non-banking
entities build up the needed
infrastructure and obtain capital.
However, because the Agencies have
substantially modified this exemption
in response to comments to ensure that
617 See supra notes 560 and 564 and
accompanying text (discussing comments on the
issue of whether non-banking entities are likely to
enter the market or increase their trading activities
in response to reduced trading activity by banking
entities). For example, one commenter stated that
broker-dealers that are not affiliated with a bank
would have reduced access to lender-of-last resort
liquidity from the central bank, which could limit
their ability to make markets during times of market
stress or when capital buffers are small. See Prof.
Duffie. However, another commenter noted that the
presence and evolution of market making after the
enactment of the Glass-Steagall Act mutes this
particular concern. See Prof. Richardson.

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market making related to near-term
customer demand is permitted as
contemplated by the statute, the
Agencies do not believe the final rule
should significantly impact currentlyavailable market-making services.618
c. Detailed Explanation of the MarketMaking Exemption
1. Requirement To Routinely Stand
Ready to Purchase and Sell

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a. Proposed Requirement To Hold Self
Out
Section ll.4(b)(2)(ii) of the
proposed rule would have required the
trading desk or other organizational unit
that conducts the purchase or sale in
reliance on the market-making
exemption to hold itself out as being
willing to buy and sell, including
through entering into long and short
positions in, the financial instrument for
its own account on a regular or
continuous basis.619 The proposal stated
that a banking entity could rely on the
proposed exemption only for the type of
financial instrument that the entity
actually made a market in.620
The proposal recognized that 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 financial
instrument.621 To account for these
variations, the Agencies proposed
indicia for assessing compliance with
this requirement that differed between
relatively liquid markets and less liquid
618 Certain non-banking entities, such as some
SEC-registered broker-dealers that are not banking
entities subject to the final rule, currently engage in
market-making activities and, thus, should have the
needed infrastructure and may attract additional
capital. If the final rule has a marginal impact on
banking entities’ willingness to engage in market
making-related activities, these non-banking entities
should be able to respond by increasing their
market making-related activities. The Agencies
recognize, however, that firms that do not have
existing infrastructure or sufficient capital are
unlikely to be able to act as market makers shortly
after the final rule is implemented. Nevertheless,
because some non-bank-affiliated broker-dealers
currently operate market-making desks, and
because it was the dominant model prior to the
Gramm-Leach-Bliley Act, the Agencies believe that
non-bank-affiliated financial intermediaries will be
able to provide market-making services longer term.
619 See proposed rule § ll.4(b)(2)(ii).
620 See Joint Proposal, 76 FR 68,870 (‘‘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
[financial instrument] involved; simply because a
banking entity makes a market in one type of
[financial instrument] does not permit it to rely on
the market-making exemption for another type of
[financial instrument].’’); CFTC Proposal, 77 FR
8355–8356.
621 See Joint Proposal, 76 FR 68,870; CFTC
Proposal, 77 FR 8356.

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markets. Further, the Agencies
recognized that the proposed indicia
could not 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-related activity is conducted.
In particular, the proposal stated that
a trading desk or other organizational
unit’s market making-related activities
in relatively liquid markets, such as
equity securities or other exchangetraded instruments, should generally
include: (i) Making continuous, twosided quotes and holding oneself out as
willing to buy and sell on a continuous
basis; (ii) a pattern of trading that
includes both purchases and sales in
roughly comparable amounts to provide
liquidity; (iii) making continuous
quotations that are at or near the market
on both sides; and (iv) providing widely
accessible and broadly disseminated
quotes.622 With respect to market
making in less liquid markets, the
proposal noted that the appropriate
indicia of market making-related
activities will vary, but should generally
include: (i) holding oneself out as
willing and available to provide
liquidity by providing quotes on a
regular (but not necessarily continuous)
basis; 623 (ii) with respect to securities,
regularly purchasing securities from, or
selling securities to, clients, customers,
or counterparties in the secondary
market; and (iii) transaction volumes
and risk proportionate to historical
customer liquidity and investments
needs.624
In discussing this proposed
requirement, the Agencies stated that
bona fide market making-related activity
may include certain block positioning
and anticipatory position-taking. More
specifically, the proposal indicated that
the bona fide market making-related
activity described in § ll.4(b)(2)(ii) of
the proposed rule would include: (i)
block positioning if undertaken by a
trading desk or other organizational unit
of a banking entity for the purpose of
622 See Joint Proposal, 76 FR 68,870–68,871;
CFTC Proposal, 77 FR 8356. These proposed factors
are generally consistent with the indicia used by the
SEC to assess whether a broker-dealer is engaged in
bona fide market making for purposes of Regulation
SHO under the Exchange Act. See Joint Proposal,
76 FR 68,871 n.148; CFTC Proposal, 77 FR 8356
n.155.
623 The Agencies noted that, with respect to this
factor, the frequency of regular quotations will vary,
as moderately illiquid markets may involve
quotations on a daily or more frequent basis, while
highly illiquid markets may trade only by
appointment. See Joint Proposal, 76 FR 68,871
n.149; CFTC Proposal, 77 FR 8356 n.156.
624 See Joint Proposal, 76 FR 68,871; CFTC
Proposal, 77 FR 8356.

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intermediating customer trading; 625 and
(ii) 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.626
b. Comments on the Proposed
Requirement To Hold Self Out
Commenters raised many issues
regarding § ll.4(b)(2)(ii) of the
proposed exemption, which would
require a trading desk or other
organizational unit to hold itself out as
willing to buy and sell the financial
instrument for its own account on a
regular or continuous basis. As
discussed below, some commenters
viewed the proposed requirement as too
restrictive, while other commenters
stated that the requirement was too
permissive. Two commenters expressed
support for the proposed
requirement.627 A number of
commenters provided views on
statements in the proposal regarding
indicia of bona fide market making in
more and less liquid markets and the
permissibility of block positioning and
anticipatory position-taking.
Several commenters represented that
the proposed requirement was too
restrictive.628 For example, a number of
these commenters expressed concern
that the proposed requirement may limit
a banking entity’s ability to act as a
market maker under certain
circumstances, including in less liquid
markets, for instruments lacking a twosided market, or in customer-driven,
structured transactions.629 In addition, a
few commenters expressed specific
concern about how this requirement
would impact more limited marketmaking activity conducted by banks.630
625 In the preamble to the proposed rule, the
Agencies stated that the SEC’s definition of
‘‘qualified block positioner’’ may serve as guidance
in determining whether a block positioner engaged
in block positioning is engaged in bona fide market
making for purposes of § ll.4(b)(2)(ii) of the
proposed rule. See Joint Proposal, 76 FR 68,871
n.151; CFTC Proposal, 77 FR 8356 n.157.
626 See Joint Proposal, 76 FR 68,871; CFTC
Proposal, 77 FR 8356–8357.
627 See Sens. Merkley & Levin (Feb. 2012); Alfred
Brock.
628 See infra Part IV.A.3.c.1.c.iii. (addressing
these concerns).
629 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Morgan Stanley; Barclays; Goldman (Prop.
Trading); ABA; Chamber (Feb. 2012); BDA (Feb.
2012); Fixed Income Forum/Credit Roundtable;
ACLI (Feb. 2012); T. Rowe Price; PUC Texas; PNC;
MetLife; RBC; IHS; SSgA (Feb. 2012).
630 See, e.g., PNC (stating that the proposed rule
needs to account for market making by regional
banks on behalf of small and middle-market
customers whose securities are less liquid); ABA
(stating that the rule should continue to permit

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Many commenters indicated that it
was unclear whether this provision
would require a trading desk or other
organizational unit to regularly or
continuously quote every financial
instrument in which a market is made,
but expressed concern that the proposed
language could be interpreted in this
manner.631 These commenters noted
that there are thousands of individual
instruments within a given asset class,
such as corporate bonds, and that it
would be burdensome for a market
maker to provide quotes in such a large
number of instruments on a regular or
continuous basis.632 One of these
commenters represented that, because
customer demand may be infrequent in
a particular instrument, requiring a
banking entity to provide regular or
continuous quotes in the instrument
may not provide a benefit to its
customers.633 A few commenters
requested that the Agencies provide
further guidance on this issue or modify
the proposed standard to state that
holding oneself out in a range of similar
instruments will be considered to be
within the scope of permitted market
making-related activities.634
banks to provide limited liquidity by buying
securities that they feel are suitable for their retail
and institutional customer base by stating that a
bank is ‘‘holding itself out’’ when it buys and sells
securities that are suitable for its customers).
631 This issue is further discussed in Part
IV.A.3.c.1.c.iii., infra.
632 See, e.g., Goldman (Prop. Trading) (stating that
it would be burdensome for a U.S. credit marketmaking business to be required to produce and
disseminate quotes for thousands of individual
bond CUSIPs that trade infrequently and noting that
a market maker in credit markets will typically
disseminate indicative prices for the most liquid
instruments but, for the thousands of other
instruments that trade infrequently, the market
maker will generally provide a price for a trade
upon request from another market participant);
Morgan Stanley; SIFMA et al. (Prop. Trading) (Feb.
2012); RBC. See also BDA (Feb. 2012); FTN (stating
that in some markets, such as the markets for
residential mortgage-backed securities and
investment grade corporate debt, a market maker
will hold itself out in a subset of instruments (e.g.,
particular issues in the investment grade corporate
debt market with heavy trading volume or that are
in the midst of particular credit developments), but
will trade in other instruments within the group or
sector upon inquiry from customers and other
dealers); Oliver Wyman (Feb. 2012) (discussing data
regarding the number of U.S. corporate bonds and
frequency of trading in such bonds in 2009).
633 See Goldman (Prop. Trading).
634 See, e.g., RBC (recommending that the
Agencies clarify that a trading desk is required to
hold itself out as willing to buy and sell a particular
type of ‘‘product’’); SIFMA et al. (Prop. Trading)
(Feb. 2012) (suggesting that the Agencies use the
term ‘‘instrument,’’ rather than ‘‘covered financial
position,’’ to provide greater clarity); CIEBA
(supporting alternative criteria that would require a
banking entity to hold itself out generally as a
market maker for the relevant asset class, but not
for every instrument it purchases and sells);
Goldman (Prop. Trading). One of these commenters
recommended that the Agencies recognize and

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To address concerns about the
restrictiveness of this requirement,
commenters suggested certain
modifications. For example, some
commenters suggested adding language
to the requirement to account for market
making in markets that do not typically
involve regular or continuous, or twosided, quoting.635 In addition, a few
commenters requested that the
requirement expressly include
transactions in new instruments or
transactions in instruments that occur
infrequently to address situations where
a banking entity may not have
previously had the opportunity to hold
itself out as willing to buy and sell the
applicable instrument.636 Other
commenters supported alternative
criteria for assessing whether a banking
entity is acting as a market maker, such
as: (i) a willingness to respond to
customer demand by providing prices
upon request; 637 (ii) being in the
business of providing prices upon
request for that financial instrument or
other financial instruments in the same
permit the following kinds of activity in related
financial instruments: (i) Options market makers
should be deemed to be engaged in market making
in all put and call series related to a particular
underlying security and should be permitted to
trade the underlying security regardless of whether
such trade qualifies for the hedging exemption; (ii)
convertible bond traders should be permitted to
trade in the associated equity security; (iii) a market
maker in one issuer’s bonds should be considered
a market maker in similar bonds of other issuers;
and (iv) a market maker in standardized interest
rate swaps should be considered to be engaged in
market making-related activity if it engages in a
customized interest rate swap with a customer upon
request. See RBC.
635 See, e.g., Morgan Stanley (suggesting that the
Agencies add the phrase ‘‘or, in markets where
regular or continuous quotes are not typically
provided, the trading unit stands ready to provide
quotes upon request’’); Barclays (suggesting
addition of the phrase ‘‘to the extent that two-sided
markets are typically made by market makers in a
given product,’’ as well as changing the reference
to ‘‘purchase or sale’’ to ‘‘market making-related
activity’’ to avoid any inference of a trade-by-trade
analysis). See also Fixed Income Forum/Credit
Roundtable. To address concerns about the
requirement’s application to bespoke products, one
commenter suggested that the rule clearly state that
a banking entity fulfills this requirement if it
markets structured transactions to its client base
and stands ready to enter into such transactions
with customers, even though transactions may
occur on a relatively infrequent basis. See JPMC.
636 See Wells Fargo (Prop. Trading); RBC
(supporting this approach as an alternative to
removing the requirement from the rule, but
primarily supporting its removal). See also ISDA
(Feb. 2012) (stating that the analysis of compliance
with the proposed requirement must carefully
consider the degree of presence a market maker
wishes to have in a given market, which may
include being a leader in certain types of
instruments, having a secondary presence in others,
and potentially leaving or entering other
submarkets).
637 See SIFMA et al. (Prop. Trading) (Feb. 2012).
This commenter also suggested that such test be
assessed at the ‘‘trading unit’’ level. See id.

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or similar asset class or product
class; 638 or (iii) a historical test of
market-making activity, with
compliance judged on the basis of actual
trades.639 Finally, two commenters
stated that this requirement should be
moved to Appendix B of the rule,640
which, according to one of these
commenters, would provide the
Agencies greater flexibility to consider
the facts and circumstances of a
particular activity.641
Other commenters took the view that
the proposed requirement was too
permissive.642 For example, one
commenter stated that the proposed
standard provided too much room for
interpretation and would be difficult to
measure and monitor. This commenter
expressed particular concern that a
trading desk or other organizational unit
could meet this requirement by
regularly or continuously making wide,
out of context quotes that do not present
any real risk of execution and do not
contribute to market liquidity.643 Some
commenters suggested the Agencies
place greater restrictions on a banking
entity’s ability to rely on the marketmaking exemption in certain illiquid
markets, such as assets that cannot be
reliably valued, products that do not
have a genuine external market, or
instruments for which a banking entity
does not expect to have customers
wishing to both buy and sell.644 In
support of these requests, commenters
stated that trading in illiquid products
raises certain concerns under the rule,
including: a lack of reliable data for
purposes of using metrics to monitor a
banking entity’s market making-related
activity (e.g., products whose valuations
are determined by an internal model
that can be manipulated, rather than an
observable market price); 645 relation to
the last financial crisis; 646 lack of
important benefits to the real
economy; 647 similarity to prohibited
proprietary trading; 648 and
inconsistency with the statute’s
requirements that market makingrelated activity must be ‘‘designed not to
exceed the reasonably expected near
638 See

Goldman (Prop. Trading).
FTN.
640 See Flynn & Fusselman; JPMorgan.
641 See JPMC.
642 See, e.g., Occupy; AFR et al. (Feb. 2012);
Public Citizen; Johnson & Prof. Stiglitz; John Reed.
See infra note 746 and accompanying text
(responding to these comments).
643 See Occupy.
644 See Occupy; AFR et al. (Feb. 2012); Public
Citizen; Johnson & Prof. Stiglitz; Sens. Merkley &
Levin (Feb. 2012); John Reed.
645 See AFR et al. (Feb. 2012); Occupy.
646 See Occupy.
647 See John Reed.
648 See Johnson & Prof. Stiglitz.
639 See

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term demands of clients, customers, or
counterparties’’ and must not result in
a material exposure to high-risk assets
or high-risk trading strategies.649
These commenters also requested that
the proposed requirement be modified
in certain ways. In particular, several
commenters stated that the proposed
exemption should only permit market
making in assets that can be reliably
valued through external market
transactions.650 In order to implement
such a limitation, three commenters
suggested that the Agencies prohibit
banking entities from market making in
assets classified as Level 3 under FAS
157.651 One of these commenters
explained that Level 3 assets are
generally highly illiquid assets whose
fair value cannot be determined using
either market prices or models.652 In
addition, a few commenters suggested
that banking entities be subject to
additional capital charges for market
making in illiquid products.653 Another
commenter stated that the Agencies
should require all market makingrelated activity to be conducted on a
multilateral organized electronic trading
platform or exchange to make it possible
to monitor and confirm certain trading
649 See Sens. Merkley & Levin (Feb. 2012) (stating
that a banking entity must have or reasonably
expect at least two customers—one for each side of
the trade—and must have a reasonable expectation
of the second customer coming to take the position
or risk off its books in the ‘‘near term’’); AFR et al.
(Feb. 2012); Public Citizen.
650 See AFR et al. (Feb. 2012) (stating that the rule
should ban market making in illiquid and opaque
securities with no genuine external market, but
permit market making in somewhat illiquid
securities, such as certain corporate bonds, as long
as the securities can be reliably valued with
reference to other extremely similar securities that
are regularly traded in liquid markets and the
financial outcome of the transaction is reasonably
predictable); Johnson & Prof. Stiglitz
(recommending that permitted market making be
limited to assets that can be reliably valued in, at
a minimum, a moderately liquid market evidenced
by trading within a reasonable period, such as a
week, through a real transaction and not simply
with interdealer trades); Public Citizen (stating that
market making should be limited to assets that can
be reliably valued in a market where transactions
take place on a weekly basis).
651 See AFR et al. (Feb. 2012) (stating that such
a limitation would be consistent with the proposed
limitation on ‘‘high-risk assets’’ and the discussion
of this limitation in proposed Appendix C); Public
Citizen; Prof. Richardson.
652 See Prof. Richardson.
653 Two commenters recommended that banking
entities be required to treat trading in assets that
cannot be reliably valued and that trade only by
appointment, such as bespoke derivatives and
structured products, as providing an illiquid
bespoke loan, which are subject to higher capital
charges under the Federal banking agencies’ capital
rules. See Johnson & Prof. Stiglitz; John Reed.
Another commenter suggested that, if not directly
prohibited, trading in bespoke instruments that
cannot be reliably valued should be assessed an
appropriate capital charge. See Public Citizen.

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data.654 Two commenters emphasized
that their recommended restrictions on
market making in illiquid markets
should not prohibit banking entities
from making markets in corporate
bonds.655
i. The Proposed Indicia
As noted above, the proposal set forth
certain indicia of bona fide market
making-related activity in liquid and
less liquid markets that the Agencies
proposed to apply when evaluating
whether a banking entity was eligible
for the proposed exemption.656 Several
commenters provided their views
regarding the effectiveness of the
proposed indicia.
With respect to the proposed indicia
for liquid markets, a few commenters
expressed support for the proposed
indicia.657 One of these commenters
stated that while the proposed factors
are reasonably consistent with bona fide
market making, the Agencies should
add two other factors: (i) A willingness
to transact in reasonable quantities at
quoted prices, and (ii) inventory
turnover.658
Other commenters, however, stated
that the proposed use of factors from the
SEC’s analysis of bona fide market
making under Regulation SHO was
inappropriate in this context. In
particular, these commenters
represented that bona fide market
making for purposes of Regulation SHO
is a purposefully narrow concept that
permits a subset of market makers to
qualify for an exception from the
‘‘locate’’ requirement in Rule 203 of
Regulation SHO. The commenters
further expressed the belief that the
policy goals of section 13 of the BHC
Act do not necessitate a similarly
narrow interpretation of market
making.659
654 See Occupy. This commenter further
suggested that the exemption exclude all activities
that include: (i) Assets whose changes in value
cannot be mitigated by effective hedges; (ii) new
products with rapid growth, including those that do
not have a market history; (iii) assets or strategies
that include significant imbedded leverage; (iv)
assets or strategies that have demonstrated
significant historical volatility; (v) assets or
strategies for which the application of capital and
liquidity standards would not adequately account
for the risk; and (vi) assets or strategies that result
in large and significant concentrations to sectors,
risk factors, or counterparties. See id.
655 See AFR et al. (Feb. 2012); Johnson & Prof.
Stiglitz.
656 See supra Part IV.A.3.c.1.a.
657 See Occupy; AFR et al. (Feb. 2012); NYSE
Euronext (expressing support for the indicia set
forth in the FSOC study, which are substantially the
same as the indicia in the proposal); Alfred Brock.
658 See AFR et al. (Feb. 2012).
659 See Goldman (Prop. Trading); SIFMA et al.
(Prop. Trading) (Feb. 2012).

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5587

A few commenters expressed
particular concern about how the factor
regarding patterns of purchases and
sales in roughly comparable amounts
would apply to market making in
exchange-traded funds (‘‘ETFs’’).
According to these commenters,
demonstrating this factor could be
difficult because ETF market making
involves a pattern of purchases and
sales of groups of equivalent securities
(i.e., the ETF shares and the basket of
securities and cash that is exchanged for
them), not a single security. In addition,
the commenters were unsure whether
this factor could be demonstrated in
times of limited trading in ETF
shares.660
The preamble to the proposed rule
also provided certain proposed indicia
of bona fide market making-related
activity in less liquid markets.661 As
discussed above, commenters had
differing views about whether the
exemption for market making-related
activity should permit banking entities
to engage in market making in some or
all illiquid markets. Thus, with respect
to the proposed indicia for market
making in less liquid markets,
commenters generally stated that the
indicia should be broader or narrower,
depending on the commenter’s overall
view on the issue of market making in
illiquid markets. One commenter stated
that the proposed indicia are
effective.662
The first proposed factor of market
making-related activity in less liquid
markets was holding oneself out as
willing and available to provide
liquidity by providing quotes on a
regular (but not necessarily continuous)
basis. As noted above, several
commenters expressed concern about a
requirement that market makers provide
regular quotations in less liquid
instruments, including in fixed income
markets and bespoke, customized
derivatives.663 With respect to the
interaction between the rule language
requiring ‘‘regular’’ quoting and the
proposal’s language permitting trading
by appointment under certain
circumstances, some of these
commenters expressed uncertainty
about how a market maker trading only
by appointment would be able to satisfy
the proposed rule’s regular quotation
660 See

ICI (Feb. 2012); ICI Global.
supra Part IV.A.3.c.1.a.
662 See Alfred Brock.
663 See supra note 629 accompanying text. With
respect to this factor, one commenter requested that
the Agencies delete the parenthetical of ‘‘but not
necessarily continuous’’ from the proposed factor as
part of a broader effort to recognize the relative
illiquidity of swap markets. See ISDA (Feb. 2012).
661 See

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requirement.664 In addition, another
commenter stated that the proposal’s
recognition of trading by appointment
does not alleviate concerns about
applying the ‘‘regular’’ quotation
requirement to market making in less
liquid instruments in markets that are
not, as a whole, highly illiquid, such as
credit and interest rate markets.665
Other commenters expressed concern
about only requiring a market maker to
provide regular quotations or permitting
trading by appointment to qualify for
the market-making exemption. With
respect to regular quotations, some
commenters stated that such a
requirement enables evasion of the
prohibition on proprietary trading
because a proprietary trader may post a
quote at a time of little interest in a
financial product or may post wide, out
of context quotes on a regular basis with
no real risk of execution.666 Several
commenters stated that trading only by
appointment should not qualify as
market making for purposes of the
proposed rule.667 Some of these
commenters stated that there is no
‘‘market’’ for assets that trade only by
appointment, such as customized,
structured products and OTC
derivatives.668
The second proposed criterion for
market making-related activity in less
liquid markets was, with respect to
securities, regularly purchasing
securities from, or selling securities to,
clients, customers, or counterparties in
the secondary market. Two commenters
expressed concern about this proposed
factor.669 In particular, one of these
commenters stated that the language is
fundamentally inconsistent with market
making because it contemplates that
only taking one side of the market is
sufficient, rather than both buying and
selling an instrument.670 The other
commenter expressed concern that
banking entities would be allowed to
accumulate a significant amount of
illiquid risk because the indicia for
market making-related activity in less
liquid markets did not require a market
maker to buy and sell in comparable
664 See SIFMA et al. (Prop. Trading) (Feb. 2012);
CIEBA. These commenters requested greater clarity
or guidance on the meaning of ‘‘regular’’ in the
instance of a market maker trading only by
appointment. See id.
665 See Goldman (Prop. Trading).
666 See Public Citizen; Occupy. One of these
commenters further noted that most markets lack a
structural framework that would enable monitoring
of compliance with this requirement. See Occupy.
667 See, e.g., Sens. Merkley & Levin (Feb. 2012);
Johnson & Prof. Stiglitz; John Reed; Public Citizen.
668 See, e.g., John Reed; Public Citizen.
669 See AFR et al. (Feb. 2012); Occupy.
670 See AFR et al. (Feb. 2012)

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amounts (as required by the indicia for
liquid markets).671
Finally, the third proposed factor of
market making in less liquid markets
would consider transaction volumes
and risk proportionate to historical
customer liquidity and investment
needs. A few commenters indicated that
there may not be sufficient information
available for a banking entity to conduct
such an analysis.672 For example, one
commenter stated that historical
information may not necessarily be
available for new businesses or
developing markets in which a market
maker may seek to establish trading
operations.673 Another commenter
expressed concern that this factor would
not help differentiate market making
from prohibited proprietary trading
because most illiquid markets do not
have a source for such historical risk
and volume data.674
ii. Treatment of Block Positioning
Activity
The proposal provided that the
activity described in § ll.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
intermediating customer trading.675
A number of commenters supported
the general language in the proposal
permitting block positioning, but
expressed concern about the reference
to the definition of ‘‘qualified block
positioner’’ in SEC Rule 3b–8(c).676
With respect to using Rule 3b–8(c) as
guidance under the proposed rule, these
commenters represented that Rule 3b–
8(c)’s requirement to resell block
positions ‘‘as rapidly as possible’’ would
cause negative results (e.g., fire sales) or
create market uncertainty (e.g., when, if
ever, a longer unwind would be
permitted).677 According to one of these
commenters, gradually disposing of a
large long position purchased from a
customer may be the best means of
reducing near term price volatility
associated with the supply shock of
671 See

Occupy.
SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); Occupy.
673 See Goldman (Prop. Trading).
674 See Occupy.
675 See Joint Proposal, 76 FR 68,871.
676 See, e.g., RBC; SIFMA (Asset Mgmt.) (Feb.
2012); Goldman (Prop. Trading). See also infra note
735 (responding to these comments).
677 See RBC (expressing concern about fire sales);
SIFMA (Asset Mgmt.) (Feb. 2012) (expressing
concern about fire sales, particularly in less liquid
markets where a block position would overwhelm
the market and undercut the price a market maker
can obtain); Goldman (Prop. Trading) (representing
that this requirement could create uncertainty about
whether a longer unwind would be permissible
and, if so, under what circumstances).
672 See

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trying to sell the position at once.678
Another commenter expressed concern
about the second requirement of Rule
3b–8(c), which provides that the dealer
must determine in the exercise of
reasonable diligence that the block
cannot be sold to or purchased from
others on equivalent or better terms.
This commenter stated that this kind of
determination would be difficult in less
liquid markets because those markets do
not have widely disseminated quotes
that dealers can use for purposes of
comparison.679
Beyond the reference to Rule 3b–8(c),
a few commenters expressed more
general concern about the proposed
rule’s application to block positioning
activity.680 One commenter noted that
the proposal only discussed block
positioning in the context of the
proposed requirement to hold oneself
out, which implies that block
positioning activity also must meet the
other requirements of the marketmaking exemption. This commenter
requested an explicit recognition that
banking entities meet the requirements
of the market-making exemption when
they enter into block trades for
customers, including related trades
entered to support the block, such as
hedging transactions.681 Finally, one
commenter expressed concern that the
inventory metrics in proposed
Appendix A would make dealers
reluctant to execute large, principal
transactions because such trades would
have a transparent impact on inventory
metrics in the relevant asset class.682
iii. Treatment of Anticipatory Market
Making
In the proposal, the Agencies
proposed that ‘‘bona fide market
making-related activity may include
taking positions in securities in
678 See

Goldman (Prop. Trading).
RBC.
680 See SIFMA (Asset Mgmt.) (Feb. 2012); Fidelity
(requesting that the Agencies explicitly recognize
that block trades qualify for the market-making
exemption); Oliver Wyman (Feb. 2012).
681 See SIFMA (Asset Mgmt.) (Feb. 2012).
682 See Oliver Wyman (Feb. 2012). This
commenter estimated that investors trading out of
large block positions on their own, without a
market maker directly providing liquidity, would
have to pay incremental transaction costs between
$1.7 and $3.4 billion per year. This commenter
estimated a block trading size of $850 billion, based
on a haircut of total block trading volume reported
for NYSE and Nasdaq. The commenter then
estimated, based on market interviews and analysis
of standard market impact models provided by
dealers, that the market impact of executing large
block orders without direct market maker liquidity
provision would be the difference between the
market impact costs of executing a block trade over
a 5-day period versus a 1-day period—which would
be approximately 20 to 50 basis points, depending
on the size of the trade. See id.
679 See

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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.’’ 683 Many commenters
indicated that the language in the
proposal is inconsistent with the
statute’s language regarding near term
demands of clients, customers, or
counterparties. According to these
commenters, the statute’s ‘‘designed’’
and ‘‘reasonably expected’’ language
expressly acknowledges that a market
maker may need to accumulate
inventory before customer demand
manifests itself. Commenters further
represented that the proposed standard
may unduly limit a banking entity’s
ability to accumulate inventory in
anticipation of customer demand.684
In addition, two commenters
expressed concern that the proposal’s
language would effectively require a
banking entity to engage in
impermissible front running.685 One of
these commenters indicated that the
Agencies should not restrict
anticipatory trading to such a short time
period.686 To the contrary, the other
commenter stated that anticipatory
accumulation of inventory should be
considered to be prohibited proprietary
trading.687 A few commenters noted that
the standard in the proposal explicitly
refers to securities and requested that
the reference be changed to encompass
the full scope of financial instruments
covered by the rule to avoid
ambiguity.688 Several commenters
recommended that the language be

683 Joint Proposal, 76 FR 68,871; CFTC Proposal,
77 FR 8356–8357.
684 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012) (expressing concern that requiring trades to
be related to clear demonstrable trading interest
could curtail the market-making function by
removing a market maker’s discretion to develop
inventory to best serve its customers and adversely
restrict liquidity); Goldman (Prop. Trading);
Chamber (Feb. 2012); Comm. on Capital Markets
Regulation. See also Morgan Stanley (requesting
certain revisions to more closely track the statute);
SIFMA (Asset Mgmt.) (Feb. 2012) (expressing
general concern that the standard creates
limitations on a market maker’s inventory). These
comments are addressed in Part IV.A.3.c.2., infra.
685 See Goldman (Prop. Trading); Occupy. See
also Public Citizen (expressing general concern that
accumulating positions in anticipation of demand
opens issues of front running).
686 See Goldman (Prop. Trading).
687 See Occupy.
688 See Goldman (Prop. Trading); ISDA (Feb.
2012); SIFMA et al. (Prop. Trading) (Feb. 2012).

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eliminated 689 or modified 690 to address
the concerns discussed above.
iv. High-Frequency Trading
A few commenters stated that highfrequency trading should be considered
prohibited proprietary trading under the
rule, not permitted market makingrelated activity.691 For example, one
commenter stated that the Agencies
should not confuse high volume trading
and market making. This commenter
emphasized that algorithmic traders in
general—and high-frequency traders in
particular—do not hold themselves out
in the manner required by the proposed
rule, but instead only offer to buy and
sell when they think it is profitable.692
Another commenter suggested the
Agencies impose a resting period on any
order placed by a banking entity in
reliance on any exemption in the rule
by, for example, prohibiting a banking
entity from buying and subsequently
selling a position within a span of two
seconds.693
c. Final Requirement To Routinely
Stand Ready To Purchase And Sell
Section ll.4(b)(2)(i) of the final rule
provides that the trading desk that
establishes and manages the financial
exposure must routinely stand ready to
purchase and sell one or more types of
financial instruments related to its
financial exposure and be willing and
available to quote, buy and sell, or
otherwise enter into long and short
positions in those types of financial
689 See BoA (stating that a market maker must
acquire inventory in advance of express customer
demand and customers expect a market maker’s
inventory to include not only the financial
instruments in which customers have previously
traded, but also instruments that the banking entity
believes they may want to trade); Occupy.
690 See Morgan Stanley (suggesting a new
standard providing that a purchase or sale must be
‘‘reasonably consistent with observable customer
demand patterns and, in the case of new asset
classes or markets, with reasonably expected future
developments on the basis of the trading unit’s
client relationships’’); Chamber (Feb. 2012)
(requesting that the final rule permit market makers
to make individualized assessments of anticipated
customer demand based on their expertise and
experience in the markets and make trades
according to those assessments); Goldman (Prop.
Trading) (recommending that the Agencies instead
focus on how trading activities are ‘‘designed’’ to
meet the reasonably expected near term demands of
clients over time, rather than whether those
demands have actually manifested themselves at a
given point in time); ISDA (Feb. 2012) (stating that
the Agencies should clarify this language to
recognize differences between liquid and illiquid
markets and noting that illiquid and low volume
markets necessitate that swap dealers take a longer
and broader view than dealers in liquid markets).
691 See, e.g., Better Markets (Feb. 2012); Occupy;
Public Citizen.
692 See Better Markets (Feb. 2012). See also infra
note 742 (addressing this issue).
693 See Occupy.

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instruments for its own account, in
commercially reasonable amounts and
throughout market cycles, on a basis
appropriate for the liquidity, maturity,
and depth of the market for the relevant
types of financial instruments. As
discussed in more detail below, the
standard of ‘‘routinely’’ standing ready
to purchase and sell one or more types
of financial instruments will be
interpreted to account for differences
across markets and asset classes. In
addition, this requirement provides that
a trading desk must be willing and
available to provide quotations and
transact in the particular types of
financial instruments in commercially
reasonable amounts and throughout
market cycles. Thus, a trading desk’s
activities would not meet the terms of
the market-making exemption if, for
example, the trading desk only provides
wide quotations on one or both sides of
the market relative to prevailing market
conditions or is only willing to trade on
an irregular, intermittent basis.
While this provision of the marketmaking exemption has some similarity
to the requirement to hold oneself out
in § ll.4(b)(2)(ii) of the proposed rule,
the Agencies have made a number of
refinements in response to comments.
Specifically, a number of commenters
expressed concern that the proposed
requirement did not sufficiently account
for differences between markets and
asset classes and would unduly limit
certain types of market making by
requiring ‘‘regular or continuous’’
quoting in a particular instrument.694
The explanation of this requirement in
the proposal was intended to address
many of these concerns. For example,
the Agencies stated that the proposed
‘‘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.’’ 695 Nonetheless, the
Agencies believe that certain
modifications are warranted to clarify
the rule and to prevent a potential
chilling effect on market making-related
activities conducted by banking entities.
Commenters represented that the
requirement that a trading desk hold
itself out as being willing to buy and sell
‘‘on a regular or continuous basis,’’ as
was originally proposed, was impossible
694 See supra Part IV.A.3.c.1.b. (discussing
comments on this issue). The Agencies did not
intend for the reference to ‘‘covered financial
position’’ in the proposed rule to imply a single
instrument, although commenters contended that
the proposal may not have been sufficiently clear
on this point.
695 Joint Proposal, 76 FR 68,871; CFTC Proposal,
77 FR 8356.

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to meet or impractical in the context of
many markets, especially less liquid
markets.696 Accordingly, the final rule
requires a trading desk that establishes
and manages the financial exposure to
‘‘routinely’’ stand ready to trade one or
more types of financial instruments
related to its financial exposure. As
discussed below, the meaning of
‘‘routinely’’ will account for the
liquidity, maturity, and depth of the
market for a type of financial
instrument, which should address
commenter concern that the proposed
standard would not work in less liquid
markets and would have a chilling effect
on banking entities’ ability to act as
market makers in less liquid markets. A
concept of market making that is
applicable across securities, commodity
futures, and derivatives markets has not
previously been defined by any of the
Agencies. Thus, while this standard is
based generally on concepts from the
securities laws and is consistent with
the CFTC’s and SEC’s description of
market making in swaps,697 the
Agencies note that it is not directly
based on an existing definition of
market making.698 Instead, the approach
696 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Morgan Stanley; Barclays; Goldman (Prop.
Trading); ABA; Chamber (Feb. 2012); BDA (Feb.
2012); Fixed Income Forum/Credit Roundtable;
ACLI (Feb. 2012); T. Rowe Price; PUC Texas; PNC;
MetLife; RBC; SSgA (Feb. 2012). Some commenters
suggested alternative criteria, such as providing
prices upon request, using a historical test of market
making, or a purely guidance-based approach. See
SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman
(Prop. Trading); FTN; Flynn & Fusselman; JPMC.
The Agencies are not adopting a requirement that
the trading desk only provide prices upon request
because the Agencies believe it would be
inconsistent with market making in liquid
exchange-traded instruments where market makers
regularly or continuously post quotes on an
exchange. With respect to one commenter’s
suggested approach of a historical test of market
making, this commenter did not provide enough
information about how such a test would work for
the Agencies’ consideration. Finally, the final rule
does not adopt a purely guidance-based approach
because, as discussed further above, the Agencies
believe it could lead to an increased risk of evasion.
697 See Further Definition of ‘‘Swap Dealer,’’
‘‘Security-Based Swap Dealer,’’ ‘‘Major Swap
Participant,’’ ‘‘Major Security-Based Swap
Participant’’ and ‘‘Eligible Contract Participant’’, 77
FR 30596, 30609 (May 23, 2012) (describing market
making in swaps as ‘‘routinely standing ready to
enter into swaps at the request or demand of a
counterparty’’).
698 As a result, activity that is considered market
making under this final rule may not necessarily be
considered market making for purposes of other
laws or regulations, such as the U.S. securities laws,
the rules and regulations thereunder, or selfregulatory organization rules. In addition, the
Agencies note that a banking entity acting as an
underwriter would continue to be treated as an
underwriter for purposes of the securities laws and
the regulations thereunder, including any liability
arising under the securities laws as a result of acting
in such capacity, regardless of whether it is able to
meet the terms of the market-making exemption for
its activities. See Sens. Merkley & Levin (Feb. 2012).

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taken in the final rule is intended to
take into account and accommodate the
conditions in the relevant market for the
financial instrument in which the
banking entity is making a market.
i. Definition of ‘‘Trading Desk’’
The Agencies are adopting a marketmaking exemption with requirements
that generally focus on a financial
exposure managed by a ‘‘trading desk’’
of a banking entity and such trading
desk’s market-maker inventory. The
market-making exemption as originally
proposed would have applied to ‘‘a
trading desk or other organizational
unit’’ of a banking entity. In addition,
for purposes of the proposed
requirement to report and record certain
quantitative measurements, the proposal
defined the term ‘‘trading unit’’ as each
of the following units of organization of
a banking entity: (i) Each discrete unit
that is engaged in the coordinated
implementation of a revenue-generation
strategy and that participates in the
execution of any covered trading
activity; (ii) each organizational unit
that is used to structure and control the
aggregate risk-taking activities and
employees of one or more trading units
described in paragraph (i); and (iii) all
trading operations, collectively.699
The Agencies received few comments
regarding the organizational level at
which the requirements of the marketmaking exemption should apply, and
many of the commenters that addressed
this issue did not describe their
suggested approach in detail.700 One
commenter suggested that the marketmaking exemption apply to each
‘‘trading unit’’ of a banking entity,
defined as ‘‘each organizational unit
that is used to structure and control the
aggregate risk-taking activities and
employees that are engaged in the
coordinated implementation of a
customer-facing revenue generation
strategy and that participate in the
execution of any covered trading
activity.’’ 701 This suggested approach is
substantially similar to the second
prong of the Agencies’ proposed
definition of ‘‘trading unit’’ in Appendix
A of the proposal. The Agencies
described this prong as generally
including management or reporting
divisions, groups, sub-groups, or other
intermediate units of organization used
by the banking entity to manage one or
more discrete trading units (e.g., ‘‘North
American Credit Trading,’’ ‘‘Global
699 See Joint Proposal, 76 FR 68,957; CFTC
Proposal, 77 FR 8436.
700 See Wellington; SIFMA et al. (Prop. Trading)
(Feb. 2012).
701 Morgan Stanley.

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Credit Trading,’’ etc.).702 The Agencies
are concerned that this commenter’s
suggested approach, or any other
approach applying the exemption’s
requirements to a higher level of
organization than the trading desk,
would impede monitoring of market
making-related activity and detection of
impermissible proprietary trading by
combining a number of different trading
strategies and aggregating a larger
volume of trading activities.703 Further,
key requirements in the market-making
exemption, such as the required limits
and risk management procedures, are
generally used by banking entities for
risk control and applied at the trading
desk level. Thus, applying them at a
broader organizational level than the
trading desk would create a separate
system for compliance with this
exemption designed to permit a banking
entity to aggregate disparate trading
activities and apply limits more
generally. Applying the conditions of
the exemption at a more aggregated
level would allow banking entities more
flexibility in trading and could result in
a higher volume of trading that could
contribute modestly to liquidity.704
Instead of taking that approach, the
Agencies have determined to permit a
broader range of market making-related
activities that can be effectively
controlled by building on risk controls
used by trading desks for business
purposes. This will allow an individual
trader to use instruments or strategies
within limits established in the
compliance program to confidently
trade in the type of financial
instruments in which his or her trading
desk makes a market. The Agencies
believe this addresses concerns that
uncertainty would negatively impact
liquidity. It also addresses concerns that
applying the market-making exemption
at a higher level of organization would
reduce the effectiveness of the
requirements in the final rule aimed at
ensuring that the quality and character
of trading is consistent with market
702 See

Joint Proposal, 76 FR 68,957 n.2.
e.g., Occupy (expressing concern that,
with respect to the proposed definition of ‘‘trading
unit,’’ an ‘‘oversized’’ unit could combine
significantly unrelated trading desks, which would
impede detection of proprietary trading activity).
704 The Agencies recognize that the proposed
rule’s application to a trading desk ‘‘or other
organizational unit’’ would have provided banking
entities with this type of flexibility to determine the
level of organization at which the market-making
exemption should apply based on the entity’s
particular business structure and trading strategies,
which would likely reduce the burdens of this
aspect of the final rule. However, for the reasons
noted above regarding application of this exemption
to a higher organizational level than the trading
desk, the Agencies are not adopting the ‘‘or other
organizational unit’’ language.
703 See,

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
making-related activity and would
increase the risk of evasion. Moreover,
several provisions of the final rule are
intended to account for the liquidity,
maturity, and depth of the market for a
given type of financial instrument in
which the trading desk makes a market.
The final rule takes account of these
factors to, among other things, respond
to commenters’ concerns about the
proposed rule’s potential impact on
market making in less liquid markets.
Applying these requirements at an
organizational level above the trading
desk would be more likely to result in
aggregation of trading in various types
of instruments with differing levels of
liquidity, which would make it more
difficult for these market factors to be
taken into account for purposes of the
exemption (for example, these factors
are considered for purposes of tailoring
the analysis of reasonably expected near
term demands of customers and
establishing risk, inventory, and
duration limits).
Thus, the Agencies continue to
believe that certain requirements of the
exemption should apply to a relatively
granular level of organization within a
banking entity (or across two or more
affiliated banking entities). These
requirements of the final market-making
exemption have been formulated to best
reflect the nature of activities at the
trading desk level of granularity.
As explained below, the Agencies are
applying certain requirements to a
‘‘trading desk’’ of a banking entity and
adopting a definition of this term in the
final rule.705 The definition of ‘‘trading
desk’’ is similar to the first prong of the
proposed definition of ‘‘trading unit.’’
The Agencies are not adopting the
proposed ‘‘or other organizational unit’’
language because the Agencies are
concerned that approach would have
provided banking entities with too
much discretion to independently
determine the organizational level at
which the requirements should apply,
including a more aggregated level of
organization, which could lead to
evasion of the general prohibition on
proprietary trading and the other
concerns noted above. The Agencies
believe that adopting an approach
focused on the trading desk level will
allow banking entities and the Agencies
to better distinguish between permitted
market making-related activities and
trading that is prohibited by section 13
of the BHC Act and, thus, will prevent
evasion of the statutory requirements, as
discussed in more detail below. Further,
as discussed below, the Agencies
believe that applying requirements at
705 See

final rule § ll.3(e)(13).

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the trading desk level is balanced by the
financial exposure-based approach,
which will address commenters’
concerns about the burdens of trade-bytrade analyses.
In the final rule, trading desk is
defined to mean the smallest discrete
unit of organization of a banking entity
that buys or sells financial instruments
for the trading account of the banking
entity or an affiliate thereof. The
Agencies expect that a trading desk
would be managed and operated as an
individual unit and should reflect the
level at which the profit and loss of
market-making traders is attributed.706
The geographic location of individual
traders is not dispositive for purposes of
the analysis of whether the traders may
comprise a single trading desk. For
instance, a trading desk making markets
in U.S. investment grade telecom
corporate credits may use trading
personnel in both New York (to trade
U.S. dollar-denominated bonds issued
by U.S.-incorporated telecom
companies) and London (to trade Eurodenominated bonds issued by the same
type of companies). This approach
allows more effective management of
risks of trading activity by requiring the
establishment of limits, management
oversight, and accountability at the level
where trading activity actually occurs. It
also allows banking entities to tailor the
limits and procedures to the type of
instruments traded and markets served
by each trading desk.
In response to comments, and as
discussed below in the context of the
‘‘financial exposure’’ definition, a
trading desk may manage a financial
exposure that includes positions in
different affiliated legal entities.707
Similarly, a trading desk may include
employees working on behalf of
multiple affiliated legal entities or
booking trades in multiple affiliated
entities. Using the previous example,
the U.S. investment grade telecom
corporate credit trading desk may
include traders working for or booking
into a broker-dealer entity (for corporate
bond trades), a security-based swap
dealer entity (for single-name CDS
706 For example, the Agencies expect a banking
entity may determine the foreign exchange options
desk to be a trading desk; however, the Agencies
do not expect a banking entity to consider an
individual Japanese Yen options trader (i.e., the
trader in charge of all Yen-based options trades) as
a trading desk, unless the banking entity manages
its profit and loss, market making, and hedging in
Japanese Yen options independently of all other
financial instruments.
707 See infra note 724 and accompanying text.
Several commenters noted that market-making
activities may be conducted across separate
affiliated legal entities. See, e.g., SIFMA et al. (Prop.
Trading) (Feb. 2012); Goldman (Prop. Trading).

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trades), and/or a swap dealer entity (for
index CDS or interest rate swap hedges).
To clarify this issue, the definition of
‘‘trading desk’’ specifically provides that
the desk can buy or sell financial
instruments ‘‘for the trading account of
a banking entity or an affiliate thereof.’’
Thus, a trading desk need not be
constrained to a single legal entity,
although it is permissible for a trading
desk to only trade for a single legal
entity. A trading desk booking positions
in different affiliated legal entities must
have records that identify all positions
included in the trading desk’s financial
exposure and where such positions are
held, as discussed below.708
The Agencies believe that establishing
a defined organizational level at which
many of the market-making exemption’s
requirements apply will address
potential evasion concerns. Applying
certain requirements of the marketmaking exemption at the trading desk
level will strengthen their effectiveness
and prevent evasion of the exemption
by ensuring that the aggregate trading
activities of a relatively limited group of
traders on a single desk are conducted
in a manner that is consistent with the
exemption’s standards. In particular,
because many of the requirements in the
market-making exemption look to the
specific type(s) of financial instruments
in which a market is being made, and
such requirements are designed to take
into account differences among markets
and asset classes, the Agencies believe
it is important that these requirements
be applied to a discrete and identifiable
unit engaged in, and operated by
personnel whose responsibilities relate
to, making a market in a specific set or
type of financial instruments. Further,
applying requirements at the trading
desk level should facilitate banking
entity monitoring and review of
compliance with the exemption by
limiting the aggregate trading volume
that must be reviewed, as well as
allowing consideration of the particular
facts and circumstances of the desk’s
trading activities (e.g., the liquidity,
maturity, and depth of the market for
the relevant types of financial
instruments). As discussed above, the
Agencies believe that applying the
requirements of the market-making
exemption to a higher level of
organization would reduce the ability to
consider the liquidity, maturity, and
depth of the market for a type of
financial instrument, would impede
effective monitoring and compliance
reviews, and would increase the risk of
evasion.
708 See

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ii. Definitions of ‘‘Financial Exposure’’
and ‘‘Market-Maker Inventory’’
Certain requirements of the proposed
market-making exemption referred to a
‘‘purchase or sale of a [financial
instrument].’’ 709 Even though the
Agencies did not intend to require a
trade-by-trade review, a significant
number of commenters expressed
concern that this language could be read
to require compliance with the
proposed market-making exemption on
a transaction-by-transaction basis.710 In
response to these concerns, the
Agencies are modifying the exemption
to clarify the manner in which
compliance with certain provisions will
be assessed. In particular, rather than a
transaction-by-transaction focus, the
market-making exemption in the final
rule focuses on two related aspects of
market-making activity: A trading desk’s
‘‘market-maker inventory’’ and its
overall ‘‘financial exposure.’’ 711
The Agencies are adopting an
approach that focuses on both a trading
desk’s financial exposure and marketmaker inventory in recognition that
market making-related activity is best
viewed in a holistic manner and that,
during a single day, a trading desk may
engage in a large number of purchases
and sales of financial instruments.
While all these transactions must be
conducted in compliance with the
market-making exemption, the Agencies
recognize that they involve financial
instruments for which the trading desk
acts as market maker (i.e., by standing
ready to purchase and sell that type of
financial instrument) and instruments
that are acquired to manage the risks of
positions in financial instruments for
which the desk acts as market maker,
but in which the desk is not itself a
market maker.712
The final rule requires that activity by
a trading desk under the market-making
proposed rule § ll.4(b).
commenters also contended that
language in proposed Appendix B raised
transaction-by-transaction implications. See supra
notes 517 to 524 and accompanying text (discussing
commenters’ transaction-by-transaction concerns).
711 The Agencies are not adopting a transactionby-transaction approach because the Agencies are
concerned that such an approach would be unduly
burdensome or impractical and inconsistent with
the manner in which bona fide market makingrelated activity is conducted. Additionally, the
Agencies are concerned that the burdens of such an
approach would cause banking entities to
significantly reduce or cease market making-related
activities, which would cause negative market
impacts harmful to both investors and issuers, as
well as the financial system generally.
712 See Joint Proposal, 76 FR 68,870 n.146 (‘‘The
Agencies note that a market maker may often make
a market in one type of [financial instrument] and
hedge its activities using different [financial
instruments] in which it does not make a market.’’);
CFTC Proposal, 77 FR 8356 n.152.
709 See

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710 Some

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exemption be evaluated by a banking
entity through monitoring and setting
limits for the trading desk’s marketmaker inventory and financial exposure.
The market-maker inventory of a trading
desk includes the positions in financial
instruments, including derivatives, in
which the trading desk acts as market
maker. The financial exposure of the
trading desk includes the aggregate risks
of financial instruments in the marketmaker inventory of the trading desk plus
the financial instruments, including
derivatives, that are acquired to manage
the risks of the positions in financial
instruments for which the trading desk
acts as a market maker, but in which the
trading desk does not itself make a
market, as well as any associated loans,
commodities, and foreign exchange that
are acquired as incident to acting as a
market maker. In addition, the trading
desk generally must maintain its
market-maker inventory and financial
exposure within its market-maker
inventory limit and its financial
exposure limit, respectively and, to the
extent that any limit of the trading desk
is exceeded, the trading desk must take
action to bring the trading desk into
compliance with the limits as promptly
as possible after the limit is
exceeded.713 Thus, if market movements
cause a trading desk’s financial
exposure to exceed one or more of its
risk limits, the trading desk must
promptly take action to reduce its
financial exposure or obtain approval
for an increase to its limits through the
required escalation procedures, detailed
below. A trading desk may not,
however, enter into a trade that would
cause it to exceed its limits without first
receiving approval through its
escalation procedures.714
Under the final rule, the term marketmaker inventory is defined to mean all
of the positions, in the financial
instruments for which the trading desk
stands ready to make a market in
accordance with paragraph (b)(2)(i) of
this section, that are managed by the
trading desk, including the trading
desk’s open positions or exposures
arising from open transactions.715 Those
financial instruments in which a trading
desk acts as market maker must be
identified in the trading desk’s
compliance program under § ll
.4(b)(2)(iii)(A) of the final rule. As used
throughout this SUPPLEMENTARY
INFORMATION, the term ‘‘inventory’’
refers to both the retention of financial
instruments (e.g., securities) and, in the
context of derivatives trading, the risk
final rule § ll.4(b)(2)(iv).
final rule § ll.4(b)(2)(iii)(E).
715 See final rule § ll.4(b)(5).
713 See
714 See

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exposures arising out of market-making
related activities.716 Consistent with the
statute, the final rule requires that the
market-maker inventory of a trading
desk be designed not to exceed, on an
ongoing basis, the reasonably expected
near term demands of clients,
customers, or counterparties.
The financial exposure concept is
broader in scope than market-maker
inventory and reflects the aggregate
risks of the financial instruments (as
well as any associated loans, spot
commodities, or spot foreign exchange
or currency) the trading desk manages
as part of its market making-related
activities.717 Thus, a trading desk’s
financial exposure will take into
account a trading desk’s positions in
instruments for which it does not act as
a market maker, but which are
established as part of its market makingrelated activities, which includes risk
mitigation and hedging. For instance, a
trading desk that acts as a market maker
in Euro-denominated corporate bonds
may, in addition to Euro-denominated
bonds, enter into credit default swap
transactions on individual European
corporate bond issuers or an index of
European corporate bond issuers in
order to hedge its exposure arising from
its corporate bond inventory, in
accordance with its documented
hedging policies and procedures.
Though only the corporate bonds would
be considered as part of the trading
desk’s market-maker inventory, its
overall financial exposure would also
include the credit default swaps used
for hedging purposes.
As noted above, the Agencies believe
the extent to which a trading desk is
engaged in permitted market makingrelated activities is best determined by
716 As noted in the proposal, certain types of
market making-related activities, such as market
making in derivatives, involves the retention of
principal exposures rather than the retention of
actual financial instruments. See Joint Proposal, 76
FR 68,869 n.143; CFTC Proposal, 77 FR 8354 n.149.
This type of activity would be included under the
concept of ‘‘inventory’’ in the final rule.
717 The Agencies recognize that under the statute
a banking entity’s positions in loans, spot
commodities, and spot foreign exchange or
currency are not subject to the final rule’s
restrictions on proprietary trading. Thus, a banking
entity’s trading in these instruments does not need
to comply with the market-making exemption or
any other exemption to the prohibition on
proprietary trading. A banking entity may, however,
include exposures in loans, spot commodities, and
spot foreign exchange or currency that are related
to the desk’s market-making activities in
determining the trading desk’s financial exposure
and in turn, the desk’ s financial exposure limits
under the market-making exemption. The Agencies
believe this will provide a more accurate picture of
the trading desk’s financial exposure. For example,
a market maker in foreign exchange forwards or
swaps may mitigate the risks of its market-maker
inventory with spot foreign exchange.

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evaluating both the financial exposure
that results from the desk’s trading
activity and the amount, types, and risks
of the financial instruments in the
desk’s market-maker inventory. Both
concepts are independently valuable
and will contribute to the effectiveness
of the market-making exemption.
Specifically, a trading desk’s financial
exposure will highlight the net exposure
and risks of its positions and, along with
an analysis of the actions the trading
desk will take to demonstrably reduce
or otherwise significantly mitigate
promptly the risks of that exposure
consistent with its limits, the extent to
which it is appropriately managing the
risk of its market-maker inventory
consistent with applicable limits, all of
which are significant to an analysis of
whether a trading desk is engaged in
market making-related activities. An
assessment of the amount, types, and
risks of the financial instruments in a
trading desk’s market-maker inventory
will identify the aggregate amount of the
desk’s inventory in financial
instruments for which it acts as market
maker, the types of these financial
instruments that the desk holds at a
particular time, and the risks arising
from such holdings. Importantly, an
analysis of a trading desk’s marketmaker inventory will inform the extent
to which this inventory is related to the
reasonably expected near term demands
of clients, customers, or counterparties.
Because the market-maker inventory
concept is more directly related to the
financial instruments that a trading desk
buys and sells from customers than the
financial exposure concept, the
Agencies believe that requiring review
and analysis of a trading desk’s marketmaker inventory, as well as its financial
exposure, will enhance compliance with
the statute’s near-term customer
demand requirement. While the
amount, types, and risks of a trading
desk’s market-maker inventory are
constrained by the near-term customer
demand requirement, any other
positions in financial instruments
managed by the trading desk as part of
its market making-related activities (i.e.,
those reflected in the trading desk’s
financial exposure, but not included in
the trading desk’s market-maker
inventory) are also constrained because
they must be consistent with the
market-maker inventory or, if taken for
hedging purposes, designed to reduce
the risks of the trading desk’s marketmaker inventory.
The Agencies note that disaggregating
the trading desk’s market-maker
inventory from its other exposures also
allows for better identification of the
trading desk’s hedging positions in

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instruments for which the trading desk
does not make a market. As a result, a
banking entity’s systems should be able
to readily identify and monitor the
trading desk’s hedging positions that are
not in its market-maker inventory. As
discussed in Part IV.A.3.c.3., a trading
desk must have certain inventory and
risk limits on its market-maker
inventory, the products, instruments,
and exposures the trading desk may use
for risk management purposes, and its
financial exposure that are designed to
facilitate the trading desk’s compliance
with the exemption and that are based
on the nature and amount of the trading
desk’s market making-related activities,
including analyses regarding the
reasonably expected near term demands
of customers.718
The final rule also requires these
policies and procedures to contain
escalation procedures if a trade would
exceed the limits set for the trading
desk. However, the final rule does not
permit a trading desk to exceed the
limits solely based on customer
demand. Rather, before executing a
trade that would exceed the desk’s
limits or changing the desk’s limits, a
trading desk must first follow the
relevant escalation procedures, which
may require additional approval within
the banking entity and provide
demonstrable analysis that the basis for
any temporary or permanent increase in
limits is consistent with the reasonably
expected near term demands of
customers.
Due to these considerations, the
Agencies believe the final rule should
result in more efficient compliance
analyses on the part of both banking
entities and Agency supervisors and
examiners and should be less costly for
banking entities to implement than a
transaction-by-transaction or
instrument-by-instrument approach. For
example, the Agencies believe that some
banking entities already compute and
monitor most trading desks’ financial
exposures for risk management or other
purposes.719 The Agencies also believe
that focusing on the financial exposure
and market-maker inventory of a trading
desk, as opposed to each separate
individual transaction, is consistent
with the statute’s goal of reducing

proprietary trading risk in the banking
system and its exemption for market
making-related activities. The Agencies
recognize that banking entities may not
currently disaggregate trading desks’
market-maker inventory from their
financial exposures and that, to the
extent banking entities do not currently
separately identify trading desks’
market-maker inventory, requiring such
disaggregation for purposes of this rule
will impose certain costs. In addition,
the Agencies understand that an
approach focused solely on the
aggregate of all the unit’s trading
positions, as suggested by some
commenters, would present fewer
burdens.720 However, for the reasons
discussed above, the Agencies believe
such disaggregation is necessary to give
full effect to the statute’s near term
customer demand requirement.
The Agencies note that whether a
financial instrument or exposure
stemming from a derivative is
considered to be market-maker
inventory is based only on whether the
desk makes a market in the financial
instrument, regardless of the type of
counterparty or the purpose of the
transaction. Thus, the Agencies believe
that banking entities should be able to
develop a standardized methodology for
identifying a trading desk’s positions
and exposures in the financial
instruments for which it acts as a market
maker. As further discussed in this Part,
a trading desk’s financial exposure must
reflect the aggregate risks managed by
the trading desk as part of its market
making-related activities,721 and a
banking entity should be able to
demonstrate that the financial exposure
of a trading desk is related to its marketmaking activities.
The final rule defines ‘‘financial
exposure’’ to mean the ‘‘aggregate risks
of one or more financial instruments
and any associated loans, commodities,
or foreign exchange or currency, held by
a banking entity or its affiliate and
managed by a particular trading desk as
part of the trading desk’s market
making-related activities.’’ 722 In this
context, the term ‘‘aggregate’’ does not
imply that a long exposure in one
instrument can be combined with a
short exposure in a similar or related

718 See infra Part IV.A.3.c.2.c.; final rule
§ ll.4(b)(2)(iii)(C).
719 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012) (stating that modern trading units generally
view individual positions as a bundle of
characteristics that contribute to their complete
portfolio). See also Federal Reserve Board, Trading
and Capital-Markets Activities Manual § 2000.1
(Feb. 1998) (‘‘The risk-measurement system should
also permit disaggregation of risk by type and by
customer, instrument, or business unit to effectively
support the management and control of risks.’’).

720 See ACLI (Feb. 2012); Fixed Income Forum/
Credit Roundtable; SIFMA et al. (Prop. Trading)
(Feb. 2012).
721 See final rule § ll.4(b)(4).
722 Final rule § ll.4(b)(4). For example, in the
case of derivatives, a trading desk’s financial
position will be the residual risks of the trading
desk’s open positions. For instance, an options desk
may have thousands of open trades at any given
time, including hedges, but the desk will manage,
among other risk factors, the trading desk’s portfolio
delta, gamma, rho, and volatility.

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instrument to yield a total exposure of
zero. Instead, such a combination may
reduce a trading desk’s economic
exposure to certain risk factors that are
common to both instruments, but it
would still retain any basis risk between
those financial instruments or
potentially generate a new risk exposure
in the case of purposeful hedging.
With respect to the frequency with
which a trading desk should determine
its financial exposure and the amount,
types, and risks of the financial
instruments in its market-maker
inventory, a trading desk’s financial
exposure and market-maker inventory
should be evaluated and monitored at a
frequency that is appropriate for the
trading desk’s trading strategies and the
characteristics of the financial
instruments the desk trades, including
historical intraday volatility. For
example, a trading desk that repeatedly
acquired and then terminated
significant financial exposures
throughout the day but that had little or
no financial exposure at the end of the
day should assess its financial exposure
based on its intraday activities, not
simply its end-of-day financial
exposure. The frequency with which a
trading desk’s financial exposure and
market-maker inventory will be
monitored and analyzed should be
specified in the trading desk’s
compliance program.
A trading desk’s financial exposure
reflects its aggregate risk exposures. The
types of ‘‘aggregate risks’’ identified in
the trading desk’s financial exposure
should reflect consideration of all
significant market factors relevant to the
financial instruments in which the
trading desk acts as market maker or
that the desk uses for risk management
purposes pursuant to this exemption,
including the liquidity, maturity, and
depth of the market for the relevant
types of financial instruments. Thus,
market factors reflected in a trading
desk’s financial exposure should
include all significant and relevant
factors associated with the products and
instruments in which the desk trades as
market maker or for risk management
purposes, including basis risk arising
from such positions.723 Similarly, an
assessment of the risks of the trading
desk’s market-maker inventory must
reflect consideration of all significant
723 As

discussed in Part IV.A.3.c.3., a banking
entity must establish, implement, maintain, and
enforce policies and procedures, internal controls,
analysis, and independent testing regarding the
financial instruments each trading desk stands
ready to purchase and sell and the products,
instruments, or exposures each trading desk may
use for risk management purposes. See final rule
§ ll.4(b)(2)(iii).

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market factors relevant to the financial
instruments in which the trading desk
makes a market. Importantly, a trading
desk’s financial exposure and the risks
of its market-maker inventory will
change based on the desk’s trading
activity (e.g., buying an instrument that
it did not previously hold, increasing its
position in an instrument, or decreasing
its position in an instrument) as well as
changing market conditions related to
instruments or positions managed by
the trading desk.
Because the final rule defines ‘‘trading
desk’’ based on operational
functionality rather than corporate
formality, a trading desk’s financial
exposure may include positions that are
booked in different affiliated legal
entities.724 The Agencies understand
that positions may be booked in
different legal entities for a variety of
reasons, including regulatory reasons.
For example, a trading desk that makes
a market in corporate bonds may book
its corporate bond positions in an SECregistered broker-dealer and may book
index CDS positions acquired for
hedging purposes in a CFTC-registered
swap dealer. A financial exposure that
reflects both the corporate bond position
and the index CDS position better
reflects the economic reality of the
trading desk’s risk exposure (i.e., by
showing that the risk of the corporate
bond position has been reduced by the
index CDS position).
In addition, a trading desk engaged in
market making-related activities in
compliance with the final rule may
direct another organizational unit of the
banking entity or an affiliate to execute
a risk-mitigating transaction on the
trading desk’s behalf.725 The other
organizational unit may rely on the
market-making exemption for these
purposes only if: (i) The other
organizational unit acts in accordance
with the trading desk’s risk management
policies and procedures established in
accordance with § ll.4(b)(2)(iii) of the
final rule; and (ii) the resulting riskmitigating position is attributed to the
trading desk’s financial exposure (and
not the other organizational unit’s
financial exposure) and is included in
the trading desk’s daily profit and loss
calculation. If another organizational
unit of the banking entity or an affiliate
establishes a risk-mitigating position for
the trading desk on its own accord (i.e.,
not at the direction of the trading desk)
724 Other statutory or regulatory requirements,
including those based on prudential safety and
soundness concerns, may prevent or limit a banking
entity from booking hedging positions in a legal
entity other than the entity taking the underlying
position.
725 See infra Part IV.A.3.c.4.

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or if the risk-mitigating position is
included in the other organizational
unit’s financial exposure or daily profit
and loss calculation, then the other
organizational unit must comply with
the requirements of the hedging
exemption for such activity.726 It may
not rely on the market-making
exemption under these circumstances. If
a trading desk engages in a riskmitigating transaction with a second
trading desk of the banking entity or an
affiliate that is also engaged in
permissible market making-related
activities, then the risk-mitigating
position would be included in the first
trading desk’s financial exposure and
the contra-risk would be included in the
second trading desk’s market-maker
inventory and financial exposure. The
Agencies believe the net effect of the
final rule is to allow individual trading
desks to efficiently manage their own
hedging and risk mitigation activities on
a holistic basis, while only allowing for
external hedging directed by staff
outside of the trading desk under the
additional requirements of the hedging
exemption.
To include in a trading desk’s
financial exposure either positions held
at an affiliated legal entity or positions
established by another organizational
unit on the trading desk’s behalf, a
banking entity must be able to provide
supervisors or examiners of any Agency
that has regulatory authority over the
banking entity pursuant to section
13(b)(2)(B) of the BHC Act with records,
promptly upon request, that identify
any related positions held at an
affiliated entity that are being included
in the trading desk’s financial exposure
for purposes of the market-making
exemption. Similarly, the supervisors
and examiners of any Agency that has
supervisory authority over the banking
entity that holds financial instruments
that are being included in another
trading desk’s financial exposure for
purposes of the market-making
exemption must have the same level of
access to the records of the trading
desk.727 Banking entities should be
prepared to provide all records that
identify all positions included in a
trading desk’s financial exposure and
where such positions are held.
726 Under these circumstances, the other
organizational unit would also be required to meet
the hedging exemption’s documentation
requirement for the risk-mitigating transaction. See
final rule § ll.5(c).
727 A banking entity must be able to provide such
records when a related position is held at an
affiliate, even if the affiliate and the banking entity
are not subject to the same Agency’s regulatory
jurisdiction.

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As an example of how a trading desk’s
market-maker inventory and financial
exposure will be analyzed under the
market-making exemption, assume a
trading desk makes a market in a variety
of U.S. corporate bonds and hedges its
aggregated positions with a combination
of exposures to corporate bond indexes
and specific name CDS in which the
desk does not make a market. To qualify
for the market-making exemption, the
trading desk would have to
demonstrate, among other things, that:
(i) The desk routinely stands ready to
purchase and sell the U.S. corporate
bonds, consistent with the requirement
of § ll.4(b)(2)(i) of the final rule, and
these instruments (or category of
instruments) are identified in the
trading desk’s compliance program; (ii)
the trading desk’s market-maker
inventory in U.S. corporate bonds is
designed not to exceed, on an ongoing
basis, the reasonably expected near term
demands of clients, customers, or
counterparties, consistent with the
analysis and limits established by the
banking entity for the trading desk; (iii)
the trading desk’s exposures to
corporate bond indexes and single name
CDS are designed to mitigate the risk of
its financial exposure, are consistent
with the products, instruments, or
exposures and the techniques and
strategies that the trading desk may use
to manage its risk effectively (and such
use continues to be effective), and do
not exceed the trading desk’s limits on
the amount, types, and risks of the
products, instruments, and exposures
the trading desk uses for risk
management purposes; and (iv) the
aggregate risks of the trading desk’s
exposures to U.S. corporate bonds,
corporate bond indexes, and single
name CDS do not exceed the trading
desk’s limits on the level of exposures
to relevant risk factors arising from its
financial exposure.
Our focus on the financial exposure of
a trading desk, rather than a trade-bytrade requirement, is designed to give
banking entities the flexibility to acquire
not only market-maker inventory, but
positions that facilitate market making,
such as positions that hedge marketmaker inventory.728 As commenters
pointed out, a trade-by-trade
requirement would view trades in

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728 The

Agencies believe it is appropriate to apply
the requirements of the exemption to the financial
exposure of a ‘‘trading desk,’’ rather than the
portfolio of a higher level of organization, for the
reasons discussed above, including our concern that
aggregating a large number of disparate positions
and exposures across a range of trading desks could
increase the risk of evasion. See supra Part
IV.A.3.c.1.c.i. (discussing the determination to
apply requirements at the trading desk level).

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isolation and could fail to recognize that
certain trades that are not customerfacing are nevertheless integral to
market making and financial
intermediation.729 The Agencies
understand that the risk-reducing effects
of combining large diverse portfolios
could, in certain instances, mask
otherwise prohibited proprietary
trading.730 However, the Agencies do
not believe that taking a transaction-bytransaction approach is necessary to
address this concern. Rather, the
Agencies believe that the broader
definitions of ‘‘financial exposure’’ and
‘‘market-maker inventory’’ coupled with
the tailored definition of ‘‘trading desk’’
facilitates the analysis of aggregate risk
exposures and positions in a manner
best suited to apply and evaluate the
market-making exemption.
In short, this approach is designed to
mitigate the costs of a trade-by-trade
analysis identified by commenters. The
Agencies recognize, however, that this
approach is only effective at achieving
the goals of the section 13 of the BHC
Act—promoting financial
intermediation and limiting speculative
risks within banking entities—if there
are limits on a trading desk’s financial
exposure. That is, a permissive marketmaking exemption that gives banking
entities maximum discretion in
acquiring positions to provide liquidity
runs the risk of also allowing banking
entities to engage in speculative trades.
As discussed more fully in the following
Parts of this SUPPLEMENTARY
INFORMATION, the final market-making
exemption provides a number of
controls on a trading desk’s financial
exposure. These controls include,
among others, a provision requiring that
a trading desk’s market-maker inventory
be designed not to exceed, on an
ongoing basis, the reasonably expected
near term demands of customers and
that any other financial instruments
managed by the trading desk be
designed to mitigate the risk of such
desk’s market-maker inventory. In
addition, the final market-making
exemption requires the trading desk’s
compliance program to include
appropriate risk and inventory limits
tied to the near term demand
requirement, as well as escalation
procedures if a trade would exceed such
limits. The compliance program, which
includes internal controls and
independent testing, is designed to
prevent instances where transactions
not related to providing financial
729 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012).
730 See, e.g., Occupy.

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intermediation services are part of a
desk’s financial exposure.
iii. Routinely Standing Ready To Buy
and Sell
The requirement to routinely stand
ready to buy and sell a type of financial
instrument in the final rule recognizes
that market making-related activities
differ based on the liquidity, maturity,
and depth of the market for the relevant
type of financial instrument. For
example, a trading desk acting as a
market maker in highly liquid markets
would engage in more regular quoting
activity than a market maker in less
liquid markets. Moreover, the Agencies
recognize that the maturity and depth of
the market also play a role in
determining the character of a market
maker’s activity.
As noted above, the standard of
‘‘routinely’’ standing ready to buy and
sell will differ across markets and asset
classes based on the liquidity, maturity,
and depth of the market for the type of
financial instrument. For instance, a
trading desk that is a market maker in
liquid equity securities generally should
engage in very regular or continuous
quoting and trading activities on both
sides of the market. In less liquid
markets, a trading desk should engage in
regular quoting activity across the
relevant type(s) of financial instruments,
although such quoting may be less
frequent than in liquid equity
markets.731 Consistent with the CFTC’s
and SEC’s interpretation of market
making in swaps and security-based
swaps for purposes of the definitions of
‘‘swap dealer’’ and ‘‘security-based
swap dealer,’’ ‘‘routinely’’ in the swap
market context means that the trading
desk should stand ready to enter into
swaps or security-based swaps at the
request or demand of a counterparty
more frequently than occasionally.732
The Agencies note that a trading desk
may routinely stand ready to enter into
derivatives on both sides of the market,
or it may routinely stand ready to enter
into derivatives on either side of the
market and then enter into one or more
offsetting positions in the derivatives
market or another market, particularly
in the case of relatively less liquid
derivatives. While a trading desk may
respond to requests to trade certain
731 Indeed, in the most specialized situations,
such quotations may only be provided upon
request. See infra note 735 and accompanying text
(discussing permissible block positioning).
732 The Agencies will consider factors similar to
those identified by the CFTC and SEC in connection
with this standard. See Further Definition of ‘‘Swap
Dealer,’’ ‘‘Security-Based Swap Dealer,’’ ‘‘Major
Swap Participant,’’ ‘‘Major Security-Based Swap
Participant’’ and ‘‘Eligible Contract Participant’’, 77
FR 30596, 30609 (May 23, 2012)

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products, such as custom swaps, even if
it does not normally quote in the
particular product, the trading desk
should hedge against the resulting
exposure in accordance with its
financial exposure and hedging
limits.733 Further, the Agencies
continue to recognize that market
makers in highly illiquid markets may
trade only intermittently or at the
request of particular customers, which
is sometimes referred to as trading by
appointment.734 A trading desk’s block
positioning activity would also meet the
terms of this requirement provided that,
from time to time, the desk engages in
block trades (i.e., trades of a large
quantity or with a high dollar value)
with customers.735
733 The Agencies recognize that, as noted by
commenters, preventing a banking entity from
conducting customized transactions with customers
may impact customers’ risk exposures or
transaction costs. See Goldman (Prop. Trading);
SIFMA (Asset Mgmt.) (Feb. 2012). The Agencies are
not prohibiting this activity under the final rule, as
discussed in this Part.
734 The Agencies have considered comments on
the issue of whether trading by appointment should
be permitted under the final market-making
exemption. The Agencies believe it is appropriate
to permit trading by appointment to the extent that
there is customer demand for liquidity in the
relevant products.
735 As noted in the preamble to the proposed rule,
the size of a block will vary among different asset
classes. The Agencies also stated in the proposal
that the SEC’s definition of ‘‘qualified block
positioner’’ in Rule 3b–8(c) under the Exchange Act
may serve as guidance for determining whether
block positioning activity qualifies for the marketmaking exemption. In referencing that rule as
guidance, the Agencies did not intend to imply that
a banking entity engaged in block positioning
activity would be required to meet all terms of the
‘‘qualified block positioner’’ definition at all times.
Nonetheless, a number of commenters indicated
that it was unclear when a banking entity would
need to act as a qualified block positioner in
accordance with Rule 3b–8(c) and expressed
concern that uncertainty could have a chilling effect
on a banking entity’s willingness to facilitate
customer block trades. See, e.g., RBC; SIFMA (Asset
Mgmt.) (Feb. 2012); Goldman (Prop. Trading). For
example, a few commenters stated that certain
requirements in Rule 3b–8(c) could cause fire sales
or general market uncertainty. See id. After
considering comments, the Agencies have decided
that the reference to Rule 3b–8(c) is unnecessary for
purposes of the final rule. In particular, the
Agencies believe that the requirements in the
market-making exemption provide sufficient
safeguards, and the additional requirements of the
‘‘qualified block positioner’’ definition may present
unnecessary burdens or redundancies with the rule,
as adopted. For example, the Agencies believe that
there is some overlap between § ll.4(b)(2)(ii) of
the exemption, which provides that the amount,
types, and risks of the financial instruments in the
trading desk’s market-maker inventory must be
designed not to exceed the reasonably expected
near term demands of clients, customers, or
counterparties, and Rule 3b–8(c)(iii), which
requires the sale of the shares comprising the block
as rapidly as possible commensurate with the
circumstances. In other words, the market-making
exemption would require a banking entity to
appropriately manage its inventory when engaged
in block positioning activity, but would not speak

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Regardless of the liquidity, maturity,
and depth of the market for a particular
type of financial instrument, a trading
desk should have a pattern of providing
price indications on either side of the
market and a pattern of trading with
customers on each side of the market. In
particular, in the case of relatively
illiquid derivatives or structured
instruments, it would not be sufficient
to demonstrate that a trading desk on
occasion creates a customized
instrument or provides a price quote in
response to a customer request. Instead,
the trading desk would need to be able
to demonstrate a pattern of taking these
actions in response to demand from
multiple customers with respect to both
long and short risk exposures in
identified types of instruments.
This requirement of the final rule
applies to a trading desk’s activity in
one or more ‘‘types’’ of financial
instruments.736 The Agencies recognize
that, in some markets, such as the
corporate bond market, a market maker
may regularly quote a subset of
instruments (generally the more liquid
directly to the timing element given the diversity
of markets to which the exemption applies.
As noted above, one commenter analyzed the
potential market impact of a complete restriction on
a market maker’s ability to provide direct liquidity
to help a customer execute a large block trade. See
supra note 682 and accompanying text. Because the
Agencies are not restricting a banking entity’s
ability to engage in block positioning in the manner
suggested by this commenter, the Agencies do not
believe that the final rule will cause the cited
market impact of incremental transaction costs
between $1.7 and $3.4 billion per year. The
Agencies address this commenter’s concern about
the impact of inventory metrics on a banking
entity’s willingness to engage in block trading in
Part IV.C.3. (discussing the metrics requirement in
the final rule and noting that metrics will not be
used to determine compliance with the rule but,
rather, will be monitored for patterns over time to
identify activities that may warrant further review).
One commenter appeared to request that block
trading activity not be subject to all requirements
of the market-making exemption. See SIFMA (Asset
Mgmt.) (Feb. 2012). Any activity conducted in
reliance on the market-making exemption,
including block trading activity, must meet the
requirements of the market-making exemption. The
Agencies believe the requirements in the final rule
are workable for block positioning activity and do
not believe it would be appropriate to subject block
positioning to lesser requirements than general
market-making activity. For example, trading in
large block sizes can expose a trading desk to
greater risk than market making in smaller sizes,
particularly absent risk management requirements.
Thus, the Agencies believe it is important for block
positioning activity to be subject to the same
requirements, including the requirements to
establish risk limits and risk management
procedures, as general market-making activity.
736 This approach is generally consistent with
commenters’ requested clarification that a trading
desk’s quoting activity will not be assessed on an
instrument-by-instrument basis, but rather across a
range of similar instruments for which the trading
desk acts as a market maker. See, e.g., RBC; SIFMA
et al. (Prop. Trading) (Feb. 2012); CIEBA; Goldman
(Prop. Trading).

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instruments), but may not provide
regular quotes in other related but less
liquid instruments that the market
maker is willing and available to trade.
Instead, the market maker would
provide a price for those instruments
upon request.737 The trading desk’s
activity, in the aggregate for a particular
type of financial instrument, indicates
whether it is engaged in activity that is
consistent with § ll.4(b)(2)(i) of the
final rule.
Notably, this requirement provides
that the types of financial instruments
for which the trading desk routinely
stands ready to purchase and sell must
be related to its authorized marketmaker inventory and it authorized
financial exposure. Thus, the types of
financial instruments for which the desk
routinely stands ready to buy and sell
should compose a significant portion of
its overall financial exposure. The only
other financial instruments contributing
to the trading desk’s overall financial
exposure should be those designed to
hedge or mitigate the risk of the
financial instruments for which the
trading desk is making a market. It
would not be consistent with the
market-making exemption for a trading
desk to hold only positions in, or be
exposed to, financial instruments for
which the trading desk is not a market
maker.738
A trading desk’s routine presence in
the market for a particular type of
financial instrument would not, on its
own, be sufficient grounds for relying
on the market-making exemption. This
is because the frequency at which a
trading desk is active in a particular
market would not, on its own,
distinguish between permitted market
making-related activity and
impermissible proprietary trading. In
response to comments, the final rule
provides that a trading desk also must
be willing and available to quote, buy
and sell, or otherwise enter into long
and short positions in the relevant
type(s) of financial instruments for its
737 See, e.g., Goldman (Prop. Trading); Morgan
Stanley; RBC; SIFMA et al. (Prop. Trading) (Feb.
2012).
738 The Agencies recognize that there could be
limited circumstances under which a trading desk’s
financial exposure does not relate to the types of
financial instruments that it is standing ready to
buy and sell for a short period of time. However,
the Agencies would expect for such occurrences to
be minimal. For example, this scenario could occur
if a trading desk unwinds a hedge position after the
market-making position has already been unwound
or if a trading desk acquires an anticipatory hedge
position prior to acquiring a market-making
position. As discussed more thoroughly in Part
IV.A.3.c.3., a banking entity must establish written
policies and procedures, internal controls, analysis,
and independent testing that establish appropriate
parameters around such activities.

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own account in commercially
reasonable amounts and throughout
market cycles.739 Importantly, a trading
desk would not meet the terms of this
requirement if it provides wide
quotations relative to prevailing market
conditions and is not engaged in other
activity that evidences a willingness or
availability to provide intermediation
services.740 Under these circumstances,
a trading desk would not be standing
ready to purchase and sell because it is
not genuinely quoting or trading with
customers.
In the context of this requirement,
‘‘commercially reasonable amounts’’
means that the desk generally must be
willing to quote and trade in sizes
requested by other market
participants.741 For trading desks that
engage in block trading, this would
include block trades requested by
customers, and this language is not
meant to restrict a trading desk from
acting as a block positioner. Further, a
trading desk must act as a market maker
on an appropriate basis throughout
market cycles and not only when it is
most favorable for it to do so.742 For
example, a trading desk should be
facilitating customer needs in both
upward and downward moving markets.
As discussed further in Part
IV.A.3.c.3., the financial instruments the
trading desk stands ready to buy and
sell must be identified in the trading
desk’s compliance program.743 Certain
requirements in the final exemption
apply to the amount, types, and risks of
these financial instruments that a
trading desk can hold in its marketmaker inventory, including the near
term customer demand requirement 744
739 See,

e.g., Occupy; Better Markets (Feb. 2012).
commenter expressed concern that a
banking entity may be able to rely on the marketmaking exemption when it is providing only wide,
out of context quotes. See Occupy.
741 As discussed below, this may include
providing quotes in the interdealer trading market.
742 Algorithmic trading strategies that only trade
when market factors are favorable to the strategy’s
objectives or that otherwise frequently exit the
market would not be considered to be standing
ready to purchase or sell a type of financial
instrument throughout market cycles and, thus,
would not qualify for the market-making
exemption. The Agencies believe this addresses
commenters’ concerns about high-frequency trading
activities that are only active in the market when
it is believed to be profitable, rather than to
facilitate customers. See, e.g., Better Markets (Feb.
2012). The Agencies are not, however, prohibiting
all high-frequency trading activities under the final
rule or otherwise limiting high-frequency trading by
banking entities by imposing a resting period on
their orders, as requested by certain commenters.
See, e.g., Better Markets (Feb. 2012); Occupy; Public
Citizen.
743 See final rule § ll.4(b)(2)(iii)(A).
744 See final rule § ll.4(b)(2)(ii).

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and the need to have certain risk and
inventory limits.745
In response to the proposed
requirement that a trading desk or other
organizational unit hold itself out, some
commenters requested that the Agencies
limit the availability of the marketmaking exemption to trading in
particular asset classes or trading on
particular venues (e.g., organized
trading platforms). The Agencies are not
limiting the availability of the marketmaking exemption in the manner
requested by these commenters.746
Provided there is customer demand for
liquidity in a type of financial
instrument, the Agencies do not believe
the availability of the market-making
exemption should depend on the
liquidity of that type of financial
instrument or the ability to trade such
instruments on an organized trading
platform. The Agencies see no basis in
the statutory text for either approach
and believe that the likely harms to
investors seeking to trade affected
instruments (e.g., reduced ability to
purchase or sell a particular instrument,
potentially higher transaction costs) and
market quality (e.g., reduced liquidity)
that would arise under such an
approach would not be justified,747
particularly in light of the minimal
benefits that might result from
restricting or eliminating a banking
entity’s ability to hold less liquid assets
in connection with its market makingrelated activities. The Agencies believe
these commenters’ concerns are
adequately addressed by the final rule’s
requirements in the market-making
final rule § ll.4(b)(2)(iii)(C).
example, a few commenters requested that
the rule prohibit banking entities from market
making in assets classified as Level 3 under FAS
157. See supra note 651 and accompanying text.
The Agencies continue to believe that it would be
inappropriate to incorporate accounting standards
in the rule because accounting standards could
change in the future without consideration of the
potential impact on the final rule. See Joint
Proposal, 76 FR 68,859 n.101 (explaining why the
Agencies declined to incorporate certain accounting
standards in the proposed rule); CFTC Proposal, 77
FR 8344 n.107.
Further, a few commenters suggested that the
exemption should only be available for trading on
an organized trading facility. This type of limitation
would require significant and widespread market
structure changes (with associated systems and
infrastructure costs) in a relatively short period of
time, as market making in certain assets is primarily
or wholly conducted in the OTC market, and
organized trading platforms may not currently exist
for these assets. The Agencies do not believe that
the costs of such market structure changes would
be warranted for purposes of this rule.
747 As discussed above, a number of commenters
expressed concern about the potential market
impacts of the perceived restrictions on market
making under the proposed rule, particularly with
respect to less liquid markets, such as the corporate
bond market. See, e.g., Prof. Duffie; Wellington;
BlackRock; ICI.
745 See
746 For

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5597

exemption that are designed to ensure
that a trading desk cannot hold risk in
excess of what is appropriate to provide
intermediation services designed not to
exceed, on an ongoing basis, the
reasonably expected near term demands
of clients, customers, or counterparties.
In response to comments on the
proposed interpretation regarding
anticipatory position-taking,748 the
Agencies note that the near term
demand requirement in the final rule
addresses when a trading desk may take
positions in anticipation of reasonably
expected near term customer
demand.749 The Agencies believe this
approach is generally consistent with
the comments the Agencies received on
this issue.750 In addition, the Agencies
note that modifications to the proposed
near term demand requirement in the
final rule also address commenters
concerns on this issue.751
2. Near Term Customer Demand
Requirement
a. Proposed Near Term Customer
Demand Requirement
Consistent with the statute, the
proposed rule required that the trading
desk or other organizational unit’s
market making-related activities be,
with respect to the financial instrument,
designed not to exceed the reasonably
expected near term demands of clients,
customers, or counterparties.752 This
requirement is intended to prevent a
trading desk from taking a speculative
proprietary position that is unrelated to
customer needs as part of the desk’s
748 Joint Proposal, 76 FR 68,871 (stating that
‘‘bona fide market making-related 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’’); CFTC
Proposal, 77 FR 8356–8357; See also Morgan
Stanley (requesting certain revisions to more closely
track the statute); SIFMA et al. (Prop. Trading) (Feb.
2012); Goldman (Prop. Trading); Chamber (Feb.
2012); Comm. on Capital Markets Regulation;
SIFMA (Asset Mgmt.) (Feb. 2012).
749 See final rule § ll.4(b)(2)(ii); infra Part
IV.A.3.c.2.c.
750 See BoA; SIFMA et al. (Prop. Trading) (Feb.
2012); Goldman (Prop. Trading); Morgan Stanley;
Chamber (Feb. 2012); Comm. on Capital Markets
Regulation; SIFMA (Asset Mgmt.) (Feb. 2012).
751 For example, some commenters suggested that
the final rule allow market makers to make
individualized assessments of anticipated customer
demand, based on their expertise and experience,
and account for differences between liquid and less
liquid markets. See Chamber (Feb. 2012); ISDA
(Feb. 2012). The final rule allows such assessments,
based on historical customer demand and other
relevant factors, and recognizes that near term
demand may differ based on the liquidity, maturity,
and depth of the market for a particular type of
financial instrument. See infra Part IV.A.3.c.2.c.iii.
752 See proposed rule § ll.4(b)(2)(iii).

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purported market making-related
activities.753
In the proposal, the Agencies stated
that a banking entity’s expectations of
near term customer demand should
generally be based on the unique
customer base of the banking entity’s
specific market-making business lines
and the near term demand of those
customers based on particular factors,
beyond a general expectation of price
appreciation. The Agencies further
stated that they would not expect the
activities of a trading desk or other
organizational unit to qualify for the
market-making exemption if the trading
desk or other organizational unit is
engaged wholly or principally in trading
that is not in response to, or driven by,
customer demands, regardless of
whether those activities promote price
transparency or liquidity. The proposal
stated that, 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 marketmaking exemption.754
With respect to market making in a
security that is executed on an exchange
or other organized trading facility, the
proposal provided that a 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 nondirectional or market-neutral trading
strategy and the market maker is
registered, if the exchange or organized
trading facility registers market makers.
Under the proposal, activities on an
exchange or other organized trading
facility that primarily take liquidity,
rather than provide liquidity, would not
qualify for the market-making
exemption, even if conducted by a
registered market maker.755

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b. Comments Regarding the Proposed
Near Term Customer Demand
Requirement
As noted above, the proposed near
term customer demand requirement
would implement language found in the
statute’s market-making exemption.756
Some commenters expressed general
support for this requirement.757 For
example, these commenters emphasized
753 See Joint Proposal, 76 FR 68,871; CFTC
Proposal, 77 FR 8357.
754 See id.
755 See Joint Proposal, 76 FR 68,871–68,872;
CFTC Proposal, 77 FR 8357.
756 See supra Part IV.A.3.c.2.a.
757 See, e.g., Sens. Merkley & Levin (Feb. 2012);
Flynn & Fusselman; Better Markets (Feb. 2012).

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that the proposed near term demand
requirement is an important component
that restricts disguised position-taking
or market making in illiquid markets.758
Several other commenters expressed
concern that the proposed requirement
is too restrictive 759 because, for
example, it may impede a market
maker’s ability to build or retain
inventory 760 or may impact a market
maker’s willingness to engage in block
trading.761 Comments on particular
aspects of this proposed requirement are
discussed below, including the
proposed interpretation of this
requirement in the proposal, the
requirement’s potential impact on
market maker inventory, potential
differences in this standard across asset
classes, whether it is possible to predict
near term customer demand, and
whether the terms ‘‘client,’’ ‘‘customer,’’
or ‘‘counterparty’’ should be defined for
purposes of the exemption.
i. The Proposed Guidance for
Determining Compliance With the Near
Term Customer Demand Requirement
As discussed in more detail above, the
proposal set forth proposed guidance on
how a banking entity may comply with
the proposed near term customer
demand requirement.762 With respect to
the language indicating that a banking
entity’s determination of near term
customer demand should generally be
based on the unique customer base of a
specific market-making business line
(and not merely an expectation of future
price appreciation), one commenter
758 See Better Markets (Feb. 2012); Sens. Merkley
& Levin (Feb. 2012).
759 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Chamber (Feb. 2012); T. Rowe Price; SIFMA
(Asset Mgmt.) (Feb. 2012); ACLI (Feb. 2012);
MetLife; Comm. on Capital Markets Regulation;
CIEBA; Credit Suisse (Seidel); SSgA (Feb. 2012);
IAA (stating that the proposed requirement is too
subjective and would be difficult to administer in
a range of scenarios); Barclays; Prof. Duffie.
760 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); T. Rowe Price; CIEBA; Credit Suisse (Seidel);
Barclays; Wellington; MetLife; Chamber (Feb. 2012);
RBC; Prof. Duffie; ICI (Feb. 2012); SIFMA (Asset
Mgmt.) (Feb. 2012). The Agencies respond to these
comments in Part IV.A.3.c.2.c., infra. For a
discussion of comments regarding inventory
management activity conducted in connection with
market making, See Part IV.A.3.c.2.b.vi., infra.
761 See, e.g., ACLI (Feb. 2012); MetLife; Comm. on
Capital Markets Regulation (noting that a market
maker may need to hold significant inventory to
accommodate potential block trade requests). Two
of these commenters stated that a market maker
may provide a worse price or may be unwilling to
intermediate a large customer position if the market
maker has to determine whether holding such
position will meet the near term demand
requirement, particularly if the market maker would
be required to sell the block position over a short
period of time. See ACLI (Feb. 2012); MetLife.
These comments are addressed in Part
IV.A.3.c.2.c.iii., infra.
762 See supra Part IV.A.3.c.2.a.

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stated that it is unclear how a banking
entity would be able to make such
determinations in markets where trades
occur infrequently and customer
demand is hard to predict.763
Several commenters expressed
concern about the proposal’s statement
that a trading desk or other
organizational unit engaged wholly or
principally in trading that is not in
response to, or driven by, customer
demands (e.g., arbitrage trading with
non-customers) would not qualify for
the exemption, regardless of whether
the activities promote price
transparency or liquidity.764 In
particular, commenters stated that it
would be difficult for a market-making
business to try to divide its activities
that are in response to customer demand
(e.g., customer intermediation and
hedging) from activities that promote
price transparency and liquidity (e.g.,
interdealer trading to test market depth
or arbitrage trading) in order to
determine their proportionality.765
Another commenter stated that, as a
matter of organizational efficiency, firms
will often restrict arbitrage trading
strategies to certain specific individual
traders within the market-making
organization, who may sometimes be
referred to as a ‘‘desk,’’ and expressed
concern that this would be prohibited
under the rule.766
In response to the proposed
interpretation regarding market making
on an exchange or other organized
trading facility (and certain similar
language in proposed Appendix B),767
several commenters indicated that the
reference to passive submission of
resting orders may be too restrictive and
provided examples of scenarios where
market makers may need to use market
or marketable limit orders.768 For
763 See SIFMA et al. (Prop. Trading) (Feb. 2012).
Another commenter suggested that the Agencies
‘‘establish clear criteria that reflect appropriate
revenue from changes in the bid-ask spread,’’ noting
that a legitimate market maker should be both
selling and buying in a rising market (or, likewise,
in a declining market). Public Citizen.
764 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Credit Suisse (Seidel); JPMC; Goldman (Prop.
Trading); BoA; ICI (Feb. 2012); ICI Global;
Vanguard; SSgA (Feb. 2012); See also infra Part
IV.A.3.c.2.b.viii. (discussing comments on whether
arbitrage trading should be permitted under the
market-making exemption under certain
circumstances).
765 See Goldman (Prop. Trading); RBC. One of
these commenters agreed, however, that a trading
desk that is ‘‘wholly’’ engaged in trading that is
unrelated to customer demand should not qualify
for the proposed market-making exemption. See
Goldman (Prop. Trading).
766 See JPMC.
767 See Joint Proposal, 76 FR 68,871–68,872;
CFTC Proposal, 77 FR 8357.
768 See, e.g., NYSE Euronext; SIFMA et al. (Prop.
Trading) (Feb. 2012); Goldman (Prop. Trading);

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example, many of these commenters
stated that market makers may need to
enter market or marketable limit orders
to: (i) build or reduce inventory; 769 (ii)
address order imbalances on an
exchange by, for example, using market
orders to lessen volatility and restore
pricing equilibrium; (iii) hedge marketmaking positions; (iv) create markets; 770
(v) test the depth of the markets; (vi)
ensure that ETFs, American depositary
receipts (‘‘ADRs’’), options, and other
instruments remain appropriately
priced; 771 and (vii) respond to
movements in prices in the markets.772
Two commenters noted that distinctions
between limit and market or marketable
limit orders may not be workable in the
international context, where exchanges
may not use the same order types as
U.S. trading facilities.773
A few commenters also addressed the
proposed use of a market maker’s
exchange registration status as part of
the analysis.774 Two commenters stated
that the proposed rule should not
require a market maker to be registered
with an exchange to qualify for the
proposed market-making exemption.
According to these commenters, there
are a large number of exchanges and
organized trading facilities on which
market makers may need to trade to
maintain liquidity across the markets
and to provide customers with favorable
prices. These commenters indicated that
any restrictions or burdens on such
trading may decrease liquidity or make
it harder to provide customers with the
best price for their trade.775 One
commenter, however, stated that the
exchange registration requirement is
RBC. Comments on proposed Appendix B are
discussed further in Part IV.A.3.c.8.b., infra. This
issue is addressed in note 939 and its
accompanying text, infra.
769 Some commenters stated that market makers
may need to use market or marketable limit orders
to build inventory in anticipation of customer
demand or in connection with positioning a block
trade for a customer. See SIFMA et al. (Prop.
Trading) (Feb. 2012); RBC; Goldman (Prop.
Trading). Two of these commenters noted that these
order types may be needed to dispose of positions
taken into inventory as part of market making. See
RBC; Goldman (Prop. Trading).
770 See NYSE Euronext.
771 See Goldman (Prop. Trading).
772 See SIFMA et al. (Prop. Trading) (Feb. 2012).
773 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading).
774 See NYSE Euronext; SIFMA et al. (Prop.
Trading) (Feb. 2012); Goldman (Prop. Trading);
Occupy. See also infra notes 940 to 941 and
accompanying text (addressing these comments).
775 See SIFMA et al. (Prop. Trading) (Feb. 2012)
(stating that trading units may currently register as
market makers with particular, primary exchanges
on which they trade, but will serve in a marketmaking capacity on other trading venues from time
to time); Goldman (Prop. Trading) (noting that there
are more than 12 exchanges and 40 alternative
trading systems currently trading U.S. equities).

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reasonable and further supported
adding a requirement that traders
demonstrate adherence to the same or
commensurate standards in markets
where registration is not possible.776
Some commenters recommended
certain modifications to the proposed
analysis. For example, a few
commenters requested that the rule
presume that a trading unit is engaged
in permitted market making-related
activity if it is registered as a market
maker on a particular exchange or
organized trading facility.777 In support
of this recommendation, one commenter
represented that it would be warranted
because registered market makers
directly contribute to maintaining liquid
and orderly markets and are subject to
extensive regulatory requirements in
that capacity.778 Another commenter
suggested that the Agencies instead use
metrics to compare, in the aggregate and
over time, the liquidity that a market
maker makes rather than takes as part of
a broader consideration of the marketmaking character of the relevant trading
activity.779
ii. Potential Inventory Restrictions and
Differences Across Asset Classes
A number of commenters expressed
concern that the proposed requirement
776 See Occupy. In the alternative, this commenter
would require all market making to be performed
on an exchange or organized trading facility. See id.
777 See NYSE Euronext (recognizing that
registration status is not necessarily conclusive of
engaging in market making-related activities);
SIFMA et al. (Prop. Trading) (Feb. 2012) (stating
that to the extent a trading unit is registered on a
particular exchange or organized trading facility for
any type of financial instrument, all of its activities
on that exchange or organized trading facility
should be presumed to be market making);
Goldman (Prop. Trading). See also infra note 940
(responding to these comments). Two commenters
noted that certain exchange rules may require
market makers to deal for their own account under
certain circumstances in order to maintain fair and
orderly markets. See NYSE Euronext (discussing
NYSE rules); Goldman (Prop. Trading) (discussing
NYSE and CBOE rules). For example, according to
these commenters, NYSE Rule 104(f)(ii) requires a
market maker to maintain fair and orderly markets,
which may involve dealing for their own account
when there is a lack of price continuity, lack of
depth, or if a disparity between supply and demand
exists or is reasonably anticipated. See id.
778 See Goldman (Prop. Trading). This commenter
further stated that trading activities of exchange
market makers may be particularly difficult to
evaluate with customer-facing metrics (because
‘‘specialist’’ market makers may not have
‘‘customers’’), so conferring a positive presumption
of compliance on such market makers would ensure
that they can continue to contribute to liquidity,
which benefits customers. This commenter noted
that, for example, NYSE designated market makers
(‘‘DMMs’’) are generally prohibited from dealing
with customers and companies must ‘‘wall off’’ any
trading units that act as DMMs. See id. (citing NYSE
Rule 98).
779 See id. (stating that spread-related metrics,
such as Spread Profit and Loss, may be useful for
this purpose).

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may unduly restrict a market maker’s
ability to manage its inventory.780
Several of these commenters stated that
limitations on inventory would be
especially problematic for market
making in less liquid markets, like the
fixed-income market, where customer
demand is more intermittent and
positions may need to be held for a
longer period of time.781 Some
commenters stated that the Agencies’
proposed interpretation of this
requirement would restrict a market
maker’s inventory in a manner that is
inconsistent with the statute. These
commenters indicated that the
‘‘designed’’ and ‘‘reasonably expected’’
language of the statute seem to
recognize that market makers must
anticipate customer requests and
accumulate sufficient inventory to meet
those reasonably expected demands.782
In addition, one commenter represented
that a market maker must have wide
latitude and incentives for initiating
trades, rather than merely reacting to
customer requests for quotes, to
properly risk manage its positions or to
prepare for anticipated customer
demand or supply.783 Many
commenters requested certain
modifications to the proposed
requirement to limit its impact on
market maker inventory.784
780 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); T. Rowe Price; CIEBA; Credit Suisse (Seidel);
Barclays; Wellington; MetLife; Chamber (Feb. 2012);
RBC; Prof. Duffie; ICI (Feb. 2012); SIFMA (Asset
Mgmt.) (Feb. 2012). These concerns are addressed
in Part IV.A.3.c.2.c., infra.
781 See, e.g., SIFMA (Asset Mgmt.) (Feb. 2012); T.
Rowe Price; CIEBA; ICI (Feb. 2012); RBC.
782 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Chamber (Feb. 2012).
783 See Prof. Duffie. However, another commenter
stated that a legitimate market maker should
respond to customer demand rather than initiate
transactions, which is indicative of prohibited
proprietary trading. See Public Citizen.
784 See Credit Suisse (Seidel) (suggesting that the
rule allow market makers to build inventory in
products where they believe customer demand will
exist, regardless of whether the inventory can be
tied to a particular customer in the near term or to
historical trends in customer demand); Barclays
(recommending the rule require that ‘‘the market
making-related activity is conducted by each
trading unit such that its activities (including the
maintenance of inventory) are designed not to
exceed the reasonably expected near term demands
of clients, customers, or counterparties consistent
with the market and trading patterns of the relevant
product, and consistent with the reasonable
judgment of the banking entity where such demand
cannot be determined with reasonable accuracy’’);
CIEBA. In addition, some commenters suggested an
interpretation that would provide greater discretion
to market makers to enter into trades based on
factors such as experience and expertise dealing in
the market and market exigencies. See SIFMA et al.
(Prop. Trading) (Feb. 2012); Chamber (Feb. 2012).
Two commenters suggested that the proposed
requirement should be interpreted to permit
market-making activity as it currently exists. See

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Commenters’ views on the importance
of permitting inventory management
activity in connection with market
making are discussed below in Part
IV.A.3.c.2.b.vi.
Several commenters requested that
the Agencies recognize that near term
customer demand may vary across
different markets and asset classes and
implement this requirement flexibly.785
In particular, many of these commenters
emphasized that the concept of ‘‘near
term demand’’ should be different for
less liquid markets, where transactions
may occur infrequently, and for liquid
markets, where transactions occur more
often.786 One commenter requested that
the Agencies add the phrase ‘‘based on
the characteristics of the relevant market
and asset class’’ to the end of the
requirement to explicitly acknowledge
these differences.787

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iii. Predicting Near Term Customer
Demand
Commenters provided views on
whether and, if so how, a banking entity
may be able to predict near term
customer demand for purposes of the
proposed requirement.788 For example,
two commenters suggested ways in
which a banking entity could predict
near term customer demand.789 One of
these commenters indicated that
banking entities should be able to utilize
current risk management tools to predict
near term customer demand, although
these tools may need to be adapted to
comply with the rule’s requirements.
According to this commenter, dealers
commonly assess the following factors
across product lines, which can relate to
expected customer demand: (i) Recent
volumes and customer trends; (ii)
trading patterns of specific customers;
(iii) analysis of whether the firm has an
ability to win new customer business;
(iv) comparison of the current market
conditions to prior similar periods; (v)
liquidity of large investors; and (vi) the
MetLife; ACLI (Feb. 2012). One commenter
requested that the proposed requirement be moved
to Appendix B of the rule to provide greater
flexibility to consider facts and circumstances of a
particular activity. See JPMC.
785 See CIEBA; Morgan Stanley; RBC; ICI (Feb.
2012); ISDA (Feb. 2012); Comm. on Capital Markets
Regulation; Alfred Brock. The Agencies respond to
these comments in Part IV.A.3.c.2.c.ii., infra.
786 See ICI (Feb. 2012); CIEBA (stating that, absent
a different interpretation for illiquid instruments,
market makers will err on the side of holding less
inventory to avoid sanctions for violating the rule);
RBC.
787 See Morgan Stanley.
788 See Wellington; MetLife; SIFMA et al. (Prop.
Trading) (Feb. 2012); Sens. Merkley & Levin (Feb.
2012); Chamber (Feb. 2012); FTN; RBC; Alfred
Brock. These comments are addressed in Part
IV.A.3.c.2.c.iii., infra.
789 See Sens. Merkley & Levin (Feb. 2012); FTN.

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schedule of maturities in customers’
existing positions.790 Another
commenter stated that the
reasonableness of a market maker’s
inventory can be measured by looking to
the specifics of the particular market,
the size of the customer base being
served, and expected customer demand,
which banking entities should be
required to take into account in both
their inventory practices and policies
and their actual inventories. This
commenter recommended that the rule
permit a banking entity to assume a
position under the market-making
exemption if it can demonstrate a track
record or reasonable expectation that it
can dispose of a position in the near
term.791
Some commenters, however,
emphasized that reasonably expected
near term customer demand cannot
always be accurately predicted.792
Several of these commenters requested
the Agencies clarify that banking
entities will not be subject to regulatory
sanctions if reasonably anticipated near
term customer demand does not
materialize.793 One commenter further
noted that a banking entity entering a
new market, or gaining or losing
customers, may need greater flexibility
in applying the near term demand
requirement because its anticipated
demand may fluctuate.794
iv. Potential Definitions of ‘‘Client,’’
‘‘Customer,’’ or ‘‘Counterparty’’
Appendix B of the proposal discussed
the proposed meaning of the term
‘‘customer’’ in the context of permitted
market making-related activity.795 In
790 See FTN. The commenter further indicated
that errors in estimating customer demand are
managed through kick-out rules and oversight by
risk managers and committees, with latitude in
decisions being closely related to expected or
empirical costs of hedging positions until they
result in trading with counterparties. See id.
791 See Sens. Merkley & Levin (Feb. 2012) (stating
that banking entities should be required to collect
inventory data, evaluate the data, develop policies
on how to handle particular positions, and make
regular adjustments to ensure a turnover of assets
commensurate with near term demand of
customers). This commenter also suggested that the
rule specify the types of inventory metrics that
should be collected and suggested that the rate of
inventory turnover would be helpful. See id.
792 See MetLife; Chamber (Feb. 2012); RBC;
CIEBA; Wellington; ICI (Feb. 2012); Alfred Brock.
This issue is addressed in Part IV.A.3.c.2.c.iii.,
infra.
793 See ICI (Feb. 2012); CIEBA; RBC; Wellington;
Invesco.
794 See CIEBA.
795 See Joint Proposal, 76 FR 68,960; CFTC
Proposal, 77 FR 8439. More specifically, Appendix
B stated: ‘‘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

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addition, the proposal inquired whether
the terms ‘‘client,’’ ‘‘customer,’’ or
‘‘counterparty’’ should be defined in the
rule for purposes of the market-making
exemption.796 Commenters expressed
varying views on the proposed
interpretations in the proposal and on
whether these terms should be defined
in the final rule.797
With respect to the proposed
interpretations of the term ‘‘customer’’
in Appendix B, one commenter agreed
with the proposed interpretations and
expressed the belief that the
interpretations will allow interdealer
market making where brokers or other
dealers act as customers. However, this
commenter also requested that the
Agencies expressly incorporate
providing liquidity to other brokers and
dealers into the rule text.798 Another
commenter similarly stated that instead
of focusing solely on customer demand,
the rule should be clarified to reflect
that demand can come from other
dealers or future customers.799
In response to the proposal’s question
about whether the terms ‘‘client,’’
‘‘customer,’’ and ‘‘counterparty’’ should
be further defined, a few commenters
stated that that the terms should not be
defined in the rule.800 Other
participant. In the context of market making in a
[financial instrument] in an OTC 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.’’ Id. On this last point, the proposal
elaborated that in certain cases, depending on the
conventions of the relevant market (e.g., the OTC
derivatives market), such a ‘‘customer’’ may
consider itself or refer to itself more generally as a
‘‘counterparty.’’ See Joint Proposal, 76 FR 68,960
n.2; CFTC Proposal, 77 FR 8439 n.2.
796 See Joint Proposal, 76 FR 68,874; CFTC
Proposal, 77 FR 8359. In particular, Question 99
states: ‘‘Should the terms ‘client,’ ‘customer,’ or
‘counterparty’ be defined for purposes of the market
making 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?’’
Id.
797 Comments on this issue are addressed in Part
IV.A.3.c.2.c.i., infra.
798 See SIFMA et al. (Prop. Trading) (Feb. 2012).
See also Credit Suisse (Seidel); RBC (requesting that
the Agencies recognize ‘‘wholesale’’ market making
as permissible and representing that ‘‘[i]t is
irrelevant to an investor whether market liquidity
is provided by a broker-dealer with whom the
investor maintains a customer account, or whether
that broker-dealer looks to another dealer for market
liquidity’’).
799 See Comm. on Capital Markets Regulation.
800 See FTN; ISDA (Feb. 2012); Alfred Brock.

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commenters indicated that further
definition of these terms would be
appropriate.801 Some of these
commenters suggested that there should
be greater limitations on who can be
considered a ‘‘customer’’ under the
rule.802 These commenters generally
indicated that a ‘‘customer’’ should be a
person or institution with whom the
banking entity has a continuing, or a
direct and substantive, relationship
prior to the time of the transaction.803 In
the case of a new customer, some of
these commenters suggested requiring a
relationship initiated by the prospective
customer with a view to engaging in
transactions.804 A few commenters
indicated that a party should not be
considered a client, customer, or
counterparty if the banking entity: (i)
originates a financial product and then
finds a counterparty to take the other
side of the transaction; 805 or (ii) engages
in transactions driven by algorithmic
trading strategies.806 Three commenters
requested more permissive definitions
of these terms.807 According to one of
these commenters, because these terms
are listed in the disjunctive in the
801 See Japanese Bankers Ass’n.; Credit Suisse
(Seidel); Occupy; AFR et al. (Feb. 2012); Public
Citizen.
802 See AFR et al. (Feb. 2012); Occupy; Public
Citizen. One of these commenters also requested
that the Agencies remove the terms ‘‘client’’ and
‘‘counterparty’’ from the proposed near term
demand requirement. See Occupy.
803 See AFR et al. (Feb. 2012); Occupy; Public
Citizen. These commenters stated that other
banking entities should never be ‘‘customers’’ under
the rule. See id. In addition, one of these
commenters would further prevent a banking
entity’s employees and covered funds from being
‘‘customers’’ under the rule. See AFR et al. (Feb.
2012).
804 See AFR et al. (Feb. 2012) (providing a similar
definition for the term ‘‘client’’ as well); Public
Citizen.
805 See AFR et al. (Feb. 2012); Public Citizen. See
also Sens. Merkley & Levin (Feb. 2012) (stating that
a banking entity’s activities that involve attempting
to sell clients financial instruments that it
originated, rather than facilitating a secondary
market for client trades in previously existing
financial products, should be analyzed under the
underwriting exemption, not the market-making
exemption; in addition, compiling inventory of
financial instruments that the bank originated
should be viewed as proprietary trading).
806 See AFR et al. (Feb. 2012).
807 See Credit Suisse (Seidel) (stating that
‘‘customer’’ should be explicitly defined to include
any counterparty to whom a banking entity is
providing liquidity); ISDA (Feb. 2012)
(recommending that, if the Agencies decide to
define these terms, a ‘‘counterparty’’ should be
defined as the entity on the other side of a
transaction, and the terms ‘‘client’’ and ‘‘customer’’
should not be interpreted to require a relationship
beyond the isolated provision of a transaction);
Japanese Bankers Ass’n. (requesting that it be
clearly noted that interbank participants can be
customers for interbank market makers).

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statute, the broadest term—a
‘‘counterparty’’—should prevail.808
v. Interdealer Trading and Trading for
Price Discovery or To Test Market Depth
With respect to interdealer trading,
many commenters expressed concern
that the proposed rule could be
interpreted to restrict a market maker’s
ability to engage in interdealer
trading.809 As a general matter,
commenters attributed these concerns to
statements in proposed Appendix B 810
or to the Customer-Facing Trade Ratio
metric in proposed Appendix A.811 A
number of commenters requested that
the rule be modified to clearly recognize
interdealer trading as a component of
permitted market making-related
activity 812 and suggested ways in which
this could be accomplished (e.g.,
through a definition of ‘‘customer’’ or
‘‘counterparty’’).813
808 See ISDA (Feb. 2012). This commenter’s
primary position was that further definitions are not
required and could create additional and
unnecessary complexity. See id.
809 See, e.g., JPMC; Morgan Stanley; Goldman
(Prop. Trading); Chamber (Feb. 2012); MetLife;
Credit Suisse (Seidel); BoA; ACLI (Feb. 2012); RBC;
AFR et al. (Feb. 2012); ISDA (Feb. 2012); Oliver
Wyman (Dec. 2011); Oliver Wyman (Feb. 2012). A
few commenters noted that the proposed rule
would permit a certain amount of interdealer
trading. See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012) (citing statements in the proposal providing
that a market maker’s ‘‘customers’’ vary depending
on the asset class and market in which
intermediation services are provided and
interpreting such statements as allowing interdealer
market making where brokers or other dealers act
as ‘‘customers’’ within the proposed construct);
Goldman (Prop. Trading) (stating that interdealer
trading related to hedging or exiting a customer
position would be permitted, but expressing
concern that requiring each banking entity to justify
each of its interdealer trades as being related to one
of its own customers would be burdensome and
would reduce the effectiveness of the interdealer
market). Commenters’ concerns regarding
interdealer trading are addressed in Part
IV.A.3.c.2.c.i., infra.
810 See infra Part IV.A.3.c.8.
811 See, e.g., JPMC; SIFMA et al. (Prop. Trading)
(Feb. 2012); Oliver Wyman (Feb. 2012) (recognizing
that the proposed rule did not include specific
limits on interdealer trading, but expressing
concern that explicit or implicit limits could be
established by supervisors during or after the
conformance period).
812 See MetLife; SIFMA et al. (Prop. Trading)
(Feb. 2012); RBC; Credit Suisse (Seidel); JPMC;
BoA; ACLI (Feb. 2012); AFR et al. (Feb. 2012); ISDA
(Feb. 2012); Goldman (Prop. Trading); Oliver
Wyman (Feb. 2012).
813 See RBC (suggesting that explicitly
incorporating liquidity provision to other brokers
and dealers in the market-making exemption would
be consistent with the statute’s reference to meeting
the needs of ‘‘counterparties,’’ in addition to the
needs of clients and customers); AFR et al. (Feb.
2012) (recognizing that the ability to manage
inventory through interdealer transactions should
be accommodated in the rule, but recommending
that this activity be conditioned on a market maker
having an appropriate level of inventory after an
interdealer transaction); Goldman (Prop. Trading)
(representing that the Agencies could evaluate and

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5601

Commenters emphasized that
interdealer trading provides certain
market benefits, including increased
market liquidity; 814 more efficient
matching of customer order flow; 815
greater hedging options to reduce
risks; 816 enhanced ability to accumulate
inventory for current or near term
customer demand, work down
concentrated positions arising from a
customer trade, or otherwise exit a
position acquired from a customer; 817
and general price discovery among
dealers.818 Regarding the impact of
interdealer trading on a market maker’s
ability to intermediate customer needs,
one commenter studied the potential
impact of interdealer trading limits—in
combination with inventory limits—on
trading in the U.S. corporate bond
market. According to this commenter, if
interdealer trading had been prohibited
and a market maker’s inventory had
been limited to the average daily
volume of the market as a whole, 69
percent of customer trades would have
been prevented.819 Some commenters
stated that a banking entity would be
less able or willing to provide marketmaking services to customers if it could
not engage in interdealer trading.820
monitor the amount of interdealer trading that is
consistent with a particular trading unit’s market
making-related or hedging activity through the
customer-facing activity category of metrics); Oliver
Wyman (Feb. 2012) (recommending removal or
modification of any metrics or principles that
would indicate that interdealer trading is not
permitted).
814 See Prof. Duffie; MetLife; ACLI (Feb. 2012);
BDA (Feb. 2012).
815 See Oliver Wyman (Dec. 2011); Oliver Wyman
(Feb. 2012); MetLife; ACLI (Feb. 2012). See also
Thakor Study (stating that, when a market maker
provides immediacy to a customer, it relies on
being able to unwind its positions at opportune
times by trading with other market makers, who
may have knowledge about impending orders form
their own customers that may induce them to trade
with the market maker).
816 See MetLife; ACLI (Feb. 2012); Goldman
(Prop. Trading); Morgan Stanley; Oliver Wyman
(Dec. 2011); Oliver Wyman (Feb. 2012).
817 See Goldman (Prop. Trading); Chamber (Feb.
2012). See also Prof. Duffie (stating that a market
maker acquiring a position from a customer may
wish to rebalance its inventory relatively quickly
through the interdealer network, which is often
more efficient than requesting immediacy from
another customer or waiting for another customer
who wants to take the opposite side of the trade).
818 See Chamber (Feb. 2012); Goldman (Prop.
Trading).
819 See Oliver Wyman (Feb. 2012) (basing its
finding on data from 2009). This commenter also
represented that the natural level of interdealer
volume in the U.S. corporate bond market made up
16 percent of total trading volume in 2010. See id.
820 See Goldman (Prop. Trading); Morgan Stanley.
See also BDA (Feb. 2012) (stating that if dealers in
the fixed-income market are not able to trade with
other dealers to ‘‘cooperate with each other to
provide adequate liquidity to the market as a
whole,’’ an essential source of liquidity will be
eliminated from the market and existing values of

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As noted above, a few commenters
stated that market makers may use
interdealer trading for price discovery
purposes.821 Some commenters
separately discussed the importance of
this activity and requested that, when
conducted in connection with marketmaking activity, trading for price
discovery be considered permitted
market making-related activity under
the rule.822 Commenters indicated that
price discovery-related trading results in
certain market benefits, including
enhancing the accuracy of prices for
customers,823 increasing price
efficiency, preventing market
instability,824 improving market
liquidity, and reducing overall costs for
market participants.825 As a converse,
one of these commenters stated that
restrictions on such activity could result
in market makers setting their prices too
high, exposing them to significant risk
and causing a reduction of marketmaking activity or widening of spreads
to offset the risk.826 One commenter
further requested that trading to test
market depth likewise be permitted
under the market-making exemption.827
This commenter represented that the
Agencies would be able to evaluate the
extent to which trading for price
discovery and market depth are
consistent with market making-related
activities for a particular market through
a combination of customer-facing
activity metrics, including the Inventory
Risk Turnover metric, and knowledge of
a banking entity’s trading business

developed by regulators as part of the
supervisory process.828
vi. Inventory Management
Several commenters requested that
the rule provide banking entities with
greater discretion to manage their
inventories in connection with market
making-related activity, including
acquiring or disposing of positions in
anticipation of customer demand.829
Commenters represented that market
makers need to be able to build, manage,
and maintain inventories to facilitate
customer demand. These commenters
further stated that the rule needs to
provide some degree of flexibility for
inventory management activities, as
inventory needs may differ based on
market conditions or the characteristics
of a particular instrument.830 A few
commenters cited legislative history in
support of allowing banking entities to
hold and manage inventory in
connection with market making-related
activities.831 Several commenters noted
benefits that are associated with a
market maker’s ability to appropriately
manage its inventory, including being
able to meet reasonably anticipated
future client, customer, or counterparty
demand; 832 accommodating customer
transactions more quickly and at
favorable prices; reducing near term
price volatility (in the case of selling a
customer block position); 833 helping
maintain an orderly market and provide
the best price to customers (in the case

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828 See

fixed income securities will decline and become
volatile, harming both investors who currently hold
such positions and issuers, who will experience
increased interest costs).
821 See Chamber (Feb. 2012); Goldman (Prop.
Trading).
822 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Chamber (Feb. 2012); Goldman (Prop. Trading). One
commenter provided the following example of such
activity: If Security A and Security B have some
price correlation but neither trades regularly, then
a trader may execute a trade in Security A for price
discovery purposes, using the price of Security A
to make an informed bid-ask market to a customer
in Security B. See SIFMA et al. (Prop. Trading)
(Feb. 2012).
823 See Goldman (Prop. Trading); Chamber (Feb.
2012) (stating that this type of trading is necessary
in more illiquid markets); SIFMA et al. (Prop.
Trading) (Feb. 2012).
824 See Goldman (Prop. Trading).
825 See Chamber (Feb. 2012).
826 See id.
827 See Goldman (Prop. Trading). This commenter
represented that market makers often make trades
with other dealers to test the depth of the markets
at particular price points and to understand where
supply and demand exist (although such trading is
not conducted exclusively with other dealers). This
commenter stated that testing the depth of the
market is necessary to provide accurate prices to
customers, particularly when customers Seeks to
enter trades in amounts larger than the amounts
offered by dealers who have sent indications to
inter-dealer brokers. See id.

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id.
e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Credit Suisse (Seidel); Goldman (Prop.
Trading); MFA; RBC. Inventory management is
addressed in Part IV.A.3.c.2.c., infra.
830 See, e.g., MFA (stating that it is critical for
banking entities to continue to be able to maintain
sufficient levels of inventory, which is dynamic in
nature and requires some degree of flexibility in
application); RBC (requesting that the Agencies
explicitly acknowledge that, depending on market
conditions or the characteristics of a particular
security, it may be appropriate or necessary for a
firm to maintain inventories over extended periods
of time in the course of market making-related
activities).
831 See, e.g., RBC; NYSE Euronext; Fidelity. These
commenters cited a colloquy in the Congressional
Record between Senator Bayh and Senator Dodd, in
which Senator Bayh stated: ‘‘With respect to
[section 13 of the BHC Act], the conference report
states that banking entities are not prohibited from
purchasing and disposing of securities and other
instruments in connection with underwriting or
market-making activities, provided that activity
does not exceed the reasonably expected near-term
demands of clients, customers, or counterparties. I
want to clarify this language would allow banks to
maintain an appropriate dealer inventory and
residual risk positions, which are essential parts of
the market-making function. Without that
flexibility, market makers would not be able to
provide liquidity to markets.’’ 156 Cong. Rec. S5906
(daily ed. July 15, 2010) (statement of Sen. Bayh).
832 See, e.g., RBC.
833 See Goldman (Prop. Trading).
829 See,

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of accumulating long or short positions
in anticipation of a large customer sale
or purchase); 834 ensuring that markets
continue to have sufficient liquidity; 835
fostering a two-way market; and
establishing a market-making
presence.836 Some commenters noted
that market makers may need to
accumulate inventory to meet customer
demand for certain products or under
certain trading scenarios, such as to
create units of structured products (e.g.,
ETFs and asset-backed securities) 837
and in anticipation of an index
rebalance.838
Commenters also expressed views
with respect to how much discretion a
banking entity should have to manage
its inventory under the exemption and
how to best monitor inventory levels.
For example, one commenter
recommended that the rule allow
market makers to build inventory in
products where they believe customer
demand will exist, regardless of whether
the inventory can be tied to a particular
customer in the near term or to
historical trends in customer
demand.839 A few commenters
suggested that the Agencies provide
banking entities with greater discretion
to accumulate inventory, but discourage
market makers from holding inventory
for long periods of time by imposing
increasingly higher capital requirements
on aged inventory.840 One commenter
834 See

id.
MFA.
836 See RBC.
837 See Goldman (Prop. Trading); BoA.
838 See Oliver Wyman (Feb. 2012). As this
commenter explained, some mutual funds and ETFs
track major equity indices and, when the
composition of an index changes (e.g., due to the
addition or removal of a security or to rising or
falling values of listed shares), an announcement is
made and all funds tracking the index need to
rebalance their portfolios. According to the
commenter, banking entities may need to step in to
provide liquidity for rebalances of less liquid
indices because trades executed on the open market
would substantially affect share prices. The
commenter estimated that if market makers are not
able to provide direct liquidity for rebalance trades,
investors tracking these indices could potentially
pay incremental costs of $600 million to $1.8
billion every year. This commenter identified the
proposed inventory metrics in Appendix A as
potentially limiting a banking entity’s willingness
or ability to facilitate index rebalance trades. See id.
Two other commenters also discussed the index
rebalancing scenario. See Prof. Duffie; Thakor
Study. Index rebalancing is addressed in note 931,
infra.
839 See Credit Suisse (Seidel).
840 See CalPERS; Vanguard. These commenters
represented that placing increasing capital
requirements on aged inventory would ease the
rule’s impact on investor liquidity, allow banking
entities to internalize the cost of continuing to hold
a position at the expense of its ability to take on
new positions, and potentially decrease the
possibility of a firm realizing a loss on a position
by decreasing the time such position is held. See
id. One commenter noted that some banking entities
835 See

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represented that a trading unit’s
inventory management practices could
be monitored with the Inventory Risk
Turnover metric, in conjunction with
other metrics.841

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vii. Acting as an Authorized Participant
or Market Maker in Exchange-Traded
Funds
With respect to ETF trading,
commenters generally requested
clarification that a banking entity can
serve as an authorized participant
(‘‘AP’’) to an ETF issuer or can engage
in ETF market making under the
proposed exemption.842 According to
commenters, APs may engage in the
following types of activities with respect
to ETFs: (i) trading directly with the
ETF issuer to create or redeem ETF
shares, which involves trading in ETF
shares and the underlying
components; 843 (ii) trading to maintain
price alignment between the ETF shares
and the underlying components; 844 (iii)
traditional market-making activity; 845
already use this approach to manage risk on their
market-making desks. See Vanguard. See also
Capital Group (suggesting that one way to
implement the statutory exemption would be to
charge a trader or a trading desk for positions held
on its balance sheet beyond set time periods and to
increase the charge at set intervals). These
comments are addressed in note 923, infra.
841 See Goldman (Prop. Trading) (representing
that the Inventory Risk Turnover metric will allow
the Agencies to evaluate the length of time that a
trading unit tends to hold risk positions in
inventory and whether that holding time is
consistent with market making-related activities in
the relevant market).
842 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Credit Suisse (Seidel); JPMC; Goldman (Prop.
Trading); BoA; ICI (stating that an AP may trade
with the ETF issuer in different capacities—in
connection with traditional market-making activity,
on behalf of customers, or for the AP’s own
account); ICI Global (discussing non-U.S. ETFs
specifically); Vanguard; SSgA (Feb. 2012). One
commenter represented that an AP’s transactions in
ETFs do not create risks associated with proprietary
trading because, when an AP trades with an ETF
issuer for its own account, the AP typically enters
into an offsetting transaction in the underlying
portfolio of securities, which cancels out
investment risk and limits the AP’s exposure to the
difference between the market price for ETF shares
and the ETF’s net asset value (‘‘NAV’’). See
Vanguard.
With respect to market-making activity in an ETF,
several commenters noted that market makers play
an important role in maintaining price alignment by
engaging in arbitrage transactions between the ETF
shares and the shares of the underlying
components. See, e.g., JPMC; Goldman (Prop.
Trading) (making similar statement with respect to
ADRs as well); SSgA (Feb. 2012); SIFMA et al.
(Prop. Trading) (Feb. 2012); Credit Suisse (Seidel);
RBC. AP and market maker activity in ETFs are
addressed in Part IV.A.3.c.2.c.i., infra.
843 See SIFMA et al. (Prop. Trading) (Feb. 2012);
BoA; ICI (Feb. 2012) ICI Global; Vanguard; SSgA
(Feb. 2012).
844 See JPMC; Goldman (Prop. Trading); SIFMA et
al. (Prop. Trading) (Feb. 2012); SSgA (Feb. 2012);
ICI (Feb. 2012) ICI Global.
845 See ICI Global; ICI (Feb. 2012) SIFMA et al.
(Prop. Trading) (Feb. 2012); BoA.

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(iv) ‘‘seeding’’ a new ETF by entering
into several initial creation transactions
with an ETF issuer and holding the ETF
shares, possibly for an extended period
of time, until the ETF establishes regular
trading and liquidity in the secondary
markets; 846 (v) ‘‘create to lend’’
transactions, where an AP enters a
creation transaction with the ETF issuer
and lends the ETF shares to an
investor; 847 and (vi) hedging.848 A few
commenters noted that an AP may not
engage in traditional market-making
activity in the relevant ETF and
expressed concern that the proposed
rule may limit a banking entity’s ability
to act in an AP capacity.849 One
commenter estimated that APs that are
banking entities make up between 20
percent to 100 percent of creation and
redemption activity for individual ETFs,
with an average of approximately 35
percent of creation and redemption
activity across all ETFs attributed to
banking entities. This commenter
expressed the view that, if the rule
limits banking entities’ ability to serve
as APs, then individual investors’
investments in ETFs will become more
expensive due to higher premiums and
discounts versus the ETF’s NAV.850
A number of commenters stated that
certain requirements of the proposed
exemption may limit a banking entity’s
ability to serve as AP to an ETF,
including the proposed near term
customer demand requirement,851 the
proposed source of revenue
requirement,852 and language in the
846 See

BoA; ICI (Feb. 2012); ICI Global.
BoA (stating that lending the ETF shares
to an investor gives the investor a more efficient
way to hedge its exposure to assets correlated with
those underlying the ETF).
848 See ICI Global; ICI (Feb. 2012).
849 See, e.g., Vanguard (noting that APs may not
engage in market-making activity in the ETF and
expressing concern that if AP activities are not
separately permitted, banking entities may exit or
not enter the ETF market); SSgA (Feb. 2012) (stating
that APs are under no obligation to make markets
in ETF shares and requiring such an obligation
would discourage banking entities from acting as
APs); ICI (Feb. 2012).
850 See SSgA (Feb. 2012). This commenter further
stated that as of 2011, an estimated 3.5 million—
or 3 percent—of U.S. households owned ETFs and,
as of September 2011, ETFs represented assets of
approximately $951 billion. See id.
851 See BoA; Vanguard (stating that this
determination may be particularly difficult in the
case of a new ETF).
852 See BoA. This commenter noted that the
proposed source of revenue requirement could be
interpreted to prevent a banking entity acting as AP
from entering into creation and redemption
transactions, ‘‘Seeding’’ an ETF, engaging in ‘‘create
to lend’’ transactions, and performing secondary
market making in an ETF because all of these
activities require an AP to build an inventory—
either in ETF shares or the underlying
components—which often result in revenue
attributable to price movements. See id.

5603

proposal regarding arbitrage trading.853
With respect to the proposed near term
customer demand requirement, a few
commenters noted that this requirement
could prevent an AP from building
inventory to assemble creation units.854
Two other commenters expressed the
view that the ETF issuer would be the
banking entity’s ‘‘counterparty’’ when
the banking entity trades directly with
the ETF issuer, so this trading and
inventory accumulation would meet the
terms of the proposed requirement.855
To permit banking entities to act as APs,
two commenters suggested that trading
in the capacity of an AP should be
deemed permitted market makingrelated activity, regardless of whether
the AP is acting as a traditional market
maker.856
viii. Arbitrage or Other Activities That
Promote Price Transparency and
Liquidity
In response to a question in the
proposal,857 a number of commenters
stated that certain types of arbitrage
activity should be permitted under the
market-making exemption.858 For
example, some commenters stated that a
banking entity’s arbitrage activity
should be considered market making to
the extent the activity is driven by
creating markets for customers tied to
the price differential (e.g., ‘‘box’’
strategies, ‘‘calendar spreads,’’ merger
arbitrage, ‘‘Cash and Carry,’’ or basis
trading) 859 or to the extent that demand
is predicated on specific price
relationships between instruments (e.g.,
ETFs, ADRs) that market makers must

847 See

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853 Commenters noted that this language would
restrict an AP from engaging in price arbitrage to
maintain efficient markets in ETFs. See Vanguard;
RBC; Goldman (Prop. Trading); JPMC; SIFMA et al.
(Prop. Trading) (Feb. 2012). See supra Part
IV.A.3.c.2.a. (discussing the proposal’s proposed
interpretation regarding arbitrage trading).
854 See BoA; Vanguard (stating that this
determination may be particularly difficult in the
case of a new ETF).
855 See ICI Global; ICI (Feb. 2012).
856 See ICI (Feb. 2012) ICI Global. These
commenters provided suggested rule text on this
issue and suggested that the Agencies could require
a banking entity’s compliance policies and internal
controls to take a comprehensive approach to the
entirety of an AP’s trading activity, which would
facilitate easy monitoring of the activity to ensure
compliance. See id.
857 See Joint Proposal, 76 FR 68,873 (question 91)
(inquiring whether the proposed exemption should
be modified to permit certain arbitrage trading
activities engaged in by market makers that promote
liquidity or price transparency but do not service
client, customer, or counterparty demand); CFTC
Proposal, 77 FR 8359.
858 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Credit Suisse (Seidel); JPMC; Goldman (Prop.
Trading); FTN; RBC; ISDA (Feb. 2012). Arbitrage
trading is further discussed in Part IV.A.3.c.2.c.i.,
infra.
859 See SIFMA et al. (Prop. Trading) (Feb. 2012).

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maintain.860 Similarly, another
commenter suggested that arbitrage
activity that aligns prices should be
permitted, such as index arbitrage, ETF
arbitrage, and event arbitrage.861 One
commenter noted that many markets,
such as futures and options markets,
rely on arbitrage activities of market
makers for liquidity purposes and to
maintain convergence with underlying
instruments for cash-settled options,
futures, and index-based products.862
Commenters stated that arbitrage trading
provides certain market benefits,
including enhanced price
transparency,863 increased market
efficiency,864 greater market
liquidity,865 and general benefits to
customers.866 A few commenters noted
that certain types of hedging activity
may appear to have characteristics of
arbitrage trading.867
Commenters suggested certain
methods for permitting and monitoring
arbitrage trading under the exemption.
For example, one commenter suggested
a framework for permitting certain
arbitrage within the market-making
exemption, with requirements such as:
(i) Common personnel with marketmaking activity; (ii) policies that cover
the timing and appropriateness of
arbitrage positions; (iii) time limits on
arbitrage positions; and (iv)
compensation that does not reward
successful arbitrage, but instead pools
any such revenues with market-making
profits and losses.868 A few commenters
860 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC.
861 See Credit Suisse (Seidel).
862 See RBC.
863 See SIFMA et al. (Prop. Trading) (Feb. 2012).
864 See Credit Suisse (Seidel); RBC.
865 See RBC.
866 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC; FTN; ISDA (Feb. 2012) (stating that arbitrage
activities often yield positions that are ultimately
put to use in serving customer demand and
representing that the process of consistently trading
makes a dealer ready and available to serve
customers on a competitive basis).
867 See JPMC (stating that firms commonly
organize their market-making activities so that risks
delivered to client-facing desks are aggregated and
transferred by means of internal transactions to a
single utility desk (which hedges all of the risks in
the aggregate), and this may optically bear some
characteristics of arbitrage, although the commenter
requested that such activity be recognized as
permitted market making-related activity under the
rule); ISDA (Feb. 2012) (stating that in some swaps
markets, dealers hedge through multiple
instruments, which can give an impression of
arbitrage in a function that is risk reducing; for
example, a dealer in a broad index equity swap may
simultaneously hedge in baskets of stocks, futures,
and ETFs). But See Sens. Merkley & Levin (Feb.
2012) (‘‘When banks use complex hedging
techniques or otherwise engage in trading that is
suggestive of arbitrage, regulators should require
them to provide evidence and analysis
demonstrating what risk is being reduced.’’).
868 See FTN.

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represented that, if permitted under the
rule, the Agencies would be able to
monitor arbitrage activities for patterns
of impermissible proprietary trading
through the use of metrics, as well as
compliance and examination tools.869
Other commenters stated that the
exemption should not permit certain
types of arbitrage. One commenter
stated that the rule should ensure that
relative value and complex arbitrage
strategies cannot be conducted.870
Another commenter expressed the view
that the market-making exemption
should not permit any type of arbitrage
transactions. This commenter stated
that, in the event that liquidity or
transparency is inhibited by a lack of
arbitrage trading, a market maker should
be able to find a customer who would
seek to benefit from it.871
ix. Primary Dealer Activities
A number of commenters requested
that the market-making exemption
permit banking entities to meet their
primary dealer obligations in foreign
jurisdictions, particularly if trading in
foreign sovereign debt is not separately
exempted in the final rule.872 According
to commenters, a banking entity may be
obligated to perform the following
activities in its capacity as a primary
dealer: undertaking to maintain an
orderly market, preventing or correcting
any price dislocations,873 and bidding
on each issuance of the relevant
jurisdiction’s sovereign debt.874
Commenters expressed concern that a
banking entity’s trading activity as
primary dealer may not comply with the
proposed near term customer demand
requirement 875 or the proposed source
869 See SIFMA et al. (Prop. Trading) (Feb. 2012);
RBC; Goldman (Prop. Trading). One of these
commenters stated that the customer-facing activity
category of metrics, as well as other metrics, would
be available to evaluate whether the trading unit is
engaged in a directly customer-facing business and
the extent to which its activities are consistent with
the market-making exemption. See Goldman (Prop.
Trading).
870 See Johnson & Prof. Stiglitz. See also AFR et
al. (Feb. 2012) (noting that arbitrage, spread, or
carry trades are a classic type of proprietary trade).
871 See Occupy.
872 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012) (stating that permitted activities should
include trading necessary to meet the relevant
jurisdiction’s primary dealer and other
requirements); JPMC (indicating that the exemption
should cover all of a firm’s activities that are
necessary or reasonably incidental to its acting as
a primary dealer in a foreign government’s debt
securities); Goldman (Prop. Trading); Banco de
Me´xico; IIB/EBF. See infra notes 905 to 906 and
accompanying text (addressing these comments).
873 See Goldman (Prop. Trading).
874 See Banco de Me
´ xico.
875 See JPMC; Banco de Me
´ xico. These
commenters stated that a primary dealer is required
to assume positions in foreign sovereign debt even
when near term customer demand is unpredictable.
See id.

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of revenue requirement.876 To address
the first issue, one commenter stated
that the final rule should clarify that a
banking entity acting as a primary
dealer of foreign sovereign debt is
engaged in primary dealer activity in
response to the near term demands of
the sovereign, which should be
considered a client, customer, or
counterparty of the banking entity.877
Another commenter suggested that the
Agencies permit primary dealer
activities through commentary stating
that fulfilling primary dealer obligations
will not be included in determinations
of whether the market-making
exemption applies to a trading unit.878
x. New or Bespoke Products or
Customized Hedging Contracts
Several commenters indicated that the
proposed exemption does not
adequately address market making in
new or bespoke products, including
structured, customer-driven
transactions, and requested that the rule
be modified to clearly permit such
activity.879 Many of these commenters
emphasized the role such transactions
play in helping customers hedge the
unique risks they face.880 Commenters
stated that, as a result, limiting a
banking entity’s ability to conduct such
transactions would subject customers to
increased risks and greater transaction
costs.881 One commenter suggested that
the Agencies explicitly state that a
banking entity’s general willingness to
engage in bespoke transactions is
sufficient to make it a market maker in
unique products for purposes of the
rule.882
Other commenters stated that banking
entities should be limited in their ability
to rely on the market-making exemption
to conduct transactions in bespoke or
876 See Banco de Me
´ xico (stating that primary
dealers need to be able to profit from their positions
in sovereign debt, including by holding significant
positions in anticipation of future price movements,
so that the primary dealer business is financially
attractive); IIB/EBF (stating that primary dealers
may actively Seek to profit from price and interest
rate movements based on their debt holdings,
which governments support as providing muchneeded liquidity for securities that are otherwise
purchased largely pursuant to buy-and-hold
strategies of institutional investors and other
entities Seeking safe returns and liquidity buffers).
877 See Goldman (Prop. Trading).
878 See SIFMA et al. (Prop. Trading) (Feb. 2012).
879 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Credit Suisse (Seidel); JPMC; Goldman (Prop.
Trading); SIFMA (Asset Mgmt.) (Feb. 2012). This
issue is addressed in Part IV.A.3.c.1.c.iii., supra,
and Part IV.A.3.c.2.c.iii., infra.
880 See Credit Suisse (Seidel); Goldman (Prop.
Trading); SIFMA (Asset Mgmt.) (Feb. 2012).
881 See Goldman (Prop. Trading); SIFMA (Asset
Mgmt.) (Feb. 2012).
882 See SIFMA (Asset Mgmt.) (Feb. 2012).

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
customized derivatives.883 For example,
one commenter suggested that a banking
entity be required to disaggregate such
derivatives into liquid risk elements and
illiquid risk elements, with liquid risk
elements qualifying for the marketmaking exemption and illiquid risk
elements having to be conducted on a
riskless principal basis under § __
.6(b)(1)(ii) of the proposed rule.
According to this commenter, such an
approach would not impact the end user
customer.884 Another commenter stated
that a banking entity making a market in
bespoke instruments should be required
both to hold itself out in accordance
with § __.4(b)(2)(ii) of the proposed rule
and to demonstrate the purchase and
the sale of such an instrument.885
c. Final Near Term Customer Demand
Requirement
Consistent with the statute, § __
.4(b)(2)(ii) of the final rule’s marketmaking exemption requires that the
amount, types, and risks of the financial
instruments in the trading desk’s
market-maker inventory be designed not
to exceed, on an ongoing basis, the
reasonably expected near term demands
of clients, customers, or counterparties,
based on certain market factors and
analysis.886 As discussed above in Part
IV.A.3.c.1.c.ii., the trading desk’s
market-maker inventory consists of
positions in financial instruments in
which the trading desk stands ready to
purchase and sell consistent with the
final rule.887 The final rule requires the
financial instruments to be identified in
the trading desk’s compliance program.
Thus, this requirement focuses on a
trading desk’s positions in financial
instruments for which it acts as market
maker. These positions of a trading desk
are more directly related to the demands
of customers than positions in financial
instruments used for risk management
purposes, but in which the trading desk
does not make a market. As noted
above, a position or exposure that is
included in a trading desk’s marketmaker inventory will remain in its
market-maker inventory for as long as
the position or exposure is managed by
the trading desk. As a result, the trading
883 See

AFR et al. (Feb. 2012); Public Citizen.
AFR et al. (Feb. 2012).
885 See Public Citizen.
886 The final rule includes certain refinements to
the proposed standard, which would have required
that the market making-related activities of the
trading desk or other organizational unit that
conducts the purchase or sale are, with respect to
the financial instrument, designed not to exceed the
reasonably expected near term demands of clients,
customers, or counterparties. See proposed rule
§ __.4(b)(2)(iii).
887 See supra Part IV.A.3.c.1.c.ii.; final rule
§ __.4(b)(5).

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desk must continue to account for that
position or exposure, together with
other positions and exposures in its
market-maker inventory, in determining
whether the amount, types, and risks of
its market-maker inventory are designed
not to exceed, on an ongoing basis, the
reasonably expected near term demands
of customers.
While the near term customer demand
requirement directly applies only to the
trading desk’s market-maker inventory,
this does not mean a trading desk may
establish other positions, outside its
market-maker inventory, that exceed
what is needed to manage the risks of
the trading desk’s market makingrelated activities and inventory. Instead,
a trading desk must have limits on its
market-maker inventory, the products,
instruments, and exposures the trading
desk may use for risk management
purposes, and its aggregate financial
exposure that are based on the factors
set forth in the near term customer
demand requirement, as well as other
relevant considerations regarding the
nature and amount of the trading desk’s
market making-related activities. A
banking entity must establish,
implement, maintain, and enforce a
limit structure, as well as other
compliance program elements (e.g.,
those specifying the instruments a
trading desk trades as a market maker or
may use for risk management purposes
and providing for specific risk
management procedures), for each
trading desk that are designed to
prevent the trading desk from engaging
in trading activity that is unrelated to
making a market in a particular type of
financial instrument or managing the
risks associated with making a market in
that type of financial instrument.888
To clarify the application of this
standard in response to comments,889
the final rule provides two factors for
assessing whether the amount, types,
and risks of the financial instruments in
the trading desk’s market-maker
inventory are designed not to exceed, on
an ongoing basis, the reasonably
expected near term demands of clients,
customers, or counterparties.
Specifically, the following must be
considered under the revised standard:
(i) The liquidity, maturity, and depth of
the market for the relevant type of
financial instrument(s),890 and (ii)
888 See infra Part IV.A.3.c.3. (discussing the
compliance program requirements); final rule
§ __.4(b)(2)(iii).
889 See supra Part IV.A.3.c.2.b.i.
890 This language has been added to the final rule
to respond to commenters’ concerns that the
proposed near term demand requirement would be
unworkable in less liquid markets or would
otherwise restrict a market maker’s ability to hold

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5605

demonstrable analysis of historical
customer demand, current inventory of
financial instruments, and market and
other factors regarding the amount,
types, and risks of or associated with
positions in financial instruments in
which the trading desk makes a market,
including through block trades. Under
the final rule, a banking entity must
account for these considerations when
establishing risk and inventory limits
for each trading desk.891
For purposes of this provision,
‘‘demonstrable analysis’’ means that the
analysis for determining the amount,
types, and risks of financial instruments
a trading desk may manage in its
market-maker inventory, in accordance
with the near term demand requirement,
must be based on factors that can be
demonstrated in a way that makes the
analysis reviewable. This may include,
among other things, the normal trading
records of the trading desk and market
information that is readily available and
retrievable. If the analysis cannot be
supported by the banking entity’s books
and records and available market data,
on their own, then the other factors
utilized must be identified and
documented and the analysis of those
factors together with the facts gathered
from the trading and market records
must be identified in a way that makes
it possible to test the analysis.
Importantly, a determination of
whether a trading desk’s market-maker
inventory is appropriate under this
requirement will take into account
reasonably expected near term customer
demand, including historical levels of
customer demand, expectations based
on market factors, and current demand.
For example, at any particular time, a
trading desk may acquire a position in
a financial instrument in response to a
customer’s request to sell the financial
instrument or in response to reasonably
expected customer buying interest for
such instrument in the near term.892 In
addition, as discussed below, this
requirement is not intended to impede
a trading desk’s ability to engage in
and manage its inventory in less liquid markets. See
supra Part IV.A.3.c.2.b.ii. In addition, this provision
is substantially similar to one commenter’s
suggested approach of adding the phrase ‘‘based on
the characteristics of the relevant market and asset
class’’ to the proposed requirement, but the
Agencies have added more specificity about the
relevant characteristics that should be taken into
consideration. See Morgan Stanley.
891 See infra Part IV.A.3.c.3.
892 As discussed further below, acquiring a
position in a financial instrument in response to
reasonably expected customer demand would not
include creating a structured product for which
there is no current customer demand and, instead,
soliciting customer demand during or after its
creation. See infra note 938 and accompanying text;
Sens. Merkley & Levin (Feb. 2012).

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certain market making-related activities
that are consistent with and needed to
facilitate permissible trading with its
clients, customers, or counterparties,
such as inventory management and
interdealer trading. These activities
must, however, be consistent with the
analysis conducted under the final rule
and the trading desk’s limits discussed
below.893 Moreover, as explained below,
the banking entity must also have in
place escalation procedures to address,
analyze, and document trades made in
response to customer requests that
would exceed one of a trading desk’s
limits.
The near term demand requirement is
an ongoing requirement that applies to
the amount, types, and risks of the
financial instruments in the trading
desk’s market-maker inventory. For
instance, a trading desk may acquire
exposures as a result of entering into
market-making transactions with
customers that are within the desk’s
market-marker inventory and financial
exposure limits. Even if the trading desk
is appropriately managing the risks of
its market-maker inventory, its marketmaker inventory still must be consistent
with the analysis of the reasonably
expected near term demands of clients,
customers, and counterparties and the
liquidity, maturity and depth of the
market for the relevant instruments in
the inventory. Moreover, the trading
desk must take action to ensure that its
financial exposure does not exceed its
financial exposure limits.894 A trading
desk may not maintain an exposure in
its market-maker inventory, irrespective
of customer demand, simply because
the exposure is hedged and the resulting
financial exposure is below the desk’s
financial exposure limit. In addition, the
amount, types, and risks of financial
instruments in a trading desk’s marketmaker inventory would not be
consistent with permitted marketmaking activities if, for example, the
trading desk has a pattern or practice of
retaining exposures in its market-maker
inventory, while refusing to engage in
customer transactions when there is
customer demand for those exposures at
commercially reasonable prices.
The following is an example of the
interplay between a trading desk’s
market-maker inventory and financial
exposure. An airline company customer
may seek to hedge its long-term
exposure to price fluctuations in jet fuel
by asking a banking entity to create a
structured ten-year, $1 billion jet fuel
893 The formation of structured finance products
and securitizations is discussed in detail in Part
IV.B.2.b. of this SUPPLEMENTARY INFORMATION.
894 See final rule § __.4(b)(2)(iii)(B), (C).

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swap for which there is no liquid
market. A trading desk that makes a
market in energy swaps may service its
customer’s needs by executing a custom
jet fuel swap with the customer and
holding the swap in its market-maker
inventory, if the resulting transaction
does not cause the trading desk to
exceed its market-maker inventory limit
on the applicable class of instrument, or
the trading desk has received approval
to increase the limit in accordance with
the authorization and escalation
procedures under paragraph
(b)(2)(iii)(E). In keeping with the marketmaking exemption as provided in the
final rule, the trading desk would be
required to hedge the risk from this
swap, either individually or as part of a
set of aggregated positions, if the trade
would result in a financial exposure that
exceeds the desk’s financial exposure
limits. The trading desk may hedge the
risk of the swap, for example, by
entering into one or more futures or
swap positions that are identified as
permissible hedging products,
instruments, or exposures in the trading
desk’s compliance program and that
analysis, including correlation analysis
as appropriate, indicates would
demonstrably reduce or otherwise
significantly mitigate risks associated
with the financial exposure from its
market-making activities. Alternatively,
if the trading desk also acts as a market
maker in crude oil futures, then the
desk’s exposures arising from its
market-making activities may naturally
hedge the jet fuel swap (i.e., it may
reduce its financial exposure levels
resulting from such instruments).895 The
trading desk must continue to
appropriately manage risks of its
financial exposure over time in
accordance with its financial exposure
limits.
As discussed above, several
commenters expressed concern that the
near-term customer demand
requirement is too restrictive and that it
could impede a market maker’s ability
to build or retain inventory, particularly
in less liquid markets where demand is
intermittent.896 Because customer
demand in illiquid markets can be
difficult to predict with precision,
market-maker inventory may not closely
track customer order flow. The Agencies
acknowledge that market makers will
face costs associated with demonstrating
that market-maker inventory is designed
not to exceed, on an ongoing basis, the
895 This natural hedge with futures would
introduce basis risk which, like other risks of the
trading desk, must be managed within the desk’s
limits.
896 See SIFMA (Asset Mgmt.) (Feb. 2012); T. Rowe
Price; CIEBA; ICI (Feb. 2012) RBC.

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reasonably expected near term demands
of customers, as required by the statute
and the final rule because this is an
analysis that banking entities may not
currently undertake. However, the final
rule includes certain modifications to
the proposed rule that are intended to
reduce the negative impacts cited by
commenters, such as limitations on
inventory management activity and
potential restrictions on market making
in less liquid instruments, which the
Agencies believe should reduce the
perceived burdens of the proposed near
term demand requirement. For example,
the final rule recognizes that liquidity,
maturity, and depth of the market vary
across asset classes. The Agencies
expect that the express recognition of
these differences in the rule should
avoid unduly impeding a market
maker’s ability to build or retain
inventory. More specifically, the
Agencies recognize the relationship
between market-maker inventory and
customer order flow can vary across
asset classes and that an inflexible
standard for demonstrating that
inventory does not exceed reasonably
expected near term demand could
provide an incentive to stop making
markets in illiquid asset classes.
i. Definition of ‘‘Client,’’ ‘‘Customer,’’
and ‘‘Counterparty’’
In response to comments requesting
further definition of the terms ‘‘client,’’
‘‘customer,’’ and ‘‘counterparty’’ for
purposes of this standard,897 the
Agencies have defined these terms in
the final rule. In particular, the final
rule defines ‘‘client,’’ ‘‘customer,’’ and
‘‘counterparty’’ as, on a collective or
individual basis, ‘‘market participants
that make use of the banking entity’s
market making-related services by
obtaining such services, responding to
quotations, or entering into a continuing
relationship with respect to such
services.’’ 898 However, for purposes of
the analysis supporting the marketmaker inventory held to meet the
reasonably expected near-term demands
of clients, customers and counterparties,
a client, customer, or counterparty of
the trading desk does not include a
trading desk or other organizational unit
of another entity if that entity has $50
billion or more in total trading assets
and liabilities, measured in accordance
with § ll.20(d)(1),899 unless the
897 See Japanese Bankers Ass’n.; Credit Suisse
(Seidel); Occupy; AFR et al. (Feb. 2012); Public
Citizen.
898 Final rule § ll.4(b)(3).
899 See final rule § ll.4(b)(3)(i). The Agencies
are using a $50 billion threshold for these purposes
in recognition that firms engaged in substantial
trading activity do not typically act as customers to

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trading desk documents how and why
such trading desk or other
organizational unit should be treated as
a customer or the transactions are
conducted anonymously on an
exchange or similar trading facility that
permits trading on behalf of a broad
range of market participants.900
The Agencies believe this definition is
generally consistent with the proposed
interpretation of ‘‘customer’’ in the
proposal. The proposal generally
provided that, for purposes of market
making on an exchange or other
organized trading facility, a customer is
any person on behalf of whom a buy or
sell order has been submitted. In the
context of the over-the-counter market,
a customer was generally considered to
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 for such services.901 The
definition of client, customer, and
counterparty in the final rule recognizes
that, in the context of market making in
a financial instrument that is executed
on an exchange or other organized
trading facility, a client, customer, or
counterparty would be any person
whose buy or sell order executes against
the banking entity’s quotation posted on
the exchange or other organized trading
facility.902 Under these circumstances,
the person would be trading with the
banking entity in response to the
banking entity’s quotations and
obtaining the banking entity’s market
making-related services. In the context
of market making in a financial
other market makers, while smaller regional firms
may Seek liquidity from larger firms as part of their
market making-related activities.
900 See final rule § ll.4(b)(3)(i)(A), (B). In
Appendix C of the proposed rule, a trading unit
engaged in market making-related activities would
have been required to describe how it identifies its
customers for purposes of the Customer-Facing
Trading Ratio, if applicable, including
documentation explaining when, how, and why a
broker-dealer, swap dealer, security-based swap
dealer, or any other entity engaged in market
making-related activities, or any affiliate thereof, is
considered to be a customer of the trading unit. See
Joint Proposal, 76 FR 68,964. While the proposed
approach would not have necessarily prevented any
of these entities from being considered a customer
of the trading desk, it would have required
enhanced documentation and justification for
treating any of these entities as a customer. The
final rule’s exclusion from the definition of client,
customer, and counterparty is similar to the
proposed approach, but is more narrowly focused
on firms that have $50 billion or more trading assets
and liabilities because, as noted above, the Agencies
believe firms engaged in such substantial trading
activity are less likely to act as customers to market
makers than smaller regional firms.
901 See Joint Proposal, 76 FR 68,960; CFTC
Proposal, 77 FR 8439.
902 See, e.g., Goldman (Prop. Trading) (explaining
generally how exchange-based market makers
operate).

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instrument in the OTC market, a client,
customer, or counterparty generally
would be a person that makes use of the
banking entity’s intermediation services,
either by requesting such services
(possibly via a request-for-quote on an
established trading facility) or entering
into a continuing relationship with the
banking entity with respect to such
services. For purposes of determining
the reasonably expected near-term
demands of customers, a client,
customer, or counterparty generally
would not include a trading desk or
other organizational unit of another
entity that has $50 billion or more in
total trading assets except if the trading
desk has a documented reason for
treating the trading desk or other
organizational unit of such entity as a
customer or the trading desk’s
transactions are executed anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
The Agencies believe that this exclusion
balances commenters’ suggested
alternatives of either defining as a
client, customer, or counterparty anyone
who is on the other side of a market
maker’s trade 903 or preventing any
banking entity from being a client,
customer, or counterparty.904 The
Agencies believe that the first
alternative is overly broad and would
not meaningfully distinguish between
permitted market making-related
activity and impermissible proprietary
trading. For example, the Agencies are
concerned that such an approach would
allow a trading desk to maintain an
outsized inventory and to justify such
inventory levels as being tangentially
related to expected market-wide
demand. On the other hand, preventing
any banking entity from being a client,
customer, or counterparty under the
final rule would result in an overly
narrow definition that would
significantly impact banking entities’
ability to provide and access market
making-related services. For example,
most banks look to market makers to
provide liquidity in connection with
their investment portfolios.
The Agencies further note that, with
respect to a banking entity that acts as
a primary dealer (or functional
equivalent) for a sovereign government,
the sovereign government and its central
bank are each a client, customer, or
903 See ISDA (Feb. 2012). In addition, a number
of commenters suggested that the rule should not
limit broker-dealers from being customers of a
market maker. See SIFMA et al. (Prop. Trading)
(Feb. 2012); Credit Suisse (Seidel); RBC; Comm. on
Capital Markets Regulation.
904 See AFR et al. (Feb. 2012); Occupy; Public
Citizen.

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5607

counterparty for purposes of the marketmaking exemption as well as the
underwriting exemption.905 The
Agencies believe this interpretation,
together with the modifications in the
rule that eliminate the requirement to
distinguish between revenues from
spreads and price appreciation and the
recognition that the market-making
exemption extends to market makingrelated activities appropriately captures
the unique relationship between a
primary dealer and the sovereign
government. Thus, generally a banking
entity may rely on the market-making
exemption for its activities as primary
dealer (or functional equivalent) to the
extent those activities are outside of the
underwriting exemption.906
For exchange-traded funds (‘‘ETFs’’)
(and related structures), Authorized
Participants (‘‘APs’’) are generally the
conduit for market participants seeking
to create or redeem shares of the fund
905 A primary dealer is a firm that trades a
sovereign government’s obligations directly with
the sovereign (in many cases, with the sovereign’s
central bank) as well as with other customers
through market making. The sovereign government
may impose conditions on a primary dealer or
require that it engage in certain trading in the
relevant government obligations (e.g., participate in
auctions for the government obligation or maintain
a liquid secondary market in the government
obligations). Further, a sovereign government may
limit the number of primary dealers that are
authorized to trade with the sovereign. A number
of countries use a primary dealer system, including
Australia, Brazil, Canada, China-Hong Kong,
France, Germany, Greece, India, Indonesia, Ireland,
Italy, Japan, Mexico, Netherlands, Portugal, South
Africa, South Korea, Spain, Turkey, the U.K., and
the U.S. See, e.g., Oliver Wyman (Feb. 2012). The
Agencies note that this standard would similarly
apply to the relationship between a banking entity
and a sovereign that does not have a formal primary
dealer system, provided the sovereign’s process
functions like a primary dealer framework.
906 See Goldman (Prop. Trading). See also supra
Part IV.A.3.c.2.b.ix. (discussing commenters’
concerns regarding primary dealer activity). Each
suggestion regarding the treatment of primary
dealer activity has not been incorporated into the
rule. Specifically, the exemption for market making
as applied to a primary dealer does not extend
without limitation to primary dealer activities that
are not conducted under the conditions of one of
the exemptions. These interpretations would be
inconsistent with Congressional intent for the
statute, to limit permissible market-making activity
through the statute’s near term demand requirement
and, thus, does not permit trading without
limitation. See SIFMA et al. (Prop. Trading) (Feb.
2012) (stating that permitted activities should
include trading necessary to meet the relevant
jurisdiction’s primary dealer and other
requirements); JPMC (indicating that the exemption
should cover all of a firm’s activities that are
necessary or reasonably incidental to its acting as
a primary dealer in a foreign government’s debt
securities); Goldman (Prop. Trading); Banco de
Me´xico; IIB/EBF. Rather, recognizing that market
making by primary dealers is a key function, the
limits and other conditions of the rule are flexible
enough to permit necessary market making-related
activities.

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(or equivalent structure).907 For
example, an AP may buy ETF shares
from market participants who would
like to redeem those shares for cash or
a basket of instruments upon which the
ETF is based. To provide this service,
the AP may in turn redeem these shares
from the ETF itself. Similarly, an AP
may receive cash or financial
instruments from a market participant
seeking to purchase ETF shares, in
which case the AP may use that cash or
set of financial instruments to create
shares from the ETF. In either case, for
the purpose of the market-making
exemption, such market participants as
well as the ETF itself would be
considered clients, customers, or
counterparties of the AP.908 The
inventory of ETF shares or underlying
instruments held by the AP can
therefore be evaluated under the criteria
of the market-making exemption, such
as how these holdings relate to
reasonably expected near term customer
demand.909 These criteria can be
907 ETF sponsors enter into relationships with one
or more financial institutions that become APs for
the ETF. Only APs are permitted to purchase and
redeem shares directly from the ETF, and they can
do so only in large aggregations or blocks that are
commonly called ‘‘creation units.’’ In response to a
question in the proposal, a number of commenters
expressed concern that the proposed market-making
exemption may not permit certain AP and market
maker activities in ETFs and requested clarification
that these activities would be permitted under the
market-making exemption. See Joint Proposal, 76
FR 68,873 (question 91) (‘‘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?’’); CFTC
Proposal, 77 FR 8359 (question 91); supra Part
IV.A.3.c.2.b.vii. (discussing comments on this
issue).
908 This is consistent with two commenters’
request that an ETF issuer be considered a
‘‘counterparty’’ of the banking entity when it trades
directly with the ETF issuer as an AP. See ICI
Global; ICI (Feb. 2012). Further, this approach is
intended to address commenters’ concerns that the
near term demand requirement may limit a banking
entity’s ability to act as AP for an ETF. See BoA;
Vanguard. The Agencies believe that one
commenter’s concern about the impact of the
proposed source of revenue requirement on AP
activity should be addressed by the replacement of
this proposed requirement with a metric-based
focus on when a trading desk generates revenue
from its trading activity. See BoA; infra Part
IV.A.3.c.7.c. (discussing the new approach to
assessing a trading desk’s pattern of profit and loss).
909 This does not imply that the AP must perfectly
predict future customer demand, but rather that
there is a demonstrable, statistical, or historical
basis for the size of the inventory held, as more
fully discussed below. Consider, for example, a
fixed-income ETF with $500 million in assets. If, on
a typical day, an AP generates requests for $10 to
$20 million of creations or redemptions, then an
inventory of $10 to $20 million in bonds upon
which the ETF is based (or some small multiple
thereof) could be construed as consistent with
reasonably expected near term customer demand.
On the other hand, if under the same circumstances
an AP holds $1 billion of these bonds solely in its

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similarly applied to other activities of
the AP, such as building inventory to
‘‘seed’’ a new ETF or engaging in ETFloan related transactions.910 The
Agencies recognize that banking entities
currently conduct a substantial amount
of AP creation and redemption activity
in the ETF market and, thus, if the rule
were to prevent or restrict a banking
entity from acting as an AP for an ETF,
then the rule would impact the
functioning of the ETF market.911
Some firms, whether or not an AP in
a given ETF, may also actively engage in
buying and selling shares of an ETF and
its underlying instruments in the market
to maintain price continuity between
the ETF and its underlying instruments,
which are exchangeable for one another.
Sometimes these firms will register as
market makers on an exchange for a
given ETF, but other times they may not
register as market maker. Regardless of
whether or not the firm is registered as
a market maker on any given exchange,
this activity not only provides liquidity
for ETFs, but also, and very importantly,
helps keep the market price of an ETF
in line with the NAV of the fund. The
market-making exemption can be used
to evaluate trading that is intended to
maintain price continuity between these
exchangeable instruments by
considering how the firm quotes,
maintains risk and exposure limits,
manages its inventory and risk, and, in
the case of APs, exercises its ability to
create and redeem shares from the fund.
Because customers take positions in
capacity as an AP for this ETF, it would be more
difficult to justify this as needed for reasonably
expected near term customer demand and may be
indicative of an AP engaging in prohibited
proprietary trading.
910 In ETF loan transactions (also referred to as
‘‘create-to-lend’’ transactions), an AP borrows the
underlying instruments that form the creation
basket of an ETF, submits the borrowed instruments
to the ETF agent in exchange for a creation unit of
ETF shares, and lends the resulting ETF shares to
a customer that wants to borrow the ETF. At the
end of the ETF loan, the borrower returns the ETF
shares to the AP, and the AP redeems the ETF
shares with the ETF agent in exchange for the
underlying instruments that form the creation
basket. The AP may return the underlying
instruments to the parties from whom it borrowed
them or may use them for another loan, as long as
the AP is not obligated to return them at that time.
For the term of the ETF loan transaction, the AP
hedges against market risk arising from any
rebalancing of the ETF, which would change the
amount or type of underlying instruments the AP
would receive in exchange for the ETF compared
to the underlying instruments the AP borrowed and
submitted to the ETF agent to create the ETF shares.
See David J. Abner, The ETF Handbook, Ch. 12
(2010); Jean M. McLoughlin, Davis Polk & Wardwell
LLP, to Division of Corporation Finance, U.S.
Securities and Exchange Commission, dated Jan. 23,
2013, available at http://www.sec.gov/divisions/
corpfin/cf-noaction/2013/davis-polk-wardwell-llp012813–16a.pdf.
911 See SSgA (Feb. 2012).

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ETFs with an expectation that the price
relationship will be maintained, such
trading can be considered to be market
making-related activity.912
After considering comments, the
Agencies continue to take the view that
a trading desk would not qualify for the
market-making exemption if it is wholly
or principally engaged in arbitrage
trading or other trading that is not in
response to, or driven by, the demands
of clients, customers, or
counterparties.913 The Agencies believe
this activity, which is not in response to
or driven by customer demand, is
inconsistent with the Congressional
intent that market making-related
activity be designed not to exceed the
reasonably expected near term demands
of clients, customers, or counterparties.
For example, a trading desk would not
be permitted to engage in general
statistical arbitrage trading between
instruments that have some degree of
correlation but where neither
instrument has the capability of being
exchanged, converted, or exercised for
or into the other instrument. A trading
desk may, however, act as market maker
to a customer engaged in a statistical
arbitrage trading strategy. Furthermore
as suggested by some commenters,914
trading activity used by a market maker
to maintain a price relationship that is
expected and relied upon by clients,
customers, and counterparties is
permitted as it is related to the demands
of clients, customers, or counterparties
because the relevant instrument has the
capability of being exchanged,
912 A number of commenters expressed concern
that the proposed rule would limit market making
or AP activity in ETFs because market makers and
APs engage in trading to maintain a price
relationship between ETFs and their underlying
components, which promotes ETF market
efficiency. See Vanguard; RBC; Goldman (Prop.
Trading); JPMC; SIFMA et al. (Prop. Trading) (Feb.
2012); SSgA (Feb. 2012); Credit Suisse (Prop.
Trading).
913 Some commenters suggested that a range of
arbitrage trading should be permitted under the
market-making exemption. See, e.g., Goldman
(Prop. Trading); RBC; SIFMA et al. (Prop. Trading)
(Feb. 2012); JPMC. Other commenters, however,
stated that arbitrage trading should be prohibited
under the final rule. See AFR et al. (Feb. 2012);
Volcker; Occupy. In response to commenters
representing that it would be difficult to comply
with this standard because it requires a trading desk
to determine the proportionality of its activities in
response to customer demand compared to its
activities that are not in response to customer
demand, the Agencies believe that the statute
requires a banking entity to distinguish between
market making-related activities that are designed
not to exceed the reasonably expected near term
demands of customers and impermissible
proprietary trading. See Goldman (Prop. Trading);
RBC.
914 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); JPMC.

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converted, or exercised for or into
another instrument.915
The Agencies recognize that a trading
desk, in anticipating and responding to
customer needs, may engage in
interdealer trading as part of its
inventory management activities and
that interdealer trading provides certain
market benefits, such as more efficient
matching of customer order flow, greater
hedging options to reduce risk, and
enhanced ability to accumulate or exit
customer-related positions.916 The final
rule does not prohibit a trading desk
from using the market-making
exemption to engage in interdealer
trading that is consistent with and
related to facilitating permissible
trading with the trading desk’s clients,
customers, or counterparties.917
However, in determining the reasonably
expected near term demands of clients,
customers, or counterparties, a trading
desk generally may not account for the
expected trading interests of a trading
desk or other organizational unit of an
entity with aggregate trading assets and
liabilities of $50 billion or greater
(except if the trading desk documents
why and how a particular trading desk
or other organizational unit at such a
firm should be considered a customer or
the trading desk or conduct marketmaking activity anonymously on an
exchange or similar trading facility that
915 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); JPMC; Credit Suisse (Seidel). For example,
customers have an expectation of general price
alignment under these circumstances, both at the
time they decide to invest in the instrument and for
the remaining time they hold the instrument. To the
contrary, general statistical arbitrage does not
maintain a price relationship between related
instruments that is expected and relied upon by
customers and, thus, is not permitted under the
market-making exemption. Firms engage in general
statistical arbitrage to profit from differences in
market prices between instruments, assets, or price
or risk elements associated with instruments or
assets that are thought to be statistically related, but
which do not have a direct relationship of being
exchangeable, convertible, or exercisable for the
other.
916 See MetLife; ACLI (Feb. 2012); Goldman
(Prop. Trading); Morgan Stanley; Chamber (Feb.
2012); Prof. Duffie; Oliver Wyman (Dec. 2011);
Oliver Wyman (Feb. 2012).
917 A number of commenters requested that the
rule be modified to clearly recognize interdealer
trading as a component of permitted market
making-related activity. See MetLife; SIFMA et al.
(Prop. Trading) (Feb. 2012); RBC; Credit Suisse
(Seidel); JPMC; BoA; ACLI (Feb. 2012); AFR et al.
(Feb. 2012); ISDA (Feb. 2012); Goldman (Prop.
Trading); Oliver Wyman (Feb. 2012). One of these
commenters analyzed the potential market impact
of preventing interdealer trading, combined with
inventory limits. See Oliver Wyman (Feb. 2012).
Because the final rule does not prohibit interdealer
trading or limit inventory in the manner this
commenter assumed for purposes of its analysis, the
Agencies do not believe the final rule will have the
market impact cited by this commenter.

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permits trading on behalf of a broad
range of market participants).918
A trading desk may engage in
interdealer trading to: Establish or
acquire a position to meet the
reasonably expected near term demands
of its clients, customers, or
counterparties, including current
demand; unwind or sell positions
acquired from clients, customers, or
counterparties; or engage in riskmitigating or inventory management
transactions.919 The Agencies believe
that allowing a trading desk to continue
to engage in customer-related
interdealer trading is appropriate
because it can help a trading desk
appropriately manage its inventory and
risk levels and can effectively allow
clients, customers, or counterparties to
access a larger pool of liquidity. While
the Agencies recognize that effective
intermediation of client, customer, or
counterparty trading may require a
trading desk to engage in a certain
amount of interdealer trading, this is an
activity that will bear some scrutiny by
the Agencies and should be monitored
by banking entities to ensure it reflects
market-making activities and not
impermissible proprietary trading.
ii. Impact of the Liquidity, Maturity, and
Depth of the Market on the Analysis
Several commenters expressed
concern about the potential impact of
the proposed near term demand
requirement on market making in less
liquid markets and requested that the
Agencies recognize that near term
customer demand may vary across
different markets and asset classes.920
The Agencies understand that
reasonably expected near term customer
demand may vary based on the
liquidity, maturity, and depth of the
market for the relevant type of financial
instrument(s) in which the trading desk
918 See AFR et al. (Feb. 2012) (recognizing that
the ability to manage inventory through interdealer
transactions should be accommodated in the rule,
but recommending that this activity be conditioned
on a market maker having an appropriate level of
inventory after an interdealer transaction).
919 Provided it is consistent with the requirements
of the market-making exemption, including the near
term customer demand requirement, a trading desk
may trade for purposes of determining how to price
a financial instrument a customer Seeks to trade
with the trading desk or to determine the depth of
the market for a financial instrument a customer
Seeks to trade with the trading desk. See Goldman
(Prop. Trading).
920 See CIEBA (stating that, absent a different
interpretation for illiquid instruments, market
makers will err on the side of holding less inventory
to avoid sanctions for violating the rule); Morgan
Stanley; RBC; ICI (Feb. 2012) ISDA (Feb. 2012);
Comm. on Capital Markets Regulation; Alfred
Brock.

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acts as market maker.921 As a result, the
final rule recognizes that these factors
impact the analysis of reasonably
expected near term demands of clients,
customers, or counterparties and the
amount, types, and risks of marketmaker inventory needed to meet such
demand.922 In particular, customer
demand is likely to be more frequent in
more liquid markets than in less liquid
or illiquid markets. As a result, market
makers in more liquid cash-based
markets, such as liquid equity
securities, should generally have higher
rates of inventory turnover and less aged
inventory than market makers in less
liquid or illiquid markets.923 Market
makers in less liquid cash-based
markets are more likely to hold a
particular position for a longer period of
time due to intermittent customer
demand. In the derivatives markets,
market makers carry open positions and
manage various risk factors, such as
exposure to different points on a yield
curve. These exposures are analogous to
inventory in the cash-based markets.
Further, it may be more difficult to
reasonably predict near term customer
demand in less mature markets due to,
among other things, a lack of historical
experience with client, customer, or
counterparty demands for the relevant
product. Under these circumstances, the
Agencies encourage banking entities to
consider their experience with similar
products or other relevant factors.924
iii. Demonstrable Analysis of Certain
Factors
In the proposal, the Agencies stated
that permitted market making includes
taking positions in securities in
anticipation of customer demand, so
long as any anticipatory buying or
921 See supra Part IV.A.3.c.2.b.ii. (discussing
comments on this issue).
922 See final rule § ll.4(b)(2)(ii)(A).
923 The final rule does not impose additional
capital requirements on aged inventory to
discourage a trading desk from retaining positions
in inventory, as suggested by some commenters. See
CalPERS; Vanguard. The Agencies believe the final
rule already limit a trading desk’s ability to hold
inventory over an extended period and do not See
a need at this time to include additional capital
requirements in the final rule. For example, a
trading desk must have written policies and
procedures relating to its inventory and must be
able to demonstrate, as needed, its analysis of why
the levels of its market-maker inventory are
necessary to meet, or is a result of meeting,
customer demand. See final rule § ll.4(b)(2)(ii),
(iii)(C).
924 The Agencies agree, as suggested by one
commenter, it may be appropriate for a market
maker in a new asset class or market to look to
reasonably expected future developments on the
basis of the trading desk’s customer relationships.
See Morgan Stanley. As discussed further below,
the Agencies recognize that a trading desk could
encounter similar issues if it is a new entrant in an
existing market.

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selling activity is reasonable and related
to clear, demonstrable trading interest of
clients, customers, or counterparties.925
A number of commenters expressed
concern about this proposed
interpretation’s impact on market
makers’ inventory management activity
and represented that it was inconsistent
with the statute’s near term demand
standard, which permits market-making
activity that is ‘‘designed’’ not to exceed
the ‘‘reasonably expected’’ near term
demands of customers.926 In response to
comments, the Agencies are permitting
a trading desk to take positions in
reasonable expectation of customer
demand in the near term based on a
demonstrable analysis that the amount,
types, and risks of the financial
instruments in the trading desk’s
market-maker inventory are designed
not to exceed, on an ongoing basis, the
reasonably expected near term demands
of customers.
The proposal also stated that a
banking entity’s determination of near
term customer demand should generally
be based on the unique customer base
of a specific market-making business
line (and not merely an expectation of
future price appreciation). Several
commenters stated that it was unclear
how such determinations should be
made and expressed concern that near
term customer demand cannot always
be accurately predicted,927 particularly
in markets where trades occur
infrequently and customer demand is
hard to predict 928 or when a banking
entity is entering a new market.929 To
address these comments, the Agencies
are providing additional information
about how a banking entity can comply
with the statute’s near term customer
demand requirement, including a new
requirement that a banking entity
conduct a demonstrable assessment of
reasonably expected near term customer
demand and several examples of factors
that may be relevant for conducting
such an assessment. The Agencies
believe it is important to require such
demonstrable analysis to allow
determinations of reasonably expected
near term demand and associated
inventory levels to be monitored and
925 See Joint Proposal, 76 FR 68,871; CFTC
Proposal, 77 FR 8356–8357.
926 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Goldman (Prop. Trading); Chamber (Feb.
2012); Comm. on Capital Markets Regulation. See
also Morgan Stanley; SIFMA (Asset Mgmt.) (Feb.
2012).
927 See SIFMA et al. (Prop. Trading) (Feb. 2012);
MetLife; Chamber (Feb. 2012); RBC; CIEBA;
Wellington; ICI (Feb. 2012) Alfred Brock.
928 See SIFMA et al. (Prop. Trading) (Feb. 2012).
929 See CIEBA.

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tested to ensure compliance with the
statute and the final rule.
The final rule provides that, to help
determine the appropriate amount,
types, and risks of the financial
instruments in the trading desk’s
market-maker inventory and to ensure
that such inventory is designed not to
exceed, on an ongoing basis, the
reasonably expected near term demands
of client, customers, or counterparties, a
banking entity must conduct
demonstrable analysis of historical
customer demand, current inventory of
financial instruments, and market and
other factors regarding the amount,
types, and risks of or associated with
financial instruments in which the
trading desk makes a market, including
through block trades. This analysis
should not be static or fixed solely on
current market or other factors. Instead,
an appropriately conducted analysis
under this provision will be both
backward- and forward-looking by
taking into account relevant historical
trends in customer demand 930 and any
events that are reasonably expected to
occur in the near term that would likely
impact demand.931 Depending on the
facts and circumstances, it may be
proper for a banking entity to weigh
these factors differently when
conducting an analysis under this
provision. For example, historical
trends in customer demand may be less
relevant when a trading desk is
experiencing or expects to experience a
change in the pattern of customer needs
(e.g., requests for block positioning),
adjustments to its business model (e.g.,
930 To determine an appropriate historical dataset,
a banking entity should assess the relation between
current or reasonably expected near term conditions
and demand and those of prior market cycles.
931 This analysis may, where appropriate, take
into account prior and/or anticipated cyclicality to
the demands of clients, customers, or
counterparties, which may cause variations in the
amounts, types, and risks of financial instruments
needed to provide intermediation services at
different points in a cycle. For example, the final
rule recognizes that a trading desk may need to
accumulate a larger-than-average amount of
inventory in anticipation of an index rebalance. See
supra note 838 (discussing a comment on this
issue). The Agencies are aware that a trading desk
engaged in block positioning activity may have a
less consistent pattern of inventory because of the
need to take on large block positions at the request
of customers. See supra note 761 and
accompanying text (discussing comments on this
issue).
Because the final rule does not prevent banking
entities from providing direct liquidity for
rebalance trades, the Agencies do not believe that
the final rule will cause the market impacts that one
commenter predicted would occur were such a
restriction adopted. See Oliver Wyman (Feb. 2012)
(estimating that if market makers are not able to
provide direct liquidity for rebalance trades,
investors tracking these indices could potentially
pay incremental costs of $600 million to $1.8
billion every year).

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efforts to expand or contract its market
shares), or changes in market
conditions.932 On the other hand, absent
these types of current or anticipated
events, the amount, types, and risks of
the financial instruments in the trading
desk’s market-maker inventory should
be relatively consistent with such
trading desk’s historical profile of
market-maker inventory.933
Moreover, the demonstrable analysis
required under § ll.4(b)(2)(ii)(B)
should account for, among other things,
how the market factors discussed in § l
l.4(b)(2)(ii)(A) impact the amount,
types, and risks of market-maker
inventory the trading desk may need to
facilitate reasonably expected near term
demands of clients, customers, or
counterparties.934 Other potential
factors that could be used to assess
reasonably expected near term customer
demand and the appropriate amount,
types, and risks of financial instruments
in the trading desk’s market-maker
inventory include, among others: (i)
Recent trading volumes and customer
trends; (ii) trading patterns of specific
customers or other observable customer
demand patterns; (iii) analysis of the
banking entity’s business plan and
ability to win new customer business;
(iv) evaluation of expected demand
under current market conditions
932 In addition, the Agencies recognize that a new
entrant to a particular market or asset class may not
have knowledge of historical customer demand in
that market or asset class at the outset. See supra
note 924 and accompanying text (discussing factors
that may be relevant to new market entrants for
purposes of determining the reasonably expected
near term demands of clients, customers, or
counterparties).
933 One commenter suggested an approach that
would allow market makers to build inventory in
products where they believe customer demand will
exist, regardless of whether inventory can be tied
to a particular customer in the near term or to
historical trends in customer demand. See Credit
Suisse (Seidel). The Agencies believe an approach
that does not provide for any consideration of
historical trends could result in a heightened risk
of evasion. At the same time, as discussed above,
the Agencies recognize that historical trends may
not always determine the amount of inventory a
trading desk may need to meet reasonably expected
near term demand and it may under certain
circumstances be appropriate to build inventory in
anticipation of a reasonably expected near term
event that would likely impact customer demand.
While the Agencies are not requiring that marketmaker inventory be tied to a particular customer,
The Agencies are requiring that a banking entity
analyze and support its expectations for near term
customer demand.
934 The Agencies recognize that a trading desk
could acquire either a long or short position in
reasonable anticipation of near term demands of
clients, customers, or counterparties. In particular,
if it is expected that customers will want to buy an
instrument in the near term, it may be appropriate
for the desk to acquire a long position in such
instrument. If it is expected that customers will
want to sell the instrument, acquiring a short
position may be appropriate under certain
circumstances.

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
compared to prior similar periods; (v)
schedule of maturities in customers’
existing portfolios; and (vi) expected
market events, such as an index
rebalancing, and announcements. The
Agencies believe that some banking
entities already analyze these and other
relevant factors as part of their overall
risk management processes.935
With respect to the creation and
distribution of complex structured
products, a trading desk may be able to
use the market-making exemption to
acquire some or all of the risk exposures
associated with the product if the
trading desk has evidence of customer
demand for each of the significant risks
associated with the product.936 To have
evidence of customer demand under
these circumstances, there must be prior
express interest from customers in the
specific risk exposures of the product.
Without such express interest, a trading
desk would not have sufficient
information to support the required
demonstrable analysis (e.g., information
about historical customer demand or
other relevant factors).937 The Agencies
are concerned that, absent express
interest in each significant risk
associated with the product, a trading
desk could evade the market-making
exemption by structuring a deal with
certain risk exposures, or amounts of
risk exposures, for which there is no
customer demand and that would be
retained in the trading desk’s inventory,
potentially for speculative purposes.
Thus, a trading desk would not be
engaged in permitted market makingrelated activity if, for example, it
structured a product solely to acquire a
desired exposure and not to respond to
customer demand.938 When a trading
desk acquires risk exposures in these
circumstances, the trading desk would
be expected to enter into appropriate

hedging transactions or otherwise
mitigate the risks of these exposures,
consistent with its hedging policies and
procedures and risk limits.
With regard to a trading desk that
conducts its market-making activities on
an exchange or other similar anonymous
trading facility, the Agencies continue
to believe that market-making 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 or by
regularly responding to requests for
quotes in markets where resting orders
are not generally provided. This ensures
that the trading desk has a pattern of
providing, rather than taking, liquidity.
However, this does not mean that a
trading desk acting as a market maker
on an exchange or other similar
anonymous trading facility is only
permitted to use these types of orders in
connection with its market makingrelated activities. The Agencies
recognize that it may be appropriate for
a trading desk to enter market or
marketable limit orders on an exchange
or other similar anonymous trading
facility, or to request quotes from other
market participants, in connection with
its market making-related activities for a
variety of purposes including, among
others, inventory management,
addressing order imbalances on an
exchange, and hedging.939 In response
to comments, the Agencies are not
requiring a banking entity to be
registered as a market maker on an
exchange or other similar anonymous
trading facility, if the exchange or other
similar anonymous trading facility
registers market makers, for purposes of
the final rule.940 The Agencies

935 See supra Part IV.A.3.c.2.b.iii. See FTN;
Morgan Stanley (suggesting a standard that would
require a position to be ‘‘reasonably consistent with
observable customer demand patterns’’).
936 Complex structured products can contain a
combination of several different types of risks,
including, among others, market risk, credit risk,
volatility risk, and prepayment risk.
937 In contrast, a trading desk may respond to
requests for customized transactions, such as
custom swaps, provided that the trading desk is a
market maker in the risk exposures underlying the
swap or can hedge the underlying risk exposures,
consistent with its financial exposure and hedging
limits, and otherwise meets the requirements of the
market-making exemption. For example, a trading
desk may routinely make markets in underlying
exposures and, thus, would meet the requirements
for engaging in transactions in derivatives that
reflect the same exposures. Alternatively, a trading
desk might meet the requirements by routinely
trading in the derivative and hedging in the
underlying exposures. See supra Part
IV.A.3.c.1.c.iii.
938 See, e.g., Sens. Merkley & Levin (Feb. 2012).

939 The Agencies are clarifying this point in
response to commenters who expressed concern
that the proposal would prevent an exchange
market maker from using market or marketable limit
orders under these circumstances. See, e.g., NYSE
Euronext; SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); RBC.
940 See supra notes 774 to 779 and accompanying
text (discussing commenters’ response to statements
in the proposal requiring exchange registration as
a market maker under certain circumstances).
Similarly, the final rule does not establish a
presumption of compliance with the market-making
exemption based on registration as a market maker
with an exchange, as requested by a few
commenters. See supra note 777 and accompanying
text. As noted above, activity that is considered
market making for purposes of this rule may not be
considered market making for purposes of other
rules, including self-regulatory organization rules,
and vice versa. In addition, exchange requirements
for registered market makers are subject to change
without consideration of the impact on this rule.
Although a banking entity is not required to be an
exchange-registered market maker under the final

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5611

recognize, as noted by commenters, that
there are a large number of exchanges
and organized trading facilities on
which market makers may need to trade
to maintain liquidity across the markets
and to provide customers with favorable
prices and that requiring registration
with each exchange or other trading
facility may unnecessarily restrict or
impose burdens on exchange marketmaking activities.941
A banking entity is not required to
conduct the demonstrable analysis
under § ll.4(b)(2)(B) of the final rule
on an instrument-by-instrument basis.
The Agencies recognize that, in certain
cases, customer demand may be for a
particular type of exposure, and a
customer may be willing to trade any
one of a number of instruments that
would provide the demanded exposure.
Thus, an assessment of the amount,
types, and risks of financial instruments
that the trading desk may hold in
market-maker inventory and that would
be designed not to exceed, on an
ongoing basis, the reasonably expected
near term demands of clients,
customers, or counterparties does not
need to be made for each financial
instrument in which the trading desk
acts as market maker. Instead, the
amount and types of financial
instruments in the trading desk’s
market-maker inventory should be
consistent with the types of financial
instruments in which the desk makes a
market and the amount and types of
such instruments that the desk’s
customers are reasonably expected to be
interested in trading.
In response to commenters’ concern
that banking entities may be subject to
regulatory sanctions if reasonably
expected customer demand does not
materialize,942 the Agencies recognize
that predicting the reasonably expected
near term demands of clients,
customers, or counterparties is
inherently subject to changes based on
market and other factors that are
difficult to predict with certainty. Thus,
there may at times be differences
between predicted demand and actual
demand from clients, customers, or
rule, a banking entity must be licensed or registered
to engage in market making-related activities in
accordance with applicable law. For example, a
banking entity would be required to be an SECregistered broker-dealer to engage in market
making-related activities in securities in the U.S.
unless the banking entity is exempt from
registration or excluded from regulation as a dealer
under the Exchange Act. See infra Part IV.A.3.c.6.;
final rule § ll.4(b)(2)(vi).
941 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading) (noting that there are more
than 12 exchanges and 40 alternative trading
systems currently trading U.S. equities).
942 See RBC; CIEBA; Wellington; ICI (Feb. 2012)
Invesco.

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counterparties. However, assessments of
expected near term demand may not be
reasonable if, in the aggregate and over
longer periods of time, a trading desk
exhibits a repeated pattern or practice of
significant variation in the amount,
types, and risks of financial instruments
in its market-maker inventory in excess
of what is needed to facilitate near term
customer demand.

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iv. Relationship to Required Limits
As discussed further below, a banking
entity must establish limits for each
trading desk on the amount, types, and
risks of its market-maker inventory,
level of exposures to relevant risk
factors arising from its financial
exposure, and period of time a financial
instrument may be held by a trading
desk. These limits must be reasonably
designed to ensure compliance with the
market-making exemption, including
the near term customer demand
requirement, and must take into account
the nature and amount of the trading
desk’s market making-related activities.
Thus, the limits should account for and
generally be consistent with the
historical near term demands of the
desk’s clients, customers, or
counterparties and the amount, types,
and risks of financial instruments that
the trading desk has historically held in
market-maker inventory to meet such
demands. In addition to the limits that
a trading desk selects in managing its
positions to ensure compliance with the
market-making exemption set out in
§ ll.4(b), the Agencies are requiring,
for banking entities that must report
metrics in Appendix A, such limits
include, at a minimum, ‘‘Risk Factor
Sensitivities’’ and ‘‘Value-at-Risk and
Stress Value-at-Risk’’ metrics as limits,
except to the extent any of the ‘‘Risk
Factor Sensitivities’’ or ‘‘Value-at-Risk
and Stress Value-at-Risk’’ metrics are
demonstrably ineffective for measuring
and monitoring the risks of a trading
desk based on the types of positions
traded by, and risk exposures of, that
desk.943 The Agencies believe that these
metrics can be useful for measuring and
managing many types of positions and
trading activities and therefore can be
useful in establishing a minimum set of
metrics for which limits should be
applied.944
As this requirement applies on an
ongoing basis, a trade in excess of one
943 See

Appendix A.
Agencies recognize that for some types of
positions or trading strategies, the use of ‘‘Risk
Factor Sensitivities’’ and ‘‘Value-at-Risk and Stress
Value-at-Risk’’ metrics may be ineffective and
accordingly limits do not need to be set for those
metrics if such ineffectiveness is demonstrated by
the banking entity.
944 The

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or more limits set for a trading desk
should not be permitted simply because
it responds to customer demand. Rather,
a banking entity’s compliance program
must include escalation procedures that
require review and approval of any
trade that would exceed one or more of
a trading desk’s limits, demonstrable
analysis that the basis for any temporary
or permanent increase to one or more of
a trading desk’s limits is consistent with
the requirements of this near term
demand requirement and with the
prudent management of risk by the
banking entity, and independent review
of such demonstrable analysis and
approval.945 The Agencies expect that a
trading desk’s escalation procedures
will generally explain the circumstances
under which a trading desk’s limits can
be increased, either temporarily or
permanently, and that such increases
must be consistent with reasonably
expected near term demands of the
desk’s clients, customers, or
counterparties and the amount and type
of risks to which the trading desk is
authorized to be exposed.
3. Compliance Program Requirement
a. Proposed Compliance Program
Requirement
To ensure that a banking entity
relying on the market-making
exemption had an appropriate
framework in place to support its
compliance with the exemption, § ll
.4(b)(2)(i) of the proposed rule required
a banking entity to establish an internal
compliance program, as required by
subpart D of the proposal, designed to
ensure compliance with the
requirements of the market-making
exemption.946
b. Comments on the Proposed
Compliance Program Requirement
A few commenters supported the
proposed requirement that a banking
entity establish a compliance program
under § ll.20 of the proposed rule as
effective.947 For example, one
commenter stated that the requirement
‘‘keeps a strong focus on the bank’s own
workings and allows banks to selfmonitor.’’ 948 One commenter indicated
that a comprehensive compliance
program is a ‘‘cornerstone of effective
corporate governance,’’ but cautioned
against placing ‘‘undue reliance’’ on
945 See final rule § ll.4(b)(2)(iii); infra Part
IV.A.3.c.3.c. (discussing the meaning of
‘‘independent’’ review for purposes of this
requirement).
946 See proposed rule § ll.4(b)(2)(i); Joint
Proposal, 76 FR 68,870; CFTC Proposal, 77 FR 8355.
947 See Flynn & Fusselman; Morgan Stanley.
948 See Flynn & Fusselman.

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compliance programs.949 As discussed
further below in Parts IV.C.1. and
IV.C.3., many commenters expressed
concern about the potential burdens of
the proposed rule’s compliance program
requirement, as well as the proposed
requirement regarding quantitative
measurements. According to one
commenter, the compliance burdens
associated with these requirements may
dissuade a banking entity from
attempting to comply with the marketmaking exemption.950
c. Final Compliance Program
Requirement
Similar to the proposed exemption,
the market-making exemption adopted
in the final rule requires that a banking
entity establish and implement,
maintain, and enforce an internal
compliance program required by
subpart D that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of the marketmaking exemption, including
reasonably designed written policies
and procedures, internal controls,
analysis, and independent testing.951
This provision further requires that the
compliance program include particular
written policies and procedures,
internal controls, analysis, and
independent testing identifying and
addressing:
• The financial instruments each
trading desk stands ready to purchase
and sell as a market maker;
• The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the required
limits; the products, instruments, and
exposures each trading desk may use for
risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and
inventory; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective;
• Limits for each trading desk, based
on the nature and amount of the trading
desk’s market making-related activities,
that address the factors prescribed by
the near term customer demand
requirement of the final rule, on:
Æ The amount, types, and risks of its
market-maker inventory;
949 See

Occupy.
ICI (Feb. 2012).
951 The independent testing standard is discussed
in more detail in Part IV.C., which discusses the
compliance program requirement in § ll.20 of the
final rule.
950 See

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Æ The amount, types, and risks of the
products, instruments, and exposures
the trading desk uses for risk
management purposes;
Æ Level of exposures to relevant risk
factors arising from its financial
exposure; and
Æ Period of time a financial
instrument may be held;
• Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its required
limits; and
• Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis that the
basis for any temporary or permanent
increase to a trading desk’s limit(s) is
consistent with the requirements of
§ ll.4(b)(2)(ii) of the final rule, and
independent review (i.e., by risk
managers and compliance officers at the
appropriate level independent of the
trading desk) of such demonstrable
analysis and approval.952
The compliance program requirement
in the proposed market-making
exemption did not include specific
references to all the compliance
program elements now listed in the final
rule. Instead, these elements were
generally included in the compliance
requirements of Appendix C of the
proposed rule. The Agencies are moving
certain of these requirements into the
market-making exemption to ensure that
critical components are made part of the
compliance program for market makingrelated activities. Further, placing these
requirements within the market-making
exemption emphasizes the important
role they play in overall compliance
with the exemption.953 Banking entities
final rule § ll.4(b)(2)(iii).
Agencies note that a number of
commenters requested that the Agencies place a
greater emphasis on inventory limits and risk limits
in the final exemption. See, e.g., Citigroup
(suggesting that the market-making exemption
utilize risk limits that would be set for each trading
unit based on expected levels of customer trading—
estimated by looking to historical results, target
product and customer lists, and target market
share—and an appropriate amount of required
inventory to support that level of customer trading);
Prof. Colesanti et al. (suggesting that the exemption
include, among other things, a bright-line threshold
of the amount of risk that can be retained (which
cannot be in excess of the size and type required
for market making), positions limits, and limits on
holding periods); Sens. Merkley & Levin (Feb. 2012)
(suggesting the use of specific parameters for
inventory levels, along with a number of other
criteria, to establish a safe harbor); SIFMA et al.
(Prop. Trading) (Feb. 2012) (recommending the use
of risk limits in combination with a guidance-based
approach); Japanese Bankers Ass’n. (suggesting that
the rule set risk allowances for market makingrelated activities based on required capital for such
activities). The Agencies are not establishing
specific limits in the final rule, as some commenters
952 See

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953 The

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should note that these compliance
procedures must be established,
implemented, maintained, and enforced
for each trading desk engaged in market
making-related activities under the final
rule. Each of the requirements in
paragraphs (b)(2)(iii)(A) through (E)
must be appropriately tailored to the
individual trading activities and
strategies of each trading desk on an
ongoing basis.
As a threshold issue, the compliance
program must identify the products,
instruments, and exposures the trading
desk may trade as market maker or for
risk management purposes.954
Identifying the relevant instruments in
which a trading desk is permitted to
trade will facilitate monitoring and
oversight of compliance with the
exemption by preventing an individual
trader on a market-making desk from
establishing positions in instruments
that are unrelated to the desk’s marketmaking function. Further, this
identification of instruments helps form
the basis for the specific types of
inventory and risk limits that the
banking entity must establish and is
relevant to considerations throughout
the exemption regarding the liquidity,
depth, and maturity of the market for
the relevant type of financial
instrument. The Agencies note that a
banking entity should be able to
demonstrate the relationship between
the instruments in which a trading desk
may act as market maker and the
instruments the desk may use to manage
the risk of its market making-related
activities and inventory and why the
instruments the desk may use to manage
its risk appropriately and effectively
appeared to recommend, in recognition of the fact
that appropriate limits will differ based on a
number of factors, including the size of the marketmaking operation and the liquidity, depth, and
maturity of the market for the particular type(s) of
financial instruments in which the trading desk is
permitted to trade. See Sens. Merkley & Levin (Feb.
2012); Prof. Colesanti et al. However, banking
entities relying on the market-making exemption
must set limits and demonstrate how the specific
limits and limit methodologies they have chosen
are reasonably designed to limit the amount, types,
and risks of the financial instruments in a trading
desk’s market-maker inventory consistent with the
reasonably expected near term demands of the
banking entity’s clients, customers, and
counterparties, subject to the market and conditions
discussed above, and to commensurately control
the desk’s overall financial exposure.
954 See final rule § ll.4(b)(2)(iii)(A) (requiring
written policies and procedures, internal controls,
analysis, and independent testing regarding the
financial instruments each trading desk stands
ready to purchase and sell in accordance with § l
l.4(b)(2)(i) of the final rule); final rule § ll
.4(b)(2)(iii)(B) (requiring written policies and
procedures, internal controls, analysis, and
independent testing regarding the products,
instruments, or exposures each trading desk may
use for risk management purposes).

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5613

mitigate the risk of its market makingrelated activities without generating an
entirely new set of risks that outweigh
the risks that are being hedged.
The final rule provides that a banking
entity must establish an appropriate risk
management framework for each of its
trading desks that rely on the marketmaking exemption.955 This includes not
only the techniques and strategies that
a trading desk may use to manage its
risk exposures, but also the actions the
trading desk will take to demonstrably
reduce or otherwise significantly
mitigate promptly the risks of its
financial exposures consistent with its
required limits, which are discussed in
more detail below. While the Agencies
do not expect a trading desk to hedge all
of the risks that arise from its market
making-related activities, the Agencies
do expect each trading desk to take
appropriate steps consistent with
market-making activities to contain and
limit risk exposures (such as by
unwinding unneeded positions) and to
follow reasonable procedures to monitor
the trading desk’s risk exposures (i.e., its
financial exposure) and hedge risks of
its financial exposure to remain within
its relevant risk limits.956
955 This standard addresses issues raised by
commenters concerning: Certain language in
proposed Appendix B regarding market makingrelated risk management; the market making-related
hedging provision in § ll.4(b)(3) of the proposed
rule; and, to some extent, the proposed source of
revenue requirement in § ll.4(b)(2)(v) of the
proposed rule. See Joint Proposal, 76 FR 68,960;
CFTC Proposal, 77 FR 8439–8440; proposed rule
§ ll.4(b)(3); Joint Proposal, 76 FR 68,873; CFTC
Proposal, 77 FR 8358; Wellington; Credit Suisse
(Seidel); Morgan Stanley; PUC Texas; CIEBA; SSgA
(Feb. 2012); Alliance Bernstein; Investure; Invesco;
Japanese Bankers Ass’n.; SIFMA et al. (Prop.
Trading) (Feb. 2012); FTN; RBC; NYSE Euronext;
MFA. As discussed in more detail above, a number
of commenters emphasized that market makingrelated activities necessarily involve a certain
amount of risk-taking to provide ‘‘immediacy’’ to
customers. See, e.g., Prof. Duffie; Morgan Stanley;
SIFMA et al. (Prop. Trading) (Feb. 2012).
Commenters also represented that the amount of
risk a market maker needs to retain may differ
across asset classes and markets. See, e.g., Morgan
Stanley; Credit Suisse (Seidel). The Agencies
believe that the requirement we are adopting better
recognizes that appropriate risk management will
tailor acceptable position, risk and inventory limits
based on the type(s) of financial instruments in
which the trading desk is permitted to trade and the
liquidity, maturity, and depth of the market for the
relevant type of financial instrument.
956 It may be more efficient for a banking entity
to manage some risks at a higher organizational
level than the trading desk level. As a result, a
banking entity’s written policies and procedures
may delegate the responsibility to mitigate specific
risks of the trading desk’s financial exposure to an
entity other than the trading desk, including
another organizational unit of the banking entity or
of an affiliate, provided that such organizational
unit of the banking entity or of an affiliate is
identified in the banking entity’s written policies
and procedures. Under these circumstances, the

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As discussed in Part IV.A.3.c.4.c.,
managing the risks associated with
maintaining a market-maker inventory
that is appropriate to meet the
reasonably expected near-term demands
of customers is an important part of
market making.957 The Agencies
understand that, in the context of
market-making activities, inventory
management includes adjustment of the
amount and types of market-maker
inventory to meet the reasonably
expected near term demands of
customers.958 Adjustments of the size
and types of a financial exposure are
also made to reduce or mitigate the risks
associated with financial instruments
held as part of a trading desk’s marketmaker inventory. A common strategy in
market making is to establish marketmaker inventory in anticipation of
reasonably expected customer needs
and then to reduce that market-maker
inventory over time as customer
demand materializes.959 If customer
demand does not materialize, the
market maker addresses the risks
associated with its market-maker
inventory by adjusting the amount or
types of financial instruments in its
inventory as well as taking steps
otherwise to mitigate the risk associated
with its inventory.
The Agencies recognize that, to
provide effective intermediation
services, a trading desk engaged in
permitted market making-related
activities retains a certain amount of
risk arising from the positions it holds
in inventory and may hedge certain
aspects of that risk. The requirements in
the final rule establish controls around
a trading desk’s risk management
activities, yet still recognize that a
trading desk engaged in market makingrelated activities may retain a certain
amount of risk in meeting the
reasonably expected near term demands
of clients, customers, or counterparties.
other organizational unit of the banking entity or of
an affiliate must conduct such hedging activity in
accordance with the requirements of the hedging
exemption in § ll.5 of the final rule, including
the documentation requirement in § ll.5(c). As
recognized in Part IV.A.4.d.4., hedging activity
conducted by a different organizational unit than
the unit responsible for the positions being hedged
presents a greater risk of evasion. Further, the risks
being managed by a higher organizational level than
the trading desk may be generated by trading desks
engaged in market making-related activity or by
trading desks engaged in other permitted activities.
Thus, it would be inappropriate for such hedging
activity to be conducted in reliance on the marketmaking exemption.
957 See supra Part IV.A.3.c.2.c. (discussing the
final near term demand requirement).
958 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Credit Suisse (Seidel); Goldman (Prop.
Trading); MFA; RBC.
959 See, e.g., BoA; SIFMA et al. (Prop. Trading)
(Feb. 2012); Chamber (Feb. 2012).

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As the Agencies noted in the proposal,
where the purpose of a transaction is to
hedge a market making-related position,
it would appear to be market makingrelated activity of the type described in
section 13(d)(1)(B) of the BHC Act.960
The Agencies emphasize that the only
risk management activities that qualify
for the market-making exemption—and
that are not subject to the hedging
exemption—are risk management
activities conducted or directed by the
trading desk in connection with its
market making-related activities and in
conformance with the trading desk’s
risk management policies and
procedures.961 A trading desk engaged
in market making-related activities
would be required to comply with the
hedging exemption or another available
exemption for any risk management or
other activity that is not in conformance
with the trading desk’s required marketmaking risk management policies and
procedures.
A banking entity’s written policies
and procedures, internal controls,
analysis, and independent testing
identifying and addressing the products,
instruments, or exposures and the
techniques and strategies that may be
used by each trading desk to manage the
risks of its market making-related
activities and inventory must cover both
how the trading desk may establish
hedges and how such hedges are
removed once the risk they were
mitigating is unwound. With respect to
establishing positions that hedge or
otherwise mitigate the risk(s) of market
making-related positions held by the
trading desk, the written policies and
procedures may consider the natural
hedging and diversification that occurs
960 See Joint Proposal, 76 FR 68,873; CFTC
Proposal, 77 FR 8358.
961 As discussed above, if a trading desk operating
under the market-making exemption directs a
different organizational unit of the banking entity
or an affiliate to establish a hedge position on the
desk’s behalf, then the other organizational unit
may rely on the market-making exemption to
establish the hedge position as long as: (i) The other
organizational unit’s hedging activity is consistent
with the trading desk’s risk management policies
and procedures (e.g., the hedge instrument,
technique, and strategy are consistent with those
identified in the trading desk’s policies and
procedures); and (ii) the hedge position is attributed
to the financial exposure of the trading desk and is
included in the trading desk’s daily profit and loss.
If a different organizational unit of the banking
entity or of an affiliate establishes a hedge for the
trading desk’s financial exposure based on its own
determination, or if such position was not
established in accordance with the trading desk’s
required procedures or was included in that other
organizational unit’s financial exposure and/or
daily profit and loss, then that hedge position must
be established in compliance with the hedging
exemption in § ll.5 of the rule, including the
documentation requirement in § ll.5(c). See
supra Part IV.A.3.c.1.c.ii.

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in an aggregation of long and short
positions in financial instruments for
which the trading desk is a market
maker,962 as it documents its specific
risk-mitigating strategies that use
instruments for which the desk is a
market maker or instruments for which
the desk is not a market maker. Further,
the written policies and procedures
identifying and addressing permissible
hedging techniques and strategies must
address the circumstances under which
the trading desk may be permitted to
engage in anticipatory hedging. Like the
proposed rule’s hedging exemption, a
trading desk may establish an
anticipatory hedge position before it
becomes exposed to a risk that it is
highly likely to become exposed to,
provided there is a sound risk
management rationale for establishing
such an anticipatory hedge position.963
For example, a trading desk may hedge
against specific positions promised to
customers, such as volume-weighted
average price (‘‘VWAP’’) orders or large
block trades, to facilitate the customer
trade.964 The amount of time that an
anticipatory hedge may precede the
establishment of the position to be
hedged will depend on market factors,
such as the liquidity of the hedging
position.
Written policies and procedures,
internal controls, analysis, and
independent testing established
pursuant to the final rule identifying
and addressing permissible hedging
techniques and strategies should be
designed to prevent a trading desk from
over-hedging its market-maker
inventory or financial exposure. Overhedging would occur if, for example, a
trading desk established a position in a
financial instrument for the purported
purpose of reducing a risk associated
with one or more market-making
positions when, in fact, that risk had
already been mitigated to the full extent
possible. Over-hedging results in a new
risk exposure that is unrelated to
market-making activities and, thus, is
not permitted under the market-making
exemption.
962 For example, this may occur if a U.S.
corporate bond trading desk acquires a $100 million
long position in the corporate bonds of one issuer
from clients, customers, or counterparties and
separately acquires a $50 million short position in
another issuer in the same market sector in
reasonable expectation of near term demand of
clients, customers, or counterparties. Although both
positions were acquired to facilitate customer
demand, the positions may also naturally hedge
each other, to some extent.
963 See Joint Proposal, 76 FR 68,875; CFTC
Proposal, 77 FR 8361.
964 Two commenters recommended that banking
entities be permitted to establish hedges prior to
acquiring the underlying risk exposure under these
circumstances. See Credit Suisse (Seidel); BoA.

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
A trading desk’s financial exposure
generally would not be considered to be
consistent with market making-related
activities to the extent the trading desk
is engaged in hedging activities that are
inconsistent with the management of
identifiable risks in its market-maker
inventory or maintains significant hedge
positions after the underlying risk(s) of
the market-maker inventory have been
unwound. A banking entity’s written
policies and procedures, internal
controls, analysis, and independent
testing regarding the trading desk’s
permissible hedging techniques and
strategies must be designed to prevent a
trading desk from engaging in overhedging or maintaining hedge positions
after they are no longer needed.965
Further, the compliance program must
provide for the process and personnel
responsible for ensuring that the actions
taken by the trading desk to mitigate the
risks of its market making-related
activities are and continue to be
effective, which would include
monitoring for and addressing any
scenarios where a trading desk may be
engaged in over-hedging or maintaining
unnecessary hedge positions or new
significant risks have been introduced
by the hedging activity.
As a result of these limitations, the
size and risks of the trading desk’s
hedging positions are naturally
constrained by the size and risks of its
market-maker inventory, which must be
designed not to exceed the reasonably
expected near term demands of clients,
customers, or counterparties, as well as
by the risk limits and controls
established under the final rule. This
ultimately constrains a trading desk’s
overall financial exposure since such
position can only contain positions,
risks, and exposures related to the
market-maker inventory that are
designed to meet current or near term
customer demand and positions, risks
and exposures designed to mitigate the
risks in accordance with the limits
previously established for the trading
desk.
The written policies and procedures
identifying and addressing a trading
desk’s hedging techniques and strategies
also must describe how and under what
timeframe a trading desk must remove
hedge positions once the underlying
risk exposure is unwound. Similarly,
the compliance program established by
the banking entity to specify and control
the trading desk’s hedging activities in
accordance with the final rule must be
designed to prevent a trading desk from
purposefully or inadvertently
transforming its positions taken to
965 See

final rule § ll.4(b)(2)(iii)(B).

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manage the risk of its market-maker
inventory under the exemption into
what would otherwise be considered
prohibited proprietary trading.
Moreover, the compliance program
must provide for the process and
personnel responsible for ensuring that
the actions taken by the trading desk to
mitigate the risks of its market makingrelated activities and inventory—
including the instruments, techniques,
and strategies used for risk management
purposes—are and continue to be
effective. This includes ensuring that
hedges taken in the context of market
making-related activities continue to be
effective and that positions taken to
manage the risks of the trading desk’s
market-maker inventory are not
purposefully or inadvertently
transformed into what would otherwise
be considered prohibited proprietary
trading. If a banking entity’s monitoring
procedures find that a trading desk’s
risk management procedures are not
effective, such deficiencies must be
promptly escalated and remedied in
accordance with the banking entity’s
escalation procedures. A banking
entity’s written policies and procedures
must set forth the process for
determining the circumstances under
which a trading desk’s risk management
strategies may be modified. In addition,
risk management techniques and
strategies developed and used by a
trading desk must be independently
tested or verified by management
separate from the trading desk.
To control and limit the amount and
types of financial instruments and risks
that a trading desk may hold in
connection with its market makingrelated activities, a banking entity must
establish, implement, maintain, and
enforce reasonably designed written
policies and procedures, internal
controls, analysis, and independent
testing identifying and addressing
specific limits on a trading desk’s
market-maker inventory, risk
management positions, and financial
exposure. In particular, the compliance
program must establish limits for each
trading desk, based on the nature and
amount of its market making-related
activities (including the factors
prescribed by the near term customer
demand requirement), on the amount,
types, and risks of its market-maker
inventory, the amount, types, and risks
of the products, instruments, and
exposures the trading desk may use for
risk management purposes, the level of
exposures to relevant risk factors arising
from its financial exposure, and the
period of time a financial instrument

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5615

may be held.966 The limits would be set,
as appropriate, and supported by an
analysis for specific types of financial
instruments, levels of risk, and duration
of holdings, which would also be
required by the compliance appendix.
This approach will build on existing
risk management infrastructure for
market-making activities that subject
traders to a variety of internal,
predefined limits.967 Each of these
limits is independent of the others, and
a trading desk must maintain its
aggregated market-making position
within each of these limits, including by
taking action to bring the trading desk
into compliance with the limits as
promptly as possible after the limit is
exceeded.968 For example, if changing
market conditions cause an increase in
one or more risks within the trading
desk’s financial exposure and that
increased risk causes the desk to exceed
one or more of its limits, the trading
desk must take prompt action to reduce
its risk exposure (either by hedging the
risk or unwinding its existing positions)
or receive approval of a temporary or
permanent increase to its limit through
the required escalation procedures.
The Agencies recognize that trading
desks’ limits will differ across asset
classes and acknowledge that trading
desks engaged in market making-related
activities in less liquid asset classes,
such as corporate bonds, certain
derivatives, and securitized products,
may require different inventory, risk
exposure, and holding period limits
than trading desks engaged in market
making-related activities in more liquid
financial instruments, such as certain
listed equity securities. Moreover, the
types of risk factors for which limits are
established should not be limited solely
to market risk factors. Instead, such
limits should also account for all risk
factors that arise from the types of
financial instruments in which the
trading desk is permitted to trade. In
addition, these limits should be
sufficiently granular and focused on the
particular types of financial instruments
in which the desk may trade. For
example, a trading desk that makes a
market in derivatives would have
exposures to counterparty risk, among
others, and would need to have
appropriate limits on such risk. Other
types of limits that may be relevant for
a trading desk include, among others,
final rule § ll.4(b)(2)(iii)(C).
e.g., Citigroup (Feb. 2012) (noting that its
suggested approach to implementing the marketmaking exemption, which would focus on risk
limits and risk architecture, would build on existing
risk limits and risk management systems already
present in institutions).
968 See final rule § ll.4(b)(2)(iv).
966 See

967 See,

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations

position limits, sector limits, and
geographic limits.
A banking entity must have a
reasonable basis for the limits it
establishes for a trading desk and must
have a robust procedure for analyzing,
establishing, and monitoring limits, as
well as appropriate escalation
procedures.969 Among other things, the
banking entity’s compliance program
must provide for: (i) Written policies
and procedures and internal controls
establishing and monitoring specific
limits for each trading desk; and (ii)
analysis regarding how and why these
limits are determined to be appropriate
and consistent with the nature and
amount of the desk’s market makingrelated activities, including
considerations related to the near term
customer demand requirement. In
making these determinations, a banking
entity should take into account and be
consistent with the type(s) of financial
instruments the desk is permitted to
trade, the desk’s trading and risk
management activities and strategies,
the history and experience of the desk,
and the historical profile of the desk’s
near term customer demand and market
and other factors that may impact the
reasonably expected near term demands
of customers.
The limits established by a banking
entity should generally reflect the
amount and types of inventory and risk
that a trading desk holds to meet the
reasonably expected near term demands
of clients, customers, or counterparties.
As discussed above, while the trading
desk’s market-maker inventory is
directly limited by the reasonably
expected near term demands of
customers, the positions managed by the
trading desk outside of its market-maker
inventory are similarly constrained by
the near term demand requirement
because they must be designed to
manage the risks of the market-maker
inventory in accordance with the desk’s
risk management procedures. As a
result, the trading desk’s risk
management positions and aggregate
financial exposure are also limited by
the current and reasonably expected
near term demands of customers. A
trading desk’s market-maker inventory,
risk management positions, or financial
exposure would not, however, be
permissible under the market-making
exemption merely because the marketmaker inventory, risk management
positions, or financial exposure happens
to be within the desk’s prescribed
limits.970
final rule § ll.4(b)(2)(iii)(C).
example, if a U.S. corporate bond trading
desk has a prescribed limit of $200 million net
969 See
970 For

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In addition, a banking entity must
establish internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits,
including the frequency, nature, and
extent of a trading desk exceeding its
limits and patterns regarding the
portions of the trading desk’s limits that
are accounted for by the trading desk’s
activity.971 This may include the use of
management and exception reports.
Moreover, the compliance program must
set forth a process for determining the
circumstances under which a trading
desk’s limits may be modified on a
temporary or permanent basis (e.g., due
to market changes or modifications to
the trading desk’s strategy).972 This
process must cover potential scenarios
when a trading desk’s limits should be
raised, as well as potential scenarios
when a trading desk’s limits should be
lowered. For example, if a trading desk
experiences reduced customer demand
over a period of time, that trading desk’s
limits should be decreased to address
the factors prescribed by the near term
demand requirement.
A banking entity’s compliance
program must also include escalation
procedures that require review and
approval of any trade that would exceed
one or more of a trading desk’s limits,
demonstrable analysis that the basis for
any temporary or permanent increase to
one or more of a trading desk’s limits is
consistent with the near term customer
demand requirement, and independent
review of such demonstrable analysis
and approval of any increase to one or
more of a trading desk’s limits.973 Thus,
in order to increase a limit of a trading
exposure to any single sector of related issuers, the
desk’s limits may permit it to acquire a net
economic exposure of $400 million long to issuer
ABC and a net economic exposure of $300 million
short to issuer XYZ, where ABC and XYZ are in the
same sector. This is because the trading desk’s net
exposure to the sector would only be $100 million,
which is within its limits. Even though the net
exposure to this sector is within the trading desk’s
prescribed limits, the desk would still need to be
able to demonstrate how its net exposure of $400
million long to issuer ABC and $300 million short
to issuer XYZ is related to customer demand.
971 See final rule § ll.4(b)(2)(iii)(D).
972 For example, a banking entity may determine
to permit temporary, short-term increases to a
trading desk’s risk limits due to an increase in
short-term credit spreads or in response to volatility
in instruments in which the trading desk makes a
market, provided the increased limit is consistent
with the reasonably expected near term demands of
clients, customers, or counterparties. As noted
above, other potential circumstances that could
warrant changes to a trading desk’s limits include:
A change in the pattern of customer needs,
adjustments to the market maker’s business model
(e.g., new entrants or existing market makers trying
to expand or contract their market share), or
changes in market conditions. See supra note 932
and accompanying text.
973 See final rule § ll.4(b)(2)(iii)(E).

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desk—on either a temporary or
permanent basis—there must be an
analysis of why such increase would be
appropriate based on the reasonably
expected near term demands of clients,
customers, or counterparties, including
the factors identified in § ll.4(b)(2)(ii)
of the final rule, which must be
independently reviewed. A banking
entity also must maintain
documentation and records with respect
to these elements, consistent with the
requirement of § ll.20(b)(6).
As already discussed, commenters
have represented that the compliance
costs associated with the proposed rule,
including the compliance program and
metrics requirements, may be significant
and ‘‘may dissuade a banking entity
from attempting to comply with the
market making-related activities
exemption.’’974 The Agencies believe
that a robust compliance program is
necessary to ensure adherence to the
rule and to prevent evasion, although, as
discussed in Part IV.C.3., the Agencies
are adopting a more tailored set of
quantitative measurements to better
focus on those that are most germane to
evaluating market making-related
activity. The Agencies acknowledge that
the compliance program requirements
for the market-making exemption,
including reasonably designed written
policies and procedures, internal
controls, analysis, and independent
testing, represent a new regulatory
requirement for banking entities and the
Agencies have thus been mindful that it
may impose significant costs and may
cause a banking entity to reconsider
whether to conduct market makingrelated activities. Despite the potential
costs of the compliance program, the
Agencies believe they are warranted to
ensure that the goals of the rule and
statute will be met, such as promoting
the safety and soundness of banking
entities and the financial stability of the
United States.
4. Market Making-Related Hedging
a. Proposed Treatment of Market
Making-Related Hedging
In the proposal, certain hedging
transactions related to market making
were considered to be made in
connection with a banking entity’s
market making-related activity for
purposes of the market-making
exemption. The Agencies explained that
where the purpose of a transaction is to
hedge a market making-related position,
it would appear to be market makingrelated activity of the type described in
974 See

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section 13(d)(1)(B) of the BHC Act.975
To qualify for the market-making
exemption, a hedging transaction would
have been required to meet certain
requirements under § ll.4(b)(3) of the
proposed rule. This provision required
that the purchase or sale of a financial
instrument: (i) Be conducted 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; and (ii) meet the criteria
specified in § ll.5(b) of the proposed
hedging exemption and, where
applicable, § ll.5(c) of the
proposal.976 In the proposal, the
Agencies noted that a market maker may
often make a market in one type of
financial instrument and hedge its
activities using different financial
instruments in which it does not make
a market. The Agencies stated that this
type of hedging transaction would meet
the terms of the market-making
exemption if the hedging transaction
met the requirements of
§ ll.4(b)(3) of the proposed rule.977

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b. Comments on the Proposed
Treatment of Market Making-Related
Hedging
Several commenters recommended
that the proposed market-making
exemption be modified to establish a
more permissive standard for market
maker hedging.978 A few of these
commenters stated that, rather than
applying the standards of the riskmitigating hedging exemption to market
maker hedging, a market maker’s hedge
position should be permitted as long as
it is designed to mitigate the risk
associated with positions acquired
through permitted market makingrelated activities.979 Other commenters
emphasized the need for flexibility to
permit a market maker to choose the
most effective hedge.980 In general,
these commenters expressed concern
that limitations on hedging market
975 See Joint Proposal, 76 FR 68,873; CFTC
Proposal, 77 FR 8358.
976 See proposed rule § ll.4(b)(3); Joint
Proposal, 76 FR 68,873; CFTC Proposal, 77 FR 8358.
977 See Joint Proposal, 76 FR 68,870 n.146; CFTC
Proposal, 77 FR 8356 n.152.
978 See, e.g., Japanese Bankers Ass’n.; SIFMA et
al. (Prop. Trading) (Feb. 2012); Credit Suisse
(Seidel); FTN; RBC; NYSE Euronext; MFA. These
comments are addressed in Part IV.A.3.c.4.c., infra.
979 See SIFMA et al. (Prop. Trading) (Feb. 2012);
RBC. See also FTN (stating that the principal
requirement for such hedges should be that they
reduce the risk of market making).
980 See NYSE Euronext (stating that the best
hedge sometimes involves a variety of complex and
dynamic transactions over the time in which an
asset is held, which may fall outside the parameters
of the exemption); MFA; JPMC.

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making-related positions may cause a
reduction in liquidity, wider spreads, or
increased risk and trading costs for
market makers.981 For example, one
commenter stated that ‘‘[t]he ability of
market makers to freely offset or hedge
positions is what, in most cases, makes
them willing to buy and sell [financial
instruments] to and from customers,
clients or counterparties,’’ so ‘‘[a]ny
impediment to hedging market makingrelated positions will decrease the
willingness of banking entities to make
markets and, accordingly, reduce
liquidity in the marketplace.’’ 982
In addition, some commenters
expressed concern that certain
requirements in the proposed hedging
exemption may result in a reduction in
market-making activities under certain
circumstances.983 For example, one
commenter expressed concern that the
proposed hedging exemption would
require a banking entity to identify and
tag hedging transactions when hedges in
a particular asset class take place
alongside a trading desk’s customer flow
trading and inventory management in
that same asset class.984 Further, a few
commenters represented that the
proposed reasonable correlation
requirement in the hedging exemption
could impact market making by
discouraging market makers from
entering into customer transactions that
do not have a direct hedge 985 or making
it more difficult for market makers to
cost-effectively hedge the fixed income
securities they hold in inventory,
including hedging such inventory
positions on a portfolio basis.986
One commenter, however, stated that
the proposed approach is effective.987
Another commenter indicated that it is
confusing to include hedging within the
market-making exemption and
suggested that a market maker be
required to rely on the hedging
exemption under § ll.5 of the
proposed rule for its hedging activity.988
As noted above in the discussion of
comments on the proposed source of
revenue requirement, a number of
commenters expressed concern that the
proposed rule assumed that there are
effective, or perfect, hedges for all
market making-related positions.989
981 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Credit Suisse (Seidel); NYSE Euronext; MFA;
Japanese Bankers Ass’n.; RBC.
982 RBC.
983 See BoA; SIFMA (Asset Mgmt.) (Feb. 2012).
984 See Goldman (Prop. Trading).
985 See BoA.
986 See SIFMA (Asset Mgmt.) (Feb. 2012).
987 See Alfred Brock.
988 See Occupy.
989 See infra notes 1068 to 1070 and
accompanying text.

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5617

Another commenter stated that market
makers should be required to hedge
whenever an inventory imbalance
arises, and the absence of a hedge in
such circumstances may evidence
prohibited proprietary trading.990
c. Treatment of Market Making-Related
Hedging in the Final Rule
Unlike the proposed rule, the final
rule does not require that market
making-related hedging activities
separately comply with the
requirements found in the riskmitigating hedging exemption if
conducted or directed by the same
trading desk conducting the marketmaking activity. Instead, the Agencies
are including requirements for market
making-related hedging activities within
the market-making exemption in
response to comments.991 As discussed
above, a trading desk’s compliance
program must include written policies
and procedures, internal controls,
independent testing and analysis
identifying and addressing the products,
instruments, exposures, techniques, and
strategies a trading desk may use to
manage the risks of its market makingrelated activities, as well as the actions
the trading desk will take to
demonstrably reduce or otherwise
significant mitigate the risks of its
financial exposure consistent with its
required limits.992 The Agencies believe
this approach addresses commenters’
concerns that limitations on hedging
market making-related positions may
cause a reduction in liquidity, wider
spreads, or increased risk and trading
costs for market makers because it
allows banking entities to determine
how best to manage the risks of trading
desks’ market making-related activities
through reasonable policies and
procedures, internal controls,
independent testing, and analysis,
rather than requiring compliance with
the specific requirements of the hedging
exemption.993 Further, this approach
addresses commenters’ concerns about
the impact of certain requirements of
the hedging exemption on market
making-related activities.994
The Agencies believe it is consistent
with the statute’s reference to ‘‘market
making-related’’ activities to permit
990 See

Public Citizen.
e.g., Japanese Bankers Ass’n.; SIFMA et
al. (Prop. Trading) (Feb. 2012); Credit Suisse
(Seidel); FTN; RBC; NYSE Euronext; MFA.
992 See final rule § ll.4(b)(2)(iii)(B); supra Part
IV.A.3.c.3.c.
993 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Credit Suisse (Seidel); NYSE Euronext; MFA;
Japanese Bankers Ass’n.; RBC.
994 See BoA; SIFMA (Asset Mgmt.) (Feb. 2012);
Goldman (Prop. Trading).
991 See,

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market making-related hedging
activities under this exemption. In
addition, the Agencies believe it is
appropriate to require a trading desk to
appropriately manage its risks,
consistent with its risk management
procedures and limits, because
management of risk is a key factor that
distinguishes permitted market makingrelated activity from impermissible
proprietary trading. As noted in the
proposal, while ‘‘a market maker
attempts to eliminate some [of the risks
arising from] its retained principal
positions and risks by hedging or
otherwise managing those risks [ ], 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.’’ 995
The Agencies recognize that some
banking entities may manage the risks
associated with market making at a
different level than the individual
trading desk.996 While this risk
management activity is not permitted
under the market-making exemption, it
may be permitted under the hedging
exemption, provided the requirements
of that exemption are met. Thus, the
Agencies believe banking entities will
continue to have options available that
allow them to efficiently hedge the risks
arising from their market-making
operations. Nevertheless, the Agencies
understand that this rule will result in
additional documentation or other
potential burdens for market makingrelated hedging activity that is not
conducted by the trading desk
responsible for the market-making
positions being hedged.997 As discussed
in Part IV.A.4.d.4., hedging conducted
by a different organizational unit than
the trading desk that is responsible for
the underlying positions presents an
increased risk of evasion, so the
Agencies believe it is appropriate for
such hedging activity to be required to
comply with the hedging exemption,
including the associated documentation
requirement.
5. Compensation Requirement

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a. Proposed Compensation Requirement
Section ll.4(b)(2)(vii) of the
proposed market-making exemption
would have required that the
compensation arrangements of persons
995 See

Joint Proposal, 76 FR 68,961.
e.g., letter from JPMC (stating that, to
minimize risk management costs, firms commonly
organize their market-making activities so that risks
delivered to client-facing desks are aggregated and
passed by means of internal transactions to a single
utility desk and suggesting this be recognized as
permitted market making-related behavior).
997 See final rule § ll.5(c).
996 See,

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performing market making-related
activities at the banking entity be
designed not to reward proprietary risktaking.998 In the proposal, the Agencies
noted that activities for which a banking
entity has established a compensation
incentive structure that rewards
speculation in, and appreciation of, the
market value of a financial instrument
position held in inventory, rather than
success in providing effective and
timely intermediation and liquidity
services to customers, would be
inconsistent with the proposed marketmaking exemption.
The Agencies stated that under the
proposed rule, a banking entity relying
on the market-making exemption should
provide compensation incentives that
primarily reward customer revenues
and effective customer service, not
proprietary risk-taking. However, the
Agencies noted that a banking entity
relying on the proposed market-making
exemption would be able to
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.999
b. Comments Regarding the Proposed
Compensation Requirement
Several commenters recommended
certain revisions to the proposed
compensation requirement.1000 Two
commenters stated that the proposed
requirement is effective,1001 while one
commenter stated that it should be
removed from the rule.1002 Moreover, in
addressing this proposed requirement,
commenters provided views on:
identifiable characteristics of
compensation arrangements that
incentivize prohibited proprietary
trading,1003 methods of monitoring
compliance with this requirement,1004
and potential negative incentives or
outcomes this requirement could
cause.1005
With respect to suggested
modifications to this requirement, a few
commenters suggested that a market
maker’s compensation should be subject
proposed rule § ll.4(b)(2)(vii).
Joint Proposal, 76 FR 68,872; CFTC
Proposal, 77 FR 8358.
1000 See Prof. Duffie; SIFMA et al. (Prop. Trading)
(Feb. 2012); John Reed; Credit Suisse (Seidel);
JPMC; Morgan Stanley; Better Markets (Feb. 2012);
Johnson & Prof. Stiglitz; Occupy; AFR et al. (Feb.
2012); Public Citizen.
1001 See FTN; Alfred Brock.
1002 See Japanese Bankers Ass’n.
1003 See Occupy.
1004 See Occupy; Goldman (Prop. Trading).
1005 See AllianceBernstein; Prof. Duffie; Investure;
STANY; Chamber (Dec. 2011).
998 See
999 See

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to additional limitations.1006 For
example, two commenters stated that
compensation should be restricted to
particular sources, such as fees,
commissions, and spreads.1007 One
commenter suggested that compensation
should not be symmetrical between
gains and losses and, further, that
trading gains reflecting an unusually
high variance in position values should
either not be reflected in compensation
and bonuses or should be less reflected
than other gains and losses.1008 Another
commenter recommended that the
Agencies remove ‘‘designed’’ from the
rule text and provide greater clarity
about how a banking entity’s
compensation regime must be
structured.1009 Moreover, a number of
commenters stated that compensation
should be vested for a period of time,
such as until the trader’s market making
positions have been fully unwound and
are no longer in the banking entity’s
inventory.1010 As one commenter
explained, such a requirement would
discourage traders from carrying
inventory and encourage them to get out
of positions as soon as possible.1011
Some commenters also recommended
that compensation be risk adjusted.1012
A few commenters indicated that the
proposed approach may be too
restrictive.1013 Two of these commenters
stated that the compensation
requirement should instead be set forth
as guidance in Appendix B.1014 In
addition, two commenters requested
that the Agencies clarify that
compensation arrangements must be
designed not to reward prohibited
proprietary risk-taking. These
commenters were concerned the
proposed approach may restrict a
banking entity’s ability to provide
compensation for permitted activities,
1006 See Better Markets (Feb. 2012); Public
Citizen; AFR et al. (Feb. 2012); Occupy; John Reed;
AFR et al. (Feb. 2012); Johnson & Prof. Stiglitz; Prof.
Duffie; Sens. Merkley & Levin (Feb. 2012). These
comments are addressed in note 1027, infra.
1007 See Better Markets (Feb. 2012); Public
Citizen.
1008 See AFR et al. (Feb. 2012)
1009 See Occupy.
1010 See John Reed; AFR et al. (Feb. 2012);
Johnson & Prof. Stiglitz; Prof. Duffie (‘‘A trader’s
incentives for risk taking can be held in check by
vesting incentive-based compensation over a
substantial period of time. Pending compensation
can thus be forfeited if a trader’s negligence causes
substantial losses or if his or her employer fails.’’);
Sens. Merkley & Levin (Feb. 2012).
1011 See John Reed.
1012 See Johnson & Prof. Stiglitz; John Reed; Sens.
Merkley & Levin (Feb. 2012).
1013 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC; Morgan Stanley.
1014 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC.

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which also involve proprietary
trading.1015
Two commenters discussed
identifiable characteristics of
compensation arrangements that clearly
incentivize prohibited proprietary
trading.1016 For example, one
commenter stated that rewarding pure
profit and loss, without consideration
for the risk that was assumed to capture
it, is an identifiable characteristic of an
arrangement that incentivizes
proprietary risk-taking.1017 For purposes
of monitoring and ensuring compliance
with this requirement, one commenter
noted that existing Board regulations for
systemically important banking entities
require comprehensive firm-wide
policies that determine compensation.
This commenter stated that those
regulations, along with appropriately
calibrated metrics, should ensure that
compensation arrangements are not
designed to reward prohibited
proprietary risk-taking.1018 For similar
purposes, another commenter suggested
that compensation incentives should be
based on a metric that meaningfully
accounts for the risk underlying
profitability.1019
Certain commenters expressed
concern that the proposed
compensation requirement could
incentivize market makers to act in a
way that would not be beneficial to
customers or market liquidity.1020 For
example, two commenters expressed
concern that the requirement could
cause market makers to widen their
spreads or charge higher fees because
their personal compensation depends
on these factors.1021 One commenter
stated that the proposed requirement
could dampen traders’ incentives and
discretion and may make market makers
less likely to accept trades involving
significant increases in risk or profit.1022
Another commenter expressed the view
that profitability-based compensation
arrangements encourage traders to
exercise due care because such
arrangements create incentives to avoid
losses.1023 Finally, one commenter
stated that compliance with the
proposed requirement may be difficult
or impossible if the Agencies do not
1015 See Morgan Stanley; SIFMA et al. (Prop.
Trading) (Feb. 2012). The Agencies respond to these
comments in note 1026 and its accompanying text,
infra.
1016 See Occupy; Alfred Brock.
1017 See Occupy. The Agencies respond to this
comment in Part IV.A.3.c.5.c., infra.
1018 See Goldman (Prop. Trading).
1019 See Occupy.
1020 See AllianceBernstein; Investure; Prof. Duffie;
STANY. This issue is addressed in note 1027, infra.
1021 See AllianceBernstein; Investure.
1022 See Prof. Duffie.
1023 See STANY.

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take into account the incentive-based
compensation rulemaking.1024
c. Final Compensation Requirement
Similar to the proposed rule, the
market-making exemption requires that
the compensation arrangements of
persons performing the banking entity’s
market making-related activities, as
described in the exemption, are
designed not to reward or incentivize
prohibited proprietary trading.1025 The
language of the final compensation
requirement has been modified in
response to comments expressing
concern about the proposed language
regarding ‘‘proprietary risk-taking.’’ 1026
The Agencies note that the Agencies do
not intend to preclude an employee of
a market-making desk from being
compensated for successful market
making, which involves some risktaking.
The Agencies continue to hold the
view that activities for which a banking
entity has established a compensation
incentive structure that rewards
speculation in, and appreciation of, the
market value of a position held in
inventory, rather than use of that
inventory to successfully provide
effective and timely intermediation and
liquidity services to customers, are
inconsistent with permitted market
making-related activities. Although a
banking entity relying on the marketmaking 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
retained principal risk, a banking entity
relying on the market-making
exemption should provide
compensation incentives that primarily
reward customer revenues and effective
customer service, not prohibited
proprietary trading.1027 For example, a
1024 See

Chamber (Dec. 2011).
final rule § ll.4(b)(2)(v).
1026 See Morgan Stanley; SIFMA et al. (Prop.
Trading) (Feb. 2012).
1027 Because the Agencies are not limiting a
market maker’s compensation to specific sources,
such as fees, commissions, and bid-ask spreads, as
recommended by a few commenters, the Agencies
do not believe the compensation requirement in the
final rule will incentivize market makers to widen
their quoted spreads or charge higher fees and
commissions, as suggested by certain other
commenters. See Better Markets (Feb. 2012); Public
Citizen; AllianceBernstein; Investure. In addition,
the Agencies note that an approach requiring
revenue from fees, commissions, and bid-ask
spreads to be fully distinguished from revenue from
price appreciation can raise certain practical
difficulties, as discussed in Part IV.A.3.c.7. The
Agencies also are not requiring compensation to be
vested for a period of time, as recommended by
some commenters to reduce traders’ incentives for
undue risk-taking. The Agencies believe the final
1025 See

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5619

compensation plan based purely on net
profit and loss with no consideration for
inventory control or risk undertaken to
achieve those profits would not be
consistent with the market-making
exemption.
6. Registration Requirement
a. Proposed Registration Requirement
Under § ll.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 would be required to be
appropriately registered as a securities
dealer, swap dealer, or security-based
swap dealer, or exempt from registration
or excluded from regulation as such
type of dealer, under applicable
securities or commodities laws. Further,
if the banking entity was 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 would be
required to be subject to substantive
regulation of its dealing business in the
jurisdiction in which the business is
located.1028
b. Comments on the Proposed
Registration Requirement
A few commenters stated that the
proposed dealer registration
requirement is effective.1029 However, a
number of commenters opposed the
proposed dealer registration
requirement in whole or in part.1030
Commenters’ primary concern with the
requirement appeared to be its
application to market making-related
activities outside of the United States
for which no U.S. registration is
required.1031 For example, several
commenters stated that many non-U.S.
markets do not provide substantive
regulation of dealers for all asset
classes.1032 In addition, two
rule includes sufficient controls around risk-taking
activity without a compensation vesting
requirement. See John Reed; AFR et al. (Feb. 2012);
Johnson & Prof. Stiglitz; Prof. Duffie; Sens. Merkley
& Levin (Feb. 2012).
1028 See proposed rule § ll.4(b)(2)(iv); Joint
Proposal, 76 FR 68,872; CFTC Proposal, 77 FR
8357–8358.
1029 See Occupy; Alfred Brock.
1030 See SIFMA et al. (Prop. Trading) (Feb. 2012)
(stating that if the requirement is not removed from
the rule, then it should only be an indicative factor
of market making); Morgan Stanley; Goldman (Prop.
Trading); ISDA (Feb. 2012).
1031 See Goldman (Prop. Trading); Morgan
Stanley; RBC; SIFMA et al. (Prop. Trading) (Feb.
2012); ISDA (Feb. 2012); JPMC. This issue is
addressed in note 1044 and its accompanying text,
infra.
1032 See Goldman (Prop. Trading); RBC; SIFMA et
al. (Prop. Trading) (Feb. 2012).

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commenters stated that booking entities
may be able to rely on intra-group
exemptions under local law rather than
carrying dealer registrations, or a
banking entity may execute customer
trades through an international dealer
but book the position in a non-dealer
entity for capital adequacy and risk
management purposes.1033 Several of
these commenters requested, at a
minimum, that the dealer registration
requirement not apply to dealers in nonU.S. jurisdictions.1034
In addition, with respect to the
provisions that would generally require
a banking entity to be a form of SEC- or
CFTC-registered dealer for marketmaking activities in securities or
derivatives in the United States, a few
commenters stated that these provisions
should be removed from the rule.1035
These commenters represented that
removing these provisions would be
appropriate for several reasons. For
example, one commenter stated that
dealer registration does not help
distinguish between market making and
speculative trading.1036 Another
commenter indicated that effective
market making often requires a banking
entity to trade on several exchange and
platforms in a variety of markets,
including through legal entities other
than SEC- or CFTC-registered dealer
entities.1037 One commenter expressed
general concern that the proposed
requirement may result in the marketmaking exemption being unavailable for
market making in exchange-traded
futures and options because those
markets do not have a corollary to
dealer registration requirements in
securities, swaps, and security-based
swaps markets.1038
Some commenters expressed
particular concern about the provisions
that would generally require registration
as a swap dealer or a security-based
swap dealer.1039 For example, one
commenter expressed concern that these
provisions may require banking
JPMC; Goldman (Prop. Trading).
Goldman (Prop. Trading); RBC; SIFMA et
al. (Prop. Trading) (Feb. 2012). See also Morgan
Stanley (requesting the addition of the phrase ‘‘to
the extent it is legally required to be subject to such
regulation’’ to the non-U.S. dealer provisions).
1035 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); Morgan Stanley; ISDA
(Feb. 2012). Rather than remove the requirement
entirely, one commenter recommended that the
Agencies move the dealer registration requirement
to proposed Appendix B, which would allow the
Agencies to take into account the facts and
circumstances of a particular trading activity. See
JPMC.
1036 See SIFMA et al. (Prop. Trading) (Feb. 2012).
1037 See Goldman (Prop. Trading).
1038 See CME Group.
1039 See ISDA (Feb. 2012); SIFMA et al. (Prop.
Trading) (Feb. 2012).

regulators to redundantly enforce CFTC
and SEC registration requirements.
Moreover, according to this commenter,
the proposed definitions of ‘‘swap
dealer’’ and ‘‘security-based swap
dealer’’ do not focus on the market
making core of the swap dealing
business.1040 Another commenter stated
that incorporating the proposed
definitions of ‘‘swap dealer’’ and
‘‘security-based swap dealer’’ is contrary
to the Administrative Procedure Act.1041
c. Final Registration Requirement
The final requirement of the marketmaking exemption provides that the
banking entity must be licensed or
registered to engage in market makingrelated activity in accordance with
applicable law.1042 The Agencies have
considered comments regarding the
dealer registration requirement in the
proposed rule.1043 In response to
comments, the Agencies have narrowed
the scope of the proposed requirement’s
application to banking entities engaged
in market making-related activity in
foreign jurisdictions.1044 Rather than
requiring these banking entities to be
subject to substantive regulation of their
dealing business in the relevant foreign
jurisdiction, the final rule only require
a banking entity to be a registered dealer
in a foreign jurisdiction to the extent
required by applicable foreign law. The
Agencies have also simplified the
language of the proposed requirement,
although the Agencies have not
modified the scope of the requirement
with respect to U.S. dealer registration
requirements.
This provision is not intended to
expand the scope of licensing or
registration requirements under relevant
U.S. or foreign law that are applicable
to a banking entity engaged in marketmaking activities. Instead, this provision
recognizes that compliance with
applicable law is an essential indicator
that a banking entity is engaged in

1033 See

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1034 See

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1040 See

ISDA (Feb. 2012).
SIFMA et al. (Prop. Trading) (Feb. 2012).
1042 See final rule § ll.4(b)(2)(vi).
1043 See supra Part IV.A.3.c.5.b. One commenter
expressed concern that the instruments listed in
§ ll.4(b)(2)(iv) of the proposed rule could be
interpreted as limiting the availability of the
market-making exemption to other instruments,
such as exchange-traded futures and options. In
response to this comment, the Agencies note that
the reference to particular instruments in § ll
.4(b)(2)(iv) was intended to reflect that trading in
certain types of instruments gives rise to dealer
registration requirements. This provision was not
intended to limit the availability of the marketmaking exemption to certain types of financial
instruments. See CME Group.
1044 See Goldman (Prop. Trading); RBC; SIFMA et
al. (Prop. Trading) (Feb. 2012); Morgan Stanley.
1041 See

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market-making activities.1045 For
example, a U.S. banking entity would be
expected to be an SEC-registered dealer
to rely on the market-making exemption
for trading in securities—other than
exempted securities, security-based
swaps, commercial paper, bankers
acceptances, or commercial bills—
unless the banking entity is exempt
from registration or excluded from
regulation as a dealer.1046 Similarly, a
U.S. banking entity is expected to be a
CFTC-registered swap dealer or SECregistered security-based swap dealer to
rely on the market-making exemption
for trading in swaps or security-based
swaps, respectively,1047 unless the
banking entity is exempt from
registration or excluded from regulation
as a swap dealer or security-based swap
dealer.1048 In response to comments on
whether this provision should generally
require registration as a swap dealer or
security-based swap dealer to make a
market in swaps or security-based
swaps,1049 the Agencies continue to
1045 In response to commenters who stated that
the dealer registration requirement should be
removed from the rule because, among other things,
registration as a dealer does not distinguish
between permitted market making and
impermissible proprietary trading, the Agencies
recognize that acting as a registered dealer does not
ensure that a banking entity is engaged in permitted
market making-related activity. See SIFMA et al.
(Prop. Trading) (Feb. 2012); Goldman (Prop.
Trading); Morgan Stanley; ISDA (Feb. 2012).
However, this requirement recognizes that
registration as a dealer is an indicator of market
making-related activities in the circumstances in
which a person is legally obligated to be a registered
dealer to act as a market maker.
1046 A banking entity relying on the marketmaking exemption for transactions in securitybased swaps would generally be required to be a
registered security-based swap dealer and would
not be required to be a registered securities dealer.
However, a banking entity may be required to be
a registered securities dealer if it engages in marketmaking transactions involving security-based swaps
with persons that are not eligible contract
participants. The definition of ‘‘dealer’’ in section
3(a)(5) of the Exchange Act generally includes ‘‘any
person engaged in the business of buying and
selling securities (not including security-based
swaps, other than security-based swaps with or for
persons that are not eligible contract participants),
for such person’s own account.’’ 15 U.S.C. 78c(a)(5).
To the extent, if any, that a banking entity relies
on the market-making exemption for its trading in
municipal securities or government securities,
rather than the exemption in § ll.6(a) of the final
rule, this provision may require the banking entity
to be registered or licensed as a municipal securities
dealer or government securities dealer.
1047 As noted above, under certain circumstances,
a banking entity acting as market maker in securitybased swaps may be required to be a registered
securities dealer. See supra note 1046.
1048 For example, a banking entity meeting the
conditions of the de minimis exception in SEC Rule
3a71–2 under the Exchange Act would not need to
be a registered security-based swap dealer to act as
a market maker in security-based swaps. See 17
CFR 240.3a71–2.
1049 See ISDA (Feb. 2012); SIFMA et al. (Prop.
Trading) (Feb. 2012).

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
believe that this requirement is
appropriate. In general, a person that is
engaged in making a market in swaps or
security-based swaps or other activity
causing oneself to be commonly known
in the trade as a market maker in swaps
or security-based swaps is required to be
a registered swap dealer or registered
security-based swap dealer, unless
exempt from registration or excluded
from regulation as such.1050 As noted
above, compliance with applicable law
is an essential indicator that a banking
entity is engaged in market-making
activities.
As noted above, the Agencies have
determined that, rather than require a
banking entity engaged in the business
of a securities dealer, swap dealer, or
security-based swap dealer outside the
United States to be subject to
substantive regulation of its dealing
business in the foreign jurisdiction in
which the business is located, a banking
entity’s dealing activity outside the U.S.
should only be subject to licensing or
registration requirements under
applicable foreign law (provided no U.S.
registration or licensing requirements
apply to the banking entity’s activities).
As a result, this requirement will not
impact a banking entity’s ability to
engage in permitted market makingrelated activities in a foreign
jurisdiction that does not provide for
substantive regulation of dealers.1051
7. Source of Revenue Analysis

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a. Proposed Source of Revenue
Requirement
To qualify for the market-making
exemption, the proposed rule required
that the market making-related activities
of the trading desk or other
organizational unit be designed to
generate revenues primarily from fees,
commissions, bid/ask spreads or other
income not attributable to appreciation
in the value of financial instrument
positions it holds in trading accounts or
the hedging of such positions.1052 This
proposed requirement was 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
1050 See 7 U.S.C. 1a(49)(A); 15 U.S.C.
78c(a)(71)(A).
1051 See Goldman (Prop. Trading); RBC; SIFMA et
al. (Prop. Trading) (Feb. 2012); Morgan Stanley.
This is consistent with one commenter’s suggestion
that the Agencies add ‘‘to the extent it is legally
required to be subject to such regulation’’ to the
non-U.S. dealer provisions. See Morgan Stanley.
1052 See proposed rule § ll.4(b)(2)(v).

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of the positions or risks held in
inventory.1053
b. Comments Regarding the Proposed
Source of Revenue Requirement
As discussed in more detail below,
many commenters expressed concern
about the proposed source of revenue
requirement. These commenters raised a
number of concerns including, among
others, the proposed requirement’s
potential impact on a market maker’s
inventory or on costs to customers, the
difficulty of differentiating revenues
from spreads and revenues from price
appreciation in certain markets, and the
need for market makers to be
compensated for providing
intermediation services.1054 Several of
these commenters requested that the
proposed source of revenue requirement
be removed from the rule or modified in
certain ways. Some commenters,
however, expressed support for the
proposed requirement or requested that
the Agencies place greater restrictions
on a banking entity’s permissible
sources of revenue under the marketmaking exemption.1055
i. Potential Restrictions on Inventory,
Increased Costs for Customers, and
Other Changes to Market-Making
Services
Many commenters stated that the
proposed source of revenue requirement
may limit a market maker’s ability to
hold sufficient inventory to facilitate
customer demand.1056 Several of these
commenters expressed particular
concern about applying this
requirement to less liquid markets or to
facilitating large customer positions,
where a market maker is more likely to
hold inventory for a longer period of
time and has increased risk of potential
price appreciation (or depreciation).1057
1053 See

Joint Proposal, 76 FR 68,872; CFTC
Proposal, 77 FR 8358.
1054 These concerns are addressed in Part
IV.A.3.c.7.c., infra.
1055 See infra note 1103 (responding to these
comments).
1056 See, e.g., NYSE Euronext; SIFMA et al. (Prop.
Trading) (Feb. 2012); Morgan Stanley; Goldman
(Prop. Trading); BoA; Citigroup (Feb. 2012);
STANY; BlackRock; SIFMA (Asset Mgmt.) (Feb.
2012); ACLI (Feb. 2012); T. Rowe Price; PUC Texas;
SSgA (Feb. 2012); ICI (Feb. 2012) Invesco; MetLife;
MFA.
1057 See, e.g., Morgan Stanley; BoA; BlackRock; T.
Rowe Price; Goldman (Prop. Trading); NYSE
Euronext (suggesting that principal trading by
market makers in large sizes is essential in some
securities, such as an AP’s trading in ETFs); Prof.
Duffie; SSgA (Feb. 2012); CIEBA; SIFMA et al.
(Prop. Trading) (Feb. 2012); MFA. To explain its
concern, one commenter stated that bid-ask spreads
are useful to capture the concept of market-making
revenues when a market maker is intermediating on
a close to real-time basis between balanced
customer buying and selling interest for the same

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5621

Further, another commenter questioned
how the proposed requirement would
apply when unforeseen market pressure
or disappearance of customer demand
results in a market maker holding a
particular position in inventory for
longer than expected.1058 In response to
this proposed requirement, a few
commenters stated that it is important
for market makers to be able to hold a
certain amount of inventory to: Provide
liquidity (particularly in the face of
order imbalances and market
volatility),1059 facilitate large trades, and
hedge positions acquired in the course
of market making.1060
Several commenters expressed
concern that the proposed source of
revenue requirement may incentivize a
market maker to widen its quoted
spreads or otherwise impose higher fees
to the detriment of its customers.1061
For example, some commenters stated
that the proposed requirement could
result in a market maker having to sell
a position in its inventory within an
artificially prescribed period of time
and, as a result, the market maker would
pay less to initially acquire the position
from a customer.1062 Other commenters
represented that the proposed source of
revenue requirement would compel
market makers to hedge their exposure
to price movements, which would likely
increase the cost of intermediation.1063
Some commenters stated that the
proposed source of revenue requirement
may make a banking entity less willing
to make markets in instruments that it
may not be able to resell immediately or
in the short term.1064 One commenter
indicated that this concern may be
heightened in times of market stress.1065
Further, a few commenters expressed
the view that the proposed requirement
would cause banking entities to exit the
instrument, but such close-in-time intermediation
does not occur in many large or illiquid assets,
where demand gaps may be present for days, weeks,
or months. See Morgan Stanley.
1058 See Capital Group.
1059 See NYSE Euronext; CIEBA (stating that if the
rule discourages market makers from holding
inventory, there will be reduced liquidity for
investors and issuers).
1060 See NYSE Euronext. For a more in-depth
discussion of comments regarding the benefits of
permitting market makers to hold and manage
inventory, See Part IV.A.3.c.2.b.vi., infra.
1061 See, e.g., Wellington; CIEBA; MetLife; ACLI
(Feb. 2012); SSgA (Feb. 2012); PUC Texas; ICI (Feb.
2012) BoA.
1062 See MetLife; ACLI (Feb. 2012); ICI (Feb. 2012)
SSgA (Feb. 2012).
1063 See SSgA (Feb. 2012); PUC Texas.
1064 See ICI (Feb. 2012) SSgA (Feb. 2012); SIFMA
(Asset Mgmt.) (Feb. 2012); BoA.
1065 See CIEBA (arguing that banking entities may
be reluctant to provide liquidity when markets are
declining and there are more sellers than buyers
because it would be necessary to hold positions in
inventory to avoid losses).

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market-making business due to
restrictions on their ability to make a
profit from market-making activities.1066
Moreover, in one commenter’s opinion,
the proposed requirement would
effectively compel market makers to
trade on an agency basis.1067
ii. Certain Price Appreciation-Related
Profits Are an Inevitable or Important
Component of Market Making

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A number of commenters indicated
that market makers will inevitably make
some profit from price appreciation of
certain inventory positions because
changes in market values cannot be
precisely predicted or hedged.1068 In
particular, several commenters
emphasized that matched or perfect
hedges are generally unavailable for
most types of positions.1069 According
to one commenter, a provision that
effectively requires a market-making
business to hedge all of its principal
positions would discourage essential
market-making activity. The commenter
explained that effective hedges may be
unavailable in less liquid markets and
hedging can be costly, especially in
relation to the relative risk of a trade
and hedge effectiveness.1070 A few
commenters further indicated that
making some profit from price
appreciation is a natural part of market
1066 See Credit Suisse (Seidel) (arguing that
banking entities are likely to cease being market
makers if they are: (i) Unable to take into account
the likely direction of a financial instrument, or (ii)
forced to take losses if a financial instrument moves
against them, but cannot take gains if the
instrument’s price moves in their favor); STANY
(contending that banking entities cannot afford to
maintain unprofitable or marginally profitable
operations in highly competitive markets, so this
requirement would cause banking entities to
eliminate a majority of their market-making
functions).
1067 See IR&M (arguing that domestic corporate
and securitized credit markets are too large and
heterogeneous to be served appropriately by a
primarily agency-based trading model).
1068 See Wellington; Credit Suisse (Seidel);
Morgan Stanley; PUC Texas (contending that it is
impossible to predict the behavior of even the most
highly correlated hedge in comparison to the
underlying position); CIEBA; SSgA (Feb. 2012);
AllianceBernstein; Investure; Invesco.
1069 See Morgan Stanley; Credit Suisse (Seidel);
SSgA (Feb. 2012); PUC Texas; Wellington;
AllianceBernstein; Investure.
1070 See Wellington. Moreover, one commenter
stated that, as a general matter, market makers need
to be compensated for bearing risk related to
providing immediacy to a customer. This
commenter stated that ‘‘[t]he greater the inventory
risk faced by the market maker, the higher the
expected return (compensation) that the market
maker needs,’’ to compensate the market maker for
bearing the risk and reward its specialization skills
in that market (e.g., its knowledge about market
conditions and early indicators that may imply
future price movements in a particular direction).
This commenter did not, however, discuss the
source of revenue requirement in the proposed rule.
See Thakor Study.

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making or is necessary to compensate a
market maker for its willingness to take
a position, and its associated risk (e.g.,
the risk of market changes or decreased
value), from a customer.1071
iii. Concerns Regarding the Workability
of the Proposed Standard in Certain
Markets or Asset Classes
Some commenters represented that it
would be difficult or burdensome to
identify revenue attributable to the bidask spread versus revenue arising from
price appreciation, either as a general
matter or for specific markets.1072 For
example, one commenter expressed the
opinion that the difference between the
bid-ask spread and price appreciation is
‘‘metaphysical’’ in some sense,1073
while another stated that it is almost
impossible to objectively identify a bidask spread or to capture profit and loss
solely from a bid-ask spread in most
markets.1074 Other commenters
represented that it is particularly
difficult to make this distinction when
trades occur infrequently or where
prices are not transparent, such as in the
fixed-income market where no spread is
published.1075
Many commenters expressed
particular concern about the proposed
requirement’s application to specific
markets, including: The fixed-income
markets; 1076 the markets for
commodities, derivatives, securitized
products, and emerging market
1071 See Capital Group; Prof. Duffie; Investure;
SIFMA et al. (Prop. Trading) (Feb. 2012); STANY;
SIFMA (Asset Mgmt.) (Feb. 2012); RBC; PNC.
1072 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Goldman (Prop. Trading); BoA; Citigroup
(Feb. 2012); Japanese Bankers Ass’n.; Sumitomo
Trust; Morgan Stanley; Barclays; RBC; Capital
Group.
1073 See SIFMA et al. (Prop. Trading) (Feb. 2012).
1074 See Citigroup (Feb. 2012). See also Barclays
(arguing that a bid-ask spread cannot be defined on
a consistent basis with respect to many
instruments).
1075 See Goldman (Prop. Trading); BoA; Morgan
Stanley (‘‘Observable, actionable, bid/ask spreads
exist in only a small subset of institutional products
and markets. Indicative bid/ask spreads may be
observable for certain products, but this pricing
would typically be specific to small size standard
lot trades and would not represent a spread
applicable to larger and/or more illiquid trades.
End-of-day valuations for assets are calculated, but
they are not an effective proxy for real-time bid/ask
spreads because of intra-day price movements.’’);
RBC; Capital Group (arguing that bid-ask spreads in
fixed-income markets are not always quantifiable or
well defined and can fluctuate widely within a
trading day because of small or odd lot trades, price
discovery activity, a lack of availability to cover
shorts, or external factors not directly related to the
security being traded).
1076 See Capital Group; CIEBA; SIFMA et al.
(Prop. Trading) (Feb. 2012); SSgA (Feb. 2012).
These commenters stated that the requirement may
be problematic for the fixed-income markets
because, for example, market makers must hold
inventory in these markets for a longer period of
time than in more liquid markets. See id.

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securities; 1077 equity and physical
commodity derivatives markets; 1078 and
customized swaps used by customers of
banking entities for hedging
purposes.1079 Another commenter
expressed general concern about
extremely volatile markets, where
market makers often see large upward or
downward price swings over time.1080
Two commenters emphasized that the
revenues a market maker generates from
hedging the positions it holds in
inventory are equivalent to spreads in
many markets. These commenters
explained that, under these
circumstances, a market maker
generates revenue from the difference
between the customer price for the
position and the banking entity’s price
for the hedge. The commenters noted
that proposed Appendix B expressly
recognizes this in the case of derivatives
and recommended that Appendix B’s
guidance on this point apply equally to
certain non-derivative positions.1081
A few commenters questioned how
this requirement would work in the
context of block trading or otherwise
facilitating large trades, where a market
maker may charge a premium or
discount for taking on a large position
1077 See SIFMA et al. (Prop. Trading) (Feb. 2012)
(stating that these markets are characterized by even
less liquidity and less frequent trading than the U.S.
corporate bond market). This commenter also stated
that in markets where trades are large and less
frequent, such as the market for customized
securitized products, appreciation in price of one
position may be a predominate contributor to the
overall profit and loss of the trading unit. See id.
1078 See BoA. According to this commenter, the
distinction between capturing a spread and price
appreciation is fundamentally flawed in some
markets, like equity derivatives, because the market
does not trade based on movements of a particular
security or underlying instrument. This commenter
indicated that expected returns are instead based on
the bid-ask spread the market maker charges for
implied volatility as reflected in options premiums
and hedging of the positions. See id.
1079 See CIEBA (stating that because it would be
difficult for a market maker to enter promptly into
an offsetting swap, the market maker would not be
able to generate income from the spread).
1080 See SIFMA et al. (Prop. Trading) (Feb. 2012).
This commenter questioned whether proposed
Appendix B’s reference to ‘‘unexpected market
disruptions’’ as an explanatory fact and
circumstance was intended to permit such market
making. See id.
1081 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading). In its discussion of
‘‘customer revenues,’’ Appendix B states: ‘‘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.’’ Joint Proposal, 76 FR 68,960; CFTC
Proposal, 77 FR 8440. See also RBC (requesting
clarification on how the proposed standard would
apply if a market maker took an offsetting position
in a different instrument (e.g., a different bond) and
inquiring whether, if the trader took the offsetting
position, its revenue gain is attributable to price
appreciation of the two offsetting positions or from
the bid-ask spread in the respective bonds).

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to provide ‘‘immediacy’’ to its
customer.1082 One commenter further
explained that explicitly quoted bid-ask
spreads are only valid for indicated
trade sizes that are modest enough to
have negligible market impact, and such
spreads cannot be used for purposes of
a significantly larger trade.1083

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iv. Suggested Modifications to the
Proposed Requirement
To address some or all of the concerns
discussed above, many commenters
recommended that the source of
revenue requirement be modified 1084 or
removed from the rule entirely.1085 With
respect to suggested changes, some
commenters stated that the Agencies
should modify the rule text,1086 use a
metrics-based approach to focus on
customer revenues,1087 or replace the
proposed requirement with
guidance.1088 Some commenters
requested that the Agencies modify the
focus of the requirement so that, for
example, dealers’ market-making
activities in illiquid securities can
function as close to normal as
possible 1089 or market makers can take
short-term positions that may ultimately
1082 See Prof. Duffie; NYSE Euronext; Capital
Group; RBC; Goldman (Prop. Trading). See also
Thakor Study (discussing market makers’ role of
providing ‘‘immediacy’’ in general).
1083 See CIEBA.
1084 See, e.g., JPMC; Barclays; Goldman (Prop.
Trading); BoA; CFA Inst.; ICI (Feb. 2012) Flynn &
Fusselman.
1085 See, e.g., CIEBA; SIFMA et al. (Prop. Trading)
(Feb. 2012); Morgan Stanley; Goldman (Prop.
Trading); Capital Group; RBC. In addition to the
concerns discussed above, one commenter stated
that the proposed requirement may set limits on the
values of certain metrics, and it would be
inappropriate to prejudge the appropriate results of
such metrics at this time. See SIFMA et al. (Prop.
Trading) (Feb. 2012).
1086 See, e.g., Barclays. This commenter provided
alternative rule text stating that ‘‘market makingrelated activity is conducted by each trading unit
such that its activities are reasonably designed to
generate revenues primarily from fees,
commissions, bid-ask spreads, or other income
attributable to satisfying reasonably expected
customer demand.’’ See id.
1087 See Goldman (Prop. Trading) (suggesting that
the Agencies use a metrics-based approach to focus
on customer revenues, as measured by Spread Profit
and Loss (when it is feasible to calculate) or other
metrics, especially because a proprietary trading
desk would not be expected to earn any revenues
this way). This commenter also indicated that the
‘‘primarily’’ standard in the proposed rule is
problematic and can be read to mean ‘‘more than
50%,’’ which is different from Appendix B’s
acknowledgment that the proportion of customer
revenues relative to total revenues will vary by asset
class. See id.
1088 See BoA (recommending that the guidance
state that the Agencies would consider the design
and mix of such revenues as an indicator of
potentially prohibited proprietary trading, but only
for those markets for which revenues are
quantifiable based on publicly available data, such
as segments of certain highly liquid equity markets).
1089 See CFA Inst.

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result in a profit or loss.1090 As
discussed below, some commenters
stated that the Agencies should modify
the proposed requirement to place
greater restrictions on market maker
revenue.
v. General Support for the Proposed
Requirement or for Placing Greater
Restrictions on a Market Maker’s
Sources of Revenue
Some commenters expressed support
for the proposed source of revenue
requirement or stated that the
requirement should be more
restrictive.1091 For example, one of these
commenters stated that a real market
maker’s trading book should be fully
hedged, so it should not generate profits
in excess of fees and commissions
except in times of rare and
extraordinary market conditions.1092
According to another commenter, the
final rule should make it clear that
banking entities seeking to rely on the
market-making exemption may not
generally seek to profit from price
movements in their inventories,
although their activities may give rise to
modest and relatively stable profits
arising from their limited inventory.1093
One commenter recommended that the
proposed requirement be interpreted to
limit market making in illiquid
positions because a banking entity
cannot have the required revenue
motivation when it enters into a
position for which there is no readily
discernible exit price.1094
Further, some commenters suggested
that the Agencies remove the word
‘‘primarily’’ from the provision to limit
banking entities to specified sources of
revenue.1095 In addition, one of these
commenters requested that the Agencies
restrict a market maker’s revenue to fees
and commissions and remove the
allowance for revenue from bid-ask
1090 See

ICI (Feb. 2012).
Sens. Merkley & Levin (Feb. 2012); Better
Markets (Feb. 2012); FTN; Public Citizen; Occupy;
Alfred Brock.
1092 See Better Markets (Feb. 2012). See also
Public Citizen (arguing that the imperfection of a
hedge should signal potential disqualification of the
underlying position from the market-making
exemption).
1093 See Sens. Merkley & Levin (Feb. 2012). This
commenter further suggested that the rule identify
certain red flags and metrics that could be used to
monitor this requirement, such as: (i) Failure to
obtain relatively low ratios of revenue-to-risk, low
volatility, and relatively high turnover; (ii)
significant revenues from price appreciation
relative to the value of securities being traded; (iii)
volatile revenues from price appreciation; or (iv)
revenue from price appreciation growing out of
proportion to the risk undertaken with the security.
See id.
1094 See AFR et al. (Feb. 2012).
1095 See Occupy; Better Markets (Feb. 2012). See
supra note 1103 (addressing these comments).
1091 See

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5623

spreads because generating bid-ask
revenues relies exclusively on changes
in market values of positions held in
inventory.1096 For enforcement
purposes, a few commenters suggested
that the Agencies require banking
entities to disgorge any profit obtained
from price appreciation.1097
c. Final Rule’s Approach to Assessing
Revenues
Unlike the proposed rule, the final
rule does not include a requirement that
a trading desk’s market making-related
activity be designed to generate revenue
primarily from fees, commissions, bidask spreads, or other income not
attributable to appreciation in the value
of a financial instrument or hedging.1098
The revenue requirement was one of the
most commented upon aspects of the
market-making exemption in the
proposal.1099
The Agencies believe that an analysis
of patterns of revenue generation and
profitability can help inform a judgment
regarding whether trading activity is
consistent with the intermediation and
liquidity services that a market maker
provides to its customers in the context
of the liquidity, maturity, and depth of
the relevant market, as opposed to
prohibited proprietary trading activities.
To facilitate this type of analysis, the
Agencies have included a metrics data
reporting requirement that is refined
from the proposed metric regarding
profits and losses. The Comprehensive
Profit and Loss Attribution metric
collects information regarding the daily
fluctuation in the value of a trading
desk’s positions to various sources,
along with its volatility, including: (i)
Profit and loss attributable to current
positions that were also held by the
banking entity as of the end of the prior
day (‘‘existing positions); (ii) profit and
loss attributable to new positions
resulting from the current day’s trading
activity (‘‘new positions’’); and (iii)
residual profit and loss that cannot be
specifically attributed to existing
positions or new positions.1100
This quantitative measurement has
certain conceptual similarities to the
proposed source of revenue requirement
in § ll.4(b)(2)(v) of the proposed rule
1096 See

Occupy.
Occupy; Public Citizen.
1098 See proposed rule § ll.4(b)(2)(v).
1099 See infra Part IV.A.3.c.7.b.
1100 See Appendix A of the final rule (describing
the Comprehensive Profit and Loss Attribution
metric). This approach is generally consistent with
one commenter’s suggested metrics-based approach
to focus on customer-related revenues. See
Goldman (Prop. Trading); See also Sens. Merkley &
Levin (Feb. 2012) (suggesting the use of metrics to
monitor a firm’s source of revenue); proposed
Appendix A.
1097 See

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and certain of the proposed quantitative
measurements.1101 However, in
response to comments on those
provisions, the Agencies have
determined to modify the focus from
particular revenue sources (e.g., fees,
commissions, bid-ask spreads, and price
appreciation) to when the trading desk
generates revenue from its positions.
The Agencies recognize that when the
trading desk is engaged in market
making-related activities, the day one
profit and loss component of the
Comprehensive Profit and Loss
Attribution metric may reflect customergenerated revenues, like fees,
commissions, and spreads (including
embedded premiums or discounts), as
well as that day’s changes in market
value. Thereafter, profit and loss
associated with the position carried in
the trading desk’s book may reflect
changes in market price until the
position is sold or unwound. The
Agencies also recognize that the metric
contains a residual component for profit
and loss that cannot be specifically
attributed to existing positions or new
positions.
The Agencies believe that evaluation
of the Comprehensive Profit and Loss
Attribution metric could provide
valuable information regarding patterns
of revenue generation by market-making
trading desks involved in marketmaking activities that may warrant
further review of the desk’s activities,
while eliminating the requirement from
the proposal that the trading desk
demonstrate that its primary source of
revenue, under all circumstances, is
fees, commissions and bid/ask spreads.
This modified focus will reduce the
burden associated with the proposed
source of revenue requirement and
better account for the varying depth and
liquidity of markets.1102 In addition, the
1101 See supra Part IV.A.3.c.7. and infra Part
IV.C.3.
1102 The Agencies understand that some
commenters interpreted the proposed requirement
as requiring that both the bid-ask spread for a
financial instrument and the revenue a market
maker acquired from such bid-ask spread through
a customer trade be identifiable on a close-to-realtime basis and readily distinguishable from any
additional revenue gained from price appreciation
(both on the day of the transaction and for the rest
of the holding period). See, e.g., SIFMA et al. (Prop.
Trading) (Feb. 2012); Goldman (Prop. Trading);
BoA; Citigroup (Feb. 2012); Japanese Bankers
Ass’n.; Sumitomo Trust; Morgan Stanley; Barclays;
RBC; Capital Group. We recognize that such a
requirement would be unduly burdensome. In fact,
the proposal noted that bid-ask spreads or similar
spreads may not be widely disseminated on a
consistent basis or otherwise reasonably
ascertainable in certain asset classes for purposes of
the proposed Spread Profit and Loss metric in
Appendix A of the proposal. See Joint Proposal, 76
FR 68,958–68,959; CFTC Proposal, 77 FR 8438.
Moreover, the burden associated with the proposed

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Agencies believe these modifications
appropriately address commenters’
concerns about the proposed source of
revenue requirement and reduce the
potential for negative market impacts of
the proposed requirement cited by
commenters, such as incentives to
widen spreads or disincentives to
engage in market making in less liquid
markets.1103
The Agencies recognize that this
analysis is only informative over time,
and should not be determinative of an
analysis of whether the amount, types,
and risks of the financial instruments in
the trading desk’s market-maker
inventory are designed not to exceed the
reasonably expected near term demands
of clients, customers, or counterparties.
The Agencies believe this quantitative
measurement provides appropriate
flexibility to obtain information on
market-maker revenues, which is
designed to address commenters’
concerns about the proposal’s source of
revenue requirement (e.g., the burdens
requirement should be further reduced because we
are not adopting a stand-alone requirement
regarding a trading desk’s source of revenue.
Instead, when and how a trading desk generates
profit and loss from its trading activities is a factor
that must be considered for purposes of the near
term customer demand requirement. It is not a
dispositive factor for determining compliance with
the exemption.
Further, some commenters expressed concern
that the proposed requirement suggested market
makers were not permitted to profit from price
appreciation, but rather only from observable
spreads or explicit fees or commissions. See, e.g.,
Wellington, Credit Suisse (Seidel); Morgan Stanley;
PUC Texas; CIEBA; SSgA (Feb. 2012);
AllianceBernstein; Investure; Invesco. The Agencies
confirm that the intent of the market-making
exemption is not to preclude a trading desk from
generating any revenue from price appreciation.
Because this approach clarifies that a trading desk’s
source of revenue is not limited to its quoted
spread, the Agencies believe this quantitative
measurement will address commenters concerns
that the proposed source of revenue requirement
could create incentives for market makers to widen
their spreads, result in higher transaction costs,
require market makers to hedge any exposure to
price movements, or discourage a trading desk from
making a market in instruments that it may not be
able to sell immediately. See Wellington; CIEBA;
MetLife; ACLI (Feb. 2012); SSgA (Feb. 2012); PUC
Texas; ICI (Feb. 2012) BoA; SIFMA (Asset Mgmt.)
(Feb. 2012). The modifications to this provision are
designed to better reflect when, on average and
across many transactions, profits are gained rather
than how they are gained, similar to the way some
firms measure their profit and loss today. See, e.g.,
Goldman (Prop. Trading).
1103 See, e.g., Wellington; CIEBA; MetLife; ACLI
(Feb. 2012); SSgA (Feb. 2012); PUC Texas; ICI (Feb.
2012) BoA. The Agencies are not adopting an
approach that limits a market maker to specified
revenue sources (e.g., fees, commissions, and
spreads), as suggested by some commenters, due to
the considerations discussed above. See Occupy;
Better Markets (Feb. 2012). In response to the
proposed source of revenue requirement, some
commenters noted that a market maker may charge
a premium or discount for taking on a large position
from a customer. See Prof. Duffie; NYSE Euronext;
Capital Group; RBC; Goldman (Prop. Trading).

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associated with differentiating spread
revenue from price appreciation
revenue) while also helping assess
patterns of revenue generation that may
be informative over time about whether
a market maker’s activities are designed
to facilitate and provide customer
intermediation.
8. Appendix B of the Proposed Rule
a. Proposed Appendix B Requirement
The proposed market-making
exemption would have required that the
market making-related activities of the
trading desk or other organizational unit
of the banking entity be consistent with
the commentary in proposed Appendix
B.1104 In this proposed Appendix, the
Agencies provided overviews of
permitted market making-related
activity and prohibited proprietary
trading activity.1105
The proposed Appendix also set forth
various factors that the Agencies
proposed to use to help distinguish
prohibited proprietary trading from
permitted market making-related
activity. More specifically, proposed
Appendix B set forth six factors that,
absent explanatory facts and
circumstances, would cause particular
trading activity to be considered
prohibited proprietary trading activity
and not permitted market makingrelated activity. The proposed factors
focused on: (i) Retaining risk in excess
of the size and type required to provide
intermediation services to customers
(‘‘risk management factor’’); (ii)
primarily generating revenues from
price movements of retained principal
positions and risks, rather than
customer revenues (‘‘source of revenues
factor’’); (iii) generating only very small
or very large amounts of revenue per
unit of risk, not demonstrating
consistent profitability, or
demonstrating high earnings volatility
(‘‘revenues relative to risk factor’’); (iv)
not trading 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 retaining principal
positions in excess of reasonably
expected near term customer demands
(‘‘customer-facing activity factor’’); (v)
routinely paying rather than earning
fees, commissions, or spreads
(‘‘payment of fees, commissions, and
spreads factor’’); and (vi) providing
compensation incentives to employees
that primarily reward proprietary riskproposed rule § ll.4(b)(2)(vi).
Joint Proposal, 76 FR 68,873, 68,960–
68,961; CFTC Proposal, 77 FR 8358, 8439–8440.
1104 See
1105 See

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taking (‘‘compensation incentives
factor’’).1106

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b. Comments on Proposed Appendix B
Commenters expressed differing
views about the accuracy of the
commentary in proposed Appendix B
and the appropriateness of including
such commentary in the rule. For
example, some commenters stated that
the description of market makingrelated activity in the proposed
appendix is accurate 1107 or
appropriately accounts for differences
among asset classes.1108 Other
commenters indicated that the appendix
is too strict or narrow.1109 Some
commenters recommended that the
Agencies revise proposed Appendix B’s
approach by, for example, placing
greater focus on what market making is
rather than what it is not,1110 providing
presumptions of activity that will be
treated as permitted market makingrelated activity,1111 re-formulating the
appendix as nonbinding guidance,1112
or moving certain requirements of the
proposed exemption to the
appendix.1113 One commenter suggested
1106 See Joint Proposal, 76 FR 68,873, 68,961–
68,963; CFTC Proposal, 77 FR 8358, 8440–8442.
1107 See MetLife; ACLI (Feb. 2012).
1108 See Alfred Brock. But See, e.g., Occupy
(stating that the proposed commentary only
accounts for the most liquid and transparent
markets and fails to accurately describe market
making in most illiquid or OTC markets).
1109 See Morgan Stanley; IIF; Sumitomo Trust;
ISDA (Apr. 2012); BDA (Feb. 2012) (Oct. 2012)
(stating that proposed Appendix B places too great
of a focus on derivatives trading and does not
reflect how principal trading operations in equity
and fixed income markets are structured). One of
these commenters requested that the appendix be
modified to account for certain activities conducted
in connection with market making in swaps. This
commenter indicated that a swap dealer may not
regularly enjoy a dominant flow of customer
revenues and may consistently need to make
revenue from its book management. In addition, the
commenter stated that the appendix should
recognize that making a two-way market may be a
dominant theme, but there are certain to be frequent
occasions when, as a matter of market or internal
circumstances, a market maker is unavailable to
trade. See ISDA (Apr. 2012).
1110 See SIFMA et al. (Prop. Trading) (Feb. 2012).
1111 See Sens. Merkley & Levin (Feb. 2012). This
commenter stated that, for example, Appendix B
could deem market making involving widely-traded
stocks and bonds issued by well-established
corporations, government securities, or highly
liquid asset-backed securities as the type of plain
vanilla, low risk capital activities that are
presumptively permitted, provided the activity is
within certain, specified parameters for inventory
levels, revenue-to-risk metrics, volatility, and
hedging. See id.
1112 See Morgan Stanley; Flynn & Fusselman.
1113 See JPMC. In support of such an approach,
the commenter argued that sometimes proposed
§ ll.4(b) and Appendix B addressed the same
topic and, when this occurs, it is unclear whether
compliance with Appendix B constitutes
compliance with § ll.4(b) or if additional
compliance steps are required. See id.

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the Agencies remove Appendix B from
the rule and instead use the
conformance period to analyze and
develop a body of supervisory guidance
that appropriately characterizes the
nature of market making-related
activity.1114
A few commenters expressed concern
about the appendix’s facts-andcircumstances-based approach to
distinguishing between prohibited
proprietary trading and permitted
market making-related activity and
stated that such an approach will make
it more difficult or burdensome for
banking entities to comply with the
proposed rule 1115 or will generate
regulatory uncertainty.1116 As discussed
below, other commenters opposed
proposed Appendix B because of its
level of granularity 1117 or due to
perceived restrictions on interdealer
trading or generating revenue from
retained principal positions or risks in
the proposed appendix.1118 A number of
commenters expressed concern about
the complexity or prescriptiveness of
the six proposed factors for
distinguishing permitted market
making-related activity from prohibited
proprietary trading.1119
With respect to the level of
granularity of proposed Appendix B, a
number of commenters expressed
concern that the reference to a ‘‘single
significant transaction’’ indicated that
the Agencies will review compliance
with the proposed market-making
exemption on a trade-by-trade basis and
stated that assessing compliance at the
level of individual transactions would
be unworkable.1120 One of these
commenters further stated that assessing
compliance at this level of granularity
would reduce a market maker’s
willingness to execute a customer sell
1114 See

Morgan Stanley.
NYSE Euronext; Morgan Stanley.
1116 See IAA.
1117 See Wellington; Goldman (Prop. Trading);
SIFMA (Asset Mgmt.) (Feb. 2012).
1118 See Morgan Stanley; Chamber (Feb. 2012);
Goldman (Prop. Trading).
1119 See Japanese Bankers Ass’n.; Credit Suisse
(Seidel); Chamber (Feb. 2012); ICFR; Morgan
Stanley; Goldman (Prop. Trading); Occupy; Oliver
Wyman (Feb. 2012); Oliver Wyman (Dec. 2011);
Public Citizen; NYSE Euronext. But See Alfred
Brock (stating that the proposed factors are
effective).
1120 See Wellington; Goldman (Prop. Trading);
SIFMA (Asset Mgmt.) (Feb. 2012). In particular,
proposed Appendix B provided that ‘‘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.’’ Joint Proposal, 76 FR
68,961; CFTC Proposal, 77 FR 8441. The Agencies
address commenters’ trade-by-trade concerns in
Part IV.A.3.c.1.c.ii., infra.
1115 See

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5625

order as principal due to concern that
the market maker may not be able to
immediately resell such position. The
commenter noted that this chilling
effect would be heightened in declining
markets.1121
A few commenters interpreted certain
statements in proposed Appendix B as
limiting interdealer trading and
expressed concerns regarding potential
limitations on this activity.1122 These
commenters emphasized that market
makers may need to trade with noncustomers to: (i) Provide liquidity to
other dealers and, indirectly, their
customers, or to otherwise allow
customers to access a larger pool of
liquidity; 1123 (ii) conduct price
discovery to inform the prices a market
maker can offer to customers; 1124 (iii)
unwind or sell positions acquired from
customers; 1125 (iv) establish or acquire
positions to meet reasonably expected
near term customer demand; 1126 (v)
hedge; 1127 and (vi) sell a financial
instrument when there are more buyers
than sellers for the instrument at that
time.1128 Further, one of these
commenters expressed the view that the
proposed appendix’s statements are
inconsistent with the statutory marketmaking exemption’s reference to
‘‘counterparties.’’ 1129
1121 See

Goldman (Prop. Trading).
Morgan Stanley; Goldman (Prop.
Trading); Chamber (Feb. 2012). Specifically,
commenters cited statements in proposed Appendix
B indicating that market makers ‘‘typically only
engage in transactions with non-customers to the
extent that these transactions directly facilitate or
support customer transactions.’’ On this issue, the
appendix further stated that ‘‘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 appendix
recognized, however, that 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 non-customer transactions.’’ Joint
Proposal, 76 FR 68,961; CFTC Proposal, 77 FR 8440.
Commenters’ concerns regarding interdealer trading
are addressed in Part IV.A.3.c.2.c.i., infra.
1123 See Morgan Stanley; Goldman (Prop.
Trading).
1124 See Morgan Stanley; Goldman (Prop.
Trading); Chamber (Feb. 2012).
1125 See Morgan Stanley; Chamber (Feb. 2012)
(stating that market makers in the corporate bond,
interest rate derivative, and natural gas derivative
markets frequently trade with other dealers to work
down a concentrated position originating with a
customer trade).
1126 See Morgan Stanley; Chamber (Feb. 2012).
1127 See Goldman (Prop. Trading).
1128 See Chamber (Feb. 2012).
1129 See Goldman (Prop. Trading).
1122 See

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In addition, a few commenters
expressed concern about statements in
proposed Appendix B about a market
maker’s source of revenue.1130
According to one commenter, the
statement that profit and loss generated
by inventory appreciation or
depreciation must be ‘‘incidental’’ to
customer revenues is inconsistent with
market making-related activity in less
liquid assets and larger transactions
because market makers often must
retain principal positions for longer
periods of time in such circumstances
and are unable to perfectly hedge these
positions.1131 As discussed above with
respect to the source of revenue
requirement in § ll.4(b)(v) of the
proposed rule, a few commenters
requested that Appendix B’s discussion
of ‘‘customer revenues’’ be modified to
state that revenues from hedging will be
considered to be customer revenues in
certain contexts beyond derivatives
contracts.1132
A number of commenters discussed
the six proposed factors in Appendix B
that, absent explanatory facts and
circumstances, would have caused a
particular trading activity to be
considered prohibited proprietary
trading activity and not permitted
market making-related activity.1133 With
respect to the proposed factors, one
commenter indicated that they are
appropriate,1134 while another
commenter stated that they are complex
and their effectiveness is uncertain.1135
Another commenter expressed the view
that ‘‘[w]hile each of the selected factors
provides evidence of ‘proprietary
trading,’ warrants regulatory attention,
and justifies a shift in the burden of
proof, some require subjective
judgments, are subject to gaming or data
manipulation, and invite excessive
reliance on circumstantial evidence and
lawyers’ opinions.’’ 1136
1130 See Morgan Stanley; SIFMA et al. (Prop.
Trading) (Feb. 2012); Goldman (Prop. Trading). On
this issue, Appendix B stated that certain types of
‘‘customer revenues’’ provide the primary source of
a market maker’s profitability and, while a market
maker also incurs losses or generates profits as price
movements occur in its retained principal positions
and risks, ‘‘such losses or profits are incidental to
customer revenues and significantly limited by the
banking entity’s hedging activities.’’ Joint Proposal,
76 FR 68,960; CFTC Proposal, 77 FR 8440. The
Agencies address commenters’ concerns about
proposed requirements regarding a market maker’s
source of revenue in Part IV.A.3.c.7.c., infra.
1131 See Morgan Stanley.
1132 See supra note 1081 and accompanying text.
1133 See supra note 1106 and accompanying text.
1134 See Alfred Brock.
1135 See Japanese Bankers Ass’n.
1136 Sens. Merkley & Levin (Feb. 2012).

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In response to the proposed risk
management factor,1137 one commenter
expressed concern that it could prevent
a market maker from warehousing
positions in anticipation of predictable
but unrealized customer demands and,
further, could penalize a market maker
that misestimated expected demand.
This commenter expressed the view that
such an outcome would be contrary to
the statute and would harm market
liquidity.1138 Another commenter
requested that this presumption be
removed because in less liquid markets,
such as markets for corporate bonds,
equity derivatives, securitized products,
emerging markets, foreign exchange
forwards, and fund-linked products, a
market maker needs to act as principal
to facilitate client requests and, as a
result, will be exposed to risk.1139
Two commenters expressed concern
about the proposed source of revenue
factor.1140 One commenter stated that
this factor does not accurately reflect
how market making occurs in a majority
of markets and asset classes.1141 The
other commenter expressed concern that
this factor shifted the emphasis of § ll
.4(b)(v) of the proposed rule, which
required that market making-related
activities be ‘‘designed’’ to generate
revenue primarily from certain sources,
to the actual outcome of activities.1142
With respect to the proposed revenues
relative to risk factor, one commenter
supported this aspect of the
proposal.1143 Some commenters,
however, expressed concern about using
these factors to differentiate permitted
market making-related activity from
1137 The proposed appendix stated that the
Agencies would use certain quantitative
measurements required in proposed Appendix A to
help assess the extent to which a trading unit’s risks
are potentially being retained in excess amounts,
including VaR, Stress VaR, VaR Exceedance, and
Risk Factor Sensitivities. See Joint Proposal, 76 FR
68,961–68,962; CFTC Proposal, 77 FR 8441. One
commenter questioned whether, assuming such
metrics are effective and the activity does not
exceed the banking entity’s expressed risk appetite,
it is necessary to place greater restrictions on risktaking, based on the Agencies’ judgment of the level
of risk necessary for bona fide market making. See
ICFR.
1138 See Chamber (Feb. 2012).
1139 See Credit Suisse (Seidel).
1140 See Goldman (Prop. Trading); Morgan
Stanley.
1141 See Morgan Stanley.
1142 See Goldman (Prop. Trading). This
commenter suggested that the Agencies remove any
negative presumptions based on revenues and
instead use revenue metrics, such as Spread Profit
and Loss (when it is feasible to calculate) or other
metrics for purposes of monitoring a banking
entity’s trading activity. See id.
1143 See Occupy (stating that these factors are
important and will provide invaluable information
about the nature of the banking entity’s trading
activity).

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prohibited proprietary trading.1144
These commenters stated that volatile
risk-taking and revenue can be a natural
result of principal market-making
activity.1145 One commenter noted that
customer flows are often ‘‘lumpy’’ due
to, for example, a market maker’s
facilitation of large trades.1146
A few commenters indicated that the
analysis in the proposed customerfacing activity factor may not accurately
reflect how market making occurs in
certain markets and asset classes due to
potential limitations on interdealer
trading.1147 According to another
commenter, however, a banking entity’s
non-customer facing trades should be
required to be matched with existing
customer counterparties.1148 With
respect to the near term customer
demand component of this factor, one
commenter expressed concern that it
goes farther than the statute’s activitybased ‘‘design’’ test by analyzing
whether a trading unit’s inventory has
exceeded reasonably expected near term
customer demand at any particular
point in time.1149
Some commenters expressed concern
about the payment of fees, commissions,
and spreads factor.1150 One commenter
appeared to support this proposed
factor.1151 According to one commenter,
this factor fails to recognize that market
makers routinely pay a variety of fees in
connection with their market makingrelated activity, including, for example,
fees to access liquidity on another
market to satisfy customer demand,
transaction fees as a matter of course,
and fees in connection with hedging
transactions. This commenter also
indicated that, because spreads in
current, rapidly-moving markets are
volatile, short-term measurements of
profit compared to spread revenue is
problematic, particularly for less liquid
1144 See Morgan Stanley; Credit Suisse (Seidel);
Oliver Wyman (Feb. 2012); Oliver Wyman (Dec.
2011).
1145 See Morgan Stanley; Credit Suisse (Seidel);
Oliver Wyman (Feb. 2012); Oliver Wyman (Dec.
2011). For example, one commenter stated that
because markets and trading volumes are volatile,
consistent profitability and low earnings volatility
are outside a market maker’s control. In support of
this statement, the commenter indicated that: (i)
customer trading activity varies significantly with
market conditions, which results in volatility in a
market maker’s earnings and profitability; and (ii)
a market maker will experience volatility associated
with changes in the value of its inventory positions,
and principal risk is a necessary feature of market
making. See Morgan Stanley.
1146 See Oliver Wyman (Feb. 2012); Oliver
Wyman (Dec. 2011).
1147 See Morgan Stanley; Goldman (Prop.
Trading).
1148 See Public Citizen.
1149 See Oliver Wyman (Feb. 2012).
1150 See NYSE Euronext; Morgan Stanley.
1151 See Public Citizen.

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stocks.1152 Another commenter stated
that this factor reflects a bias toward
agency trading and principal market
making in highly liquid, exchangetraded markets and does not reflect the
nature of principal market making in
most markets.1153 One commenter
recommended that the rule require that
a trader who pays a fee be prepared to
document the chain of custody to show
that the instrument is shortly re-sold to
an interested customer.1154
Regarding the proposed compensation
incentives factor, one commenter
requested that the Agencies make clear
that explanatory facts and
circumstances cannot justify a trading
unit providing compensation incentives
that primarily reward proprietary risktaking to employees engaged in market
making. In addition, the commenter
recommended that the Agencies delete
the word ‘‘primarily’’ from this
factor.1155
c. Determination To Not Adopt
Proposed Appendix B
To improve clarity, the final rule
establishes particular criteria for the
exemption and does not incorporate the
commentary in proposed Appendix B
regarding the identification of permitted
market making-related activities. This
SUPPLEMENTARY INFORMATION provides
guidance on the standards for
compliance with the market-making
exemption.
9. Use of Quantitative Measurements
Consistent with the FSOC study and
the proposal, the Agencies continue to
believe that quantitative measurements
can be useful to banking entities and the
Agencies to help assess the profile of a
trading desk’s trading activity and to
help identify trading activity that may
warrant a more in-depth review.1156 The
Agencies will not use quantitative
measurements as a dispositive tool for
differentiating between permitted
market making-related activities and
prohibited proprietary trading. Like the
framework the Agencies have developed
for the market-making exemption, the
Agencies recognize that there may be
differences in the quantitative
measurements across markets and asset
classes.

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1152 See

NYSE Euronext.
1153 See Morgan Stanley.
1154 See Public Citizen.
1155 See Occupy. This commenter also stated that
the commentary in Appendix B stating that a
banking entity may give some consideration of
profitable hedging activities in determining
compensation would provide inappropriate
incentives. See id.
1156 See infra Part IV.C.3.; final rule Appendix A.

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4. Section ll.5: Permitted RiskMitigating Hedging Activities
Section ll.5 of the proposed rule
implemented 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.1157 Section
13(d)(1)(C) provides an exemption for
risk-mitigating hedging activities in
connection with and related to
individual or aggregated positions,
contracts, or other holdings of a banking
entity that are designed to reduce the
specific risks to the banking entity in
connection with and related to such
positions, contracts, or other holdings
(the ‘‘hedging exemption’’). Section ll
.5 of the final rule implements the
hedging exemption with a number of
modifications from the proposed rule to
respond to commenters’ concerns as
described more fully below.
a. Summary of Proposal’s Approach to
Implementing the Hedging Exemption
The proposed rule would have
required seven criteria to be met in
order for a banking entity’s activity to
qualify for the hedging exemption. First,
§§ ll.5(b)(1) and ll.5(b)(2)(i) of the
proposed rule generally required that
the banking entity establish an internal
compliance program that is designed to
ensure the banking entity’s compliance
with the requirements of the hedging
limitations, including reasonably
designed written policies and
procedures, internal controls, and
independent testing, and that a
transaction for which the banking entity
is relying on the hedging exemption be
made in accordance with the
compliance program established under
§ ll.5(b)(1). Next, § ll.5(b)(2)(ii) of
the proposed rule required 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
the banking entity. Moreover, § ll
.5(b)(2)(iii) of the proposed rule required
that the transaction be 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 transaction is intended to
hedge or otherwise mitigate.
Furthermore, § ll.5(b)(2)(iv) of the
proposed rule required that the hedging
transaction not give rise, at the
1157 See 12 U.S.C. 1851(d)(1)(C); proposed rule
§ ll.5.

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5627

inception of the hedge, to significant
exposures that are not themselves
hedged in a contemporaneous
transaction. Section ll.5(b)(2)(v) of
the proposed rule required that any
hedge position established in reliance
on the hedging exemption be subject to
continuing review, monitoring and
management. Finally, § ll.5(b)(2)(vi)
of the proposed rule required that the
compensation arrangements of persons
performing the risk-mitigating hedging
activities be designed not to reward
proprietary risk-taking. Additionally,
§ ll.5(c) of the proposed rule required
the banking entity to document certain
hedging transactions at the time the
hedge is established.
b. Manner of Evaluating Compliance
With the Hedging Exemption
A number of commenters expressed
concern that the final rule required
application of the hedging exemption on
a trade-by-trade basis.1158 One
commenter argued that the text of the
proposed rule seemed to require a tradeby-trade analysis because each
‘‘purchase or sale’’ or ‘‘hedge’’ was
subject to the requirements.1159 The
final rule modifies the proposal by
generally replacing references to a
‘‘purchase or sale’’ in the § ll.5(b)
requirements with ‘‘risk-mitigating
hedging activity.’’ The Agencies believe
this approach is consistent with the
statute, which refers to ‘‘risk-mitigating
hedging activity.’’ 1160
Section 13(d)(1)(C) of the BHC Act
specifically authorizes risk-mitigating
hedging activities in connection with
and related to ‘‘individual or aggregated
positions, contracts or other
holdings.’’ 1161 Thus, the statute does
not require that exempt hedging be
conducted on a trade-by-trade basis, and
permits hedging of aggregated positions.
The Agencies recognized this in the
proposed rule, and the final rule
continues to permit hedging activities in
connection with and related to
individual or aggregated positions.
The statute also requires that, to be
exempt under section 13(d)(1)(C),
hedging activities be risk-mitigating.
The final rule incorporates this statutory
requirement. As explained in more
detail below, the final rule requires that,
in order to qualify for the exemption for
1158 See Ass’n. of Institutional Investors (Feb.
2012); See also Barclays; ICI (Feb. 2012); Investure;
MetLife; RBC; SIFMA et al. (Prop. Trading) (Feb.
2012); SIFMA (Asset Mgmt.) (Feb. 2012); Morgan
Stanley; Fixed Income Forum/Credit Roundtable;
Fidelity; FTN.
1159 See Barclays.
1160 See 12 U.S.C. 1851(d)(1)(C) (stating that ‘‘riskmitigating hedging activities’’ are permitted under
certain circumstances).
1161 See 12 U.S.C. 1851(d)(1)(C).

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risk-mitigating hedging activities: The
banking entity implement, maintain,
and enforce an internal compliance
program, including policies and
procedures that govern and control
these hedging activities; the hedging
activity be designed to reduce or
otherwise significantly mitigate and
demonstrably reduces or otherwise
significantly mitigates specific,
identifiable risks; the hedging activity
not give rise to significant new risks that
are left unhedged; the hedging activity
be subject to continuing review,
monitoring and management to address
risk that might develop over time; and
the compensation arrangements for
persons performing risk-mitigating
hedging activities be designed not to
reward or incentivize prohibited
proprietary trading. These requirements
are designed to focus the exemption on
hedging activities that are designed to
reduce risk and that also demonstrably
reduce risk, in accordance with the
requirement under section 13(d)(1)(C)
that hedging activities be risk-mitigating
to be exempt. Additionally, the final
rule imposes a documentation
requirement on certain types of hedges.
Consistent with the other exemptions
from the ban on proprietary trading for
market-making and underwriting, the
Agencies intend to evaluate whether an
activity complies with the hedging
exemption under the final rule based on
the totality of circumstances involving
the products, techniques, and strategies
used by a banking entity as part of its
hedging activity.1162

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c. Comments on the Proposed Rule and
Approach to Implementing the Hedging
Exemption
Commenters expressed a variety of
views on the proposal’s hedging
exemption. A few commenters offered
specific suggestions described more
fully below regarding how, in their
view, the hedging exemption should be
strengthened to ensure proper oversight
of hedging activities.1163 These
commenters expressed concern that the
proposal’s exemption was too broad and
argued that all proprietary trading could
be designated as a hedge under the
proposal and thereby evade the
prohibition of section 13.1164
By contrast, a number of other
commenters argued that the proposal
imposed burdensome requirements that
were not required by statute, would
limit the ability of banking entities to
1162 See

Part IV.A.4.b., infra.
e.g., AFR et al. (Feb. 2012); AFR (June
2013); Better Markets (Feb. 2012); Sens. Merkley &
Levin (Feb. 2012).
1164 See, e.g., Occupy.
1163 See,

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hedge in a prudent and cost-effective
manner, and would reduce market
liquidity.1165 These commenters argued
that implementation of the requirements
of the proposal would decrease safety
and soundness of banking entities and
the financial system by reducing costeffective risk management options.
Some commenters emphasized that the
ability of banking entities to hedge their
positions and manage risks taken in
connection with their permissible
activities is a critical element of liquid
and efficient markets, and that the
cumulative impact of the proposal
would inhibit this risk-mitigation by
raising transaction costs and
suppressing essential and beneficial
hedging activities.1166
A number of commenters expressed
concern that the proposal’s hedging
exemption did not permit the full
breadth of transactions in which
banking entities engage to hedge or
mitigate risks, such as portfolio
hedging,1167 dynamic hedging,1168
anticipatory hedging,1169 or scenario
hedging.1170 Some commenters stated
that restrictions on a banking entity’s
ability to hedge may have a chilling
effect on its willingness to engage in
other permitted activities, such as
market making.1171 In addition, many of
these commenters stated that, if a
banking entity is limited in its ability to
hedge its market-making inventory, it
may be less willing or able to assume
risk on behalf of customers or provide
financial products to customers that are
used for hedging purposes. As a result,
according to these commenters, it will
be more difficult for customers to hedge
1165 See, e.g., Australian Bankers’ Ass’n (Feb.
2012); BoA; Barclays; Credit Suisse (Seidel);
Goldman (Prop. Trading); HSBC; ICI (Feb. 2012);
Japanese Bankers Ass’n.; JPMC; Morgan Stanley;
Chamber (Feb. 2012); Wells Fargo (Prop. Trading);
Rep. Bachus et al.; RBC; SIFMA et al. (Prop.
Trading) (Feb. 2012); See also Stephen Roach.
1166 See Credit Suisse (Seidel); ICI (Feb. 2012);
Wells Fargo (Prop. Trading); See also Banco de
Me´xico; SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); BoA.
1167 See MetLife; SIFMA et al. (Prop. Trading)
(Feb. 2012); Morgan Stanley; Barclays; Goldman
(Prop. Trading); BoA; ABA; HSBC; Fixed Income
Forum/Credit Roundtable; ICI (Feb. 2012); ISDA
(Feb. 2012).
1168 See Goldman (Prop. Trading); BoA.
1169 See Barclays; State Street (Feb. 2012); SIFMA
et al. (Prop. Trading) (Feb. 2012); Japanese Bankers
Ass’n.; Credit Suisse (Seidel); BoA; PNC et al.; ISDA
(Feb. 2012).
1170 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC; Goldman (Prop. Trading); BoA; Comm. on
Capital Markets Regulation. Each of these types of
activities is discussed further below. See infra Part
IV.A.4.d.2.
1171 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Credit Suisse (Seidel); Barclays; Goldman (Prop.
Trading); BoA.

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their risks and customers may be forced
to retain risk.1172
Another commenter contended that
the proposal represented an
inappropriate ‘‘one-size-fits-all’’
approach to hedging that did not
properly take into account the way
banking entities and especially market
intermediaries operate, particularly in
less-liquid markets.1173 Two
commenters requested that the Agencies
clarify that a banking entity may use its
discretion to choose any hedging
strategy that meets the requirements of
the proposed exemption and, in
particular, that a banking entity is not
obligated to choose the ‘‘best hedge’’
and may use the cheapest instrument
available.1174 One commenter suggested
uncertainty about the permissibility of a
situation where gains on a hedge
position exceed losses on the
underlying position. The commenter
suggested that uncertainty may lead
banking entities to not use the most
cost-effective hedge, which would make
hedging less efficient and raise costs for
banking entities and customers.1175
However, another commenter expressed
concern about banking entities relying
on the cheapest satisfactory hedge. The
commenter explained that such hedges
lead to more complicated risk profiles
and require banking entities to engage in
additional transactions to hedge the
exposures resulting from the imperfect,
cheapest hedge.1176
A few commenters suggested the
hedging exemption be modified in favor
of a simpler requirement that banking
entities adopt risk limits and policies
and procedures commensurate with
qualitative guidance issued by the
Agencies.1177 Many of these
commenters also expressed concerns
that the proposed rule’s hedging
exemption would not allow so-called
asset-liability management (‘‘ALM’’)
activities.1178 Some commenters
proposed that the risk-mitigating
hedging exemption reference a set of
relevant descriptive factors rather than
1172 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Goldman (Prop. Trading); Credit Suisse (Seidel).
1173 See Barclays.
1174 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Credit Suisse (Seidel).
1175 See SIFMA et al. (Prop. Trading) (Feb. 2012).
1176 See Occupy.
1177 See BoA; Barclays; CH/ABASA; Credit Suisse
(Seidel); HSBC; ICI (Feb. 2012); ISDA (Apr. 2012);
JPMC; Morgan Stanley; PNC; SIFMA et al. (Prop.
Trading) (Feb. 2012); See also Stephen Roach.
1178 A detailed discussion of ALM activities is
provided in Part IV.A.1.d.2 of this SUPPLEMENTARY
INFORMATION relating to the definition of trading
account. As explained in that part, the final rule
does not allow use of the hedging exemption for
ALM activities that are outside of the hedging
activities specifically permitted by the final rule.

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specific prescriptive requirements.1179
Other alternative frameworks suggested
by commenters include: (i)
Reformulating the proposed
requirements as supervisory
guidance; 1180 (ii) establishing a safe
harbor,1181 presumption of
compliance,1182 or bright line test; 1183
or (iii) a principles-based approach that
would require a banking entity to
document its risk-mitigating hedging
strategies for submission to its
regulator.1184
d. Final Rule
The final rule provides a multifaceted approach to implementing the
hedging exemption that seeks to ensure
that hedging activity is designed to be
risk-reducing in nature and not
designed to mask prohibited proprietary
trading.1185 The final rule includes a
number of modifications in response to
comments.
This multi-faceted approach is
intended to permit hedging activities
that are risk-mitigating and to limit
potential abuse of the hedging
exemption while not unduly
constraining the important riskmanagement function that is served by
a banking entity’s hedging activities.
This approach is also intended to ensure
that any banking entity relying on the
hedging exemption has in place
appropriate internal control processes to
support its compliance with the terms of
the exemption. While commenters
proposed a number of alternative
frameworks for the hedging exemption,
the Agencies believe the final rule’s
multi-faceted approach most effectively
balances commenter concerns with
statutory purpose. In response to
commenter requests to reformulate the
proposed rule as supervisory
guidance,1186 including the suggestion
that the Agencies simply require
banking entities to adopt risk limits and
policies and procedures commensurate
with qualitative Agency guidance,1187
the Agencies believe that such an
approach would provide less clarity
than the adopted approach. Although a
purely guidance-based approach could
1179 See

BoA; JPMC; Morgan Stanley.
SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC; PNC et al.; ICI.
1181 See Prof. Richardson; ABA (Keating).
1182 See Barclays; BoA; ISDA (Feb. 2012).
1183 See Johnson & Prof. Stiglitz.
1184 See HSBC.
1185 See final rule § ll.5.
1186 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC; PNC et al.; ICI (Feb. 2012); BoA; Morgan
Stanley.
1187 See BoA; Barclays; CH/ABASA; Credit Suisse
(Seidel); HSBC; ICI (Feb. 2012); ISDA (Apr. 2012);
JPMC; Morgan Stanley; PNC; SIFMA et al. (Prop.
Trading) (Feb. 2012); See also Stephen Roach.

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1180 See

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provide greater flexibility, it would also
provide less specificity, which could
make it difficult for banking entity
personnel and the Agencies to
determine whether an activity complies
with the rule and could lead to an
increased risk of evasion of the statutory
requirements. Further, while a brightline or safe harbor approach to the
hedging exemption would generally
provide a high degree of certainty about
whether an activity qualifies for the
exemption, it would also provide less
flexibility to recognize the differences in
hedging activity across markets and
asset classes.1188 In addition, the use of
any bright-line approach would more
likely be subject to gaming and
avoidance as new products and types of
trading activities are developed than
other approaches to implementing the
hedging exemption. Similarly, the
Agencies decline to establish a
presumption of compliance because, in
light of the constant innovation of
trading activities and the differences in
hedging activity across markets and
asset classes, establishing appropriate
parameters for a presumption of
compliance with the hedging exemption
would potentially be less capable of
recognizing these legitimate differences
than our current approach.1189
Moreover, the Agencies decline to
follow a principles-based approach
requiring a banking entity to document
its hedging strategies for submission to
its regulator.1190 The Agencies believe
that evaluating each banking entity’s
trading activity based on an
individualized set of documented
hedging strategies could be
unnecessarily burdensome and result in
unintended competitive impacts since
banking entities would not be subject to
one uniform rule. The Agencies believe
the multi-faceted approach adopted in
the final rule establishes a consistent
framework applicable to all banking
entities that will reduce the potential for
such adverse impacts.
Further, the Agencies believe the
scope of the final hedging exemption is
appropriate because it permits riskmitigating hedging activities, as
mandated by section 13 of the BHC
Act,1191 while requiring a robust
1188 Some commenters requested that the
Agencies establish a safe harbor. See Prof.
Richardson; ABA (Keating). One commenter
requested that the Agencies adopt a bright-line test.
See Johnson & Prof. Stiglitz.
1189 A few commenters requested that the
Agencies establish a presumption of compliance.
See Barclays; BoA; ISDA (Feb. 2012).
1190 One commenter suggested this principlesbased approach. See HSBC.
1191 Section 13(d)(1)(C) of the BHC Act permits
‘‘risk-mitigating hedging activities in connection
with and related to individual or aggregated

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5629

compliance program and other internal
controls to help ensure that only
genuine risk-mitigating hedges can be
used in reliance on the exemption.1192
In response to concerns that the
proposed hedging exemption would
reduce legitimate hedging activity and
thus impact market liquidity and the
banking entity’s willingness to engage in
permissible customer-related
activity,1193 the Agencies note that the
requirements of the final hedging
exemption are designed to permit
banking entities to properly mitigate
specific risk exposures, consistent with
the statute. In addition, hedging related
to market-making activity conducted by
a market-making desk is subject to the
requirements of the market-making
exemption, which are designed to
permit banking entities to continue
providing valuable intermediation and
liquidity services, including related
risk-management activity.1194 Thus, the
final hedging exemption will not
negatively impact the safety and
soundness of banking entities or the
financial system or have a chilling effect
on a banking entity’s willingness to
engage in other permitted activities,
such as market making.1195
These limits and requirements are
designed to prevent the type of activity
conducted by banking entities in the
past that involved taking large positions
using novel strategies to attempt to
profit from potential effects of general
economic or market developments and
thereby potentially offset the general
effects of those events on the revenues
or profits of the banking entity. The
documentation requirements in the final
rule support these limits by identifying
activity that occurs in reliance on the
risk-mitigating hedging exemption at an
organizational level or desk that is not
responsible for establishing the risk or
positions being hedged.
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.’’ 12
U.S.C. 1851(d)(1)(C).
1192 Some commenters were concerned that the
proposed hedging exemption was too broad and
that all proprietary trading could be designated as
a hedge. See, e.g., Occupy.
1193 See, e.g., Australian Bankers Ass’n. (Feb.
2012).; BoA; Barclays; Credit Suisse (Seidel);
Goldman (Prop. Trading); HSBC; Japanese Bankers
Ass’n.; JPMC; Morgan Stanley; Chamber (Feb.
2012); Wells Fargo (Prop. Trading); Rep. Bachus et
al.; RBC; SIFMA et al. (Prop. Trading) (Feb. 2012).
1194 See supra Part IV.A.3.c.4.
1195 Some commenters believed that restrictions
on hedging would have a chilling effect on banking
entities’ willingness to engage in market making,
and may result in customers experiencing difficulty
in hedging their risks or force customers to retain
risk. See SIFMA et al. (Prop. Trading) (Feb. 2012);
Credit Suisse (Seidel); Barclays; Goldman (Prop.
Trading); BoA; IHS.

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1. Compliance Program Requirement

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The first criterion of the proposed
hedging exemption required a banking
entity to establish an internal
compliance program designed to ensure
the banking entity’s compliance with
the requirements of the hedging
exemption and conduct its hedging
activities in compliance with that
program. While the compliance program
under the proposal was expected to be
appropriate for the size, scope, and
complexity of each banking entity’s
activities and structure, the proposal
would have required each banking
entity with significant trading activities
to implement robust, detailed hedging
policies and procedures and related
internal controls and independent
testing designed to prevent prohibited
proprietary trading in the context of
permitted hedging activity.1196 These
enhanced programs for banking entities
with large trading activity were
expected to include written hedging
policies at the trading unit level and
clearly articulated trader mandates for
each trader designed to ensure that
hedging strategies mitigated risk and
were not for the purpose of engaging in
prohibited proprietary trading.
Commenters, including industry
groups, generally expressed support for
requiring policies and procedures to
monitor the safety and soundness, as
well as appropriateness, of hedging
activity.1197 Some of these commenters
advocated that the final rule presume
that a banking entity is in compliance
with the hedging exemption if the
banking entity’s hedging activity is done
in accordance with the written policies
and procedures required under its
compliance program.1198 One
commenter represented that the
proposed compliance framework was
burdensome and complex.1199
Other commenters expressed
concerns that the hedging exemption
would be too limiting and burdensome
for community and regional banks.1200
Some commenters argued that foreign
banking entities should not be subject to
the requirements of the hedging
exemption for transactions that do not
introduce risk into the U.S. financial
1196 These aspects of the compliance program
requirement are described in further detail in Part
IV.C. of this SUPPLEMENTARY INFORMATION.
1197 See SIFMA et al. (Prop. Trading) (Feb. 2012).
1198 See BoA; Barclays; HSBC; JPMC; Morgan
Stanley; See also Goldman (Prop. Trading); RBC;
Barclays; ICI (Feb. 2012); ISDA (Apr. 2012); PNC;
SIFMA et al. (Prop. Trading) (Feb. 2012). See the
discussion of why the Agencies decline to take a
presumption of compliance approach above.
1199 See Barclays.
1200 See ICBA; M&T Bank.

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system.1201 Other commenters stated
that coordinated hedging through and
by affiliates should qualify as permitted
risk-mitigating hedging activity.1202
Some commenters urged the Agencies
to adopt detailed limitations on hedging
activities. For example, one commenter
urged that all hedging trades be labeled
as such at the inception of the trade and
detailed information regarding the
trader, manager, and supervisor
authorizing the trade be kept and
reviewed.1203 Another commenter
suggested that the hedging exemption
contain a requirement that the banking
entity employee who approves a hedge
affirmatively certify that the hedge
conforms to the requirements of the rule
and has not been put in place for the
direct or indirect purpose or effect of
generating speculative profits.1204 A few
commenters requested limitations on
instruments that can be used for
hedging purposes.1205
The final rule retains the proposal’s
requirement that a banking entity
establish an internal compliance
program that is designed to ensure the
banking entity limits its hedging
activities to hedging that is riskmitigating.1206 The final rule largely
retains the proposal’s approach to the
compliance program requirement,
except to the extent that, as requested by
some commenters,1207 the final rule
modifies the proposal to provide
additional detail regarding the elements
that must be included in a compliance
program. Similar to the proposal, the
final rule contemplates that the scope
and detail of a compliance program will
reflect the size, activities, and
complexity of banking entities in order
to ensure that banking entities engaged
in more active trading have enhanced
compliance programs without imposing
undue burden on smaller organizations
and entities that engage in little or no
1201 See, e.g., Bank of Canada; Allen & Overy (on
behalf of Canadian Banks). Additionally, foreign
banking entities engaged in hedging activity may be
able to rely on the exemption for trading activity
conducted by foreign banking entities in lieu of the
hedging exemption, provided they meet the
requirements of the exemption for trading by
foreign banking entities under § ll.6(e) of the
final rule. See infra Part IV.A.8.
1202 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC.
1203 See Sens. Merkley & Levin (Feb. 2012).
1204 See Better Markets (Feb. 2012).
1205 See Sens. Merkley & Levin (Feb. 2012);
Occupy; Andrea Psoras.
1206 See final rule § ll.5(b)(1). The final rule
retains the proposal’s requirement that the
compliance program include, among other things,
written hedging policies.
1207 See, e.g., BoA; ICI (Feb. 2012); ISDA (Feb.
2012); JPMC; Morgan Stanley; PNC; SIFMA et al.
(Prop. Trading) (Feb. 2012).

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trading activity.1208 The final rule also
requires, like the proposal, that the
banking entity implement, maintain,
and enforce the program.1209
In response to commenter concerns
about ensuring the appropriate level of
senior management involvement in
establishing these policies,1210 the final
rule requires that the written policies
and procedures be developed and
implemented by a banking entity at the
appropriate level of organization and
expressly address the banking entity’s
requirements for escalation procedures,
supervision, and governance related to
hedging activities.1211
Like the proposal, the final rule
specifies that a banking entity’s
compliance regime must include
reasonably designed written policies
and procedures regarding the positions,
techniques and strategies that may be
used for hedging, including
documentation indicating what
positions, contracts or other holdings a
trading desk may use in its riskmitigating hedging activities.1212 The
1208 See final rule § ll.20(a) (stating that ‘‘[t]he
terms, scope and detail of [the] compliance program
shall be appropriate for the types, size, scope and
complexity of activities and business structure of
the banking entity’’). The Agencies believe this
helps address some commenters’ concern that the
hedging exemption would be too limiting and
burdensome for community and regional banks. See
ICBA; M&T Bank.
1209 Many of these policies and procedures were
contained as part of the proposed rule’s compliance
program requirements under Appendix C. They
have been moved, and in some cases modified, in
order to more clearly demonstrate how they are
incorporated into the requirements of the hedging
exemption.
1210 See Better Markets (Feb. 2012). The final rule
does not require affirmative certification of each
hedge, as suggested by this commenter, because the
Agencies believe it would unnecessarily slow
legitimate transactions. The Agencies believe the
final rule’s required management framework and
escalation procedures achieve the same objective as
the commenter’s suggested approach, while
imposing fewer burdens on legitimate riskmitigating hedging activity.
1211 See final rule §§ ll.20(b), ll.5(b). This
approach builds on the proposal’s requirement that
senior management and intermediate managers be
accountable for the effective implementation of the
compliance program.
1212 This approach is generally consistent with
some commenters’ suggested approach of limiting
the instruments that can be used for hedging
purposes; although the final rules provide banking
entities with discretion to determine the types of
positions, contracts, or other holdings that will
mitigate specific risks of individual or aggregated
holdings and thus may be used for risk-mitigating
hedging activity. See Sens. Merkley & Levin (Feb.
2012); Occupy; Andrea Psoras. In response to one
commenter’s request that the final rule require all
hedges to be labeled at inception and certain
detailed information be documented for each hedge,
the Agencies note that the final rules continue to
require detailed documentation for hedging activity
that presents a heightened risk of evasion. See Sens.
Merkley & Levin (Feb. 2012); final rule § ll.5(c);
infra Part IV.A.4.d.4. The Agencies believe a
documentation requirement targeted at these

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focus on policies and procedures
governing risk identification and
mitigation, analysis and testing of
position limits and hedging strategies,
and internal controls and ongoing
monitoring is expected to limit use of
the hedging exception to risk-mitigating
hedging. The final rule adds to the
proposed compliance program approach
by requiring that the banking entity’s
written policies and procedures include
position and aging limits with respect to
such positions, contracts, or other
holdings.1213 The final rule, similar to
the proposed rule, also requires that the
compliance program contain internal
controls and ongoing monitoring,
management, and authorization
procedures, including relevant
escalation procedures.1214 Further, the
final rule retains the proposed
requirement that the compliance
program provide for the conduct of
analysis and independent testing
designed to ensure that the positions,
techniques, and strategies that may be
used for hedging may reasonably be
expected to demonstrably reduce or
otherwise significantly mitigate the
specific, identifiable risks being
hedged.1215
The final rule also adds that
correlation analysis be undertaken as
part of the analysis of the hedging
positions, techniques, and strategies that
may be used. This provision effectively
changes the requirement in the
proposed rule that the hedge must
maintain correlation into a requirement
that correlation be analyzed as part of
the compliance program before a
hedging activity is undertaken. This
provision incorporates the concept in
the proposed rule that a hedge should
be correlated (negatively, when sign is
considered) to the risk being hedged.
However, the Agencies recognize that
some effective hedging activities, such
as deep out-of-the-money puts and calls,
may not be exhibit a strong linear
correlation to the risks being hedged
and also that correlation over a period
of time between two financial positions
does not necessarily mean one position
scenarios balances the need to prevent evasion of
the general prohibition on proprietary trading with
the concern that documentation requirements can
slow or impede legitimate risk-mitigating activity in
the normal course.
1213 See final rule § ll.5(b)(1)(i). Some
commenters expressed support for the use of risk
limits in determining whether trading activity
qualifies for the hedging exemption. See, e.g.,
Barclays; Credit Suisse (Seidel); ICI (Feb. 2012);
Morgan Stanley.
1214 See final rule § ll.5(b)(1)(ii).
1215 See final rule § ll.5(b)(1)(iii). The final
rule’s requirement to demonstrably reduce or
otherwise significantly mitigate is discussed in
greater detail below.

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will in fact reduce or mitigate a risk of
the other. Rather, the Agencies expect
the banking entity to undertake a
correlation analysis that will, in many
but not all instances, provide a strong
indication of whether a potential
hedging position, strategy, or technique
will or will not demonstrably reduce the
risk it is designed to reduce. It is
important to recognize that the rule does
not require the banking entity to prove
correlation mathematically or by other
specific methods. Rather, the nature and
extent of the correlation analysis
undertaken would be dependent on the
facts and circumstances of the hedge
and the underlying risks targeted. If
correlation cannot be demonstrated,
then the Agencies would expect that
such analysis would explain why not
and also how the proposed hedging
position, technique, or strategy is
designed to reduce or significantly
mitigate risk and how that reduction or
mitigation can be demonstrated without
correlation.
Moreover, the final rule requires
hedging activity conducted in reliance
on the hedging exemption be subject to
continuing review, monitoring, and
management that is consistent with the
banking entity’s written hedging
policies and procedures and is designed
to reduce or otherwise significantly
mitigate, and demonstrably reduces or
otherwise significantly mitigates, the
specific, identifiable risks that develop
over time from hedging activity and
underlying positions.1216 This ongoing
review should consider market
developments, changes in positions or
the configuration of aggregated
positions, changes in counterparty risk,
and other facts and circumstances
related to the risks associated with the
underlying and hedging positions,
contracts, or other holdings.
The Agencies believe that requiring
banking entities to develop and follow
detailed compliance policies and
procedures related to risk-mitigating
hedging activity will help both banking
entities and examiners understand the
risks to which banking entities are
exposed and how these risks are
managed in a safe and sound manner.
With this increased understanding,
banking entities and examiners will be
1216 The proposal also contained a continuing
review, monitoring, and management requirement.
See proposed rule § ll.5(b)(2)(v). The final rule
modifies the proposed requirement, however, by
removing the ‘‘reasonable correlation’’ requirement
and instead requiring that the hedge demonstrably
reduce or otherwise significantly mitigate specific
identifiable risks. Correlation analysis is, however,
a necessary component of the analysis element in
the compliance program requirement of the hedging
exemption in the final rule. See final rule § ll
.5(b). This change is discussed below.

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5631

better able to evaluate whether banking
entities are engaged in legitimate, riskreducing hedging activity, rather than
impermissible proprietary trading.
While the Agencies recognize there are
certain costs associated with this
compliance program requirement,1217
we believe this provision is necessary to
ensure compliance with the statute and
the final rule. As discussed in Part
IV.C.1., the Agencies have modified the
proposed compliance program structure
to reduce burdens on small banking
entities.1218
The Agencies note that hedging may
occur across affiliates under the hedging
exemption.1219 To ensure that hedging
across trading desks or hedging done at
a level of the organization outside of the
trading desk does not result in
prohibited proprietary trading, the final
rule imposes enhanced documentation
requirements on these activities, which
are discussed more fully below. The
Agencies also note that nothing in the
final rule limits or restricts the ability of
the appropriate supervisory agency of a
banking entity to place limits on
interaffiliate hedging in a manner
consistent with their safety and
soundness authority to the extent the
agency has such authority.1220
Additionally, nothing in the final rule
limits or modifies the applicability of
CFTC regulations with respect to the
clearing of interaffiliate swaps.1221
2. Hedging of Specific Risks and
Demonstrable Reduction of Risk
Section ll.5(b)(2)(ii) of the
proposed rule required that a qualifying
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.1222 This criterion
1217 See

Barclays.
infra Part IV.C.1. Some commenters
expressed concern that the compliance program
requirement would place undue burden on regional
or community banks. See ICBA; M&T Bank.
1219 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC.
1220 In addition, section 608 of the Dodd-Frank
Act added credit exposure arising from securities
borrowing and lending or a derivative transaction
with an affiliate to the list of covered transactions
subject to the restrictions of section 23A of the FR
Act, in each case to the extent that such transaction
causes a bank to have credit exposure to the
affiliate. See 12 U.S.C. 371c(b)(7) and (8). As a
consequence, interaffiliate hedging activity within a
banking entity may be subject to limitation or
restriction under section 23A of the FR Act.
1221 See 17 CFR 50.52.
1222 See proposed rule § ll.5(b)(2)(ii); See also
Joint Proposal, 76 FR 68,875.
1218 See

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implemented the essential element of
the hedging exemption that the
transaction be risk-mitigating.
Some commenters expressed support
for this provision, particularly the
requirement that a banking entity be
able to tie a hedge to a specific risk.1223
One of these commenters stated that a
demonstrated reduction in risk should
be a key indicator of whether a hedge
is in fact permitted.1224 However, some
commenters argued that the list of risks
eligible to be hedged under the
proposed rule, which included risks
arising from aggregated positions, could
justify transactions that should be
viewed as prohibited proprietary
trading.1225 Another commenter
contended that the term ‘‘basis risk’’
was undefined and could heighten the
potential that this exemption would be
used to evade the prohibition on
proprietary trading.1226
Other commenters argued that
requiring a banking entity to specify the
particular risk being hedged discourages
effective hedging and increases the risk
at banking entities. These commenters
contended that hedging activities must
address constantly changing positions
and market conditions.1227 Another
commenter argued that this requirement
could render a banking entity’s hedges
impermissible if those hedges do not
succeed in fully hedging or mitigating
an identified risk as determined by a
post hoc analysis and could prevent
banking entities from entering into
hedging transactions in anticipation of
risks that the banking entity expects will
arise (or increase).1228 Certain
commenters requested that the hedging
exemption provide a safe harbor for
positions that satisfy FASB ASC Topic
815 (formerly FAS 133) hedging
accounting standards, which provides
that an entity recognize derivative
instruments, including certain
derivative instruments embedded in
other contracts, as assets or liabilities in
the statement of financial position and
measure them at fair value.1229 Another
1223 See AFR (June 2013); Sens. Merkley & Levin
(Feb. 2012); Public Citizen; Johnson & Prof. Stiglitz.
1224 See Sens. Merkley & Levin (Feb. 2012).
1225 See Public Citizen; See also Occupy.
1226 See Occupy.
1227 See, e.g., Japanese Bankers Ass’n.
1228 See Barclays.
1229 See ABA (Keating); Wells Fargo (Prop.
Trading). Although certain accounting standards,
such as FASB ASC Topic 815 hedge accounting
standards, address circumstances in which a
transaction may be considered a hedge of another
transaction, the final rule does not refer to or
expressly 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

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commenter suggested that scenario
hedges could be identifiable and subject
to review by the Agencies using VaR,
Stress VaR, and VaR Exceedance, as
well as revenue metrics.1230
The Agencies have considered these
comments carefully in light of the
statute. Section 13(d)(1)(C) of the BHC
Act provides an exemption from the
prohibition on proprietary trading only
for hedging activity that is ‘‘designed to
reduce the specific risks to the banking
entity in connection with and related
to’’ individual or aggregated positions,
contracts, or other holdings of the
banking entity.1231 Thus, while the
statute permits hedging of individual or
aggregated positions (as discussed more
fully below), the statute requires that, to
be exempt from the prohibition on
proprietary trading, hedging
transactions be designed to reduce
specific risks.1232 Moreover, it requires
that these specific risks be in connection
with or related to the individual or
aggregated positions, contracts, or other
holdings of the banking entity.
The final rule implements these
requirements. To ensure that exempt
hedging activities are designed to
reduce specific risks, the final rule
requires that the hedging activity at
inception of the hedging activity,
including, without limitation, any
adjustments to the hedging activity, be
designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks, including market risk,
counterparty or other credit risk,
currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified individual or aggregated
positions, contracts, or other holdings of
the banking entity, based upon the facts
and circumstances of the individual or
aggregated underlying and hedging
positions, contracts, or other holdings of
the banking entity and the risks and
liquidity thereof.1233 Hedging activities
and limits should be based on analysis
conducted by the banking entity of the
appropriateness of hedging instruments,
strategies, techniques, and limits. As
discussed above, this analysis must
include analysis of correlation between
of the potential impact on section 13 of the BHC
Act.
1230 See JPMC.
1231 12 U.S.C. 1851(d)(1)(C).
1232 Some commenters expressed support for the
requirement that a banking entity tie a hedge to a
specific risk. See AFR (June 2012); Sens. Merkley
& Levin (Feb. 2012); Public Citizen; Johnson & Prof.
Stiglitz.
1233 See final rule § ll.5(b)(2)(ii).

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the hedge and the specific identifiable
risk or risks that the hedge is designed
to reduce or significantly mitigate.1234
This language retains the focus of the
statute and the proposed rule on
reducing or mitigating specific and
identified risks.1235 As discussed more
fully above, banking entities are
required to describe in their compliance
policies and procedures the types of
strategies, techniques, and positions that
may be used for hedging.
The final rule does not prescribe the
hedging strategy that a banking entity
must employ. While one commenter
urged that the final rule require each
banking entity to adopt the ‘‘best hedge’’
for every transaction,1236 the Agencies
believe that the complexity of positions,
market conditions at the time of a
transaction, availability of hedging
transactions, costs of hedging, and other
circumstances at the time of the
transaction make a requirement that a
banking entity always adopt the ‘‘best
hedge’’ impractical, unworkable, and
subjective.
Nonetheless, the statute requires that,
to be exempt under section 13(d)(1)(C),
hedging activity must be risk-mitigating.
To ensure that only risk-mitigating
hedging is permitted under this
exemption, the final rule requires that in
its written policies and procedures the
banking entity identify the instruments
and positions that may be used in
hedging, the techniques and strategies
the banking entity deems appropriate
for its hedging activities, as well as
position limits and aging limits on
hedging positions. These written
policies and procedures also must
specify the escalation and approval
procedures that apply if a trader seeks
to conduct hedging activities beyond the
limits, position types, strategies, or
techniques authorized for the trader’s
activities.1237
final rule § ll.5(b)(1)(iii).
commenters represented that the
proposed list of risks eligible to be hedged could
justify transactions that should be considered
proprietary trading. See Public Citizen; Occupy.
One commenter was concerned about the proposed
inclusion of ‘‘basis risk’’ in this list. See Occupy.
As noted in the proposal, the Agencies believe the
inclusion of a list of eligible risks, including basis
risk, helps implement the essential element of the
statutory hedging exemption—i.e., that the
transaction is risk-reducing in connection with a
specific risk. See Joint Proposal, 76 FR 68,875. See
also 12 U.S.C. 1851(d)(1)(C). Further, the Agencies
believe the other requirements of the final hedging
exemption, including requirements regarding
internal controls and a compliance program, help
to ensure that only legitimate hedging activity
qualifies for the exemption.
1236 See, e.g., Occupy.
1237 A banking entity must satisfy the enhanced
documentation requirements of § ll.5(c) if it
engages in hedging activity utilizing positions,
contracts, or holdings that were not identified in its
written policies and procedures.
1234 See

1235 Some

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As noted above, commenters were
concerned that risks associated with
permitted activities and holdings
change over time, making a
determination regarding the
effectiveness of hedging activities in
reducing risk dependent on the time
when risk is measured. To address this,
the final rule requires that the exempt
hedging activity be designed to reduce
or otherwise significantly mitigate, and
demonstrably reduces or otherwise
significantly mitigates, risk at the
inception of the hedge. As explained
more fully below, because risks and the
effectiveness of a hedging strategy may
change over time, the final rule also
requires the banking entity to
implement a program to review,
monitor, and manage its hedging
activity over the period of time the
hedging activity occurs in a manner
designed to reduce or significantly
mitigate and demonstrably reduce or
otherwise significantly mitigate new or
changing risks that may develop over
time from both the banking entity’s
hedging activities and the underlying
positions. Many commenters expressed
concern that the proposed ongoing
review, monitoring, and management
requirement would limit a banking
entity’s ability to engage in aggregated
position hedging.1238 One commenter
stated that because aggregated position
hedging may result in modification of
hedging exposures across a variety of
underlying risks, even as the overall risk
profile of a banking entity is reduced, it
would become impossible to
subsequently review, monitor, and
manage individual hedging transactions
for compliance.1239 The Agencies note
that the final rule, like the statute,
requires that the hedging activity relate
to individual or aggregated positions,
contracts or other holdings being
hedged, and accordingly, the review,
monitoring and management
requirement would not limit the extent
of permitted hedging provided for in
section 13(d)(1)(C) as implied by some
commenters. Further, the final rule
recognizes that the determination of
whether hedging activity demonstrably
reduces or otherwise significantly
mitigates risks that may develop over
time should be ‘‘based upon the facts
and circumstances of the underlying
and hedging positions, contracts and
other holdings of the banking entity and
the risks and liquidity thereof.’’ 1240
1238 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Barclays; ICI (Feb. 2012); Morgan Stanley.
1239 See Barclays.
1240 Final rule § ll.5(b)(2)(iv)(B). The Agencies
believe this provision addresses some commenters’
concern that the ongoing review, monitoring, and
management requirement would limit hedging of

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A number of other commenters
argued that a legitimate risk-reducing
hedge may introduce new risks at
inception.1241 A few commenters
contended that a requirement that no
new risks be associated with a hedge
would be inconsistent with prudent risk
management and greatly reduce the
ability of banking entities to reduce
overall risk through hedging.1242 A few
commenters stated that the proposed
requirement does not recognize that it is
not always possible to hedge a new risk
exposure arising from a hedge in a costeffective manner.1243 With respect to the
timing of the initial hedge and any
additional transactions necessary to
reduce significant exposures arising
from it, one of these commenters
represented that requiring
contemporaneous hedges is
impracticable, would raise transaction
costs, and would make hedging
uneconomic.1244 Another commenter
stated that this requirement could have
a chilling effect on risk managers’
willingness to engage in otherwise
permitted hedging activity.1245
Other commenters stated that a
position that does not fully offset the
risk of an underlying position is not in
fact a hedge.1246 These commenters
believed that the introduction of new
risks at inception of a transaction
indicated that the transaction was
impermissible proprietary trading and
not a hedge.1247
The Agencies recognize that prudent
risk-reducing hedging activities by
banking entities are important to the
efficiency of the financial system.1248
The Agencies further recognize that
hedges are generally imperfect;
consequently, hedging activities can
introduce new and sometimes
significant risks, such as credit risk,
basis risk, or new market risk, especially

5633

when hedging illiquid positions.1249
However, the Agencies also recognize
that hedging activities present an
opportunity to engage in impermissible
proprietary trading designed to profit
from exposure to these types of risks.
To address these competing concerns,
the final rule substantially retains the
proposed requirement that, at the
inception of the hedging activity, the
risk-reducing hedging activity does not
give rise to significant new or additional
risk that is not itself contemporaneously
hedged. This approach is designed to
allow banking entities to continue to
engage in prudent risk-mitigating
activities while ensuring that the
hedging exemption is not used to engage
in prohibited proprietary trading by
taking on prohibited short-term
exposures under the guise of
hedging.1250 As noted in the proposal,
however, the Agencies recognize that
exposure to new risks may result from
legitimate hedging transactions; 1251 this
provision only prohibits the
introduction of additional significant
exposures through the hedging
transaction unless those additional
exposures are contemporaneously
hedged.
As noted above, the final rule
recognizes that whether hedging activity
will demonstrably reduce risk must be
based upon the facts and circumstances
of the individual or aggregated
underlying and hedging positions,
contracts, or other holdings of the
banking entity and the risks and
liquidity thereof.1252 The Agencies
believe this approach balances
commenters’ request that the Agencies
clarify that a banking entity may use its
discretion to choose any hedging
strategy that meets the requirements of
1249 See,

e.g., SIFMA et al. (Prop. Trading) (Feb.

2012).
aggregated positions, and that such ongoing review
of individual hedge transactions with a variety of
underlying risks would be impossible. See SIFMA
(Prop. Trading) (Feb. 2012); Barclays; ICI (Feb.
2012); Morgan Stanley.
1241 See ABA (Keating); BoA; Barclays; Credit
Suisse (Seidel); Goldman (Prop. Trading); SIFMA et
al. (Prop. Trading) (Feb. 2012); See also AFR et al.
(Feb. 2012).
1242 See Credit Suisse (Seidel); Goldman (Prop.
Trading); SIFMA et al. (Prop. Trading) (Feb. 2012).
1243 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Barclays.
1244 See SIFMA et al. (Prop. Trading) (Feb. 2012).
1245 See BoA.
1246 See Sens. Merkley & Levin (Feb. 2012); Public
Citizen; AFR (Nov. 2012).
1247 See Better Markets (Feb. 2012); AFR et al.
(Feb. 2012).
1248 See FSOC study (stating that ‘‘[p]rudent risk
management is at the core of both institutionspecific safety and soundness, as well as
macroprudential and financial stability’’).

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1250 Some commenters stated that it is not always
possible to hedge a new risk exposure arising from
a hedge in a cost-effective manner, and requiring
contemporaneous hedges would raise transaction
costs and the potential for hedges to become
uneconomical. See SIFMA et al. (Prop. Trading)
(Feb. 2012); Barclays. As noted in the proposal, the
Agencies believe that requiring a contemporaneous
hedge of any significant new risk that arises at the
inception of a hedge is appropriate because 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. See Joint Proposal, 76 FR
68,876. Thus, the Agencies believe this requirement
is necessary to prevent evasion of the general
prohibition on proprietary trading. In response to
commenters’ concerns about transaction costs and
uneconomical hedging, the Agencies note that this
provision only requires additional hedging of
‘‘significant’’ new or additional risk and does not
apply to any risk exposure arising from a hedge.
1251 See Joint Proposal, 76 FR 68,876.
1252 See final rule § ll.5(b)(2)(ii).

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the proposed exemption 1253 with
concerns that allowing banking entities
to rely on the cheapest satisfactory
hedge will lead to additional hedging
transactions.1254 The Agencies expect
that hedging strategies and techniques,
as well as assessments of risk, will vary
across positions, markets, activities and
banking entities, and that a ‘‘one-sizefits-all’’ approach would not
accommodate all types of appropriate
hedging activity.1255
By its terms, section 13(d)(1)(C) of the
BHC Act permits a banking entity to
engage in risk-mitigating hedging
activity ‘‘in connection with and
related to individual or aggregated
positions . . . .’’ 1256 The preamble to
the proposed rule made clear that,
consistent with the statutory reference
to mitigating risks of individual or
aggregated positions, this criterion
permits hedging of risks associated with
aggregated positions.1257 This approach
is consistent with prudent riskmanagement and safe and sound
banking practice.1258
The proposed rule explained that, to
be exempt under this provision, hedging
activities must reduce risk with respect
to ‘‘positions, contracts, or other
holdings of the banking entity.’’ The
proposal also required that a banking
entity relying on the exemption be
prepared to identify the specific
position or risks associated with
aggregated positions being hedged and
demonstrate that the hedging
transaction was risk-reducing in the
aggregate, as measured by appropriate
risk management tools.
Some commenters were of the view
that the hedging exemption applied to
aggregated positions or portfolio
hedging and was consistent with
prudent risk-management practices.
These commenters argued that
permitting a banking entity to hedge
aggregate positions and risks arising
from a portfolio of assets would be more
efficient from both a procedural and
business standpoint.1259
1253 See SIFMA (Prop. Trading) (Feb. 2012);
Credit Suisse (Seidel); Barclays; Goldman (Prop.
Trading); BoA.
1254 See Occupy.
1255 See Barclays.
1256 12 U.S.C. 1851(d)(1)(C).
1257 See Joint Proposal, 76 FR 68,875.
1258 See, e.g., Australian Bankers’ Ass’n. (Feb.
2012); BoA; Barclays; Credit Suisse (Seidel);
Goldman (Prop. Trading); HSBC; ICI (Feb. 2012);
Japanese Bankers Ass’n.; JPMC; Morgan Stanley;
Wells Fargo (Prop. Trading); Rep. Bachus et al.;
RBC; SIFMA (Prop. Trading) (Feb. 2012).
1259 See, e.g. ABA (Keating); Ass’n. of
Institutional Investors (Sept. 2012); BoA; See also
Barclays (expressing concern that the proposed rule
could result in regulatory review of individual
hedging trades for compliance on a post hoc basis);

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By contrast, other commenters argued
that portfolio-based hedging could be
used to mask prohibited proprietary
trading.1260 One commenter contended
that the statute provides no basis for
portfolio hedging, and another
commenter similarly suggested that
portfolio hedging should be
prohibited.1261 Another commenter
suggested adopting limits that would
prevent the use of the hedging
exemption to conduct proprietary
activity at one desk as a theoretical
‘‘hedge for proprietary trading at
another desk.’’ 1262 Among the limits
suggested by these commenters were a
requirement that a banking entity have
a well-defined compliance program, the
formation of central ‘‘risk management’’
groups to perform and monitor hedges
of aggregated positions, and a
requirement that the banking entity
demonstrate the capacity to measure
aggregate risk across the institution with
precision using proven models.1263 A
few commenters suggested that the
presence of portfolio hedging should be
viewed as an indicator of imperfections
in hedging at the desk level and be a flag
used by examiners to identify and
review the integrity of specific
hedges.1264
The final rule, like the proposed rule,
implements the statutory language
providing for risk-mitigating hedging
activities related to individual or
aggregated positions. For example,
activity permitted under the hedging
exemption would include the hedging
of one or more specific risks arising
from identified positions, contracts, or
other holdings, such as the hedging of
the aggregate risk of identified positions
of one or more trading desks. Further,
the final rule requires that these hedging
activities be risk-reducing with respect
to the identified positions, contracts, or
other holdings being hedged and that
the risk reduction be demonstrable.
Specifically, the final rule requires,
among other things: That the banking
entity has a robust compliance program
reasonably designed to ensure
HSBC; ISDA (Apr. 2012); ICI (Feb. 2012); PNC;
MetLife; RBC; SIFMA (Prop. Trading) (Feb. 2012).
1260 See, e.g., AFR et al. (Feb. 2012); Sens.
Merkley & Levin (Feb. 2012); Occupy; Public
Citizen; Johnson & Prof. Stiglitz.
1261 See Sens. Merkley & Levin (Feb. 2012)
(commenting that the use of the term ‘‘aggregate’’
positions was intended to note that firms do not
have to hedge on a trade-by-trade basis but could
not hedge on a portfolio basis); Johnson & Prof.
Stiglitz.
1262 See AFR et al. (Feb. 2012) (citing 156 Cong.
Rec. S5898 (daily ed. July 15, 2010) (statement of
Sen. Merkley)).
1263 See, e.g., Occupy; Public Citizen.
1264 See Public Citizen; Occupy; AFR et al. (Feb.
2012).

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compliance with the exemption; that
each hedge is subject to continuing
review, monitoring and management
designed to demonstrably reduce or
otherwise significantly mitigate the
specific, identifiable risks that develop
over time related to the hedging activity
and the underlying positions, contracts,
or other holdings of the banking entity;
and that the banking entity meet a
documentation requirement for hedges
not established by the trading desk
responsible for the underlying position
or for hedges effected through a
financial instrument, technique or
strategy that is not specifically
identified in the trading desk’s written
policies and procedures. The Agencies
believe this approach addresses
concerns that a banking entity could use
the hedging exemption to conduct
proprietary activity at one desk as a
theoretical hedge for proprietary trading
at another desk in a manner consistent
with the statute.1265 Further, the
Agencies believe the adopted exemption
allows banking entities to engage in
hedging of aggregated positions 1266
while helping to ensure that such
hedging activities are truly riskmitigating.1267
As noted above, several commenters
questioned whether the hedging
exemption should apply to ‘‘portfolio’’
hedging and whether portfolio hedging
may create the potential for abuse of the
hedging exemption. The term ‘‘portfolio
hedging’’ is not used in the statute. The
language of section 13(d)(1)(C) of the
BHC Act permits a banking entity to
engage in risk-mitigating hedging
activity ‘‘in connection with and related
to individual or aggregated positions .
. . .’’ 1268 After consideration of the
comments regarding portfolio hedging,
and in light of the statutory language,
the Agencies are of the view that the
statutory language is clear on its face
that a banking entity may engage in riskmitigating hedging in connection with
aggregated positions of the banking
entity. The permitted hedging activity,
when involving more than one position,
contract, or other holding, must be in
1265 See AFR et al. (Feb. 2012) (citing 156 Cong.
Rec. S5898 (daily ed. July 15, 2010) (statement of
Sen. Merkley)).
1266 See MetLife; SIFMA et al. (Prop. Trading)
(Feb. 2012); Morgan Stanley; Barclays; Goldman
(Prop. Trading); BoA; ABA (Keating); HSBC; Fixed
Income Forum/Credit Roundtable; ICI (Feb. 2012);
ISDA (Feb. 2012).
1267 The Agencies believe certain limits suggested
by commenters, such as the formation of central
‘‘risk management’’ groups to monitor hedges of
aggregated positions, are unnecessary given the
aforementioned limits in the final rule. See Occupy;
Public Citizen.
1268 See 12 U.S.C. 1851(d)(1)(C).

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connection with or related to aggregated
positions of the banking entity.
Moreover, hedging of aggregated
positions under this exemption must be
related to identifiable risks related to
specific positions, contracts, or other
holdings of the banking entity. Hedging
activity must mitigate one or more
specific risks arising from an identified
position or aggregation of positions. The
risks in this context are not intended to
be more generalized risks that a trading
desk or combination of desks, or the
banking entity as a whole, believe exists
based on non-position-specific
modeling or other considerations. For
example, the hedging activity cannot be
designed to: Reduce risks associated
with the banking entity’s assets and/or
liabilities generally, general market
movements or broad economic
conditions; profit in the case of a
general economic downturn;
counterbalance revenue declines
generally; or otherwise arbitrage market
imbalances unrelated to the risks
resulting from the positions lawfully
held by the banking entity.1269 Rather,
the hedging exemption permits the
banking entity to engage in trading
activity designed to reduce or otherwise
mitigate specific, identifiable risks
related to identified individual or
aggregated positions that the banking
entity it otherwise lawfully permitted to
have.
When undertaking a hedge to mitigate
the risk of an aggregation of positions,
the banking entity must be able to
specifically identify the risk factors
arising from this set of positions. In
identifying the aggregate set of positions
that is being hedged for purposes of
§ ll.5(b)(2)(ii) and, where applicable,
§ ll.5(c)(2)(i), the banking entity
needs to identify the positions being
hedged with sufficient specificity so
that at any point in time, the specific
financial instrument positions or
components of financial instrument
positions held by the banking entity that
comprise the set of positions being
hedged can be clearly identified.
The proposal would have permitted a
series of hedging transactions designed
to rebalance hedging position(s) based
on changes resulting from permissible
activities or from a change in the price
or other characteristic of the individual
or aggregated positions, contracts, or
other holdings being hedged.1270 The
1269 The Agencies believe that it would be
inconsistent with Congressional intent to permit
some or all of these activities under the hedging
exemption, regardless of whether certain metrics
could be useful for monitoring such activity. See
JPMC.
1270 See proposed rule § ll.5(b)(2)(ii) (requiring
that the hedging transaction ‘‘hedges or otherwise

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Agencies recognized that, in such
dynamic hedging, material changes in
risk may require a corresponding
modification to the banking entity’s
current hedge positions.1271
Some commenters questioned the
risk-mitigating nature of a hedge if, at
inception, that hedge contained
component risks that must be
dynamically managed throughout the
life of the hedge. These commenters
stated that hedges that do not
continuously match the risk of
underlying positions are not in fact riskmitigating hedges in the first place.1272
On the other hand, other commenters
argued that banking entities must be
permitted to engage in dynamic hedging
activity, such as in response to market
conditions which are unforeseeable or
out of the control of the banking
entity,1273 and expressed concern that
the limitations of the proposed rule,
especially the requirement that hedging
transactions ‘‘maintain a reasonable
level of correlation,’’ might impede truly
risk-reducing hedging activity.1274
A number of commenters asserted
that there could be confusion over the
meaning of ‘‘reasonable correlation,’’
which was used in the proposal as part
of explaining what type of activity
would qualify for the hedging
exemption. Some commenters urged
requiring that there be a ‘‘high’’ or
‘‘strong’’ correlation between the hedge
and the risk of the underlying asset.1275
Other commenters indicated that
uncertainty about the meaning of
reasonable correlation could limit valid
risk-mitigating hedging activities
because the level of correlation between
a hedge and the risk of the position or
aggregated positions being hedged
changes over time as a result of changes
in market factors and conditions.1276
mitigates one or more specific risks . . . arising in
connection with and related to individual or
aggregated positions, contracts, or other holdings of
[the] banking entity’’). The proposal noted that this
requirement would include, for example, dynamic
hedging. See Joint Proposal, 76 FR 68,875.
1271 The proposal noted that 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 § ll.5(b)(2)(iii) of the proposed rule.
1272 See AFR et al. (Feb. 2012); Public Citizen; See
also Better Markets (Feb. 2012), Sens. Merkley &
Levin (Feb. 2012).
1273 See Japanese Bankers Ass’n.
1274 See, e.g., BoA; Barclays; ISDA (Apr. 2012);
PNC; PNC et al.; SIFMA et al. (Prop. Trading) (Feb.
2012).
1275 See, e.g., Occupy; Public Citizen; AFR et. al.
(Feb. 2012); AFR (June 2013); Better Markets (Feb.
2012); Sens. Merkley & Levin (Feb. 2012).
1276 See BoA; Barclays; Comm. on Capital Markets
Regulation; Credit Suisse (Seidel); FTN; Goldman
(Prop. Trading); ICI (Feb. 2012); Japanese Bankers
Ass’n.; JPMC; Morgan Stanley; SIFMA et al. (Prop.
Trading) (Feb. 2012); STANY; See also Chamber
(Feb. 2012).

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Some commenters represented that the
proposed provision would cause certain
administrative burdens 1277 or may
result in a reduction in market-making
activities in certain asset classes.1278 A
few commenters expressed concern that
the reasonable correlation requirement
could render a banking entity’s hedges
impermissible if they do not succeed in
being reasonably correlated to the
relevant risk or risks based on an afterthe-fact analysis that incorporates
market developments that could not
have been foreseen at the time the hedge
was placed. These commenters tended
to favor a different approach or a type
of safe harbor based on an initial
determination of correlation.1279 Some
commenters argued the focus of the
hedging exemption should be on risk
reduction and not on reasonable
correlation.1280 One commenter
suggested that risk management metrics
such as VaR and risk factor sensitivities
could be the focus for permitted hedging
instead of requirements like reasonable
correlation under the proposal.1281
In consideration of commenter
concerns about the proposed reasonable
correlation requirement, the final rule
modifies the proposal in the following
key respects. First, the final rule
modifies the requirement of ‘‘reasonable
correlation’’ by providing that the hedge
demonstrably reduce or otherwise
significantly mitigate specific
identifiable risks.1282 This change is
1277 See Japanese Bankers Ass’n.; Goldman (Prop.
Trading); BoA.
1278 See BoA; SIFMA (Asset Mgmt.) (Feb. 2012).
As discussed above, market-maker hedging at the
trading desk level is no longer subject to the
hedging exemption and is instead subject to the
requirements of the market-making exemption,
which is designed to permit banking entities to
continue providing legitimate market-making
services, including managing the risk of marketmaking activity. See also supra Part IV.A.3.c.4. of
this SUPPLEMENTARY INFORMATION.
1279 See Barclays; Goldman (Prop. Trading);
Chamber (Feb. 2012); SIFMA et al. (Prop. Trading)
(Feb. 2012); See also FTN; BoA.
1280 See, e.g., FTN; Goldman (Prop. Trading);
ISDA (Apr. 2012); See also Sens. Merkley & Levin
(Feb. 2012); Occupy.
1281 See Goldman (Prop. Trading). Consistent
with the FSOC study and the proposal, the
Agencies continue to believe that quantitative
measurements can be useful to banking entities and
the Agencies to help assess the profile of a trading
desk’s trading activity and to help identify trading
activity that may warrant a more in-depth review.
See infra Part IV.C.3.; final rule Appendix A. The
Agencies do not intend to use quantitative
measurements as a dispositive tool for
differentiating between permitted hedging activities
and prohibited proprietary trading.
1282 Some commenters stated that the hedging
exemption should focus on risk reduction, not
reasonable correlation. See, e.g., FTN; Goldman
(Prop. Trading); ISDA (Apr. 2012); Sens. Merkley &
Levin (Feb. 2012); Occupy. One of these
commenters noted that demonstrated risk reduction

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designed to reinforce that hedging
activity should be demonstrably risk
reducing or mitigating rather than
simply correlated to risk. This change
acknowledges that hedges need not
simply be correlated to underlying
positions, and that hedging activities
should be consciously designed to
reduce or mitigate identifiable risks, not
simply the result of pairing correlated
positions, as some commenters
suggested.1283 As discussed above, the
Agencies do, however, recognize that
correlation is often a critical element of
demonstrating that a hedging activity
reduces the risks it is designed to
address. Accordingly, the final rule
requires that banking entities conduct
correlation analysis as part of the
required compliance program in order
to utilize the hedging exemption.1284
The Agencies believe this change better
allows consideration of the facts and
circumstances of the particular hedging
activity as part of the correlation
analysis and therefore addresses
commenters’ concerns that the proposed
reasonable correlation requirement
could cause administrative burdens,
impede legitimate hedging activity,1285
and require an after-the-fact
analysis.1286
Second, the final rule provides that
the determination of whether an activity
or strategy is risk-reducing or mitigating
must, in the first instance, be made at
the inception of the hedging activity. A
trade that is not risk-reducing at its
inception is not viewed as a hedge for
purposes of the exemption in § ll
.5.1287
Third, the final rule requires that the
banking entity conduct analysis and
independent testing designed to ensure
that the positions, techniques, and
strategies used for hedging are
reasonably designed to reduce or
should be a key requirement. See Sens. Merkley &
Levin (Feb. 2012).
1283 See FTN; Goldman (Prop. Trading); ISDA
(Apr. 2012); See also Sens. Merkley & Levin (Feb.
2012); Occupy.
1284 See final rule § ll.5(b)(1)(iii).
1285 Some commenters expressed concern that the
proposed ‘‘reasonable correlation’’ requirement
might impede truly risk-reducing activity. See, e.g.,
BoA; Barclays; Comm. on Capital Markets
Regulation; Credit Suisse (Seidel); FTN; Goldman
(Prop. Trading); ICI (Feb. 2012); ISDA (Apr. 2012);
Japanese Bankers Ass’n.; JPMC; Morgan Stanley;
PNC; PNC et al.; SIFMA et al. (Prop. Trading) (Feb.
2012); STANY. Some of these commenters stated
that the proposed requirement would cause
administrative burdens. See Japanese Bankers
Ass’n.; Goldman (Prop. Trading); BoA.
1286 See Barclays; Goldman (Prop. Trading);
Chamber (Feb. 2012); SIFMA et al. (Prop. Trading)
(Feb. 2012; See also FTN.
1287 By contrast, the proposed requirement did
not specify that the hedging activity reduce risk ‘‘at
the inception of the hedge.’’ See proposed rule
§ ll.5(b)(2)(ii).

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otherwise mitigate the risk being
hedged. As noted above, such analysis
and testing must include correlation
analysis. Evidence of negative
correlation may be a strong indicator
that a given hedging position or strategy
is risk-reducing. Moreover, positive
correlation, in some instances, may be
an indicator that a hedging position or
strategy is not designed to be riskmitigating. The type of analysis and
factors considered in the analysis
should take account of the facts and
circumstances, including type of
position being hedged, market
conditions, depth and liquidity of the
market for the underlying and hedging
position, and type of risk being hedged.
The Agencies recognize that markets
and risks are dynamic and that the risks
from a permissible position or
aggregated positions may change over
time, new risks may emerge in the
positions underlying the hedge and in
the hedging position, new risks may
emerge from the hedging strategy over
time, and hedges may become less
effective over time in addressing the
related risk.1288 The final rule, like the
proposal, continues to allow dynamic
hedging. Additionally, the final rule
requires the banking entity to engage in
ongoing review, monitoring, and
management of its positions and related
hedging activity to reduce or otherwise
significantly mitigate the risks that
develop over time. This ongoing
hedging activity must be designed to
reduce or otherwise significantly
mitigate, and must demonstrably reduce
or otherwise significantly mitigate, the
material changes in risk that develop
over time from the positions, contracts,
or other holdings intended to be hedged
or otherwise mitigated in the same way,
as required for the initial hedging
activity. Moreover, the banking entity is
required under the final rule to support
its decisions regarding appropriate
hedging positions, strategies and
techniques for its ongoing hedging
activity in the same manner as for its
initial hedging activities. In this
manner, the final rule permits a banking
entity to engage in effective
management of its risks throughout
changing market conditions 1289 while
1288 Some

commenters noted that hedging
activities must address constantly changing
positions and market conditions and expressed
concern about requiring a banking entity to identify
the particular risk being hedged. See Japanese
Bankers Ass’n.; Barclays.
1289 A few commenters expressed concern that
the proposed ‘‘reasonable correlation’’ requirement
would render hedges impermissible if not
reasonably correlated to the relevant risk(s) based
on a post hoc analysis. See, e.g., Barclays; Goldman
(Prop. Trading); Chamber (Feb. 2012); SIFMA et al.
(Prop. Trading) (Feb. 2012).

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also seeking to prohibit the banking
entity from taking large proprietary
positions through action or inaction
related to an otherwise permissible
hedge.1290
As explained above, the final rule
requires a banking entity relying on the
hedging exemption to be able to
demonstrate that the banking entity is
exposed to the specific risks being
hedged at the inception of the hedge
and any adjustments thereto. However,
in the proposal, the Agencies requested
comment on whether the hedging
exemption should be available in
certain cases where hedging activity
begins before the banking entity
becomes exposed to the underlying risk.
The Agencies proposed that 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)
Was consistent with appropriate risk
management practices; (ii) otherwise
met the terms of the hedging exemption;
and (iii) did not involve the potential for
speculative profit. For example, a
banking entity that was contractually
obligated or otherwise highly likely to
become exposed to a particular risk
could engage in hedging that risk in
advance of actual exposure.1291
A number of commenters argued that
anticipatory hedging is a necessary and
prudent activity and that the final rule
should permit anticipatory hedging
more broadly than did the proposed
rule.1292 In particular, commenters were
concerned that permitting hedging
activity only if it occurs ‘‘slightly’’
before a risk is taken could limit
hedging activities that are crucial to risk
management.1293 Commenters
expressed concern that the proposed
approach would, among other things,
make it difficult for banking entities to
accommodate customer requests for
transactions with specific price or size
executions 1294 and limit dynamic
hedging activities that are important to
sound risk management.1295 In addition,
a number of commenters requested that
the rule permit banking entities to
engage in scenario hedging, a form of
1290 Some commenters questioned the riskmitigating nature of a hedge if, at inception, it
contained risks that must be dynamically managed
throughout the life of the hedge. See, e.g., AFR et
al. (Feb. 2012); Public Citizen.
1291 See Joint Proposal, 76 FR 68,875.
1292 See, e.g., Barclays; SIFMA et al. (Prop.
Trading); Japanese Bankers Ass’n.; Credit Suisse
(Seidel); BoA; PNC et al.; ISDA (Feb. 2012).
1293 See BoA; Credit Suisse (Seidel); ISDA (Feb.
2012); JPMC; Morgan Stanley; PNC et al.; SIFMA et
al. (Prop. Trading) (Feb. 2012).
1294 See Credit Suisse (Seidel); BoA.
1295 See PNC et al.

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anticipatory hedging that addresses
potential exposures to ‘‘tail risks.’’1296
Some commenters expressed concern
about the proposed criterion that the
hedging activity not involve the
potential for speculative profit.1297
These commenters argued that the
proper focus of the hedging exemption
should be on the purpose of the
transaction, and whether the hedge is
correlated to the underlying risks being
hedged (in other words, whether the
hedge is effective in mitigating risk).1298
By contrast, another commenter urged
the Agencies to adopt a specific metric
to track realized profits on hedging
activities as an indicator of prohibited
arbitrage trading.1299
Like the proposal, the final rule does
not prohibit anticipatory hedging.
However, in response to commenter
concerns that the proposal would limit
a banking entity’s ability to respond to
customer requests and engage in
prudent risk management, the final rule
does not retain the proposed
requirement discussed above that an
anticipatory hedge be established
‘‘slightly’’ before the banking entity
becomes exposed to the underlying risk
and meet certain conditions. To address
commenter concerns with the statutory
mandate, several parts of the final rule
are designed to ensure that all hedging
activities, including anticipatory
hedging activities, are designed to be
risk reducing and not impermissible
proprietary trading activities. For
example, the final rule retains the
proposed requirement that a banking
entity have reasonably designed policies
1296 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC; Goldman (Prop. Trading); BoA; Comm. on
Capital Market Regulation. As discussed above,
hedging activity relying on this exemption cannot
be designed to: Reduce risks associated with the
banking entity’s assets and/or liabilities generally,
general market movements or broad economic
conditions; profit in the case of a general economic
downturn; counterbalance revenue declines
generally; or otherwise arbitrage market imbalances
unrelated to the risks resulting from the positions
lawfully held by the banking entity.
1297 See ABA (Keating); CH/ABASA; See also
Credit Suisse (Seidel); PNC; PNC et al.; SIFMA et
al. (Prop. Trading) (Feb. 2012). One commenter
argued that anticipatory hedging should not be
permitted because it represents illegal front
running. See Occupy. The Agencies note that not
all anticipatory hedging would constitute illegal
front running. Any activity that is illegal under
another provision of law, such as front running
under section 10(b) of the Exchange Act, remains
illegal; and section 13 of the BHC Act and any
implementing rules thereunder do not represent a
grant of authority to engage in any such activity.
See 15 U.S.C. 78j.
1298 As discussed above, the final hedging
exemption replaces the ‘‘reasonable correlation’’
concept with the requirement that hedging activity
‘‘demonstrably reduce or otherwise significantly
mitigate’’ specific, identifiable risks.
1299 See AFR et al. (Feb. 2012); See also Part
IV.C.3.d., infra.

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and procedures indicating the positions,
techniques and strategies that each
trading desk may use for hedging. These
policies and procedures should
specifically address when anticipatory
hedging is appropriate and what
policies and procedures apply to
anticipatory hedging.
The final rule also requires that a
banking entity relying on the hedging
exemption be able to demonstrate that
the hedging activity is designed to
reduce or significantly mitigate, and
does demonstrably reduce or otherwise
significantly mitigate, specific,
identifiable risks in connection with
individual or aggregated positions of the
banking entity.1300 Importantly, to use
the hedging exemption, the final rule
requires that the banking entity subject
its hedging activity to continuing
review, monitoring, and management
that is designed to reduce or
significantly mitigate specific,
identifiable risks, and that demonstrably
reduces or otherwise significantly
mitigates identifiable risks, in
connection with individual or
aggregated positions of the banking
entity.1301 The final rule also requires
ongoing recalibration of the hedging
activity by the banking entity to ensure
that the hedging activity satisfies the
requirements set out in § ll.5(b)(2)
and is not prohibited proprietary
trading. If an anticipated risk does not
materialize within a limited time period
contemplated when the hedge is entered
into, under these provisions, the
banking entity would be required to
extinguish the anticipatory hedge or
otherwise demonstrably reduce the risk
associated with that position as soon as
reasonably practicable after it is
determined that the anticipated risk will
not materialize. This requirement
focuses on the purpose of the hedge as
a trade designed to reduce anticipated
risk and not for other purposes. The
Agencies will (and expect that banking
entities also will) monitor the activities
of banking entities to identify prohibited
1300 This requirement modifies proposed rule
§§ ll.5(b)(2)(ii) and (iii). As discussed above, the
addition of ‘‘demonstrably reduces or significantly
mitigates’’ language replaces the proposed
‘‘reasonable correlation’’ requirement.
1301 The proposed rule contained a similar
provision, except that the proposed provision also
required that the continuing review maintain a
reasonable level of correlation between the hedge
transaction and the risk being hedged. See proposed
rule § ll.5(b)(2)(v). As discussed above, the
proposed ‘‘reasonable correlation’’ requirement was
removed from that provision and instead a
requirement has been added to the compliance
program provision that correlation analysis be
undertaken when analyzing hedging positions,
techniques, and strategies before they are
implemented.

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trading activity that is disguised as
anticipatory hedging.
As noted above, one commenter
suggested the Agencies adopt a metric to
monitor the profitability of a banking
entity’s hedging activity.1302 We are not
adopting such a metric because we do
not believe it would be useful to
monitor the profit and loss associated
with hedging activity in isolation
without considering the profit and loss
associated with the individual or
aggregated positions being hedged. For
example, the commenter’s suggested
metric would not appear to provide
information about whether the gains
arising from hedging positions offset or
mitigate losses from individual or
aggregated positions being hedged.
3. Compensation
The proposed rule required that the
compensation arrangements of persons
performing risk-mitigating hedging
activities be designed not to reward
proprietary risk-taking.1303 In the
proposal, the Agencies stated that
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
risk-mitigating hedging activities.1304
Commenters generally supported this
requirement and indicated that its
inclusion was very important and
valuable.1305 Some commenters argued
that the final rule should limit
compensation based on profits derived
from hedging transactions, even if those
hedging transactions were in fact riskmitigating hedges, and urged that
employees be compensated instead
based on success in risk mitigation at
the end of the life of the hedge.1306 In
contrast, other commenters argued that
the compensation requirement should
restrict only compensation
arrangements that incentivize
employees to engage in prohibited
proprietary risk-taking.1307
After considering comments received
on the compensation requirements of
the proposed hedging exemption, the
final rule substantially retains the
proposed requirement that the
compensation arrangements of persons
performing risk-mitigating hedging
activities be designed not to reward
prohibited proprietary trading. The final
1302 See

AFR et al. (Feb. 2012).
proposed rule § ll.5(b)(2)(vi).
1304 See Joint Proposal, 76 FR 68,868.
1305 See, e.g., AFR et al. (Feb. 2012); Sens.
Merkley & Levin (Feb. 2012); Public Citizen.
1306 See AFR et al. (Feb. 2012); AFR (June 2013).
1307 See Morgan Stanley.
1303 See

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rule is also modified to make clear that
rewarding or incentivizing profit
making from prohibited proprietary
trading is not permitted.1308
The Agencies recognize that
compensation, especially incentive
compensation, may be both an
important motivator for employees as
well as a useful indicator of the type of
activity that an employee or trading
desk is engaged in. For instance, an
incentive compensation plan that
rewards an employee engaged in
activities under the hedging exemption
based primarily on whether that
employee’s positions appreciate in
value instead of whether such positions
reduce or mitigate risk would appear to
be designed to reward prohibited
proprietary trading rather than riskreducing hedging activities.1309
Similarly, a compensation arrangement
that is designed to incentivize an
employee to exceed the potential losses
associated with the risks of the
underlying position rather than reduce
risks of underlying positions would
appear to reward prohibited proprietary
trading rather than risk-mitigating
hedging activities. The banking entity
should review its compensation
arrangements in light of the guidance
and rules imposed by the appropriate
Federal supervisor for the entity
regarding compensation.1310
4. Documentation Requirement
Section ll.5(c) of the proposed rule
would have imposed 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 involved a hedge
established at a level of organization
different than the level of organization
establishing or responsible for the
positions, contracts, or other holdings
the risks of which the hedging
transaction is designed to reduce, the
banking entity was required, at a
minimum, to document: the riskmitigating purpose of the transaction;
the risks of the individual or aggregated

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1308 One

commenter stated that the compensation
requirement should restrict only compensation
arrangements that incentivize employees to engage
in prohibited proprietary risk-taking, rather than
apply to hedging activities. See Morgan Stanley.
1309 Thus, the Agencies agree with one
commenter who stated that compensation for
hedging should not be based purely on profits
derived from hedging. However, the final rule does
not require compensation vesting, as suggested by
this commenter, because the Agencies believe the
final hedging exemption includes sufficient
requirements to ensure that only risk-mitigating
hedging is permitted under the exemption without
a compensation vesting provision. See AFR et al.
(Feb. 2012); AFR (June 2013).
1310 See 12 U.S.C. 5641.

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positions, contracts, or other holdings of
a banking entity that the transaction is
designed to reduce; and the level of
organization that is establishing the
hedge.1311 Such documentation was
required to be established at the time
the hedging transaction is effected. The
Agencies expressed concern in the
proposal 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, either at the trading
desk level or at the level instituting the
hedging transaction. In other words, the
further removed hedging activities are
from the specific positions, contracts, or
other holdings the banking entity
intends to hedge, the greater the danger
that such activity is not limited to
hedging specific risks of individual or
aggregated positions, contracts, or other
holdings of the banking entity, as
required by the rule.
Some commenters argued that the
final rule should require comprehensive
documentation for all activity
conducted pursuant to the hedging
exemption, regardless of where it occurs
in an organization.1312 One of these
commenters stated that such
documentation can be easily and
quickly produced by traders and noted
that traders already record execution
details of every trade.1313 Several
commenters argued that the rule should
impose a requirement that banks label
all hedges at their inception and provide
information regarding the specific risk
being offset, the expected duration of
the hedge, how it will be monitored,
how it will be wound down, and the
names of the trader, manager, and
supervisor approving the hedge.1314
Some commenters requested that the
documentation requirement be applied
at a higher level of organization,1315 and
some commenters noted that policies
and procedures alone would be
sufficient to address hedging activity,
wherever conducted within the
organization.1316 Two commenters
1311 For example, as explained under the
proposal, 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 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. See Joint Proposal, 76 FR 68,876 n.161.
1312 See AFR (June 2013); Occupy.
1313 See Occupy.
1314 See Sens. Merkley & Levin (Feb. 2012);
Occupy; AFR (June 2013).
1315 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC; Barclays; See also Japanese Bankers Ass’n.
1316 See JPMC; SIFMA et al. (Prop. Trading) (Feb.
2012).

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indicated that making the
documentation requirement narrower is
necessary to avoid impacts or delays in
daily trading operations that could lead
to a banking entity being exposed to
greater risks.1317 A number of
commenters stated that any enhanced
documentation requirement would be
burdensome and costly, and would
impede rapid and effective risk
mitigation, whether done at a trading
desk or elsewhere in the banking
entity.1318
At least one commenter also argued
that a banking entity should be
permitted to consolidate some or all of
its hedging activity into a trading desk
that is not responsible for the
underlying positions without triggering
a requirement that all hedges
undertaken by a trading desk be
documented solely because the hedges
are not undertaken by the trading desk
that originated the underlying
position.1319
The final rule substantially retains the
proposed requirement for enhanced
documentation for hedging activity
conducted under the hedging exemption
if the hedging is not conducted by the
specific trading desk establishing or
responsible for the underlying positions,
contracts, or other holdings, the risks of
which the hedging activity is designed
to reduce. The final rule clarifies that a
banking entity must prepare enhanced
documentation if a trading desk
establishes a hedging position and is not
the trading desk that established the
underlying positions, contracts, or other
holdings. The final rule also requires
enhanced documentation for hedges
established to hedge aggregated
positions across two or more desks. This
change in the final rule clarifies that the
level of the organization at which the
trading desk exists is important for
determining whether the trading desk
established or is responsible for the
underlying positions, contracts, or other
holdings. The final rule recognizes that
a trading desk may be responsible for
hedging aggregated positions of that
desk and other desks, business units, or
affiliates. In that case, the trading desk
putting on the hedge is at least one step
removed from some of the positions
being hedged. Accordingly, the final
rule provides that the documentation
requirements in § ll.5 apply if a
trading desk is hedging aggregated
positions that include positions from
more than one trading desk.
1317 See

JPMC; Barclays.
Barclays; JPMC; SIFMA et al. (Prop.
Trading) (Feb. 2012); See also Japanese Bankers
Ass’n.
1319 See JPMC.
1318 See

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
The final rule adds to the proposal by
requiring enhanced documentation for
hedges established by the specific
trading desk establishing or directly
responsible for the underlying positions,
contracts, or other holdings, the risks of
which the purchases or sales are
designed to reduce, if the hedge is
effected through a financial instrument,
technique, or strategy that is not
specifically identified in the trading
desk’s written policies and procedures
as a product, instrument, exposure,
technique, or strategy that the trading
desk may use for hedging.1320 The
Agencies note that this documentation
requirement does not apply to hedging
activity conducted by a trading desk in
connection with the market makingrelated activities of that desk or by a
trading desk that conducts hedging
activities related to the other
permissible trading activities of that
desk so long as the hedging activity is
conducted in accordance with the
compliance program for that trading
desk.
The Agencies continue to believe that,
for the reasons stated in the proposal, it
is appropriate to retain documentation
of hedging transactions conducted by
those other than the traders responsible
for the underlying position in order to
permit evaluation of the activity. In
order to reduce the burden of the
documentation requirement while still
giving effect to the rule’s purpose, the
final rule requires limited
documentation for hedging activity that
is subject to a documentation
requirement, consisting of: (1) The
specific, identifiable risk(s) of the
identified positions, contracts, or other
holdings that the purchase or sale is
designed to reduce; (2) the specific riskmitigating strategy that the purchase or
sale is designed to fulfill; and (3) the
trading desk or other business unit that
is establishing and responsible for the
hedge transaction. As in the proposal,
this documentation must be established
contemporaneously with the hedging
transaction. Documentation would be
contemporaneous if it is completed
reasonably promptly after a trade is

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1320 One

commenter suggested that the rule
require documentation when a banking entity needs
to engage in new types of hedging transactions that
are not covered by its hedging policies, although
this commenter’s suggested approach would only
apply when a hedge is conducted two levels above
the level at which the risk arose. See SIFMA et al.
(Prop. Trading) (Feb. 2012). The Agencies agree that
documentation is needed when a trading desk is
acting outside of its hedging policies and
procedures. However, the final rule does not limit
this documentation requirement to circumstances
when the hedge is conducted two organizational
levels above the trading desk. Such an approach
would be less effective than the adopted approach
at addressing evasion concerns.

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executed. The banking entity is required
to retain records for no less than 5 years
(or such longer period as may be
required under other law) in a form that
allows the banking entity to promptly
produce such records to the Agency on
request.1321 While the Agencies
recognize this documentation
requirement may result in certain costs,
the Agencies believe this requirement is
necessary to prevent evasion of the
statute and final rule.
5. Section ll.6(a)–(b): Permitted
Trading in Certain Government and
Municipal Obligations
Section ll.6 of the proposed rule
permitted a banking entity to engage in
trading activities that were authorized
by section 13(d)(1) of the BHC Act,1322
including 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.1323 Section ll.6 of the final
rule generally incorporates these same
statutory exemptions. However, the
final rule has been modified in some
ways in response to comments received
on the proposal.
a. Permitted Trading in U.S.
Government Obligations
Section 13(d)(1)(A) permits trading in
various U.S. government, U.S. agency
and municipal securities.1324 Section
ll.6(a) of the proposed rule, which
implemented section 13(d)(1)(A) of the
BHC Act, permitted the purchase or sale
of a financial instrument that is an
obligation of the United States or any
agency thereof or 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.).1325 The
final rule § ll5(c)(3).
proposed rule § ll.6.
1323 See 12 U.S.C. 1851(d)(1)(A), (C), (F), and (H).
1324 12 U.S.C. 1851(d)(1)(A).
1325 The Agencies proposed that United States
‘‘agencies’’ for this purpose would include those
agencies described in section 201.108(b) of the
Board’s Regulation A. See 12 CFR 201.108(b). The
Agencies also noted 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). In
addition, this would include pass-through or
participation certificates that are issued and
guaranteed by a government-sponsored entity (e.g.,
the Federal National Mortgage Association and the
1321 See
1322 See

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5639

proposal did not contain an exemption
for trading in derivatives referencing
exempt U.S. government and agency
securities, but requested comment on
whether the final rule should contain an
exemption for proprietary trading in
options or other derivatives referencing
an exempt government obligation.1326
Commenters were generally
supportive of the manner in which the
proposal implemented the exemption
for permitted trading in U.S.
government and U.S. agency
obligations.1327 Many commenters
argued that the exemption for
permissible proprietary trading in
government obligations should be
expanded, however, to include trading
in derivatives on government
obligations.1328 These commenters
asserted that failure to provide an
exemption would adversely impact
liquidity in the underlying government
obligations themselves and increase
borrowing costs to governments.1329
Several commenters asserted that U.S.
government and agency obligations and
derivatives on those instruments are
substitutes and pose the same
investment risks and opportunities.1330
According to some commenters, the
significant connections between these
markets and the interchangeable nature
of these instruments significantly
contribute to price discovery, in
particular, in the cash market for U.S.
Treasury obligations.1331 Commenters
also argued that trading in Treasury
futures and options improves liquidity
in Treasury securities markets by
providing an outlet to relieve any
supply and demand imbalances in spot
obligations. Many commenters argued
that the authority to engage in trading in
derivatives on U.S. government, agency,
and municipal obligations is inherent in
the statutory exceptions granted by
section 13(d)(1)(A) to trade in the
underlying obligation.1332 To the extent
there is any doubt about the scope of
those exemptions, commenters urged
the Agencies to use the exemptive
Federal Home Loan Mortgage Corporation) in
connection with its securitization activities.
1326 See Joint Proposal, 76 FR 68,878.
1327 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Sens. Merkley & Levin (Feb. 2012).
1328 See BoA; CalPERS; Credit Suisse (Seidel);
CME Group; Fixed Income Forum/Credit
Roundtable; FIA; JPMC; Morgan Stanley; PNC;
SIFMA et al. (Prop. Trading) (Feb. 2012); Wells
Fargo (Prop. Trading).
1329 See BoA; FIA; HSBC; JPMC; Morgan Stanley;
Wells Fargo (Prop. Trading).
1330 See Barclays; Credit Suisse (Seidel); Fixed
Income Forum/Credit Roundtable; FIA.
1331 See Barclays; CME Group; Fixed Income
Forum/Credit Roundtable; See also UBS.
1332 See CME Group; See also Morgan Stanley;
PNC; SIFMA et al. (Prop. Trading) (Feb. 2012);
Wells Fargo (Prop. Trading).

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations

authority under section 13(d)(1)(J) if
necessary to permit proprietary trading
in derivatives on government
obligations.1333 Two commenters
opposed providing an exemption for
proprietary trading in derivatives on
exempt government obligations.1334
The final rule has not been modified
to permit a banking entity to engage in
proprietary trading of derivatives on
U.S. government and agency
obligations.
The Agencies note that the cash
market for exempt government
obligations is already one of the most
liquid markets in the world, and the
final rule will permit banking entities to
participate fully in these cash markets.
In addition, the final rule permits
banking entities to make a market in
U.S. government securities and in
derivatives on those securities.
Moreover, the final rule allows banking
entities to continue to use U.S.
government obligations and derivatives
on those obligations in risk-mitigating
hedging activities permitted by the rule.
Further, proprietary trading in
derivatives on such obligations will
continue by entities other than banking
entities.
Proprietary trading of derivatives on
U.S. government obligations is not
necessary to promote and protect the
safety and soundness of a banking entity
or the financial stability of the United
States. Commenters offered no
compelling reasons why derivatives on
exempt government obligations pose
little or no risk to the financial system
as compared to derivatives on other
financial products for which proprietary
trading is generally prohibited and did
not indicate how proprietary trading in
derivatives of U.S. government and
agency obligations by banking entities
would promote the safety and
soundness of those entities or the
financial stability of the United States.
For these reasons, the Agencies have not
determined to provide an exemption for
proprietary trading in derivatives on
exempt government obligations.
The Agencies believe banking entities
will continue to provide significant
support and liquidity to the U.S.
government and agency security
markets through permitted trading in
the cash exempt government obligations
markets, making markets in government
obligation derivatives and through
derivatives trading for hedging
purposes. The final rule adopts the same
approach as the proposed rule for the
exemption for permitted trading in U.S.
government and U.S. agency
1333 See
1334 See

Barclays; CME Group; JPMC.
Occupy; Alfred Brock.

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obligations. In response to commenters,
the Agencies are clarifying how banking
entities would be permitted to use
Treasury derivatives on Treasury
securities when relying on the
exemptions for market-making related
activities and risk-mitigating hedging
activities. The Agencies agree with
commenters that some Treasury
derivatives are close economic
substitutes for Treasury securities and
provide many of the same economic
exposures.1335 The Agencies also
understand that the markets for
Treasury securities and Treasury futures
are fully integrated, and that trading in
these derivative instruments is essential
to ensuring the continued smooth
functioning of market-making related
activities in Treasury securities.
Treasury derivatives are frequently used
by market makers to hedge their marketmaking related positions across many
different types of fixed-income
securities. Under the final rule, market
makers will generally be able to
continue their practice of using
Treasury futures to hedge their activities
as block positioners off exchanges.
Additionally, when engaging in
permitted market-making related or riskmitigating hedging activities in
accordance with the requirements in
§§ ll.4(b) or ll.(5), the final rule
permits banking entities to acquire a
short or long position in Treasury
futures through manual trading or
automated processes. For example, a
banking entity would be permitted to
use Treasury futures to hedge the
duration risk (i.e., the measure of a
bond’s price sensitivity to interest rates
movements) associated with the banking
entity’s market-making in Treasury
securities or other fixed-income
products, provided that the banking
entity complies with the market-making
requirements in § ll.4(b). In their
market making, banking entities also
frequently trade Treasury futures (and
acquire a corresponding long or short
position) in reasonable anticipation of
the near-term demands of their clients,
customers, and counterparties. For
example, banking entities may acquire a
long or short position in Treasury
futures to hedge anticipated market risk
when they reasonably expect clients,
customers, or counterparties will seek to
establish long or short positions in onor off-the-run Treasury securities.
Similarly, banking entities could
acquire a long or short position in the
‘‘Treasury basis’’ to hedge the
anticipated basis risk associated with
making markets for clients, customers,
or counterparties that are reasonably
1335 See

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Fmt 4701

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expected to engage in basis trading of
the price spread between Treasury
futures and Treasury securities. A
banking entity can also use Treasury
futures (or other derivatives on exempt
government obligations) to hedge other
risks such as the aggregated interest rate
risk for specifically identified loans as
well as other financial instruments such
as asset-backed securities, corporate
bonds, and interest rate swaps.
Therefore, depending on the relevant
facts and circumstances, banking
entities would be permitted to acquire a
very large long or short position in
Treasury derivatives provided that they
comply with the requirements in
§§ ll.4(b) or ll.(5). The Agencies
also understand that banking entities
that have been designated as ‘‘primary
dealers’’ by the Federal Reserve Bank of
New York are required to underwrite
issuances of Treasury securities. This
necessitates the banking entities to
frequently establish very large short
positions in Treasury futures to order to
hedge the duration risk associated with
potentially owning a large volume of
Treasury securities. As described
below,1336 the Agencies note that, with
respect to a banking entity that acts as
a primary dealer for Treasury securities,
the U.S. government will be considered
a client, customer, or counterparty of
the banking entity for purposes of the
market-making exemption.1337 We
believe this interpretation appropriately
captures the unique relationship
between a primary dealer and the
government. Moreover, this
interpretation clarifies that a banking
entity may rely on the market-making
exemption for its activities as primary
dealer to the extent those activities are
outside the scope of the underwriting
exemption.1338
The final rule also includes an
exemption for obligations of or
guaranteed by the United States or an
agency of the United States. An
obligation guaranteed by the U.S. or an
agency of the U.S. is, in effect, an
obligation of the U.S. or that agency.
The final rule also includes an
exemption for an obligation of the FDIC,
or any entity formed by or on behalf of
the FDIC for the purpose of facilitating
the disposal of assets acquired or held
by the FDIC in its corporate capacity or
as conservator or receiver under the
Federal Deposit Insurance Act (‘‘FDI
Act’’) or Title II of the Dodd-Frank
1336 See

infra Part IV.A.3.c.2.c.i.
supra note 905 (explaining the functions
of primary dealers).
1338 See supra Part IV.A.3.c.2.b.ix. (discussing
commenters’ concerns regarding primary dealer
activity, as well as one commenter’s request for
such an interpretation).
1337 See

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
Act.1339 These FDIC receivership and
conservatorship operations are
authorized under the FDI Act and Title
II of the Dodd-Frank Act and are
designed to lower the FDIC’s resolution
costs. The Agencies believe that an
exemption for these types of obligations
would promote and protect the safety
and soundness of banking entities and
the financial stability of the United
States because they facilitate the FDIC’s
ability to conduct receivership and
conservatorship operations in an orderly
manner, thereby limiting risks to the
financial system generally that might
otherwise occur if the FDIC was
restricted in its ability to conduct these
operations.
b. Permitted Trading in Foreign
Government Obligations
The proposed rule did not contain an
exemption for trading in obligations of
foreign sovereign entities. As part of the
proposal, however, the Agencies
specifically requested comment on
whether proprietary trading in the
obligations of foreign governments
would promote and protect the safety
and soundness of banking entities and
the financial stability of the United
States under section 13(d)(1)(J) of the
BHC Act.1340
The treatment of proprietary trading
in foreign sovereign obligations
prompted a significant number of
comments. Many commenters,
including foreign governments, foreign
and domestic banking entities, and
various trade groups, argued that the
final rule should permit trading in
foreign sovereign debt, including
obligations issued by political
subdivisions of foreign governments.1341
Representatives from foreign
governments such as Canada, Germany,
Luxembourg, Japan, Australia, and
Mexico specifically requested an
exemption for trading in obligations of
their governments and argued that an
exemption was necessary and
appropriate to maintain and promote
final rule § ll.6(a)(4).
Joint Proposal, 76 FR 68,878.
1341 See, e.g., Allen & Overy (Gov’t Obligations);
Allen & Overy (Canadian Banks); BoA; Australian
Bankers Ass’n. (Feb. 2012); AFMA; Banco de
Me´xico; Bank of Canada; Ass’n of German Banks;
BAROC; Barclays; BEC (citing the National Institute
of Banking and Finance); British Bankers’ Ass’n.;
BaFin/Deutsche Bundesbank; Chamber (Feb. 2012);
Mexican Banking Comm’n.; French Treasury et al.;
EFAMA; ECOFIN; EBF; French Banking Fed’n.;
FSA (Apr. 2012); FIA; Goldman (Prop. Trading);
HSBC; Hong Kong Inv. Funds Association; IIB/EBF;
ICFR; ICSA; IRSG; Japanese Bankers Ass’n.; Ass’n.
of Banks in Malaysia; OSFI; British Columbia;
Que´bec; Sumitomo Trust; TMA Hong Kong; UBS;
Union Asset.
1339 See

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financial stability in their markets.1342
Some commenters also requested an
exemption for trading in obligations of
multinational central banks, such as
Eurobonds issued or guaranteed by the
European Central Bank.1343
Many commenters argued that the
same rationale for the statutory
exemption for proprietary trading in
U.S. government obligations supported
exempting proprietary trading in foreign
sovereign debt and related
obligations.1344 Commenters contended
that lack of an express exemption for
trading in foreign sovereign obligations
could critically impact the functioning
of money market operations of foreign
central banks and limit the ability of
foreign sovereign governments to
conduct monetary policy or finance
their operations.1345 These commenters
also contended that an exemption for
proprietary trading in foreign sovereign
debt would promote and protect the
safety and soundness and the financial
stability of the United States by
avoiding the possible negative effects of
a contraction of government bond
market liquidity.1346
Commenters also contended that in
some foreign markets, local regulations
or market practice require U.S. banking
entities operating in those jurisdictions
to hold, trade or support government
issuance of local sovereign securities.
They also indicated that these
instruments are traded in the United
States or on U.S. markets.1347 In
addition, a number of commenters
contended that U.S. and foreign banking
entities often perform functions for
1342 See, e.g., Allen & Overy (Gov’t Obligations);
Bank of Canada; British Columbia; Ontario; IIAC;
Quebec; IRSG; IIB/EBF; Mitsubishi; Gov’t of Japan/
Bank of Japan; Australian Bankers Ass’n (Feb.
2012); AFMA; Banco de Me´xico; Ass’n. of German
Banks; ALFI; Embassy of Switzerland.
1343 See Ass’n. of German Banks; Goldman (Prop.
Trading); IIB/EBF; ICFR; FIA; Mitsubishi;
Sumitomo Trust; Allen & Overy (Gov’t Obligations).
1344 See Allen & Overy (Gov’t. Obligations); Banco
de Me´xico; Barclays; BaFIN/Deutsche Bundesbank;
EFAMA; Union Asset; TMA Hong Kong; ICI (Feb.
2012) (arguing that such an exemption would be
consistent with Congressional intent to limit the
extra-territorial application of U.S. law).
1345 See Banco de Me
´ xico; Barclays; BoA; Gov’t of
Japan/Bank of Japan; IIAC; OSFI.
1346 See, e.g., Allen & Overy (Gov’t. Obligations);
AFMA; Banco de Me´xico; Ass’n. of German Banks;
Barclays; Mexican Banking Comm’n.; EFAMA; EBF;
French Banking Fed’n.; Goldman (Prop. Trading);
HSBC; IIB/EBF; HSBC; ICSA; T. Rowe Price; UBS;
Union Asset; IRSG; EBF; Mitsubishi (citing Japanese
Bankers Ass’n. and IIB); Wells Fargo (Prop.
Trading); ICI Global.
1347 See Allen & Overy (Gov’t. Obligations)
(contending that ‘‘even if not primary dealers,
banking entities or their branches or agencies acting
in certain foreign jurisdictions, such as Singapore
and India, are still required to hold or transact in
local sovereign debt under local law’’); BoA;
Barclays; Citigroup; SIFMA et al. (Prop. Trading)
(Feb. 2012).

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5641

foreign governments similar to those
provided in the United States by U.S.
primary dealers and alleged that
restricting these trading activities would
have a significant negative impact on
the ability of foreign governments to
implement their monetary policy and on
liquidity for such securities in many
foreign markets.1348 A few commenters
further argued that banking entities use
foreign sovereign debt, particularly debt
of their home country and of the
country in which they are operating, to
manage their risk by posting sovereign
securities as collateral in foreign
jurisdictions, to manage international
rate and foreign exchange risk
(particularly in local operations), and
for liquidity and asset-liability
management purposes in different
countries.1349 Similarly, commenters
expressed concern that the lack of an
exemption for trading in foreign
government obligations could adversely
interact with other banking regulations,
such as liquidity requirements under
the Basel III capital rules that encourage
financial institutions to hold large
concentrations of sovereign bonds to
match foreign currency denominated
obligations.1350 Commenters also
expressed particular concern that the
limitations and obligations of section 13
of the BHC Act would likely be
problematic and unduly burdensome if
banking entities were able to trade in
foreign sovereign obligations only under
the market making or other proposed
exemptions from the proprietary trading
prohibition.1351 One commenter
expressed the view that lack of an
exemption for proprietary trading in
foreign government obligations together
with the proposed exemption for trading
that occurs solely outside the U.S. may
cause foreign banks to close their U.S.
branches to avoid being subject to
section 13 of the BHC Act and any final
rule thereunder.1352
1348 See Allen & Overy (Gov’t. Obligations);
Australian Bankers Ass’n. (Feb. 2012); BoA; Banco
de Me´xico; Barclays; Citigroup; Goldman (Prop.
Trading); IIB/EBF; See also JPMC (suggesting that,
at a minimum, the Agencies should make clear that
all of a firm’s activities that are necessary or
reasonably incidental to its acting as a primary
dealer in a foreign government’s debt securities are
protected by the market-making-related permitted
activity); SIFMA et al. (Prop. Trading) (Feb. 2012).
As discussed in Parts IV.A.2.c.2.c. and
IV.A.2.c.2.b.ix of this SUPPLEMENTARY INFORMATION,
the Agencies believe primary dealing activities
would generally qualify under the scope of the
market-making or underwriting exemption.
1349 See Citigroup; SIFMA et al. (Prop. Trading)
(Feb. 2012).
1350 See Allen & Overy (Gov’t. Obligations); BoA.
1351 See Barclays; IIAC; UBS; Ass’n. of Banks in
Malaysia; IIB/EBF.
1352 See Comm. on Capital Markets Regulation.

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According to some commenters,
providing an exemption only for
proprietary trading in U.S. government
obligations, without a similar exemption
for foreign government obligations,
would be discriminatory and
inconsistent with longstanding
principles of national treatment and
with U.S. treaty obligations, such as
obligations under the World Trade
Organization framework or bilateral
trade agreements.1353 In addition,
several commenters argued that not
exempting proprietary trading of foreign
sovereign debt may encourage foreign
regulators to enact similar regulations to
the detriment of U.S. financial
institutions operating abroad.1354
However, another commenter disagreed
that the failure to exempt trading in
foreign government obligations would
violate trade agreements or that the
proposal discriminated in any way
against foreign banking entities’ ability
to compete with U.S. banking entities in
the U.S.1355
Based on these concerns, some
commenters suggested that the Agencies
exempt proprietary trading by foreign
banking entities in obligations of their
home or host country.1356 Other
commenters suggested allowing trading
in foreign government obligations that
meet some condition on quality (e.g.,
OECD-member country obligations,
government bonds eligible as collateral
for Federal Reserve advances, sovereign
bonds issued by G–20 countries, or
other highly liquid or rated
instruments).1357 One commenter
indicated that in their view, provided
appropriate risk-management
procedures are followed, investing in
non-U.S. government securities is as
low risk as investing in U.S. government
securities despite current price volatility
in certain types of sovereign debt.1358
Some commenters also suggested the
final rule give deference to home
country regulation and permit foreign
banking entities to engage in proprietary
trading in any government obligation to
1353 See Allen & Overy (Gov’t. Obligations); Banco
de Me´xico; IIB/EBF; Ass’n. of Banks in Malaysia.
1354 See Sumitomo Trust; SIFMA et al. (Prop.
Trading) (Feb. 2012); Allen & Overy (Govt.
Obligations); BoA; ICI Global; RBC; ICFR; ICI (Feb.
2012); Bank of Canada; Cadwalader (on behalf of
Singapore Banks); Ass’n. of Banks in Malaysia;
Cadwalader (on behalf of Thai Banks); Chamber
(Feb. 2012); BAROC. See also IIB/EBF.
1355 See Sens. Merkley &Levin (Feb. 2012).
1356 See Cadwalader (on behalf of Thai Banks);
IIB/EBF; Ass’n. of Banks in Malaysia; UBS; See also
BAROC.
1357 See BoA; Cadwalader (on behalf of Singapore
Banks); IIB/EBF; Norinchukin; OSFI; Cadwalader
(on behalf of Thai Banks); Ass’n. of Banks in
Malaysia; UBS; See also BAROC; ICFR; Japanese
Bankers Ass’n.; JPMC; Que´bec.
1358 See, e.g., Allen & Overy (Gov’t Obligations).

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the extent that such trading is permitted
by the entity’s primary regulator.1359
By contrast, other commenters argued
that proprietary trading in foreign
sovereign obligations represents a risky
activity and that there is no effective
way to draw the line between safe and
unsafe foreign debt.1360 Two of these
commenters pointed to several publicly
reported instances where proprietary
trading in foreign sovereign obligations
resulted in significant losses to certain
firms. These commenters argued that
restricting proprietary trading in foreign
sovereign debt would not cause reduced
liquidity in government bond markets
since banking entities would still be
permitted to make a market in and
underwrite foreign government
obligations.1361 A few commenters
suggested that, if the final rule
exempted proprietary trading in foreign
sovereign debt, foreign governments
should commit to pay for any damage to
the U.S. financial system related to
proprietary trading in their obligations
pursuant to such exemption.1362
The Agencies carefully considered all
the comments related to proprietary
trading in foreign sovereign debt in light
of the language, purpose and standards
for exempting activity contained in
section 13 of the BHC Act. Under
section 13(d)(1)(J), the Agencies may
grant an exemption from the
prohibitions of the section for any
activity that the Agencies determine
would promote and protect the safety
and soundness of the banking entity and
the financial stability of the United
States.
The Agencies note as an initial matter
that section 13 permits banking
entities—both inside the United States
and outside the United States—to make
markets in and to underwrite all types
of securities, including all types of
foreign sovereign debt. The final rule
implements the statutory market-making
and underwriting exemptions, and thus,
the key role of banking entities in
facilitating trading and liquidity in
foreign government debt through
market-making and underwriting is
maintained. This includes underwriting
and marketmaking as a primary dealer
in foreign sovereign obligations.
Banking entities may also hold foreign
sovereign debt in their long-term
investment book. In addition, the final
rule does not prevent foreign banking
entities from engaging in proprietary
1359 See Allen & Overy (Gov’t. Obligations);
HSBC.
1360 See Better Markets (Feb. 2012); Occupy; Prof.
Johnson; Sens. Merkley & Levin (Feb. 2012).
1361 See Prof. Johnson; Better Markets (Feb. 2012).
1362 See Better Markets (Feb. 2012); See also Prof.
Johnson.

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trading outside of the United States in
any type of sovereign debt.1363
Moreover, the Agencies continue to
believe that positions, including
positions in foreign government
obligations, acquired or taken for the
bona fide purpose of liquidity
management and in accordance with a
documented liquidity management plan
that is consistent with the relevant
Agency’s supervisory requirements,
guidance and expectations regarding
liquidity management are not covered
by the prohibitions in section 13.1364
The final rule continues to incorporate
this view.1365
The issue raised by commenters,
therefore, is the extent to which
proprietary trading in foreign sovereign
obligations by U.S. banking entities
anywhere in the world and by foreign
banking entities in the United States is
consistent with promoting and
protecting the safety and soundness of
the banking entity and the financial
stability of the United States. Taking
into account the information provided
by commenters, the Agencies’
understanding of market operations, and
the purpose and language of section 13,
the Agencies have determined to grant
a limited exemption to the prohibition
on proprietary trading for trading in
foreign sovereign obligations under
certain circumstances.
This exemption, which is contained
in § ll.6(b) of the final rule, permits
the U.S. operations of foreign banking
entities to engage in proprietary trading
in the United States in the foreign
sovereign debt of the foreign sovereign
under whose laws the banking entity—
or the banking entity that controls it—
is organized (hereinafter, the ‘‘home
country’’), and any multinational central
bank of which the foreign sovereign is
a member so long as the purchase or
sale as principal is not made by an
insured depository institution.1366
final rule § ll.6(e).
Joint Proposal, 76 FR 68,862.
1365 See final rule § ll.3(d)(3).
1366 See final rule § ll.6(b). Some commenters
requested an exemption for trading in obligations of
multinational central banks. See Ass’n. of German
Banks; Goldman (Prop. Trading); IIB/EBF; ICFR;
FIA; Mitsubishi; Sumitomo Trust; Allen & Overy
(Gov’t. Obligations). In the case of a foreign banking
entity that is owned or controlled by a second
foreign banking entity domiciled in a country other
than the home country of the first foreign banking
entity, the final rule would permit the eligible U.S.
operations of the first foreign banking entity to
engage in proprietary trading only in the sovereign
debt of the first foreign banking entity’s home
country, and would permit the U.S. operations of
the second foreign banking entity to engage in
proprietary trading only in the sovereign debt of the
home country of the second foreign banking entity.
As noted earlier, other provisions of the final rule
make clear that the rule does not restrict the
proprietary trading outside of the United States of
1363 See
1364 See

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Similar to the exemption for proprietary
trading in U.S. government obligations,
the permitted trading activity in the U.S.
by the eligible U.S. operations of a
foreign banking entity would extend to
obligations of political subdivisions of
the foreign banking entity’s home
country.1367
Permitting the eligible U.S. operations
of a foreign banking entity to engage in
proprietary trading in the United States
in the foreign sovereign obligations of
the foreign entity’s home country allows
these U.S. operations of foreign banking
entities to continue to support the
smooth functioning of markets in
foreign sovereign obligations in the
same manner as U.S. banking entities
are permitted to support the smooth
functioning of markets in U.S.
government and agency obligations.1368
At the same time, the risk of these
trading activities is largely determined
by the foreign sovereign that charters
the foreign bank. By not permitting
proprietary trading in foreign sovereign
debt in insured depository institutions
(other than in accordance with the
limitations in other exemptions), the
exemption limits the direct risks of
these activities to insured depository
institutions in keeping with the
statute.1369 Thus, the Agencies have
determined that this limited exemption
for proprietary trading in foreign
sovereign obligations promotes and
protects the safety and soundness of
banking entities and also promotes and
protects the financial stability of the
United States.
The Agencies have also determined to
permit a foreign bank or foreign brokereither foreign banking organization in debt of any
foreign sovereign.
1367 See Part IV.A.5.c., infra. Many commenters
requested an exemption for trading in foreign
sovereign debt, including obligations issued by
political subdivisions of foreign governments. See,
e.g., Allen & Overy (Gov’t. Obligations); BoA;
Australian Bankers Ass’n. (Feb. 2012); Banco de
Me´xico; Bank of Canada; Ass’n. of German Banks;
BAROC; Barclays.
1368 As part of this exemption, for example, the
U.S. operations of a European bank would be able
to trade in obligations issued by the European
Central Bank. Many commenters represented that
the same rationale for exempting trading in U.S.
government obligations supports exempting trading
in foreign sovereign debt. See, e.g., Allen & Overy
(Gov’t. Obligations); Banco de Me´xico; Barclays;
EFAMA; ICI (Feb. 2012).
1369 The Agencies believe this approach
appropriately balances commenter concerns that
proprietary trading in foreign sovereign obligations
represents a risky activity and the interest in
preserving the ability of U.S. operations of foreign
banking entities to continue to support the smooth
functioning of markets in foreign sovereign
obligations in the same manner as U.S. banking
entities are permitted to support the smooth
functioning of markets in U.S. government and
agency obligations. See Better Markets (Feb. 2012);
Occupy; Prof. Johnson; Sens. Merkley & Levin
(Feb. 2012).

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dealer regulated as a securities dealer
and controlled by a U.S. banking entity
to engage in proprietary trading in the
obligations of the foreign sovereign
under whose laws the foreign entity is
organized (hereinafter, the ‘‘home
country’’), including obligations of an
agency or political subdivision of that
foreign sovereign.1370 This limited
exemption is necessary to allow U.S.
banking organizations to continue to
own and acquire foreign banking
organizations and broker-dealers
without requiring those foreign banking
organizations and broker-dealers to
discontinue proprietary trading in the
sovereign debt of the foreign banking
entity’s home country.1371 The Agencies
have determined that this limited
exemption will promote the safety and
soundness of banking entities and the
financial stability of the United States
by allowing U.S. banking entities to
continue to be affiliated with and
operate foreign banking entities and
benefit from international
diversification and participation in
global financial markets.1372 However,
the Agencies intend to monitor activity
of banking entities under this exemption
to ensure that U.S. banking entities are
not seeking to evade the restrictions of
section 13 by using an affiliated foreign
bank or broker-dealer to engage in
proprietary trading in foreign sovereign
debt on behalf of or for the benefit of
other parts of the U.S. banking entity.
Apart from this limited exemption,
the Agencies have not extended this
exemption to proprietary trading in
foreign sovereign debt by U.S. banking
entities for several reasons. First, section
13 was primarily concerned with the
risks posed to the U.S. financial system
by proprietary trading activities. This
risk is most directly transmitted by U.S.
banking entities, and while commenters
alleged that prohibiting U.S. banking
entities from engaging in proprietary
final rule § ll.6(c). Many commenters
requested an exemption for trading in foreign
sovereign debt, and some commenters suggested
exempting proprietary trading by foreign banking
entities in obligations of their home country. See,
e.g., Allen & Overy (Gov’t. Obligations); BoA; FSA
(Apr. 2012); Cadwalader (on behalf of Thai Banks);
IIB/EBF; Ass’n. of Banks in Malaysia; UBS.
1371 Commenters argued that in some foreign
markets, U.S. banks operating in those jurisdictions
are required by local regulation or market practice
to trade in local sovereign securities. See, e.g., Allen
& Overy (Gov’t. Obligations); AFMA; Ass’n. of
German Banks; Barclays; EBF; Goldman (Prop.
Trading); UBS.
1372 Some commenters represented that the
limitations and obligations of section 13 would be
problematic and unduly burdensome on banking
entities because they would only be able to trade
in foreign sovereign obligations under existing
exemptions, such as the market-making exemption.
See Barclays; IIAC; UBS; Ass’n. of Banks in
Malaysia; IIB/EBF.
1370 See

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5643

trading in debt of foreign sovereigns
would harm liquidity in those markets,
the evidence provided by commenters
did not sufficiently indicate that
permitting U.S. banking entities to
engage in proprietary trading (as
opposed to market-making or
underwriting) in debt of foreign
sovereigns contributed in any
significant degree to the liquidity of
markets in foreign sovereign
instruments.1373 Thus, expanding the
exemption to permit U.S. banking
entities to engage in proprietary trading
in debt of foreign sovereigns would
likely increase the risks to these entities
and the U.S. financial system without a
significant concomitant and offsetting
benefit. As explained above, these U.S.
entities are permitted by the final rule
to continue to engage fully in marketmaking in and underwriting of debt of
foreign sovereigns anywhere in the
world. The only restriction placed on
these entities is on the otherwise
impermissible proprietary trading in
these instruments 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.
The Agencies recognize that,
depending on the extent to which
banking entities subject to the rule have
contributed to the liquidity of trading
markets for foreign sovereign debt, the
lack of an exemption for proprietary
trading in foreign sovereign debt could
result in certain negative impacts on the
markets for such debt. In general, the
Agencies believe these concerns should
be mitigated somewhat by the refined
exemptions for market making,
underwriting and permitted trading
activity of foreign banking entities;
however, those exemptions do not
address certain of the collateral, capital,
and other operational issues identified
by commenters.1374 Foreign sovereign
1373 See, e.g., BoA; Citigroup; Goldman (Prop.
Trading); IIB/EBF; Allen & Overy (Gov’t.
Obligations); Australian Bankers Ass’n. (Feb. 2012).;
Banco de Me´xico; Barclays. The Agencies recognize
some commenters’ representation that restricting
trading in foreign sovereign debt would not
necessarily cause reduced liquidity in government
bond markets because banking entities would still
be able to make a market in and underwrite foreign
government obligations. See Prof. Johnson; Better
Markets (Feb. 2012).
1374 Representatives from foreign governments
stated that an exemption allowing trading in
obligations of their governments is necessary to
maintain financial stability in their markets. See,
e.g., Allen & Overy (Gov’t. Obligations); Bank of
Canada; IRSG; IIB/EBF; Gov’t of Japan/Bank of
Japan; Australian Bankers Ass’n. (Feb. 2012); Banco
de Me´xico; Ass’n. of German Banks; ALFI.
Commenters argued that exempting trading in
foreign sovereign debt would avoid the possible
negative impacts of a contraction of government
bond market liquidity. See, e.g., BoA; Citigroup;

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debt of home and host countries
generally serves these purposes. Due to
the relationships among global financial
markets, permitting trading that
supports these essential functions
promotes the financial stability and the
safety and soundness of banking
entities.1375 In contrast, a broad
exemption for proprietary trading in all
foreign sovereign debt without the
limitations contained in the
underwriting, market making and
hedging exemptions could lead to more
complicated risk profiles and significant
unhedged risk exposures that section 13
of the BHC Act is designed to address.
Thus, the Agencies believe use of
section 13(d)(1)(J) exemptive authority
to permit proprietary trading in foreign
government obligations in certain
limited circumstances is appropriate.
The Agencies decline to follow
commenters’ suggested alternative of
allowing trading in foreign government
obligations if the obligations meet a
particular condition on quality, such as
obligations of OECD member
countries.1376 The Agencies do not
believe such an approach responds to
the statutory purpose of limiting risks
posed to the U.S. financial system by
Goldman (Feb. 2012); IIB/EBF. Additionally,
commenters suggested that failing to provide an
exemption for this activity would impact money
market operations of foreign central banks and limit
the ability of foreign sovereign governments to
conduct monetary policy or finance their
operations. See, e.g., Barclays; BoA; Gov’t of Japan/
Bank of Japan; OSFI. A number of commenters also
argued that, since U.S. and foreign banking entities
often perform functions for foreign governments
similar to those provided in the U.S. by U.S.
primary dealers, the lack of an exemption would
have a significant, negative impact on the ability of
foreign governments to implement monetary policy
and on liquidity in many foreign markets. See, e.g.,
Allen & Overy (Gov’t. Obligations); Australian
Bankers Ass’n. (Feb. 2012); BoA; Banco de Me´xico;
Barclays; Citigroup (Feb. 2012); Goldman (Prop.
Trading); IIB/EBF. Some commenters argued that
banking entities and their customers use foreign
sovereign debt to manage their risk by posting
collateral in foreign jurisdictions and to manage
international rate and foreign exchange risk. See
Citigroup (Feb. 2012); SIFMA et al. (Prop. Trading)
(Feb. 2012).
1375 The Agencies generally concur with
commenters’ concerns that because the lack of an
exemption could result in negative consequences—
such as harming liquidity in foreign sovereign debt
markets, making it more difficult and more costly
for foreign governments to fund themselves, or
subjecting banking entities to increased
concentration risk—systemic risk could increase or
there could be spillover effects that would harm
global markets, including U.S. markets. See IIF;
EBF; ICI Global; HSBC; Barclays; ICI (Feb. 2012);
IIB/EBF; Union Asset. Additionally, in
consideration of one commenter’s statements, the
Agencies believe that failing to provide this
exemption may cause foreign banks to close their
U.S. branches, which could harm U.S. markets. See
Comm. on Capital Markets Regulation.
1376 See, e.g., BoA; Cadwalader (on behalf of
Singapore Banks).; IIB/EBF; OSFI; UBS; BAROC;
Japanese Bankers Ass’n.; JPMC.

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proprietary trading activities as directly
as our current approach, which is
structured to limit the exposure of
banking entities, including insured
depository institutions, to the risks of
foreign sovereign debt. Additionally, the
Agencies decline to permit proprietary
trading in any obligation permitted
under the laws of the foreign banking
entity’s home country,1377 because such
an approach could result in unintended
competitive impacts since banking
entities would not be subject to one
uniform standard inside the United
States. Further, unlike some
commenters, the Agencies do not
believe it is appropriate to require
foreign governments to commit to
paying for any damage to the U.S.
financial system resulting from the
foreign sovereign debt exemption.1378
The proposal also did not contain an
exemption for trading in derivatives on
foreign government obligations. Many
commenters who recommended
providing an exemption for proprietary
trading in foreign government
obligations also requested that the
exemption be extended to derivatives on
foreign government obligations.1379 Two
of these commenters urged that trading
in derivatives on foreign sovereign
obligations should be exempt for the
same reason that trading in derivatives
on U.S. government obligations is
exempt because such trading supports
liquidity and price stability in the
market for the underlying government
obligations.1380 One commenter
recommended that the Agencies use the
authority in section 13(d)(1)(J) to grant
an exemption for proprietary trading in
derivatives on foreign government
obligations.1381
The final rule has not been modified
in § ll.6(b) to permit a banking entity
to engage in proprietary trading in
derivatives on foreign government
obligations. As noted above, the
Agencies have determined not to permit
proprietary trading in derivatives on
U.S. exempt government obligations
under section 13(d) and, for the same
reasons, have determined not to extend
the permitted activities to include
proprietary trading in derivatives on
foreign government obligations.
1377 Some commenters suggested permitting nonU.S. banking entities to trade in any government
obligation to the extent that such trading is
permitted by the entity’s primary regulator. See
Allen & Overy (Gov’t. Obligations); HSBC.
1378 See Better Markets (Feb. 2012); See also Prof.
Johnson.
1379 See Barclays; Credit Suisse (Seidel); IIB/EBF;
Japanese Bankers Ass’n.; Norinchukin; RBC;
Sumitomo Trust; UBS.
1380 See Barclays; FIA.
1381 See Barclays.

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c. Permitted Trading in Municipal
Securities
Section ll.6(a) of the proposed rule
implemented an exemption to the
prohibition against proprietary trading
under section 13(d)(1)(A) of the BHC
Act, which permits trading in certain
governmental obligations. This
exemption permits the purchase or sale
of obligations issued by any State or any
political subdivision thereof (the
‘‘municipal securities trading
exemption’’). The proposed rule
included both general obligation bonds
and limited obligation bonds, such as
revenue bonds, within the scope of this
municipal securities trading exemption.
The proposed rule, however, did not
extend to obligations of ‘‘agencies’’ of
States or political subdivisions
thereof.1382
Many commenters, including industry
participants, trade groups, and Federal
and state governmental representatives,
argued that the municipal securities
trading exemption should be interpreted
to permit banking entities to engage in
proprietary trading in a broader range of
municipal securities, including the
following: Obligations issued directly by
States and political subdivisions
thereof; obligations issued by agencies,
constituted authorities, and similar
governmental entities acting as
instrumentalities on behalf of States and
political subdivisions thereof; and
obligations issued by such governmental
entities that are treated as political
subdivisions under various more
expansive definitions of political
subdivisions under Federal and state
laws.1383 These commenters argued that
States and municipalities often issue
obligations through agencies and
instrumentalities and that these
obligations generally have the same
level of risk as direct obligations of
States and political subdivisions.1384
Commenters asserted that permitting
trading in a broader group of municipal
securities would be consistent with the
1382 See

Joint Proposal, 76 FR 68,878 n.165.
e.g., ABA (Keating); Ashurst; Ass’n. of
Institutional Investors (Feb. 2012); BoA; BDA (Feb.
2012); Capital Group; Chamber (Feb. 2012);
Citigroup (Jan. 2012); CHFA; Eaton Vance; Fidelity;
Fixed Income Forum/Credit Roundtable; HSBC;
MEFA; Nuveen Asset Mgmt.; Sens. Merkley & Levin
(Feb. 2012); Am. Pub. Power et al.; MSRB; Fidelity;
State of New York; STANY; SIFMA (Municipal
Securities) (Feb. 2012); State Street (Feb. 2012);
North Carolina; T. Rowe Price; Sumitomo Trust;
UBS; Washington State Treasurer; Wells Fargo
(Prop. Trading).
1384 See, e.g., CHFA; Sens. Merkley & Levin (Feb.
2012); Am. Pub. Power et al.; North Carolina;
Washington State Treasurer; See also NABL;
Ashurst; BDA (Feb. 2012); Chamber (Feb. 2012);
Eaton Vance; Fidelity; MEFA; MSRB; Am. Pub.
Power et al.; Nuveen Asset Mgmt.; PNC; SIFMA
(Municipal Securities) (Feb. 2012); UBS.
1383 See,

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terms and purposes of section 13 and
would not adversely affect the safety
and soundness of banking entities
involved in these transactions or create
additional risk to the financial stability
of the United States.1385
Commenters expressed concerns that
the proposed rule would result in a
bifurcation of the municipal securities
market that would achieve no
meaningful benefits to the safety and
soundness of banking entities, create
administrative burdens for determining
whether or not a municipal security
qualifies for the exemption, result in
inconsistent applications across
different States, increase costs, and
decrease liquidity in the diverse
municipal securities market.1386
Commenters also argued that the market
for securities issued by agencies and
instrumentalities of States and political
subdivisions thereof would be
especially disrupted, and would affect
about 40 percent of the municipal
securities market.1387
Commenters recommended that the
final rule provide a broad exemption to
the prohibition on proprietary trading
for municipal securities, based on the
definition of ‘‘municipal securities’’
used in section 3(a)(29) of the Exchange
Act,1388 which is understood by market
participants and by Congress, and has a
well-settled meaning and an established
body of law. 1389 Other commenters

contended that adopting the same
definition of municipal securities as
used in the Federal securities laws
would reduce regulatory burden,
remove uncertainty, and lead to
consistent treatment of these securities
under the banking and securities
laws.1390 According to some
commenters, the terms ‘‘agency’’ and
‘‘political subdivision’’ are used
differently under some State laws, and
some State laws identify certain
agencies as political subdivisions or
define political subdivision to include
agencies.1391 Commenters also noted
that a number of Federal statutes and
regulations define the term ‘‘political
subdivision’’ to include municipal
agencies and instrumentalities.1392
Commenters suggested that the
Agencies interpret the term ‘‘political
subdivision’’ in section 13 more broadly
than in the proposal to include a wider
range of State and municipal
governmental obligations issued by
agencies and instrumentalities or,
alternatively, that the Agencies use the
exemptive authority in section
13(d)(1)(J) if necessary to permit
proprietary trading of a broader array of
State and municipal obligations.1393
On the other hand, one commenter
contended that bonds issued by
agencies and instrumentalities of States
or municipalities pose risks to the
banking system because the commenter

1385 See Ashurst; Citigroup (Jan. 2012); Eaton
Vance; Am. Pub. Power et al.; SIFMA (Municipal
Securities) (Feb. 2012); North Carolina; T. Rowe
Price; Wells Fargo (Prop. Trading); See also Capital
Group (arguing that municipal securities are not
generally used as a profit making strategy and thus,
including all municipal securities in the exemption
by itself should not adversely affect the safety and
soundness of banking entities); PNC (arguing that
the safe and sound nature of trading in State and
municipal agency obligations was ‘‘a fact
recognized by Congress in 1999 when it authorized
well capitalized national banks to underwrite and
deal in, without limit, general obligation, limited
obligation and revenue bonds issued by or on behalf
of any State, or any public agency or authority of
any State or political subdivision of a State’’); Sens.
Merkley & Levin (Feb. 2012).
1386 See, e.g., MSRB; City of New York; Am. Pub.
Power et al.; Wells Fargo; State of New York;
Washington State Treasurer; ABA (Keating); Capital
Group; North Carolina; Eaton Vance; Port
Authority; Connecticut; Citigroup (Jan. 2012);
Ashurst; Nuveen Asset Mgmt.; SIFMA (Municipal
Securities) (Feb. 2012).
1387 See, e.g., MSRB (stating that, based on data
from Thomson Reuters, 41.4 percent of the
municipal securities issued in FY 2011 were issued
by agencies and authorities).
1388 See 15 U.S.C. 78c(a)(29).
1389 See ABA (Keating); Ashurst; BoA; Capital
Group; Chamber (Feb. 2012); Comm. on Capital
Markets Regulation; Citigroup (Jan. 2012); Eaton
Vance; Fidelity; MEFA; MTA–NY; MSRB; Am. Pub.
Power et al.; NABL; NCSL; State of New York;
Nuveen Asset Mgmt.; Port Authority; PNC; SIFMA
(Municipal Securities) (Feb. 2012); North Carolina;
T. Rowe Price; UBS; Washington State Treasurer;
Wells Fargo (Prop. Trading).

1390 See Ashurst; Citigroup (Jan. 2012) (noting
that the National Bank Act explicitly lists State
agencies and authorities as examples of political
subdivisions); MSRB.
1391 See, e.g., Citigroup (Jan. 2012).
1392 See, e.g., MSRB; Citigroup (Jan. 2012). In
addition to the Federal securities laws, the National
Bank Act explicitly includes agencies and
authorities as examples of political subdivisions.
See 12 U.S.C. 24(seventh) (permitting investments
in securities ‘‘issued by or on behalf of any State
or political subdivision of a State, including any
municipal corporate instrumentality of 1 or more
States, or any public agency or authority of any
State or political subdivision of a State . . . .’’). In
addition, a number of banking regulations also
include agencies as examples of political
subdivisions or define political subdivision to
include municipal agencies, authorities, districts,
municipal corporations and similar entities. See,
e.g., 12 CFR 1.2; 12 CFR 160.30; 12 CFR 161.38; 12
CFR 330.15. Further, for purposes of the tax-exempt
bond provisions in the Internal Revenue Code,
Treasury regulations treat obligations issued by or
‘‘on behalf of’’ States or political subdivisions by
‘‘constituted authorities’’ as obligations of such
States or political subdivisions, and the Treasury
regulations define the term ‘‘political subdivision’’
to mean ‘‘any division of any State or local
governmental unit which is a municipal
corporation or which has been delegated the right
to exercise part of the sovereign power of the
unit. . . .’’ See 26 CFR 1.103–1(b).
1393 See ABA (Keating); Ashurst; Ass’n. of
Institutional Investors (Feb. 2012); Citigroup (Jan.
2012); Comm. on Capital Markets Regulation; Sens.
Merkley & Levin (Feb. 2012); MSRB; Wells Fargo
(Prop. Trading); SIFMA et al. (Prop. Trading) (Feb.
2012).

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5645

believed the market for these bonds has
not been properly regulated or
controlled.1394 A few commenters also
recommended tightening the proposed
municipal securities trading exemption
to exclude conduit obligations that
benefit private businesses and private
organizations.1395 One commenter
suggested that the proposed municipal
securities trading exemption should not
apply to tax-exempt municipal bonds
that benefit private businesses (referred
to as ‘‘private activity bonds’’ in the
Internal Revenue Code1396) and that
allow private businesses to finance
private projects at lower interest rates as
a result of the exemption from Federal
income taxation for the interest received
by investors.1397
The final rule includes the statutory
exemption for proprietary trading of
obligations of any State or political
subdivision thereof.1398 In response to
the public comments and for the reasons
discussed below, this exemption uses
the definition of the term ‘‘municipal
security’’ modeled after the definition of
‘‘municipal securities’’ under section
3(a)(29) of the Exchange Act,1399 but
1394 See

Occupy.
AFR et al. (Feb. 2012); Occupy.
1396 See 26 U.S.C. 141. In general, the rules
applicable to the issuance of tax-exempt private
activity bonds under the Internal Revenue Code of
1986, as amended (the ‘‘Code’’) are more restrictive
than those applicable to traditional governmental
bonds issued by States or political subdivisions
thereof. Section 146 of the Code imposes an annual
State bond volume cap on most tax-exempt private
activity bonds that is tied to measures of State
populations. Sections 141–150 of the Code impose
other additional restrictions on tax-exempt private
activity bonds, including, among others, eligible
project and use restrictions, bond maturity
restrictions, land and existing property financing
restrictions, an advance refunding prohibition, and
a public approval requirement.
1397 See AFR et al. (Feb. 2012).
1398 See final rule § __.6(a)(3).
1399 Many commenters requested that the final
rule use the definition of ‘‘municipal securities’’
used in the federal securities laws because, among
other reasons, the industry is familiar with that
definition and such an approach would promote
consistent treatment of these securities under
banking and securities laws. See, e.g., ABA
(Keating); Ashurst; BoA; Comm. on Capital Markets
Regulation; Citigroup (Jan. 2012); NCSL; Port
Authority; SIFMA (Municipal Securities) (Feb.
2012); MSRB. Section 3(a)(29) of the Exchange Act
defines the term ‘‘municipal securities’’ to mean
‘‘securities which are direct obligations of, or
obligations guaranteed as to principal or interest by,
a State or any political subdivision thereof, or any
agency or instrumentality of a State or any political
subdivision thereof, or any municipal corporate
instrumentality of one or more States, or any
security which is an industrial development bond
(as defined in section 103(c)(2) of Title 26) the
interest on which is excludable from gross income
under section 103(a)(1) of Title 26 if, by reason of
the application of paragraph (4) or (6) of section
103(c) of Title 26 (determined as if paragraphs
(4)(A), (5), and (7) were not included in such
section 103(c)), paragraph (1) of such section 103(c)
1395 See

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with simplifications.1400 The final rule
defines the term ‘‘municipal security’’ to
mean ‘‘a security which is a direct
obligation of or issued by, or an
obligation guaranteed as to principal or
interest by, a State or any political
subdivision thereof, or any agency or
instrumentality of a State or any
political subdivision thereof, or any
municipal corporate instrumentality of
one or more States or political
subdivisions thereof.’’
The final rule modifies the proposal
to permit proprietary trading in
obligations issued by agencies and
instrumentalities acting on behalf of
States and municipalities (e.g., port
authority bonds and bonds issued by
municipal agencies or corporations).1401
As noted by commenters, many States
and municipalities rely on securities
issued by agencies and instrumentalities
to fund essential activities, including
utility systems, infrastructure projects,
affordable housing, hospitals,
universities, and other nonprofit
institutions.1402 Both obligations issued
directly by States and political
subdivisions thereof and obligations
issued by an agency or instrumentality
of such a State or local governmental
entity are ultimately obligations of the
State or local governmental entity on
whose behalf they act. Moreover,
exempting obligations issued by State
does not apply to such security.’’ See 15 U.S.C.
78c(a)(29).
1400 The definition of municipal securities in
section 3(a)(29) of the Exchange Act has outdated
tax references to the prior law under the former
Internal Revenue Code of 1954, including
particularly references to certain provisions
involving the concept of ‘‘industrial development
bonds.’’ The successor current Internal Revenue
Code of 1986, as amended, replaces the prior
definition of ‘‘industrial development bonds’’ with
a revised, more restrictive successor definition of
‘‘private activity bonds’’ and related definitions of
‘‘exempt facility bonds’’ and ‘‘small issue bonds.’’
In recognition of the numerous tax law changes
since the last statutory revision of section 3(a)(29)
of the Exchange Act in 1970 and the potential
attendant confusion, the Agencies determined to
use a simpler, streamlined, independent definition
of municipal securities for purposes of the
municipal securities trading exception. This revised
definition is intended to encompass, among others,
any securities that are covered by the definition of
the term ‘‘municipal securities’’ under section
3(a)(29) of the Exchange Act.
1401 Many commenters requested that the
municipal securities trading exemption be
interpreted to include a broader range of State and
municipal obligations issued by agencies and
instrumentalities. See, e.g., ABA (Keating); Ashurst;
BoA; BDA (Feb. 2012); Fixed Income Forum/Credit
Roundtable; Sens. Merkley & Levin (Feb. 2012);
SIFMA (Municipal Securities) (Feb. 2012);
Citigroup (Jan. 2012); Comm. on Capital Markets
Regulation.
1402 See, e.g., Citigroup (Jan. 2012); Ashurst;
SIFMA et al. (Prop. Trading) (Feb. 2012); SIFMA
(Municipal Securities) (Feb. 2012); Chamber (Dec.
2011); BlackRock; Fixed Income Forum/Credit
Roundtable.

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and municipal agencies and
instrumentalities in the same manner as
the direct obligations of States and
municipalities lessens potential
inconsistent treatment of government
obligations across States and
municipalities that use different funding
methods for government projects.1403
The Agencies believe that interpreting
the language of section 13(d)(1)(A) of
the BHC Act to provide an exemption to
the prohibition on proprietary trading
for obligations issued by States and
municipal agencies and
instrumentalities as described above is
consistent with the terms and purposes
of section 13 of the BHC Act.1404 The
Agencies recognize that state and
political subdivision agency obligations
generally present the same level of risk
as direct obligations of States and
political subdivisions.1405 Moreover, the
Agencies recognize that other federal
laws and regulations define the term
‘‘political subdivision’’ to include
municipal agencies and
instrumentalities.1406 The Agencies
decline to exclude from this exemption
conduit obligations that benefit private
entities, as suggested by some
commenters.1407
1403 Commenters represented that the proposed
rule would result in inconsistent applications of the
exemption across States and political subdivisions.
The Agencies also recognize, as noted by
commenters, that the proposed rule would likely
have resulted in a bifurcation of the municipal
securities market and associated administrative
burdens and disruptions. See, e.g., MSRB; Am. Pub.
Power et al.; Port Authority; Citigroup (Jan. 2012);
SIFMA et al. (Prop. Trading) (Feb. 2012); SIFMA
(Municipal Securities) (Feb. 2012).
1404 Commenters asserted that permitting trading
in a broader group of municipal securities would
be consistent with the terms and purposes of
section 13. See, e.g., Ashurst; Citigroup (Jan. 2012);
Eaton Vance; Am. Pub. Power et al.; SIFMA
(Municipal Securities) (Feb. 2012).
1405 Commenters argued that obligations issued
by agencies and instrumentalities generally have
the same level of risk as direct obligations of States
and political subdivisions. See, e.g., CHFA; Sens.
Merkley & Levin (Feb. 2012); Am. Pub. Power et al.;
North Carolina. In response to one commenter’s
concern that the markets for bonds issued by
agencies and instrumentalities are not properly
regulated, the Agencies note that all types of
municipal securities, as defined under the
securities laws to include, among others, State
direct obligation bonds and agency or
instrumentality bonds, are generally subject to the
same regulations under the securities laws. Thus,
the Agencies do not believe that obligations of
agencies and instrumentalities are subject to less
effective regulation than obligations of States and
political subdivisions. See Occupy.
1406 Commenters noted that a number of federal
statutes and regulations define ‘‘political
subdivision’’ to include municipal agencies and
instrumentalities. See, e.g., MSRB; Citigroup (Jan.
2012).
1407 See AFR et al. (Feb. 2012); Occupy. The
Agencies do not believe it is appropriate to exclude
conduit obligations, which are tax-exempt
municipal bonds, from this exemption because such
obligations are used to finance important projects

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The proposal did not exempt
proprietary trading of derivatives on
obligations of States and political
subdivisions. The proposal solicited
comment on whether exempting
proprietary trading in options or other
derivatives referencing an obligation of
a State or political subdivision thereof
was consistent with the terms and
purpose of the statute.1408 The Agencies
did not receive persuasive information
on this topic and, for the same reasons
discussed above related to derivatives
on U.S. government securities, the
Agencies have determined not to
provide an exemption for proprietary
trading in municipal securities, beyond
the underwriting, market-making,
hedging and other exemptions provided
generally in the rule. The Agencies note
that banking entities may trade
derivatives on municipal securities
under any other available exemption to
the prohibition on proprietary trading,
providing the requirements of the
relevant exemption are met.
d. Determination to Not Exempt
Proprietary Trading in Multilateral
Development Bank Obligations
The proposal did not exempt
proprietary trading in obligations of
multilateral banks or derivatives on
multilateral development bank
obligations but requested comment on
this issue.1409 A number of commenters
argued that the final rule should include
an exemption for obligations of
multilateral development banks.1410
The Agencies have not included an
exemption to permit banking entities to
engage in proprietary trading in
obligations of multilateral development
banks at this time. The Agencies do not
believe that providing an exemption for
related to, for example, multi-family housing,
healthcare (hospitals and nursing homes), colleges
and universities, power and energy companies and
resource recovery facilities. See U.S. Securities &
Exchange Comm’n., Report on the Municipal
Securities Market 7 (2012), available at http://
www.sec.gov/news/studies/2012/
munireport073112.pdf.
1408 See Joint Proposal, 76 FR 68,878.
1409 See id.
1410 Commenters argued that including
obligations of multilateral developments banks in a
foreign sovereign debt exemption is necessary to
avoid endangering international cooperation in
financial regulation and potential retaliatory
prohibitions against U.S. government obligations.
See Ass’n. of German Banks; Sumitomo; SIFMA et
al. (Prop. Trading) (Feb. 2012). Additionally, some
commenters represented that an exemption for
obligations of international and multilateral
development banks is appropriate for many of the
same reasons provided for exempting U.S.
government obligations and foreign sovereign debt
generally. See Ass’n. of German Banks; Barclays;
Goldman (Prop. Trading); IIB/EBF; ICFR; ICI Global;
FIA; Sumitomo Trust; Allen & Overy (Gov’t.
Obligations); SIFMA et al. (Prop. Trading) (Feb.
2012).

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trading obligations of multilateral
development banks will help enhance
the markets for these obligations and
therefore promote and protect the safety
and soundness of banking entities and
U.S. financial stability.
6. Section ll.6(c): Permitted Trading
on Behalf of Customers
Section 13(d)(1)(D) of the BHC Act
provides an exemption from the
prohibition on proprietary trading for
the purchase, sale, acquisition, or
disposition of financial instruments on
behalf of customers.1411 The statute
does not define when a transaction or
activity is conducted ‘‘on behalf of
customers.’’
a. Proposed Exemption for Trading on
Behalf of Customers

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Section ll.6(b) of the proposed rule
implemented the exemption for trading
on behalf of customers by exempting
three types of trading activity. Section
ll.6(b)(i) of the proposed rule
provided that a purchase or sale of a
financial instrument occurred on behalf
of customers if the transaction (i) was
conducted by a banking entity acting as
investment adviser, commodity trading
advisor, trustee, or in a similar fiduciary
capacity for the account of that
customer, and (ii) involved solely
financial instruments for which the
banking entity’s customer, and not the
banking entity or any affiliate of the
banking entity, was the beneficial
owner. This exemption was intended to
permit trading activity that a banking
entity conducts in the context of
providing investment advisory, trust, or
fiduciary services to customers provided
that the banking entity structures the
activity so that the customer, and not
the banking entity, benefits from any
gains and suffers any losses on the
traded positions.
Section ll.6(b)(ii) of the proposed
rule exempted the purchase or sale of a
covered financial position if the banking
entity was acting as riskless
principal.1412 Under the proposed rule,
a banking entity qualified as a riskless
principal if the banking entity, after
having received an order to purchase or
sell a covered financial position from a
customer, purchased or sold the covered
financial position for its own account to
offset a contemporaneous sale to or
purchase from the customer.1413
U.S.C. 1851(d)(1)(D).
Joint Proposal, 76 FR 68,879.
1413 This language generally mirrors that used in
the Board’s Regulation Y, OCC interpretive letters,
and the SEC’s Rule 3a5–1 under the Exchange Act.
See 12 CFR 225.28(b)(7)(ii); 17 CFR 240.3a5–1(b);
OCC Interpretive Letter 626 (July 7, 1993).

Section ll.6(b)(iii) of the proposed
rule permitted trading by a banking
entity that was an insurance company
for the separate account of insurance
policyholders. Under the proposed rule,
only a banking entity that is an
insurance company directly engaged in
the business of insurance and subject to
regulation by a State insurance regulator
or foreign insurance regulator was
eligible for this prong of the exemption
for trading on behalf of customers.
Additionally, the purchase or sale of the
covered financial position was exempt
only if it was solely for a separate
account established by the insurance
company in connection with one or
more insurance policies issued by that
insurance company under which all
profits and losses arising from the
purchase or sale of the financial
instrument were allocated to the
separate account and inured to the
benefit or detriment of the owners of the
insurance policies supported by the
separate account, and not the banking
entity. These types of transactions are
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 is treated as
the owner of those assets for certain
purposes.
b. Comments on the Proposed Rule
Several commenters contended that
the Agencies construed the statutory
exemption too narrowly by limiting
permissible proprietary trading on
behalf of customers to only three
categories of transactions.1414 Some of
these commenters argued the exemption
in the proposal was not consistent with
the statutory language or Congressional
intent to permit all transactions that are
‘‘on behalf of customers.’’ 1415 One of
these commenters expressed concern
that the proposed exemption for trading
on behalf of customers may be
construed to permit only customerdriven transactions involving securities
and not other financial instruments
such as foreign exchange forwards and
other derivatives.1416
Several commenters urged the
Agencies to expand the exemption for
trading on behalf of customers to permit
other categories of customer-driven
transactions in which the banking entity
may be acting as principal but that serve
legitimate customer needs including
capital formation. For example, one
commenter urged the Agencies to

1411 12

1412 See

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1414 See, e.g., Am. Express; BoA; ISDA (Apr.
2012); RBC; SIMFA et al. (Prop. Trading) (Feb.
2012); Wells Fargo (Prop. Trading).
1415 See, e.g., Am. Express; SIMFA et al. (Prop.
Trading) (Feb. 2012).
1416 See Am. Express.

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5647

permit customer-driven transactions in
which the banking entity has no ready
counterparty but that are undertaken at
the instruction or request of a customer
or client or in anticipation of such an
instruction or request, such as
facilitating customer liquidity needs or
block positioning transactions.1417
Other commenters urged the Agencies
to exempt transactions where the
banking entity acts as principal to
accommodate a customer and
substantially and promptly hedges the
risks of the transaction.1418 Commenters
argued that these kinds of transactions
are similar in purpose and level of risk
to riskless principal transactions.1419
Commenters also argued that these
transactions could be viewed as marketmaking related activities, but indicated
that the potential uncertainty and costs
of making that determination would
discourage banking entities from taking
principal risks to accommodate
customer needs.1420 Commenters also
requested that the Agencies expressly
permit transactions on behalf of
customers to create structured products,
as well as for client funding needs,
customer clearing, and prime brokerage,
if these transactions are included within
the trading account.1421
In contrast, some commenters
supported the proposed approach for
implementing the exemption for trading
on behalf of customers or urged
narrowing the exemption.1422 One
commenter expressed general support
for the requirement that all profits (or
losses) from the transaction flow to the
customer and not the banking entity
providing the service for a transaction to
be exempt.1423 One commenter
contended that the statute did not
permit transactions on behalf of
customers to be performed by an
investment adviser.1424 Another
commenter argued that the final rule
should permit a banking entity to
engage in a riskless principal
transaction only where the banking
entity has already arranged for another
customer to be on the other side of the
transaction.1425 Other commenters
urged the Agencies to ensure that both
parties to the transaction agree
1417 See RBC. The Agencies note that acting as a
block positioner is expressly contemplated and
included as part of the exemption for market
making-related activities under the final rule.
1418 See BoA; SIMFA et al. (Prop. Trading) (Feb.
2012).
1419 See SIMFA et al. (Prop. Trading) (Feb. 2012).
1420 See SIMFA et al. (Prop. Trading) (Feb. 2012).
1421 See SIMFA et al. (Prop. Trading) (Feb. 2012).
1422 See, e.g., Alfred Brock; ICBA; Occupy.
1423 See ICBA.
1424 See Occupy.
1425 See Public Citizen.

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beforehand to the time and price of any
relevant trade to ensure that the banking
entity solely stands in the middle of the
transaction and in fact passes on all
gains (or losses) from the transaction to
the customers.1426 Commenters also
urged the Agencies to define other key
terms used in the exemption. For
instance, some commenters requested
that the final rule define which entities
may qualify as a ‘‘customer’’ for
purposes of the exemption.1427
Some commenters urged the Agencies
to provide uniform guidance on how the
Agencies will interpret the riskless
principal exemption.1428 One
commenter urged the Agencies to clarify
how the riskless principal exemption
would be implemented with respect to
transactions in derivatives, including a
hedged derivative transaction executed
at the request of a customer.1429
Several commenters generally
expressed support for the exemption for
trading for the separate account of
insurance policyholders under the
proposed rule.1430 One commenter
requested that the final rule more
clearly articulate who may qualify as a
permissible owner of an insurance
policy to whom the profits and losses
arising from the purchase or sale of a
financial instrument allocated to the
separate account may inure.1431
Several commenters argued that
certain types of separate account
activities, including the allocation of
seed money by an insurance company to
a separate account or the offering of
certain non-variable separate account
contracts by the insurance company,
would not appear to be permitted under
the proposal.1432 Commenters also
expressed concern that these separate
account activities might not satisfy the
proposed requirement that all profits
and losses arising from the purchase or
sale of the financial position inure to the
benefit or detriment of the owners of the
insurance policies supported by the
separate account, and not the insurance
company.1433 In addition, commenters
argued that under the proposed rule,

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1426 See

Occupy; Alfred Brock.
1427 See Occupy; Public Citizen. Conversely, other
commenters supported the approach taken in the
proposed rule without requesting such a definition.
See Alfred Brock.
1428 See, e.g., Am. Express; SIMFA et al. (Prop.
Trading) (Feb. 2012).
1429 See Am. Express.
1430 See ACLI; Chris Barnard; NAMIC; Fin.
Services Roundtable (Feb. 3, 2012).
1431 See Chris Barnard.
1432 See ACLI; Sutherland (on behalf of Comm. of
Annuity Insurers); Fin. Services Roundtable (Feb. 3,
2012); NAMIC.
1433 See ACLI; Sutherland (on behalf of Comm. of
Annuity Insurers); Fin. Services Roundtable (Feb. 3,
2012); NAMIC.

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these activities would appear to fall
outside of the exemption for activities in
the general account of an insurance
company because the proposed rule
defined a general account as excluding
a separate account.1434 Commenters
urged the Agencies to more closely align
the exemptions for trading by an
insurance company for the general
account and separate account.1435
According to these commenters, this
change would permit insurance
companies to continue to engage in the
business of insurance by offering the
full suite of insurance products to their
customers.1436
c. Final Exemption for Trading on
Behalf of Customers
The Agencies have carefully
considered the comments and are
adopting the exemption for trading on
behalf of customers with several
modifications. The Agencies believe
that the final rule implements the
exemption in section 13(d)(1)(D) in a
manner consistent with the legislative
intent to allow banking entities to use
their own funds to purchase or sell
financial instruments when acting on
behalf of their customers.1437 At the
same time, the limited activities
permitted under the final rule limit the
potential for abuse.1438
The final rule slightly modifies the
proposed rule by providing that a
banking entity is not prohibited from
trading on behalf of customers when
that activity is conducted by the
banking entity as trustee or in a similar
fiduciary capacity for a customer and so
long as the transaction is conducted for
the account of, or on behalf of the
customer and the banking entity does
not have or retain a beneficial
ownership of the financial instruments.
The final rule removes the proposal’s
express exemption for investment
advisers. After further consideration, the
Agencies do not believe an express
reference to investment advisers is
necessary because investment advisers
1434 See ACLI; Sutherland (on behalf of Comm. of
Annuity Insurers); Fin. Services Roundtable (Feb. 3,
2012); NAMIC.
1435 See ACLI; Sutherland (on behalf of Comm. of
Annuity Insurers); Fin. Services Roundtable (Feb. 3,
2012); NAMIC.
1436 See ACLI; Sutherland (on behalf of Comm. of
Annuity Insurers); Fin. Services Roundtable (Feb. 3,
2012); NAMIC.
1437 See 156 Cong. Rec. S5896 (daily ed. July 15,
2010) (statement of Sen. Merkley) (arguing that
‘‘this permitted activity is intended to allow
financial firms to use firm funds to purchase assets
on behalf of their clients, rather than on behalf of
themselves.’’).
1438 Some commenters urged narrowing the
exemption. See, e.g., Alfred Brock; ICBA; Occupy.
The Agencies believe the final rule is appropriately
narrow to limit potential abuse.

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generally act in a fiduciary capacity on
behalf of clients in a manner that is
separately covered by other exclusions
and exemptions in the final rule.
Additionally, the final rule deletes the
proposal’s express exemption for
commodity trading advisors because the
legal relationship between a commodity
trading advisor and its client depends
on the facts and circumstances of each
relationship. Therefore, the Agencies
determined that it was appropriate to
limit the discussion to fiduciary
obligations generally and to omit any
specific discussion of commodity
trading advisors. In order to ensure that
a banking entity utilizes this exemption
to engage only in transactions for
customers and not to conduct its own
trading activity, the final rule
(consistent with the proposed rule)
requires that the purchase or sale of
financial instruments be conducted for
the account of the customer and that it
involve solely financial instruments of
which the customer, and not the
banking entity, is beneficial owner.1439
The final rule, like the proposed rule,
permits transactions in any financial
instrument, including derivatives such
as foreign exchange forwards, so long as
those transactions are on behalf of
customers.1440
While some commenters requested
that the final rule define ‘‘customer’’ for
purposes of this exemption,1441 the
Agencies believe the requirements of
this exemption address commenters’
underlying concerns about what
constitutes a ‘‘customer.’’ Specifically,
the Agencies believe that requiring a
transaction relying on this exemption to
be conducted in a fiduciary capacity for
a customer, to be conducted for the
account of the customer, and to involve
solely financial instruments of which
the customer is beneficial owner
address the underlying concerns that a
transaction could qualify for this
exemption if done on behalf of an
indirect customer or on behalf of a
customer not served by the banking
entity.
The final rule also provides that a
banking entity may act as riskless
principal in a transaction in which the
banking entity, after receiving an order
to purchase (or sell) a financial
instrument from a customer, purchases
(or sells) the financial instrument for its
1439 See final rule § ll.6(c)(1)(ii)–(iii). See also
proposed rule § ll.6(b)(2)(i)(B)–(C).
1440 Some commenters expressed concern that the
proposed exemption for trading on behalf of
customers may be construed to not permit
transactions in foreign exchange forwards and other
derivatives. See Am. Express; SIFMA et al. (Prop.
Trading) (Feb. 2012).
1441 See Occupy; Public Citizen.

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own account to offset the
contemporaneous sale of the financial
instrument to (purchase from) the
customer.1442 Any transaction
conducted pursuant to the exemption
for riskless principal activity must be
customer-driven and may not expose
the banking entity to gains (or losses) on
the value of the traded instruments as
principal.1443 Importantly, the final rule
does not permit a banking entity to
purchase (or sell) a financial instrument
without first having a customer order to
buy (sell) the instrument. While some
commenters requested that the Agencies
modify the final rule to permit activity
without a customer order,1444 the
Agencies are concerned that broadening
the exemption in this manner would
enable banking entities to evade the
requirements of section 13 and engage
in prohibited proprietary trading under
the guise of trading on behalf of
customers.
Several commenters requested that
the final rule explain how a banking
entity may determine when it is acting
as riskless principal.1445 The Agencies
note that riskless principal transactions
typically are undertaken as an
alternative method of executing orders
by customers to buy or sell financial
instruments on an agency basis. Acting
as riskless principal does not include
acting as underwriter or market maker
in the particular financial instrument
and is generally understood to be
equivalent to agency or brokerage
transactions in which all of the risks
associated with ownership of financial
instruments are borne by customers.
The Agencies have generally equivalent
standards for determining when a
banking entity acts as riskless principal
and require that the banking entity, after
receiving an order to buy (or sell) a
financial instrument from a customer,
buys (or sells) the instrument for its own
account to offset a contemporaneous
sale to (or purchase from) the
customer.1446 The Agencies intend to
determine whether a banking entity acts
final rule § ll.6(c)(2).
commenters urged the Agencies to
ensure that the banking entity passes on all gains
(or losses) from the transaction to the customers.
See Occupy; Public Citizen.
1444 See RBC; SIFMA et al. (Prop. Trading) (Feb.
2012).
1445 See, e.g., Am. Express; SIFMA et al. (Prop.
Trading) (Feb. 2012).
1446 See, e.g., 12 CFR 225.28(b)(7)(ii); 17 CFR
240.3a5–1(b); OCC Interpretive Letter 626 (July 7,
1993). One commenter stated that a banking entity
should only be allowed to engage in a riskless
principal transaction where the banking entity has
already arranged for another customer to be on the
other side of the transaction. See Public Citizen.
The Agencies believe that the contemporaneous
requirement in the final rule addresses this
comment.
1442 See

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as riskless principal in accordance with
and subject to the requirements of these
standards.
Some commenters requested that the
final rule permit a greater variety of
transactions to be conducted on behalf
of customers. Many of these
transactions, such as transactions that
facilitate customer liquidity needs or
block positioning transactions 1447 or
transactions in which the banking entity
acts as principal to accommodate a
customer and substantially and
promptly hedges the risks of the
transaction,1448 may be permissible
under the market-making exemption. To
the extent these transactions are
conducted by a market maker, the
Agencies believe that the restrictions
and limits required in connection with
market making-related activities are
important for limiting the risks to the
banking entity from these
transactions.1449 While some
commenters requested that clearing and
settlement activities and prime
brokerage activities be viewed as
permitted proprietary trading on behalf
of customers,1450 these transactions are
not considered proprietary trading as an
initial matter under the final rule.1451
Finally, the Agencies have decided to
move the exemption for trading activity
conducted by an insurance company for
a separate account into the provision
exempting trading activity in an
insurance company’s general account in
order to better align the two
exemptions.1452 As discussed below in
Part IV.A.7., the final rule provides
exemptions for trading activity
1447 One commenter requested an exemption for
transactions at the instruction or request of a
customer or client or in anticipation of such an
instruction or request, such as facilitating customer
liquidity needs or block positioning transactions.
See RBC.
1448 Some commenters requested an exemption
for these types of transactions. See BoA; SIFMA et
al. (Prop. Trading) (Feb. 2012).
1449 Some commenters stated that the potential
uncertainty and costs of determining whether an
activity qualifies for the market-making exemption
would discourage banking entities from taking
principal risks to accommodate customer needs.
See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012).
The Agencies believe that adjustments made to the
market-making exemption in the final rule help
address this concern. Specifically, the final marketmaking exemption better accounts for the varying
characteristics of market-making across markets and
assets classes.
1450 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012).
1451 See final rule § ll.3(d)(4)–(6). See also infra
Part IV.A.1.d.3–4.
1452 Some commenters requested that the
Agencies more closely align the exemptions for
trading by an insurance company for the general
account and separate account. See ACLI;
Sutherland (on behalf of Comm. of Annuity
Insurers); Fin. Services Roundtable (Feb. 3, 2012);
NAMIC.

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5649

conducted by an insurance company
that is a banking entity either in the
general account or in a separate account
of customers in § ll.6(d). As
explained below, the statute specifically
exempts trading activity that is
conducted by a regulated insurance
company engaged in the business of
insurance for the general account of the
company if conducted in accordance
with applicable state law and if not
prohibited by the appropriate Federal
banking agencies.1453 Unlike activity for
the general account of an insurance
company, investments made by
regulated insurance companies in
separate accounts in accordance with
applicable state law are made on behalf
of and for the benefit of customers of the
insurance company.1454 Also unlike
general accounts (which are supported
by all of the assets of the insurance
company), a separate account is
supported only by the assets in that
account and does not have call on the
other assets of the company. The
customer benefits (or loses) based solely
on the performance of the assets in the
separate account. These arrangements
are the equivalent for insurance
companies of fiduciary accounts at
banks. For these reasons, the final rule
recognizes that separate accounts at
regulated insurance companies
maintained in accordance with
applicable state insurance laws are
exempt from the prohibitions in section
13 as acquisitions on behalf of
customers.
7. Section ll.6(d): Permitted Trading
by a Regulated Insurance Company
Section 13(d)(1)(F) permits a banking
entity that is a regulated insurance
company acting for its general account,
1453 See

12 U.S.C. 1851(d)(1)(F).
commenter requested clarification on
who may qualify as a permissible owner of an
insurance policy to whom the profits and losses
arising from the purchase or sale of a financial
instrument allocated to the separate account may
inure. See Chris Barnard. The Agencies note that
the proposed requirement that all profits and losses
arising from the purchase or sale of a financial
instrument inure to the benefit or detriment of the
‘‘owners of the insurance policies supported by the
separate account’’ has been removed. See proposed
rule § ll.6(b)(2)(iii)(C). Instead, the final rule
requires that the income, gains, and losses from
assets allocated to a separate account be credited to
or charged against the account without regard to
other income, gains or losses of the insurance
company. See final rule § ll.2(z) (definition of
‘‘separate account’’). Thus, the final rule no longer
references ‘‘owners of the insurance policies
supported by the separate account.’’ The Agencies
note, however, that the final rule requires exempted
separate account transactions to 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.’’ See final rule
§ ll.6(d)(3).
1454 One

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or an affiliate of an insurance company
acting for the insurance company’s
general account, to purchase or sell a
financial instrument subject to certain
conditions (the ‘‘general account
exemption’’).1455 Section 13(d)(1)(D)
permits a banking entity to purchase or
sell a financial instrument on behalf of
customers.1456 In the proposed rule, the
Agencies viewed Section 13(d)(1)(D) as
permitting an insurance company to
purchase or sell a financial instrument
for certain separate accounts (the
‘‘separate account exemption’’). The
proposal implemented both these
exemptions with respect to activities of
insurance companies, in each case
subject to the restrictions discussed
below.1457
Section ll.6(c) of the proposed rule
implemented the general account
exemption by generally restating the
statutory requirements of the exemption
that:
• The insurance company 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 purchase or sell the financial
instrument solely for the general
account of the insurance company;
• The purchase or sale 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
entity or of the financial stability of the
United States.
The proposed rule defined the term
‘‘general account’’ to include all of the
assets of the insurance company that are
not legally segregated and allocated to
separate accounts under applicable
State law.1458
As noted above in Part IV.A.6.a.,
§ ll.6(b)(iii) of the proposed rule
provided an exemption for a banking
entity that is an insurance company
when it acted through a separate
account for the benefit of insurance
policyholders. The proposed rule
1455 See

12 U.S.C. 1851(d)(1)(F).
12 U.S.C. 1851(d)(1)(D).
1457 See proposed rule §§ ll.6(b)(2)(iii), ll
.6(c).
1458 See proposed rule § ll.3(c)(6).
1456 See

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defined 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.1459
To limit the potential for abuse of the
separate account exemption, the
proposed rule included 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.1460 In
particular, the proposed rule provided
that a purchase or sale of a financial
instrument qualified for the separate
account exemption only if:
• The banking entity is an insurance
company directly engaged in the
business of insurance and subject to
regulation by a State insurance regulator
or foreign insurance regulator; 1461
• The banking entity purchases or
sells the financial instrument 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 financial
instrument 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.
The proposal explained that the
proposed separate account exception
represented transactions on behalf of
customers because the insurance-related
transactions are generally customerdriven and do not expose the banking
entity to gains or losses on the value of
proposed rule § ll.2(z).
Agencies noted in the proposal they
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.
1461 The proposed rule provided definitions of the
terms ‘‘State insurance regulator’’ and ‘‘foreign
insurance regulator.’’ See proposed rule §§ ll
.3(c)(4), (13).
1459 See

1460 The

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separate account assets, even though the
banking entity may be treated as the
owner of those assets for certain
purposes.
Commenters generally supported the
general account exemption and the
separate account exemption for
regulated insurance companies as
consistent with both the statute and
Congressional intent to accommodate
the business of insurance.1462 For
instance, commenters argued that the
statute was designed to appropriately
accommodate the business of insurance,
subject to regulation in accordance with
relevant insurance company investment
laws, in recognition that insurance
company investment activities are
already subject to comprehensive
regulation and oversight.1463
A few commenters expressed
concerns about the definition of
‘‘general account’’ and ‘‘separate
account.’’ 1464 One commenter argued
the definition of general account was
unclear.1465 A few commenters
expressed concern that the proposed
definition of separate account
inappropriately excluded some separate
accounts, such as certain insurance
company investment activities such as
guaranteed investment contracts, which
would also not fall within the proposed
definition of general account.1466
Several commenters argued that the
final rule should be modified so that all
insurance company investment activity
permitted under applicable insurance
laws would qualify for either the general
account exemption or the separate
account exemption.1467
Some commenters argued that the
prohibition in the proposed definition
of separate account against any profits
or losses from activity in the account
inuring to the benefit (or detriment) of
the insurance company would exclude
some activity permitted by insurance
regulation in separate accounts.1468 For
example, commenters contended that an
insurer may allocate its own funds to a
separate account as ‘‘seed money’’ and
1462 See, e.g., Alfred Brock; Chris Barnard; Fin.
Services Roundtable (Feb. 3, 2012); Sutherland (on
behalf of Comm. of Annuity Insurers); TIAA–CREF;
NAMIC.
1463 See, e.g., ACLI (Jan. 2012); Fin. Services
Roundtable (Feb. 3, 2012); Country Fin. et al.;
Sutherland (on behalf of Comm. of Annuity
Insurers).
1464 See, e.g., Fin. Services Roundtable (Feb. 3,
2012); ACLI (Jan. 2012); Sutherland (on behalf of
Comm. of Annuity Insurers).
1465 See Sutherland (on behalf of Comm. of
Annuity Insurers).
1466 See ACLI (Jan. 2012); NAMIC.
1467 See Fin. Services Roundtable (Feb. 3, 2012);
ACLI (Jan. 2012); NAMIC; See also Nationwide.
1468 See Fin. Services Roundtable (Feb. 3, 2012);
ACLI (Jan. 2012); NAMIC; Sutherland (on behalf of
Comm. of Annuity Insurers); See also Nationwide.

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the profits and losses on those funds
inure to the benefit or detriment of the
insurance company.1469
Some commenters expressed specific
concerns about the scope or
requirements of the proposal. For
instance, one commenter argued that the
final rule should provide that a trade is
exempt if the trade is made by an
affiliate of the insurance company in
accordance with state insurance law.1470
Another commenter urged that the
Agencies consult with the foreign
insurance supervisor of an insurance
company regulated outside of the
United States before finding that an
insurance activity conducted by the
foreign insurance company was
inconsistent with the safety and
soundness or financial stability.1471
One commenter suggested that
insurance company affiliates of banking
entities should expressly be made
subject to data collection and reporting
requirements to prevent possible
evasion of the restrictions of section 13
and the final rule using their insurance
affiliates.1472 By contrast, other
commenters argued that the reporting
and recordkeeping and compliance
requirements of the rule should not
apply to permitted insurance company
investment activities.1473 These
commenters argued that insurance
companies are already subject to
comprehensive regulation of the kinds
and amounts of investments they can
make under insurance laws and
regulations and that additional
recordkeeping obligations would
impose unnecessary compliance
burdens on these entities without
producing significant offsetting benefits.
After considering the comments
received and the language and purpose
of the statute, the final rule has been
modified to better account for the
language of the statute and more
appropriately accommodate the
business of insurance.
As explained in the proposal, section
13(d)(1)(F) of the BHC Act specifically
and broadly exempts the purchase, sale,
acquisition, or disposition of securities
and other instruments by a regulated
insurance company engaged in the
business of insurance for the general
account of the company (and by an
affiliate solely for the general account of
the regulated insurance company).
Section 13(d)(1)(D) of the statute also
1469 See

Fin. Services Roundtable (Feb. 3, 2012);
ACLI (Jan. 2012).
1470 See USAA.
1471 See HSBC Life.
1472 See Sens. Merkley & Levin (Feb. 2012).
1473 See ACLI (Jan. 2012); Fin. Services
Roundtable (Feb. 3, 2012); Mutual of Omaha;
NAMIC.

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specifically exempts the same activity
when done on behalf of customers. As
explained in the proposal, separate
accounts managed and maintained by
insurance companies as part of the
business of insurance are generally
customer-driven and do not expose the
banking entity to gains or losses on the
value of assets held in the separate
account, even though the banking entity
may be treated as the owner of the assets
for certain purposes. Unlike the general
account of the insurance company,
separate accounts are managed on
behalf of specific customers, much as a
bank would manage a trust or fiduciary
account.
For these reasons, the final rule
retains both the general account
exemption and the separate account
exemption. The final rule removes any
gap between the definition of general
account and the definition of separate
account by defining the general account
to be all of the assets of an insurance
company except those allocated to one
or more separate accounts.1474
The final rule also combines the
general account exemption and the
separate account exemption into a
single section. This makes clear that
both exemptions are available only:
• If the insurance company or its
affiliate purchases or sells the financial
instruments solely for the general
account of the insurance company or a
separate account of the insurance
company;
• The purchases or sales of financial
instruments are 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
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and
relevant foreign jurisdictions, as
appropriate, have not jointly
determined, after notice and comment,
that a particular law, regulation, or
written guidance regarding insurance is
insufficient to protect the safety and
soundness of the banking entity, or the
1474 See final rule §§ ll.2(p), (bb). Some
commenters expressed concerns about the proposed
definitions of ‘‘general account’’ and ‘‘separate
account,’’ including that the proposed definition of
‘‘separate account’’ excluded some legitimate
separate account activities that do not fall within
the proposed general account definition. See, e.g.,
ACLI (Jan. 2012); NAMIC; Sutherland (on behalf of
Comm. of Annuity Insurers). See also proposed rule
§§ ll.2(z), ll.3(c)(5).

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5651

financial stability of the United
States.1475
Like section 13(d)(1)(F) of the BHC
Act, the final rule permits an affiliate of
an insurance company to purchase and
sell financial instruments in reliance on
the general account exemption, so long
as that activity is for the general account
of the insurance company. Similarly,
the final rule implements section
13(d)(1)(D) and permits an affiliate of an
insurance company to purchase and sell
financial instruments for a separate
account of the insurance company, so
long as the separate account is
established and maintained at the
insurance company.
Importantly, the final rule applies
only to covered trading activity in a
general or separate account of a licensed
insurance company engaged in the
business of insurance under the
supervision of a State or foreign
insurance regulator. As in the statute, an
affiliate of an insurance company may
not rely on this exemption for activity
in any account of the affiliate (unless it,
too, meets the definition of an insurance
company). An affiliate may rely on the
exemption to the limited extent that the
affiliate is acting solely for the account
of the insurance company.1476
As noted above, one commenter
requested that the final rule impose
special data and reporting obligations
on insurance companies. Other
commenters argued that insurance
companies are already subject to
comprehensive regulation under
insurance laws and regulations and that
additional recordkeeping obligations
would impose unnecessary compliance
burdens on these entities without
producing significant offsetting benefits.
1475 The Federal banking agencies have not at this
time determined, as part of the final 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
FSOC, 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. The Agencies believe the final
approach addresses one commenter’s request that
the Agencies consult with the foreign insurance
supervisor of an insurance company regulated
outside of the United States before finding that an
insurance activity conducted by the foreign
company was inconsistent with the safety and
soundness or financial stability. See HSBC Life.
1476 Although one commenter requested that the
final rule exempt a trade as long as the trade is
made by an affiliate of the insurance company in
accordance with state insurance law, the Agencies
believe the final approach properly implements the
statute. See USAA.

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In accordance with the statute,1477 the
Agencies expect insurance companies to
have appropriate compliance programs
in place for any activity subject to
section 13 of the BHC Act.
The final rule contains a number of
other related definitions that are
intended to help make clear the
limitations of the insurance company
exemption, including definitions of
foreign insurance regulator and State
insurance regulator.
8. Section ll.6(e): Permitted Trading
Activities of a Foreign Banking Entity

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Section 13(d)(1)(H) of the BHC
Act 1478 permits certain foreign banking
entities to engage in proprietary trading
that occurs solely outside of the United
States (the ‘‘foreign trading
exemption’’).1479 The statute does not
define when a foreign banking entity’s
trading occurs solely outside of the
United States.
The proposed rule defined both the
type of foreign banking entity that is
eligible for the exemption and activity
that constitutes trading solely outside of
the United States. The proposed rule
effectively precluded a foreign banking
entity from engaging in proprietary
trading through a transaction that had
any connection with the United States,
including: Trading with any party
located in the United States; allowing
U.S. personnel of the foreign banking
entity to be involved in the purchase or
sale; or executing any transaction in the
United States (on an exchange or
otherwise).1480
In general, commenters emphasized
the importance of and supported an
exemption for foreign trading activities
of foreign banking entities. However, a
number of commenters expressed
concerns that the proposed foreign
trading exemption was too narrow and
would not be effective in permitting
foreign banking entities to engage in
1477 See 12 U.S.C. 1851(e)(1) (requiring that the
Agencies issue regulations regarding ‘‘internal
controls and recordkeeping, in order to insure
compliance with this section’’).
1478 Section 13(d)(1)(H) of the BHC Act provides
an exemption to the prohibition on proprietary
trading for trading conducted by a foreign banking
entity pursuant to paragraph (9) or (13) of section
4(c) of the BHC Act, if the trading occurs solely
outside of the United States, and the banking entity
is not directly or indirectly controlled by a banking
entity that is organized under the laws of the United
States or of one or more States. See 12 U.S.C.
1851(d)(1)(H).
1479 This section’s discussion of the concept
‘‘solely outside of the United States’’ is provided
solely for purposes of the rule’s implementation of
section 13(d)(1)(H) of the BHC Act, and does not
affect a banking entity’s obligation to comply with
additional or different requirements under
applicable securities, banking, or other laws.
1480 See proposed rule § ll.6(d).

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foreign trading activities.1481 For
instance, many commenters stated that
the proposal’s prohibition on trading
activities that have any connection to
the U.S. was not consistent with the
purpose of section 13 of the BHC Act
where the risk of the trading activity is
taken or held outside of the United
States and does not implicate the U.S.
safety net.1482 These commenters argued
that, since one of the principal purposes
of section 13 of the BHC Act is to limit
the risk posed by prohibited proprietary
trading to the federal safety net, the
safety and soundness of U.S. banking
entities, and the financial stability of the
United States, the exemption for foreign
trading activity should similarly focus
on whether the trading activity involves
principal risk being taken or held by the
foreign banking entity inside the United
States.1483
Many commenters argued that the
proposal’s transaction-based approach
to implementing the foreign trading
exemption would harm U.S. markets
and U.S. market participants. For
example, some commenters argued that
the proposed exemption would cause
foreign banks to exit U.S. markets or
shrink their U.S.-based operations,
thereby resulting in less liquidity and
greater fragmentation in markets
without producing any significant
offsetting benefit.1484 Commenters also
asserted that the proposal would impose
significant compliance costs on the
foreign operations of foreign banking
entities and would lead to foreign firms
refusing to trade with U.S.
counterparties, including the foreign
operations of U.S. entities, to avoid
compliance costs associated with
relying on another exemption under the
proposed rule.1485 Additionally,
commenters argued that the proposal
represented an improper extraterritorial
application of U.S. law that could be
found to violate international treaty
obligations of the United States, such as
those under the North American Free
Trade Agreement, and might result in
retaliation by foreign countries in their
1481 See, e.g., IIB/EBF; ICI Global; ICI (Feb. 2012);
Wells Fargo (Prop. Trading); BoA.
1482 See IIB/EBF; Ass’n. of Banks in Malaysia;
EBF; Credit Suisse (Seidel); Cadwalader (on behalf
of Thai Banks).
1483 See BaFin/Deutsche Bundesbank; ICSA; IIB/
EBF; Allen & Overy (on behalf of Canadian Banks);
Credit Suisse (Seidel); George Osbourne.
1484 See ICE; ICI Global; BoA; Citigroup (Feb.
2012); British Bankers’ Ass’n.; IIB/EBF.
1485 See BaFin/Deutsche Bundesbank;
Norinchukin; IIF; Allen & Overy (on behalf of
Canadian Banks); ICFR; BoA; Citigroup (Feb. 2012).
As discussed below in Part IV.C. of this
SUPPLEMENTARY INFORMATION, other parts of the final
rule address commenters’ concerns regarding the
compliance burden on foreign banking entities.

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treatment of U.S. banking entities
abroad.1486
a. Foreign Banking Entities Eligible for
the Exemption
The statutory language of section
13(d)(1)(H) 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. The proposed rule
limited the scope of the exemption to
banking entities that are organized
under foreign law and, as applicable,
controlled only by entities organized
under foreign law.
Commenters generally supported this
aspect of the proposal.1487 However,
some commenters requested that the
final rule be modified to allow U.S.
banking entities’ affiliates or branches
that are physically located outside of the
United States (‘‘foreign operations of
U.S. banking entities’’) to engage in
proprietary trading outside of the
United States pursuant to this
exemption.1488 These commenters
argued that, unless foreign operations of
U.S. banking entities are provided
similar authority to engage in
proprietary trading outside of the
United States, foreign operations of U.S.
banking entities would be at a
competitive disadvantage abroad with
respect to foreign banking entities. One
commenter also asserted that, unless
foreign operations of U.S. banking
entities were able to effectively access
foreign markets, they could be shut out
of those markets and would be unable
to effectively manage their risks in a safe
and sound manner.1489
As noted above, section 13(d)(1)(H) of
the BHC Act specifically provides that
its exemption is available only to a
banking entity that 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.1490 Because of this express
statutory threshold requirement, a
foreign subsidiary controlled, directly or
indirectly, by a banking entity organized
under the laws of the United States or
1486 See Norinchukin; Cadwalader (on behalf of
Thai Banks); Barclays; EBF; Commissioner Barnier;
Ass’n. of German Banks; Socie´te´ Ge´ne´rale; Chamber
(Dec. 2012).
1487 See Sens. Merkley & Levin (Feb. 2012)
(arguing that the final rule’s foreign trading
exemption should not exempt foreign affiliates of
U.S. banking entities when they engage in trading
activity abroad); See also Occupy; Alfred Brock.
1488 See Citigroup (Feb. 2012); Sen. Carper; IIF;
ABA (Keating); Wells Fargo (Prop. Trading); Abbot
Labs. et al. (Feb. 14, 2012).
1489 See Citigroup (Feb. 2012).
1490 See 12 U.S.C. 1851(d)(1)(H).

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one of its States, and a foreign branch
office of a banking entity organized
under the laws of the United States or
one of the States, may not take
advantage of this exemption.
Like the proposal, the final rule
incorporates the statutory requirement
that the banking entity conduct its
trading activities pursuant to sections
4(c)(9) or 4(c)(13) of the BHC Act.1491
The final rule retains the tests in the
proposed rule for determining when a
banking entity would meet that
requirement. The final rule provides
qualifying criteria for both a banking
entity that is a qualifying foreign
banking organization under the Board’s
Regulation K and a banking entity that
is not a foreign banking organization for
purposes of Regulation K.1492
Section 4(c)(9) of the BHC Act applies
to 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.1493 The Board has
implemented section 4(c)(9) as part of
subpart B of the Board’s Regulation
K,1494 which specifies a number of
conditions and requirements that a
foreign banking organization must meet
in order to act pursuant to that
authority.1495 The qualifying conditions
and requirements include, for example,
that the foreign banking organization
demonstrate that more than half of its
final rule § ll.6(e)(1)(ii).
ll.6(e)(2) addresses only when a
transaction 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 to date
applied the general 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.
1493 See 12 U.S.C. 1843(c)(9).
1494 See 12 CFR 211.20 et seq.
1495 Commenters noted that the Board’s
Regulation K contains a number of limitations that
may not be appropriate to include as part of the
requirements of the foreign trading exemption. See
Allen & Overy (on behalf of Foreign Bank Group);
HSBC Life. Accordingly, the final rule does not
retain the proposal’s requirement that the activity
be conducted in compliance with subpart B of the
Board’s Regulation K (12 CFR 211.20 through
211.30). However, the exemption in section
13(d)(1)(H) of the BHC Act and the final rule
operates as an exemption and is not a separate grant
of authority to engage in an otherwise
impermissible activity. To the extent a banking
entity is a foreign banking organization, it remains
subject to the Board’s Regulation K and must, as a
separate matter, comply with any and all applicable
rules and requirements of that regulation.
1491 See

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worldwide business is banking and that
more than half of its banking business
is outside the United States.1496 Under
the final rule a banking entity that is a
qualifying foreign banking organization
for purposes of the Board’s Regulation
K, other than a foreign bank as defined
in section 1(b)(7) of the International
Banking Act of 1978 that is organized
under the laws of any commonwealth,
territory, or possession of the United
States, will qualify for the exemption for
proprietary trading activity of a foreign
banking entity.1497
Section 13 of the BHC Act also
applies to foreign companies that
control a U.S. insured depository
institution but that 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 final rule also provides that a foreign
banking entity that is not a foreign
banking organization would be
considered to be conducting activities
‘‘pursuant to section 4(c)(9)’’ for
purposes of this exemption 1498 if the
entity, on a fully-consolidated basis,
meets at least two of three requirements
that evaluate the extent to which the
foreign banking entity’s business is
conducted outside the United States, as
measured by assets, revenues, and
1496 See 12 CFR 211.23(a), (c), and (e). The
proposed rule referenced only the qualifying test
under section 211.23(a) of the Board’s Regulation K;
however, because there are two other methods by
which a foreign banking organization may meet the
requirements to be considered a qualified foreign
banking organization, the final rule incorporates a
reference to those provisions as well.
1497 This modification to the definition of foreign
banking organization is necessary because, under
the International Banking Act and the Board’s
Regulation K, depository institutions that are
located in, or organized under the laws of a
commonwealth, territory, or possession of the
United States, are foreign banking organizations.
However, for purposes of the Federal securities
laws and certain banking statutes, such as section
2(c)(1) of the BHC Act and section 3 of the FDI Act,
these same entities are defined to be and treated as
domestic entities. For instance, these entities act as
domestic broker-dealers under U.S. securities laws
and their deposits are insured by the FDIC. Because
one of the purposes of section 13 is to protect
insured depository institutions and the U.S.
financial system from the perceived risks of
proprietary trading and covered fund activities, the
Agencies believe that these entities should be
considered to be located within the United States
for purposes of section 13. The final rule includes
within the definition of State a commonwealth,
territory or possession of the United States, the
District of Columbia, the Commonwealth of Puerto
Rico, the Commonwealth of the Northern Mariana
Islands, American Samoa, Guam, or the United
States Virgin Islands.
1498 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.

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5653

income.1499 This test largely mirrors the
qualifying foreign banking organization
test that is made applicable under
section 4(c)(9) of the BHC Act and
section 211.23(a), (c), or (e) of the
Board’s Regulation K, except that the
test does not require the foreign entity
to demonstrate that more than half of its
banking business is outside the United
States.1500 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.
b. Permitted Trading Activities of a
Foreign Banking Entity
As noted above, the proposed rule
laid out a transaction-based approach to
implementing the foreign trading
exemption and provided that a
transaction would be considered to
qualify for the exemption only if (i) the
transaction was conducted by a banking
entity not organized under the laws of
the United States or of one or more
States; (ii) no party to the transaction
was a resident of the United States; (iii)
no personnel of the banking entity that
was directly involved in the transaction
was physically located in the United
States; and (iv) the transaction was
executed wholly outside the United
States.1501
Many commenters objected to the
proposed exemption, arguing that it was
unworkable and would have
unintended consequences. For example,
commenters argued that prohibiting a
foreign banking entity from conducting
a proprietary trade with a resident of the
United States, including a subsidiary or
branch of a U.S. banking entity,
wherever located, would likely cause
foreign banking entities to be unwilling
to enter into permitted trading
transactions with foreign subsidiaries or
branches of U.S. firms.1502 In addition,
1499 See final rule § ll.6(e)(2)(ii)(B). For
purposes of determining whether, on a fully
consolidated basis, it meets the requirements under
§ ll.6(e)(2)(ii)(B), a foreign banking entity that is
not a foreign banking organization should base its
calculation on the consolidated global assets,
revenues, and income of the top-tier affiliate within
the foreign banking entity’s structure.
1500 See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a),
(c), and (e); final rule § ll.6(e)(2)(ii)(B).
1501 See proposed rule § ll.6(d).
1502 See BoA; Citigroup (Feb. 2012); British
Bankers’ Ass’n.; Credit Suisse (Seidel); George
Osbourne; IIB/EBF.

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some commenters represented that it
would be difficult to determine and
track whether a party is a resident of the
United States or that this requirement
would require non-U.S. banking entities
to inefficiently bifurcate their activities
into U.S.-facing and non-U.S.-facing
trading desks.1503 For example, one
commenter noted that trading on many
exchanges and platforms is anonymous
(i.e., each party to the trade is unaware
of the identity of the other party to the
trade), so a foreign banking entity would
likely have to avoid U.S. trading
platforms and exchanges entirely to
avoid transactions with any resident of
the United States.1504 Further,
commenters stated that the proposed
rule could deter foreign banking entities
from conducting business with U.S.
parties outside of the United States,
which could also incentivize foreign
market centers to limit participation by
U.S. parties on their markets.1505
Commenters also expressed concern
about the requirement that transactions
be executed wholly outside of the
United States in order to qualify for the
proposed foreign trading exemption.
Commenters represented that foreign
banking entities currently use U.S.
trading platforms to trade in certain
products (such as U.S.-listed securities
or a variety of derivatives contracts), to
take advantage of robust U.S.
infrastructure, and for time zone
reasons.1506 Commenters indicated that
the proposed requirement could harm
the competitiveness of U.S. trading
platforms and the liquidity available on
such facilities.1507 Some commenters
stated that this requirement would
effectively result in most foreign
banking entities moving their trading
operations and personnel outside of the
United States and executing
transactions on exchanges outside of the
United States.1508 These commenters
stated that the relocation of these
activities would reduce trading activity
1503 See Cadwalader (on behalf of Singapore
Banks); Ass’n. of Banks in Malaysia; Cadwalader
(on behalf of Thai Banks); IIF; ICE; Banco de
Me´xico; ICFR; Australian Bankers Ass’n. (Feb.
2012); BAROC.
1504 See ICE.
1505 See, e.g., RBC.
1506 See, e.g., IIF; ICE; Socie
´ te´ Ge´ne´rale; Mexican
Banking Comm’n.; Australian Bankers Ass’n. (Feb.
2012); Banco de Me´xico; OSFI. In addition, a few
commenters argued that Canadian and Mexican
financial firms frequently use U.S. infrastructure to
conduct their trading activities in Canada or
Mexico. See, e.g., OSFI; Banco de Me´xico; Mexican
Banking Comm’n.
1507 See, e.g., ICE; Socie
´ te´ Ge´ne´rale (arguing that
the requirement would impair capital raising efforts
of many U.S. companies); Australian Bankers Ass’n.
(Feb. 2012); Canadian Minister of Fin.; Ass’n. of
German Banks.
1508 See IIB/EBF.

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in the United States that supports the
financial stability and efficiency of U.S.
markets. Moreover, these commenters
argued that, if foreign banking entities
relocate their personnel from the United
States to overseas, this would diminish
U.S. jobs with no concomitant benefit.
They also contended that the proposal
was at cross purposes with other parts
of the Dodd-Frank Act and would
hinder growth of market infrastructure
being developed under the requirements
of Title VII of that Act, including use of
swap execution facilities and securitybased swap execution facilities to
enhance transparency in the swaps
markets and use of central
clearinghouses to reduce counterparty
risk for the parties to a swap
transaction.1509 For example, one
commenter represented that the
proposed exemption could make it
difficult for non-U.S. swap entities to
comply with potential mandatory
execution requirements under Title VII
of the Dodd-Frank Act and could cause
market fragmentation across borders
through the creation of parallel
execution facilities outside of the
United States, which would result in
less transparency and greater systemic
risk.1510 In addition, another commenter
stated that the proposed requirement
would force issuers to dually list their
securities to permit trading on non-U.S.
exchanges and, further, clearing and
settlement systems would have to be set
up outside of the United States, which
would create inefficiencies, operational
risks, and potentially systemic risk by
adding needless complexity to the
financial system.1511
Instead of the proposal’s transactionbased approach to implementing the
foreign trading exemption, many
commenters suggested the final rule
adopt a risk-based approach.1512 These
commenters noted that a risk-based
approach would prohibit or
significantly limit the amount of
financial risk from such activities that
could be transferred to the United States
by the foreign trading activity of foreign
banking entities.1513 Commenters also
noted that foreign trading activities of
most foreign banking entities are already
subject to activities limitations, capital
requirements, and other prudential
1509 See Bank of Canada; Banco de Me
´ xico; Allen
& Overy (on behalf of Canadian Banks).
1510 See Allen & Overy (on behalf of Candian
Banks).
1511 See IIF.
1512 See BaFin/Deutsche Bundesbank; ICSA; IIB/
EBF; Allen & Overy (on behalf of Canadian Banks);
Credit Suisse (Seidel); George Osbourne.
1513 See IIB/EBF.

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requirements of their home-country
supervisor(s).1514
The Agencies have carefully
considered these comments and have
determined to modify the approach in
the final rule. The Agencies believe that
the revisions mitigate the potential
adverse impacts of the proposed
approach while still remaining faithful
to the overall purpose of section
13(d)(1)(H). Also, the Agencies believe
that section 13(d)(1)(J) of the BHC Act,
which authorizes the Agencies to
provide an exemption from the
prohibition on proprietary trading for
any activity the Agencies determine by
rule ‘‘would promote and protect the
safety and soundness of the banking
entity and the financial stability of the
United States,’’ 1515 supports allowing
foreign banking entities to use U.S.
infrastructure and trade with certain
U.S. counterparties in certain
circumstances, which will promote and
protect the safety and soundness of
banking entities and U.S. financial
stability.
Overall, the comments illustrated that
both the mechanical steps of the
specified transactions to purchase or
sell various instruments (e.g., execution,
clearing), and the identity of the entity
for whose trading account the specified
trading is conducted are important.1516
Consistent with the comments described
above, the Agencies believe that the
application of section 13(d)(1)(H) and
their exemptive authority under section
13(d)(1)(J) should focus on both how the
transaction occurs and which entity will
bear the risk of those transactions.
Although the statute does not define
expressly what it means to act ‘‘as a
principal’’ (acting as principal
ordinarily means acting for one’s own
account), the combination of references
to engaging as principal and to a trading
account focuses on an entity’s incurring
risks of profit and loss through taking
ownership of securities and other
instruments. Thus, the final rule
provides an exemption for trading
activities of foreign banking entities that
addresses both the location of the
facilities that effect the acquisition,
holding, and disposition of such
positions, and the location of the
banking entity that incurs such risks
through acquisition, holding, and
disposition of such positions.
The Agencies believe this approach is
consistent with one of the principal
purposes of section 13, which is to limit
risks that proprietary trading poses to
1514 See
1515 See

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the U.S. financial system.1517 Further,
the purpose of section 13(d)(1)(H) is to
limit the extraterritorial application of
section 13 as it applies to foreign
banking entities.1518
In addition, prohibiting foreign
banking entities from using U.S.
infrastructure or trading with all U.S.
counterparties could cause certain
trading activities to move offshore, with
corresponding negative impacts on U.S.
market participants, including U.S.
banking entities. For example,
movement of trading activities offshore,
particularly in U.S. financial
instruments, could result in bifurcated
markets for these instruments that are
less efficient and less liquid and could
reduce transparency for oversight of
trading in these instruments. In
addition, reducing access to foreign
counterparties for U.S. instruments
could concentrate risks in the United
States and to its financial system.
Moreover, the statute provides separate
exemptions for U.S. banking entities to
engage in underwriting and market
making-related activities, subject to
certain requirements, and there is no
evidence that limiting the range of
potential customers for these entities
would further the purposes of the
statute. In fact, it is possible that
limiting the customer bases of U.S.
banking entities, as well as other U.S.
firms that are not banking entities, could
reduce their ability to effectively
manage their inventories and risks and
could also result in concentration risk.
These potential effects of the
approach taken in the proposal appear
to be inconsistent with the statute’s
goals, including the promotion and
protection of the safety and soundness
of banking entities and U.S. financial
stability. To the contrary, the exemptive
approach taken in the final rule appears
to be more consistent with the goals of
the statute and would promote and
protect the safety and soundness of
banking entities and U.S. financial
stability by limiting the risks of foreign
banking entities’ proprietary trading
activities to the U.S. financial system,
while also allowing U.S. markets to
1517 See, e.g., 12 U.S.C. 1851(b)(1) (directing the
FSOC to study and make recommendations on
implementing section 13 so as to, among other
things, protect taxpayers and consumers and
enhance financial stability by minimizing the risk
that insured depository institutions and the
affiliates of insured depository institutions will
engage in unsafe and unsound activities).
1518 See, e.g., 156 Cong. Rec. S5897 (daily ed. July
15, 2010) (statement of Sen. Merkley) (stating that
the foreign trading exemption ‘‘recognize[s] rules of
international comity by permitting foreign banks,
regulated and backed by foreign taxpayers, in the
course of operating outside of the United States to
engage in activities permitted under relevant
foreign law.’’).

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continue to operate efficiently in
conjunction with foreign markets (rather
than creating incentives to establish
barriers between U.S. and foreign
markets).1519
Thus, in response to commenter
concerns, the final rule has been
modified to better reflect the text and
achieve the overall purposes of the
statute (by ensuring that the principal
risks of proprietary trading by foreign
banking entities allowed under the
foreign trading exemption remain solely
outside of the United States) while
mitigating potentially adverse effects on
competition.1520 In order to ensure these
risks remain largely outside of the
United States, and to limit potential risk
that could flow to the U.S. financial
system through trades by foreign
banking entities with or through U.S.
entities, the final rule includes several
conditions on the availability of the
exemption. Specifically, in addition to
limiting the exemption to foreign
banking entities, the final rule provides
that the exemption for the proprietary
trading activity of a foreign banking
entity is available only if:
(i) The banking entity engaging as
principal in the purchase or sale
(including any personnel of the banking
entity or its affiliate that arrange,
negotiate or execute such purchase or
sale) is not located in the United States
or organized under the laws of the
United States or of any State; 1521
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State;
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
1519 12

U.S.C. 1851(d)(1)(J).
proposed rule also contained a definition
of ‘‘resident of the United States’’ that was designed
to capture the scope of U.S. counterparties that, if
involved in the transaction, would preclude that
transaction from being considered to have occurred
solely outside the United States. The final rule
addresses this point by including a definition, for
purposes of § __.6(e) only, of the term ‘‘U.S. entity.’’
1521 Personnel that arrange, negotiate, or execute
a purchase or sale conducted under the exemption
for trading activity of a foreign banking entity must
be located outside of the United States. Thus, for
example, personnel in the United States cannot
solicit or sell to or arrange for trades conducted
under this exemption. Personnel in the United
States also cannot serve as decision makers in
transactions conducted under this exemption.
Personnel that engage in back-office functions, such
as clearing and settlement of trades, would not be
considered to arrange, negotiate, or execute a
purchase or sale for purposes of this provision.
1520 The

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5655

States or organized under the laws of
the United States or of any State;
(iv) No financing for the banking
entity’s purchase or sale is provided,
directly or indirectly, by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; 1522
(v) The purchase or sale is not
conducted with or through any U.S.
entity,1523 other than:
(A) A purchase or sale with the
foreign operations of a U.S. entity, if no
personnel of such U.S. entity that are
located in the United States are
involved in the arrangement,
negotiation or execution of such
purchase or sale.
The Agencies believe it is appropriate
to exercise their exemptive authority
under section 13(d)(1)(J) to also allow,
under clause (vi) of the final rule, the
following types of purchases or sales
conducted with a U.S. entity:
(B) A purchase or sale with an
unaffiliated market intermediary acting
as principal,1524 provided the purchase
or sale is promptly cleared and settled
through a clearing agency or derivatives
clearing organization acting as a central
counterparty; or
(C) A purchase or sale through an
unaffiliated market intermediary,
provided the purchase or sale is
conducted anonymously (i.e. each party
to the purchase or sale is unaware of the
identity of the other party(ies) to the
purchase or sale) on an exchange or
similar trading facility and promptly
cleared and settled through a clearing
agency or derivatives clearing
organization acting as a central
counterparty.
The requirements are designed to
ensure that any foreign banking entity
engaging in trading activity under this
exemption does so in a manner that
ensures the risk, decision-making,
arrangement, negotiation, execution and
financing of the activity resides solely
outside the United States and limits the
risk to the U.S. financial system from
trades by foreign banking entities with
or through U.S. entities.
The final rule specifically recognizes
that, for purposes of the exemption for
1522 This provision is not intended to restrict the
ability of a U.S. branch or affiliate of a foreign
banking entity to provide funds collected in the
United States to its foreign parent for general
purposes.
1523 ‘‘U.S. entity’’ is defined for purposes of this
provision as any entity that is, or is controlled by,
or is acting on behalf of, or at the direction of, any
other entity that is, located in the United States or
organized under the laws of the United States or of
any State. See final rule § ll.6(e)(4).
1524 This provision would generally allow market
intermediaries to engage in market-making,
underwriting or similar market intermediation
functions.

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trading activity of a foreign banking
entity, a U.S. branch, agency, or
subsidiary of a foreign bank, or any
subsidiary thereof, is located in the
United States; however, a foreign bank
that operates or controls that branch,
agency, or subsidiary is not considered
to be located in the United States solely
by virtue of operation of the U.S.
branch, agency, or subsidiary.1525 This
provision helps give effect to the
statutory language limiting the foreign
trading exemption to activities of
foreign banking entities that occur
solely outside of the United States by
clarifying that the U.S. operations of
foreign banking entities may not
conduct proprietary trading based on
this exemption.
The Agencies have considered
whether the concerns raised by
commenters that the foreign operations
of U.S. banking entities would be
disadvantaged in competing outside the
United States warrant an exemption
under section 13(d)(1)(J) of the BHC Act
that extends to foreign operations of
U.S. banking entities. The
competitiveness of U.S. banking entities
outside the United States often
improves the potential for the
operations of U.S. firms outside the
United States to succeed and be
profitable, and thereby, often improves
the safety and soundness of the entity
and financial stability in the United
States.
However, Congress has determined to
generally prohibit U.S. banking entities
(including foreign branches and
subsidiaries thereof) from engaging in
proprietary trading because of the
perceived risks of those activities to
banking entities and the U.S.
economy.1526 Allowing U.S. banking
entities to conduct, through branches or
subsidiaries that are physically located
outside the United States, the same
proprietary trading activities those U.S.
firms are expressly prohibited from
conducting directly through their
operations located within the United
States would subject U.S. banking
entities and the U.S. economy to the
very risks section 13 is designed to
avoid. The risks of proprietary trading
would continue to be borne by the U.S.
banking entity whether the activity is
conducted by the U.S. banking entity
through units physically located inside
or outside of the United States.
final rule § ll.6(e)(5).
1526 See, e.g., 156 Cong. Rec. S5897 (daily ed. July
15, 2010) (statement of Sen. Merkley) (‘‘However,
these subparagraphs are not intended to permit a
U.S. banking entity to avoid the restrictions on
proprietary trading simply by setting up an offshore
subsidiary or reincorporating offshore, and
regulators should enforce them accordingly.’’).
1525 See

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Moreover, the robust trading markets
that exist overseas could allow U.S.
banking entities to shift their prohibited
proprietary trading activities to
branches or subsidiaries that are
physically located outside the United
States under such an exemption,
without achieving a meaningful
elimination of risk. Accordingly, the
Agencies have not exercised their
authority under section 13(d)(1)(J) at
this time to allow U.S. banking entities
to conduct otherwise prohibited
proprietary trading activities through
operations located outside the United
States. As a consequence, and consistent
with the statutory language and purpose
of section 13(d)(1)(H) of the BHC Act,
the final rule provides that the
exemption is available only if the
banking entity is not organized under,
or directly or indirectly controlled by a
banking entity that is organized under,
the laws of the United States or of one
or more States.1527
As discussed above, many
commenters requested that the final rule
permit a foreign banking entity to
engage in proprietary trading
transactions with a greater variety of
counterparties, including counterparties
that are located in or organized and
incorporated under the laws of the
United States or of one or more
States.1528 These commenters also
requested that the final rule not require
that any purchase or sale under the
exemption be executed wholly outside
of the United States.
As described above and in response to
commenters’ concerns, the final rule
provides that a foreign banking entity
generally may engage in trading activity
under the exemption with U.S. entities,
provided the transaction is with the
foreign operations of an unaffiliated
U.S. firm (whether or not the U.S. firm
is a banking entity subject to section 13
of the BHC Act) and does not involve
any personnel of the U.S. entity that are
in the United States and involved in the
arrangement, negotiation, or execution
of the transaction. The Agencies have
also exercised their exemptive authority
under section 13(d)(1)(J) to allow foreign
banking entities to engage in a
transaction that is either through an
unaffiliated market intermediary and
executed anonymously on an exchange
or similar trading facility (regardless of
final rule § ll.6(e)(1)(i).
number of commenters also requested that
the foreign trading exemption permit proprietary
trading of foreign sovereign debt or similar
obligations of foreign governments. As discussed in
Part IV.A.5.b. of this SUPPLEMENTARY INFORMATION,
the final rule addresses banking entities’ ability to
engage in transaction in these types of instruments
in § ll.6(b).
1527 See
1528 A

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whether the ultimate counterparty is a
U.S. entity or not) or is executed with
a U.S. entity that is an unaffiliated
market intermediary acting as principal,
provided in either case that the
transaction is promptly cleared and
settled through a clearing agency or
derivatives clearing organization acting
as a central counterparty.
For purposes of the final rule, market
intermediary is defined as an
unaffiliated entity, acting as an
intermediary, that is: (i) A broker or
dealer registered with the SEC under
section 15 of the Exchange Act or
exempt from registration or excluded
from regulation as such; (ii) a swap
dealer registered with the CFTC under
section 4s of the Commodity Exchange
Act or exempt from registration or
excluded from regulation as such; (iii) a
security-based swap dealer registered
with the SEC under section 15F of the
Exchange Act or exempt from
registration or excluded from regulation
as such; or (iv) a futures commission
merchant registered with the CFTC
under section 4f of the Commodity
Exchange Act or exempt from
registration or excluded from regulation
as such.1529
These provisions of the final rule,
viewed as a whole, prevent the
exemption for trading of foreign banking
entities from weakening U.S. trading
markets and U.S. firms that are either
not subject to the provisions of section
13 or that conduct activities in
compliance with other parts of section
13. For instance, the final rule permits
a foreign banking entity to trade under
the exemption with the foreign
operations of a U.S. firm, so long as the
purchase or sale does not involve any
personnel of the U.S. firm who are
located in the United States and
involved in arranging, negotiating or
executing the trade.1530 Transactions
that occur outside of the United States
between foreign operations of U.S.
entities and foreign banking entities
improve access to and functioning of
liquid markets without raising the
concerns for increased risk to banking
entities in the U.S. that motivated
enactment of section 13 of the BHC Act.
The final rule permits a foreign banking
entity to engage in transactions with the
foreign operations of both U.S. nonbanking and U.S. banking entities.
Among other things, this approach will
ensure that the foreign operations of
1529 See final rule § ll.6(e)(5). For example,
under this definition, a bank that is exempt from
registration as a swap dealer under the de minimis
exception to swap dealer registration requirements
could be a market intermediary for transactions in
swaps. See 17 CFR 1.3(ggg)(4).
1530 See final rule § ll.6(e)(3)(v)(A).

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U.S. banking entities continue to be able
to access foreign markets.1531 The
language of the exemption expressly
requires that trading with the foreign
operations of a U.S. entity may not
involve the use of personnel of the U.S.
entity who are located in the United
States for purposes of arranging,
negotiating, or executing transactions.
Under the final rule, the exemption in
no way exempts the U.S. or foreign
operations of the U.S. banking entities
from having to comply with the
restrictions and limitations of section
13. Thus, the U.S. and foreign
operations of a U.S. banking entity that
is engaged in permissible market
making-related activities or other
permitted activities may engage in those
transactions with a foreign banking
entity that is engaged in proprietary
trading in accordance with the
exemption under § ll.6(e) of the final
rule. Importantly, the final rule does not
impose a duty on the foreign banking
entity or the U.S. banking entity to
ensure that its counterparty is
conducting its activity in conformance
with section 13 of the BHC Act and the
final rule. Rather, that burden is at all
times on each party subject to section 13
to ensure that it is conducting its
activities in accordance with section 13
and this implementing rule.
The final rule also permits, pursuant
to section 13(d)(1)(J), a foreign banking
entity to trade through an unaffiliated
market intermediary if the trade is
conducted anonymously on an
exchange or similar trading facility and
is promptly cleared and settled through
a clearing agency or derivatives clearing
organization.1532 Allowing foreign
banking entities to generally conduct
anonymous proprietary trades on U.S.
exchanges and similar anonymous
trading facilities allows these exchanges
and facilities—which are generally not
subject to section 13 and do not take the
risks section 13 is designed to address—
to serve the widest possible range of
counterparties. This prevents the
potential adverse impacts from possible
reductions in competitiveness of or
liquidity available on these regulated
exchanges and facilities, which could
also harm other U.S. market participants
who trade on these exchanges and
facilities. In addition, the Agencies
1531 The Agencies believe that this provision
should address commenters’ concerns that the
proposed rule could cause foreign banking entities
to avoid conducting business with U.S. firms
outside the United States or could incentivize
foreign market places to restrict access to U.S. firms.
See, e.g., RBC.
1532 Under the final rule, ‘‘anonymous’’ means
that each party to a purchase or sale is unaware of
the identity of the other party(ies) to the purchase
or sale. See final rule § ll.3(e)(1).

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recognize that anonymous trading on
exchanges and similar anonymous
trading facilities promotes transparency
and that prohibiting foreign banking
entities from trading on U.S. exchanges
and similar anonymous trading facilities
under this exemption would likely
reduce transparency for trading in U.S.
financial instruments. All of these
considerations support the Agencies’
exercise of their exemptive authority
under section 13(d)(1)(J) to allow such
trading by foreign banking entities.
The final rule requires that foreign
banking entities trade through an
unaffiliated market intermediary to
access a U.S. exchange or trading
facility in recognition that existing laws
and regulations generally require this
structure.1533 For purposes of this
exemption, an exchange would include,
unless the context otherwise requires,
any designated contract market, swap
execution facility, or foreign board of
trade registered with the CFTC, and any
exchange or security-based swap
execution facility, as such terms are
defined under the Exchange Act.1534
This provision of the final rule
requires that foreign banking entities
trade anonymously and that the trade be
centrally cleared and settled. The
Agencies understand that in these
circumstances, the foreign banking
entity would not have any prior
information regarding its counterparty
to the trade. Requiring that the trade be
executed anonymously preserves the
benefits of allowing U.S. entities to
participate in such trades, while
reducing the potential for evasion of
section 13 that could occur if foreign
banking entities directly arranged
purchases and sales with U.S.
entities.1535 The final rule specifies that
a trade is anonymous if each party to the
purchase or sale is unaware of the
identity of the other party(ies) to the
purchase or sale. That is, it is lack of
knowledge of the identity of the
counteryparty(ies) to the trade that is
relevant. The final rule does not
prohibit foreign banking entities from
accessing a trading facility through an
1533 See, e.g., 15 U.S.C. 78f(c)(1) (providing that
a national securities exchange shall deny
membership to (A) any person, other than a natural
person, which is not a registered broker or dealer
or (B) any natural person who is not, or is not
associated with, a registered broker or dealer).
1534 See final rule § ll.3(e)(6) (defining the term
‘‘exchange’’). The rule refers to an ‘‘exchange or
similar trading facility.’’ A similar trading facility
for these purposes may include, for example, an
alternative trading system.
1535 In addition, allowing a foreign banking entity
to trade directly with a U.S. end user customer
under the foreign trading exemption could give the
foreign banking entity a competitive advantage over
U.S. banking entities with respect to trading in the
United States.

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5657

unaffiliated U.S. market intermediary
(which the foreign banking entity would
necessarily know), so long as the foreign
banking entity is not aware of the
identity of the counterparty to the
transaction.
Similarly, also pursuant to section
13(d)(1)(J), the final rule allows a foreign
banking entity to trade with an
unaffiliated market intermediary acting
in a principal capacity and effecting a
market intermediation function, in a
transaction that is not conducted on an
exchange or similar anonymous trading
facility, as long as the trade is promptly
cleared and settled through a clearing
agency or derivatives clearing
organization. This provision recognizes
that not all financial instruments are
traded on an exchange or similar
anonymous trading facility and, thus,
allows foreign banking entities to trade
and contribute to market liquidity in all
types of U.S. financial instruments
without requiring separate market
infrastructure to be developed outside
the U.S. for such trading activity, which
could result in inefficiencies and reduce
U.S. market liquidity. Market
intermediaries can serve the same
general purpose as exchanges or similar
trading facilities in intermediating
between buyers and sellers, particularly
in asset classes that do not generally
trade on these exchanges or facilities,
although this intermediation function
may not be as immediate in the case of
market intermediaries.
In either case (i.e., for either an
anonymous trade or a trade with an
unaffiliated market intermediary), if the
U.S. counterparty to the transaction is a
banking entity subject to section 13 and
these rules, it must comply with an
exemption to the prohibition on
proprietary trading, such as the marketmaking exemption or the exemption for
riskless principal transactions. Allowing
foreign banking entities to trade with
unaffiliated U.S. market intermediaries,
including banking entities engaged in
permitted market making-related
activities, expands the range of potential
buyers and sellers for which the U.S.
entities can trade and may result in
more efficient and timely matching of
trades, reducing inventory risks to the
U.S. market intermediary. At the same
time, this exemption does not permit a
U.S. market intermediary that is subject
to section 13 of the BHC Act to conduct
trading activities other than in
compliance with the provisions of
section 13. Thus, the Agencies believe it
is appropriate to allow foreign banking
entities to conduct such trading under
the exemption in section 13(d)(1)(J).
To reduce risks to U.S. entities and
the potential for evasion, the provisions

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allowing trading with U.S. entities
include two additional protections.
First, the final rule does not allow a
foreign banking entity to trade through
an affiliated U.S. entity under the
exemption out of concern that it could
increase the risk of evasion.1536 Second,
a foreign banking entity’s trades
conducted through an unaffiliated
market intermediary on an exchange or
conducted directly with an unaffiliated
market intermediary must be promptly
cleared and settled through a clearing
agency or derivatives clearing
organization acting as central
counterparty. Consistent with the goals
of section 13 to reduce risk to banking
entities and the U.S. financial system,
this requirement is designed to reduce
risk to U.S. entities arising from foreign
banking entities’ proprietary trading
activity, particularly counterparty risk,
and preclude foreign banking entities
from relying on the exemption for
trading that creates exposure of U.S.
counterparties pursuant to bilateral,
uncleared transactions, which poses
heightened counterparty credit risks.1537
This condition is also consistent with
the systemic risk benefits of central
clearing and may incentivize the use of
central clearing for trading by foreign
banking entities and foreign affiliates of
U.S. banking entities. The Agencies
believe this approach is consistent with
and reinforces the goals of the central
clearing framework of Title VIII of the
Dodd-Frank Act.
The final rule does not allow a foreign
banking entity to trade with a broader
range of U.S. entities under the
exemption because the Agencies are
concerned such an approach may result
in adverse competitive impacts between
U.S. banking entities and foreign
banking entities with respect to their
trading in the United States, which
1536 In addition, allowing a foreign banking entity
to trade through or with a U.S. affiliate under the
exemption for trading activity of a foreign banking
entity could give the foreign banking entity a
competitive advantage over U.S. banking entities
that are subject to limitations on their trading
activities. Thus, the Agencies are not permitting a
foreign banking entity to trade through a U.S.
affiliate as agent, as requested by some commenters.
See, e.g., IIB/EBF. However, the Agencies recognize
that, with respect to trading anonymously, there is
no way to know the identity of the counterparty to
the trade. Thus, a foreign banking entity would not
be in violation of this rule if it traded through an
unaffiliated market intermediary on an exchange, in
accordance with the exemption for trading activity
of a foreign banking entity, and the counterparty to
its trade happened to be an affiliated entity.
1537 As discussed above, centralized clearing
redistributes counterparty risk among members of a
clearing agency or derivatives clearing organization
through mutualization of losses, reducing the
likelihood of sequential counterparty failure and
contagion. See supra note 266 and accompanying
text.

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could harm the safety and soundness of
banking entities and U.S. financial
stability. For example, such an approach
could allow foreign banking entities to
act as market makers for U.S. customers
under the exemption in § ll.6(e) of
the final rule so long as the foreign
banking entity held the risk of its
market-making trades outside the
United States. In turn, this could give
foreign banking entities a competitive
advantage over U.S. banking entities
with respect to U.S. market-making
activities because foreign banking
entities could trade directly with U.S.
non-banking entities without incurring
the additional costs, or being subject to
the limitations, associated with the
market-making or other exemptions
under the rule. This competitive
disparity in turn could create a
significant potential for regulatory
arbitrage. The Agencies do not believe
this result was intended by the statute.
Instead, the final rule seeks to alleviate
the concern that an overly broad
approach to the exemption (e.g.,
permitting trading with all U.S.
counterparties) may result in
competitive impacts and increased risks
to the U.S. financial system, while
mitigating the concern that an overly
narrow approach to the exemption (e.g.,
prohibiting trading with any U.S.
counterparty) may cause market
bifurcations, reduce the efficiency and
liquidity of markets, and harm U.S.
market participants.

Section ll.8 of the proposed rule
implemented section 13(d)(2) of the
BHC Act,1538 which provides that a
banking entity may not engage in certain
exempt activities (e.g., permitted market
making-related activities, risk-mitigating
hedging, etc.) if the 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.1539 The Agencies sought
comment on proposed definitions of the

terms ‘‘material conflict of interest,’’
‘‘high-risk asset,’’ and ‘‘high-risk trading
strategy’’ for these purposes.
With respect to general comments
regarding the proposed rule,
commenters generally agreed on the
need to limit banking entities’
proprietary trading activities so as to
avoid material conflicts of interest and
material exposures to high-risk trading
strategies and high-risk assets.1540 One
commenter expressed support for the
Agencies’ proposed approach, stating
that the proposed rule was clear and
structured in such a manner so that it
should remain effective even as
financial markets evolve and
change.1541 As discussed in greater
detail below, most commenters
suggested amendments, clarification, or
alternative approaches. For example,
some commenters expressed concern
regarding the application of the
prudential backstops to the activities of
foreign banking entities.1542 The
Agencies did not receive any comments
on the prohibition against transactions
or activities that pose a threat to the
safety or soundness of the banking
entity or the financial stability of the
United States.
As explained in detail below, the
Agencies have carefully reviewed
comments on the proposed rule’s
implementation of the prudential
backstops under section 13(d)(2) of the
BHC Act, including commenters’
suggestions for expanding, contracting,
or revising the proposed rule. After
carefully considering these comments,
the Agencies continue to believe the
expansive scope of section 13 of the
BHC Act supports a similarly inclusive
approach focusing on the facts and
circumstances of each potential conflict
or high-risk activity. Therefore, and in
consideration of all issues discussed
below, the Agencies are adopting the
final rule substantially as proposed.1543
The Agencies intend to develop
additional guidance regarding best
practices for addressing potential
material conflicts of interest, high-risk
assets and trading strategies and
practices that pose significant risks to
safety and soundness and to the U.S.
financial system as the Agencies and
banking entities gain experience with
implementation of the requirements and

1538 Section ll.8 of the proposed rule regarding
limitations on permitted trading activities is
consistent with § ll.17 of the proposed rule
regarding other limitations on permitted covered
funds activities. Accordingly, the discussion
regarding proposed rule § ll.8 and final rule
§ ll.7 in this part also pertain to § ll.17 of the
proposed rule and § ll.16 of the final rule. See
also Part IV.B.6., infra.
1539 See 12 U.S.C. 1851(d)(2).

1540 See, e.g., Sens. Merkley & Levin (Feb. 2012);
Public Citizen; Paul Volcker.
1541 See Alfred Brock.
1542 See IIB/EBF; Ass’n. of German Banks.
1543 The Agencies note that proposed Appendix
C, which required banking entities to describe how
they comply with these provisions, will be adopted
as Appendix B with similar requirements regarding
compliance with the limitations on permitted
activities.

9. Section ll.7: Limitations on
Permitted Trading Activities

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
limitations in section 13 of the BHC Act
and this rule, which are all generally
designed to limit risky behavior in
trading and investment activities.
a. Scope of ‘‘Material Conflict of
Interest’’

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1. Proposed Rule
Section ll.8(b) of the proposed rule
defined the scope of material conflicts
of interest which, if arising in
connection with a permitted trading
activity, were prohibited under the
proposal.1544 As noted in the proposal,
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.1545 In all cases, the
existence of a material conflict of
interest depends on the specific facts
and circumstances.1546
To address these types of material
conflicts of interest, § ll.8(b) of the
proposed rule specified 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
1544 Section ll.17(b) of the proposed rule
defined the scope of material conflicts of interest
which, if arising in connection with permitted
covered fund activities, are prohibited.
1545 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.
1546 See Joint Proposal, 76 FR 68,893.

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involve or result in the banking entity’s
interests being materially adverse to the
interests of its client, customer, or
counterparty with respect to such
transaction, class of transactions, or
activity, unless the banking entity has
appropriately addressed and mitigated
the conflict of interest, and subject to
specific requirements provided in the
proposal, through either (i) timely and
effective disclosure, or (ii) information
barriers.1547 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 §§ ll.4
through ll.6 of the proposed rule.1548
However, the Agencies determined
that 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,
derivatives, and banking laws and
regulations.
Section ll.8(b)(1) of the proposed
rule described 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, § ll
.8(b)(1)(A)(i) of the proposed rule
required 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.
This would also require such disclosure
to be provided in reasonable detail and
in a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest.1549
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
proposed rule § ll.8(b)(1).
Joint Proposal, 76 FR 68,893.
1549 See id.
1547 See

standard. Second, § ll.8(b)(1)(ii) of
the proposed rule required 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.1550
The Agencies noted 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 a
particular transaction, such that the
client, customer, or counterparty is
unlikely to take that disclosure into
account when evaluating the
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
reflected 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.
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

1548 See

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1550 See

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Agencies note that the proposed
disclosure provisions were provided
solely for purposes of the proposed
rule’s definition of material conflict of
interest, and did 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 ll.8(b)(2) of the proposed
rule described 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.1551
1551 See, e.g., 15 U.S.C. 78c(a)(4)(B)(i)(I)–(IV)
(finding that disclosure and physical separation of
personnel and activities addresses the potential that
consumers might be misled by the broker-dealer
activities of banks). 15 U.S.C. 80b–6(3) (‘‘It shall be
unlawful for any investment adviser, by use of the
mails or any means or instrumentality of interstate
commerce, directly or indirectly . . . acting as
principal for his own account, knowingly to sell
any security to or purchase any security from a
client, or acting as broker for a person other than
such client, knowingly to effect any sale or
purchase of any security for the account of such
client, without disclosing to such client in writing
before the completion of such transaction the
capacity in which he is acting and obtaining the
consent of the client to such transaction.’’). See also
Form ADV, the form used by investment advisers
to register with the Securities and Exchange
Commission and state securities authorities, and, in
particular, Form ADV Part 2: Uniform Requirements
for the Investment Adviser Brochure and Brochure
Supplements. A registered investment adviser
generally must deliver the Form ADV brochure,
which contains disclosure about conflicts of
interest, to its prospective and existing clients. See

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In order to address and mitigate a
conflict of interest through the use of
the information barriers pursuant to
§ ll.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. Importantly,
the proposed rule also provided 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 complied with the
requirements of proposed § ll
.8(b)(1).1552 This aspect of the proposal
was 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
through timely and effective disclosure
under the proposal.1553
The proposed definition of material
conflict of interest did not address
instances in which a banking entity has
made a material misrepresentation to its
client, customer, or counterparty in
17 CFR 275.204–3; Amendments to Form ADV,
Investment Advisers Act Release No. 3060 (July 28,
2010), 75 FR 49234 (Aug. 12, 2010) (‘‘We are
adopting a requirement that investment advisers
registered with us provide prospective and existing
clients with a narrative brochure written in plain
English . . . We believe these amendments will
greatly improve the ability of clients and
prospective clients to evaluate firms offering
advisory services and the firms’ personnel, and to
understand relevant conflicts of interest that the
firms and their personnel face and their potential
effect on the firms’ services.’’).
1552 See proposed rule § ll.8(b)(2).
1553 See Joint Proposal, 76 FR 68,894.

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connection with a transaction, class of
transactions, or activity, as such
transactions or activity appears to
involve fraud rather than a conflict of
interest. This is because such
misrepresentations are generally illegal
under a variety of Federal and State
regulatory schemes (e.g., the Federal
securities laws).1554 In addition, the
Agencies noted 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.
2. Comments on the Proposed
Limitation on Material Conflicts of
Interest
Commenters expressed a variety of
views regarding the treatment of
material conflicts of interest under the
proposal, including the manner in
which conflicts may be mitigated or
eliminated. One commenter believed
that the proposed material conflict of
interest provisions would be
effective.1555 Another commenter stated
that conflicts of interest were
unavoidable but that the final rule
should ensure that institutional
investors have confidence that the
banking entities they are dealing with
are not operating at a conflict with
investors’ goals.1556
Other commenters expressed differing
views on whether the proposed rule’s
provisions for addressing conflicts of
interest through disclosure or
information barriers were appropriate. A
few commenters stated there is no
statutory basis for allowing conflicts of
interest in connection with exempted
activities even if banking entities
provide disclosure or establish
information barriers, and the rule
should prohibit banking entities from
engaging in permitted activities if
material conflicts of interest exist.1557
One commenter believed the definition
did not appear to address issues of
customer favoritism, in which a bank is
financially incentivized to treat one
customer more favorably than another
(typically less sophisticated)
customer.1558 Some commenters
believed that the proposed definition of
material conflict of interest was too
vague or narrow and suggested it should
be strengthened by either expanding the
types of transactions that may result in
1554 See

12 U.S.C. 1851(g)(3).
Alfred Brock.
1556 See Paul Volcker.
1557 See Public Citizen; Sens. Merkley & Levin;
Occupy; AFR et al. (Feb. 2012).
1558 See Public Citizen.
1555 See

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a material conflict of interest or by
imposing additional limitations or
restrictions on transactions.1559 For
instance, one commenter suggested the
final rule consider depositors of a
banking entity to be ‘‘customers’’ for the
purpose of this provision, impose a
fiduciary duty on any banking entity
conducting an exempt activity pursuant
to section 13(d)(1) of the BHC Act, and
impose size restrictions on any banking
entity engaging in proprietary trading
under an exemption. This commenter
also stated that a banking entity
inherently has a material conflict of
interest with its customer when it takes
the opposite side of a transaction and,
therefore, that the final rule should
require a banking entity to disgorge all
principal gains from transactions
conducted pursuant to any exemption
under section 13(d)(1) of the BHC Act,
including market-making, trading in
U.S. government obligations, insurance
company activities and other exempt
activities.1560 In addition, a few
commenters stated that, if disclosure or
information barriers were permitted to
mitigates conflicts under the final rule,
clients of the banking entity must be
required to acknowledge in writing that
they understand the potential conflicts
of interest present in order for any
disclosure to be effective in mitigating a
conflict of interest.1561
Some commenters believed that the
Agencies should consider issuing
additional guidance regarding the
definition of material conflicts of
interest, high-risk assets, and high-risk
trading strategies.1562 One commenter
stated that the final rule should limit the
extraterritorial impact of section 13 by
only applying the restrictions of section
13(d)(2) of the BHC Act to the U.S.
operations or activities of foreign
banking entities and that the regulation
of safety and soundness of the foreign
operations and activities of foreign
banking entities should be left to the
home country regulator or supervisor of
a foreign banking entity.1563
Some commenters provided general
suggestions on enhancing compliance
with the prohibition on material
conflicts of interest. A common
suggestion among industry participants
was to implement the prohibition on
material conflicts of interest under these
rules in a manner consistent with the
implementation of section 621 of Dodd1559 See, e.g., Occupy; AFR et al. (Feb. 2012);
Sens. Merkley & Levin (Feb. 2012).
1560 See Occupy.
1561 See, e.g., Lynda Aiman-Smith; AFR et al.
(Feb. 2012); Sens. Merkley & Levin (Feb. 2012).
1562 See Rep. Blumenauer et al.; Sens. Merkley &
Levin (Feb. 2012).
1563 See IIB/EBF; EBF.

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Frank.1564 One commenter suggested
that trading in government obligations
should not be subject to the material
conflict of interest provision because
government obligations are broadly
traded and do not present the types of
conflicts addressed by the proposed
rule.1565 In contrast, one commenter
stated banking entities should be
required to receive pre-trade clearance
from the Federal Reserve for trading in
certain government obligations like
municipal bonds and mortgage-backed
securities, due to their role in the 2008
financial crisis.1566
a. Disclosure
Some commenters expressed concern
about potential difficulties associated
with the proposed disclosure provision
and provided suggestions to address
these difficulties. For example, a few
commenters noted the difficulty in
determining what constitutes effective
disclosure,1567 especially in relation to
the volume of disclosure or the impact
of information asymmetry in illiquid
markets.1568 One commenter stated that
unless the rule requires full disclosure
of a banking entity’s trading strategy and
the rationale behind it, allowing
disclosure will permit the banking
entity to protect itself without
adequately mitigating the harm of the
conflict. This commenter also noted the
practical difficulties associated with
disclosing anticipated future conflicts
and conflicts in the context of block
trading.1569 Another commenter stated
market participants understand inherent
conflicts of interest and believed
disclosure in such situations would be
burdensome and unnecessary.1570 One
commenter stated that the rule should
require a banking entity to negate, not
just permit the client, customer, or
counterparty to substantially mitigate,
the materially adverse effect of the
conflict.1571
A few commenters disagreed with the
disclosure provision, noting that
Congress specifically considered and
rejected disclosure as a mitigation
method for purposes of section 621 of
the Dodd-Frank Act and that this
indicates the Agencies should not
1564 See ASF (Conflicts) (Feb. 2012); SIFMA et al.
(Prop. Trading) (Feb. 2012); SIFMA (Securitization)
(Feb. 2012); LSTA (Feb. 2012); Sens. Merkley &
Levin (Feb. 2012).
1565 See BDA (Feb. 2012).
1566 See Occupy.
1567 See Occupy; ISDA (Apr. 2012); Better
Markets (Feb. 2012); SIFMA et al. (Prop. Trading)
(Feb. 2012); ICFR.
1568 See Occupy.
1569 See Public Citizen; See also AFR et al. (Feb.
2012).
1570 See SIFMA et al. (Prop. Trading) (Feb. 2012).
1571 See Occupy.

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5661

permit a material conflict of interest to
be mitigated through disclosure for
purposes of section 13 of the BHC
Act.1572
Commenters were in disagreement as
to the extent and timing of disclosure
that should be required under the rule.
Some commenters stated the disclosure
provisions would slow trading, and
suggested the rule require only one-time
disclosure at the inception of the
business relationship1573 thnsp; or
periodic disclosures to address ongoing
conflicts.1574 One of these commenters
noted that extensive trade-by-trade
disclosure requirements create the risk
of unintended breaches of
confidentiality.1575 Other commenters
requested the Agencies provide
additional guidance, such as when
transaction-specific disclosure is
necessary,1576 whether disclosure
should be written,1577 and what
constitutes ‘‘reasonable detail.’’ 1578
In addition, some commenters
provided suggestions on whether parties
should be required to acknowledge
receipt of disclosures 1579 or
affirmatively consent to the conflict.1580
One commenter proposed allowing a
majority of a committee of independent
board members to approve consent to
waivers of conflicts of interest.1581 One
commenter believed disclosure and
consent by a sophisticated investor
ought to be sufficient to serve as a
waiver to most types of conflict of
interest.1582 In contrast, another
commenter asserted general disclosure
or waivers of conflicts should never be
allowed, and the Agencies should not
provide any additional guidance as to
the extent, timing, frequency, or scope
of disclosure appropriate in any given
situation.1583 Similarly, one commenter
asserted the Agencies should not
provide guidance on what issues can be
addressed by disclosure, as such
guidance would be ‘‘dangerously
1572 See,

e.g, Occupy.
ISDA (Apr. 2012); Arnold & Porter.
1574 See SIFMA et al. (Prop. Trading) (Feb. 2012);
ISDA (Apr. 2012).
1575 See ISDA (Apr. 2012).
1576 See SIFMA et al. (Prop. Trading) (Feb. 2012).
1577 See Sens. Merkley & Levin (Feb. 2012); ICFR
(questioning the effectiveness of enforcement
mechanisms if oral disclosure permitted under the
rule); Occupy.
1578 See ICFR.
1579 See, e.g., Arnold & Porter; Sens. Merkley &
Levin (Feb. 2012); Better Markets (Feb. 2012);
Public Citizen; AFR et al. (Feb. 2012); Lynda
Aiman-Smith.
1580 See Public Citizen; Sens. Merkley & Levin
(Feb. 2012); Better Markets (Feb. 2012).
1581 See Arnold & Porter.
1582 See Arnold & Porter.
1583 See Alfred Brock (stating there is no such
thing as a ‘‘sophisticated party’’).
1573 See

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prescriptive and would introduce moral
hazards.’’ 1584
Information Barriers
A few commenters addressed the
information barriers provision of the
proposed rule. One commenter
expressed support for the proposed
approach,1585 while three commenters
stated this provision was ineffective.1586
A few commenters opposed the
information barriers provision because
they believed information barriers
would make conflict mitigation more
difficult 1587 or would effectively
mandate that no single officer be aware
of a banking entity’s collective
operations.1588
A few commenters also requested the
Agencies provide guidance regarding
the use of information barriers. One
commenter requested the Agencies
specify the type and nature of
information barriers and where they are
practical to implement.1589 Another
commenter believed that the Agencies
should view information barriers
favorably. This commenter stated that
information barriers should be
permitted for addressing conflicts of
interest unless the banking entity
knows, or should reasonably know, that
the information barrier would not be
effective in restricting the spread of
information that could lead to the
conflict.1590 To provide greater clarity,
another commenter recommended the
Agencies provide guidance on certain
elements that may be used to determine
the reasonableness of information
barriers, such as memorialization of
procedures and documentation of
actions taken pursuant to such
procedures.1591
3. Final Rule
After considering carefully comments
received on the proposal as well as the
purpose and language of section 13 of
the BHC Act, the Agencies have adopted
the final rule largely as proposed. Under
the final rule, a banking entity that
engages in any transaction, class of
transactions, or activity that would
involve or result in the banking entity’s
1584 See

ICFR.
Alfred Brock.
1586 See Better Markets (Feb. 2012); Occupy;
Public Citizen.
1587 See Occupy.
1588 See Public Citizen (contending that this
would undermine the Dodd-Frank Act’s
requirement to promote sound management, ensure
financial stability, and reduce systemic risk).
1589 See AFR et al. (Feb. 2012).
1590 See SIFMA et al. (Prop. Trading) (Feb. 2012).
1591 See ISDA (Apr. 2012) (arguing that its
suggested guidance was derived from prior SEC and
self-regulatory organization guidance on
information barriers).

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1585 See

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interests being materially adverse to the
interests of its client, customer, or
counterparty with respect to the
transaction, class of transactions, or
activity, must address and mitigate the
conflict of interest, where possible,
through either timely and effective
disclosure or informational barriers.1592
This requirement is in addition to, and
does not supplant, any limitations or
prohibitions contained in other laws.
For example, a material
misrepresentation by a banking entity to
its client, customer, or counterparty in
connection with market-making
activities may involve fraud and is
generally illegal under a variety of
Federal and State regulatory schemes
(e.g., the Federal securities laws) 1593 as
well as being prohibited under section
13 of the BHC Act.
The Agencies believe that certain of
commenters’ suggested modifications to
the proposed rule are outside the scope
of the Agencies’ statutory authority. For
example, the Agencies do not believe
section 13 of the BHC Act provides
statutory authority to directly impose
limits on the size of banking entities 1594
or to implement specific fiduciary
standards on banking entities.1595 In
addition, the Agencies do not believe it
is appropriate to expand the definition
of ‘‘customer’’ to include individuals
and entities that solely make use of the
bank’s traditional banking services
because section 13 is focused on the
trading activities and investment in
which banking entities may be
involved.1596
The final rule recognizes that a
banking entity may address or
substantially mitigate a potential
conflict of interest by making adequate
disclosures or creating and enforcing
informational barriers. Some
commenters argued that the legislative
history of the Dodd-Frank Act suggests
that disclosure or informational barriers
are not adequate to address a material
1592 The Agencies note that the definition of
material conflict of interest and the disclosure
provisions related to that definition apply solely for
purposes of the 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).
1593 See 12 U.S.C. 1851(g)(3).
1594 See Occupy.
1595 See Occupy.
1596 See Occupy.

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conflict of interest.1597 However, section
13 of the BHC Act directs the Agencies
to define ‘‘material conflict of interest’’
and gives the Agencies discretion to
determine how to define this term for
purposes of the rule. Under the final
rule, a material conflict of interest exists
when the banking entity engages in
transactions or activities that cause its
interests to be materially adverse to the
interests of its client, customer, or
counterparty. At the same time, the final
rule provides banking entities the
opportunity to take certain actions to
address the conflict, such that the
conflict does not have a materially
adverse effect on that client, customer,
or counterparty. Under the final rule, a
banking entity may address a conflict by
establishing, maintaining, and enforcing
information barriers reasonably
designed to avoid a conflict’s materially
adverse effect, or by disclosing the
conflict in a manner that allows the
client, customer, or counterparty to
substantially mitigate or negate any
materially adverse effect created by the
conflict of interest. The Agencies
believe that, to the extent the materially
adverse effect of a conflict has been
substantially mitigated, negated, or
avoided, it is appropriate to allow the
transaction, class of transaction, or
activity under the final rule. Continuing
to view the conflict as a material
conflict of interest under these
circumstances would not appear to
benefit the banking entity’s client,
customer, or counterparty. The
disclosure standard under the final rule
requires clear and meaningful
information be provided to the client,
customer, or counterparty in a manner
that provides such party the opportunity
to negate or substantially mitigate, any
materially adverse effects on such party
created by the conflict.
Some commenters suggested that
obtaining consent to or waiver of
disclosed conflicts should be sufficient
to comply with the rule.1598 The
Agencies do not believe that consent or
waivers alone are sufficient to address
material conflicts of interest, and
continue to believe that any banking
entity using disclosure to address a
conflict of interest should be required to
provide any client, customer, or
counterparty with whom the banking
entity has a conflict with the
opportunity to negate or substantially
mitigate the materially adverse effect of
the conflict on the client, customer, or
counterparty. The Agencies believe this
approach, which applies equally to all
1597 See Public Citizen; Sens. Merkley & Levin
(Feb. 2012); Occupy; AFR et al. (Feb. 2012).
1598 See, e.g., Arnold & Porter.

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types of clients, customers, or
counterparties, will reduce the potential
for unintended or differing impacts on
certain types of clients, customers, or
counterparties. In response to one
commenter’s suggestion that the final
rules require full negation of the
materially adverse effect on the client,
customer, or counterparty, the Agencies
continue to believe it is appropriate to
allow a transaction or activity to
continue if the client, customer, or
counterparty is provided an opportunity
to substantially mitigate the materially
adverse effect.1599 The Agencies are
concerned that requiring the conflict’s
impact to be fully negated under all
circumstances could prevent a banking
entity from providing a service to a
particular customer despite that
customer’s knowledge of the conflict
and ability to substantially reduce the
effect of the conflict on that customer.
With regards to commenters’
statements that information barriers and
disclosure will not work to address the
harm caused by conflicts, the Agencies
emphasize that under the final rule, like
the proposed rule, a banking entity may
use disclosure or information barriers to
address a conflict only in those
instances where the disclosure provides
the client, customer, or counterparty
with the opportunity to negate or
substantially mitigate any materially
adverse effect of the conflict on that
entity or the information barriers are
reasonably designed to prevent the
conflict of interest from involving or
resulting in a materially adverse effect
on a client, customer, or counterparty. If
the banking entity is unable to
effectively use disclosure or information
barriers in a way that meets the rule’s
requirements, then the banking entity is
prohibited from engaging in the
conflicted transaction, class of
transaction, or activity. Additionally,
the Agencies note that the material
conflict of interest provisions in the
final rule do not preempt any duties
owed to parties outside the transaction,
including any duty of
confidentiality.1600
In response to commenters’
statements that the volume of
information included in a disclosure or
the manner in which the disclosure is
presented may make it difficult for a
customer to identify and understand the
relevant information regarding the
conflict,1601 the Agencies note that the
1599 See

Occupy.
ISDA (Apr. 2012).
1601 See Better Markets (Feb. 2012) (suggesting
that a disclosure regime can facilitate abuse by
enabling market participants to point to obscure
and meaningless disclosure as a shield against
liability); Occupy (arguing that a large volume of
1600 See

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final rule requires disclosure of the
conflict or potential conflict be clear,
timely, and effective and that the
disclosure includes any other necessary
information. Disclosure is also required
to be provided in reasonable detail and
in a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest.1602
Thus, disclosure that is only general or
generic, 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, or that is hidden in
a large volume of needless information
would not meet this standard. The
Agencies believe these provisions of the
final rule are designed to ensure that
customers receive sufficient information
about the conflict of interest so that they
are well informed and, as required by
the rule, able to negate or substantially
mitigate any materially adverse effect of
the conflict.
In addition to requiring that
customers are provided with detailed
information about the conflict, the final
rule, like the proposal, requires that
disclosure is made prior to effecting the
specific transaction or class or type of
transactions, or engaging in the specific
activity, for which a conflict may arise
and is otherwise timely. As a result,
under § ll.7(b)(2)(i), disclosure must
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 take steps that would negate or
substantially mitigate the conflict. This
approach is similar to the approach
permitted by a variety of consumer
protection statutes and regulations for
addressing potential conflicts of interest
in consumer transactions.1603
disclosed information can be difficult to understand
or can serve to hide relevant information).
1602 See final rule § ll.7(b)(1)(i) and final rule
§ ll.16(b)(1)(i).
1603 See, e.g., 15 U.S.C. 78c(a)(4)(B)(i)(I)–(IV)
(finding that disclosure and physical separation of
personnel and activities addresses the potential that
consumers might be misled by the broker-dealer
activities of banks); 15 U.S.C. 80b–6(3) (‘‘It shall be
unlawful for any investment adviser, by use of the
mails or any means or instrumentality of interstate
commerce, directly or indirectly . . . acting as
principal for his own account, knowingly to sell
any security to or purchase any security from a
client, or acting as broker for a person other than
such client, knowingly to effect any sale or
purchase of any security for the account of such
client, without disclosing to such client in writing
before the completion of such transaction the
capacity in which he is acting and obtaining the
consent of the client to such transaction.’’). See also
Form ADV, the form used by investment advisers
to register with the Securities and Exchange

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Some commenters requested that the
final rule permit a conflict to be negated
or substantially mitigated through
generic or periodic disclosures, such as
at the beginning of a trading
relationship or on an annual basis.
Other commenters stated that some
conflicts, such as anticipated future
conflicts or those that arise in the
context of block trading, may require the
banking entity to provide disclosure in
advance of the actual conflict in order
to allow the client, customer, or
counterparty the opportunity to mitigate
the materially adverse effect.1604 The
Agencies emphasize, however, that
disclosure provided far in advance of a
particular transaction, such that the
client, customer, or counterparty is
unlikely to take that disclosure into
account when evaluating the
transaction, would not suffice. At the
same time, 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 be permissible
disclosure under the final rules. The
Agencies believe that, in considering the
effectiveness of disclosures, the type,
timing and frequency of disclosures
depends significantly on the customer
relationship, the type of transaction, and
the matter that creates the potential
conflict. Therefore, while written
disclosures may be appropriate in
certain circumstances, the Agencies are
not requiring banking entities to provide
written disclosure,1605 or obtain
documentation showing that disclosure
was received,1606 because the Agencies
believe it is more important that
disclosure is timely than documented.
For example, if disclosure were required
Commission and state securities authorities, and, in
particular, Form ADV Part 2: Uniform Requirements
for the Investment Adviser Brochure and Brochure
Supplements. A registered investment adviser
generally must deliver the Form ADV brochure,
which contains disclosure about conflicts of
interest, to its prospective and existing clients. See
17 CFR 275.204–3; Amendments to Form ADV,
Investment Advisers Act Release No. 3060 (July 28,
2010), 75 FR 49234 (Aug. 12, 2010) (‘‘We are
adopting a requirement that investment advisers
registered with us provide prospective and existing
clients with a narrative brochure written in plain
English . . . We believe these amendments will
greatly improve the ability of clients and
prospective clients to evaluate firms offering
advisory services and the firms’ personnel, and to
understand relevant conflicts of interest that the
firms and their personnel face and their potential
effect on the firms’ services.’’).
1604 See Public Citizen; See also AFR et al. (Feb.
2012).
1605 See Sens. Merkley & Levin (Feb. 2012); ICFR;
Occupy; Alfred Brock.
1606 See, e.g., Arnold & Porter; Sens. Merkley &
Levin (Feb. 2012); Better Markets (Feb. 2012);
Public Citizen; AFR et al. (Feb. 2012); Lynda
Aiman-Smith.

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to be in writing, this might slow a
banking entity’s ability to provide the
disclosure to the relevant customer,
which could impede the customer’s
ability to consider the disclosed
information and take steps to negate or
substantially mitigate the conflict’s
effect on the customer. The Agencies
further note that the final rule does 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.
As noted above, one commenter
expressed concern about the burdens of
disclosing inherent conflicts and stated
such disclosure is unnecessary because
market participants understand inherent
conflicts of interest.1607 As noted in the
proposal, certain inherent conflicts,
such as 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 permitted activities.1608
The Agencies continue to believe that
information barriers can be an effective
means of addressing conflicts of interest
that may arise through, for example, the
spread of information among trading
desks engaged in different trading
activities that may result in potentially
inappropriate informational advantage.
The Agencies are not adopting one
commenter’s suggestion that the final
rule specify the particular types of
scenarios where information barriers
may be effective 1609 because, as
discussed below, the Agencies believe
banking entities are better positioned to
determine when information barriers
may be effective given their trading
activities and business structure.1610 In
response to one commenter’s concern
that information barriers may result in
the banking entity’s management not
being aware of the firm’s collective
operations,1611 the Agencies note that
1607 See SIFMA et al. (Prop. Trading) (Feb. 2012);
but See Occupy.
1608 See Joint Proposal, 76 FR 68,893. Thus, the
Agencies are not adopting one commenter’s
suggestion that the final rule consider all
transactions by a banking entity to involve a
material conflict of interest because the banking
entity is necessarily on the opposite side of a
transaction with its client, customer, or
counterparty. See Occupy.
1609 See SIFMA et al. (Prop. Trading) (Feb. 2012).
1610 The Agencies note examples of information
barriers that may address or substantially mitigate
a material conflict of interest include restrictions on
information sharing, limits on types of trading,
prohibitions on common officers or employees
between functions. Such information barriers have
been recognized in Federal securities laws as a
means to address or mitigate potential conflicts of
interest or other inappropriate activities. See, e.g.,
17 U.S.C. 78o(g).
1611 See Public Citizen.

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information barriers do not require this
result. Rather, information barriers
would be established between relevant
personnel or functions while other
personnel, including senior managers,
internal auditors, and compliance
personnel, would have access to each
group separated by the barrier.
The final rule continues to recognize
that a banking entity may address or
substantially mitigate a conflict of
interest through use of information
barriers. In order to address and mitigate
a conflict of interest through the use of
the information barriers, a banking
entity is 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.1612
Importantly, the final 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 complied with the
requirements of § ll.7(b)(2)(i).1613
1612 The Agencies note that a banking entity
subject to Appendix B of the final rule 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. 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.
See Part IV.C.2.e., infra.
1613 If a conflict occurs to the detriment of a
client, customer, or counterparty despite an

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While some commenters requested
that the final rule include additional
limitations as part of implementing the
material conflict of interest provisions
in section 13(d)(2), the Agencies do not
believe additional restrictions are
appropriate at this time. 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.1614 In all cases, the
question of whether a material conflict
of interest exists will depend on an
evaluation of the specific facts and
circumstances. For example, certain
simple transactions may implicate
conflicts of interest that cannot be
mitigated by disclosure or restricted by
information barriers. On the other hand,
certain highly structured and complex
transactions may involve conflicts of
interest that can be mitigated by
disclosure or restricted by information
barriers.
The Agencies believe that conflicts of
interest must be determined and
addressed in accordance with the
specific facts and circumstances
presented. One commenter suggested
that the proposed rule be modified so
that a banking entity could conclusively
rely on information barriers unless it
knows or has reason to know that
policies, procedures, and controls
establishing barriers would not be
effective in restricting the spread of
information.1615 By focusing on whether
a banking entity knows or has reason to
know that its policies and procedures
would not be effective, rather than on
what the banking entity knows or
should reasonably know about a conflict
of interest that may involve or result in
a material adverse effect on a client,
customer, or counterparty, the
commenter’s suggestion has the
potential to allow a banking entity to
engage in transactions that involve a
material conflict of interest. Therefore,
the Agencies have determined not to
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.
1614 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/lfiles/FinanciallCrisis/
FinancialCrisisReport.pdf.
1615 See SIFMA et al. (Prop. Trading) (Feb. 2012).

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adopt the commenter’s suggested
approach. Similarly, the Agencies are
rejecting some commenters’ suggestions
that the final rule prescribe the method,
scope, or specific content of
disclosures.1616 The Agencies believe
that specific guidance on disclosure
may provide an incentive for banking
entities to consider the form of
disclosure provided, rather than
whether disclosure can address the
substance of the conflict as determined
by the specific facts and circumstances
at hand. Moreover, the Agencies believe
banking entities are in the best position
to identify and evaluate the conflicts
present in their business as well as the
most effective method of disclosing
such conflicts. Banking entities must
tailor their compliance programs to
identify, monitor, and evaluate potential
conflicts based on their business
structure and specific activities and
customer relationships.1617
Finally, some commenters requested
that the final rule specifically address
the conflict of interest provisions related
to asset-backed securitizations
contained in section 621 of the DoddFrank Act. As explained below in Part
IV.B.1., some securitizations are subject
to the final rule, and others such as
securitizations of loans are not subject
to section 13 of the BHC Act. For any
securitization that meets the definition
of covered fund under the final rule,
relationships with and transactions by a
banking entity involving those
securitizations remain subject to the
requirements of section 13, including
the requirements of section 13(d)(2). In
addition, the banking entity would be
subject to the limitations contained in
section 621 of the Dodd-Frank Act and
any rules regarding conflicts of interest
relating to securitizations implemented
under that section. The final rule in no
way limits the application of section
621 of that Act with respect to an assetbacked security that is subject to that
section.
b. Definition of ‘‘High-Risk Asset’’ and
‘‘High-Risk Trading Strategy’’

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1. Proposed Rule
Section ll.8(c) of the proposed rule
defined ‘‘high-risk asset’’ and ‘‘high-risk
trading strategy’’ for purposes of the
proposed limitations on permitted
1616 See Occupy; ISDA (Apr. 2012); Better
Markets (Feb. 2012); SIFMA et al. (Prop. Trading)
(Feb. 2012); ICFR; Alfred Brock; Public Citizen;
AFR et al. (Feb. 2012); Arnold & Porter; Sens.
Merkley & Levin (Feb. 2012).
1617 For a full discussion of the final rule’s
compliance requirements, including a discussion of
the specific compliance requirements applicable to
different banking entities, See Part IV.C. of this
SUPPLEMENTARY INFORMATION, infra.

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trading activities. Proposed § ll
.8(c)(1) defined 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. Proposed
§ ll.8(c)(2) defined 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.1618
2. Comments on Proposed Limitations
on High-Risk Assets and Trading
Strategies
With respect to the prohibition on
transactions or activities that expose
banking entities to high-risk assets or
high-risk trading strategies, one
commenter stated the provisions were
effective,1619 while other commenters
stated the proposed rule was too
vague 1620 and implied that banking
entities may be required to exit
positions in periods of market stress,
further reducing liquidity.1621 A few
commenters suggested the Agencies
identify and prohibit certain types of
high-risk assets or high-risk trading
strategies under the rule.1622 In contrast,
one commenter asserted the Agencies
should not specify certain classes of
assets or trading strategies as ‘‘high
risk.’’ 1623 A few commenters requested
greater clarity on the proposed
definitions and suggested the Agencies
provide additional guidance.1624 One of
these commenters suggested the
Agencies simplify compliance by
establishing safe harbors, setting predetermined risk limits within risk-based
approaches, or allowing individual
banking entities to set practical riskbased standards that the Agencies can
review.1625
One commenter suggested integrating
the ban on high-risk activities
1618 See Joint Proposal, 76 FR 68,894. The
Agencies noted 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). See Joint Proposal, 76 FR 68,894 n.215.
1619 See Alfred Brock.
1620 See AFR et al. (Feb. 2012); Japanese Bankers
Ass’n.; Investure; AllianceBernstein; Comm. on
Capital Markets Regulation.
1621 See Obaid Syed.
1622 See Sens. Merkley & Levin (Feb. 2012);
Johnson & Prof. Stiglitz; Occupy.
1623 See Alfred Brock.
1624 See Japanese Bankers Ass’n.; Sens. Merkley &
Levin (Feb. 2012); Occupy; Public Citizen.
1625 See Japanese Bankers Ass’n.

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throughout the rule and stated that,
given the evolving nature of financial
markets, regulators should have the
flexibility to update criteria for
identifying high-risk assets or high-risk
trading strategies.1626 This commenter
stated the definition of high-risk trading
strategies was appropriately broad and
flexible, but suggested improving the
rule by encompassing trading strategies
that are so complex the risk or value
thereof cannot be reliably and
objectively determined.1627 The
commenter also suggested that the
quantitative measurements collected
under proposed Appendix A could be
utilized to help inform whether a highrisk asset or trading strategy exists.1628
One commenter stated that in large
concentrations, all assets can be high
risk. This commenter suggested
evaluating transactions on a case-bycase basis and believed all activity
exempted under section 13(d)(1) of the
BHC Act should be viewed as ‘‘highrisk’’ absent prior regulatory approval.
This commenter further suggested that
high-risk assets or trading strategies be
defined to include any asset or trading
strategy that would have forced a
banking entity to exit the market during
the 2008 financial crisis, and that
leverage, rehypothecation,
concentration limits, and high
frequency trading should be viewed as
indicia of high-risk trading strategies.
Finally, this commenter suggested the
Agencies require banking entity CEOs to
certify that their institution’s activities
do not result in a material exposure to
high-risk assets or high-risk trading
strategies.1629
3. Final Rule
After considering carefully the
comments received, the Agencies have
modified the final rule to provide that
a high-risk asset means an asset or group
of assets that would, if held by a
banking entity, significantly increase the
likelihood that the banking entity would
incur a substantial financial loss or
would pose a threat to the financial
stability of the United States. Similarly,
the final rule defines high-risk trading
strategy to include any strategy that
would, if engaged in by a banking
entity, significantly increase the
likelihood that the banking entity would
incur a substantial financial loss or
would pose a threat to the financial
stability of the United States.
Importantly, under the final rule,
banking entities that engage in activities
1626 See

Sens. Merkley & Levin (Feb. 2012).
Sens. Merkley & Levin (Feb. 2012).
1628 See Sens. Merkley & Levin (Feb. 2012).
1629 See Occupy.
1627 See

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pursuant to an exemption must have a
reasonably designed compliance
program in place to monitor and
understand whether it is exposed to
high-risk assets or trading strategies. For
instance, any banking entity engaged in
activity pursuant to the market-making
exemption in § ll.4(b) must, as part of
its compliance program, have
reasonably designed written policies
and procedures, internal controls,
analysis and independent testing
regarding the limits for each trading
desk, including limits on the level of
exposures to relevant risk factors that
the trading desk may incur. These
policies and procedure and any activity
conducted pursuant to the final rule
will be evaluated by the Agencies, as
appropriate, as part of ensuring the
safety and soundness of banking entities
and monitoring for exposures to highrisk activities or assets.
While some commenters stated that
the definition of high risk asset or
trading strategy should be more clearly
defined, the Agencies believe that it is
appropriate to include a broad
definition of these terms that accounts
for different facts and circumstances
that may impact whether a particular
asset or trading strategy is high-risk with
respect to a banking entity. As stated by
commenters, this framework is effective
and flexible enough to be utilized by the
Agencies in a variety of contexts. For
instance, a trading strategy or asset may
be high-risk to one banking entity but
not another, or may be high-risk to a
banking entity under some market
conditions but not others. As part of
evaluating whether a banking entity is
exposed to a high-risk asset or trading
strategy, the Agencies expect that a
variety of factors will be considered,
such as the presence of excess leverage,
rehypothecation or excessively high
concentration of assets, or unsafe and
unsound trading strategies.
We believe an approach limiting this
provision’s applicability to certain
permitted activities or creating a safe
harbor for certain assets or trading
strategies would be inconsistent with
the statutory language, which prohibits
any permitted activity that involves or
results in a material exposure to a highrisk asset or high-risk trading
strategy.1630 In addition, the Agencies
decline to identify any particular assets
or trading strategies as per se high-risk
because a determination of the specific
risk posed to a banking entity depends
on the facts and circumstances.1631
Certain facts and circumstances may
include, but are not limited to, the

amount of capital at risk in a
transaction, whether or not the
transaction can be hedged, the amount
of leverage present in the transaction,
and the general financial condition of
the banking entity engaging in the
transaction. In response to one
commenter’s recommendation that the
Agencies adopt a CEO certification
requirement specific to the high-risk
provisions,1632 the Agencies believe
such a requirement is unnecessary in
light of the required management
framework in the compliance program
provision of § ll.20 of the final rule,
as well as the CEO certification
requirement included in the final
rule.1633
c. Limitations on Permitted Activities
That Pose a Threat to Safety and
Soundness of the Banking Entity or the
Financial Stability of the United States
Finally, as the Agencies did not
receive any comments on the proposed
rule’s limitations on permitted activities
that pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States and the proposed approach
mirrored the statutory language, the
Agencies have determined no changes
to final rule are necessary.
B. Subpart C—Covered Fund Activities
and Investments
As noted above and except as
otherwise permitted, section 13(a)(1)(B)
of the BHC Act generally prohibits a
banking entity from acquiring or
retaining any ownership in, or acting as
sponsor to, a covered fund.1634 Section
13(d) of the BHC Act contains certain
exemptions to this prohibition. Subpart
C of the final rule implements these and
other provisions of section 13 related to
covered funds. 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
final rule, as well as Appendix B, to the
extent applicable.
1. Section ll.10: Prohibition on
Acquisition or Retention of Ownership
Interests in, and Certain Relationships
With, a Covered Fund
Section ll.10 of the final rule
defines the scope of the prohibition on
the acquisition and retention of
1632 See

Occupy.
§ ll.20 and Appendix B of the final
rule, also discussed in Part IV.C., infra.
1634 See 12 U.S.C. 1851(a)(1)(B).

ownership interests in, and certain
relationships with, a covered fund. It
also defines a number of key terms,
including the definition of covered
fund.
The term ‘‘covered fund’’ specifies the
types of entities to which the
prohibition contained in § ll.10(a)
applies, unless the activity is
specifically permitted under an
available exemption contained in
subpart C of the final rule.1635 The final
rule modifies the proposed definition of
covered fund in a number of key
aspects. The Agencies have defined the
term ‘‘covered fund’’ with reference to
sections 3(c)(1) and 3(c)(7) of the
Investment Company Act of 1940
(‘‘Investment Company Act’’) with some
additions and subject to a number of
exclusions, several of which have been
modified from permitted activity
exemptions included in the proposal.
The Agencies have tailored the final
definition to include entities of the type
that the Agencies believe Congress
intended to capture in its definition of
private equity fund and hedge fund in
section 13(h)(2) of the BHC Act by
reference to section 3(c)(1) and 3(c)(7) of
the Investment Company Act. Thus, the
final definition focuses on the types of
entities formed for the purpose of
investing in securities or derivatives for
resale or otherwise trading in securities
or derivatives, and that are offered and
sold in offerings that do not involve a
public offering, but typically involve
offerings to institutional investors and
high-net worth individuals (rather than
to retail investors). These types of funds
are not subject to all of the securities
law protections applicable with respect
to funds that are registered with the SEC
as investment companies, and the
Agencies therefore believe that these
types of entities may be more likely to
engage in risky investment strategies. At
the same time, the Agencies have
tailored the definition to exclude
entities that have more general
corporate purposes and do not present
the same risks for banking entities as
those associated with the funds
described above, as well as certain other
entities as further discussed below.
The final rule also contains a revised
version of the proposal’s treatment of
certain foreign funds as covered funds,
which has been modified from the
proposal and tailored to include only
the types of foreign funds that the
Agencies believe are intended to be the
focus of the statute, such as certain
foreign funds that are established by

1633 See

1630 See
1631 See

BDA (Feb. 2012); Japanese Bankers Ass’n.
Occupy.

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1635 See final rule §§ ll.10(b)–(c). The term
banking entity is defined in final rule § ll.2(c).

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U.S. banking entities and not otherwise
subject to the Investment Company Act.
The Agencies have not included all
commodity pools within the definition
of covered fund as proposed. Instead,
and as discussed in more detail below,
the Agencies have included only
commodity pools for which the
commodity pool operator has claimed
exempt pool status under section 4.7 of
the CFTC’s regulations or that could
qualify as exempt pools and which have
not been publicly offered 1636 to persons
who are not qualified eligible persons
under section 4.7 of the CFTC’s
regulations.1637 Qualified eligible
persons are typically institutional
investors, banking entities and high net
worth individuals (rather than retail
investors). This more tailored approach,
together with the various exclusions
from the covered fund definition in the
final rule, is designed to include as
covered funds those commodity pools
that are similar to funds that rely on
section 3(c)(1) or 3(c)(7) while not also
including as covered funds entities, like
commercial end-users or registered
investment companies, whose activities
do not implicate the concerns that
section 13 was designed to address.
Finally, other related terms, including
‘‘ownership interest,’’ ‘‘resident of the
United States,’’ ‘‘sponsor,’’ and
‘‘trustee,’’ are also defined in § ll
.10(d) of the final rule.1638 As explained
below, these terms are largely defined in
the same manner as in the proposal
although with certain changes,
including changes to help clarify the
scope of these definitions as requested
by commenters. Some of these terms
and related provisions also have been
reorganized to improve clarity. As
explained in more detail below, the
Agencies received a number of
comments relating to some of the terms
defined in § ll.10. Some comments
directly relate to the scope of the
proposed rule and the economic effects
associated with the prohibitions on
covered funds activities and
investments, some of which
commenters argued did not further the
purposes of section 13.1639 The
Agencies have carefully considered
these and other comments when
defining the key terms used in the
statute and in providing certain
1636 See infra note 1721 and accompanying text
regarding the meaning of the term ‘‘offer’’ as used
in the final rule’s inclusion of certain commodity
pools as covered funds.
1637 See final rule § ll.10(b)(1)(ii).
1638 See final rule § ll.10(d)(6), (8), (9), and
(10).
1639 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); BoA; Goldman (Covered Funds); Rep. Himes;
SVB; Scale.

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exclusions to the definition of the term
covered fund. The Agencies also have
sought to provide guidance below,
where appropriate, on how these key
terms would operate in order to better
enable banking entities to understand
their obligations under section 13 and
the final rule.
a. Prohibition Regarding Covered Fund
Activities and Investments
Section ll.10(a) of the final rule
implements section 13(a)(1)(B) of the
BHC Act and prohibits a banking entity
from, directly or indirectly, acquiring or
retaining as principal an equity,
partnership, or other ownership interest
in, or acting as sponsor to, a covered
fund, unless otherwise permitted under
subpart C of the final rule.1640 This
provision of the rule reflects the
statutory prohibition.
The general prohibition in § ll.10(a)
of the proposed rule applied solely to
the acquisition or retention of an
ownership interest in, or acting as
sponsor to, a covered fund, ‘‘as
principal.’’ 1641 Commenters generally
supported this approach, arguing that
applying the prohibition related to
covered fund activities and investments
by a banking entity only to instances
where the banking entity acts as
principal is consistent with the statutory
focus on principal activity.1642 The final
rule takes this approach as discussed
below.
The proposed rule and preamble
accompanying it described potential
exemptions from the definition of
ownership interest for a variety of
interests, including interests related to
employee benefit plans, interests held in
the ordinary course of collecting a debt
previously contracted, positions as
trustee, or interests acquired as agent,
broker or custodian. Commenters
provided information on each of these
types of ownership interests, and
generally supported excluding each of
these from the section’s prohibition on
acquiring or retaining an ownership
interest in a covered fund.
A significant number of commenters
focused on employee benefit plans.
Commenters generally argued that the
prohibition in section 13(a) of the BHC
Act did not encompass interests held on
behalf of employees through an
employee benefit plan. While the
proposed rule did not explicitly cover
certain ‘‘qualified plans’’ under the
Internal Revenue Code, a number of
final rule § ll.10(a).
proposed rule § ll.10(a); See also Joint
Proposal, 76 FR 68,896.
1642 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); SIFMA et al. (Mar. 2012).
1640 See
1641 See

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commenters argued that the prohibition
should not cover activity or investments
related to other types of employee
benefit plans that are not a ‘‘qualified
plan’’ under the Internal Revenue
Code.1643 A significant number of
commenters urged exclusion of interests
in and relationships with foreign
employee benefit plans.1644
Commenters argued that the risks of
investments made through employee
benefit plans are borne by the employee
beneficiaries of these plans, and any
decision to cover employee benefit
plans or investments made by these
plans under the prohibitions in section
13 of the BHC Act would eliminate or
severely restrict the availability of
employee programs that are widely
offered, regulated and endorsed under a
system of Federal, state and foreign
laws.1645
Commenters also supported the
exemption under the proposed rule for
holdings in satisfaction of a debt
previously contracted in good faith.1646
This provision of the proposal
recognized that banking entities may
acquire an ownership interest in or
relationship with a covered fund as a
result of a counterparty’s failure to
repay a bona fide debt and without an
intent to engage in those activities as
principal.1647
Several commenters urged revision to
the proposal to add a specific exclusion
for investments held by a banking entity
in the capacity of trustee (including as
trustee for a charitable trust).1648 These
commenters argued that failing to
recognize and exempt these types of
activities in the final rule would prevent
banking entities that act as trustees from
effectively meeting their trust and
fiduciary obligations and from
providing these services to customers.
Commenters also argued that the
exemption for trust activities should not
be dependent on the duration of the
trust because the law governing the
duration of trusts is changing and varies
across jurisdictions.1649
As with the proposed rule, the
prohibition in § ll.10(a) of the final
rule applies only to the acquisition or
retention of an ownership interest in, or
sponsorship of, a covered fund as
1643 See Credit Suisse (Williams); Arnold &
Porter; UBS; Hong Kong Inv. Funds Ass’n.
1644 See, e.g., Credit Suisse (Williams); Arnold &
Porter; UBS; NAB; Hong Kong Inv. Funds Ass’n;
Australian Bankers Ass’n. (Feb. 2012).
1645 See, e.g., Arnold & Porter.
1646 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); LSTA (Feb. 2012).
1647 See proposed rule § ll.14(b).
1648 See, e.g., ABA (Keating).
1649 See, e.g., ABA (Keating); Arnold & Porter;
NAB.

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principal. The Agencies continue to
believe section 13 of the BHC Act was
designed to address the risks attendant
to principal activity and not those that
are borne by customers of the banking
entity or for which the banking entity
lacks design or intent to take a
proprietary interest as principal.
In order to address commenter
concerns regarding the types of activity
that are subject to the prohibition, the
Agencies have modified and
reorganized the final rule to make the
scope of acting ‘‘as principal’’ clear and
more consistent with the proprietary
trading restrictions under the final
rule.1650 The final rule provides that the
prohibition does not include acquiring
or retaining an ownership interest in a
covered fund by a banking entity: (1)
Acting solely as agent, broker, or
custodian, so long as the activity is
conducted for the account of, or on
behalf of, a customer, and the banking
entity and its affiliates do not have or
retain beneficial ownership of the
ownership interest;1651 (2) through a
deferred compensation, stock-bonus,
profit-sharing, or pension plan of the
banking entity (or an affiliate thereof)
that is established and administered in
accordance with the law of the United
States or a foreign sovereign, if the
ownership interest is held or controlled
directly or indirectly by a banking entity
as trustee for the benefit of people who
are or were employees of the banking
entity (or an affiliate thereof); 1652 (3) in
the ordinary course of collecting a debt
previously contracted in good faith,
provided that the banking entity divests
the ownership interest as soon as
practicable, and in no event may the
banking entity retain such instrument
for longer than such period permitted by
the appropriate agency; or (4) on behalf
of customers as trustee or in a similar
fiduciary capacity for a customer that is
not a covered fund, so long as the
final rule § ll.3(d)(7) (9).
1651 A banking entity acting as agent, broker, or
custodian is not acting ‘‘as principal’’ under the
final rule so long as the activity is conducted for
the account of, or on behalf of, a customer and the
banking entity does not have or retain beneficial
ownership of such ownership interest, as noted
above. This provision is consistent with the final
rule’s treatment of banking entities acting on behalf
of customers as trustee or in a fiduciary capacity.
1652 The Agencies note that this provision does
not permit joint investments between the banking
entity and its employees. Rather, this provision is
intended to enable banking entities to maintain
deferred compensation and other similar plans
formed for the benefit of employees. The Agencies
recognize that, since it is possible an employee may
forfeit its interest in such a plan, the banking entity
may have a residual or reversionary interest in the
assets referenced under the plan. However, other
than such residual or reversionary interests, a
banking entity may not rely on this provision to
invest in a covered fund.

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activity is conducted for the account of,
or on behalf of, the customer, and the
banking entity and its affiliates do not
have or retain beneficial ownership of
such ownership interest.1653
Because these activities do not
involve the banking entity engaging in
an activity intended or designed to take
ownership interests in a covered fund as
principal, they do not appear to be the
types of activities that section 13 of the
BHC Act was designed to address.
However, the Agencies note that in
order to prevent a banking entity from
evading the requirements of section 13
and the final rule, the exclusions for
these activities do not permit a banking
entity to engage in establishing,
organizing and offering, or acting as
sponsor to a covered fund in a manner
other than as permitted elsewhere in the
final rule. The Agencies intend to
monitor these activities and investments
for efforts to evade the restrictions in
section 13 of the BHC Act and the final
rule on banking entities’ investments in
and relationships with covered funds.
b. ‘‘Covered Fund’’ Definition
Section 13(h)(2) of the BHC Act
defines hedge fund and private equity
fund to mean an issuer that would be an
investment company, but for section
3(c)(1) or 3(c)(7) of the Investment
Company Act, or ‘‘such similar funds’’
as the Agencies determine by rule.1654
Given that the statute defines ‘‘hedge
fund’’ and ‘‘private equity fund’’
without differentiation, the proposed
rule and the final rule combine the
terms into the definition of a ‘‘covered
fund.’’ Sections 3(c)(1) and 3(c)(7) of the
Investment Company Act are exclusions
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.1655 The proposal included as
1653 See final rule § ll.10(a)(2). For instance, as
part of engaging in its traditional trust company
functions, a bank or savings association typically
may act through an entity that is excluded from the
definition of investment company under section
3(c)(3) or 3(c)(11). This would be included within
the scope of acting on behalf of customers as trustee
or in a similar fiduciary capacity, provided that it
meets the applicable requirements of the exclusion
under the final rule.
1654 See 12 U.S.C. 1851(h)(2).
1655 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: (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 shortterm 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 propose to

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a covered fund any entity that would be
an investment company but for the
exclusion from that definition contained
in section 3(c)(1) or 3(c)(7) of the
Investment Company Act, any foreign
entity that would also be an investment
company but for those same exclusions
were the foreign entity to be organized
or offered in the United States, and a
commodity pool as defined in section
1a(10) of the Commodity Exchange
Act.1656 The preamble to the proposal
recognized that this definition was
broad and specifically requested
comment on whether and how the
definition of covered fund should be
modified for purposes of the final rule.
Commenters contended that the
definition of covered fund should not
focus exclusively on whether an entity
relies on section 3(c)(1) or 3(c)(7) of the
Investment Company Act. Commenters
argued that sections 3(c)(1) and 3(c)(7)
of the Investment Company Act are
exclusions 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. Under the
Investment Company Act, any entity
that holds investment securities (i.e.,
generally all securities other than U.S.
government securities) representing at
least 40 percent of the entity’s total
assets would be an investment
company.1657 According to commenters,
this definition and the accompanying
exclusions are part of a securities law
and regulatory framework designed for
purposes different than the prudential
purpose that underlies section 13 of the
BHC Act.1658
A number of comments received on
the proposal argued that the proposed
definition of covered fund was overly
broad and would lead to anomalous
results inconsistent with the words,
structure, and purpose of section 13.1659
For instance, many commenters asserted
that the proposed rule’s definition of
covered fund would cause a number of
commonly used corporate entities that
are not traditionally thought of as hedge
make a public offering of such securities. See 15
U.S.C. 80a–3(c)(1) and (c)(7).
1656 See proposed rule § ll.10(b)(1).
1657 15 U.S.C. 80a–3(a)(1)(A) & (C). The definition
of securities is very broad under the Investment
Company Act and has been interpreted to include
instruments such as loans, that would not be
regarded as securities under the Securities Act of
1933 and the Securities Exchange Act of 1934. In
addition, the determination of what constitutes an
‘‘investment security’’ under the Investment
Company Act requires complex analysis and
consideration of a broad set of facts and
circumstances.
1658 See, e.g., NVCA.
1659 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); BlackRock; AHIC; Sen. Carper et al.; Rep.
Garrett et al.

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funds or private equity funds, such as
wholly-owned subsidiaries, joint
ventures, and acquisition vehicles, to be
subject to the covered fund restrictions
of section 13. These commenters argued
that this interpretation of section 13
would cause a disruption to the
operations of banking entities and their
closely related affiliates that does not
relate to the intent of section 13 and
therefore cause an unnecessary burden
on banking entities. Commenters argued
that the words, structure and purpose of
section 13 allow the Agencies to adopt
a more tailored definition of covered
fund that focuses on vehicles used for
investment purposes that were the target
of section 13’s restrictions.
In particular, commenters requested
that the final rule exclude at least the
following from the definition of covered
fund: U.S. registered investment
companies (including mutual funds);
the foreign equivalent of U.S. registered
investment companies; business
development companies; wholly-owned
subsidiaries; joint ventures; acquisition
vehicles; financial market utilities;
foreign pension or retirement funds;
insurance company separate accounts;
loan securitizations, including assetbacked commercial paper conduits; cash
management vehicles or cash collateral
pools; credit funds; real estate
investment trusts; various securitization
vehicles; tender option bond programs;
and venture capital funds.1660
Commenters requested some of these
exclusions in order to mitigate the
impact of the proposal’s inclusion of
commodity pools as part of the
definition of covered fund.1661
Some commenters argued that the
proposal failed to distinguish between
different types of investment funds.1662
These commenters expressed the view
that the statute provides the Agencies
with the discretion to distinguish
between investment funds generally and
a subset of funds—hedge funds and
private equity funds—that may engage
1660 See ABA (Keating); ABA (Abernathy); SIFMA
et al. (Covered Funds) (Feb. 2012); Allen & Overy
(on behalf of Foreign Bank Group); Allen & Overy
(on behalf of Canadian Banks); Deutsche Bank
(Repackaging Transactions); ICI (Feb. 2012);
Putnam; JPMC; GE (Feb. 2012); Chamber (Feb.
2012); Rep. Himes; BOK; Ass’n. of Institutional
Investors (Feb. 2012); Wells Fargo (Covered Funds);
BoA; NAIB et al.; PNC; SunTrust; Nationwide;
STANY; BNY Mellon et al.; RMA; Goldman
(Covered Funds); Japanese Bankers Ass’n; IRSG;
ISDA (Feb. 2012); IIB/EBF; Citigroup (Jan. 2012);
SSgA (Feb. 2012); State Street (Feb. 2012); Eaton
Vance; Fidelity; SBIA; River Cities; Ashurst; Sen.
Hagan; Sen. Bennet.
1661 As discussed below, the Agencies have
modified the final rule to include only certain
commodity pools within the definition of covered
fund.
1662 See NVCA; See also SIFMA et al. (Covered
Funds) (Feb. 2012); ABA (Keating).

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in particularly risky trading and
investment activities. For example,
several commenters argued that the
proposed rule’s restrictions on covered
fund investments should not cover
venture capital funds that provide
investment capital to new
businesses.1663 Others argued for an
exclusion for securitization vehicles
such as securitizations that are backed,
in whole or in part, by assets that are
not loans, including corporate debt
repackagings,1664 CLOs,1665 ABCP
conduits,1666 insurance-linked
securities,1667 and synthetic
securitizations backed by
derivatives.1668
As a potential solution to some of
these concerns, a number of
commenters argued that the Agencies
should define covered fund by reference
to characteristics that are designed to
distinguish hedge funds and private
equity funds from other types of entities
that rely on section 3(c)(1) or 3(c)(7) of
the Investment Company Act.1669
Commenters believed this approach
would help exclude some of the
corporate vehicles and funds mentioned
above that they did not believe were
intended by Congress to be included as
hedge funds and private equity funds
and therefore reduce costs that, in the
commenters’ view, did not further the
purposes of section 13.1670
These commenters proposed a
number of different potential types of
characteristics for defining hedge fund
1663 See, e.g., ABA (Keating); ABA (Abernathy);
Canaan (Young); Canaan (Ahrens); Canaan (Kamra);
Growth Managers; River Cities; SVB; EVCA.
1664 See AFME et al.; Allen & Overy (on behalf of
Foreign Bank Group); ASF (Feb. 2012); Cleary
Gottlieb; Deutsche Bank (Repackaging
Transactions); SIFMA (Securitization) (Feb. 2012).
1665 See SIFMA (Securitization) (Feb. 2012); Allen
& Overy (on behalf of Foreign Bank Group); ASF
(Feb. 2012); Cleary Gottlieb; Credit Suisse
(Williams); JPMC; LSTA (Feb. 2012).
1666 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); Credit Suisse (Williams);
Eaton Vance; Fidelity; GE (Feb. 2012); GE (Aug.
2012); ICI (Feb. 2012); IIB/EBF; JPMC; PNC; RBC;
SIFMA (Securitization) (Feb. 2012); AFME et al.
1667 See AFME et al.; SIFMA (Securitization)
(Feb. 2012).
1668 See AFME et al.; ASF (Feb. 2012); Cleary
Gottlieb; Credit Suisse (Williams); SIFMA
(Securitization) (Feb. 2012); ABA (Keating).
1669 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); BlackRock; Credit Suisse (Williams); SSgA
(Feb. 2012); State Street (Feb. 2012); Deutsche Bank
(Repackaging Transactions); Allen & Overy (on
behalf of Foreign Bank Group).
1670 See SIFMA et al. (Covered Funds) (Feb.
2012); AFME et al; Allen & Overy (on behalf of
Foreign Bank Group); ASF (Feb. 2012); Ashurst;
Barclays; BDA (Feb. 2012); Credit Suisse (Williams);
Commercial Real Estate Fin. Council; Fidelity; ICI
(Feb. 2012); ISDA (Feb. 2012); JPMC; Nuveen Asset
Mgmt.; PNC; RBC; SIFMA et al. (Covered Funds)
(Feb. 2012); SIFMA (Municipal Securities) (Feb.
2012); SSgA (Feb. 2012); State Street (Feb. 2012);
Vanguard; Wells Fargo (Covered Funds).

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5669

and private equity fund. Some
commenters focused on certain
structural or investment characteristics
found in traditional private equity funds
and hedge funds, such as investor
redemption rights, performance
compensation fees, leverage and the use
of short-selling.1671 Another commenter
argued that the characteristics used to
define a covered fund should focus on
the types of speculative behavior that
the statute was intended to address,
citing characteristics such as volatility
of asset performance and high
leverage.1672
In contrast to the majority of the
commenters, one commenter urged that
characteristics be used to expand the
proposed definition to include any
issuer that exhibits characteristics of
proprietary trading that the statute
prohibits to be done by a banking
entity.1673 According to this commenter,
any fund engaging in more than
minimal proprietary trading should be a
covered fund and subject to the
requirements of section 13.
However, not all commenters
supported a characteristics-based
definition. One commenter opposed a
characteristics-based definition,
suggesting that the final rule rely only
on the statutory reference to the
Investment Company Act, and arguing
that using characteristics to define a
covered fund (e.g., leverage) could
create opportunities for circumvention
of the rule.1674 Commenters that
generally supported the proposed
definition argued that its broad scope
prevented circumvention.1675
One commenter argued in favor of
broadening the definition of covered
fund to include entities that rely on an
exclusion from the definition of
investment company other than those
contained in section 3(c)(1) and 3(c)(7),
such as section 3(c)(2) (which provides
an exclusion for underwriters and
brokers) or 3(c)(6) (which provides an
exclusion for entities engaged in a
business other than investing in
1671 See Ass’n. of Institutional Investors (Feb.
2012); Barclays; JPMC; SIFMA et al. (Covered
Funds) (Feb. 2012); See also FSOC study at 62–63
(suggesting a characteristics-based approach
considering compensation structure; trading/
investment strategy; use of leverage; investor
composition); ABA (Keating); BNY Mellon et al.;
Northern Trust, SSgA (Feb. 2012); State Street (Feb.
2012); Deutsche Bank (Repackaging Transactions);
T. Rowe Price; RMA (suggesting use of
characteristics derived from the SEC’s Form PF for
registration of investment advisers of private funds).
1672 See RBC (citing FSOC study).
1673 See Occupy.
1674 See AFR et al. (Feb. 2012).
1675 See Sens. Merkley & Levin (Feb. 2012); AFR
et al. (Feb. 2012); Alfred Brock.

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securities).1676 By contrast, other
commenters argued that an entity
should not be considered a covered
fund if the entity relies on an exclusion
or exemption contained in the
Investment Company Act other than an
exclusion contained in section 3(c)(1) or
3(c)(7) under that Act, such as the
exclusion contained in section 3(c)(3)
for bank collective investment
funds.1677
The Agencies have carefully
considered all of the comments related
to the definition of covered fund. While
the Agencies believe that the proposal
reflected a reasonable interpretation of
the statutory provision, on further
review and in light of the comments the
Agencies have determined to adopt a
different approach. The Agencies have
revised the final rule to address many of
the concerns raised by commenters
regarding the scope of the original
proposal in a manner the Agencies
believe is a better reading of the
statutory provision because it is both
consistent with the language, purpose
and structure of section 13 and avoids
unintended consequences of the less
precise definitional approach of the
proposal.
In the final rule, the Agencies have
joined the definitions of ‘‘hedge fund’’
and ‘‘private equity fund’’ into a single
definition ‘‘covered fund’’ (as in the
statute) and have defined this term as
any issuer that would be an investment
company as defined in the Investment
Company Act but for section 3(c)(1) or
3(c)(7) of that Act with a number of
express exclusions and additions
(explained below) as determined by the
Agencies. Thus, for example, an entity
that invests in securities and relies on
any exclusion or exemption from the
definition of ‘‘investment company’’
under the Investment Company Act
other than the exclusion contained in
section 3(c)(1) or 3(c)(7) of that Act
would not be considered a covered fund
so long as it satisfies the conditions of
another Investment Company Act
exclusion or exemption.1678 Such an

entity would not be an investment
company but for section 3(c)(1) or
3(c)(7), and the Agencies have modified
the final rule to explicitly exclude such
an entity.1679
The Agencies believe this definition is
consistent with the words, structure,
purpose and legislative history of
section 13 of the BHC Act. As noted
above, section 13(h)(2) provides that:

1676 See Occupy (also arguing in favor of
including entities that rely on rule 3a–1 (which
provides an exemption for issuers that hold less
than 45% of their assets in securities excluding
government securities) or 3a–6 (which provides an
exemption for foreign banks and insurance
companies) to avoid being regulated as investment
companies under the Investment Company Act).
1677 See, e.g., ABA (Keating).
1678 For instance, bank common trust and
collective funds that qualify for the exclusion from
the definition of investment company pursuant to
section 3(c)(3) or 3(c)(11) of the Investment
Company Act are not covered funds. See 15 U.S.C.
78a–3(c)(3) and (c)(11). These funds are subject to
supervision and regulation by a Federal banking
agency, thus helping to distinguish them from
traditional hedge funds and private equity funds

which are generally not themselves subject to such
supervision or regulation.
1679 See final rule § ll.10(c)(12).
1680 See 12 U.S.C. 1851(h)(2) (emphasis added).
1681 In addition to the readings described above,
one commenter argued that the section could be
read to provide that both the reference to issuers
covered by section 3(c)(1) or 3(c)(7) of the
Investment Company Act in the first part of section
13(h)(2) and the reference to similar funds in the
second part of the section should be read as
qualified by the clause ‘‘as the Agencies may by
rule . . . determine.’’ Under this reading, Congress
granted the Agencies authority to determine by rule
whether an entity described by the first part would
be covered and whether an issuer would be deemed
to be a similar fund under the second part. See
SIFMA et al. (Covered Funds) (Feb. 2012).

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The terms ‘‘hedge fund’’ and ‘‘private equity
fund’’ mean an issuer that would be an
investment company as defined in the
[Investment Company Act] (15 U.S.C. 80a–1
et seq.), but for section 3(c)(1) or 3(c)(7) of
that Act, or such similar funds as the
[Agencies] may, by rule, as provided in
subsection (b)(2), determine.1680

The statutory provision contains two
parts: a first part that refers to any issuer
that is ‘‘an investment company, as
defined in the Investment Company Act,
but for section 3(c)(1) and 3(c)(7) of the
Act’’; and a second part that covers
‘‘such similar funds as the [Agencies]
may, by rule . . . determine.’’ The
proposed rule offered a reading of this
provision as a simple concurrent
definition with two self-contained,
supplementary parts. Under this
approach, all entities covered by part
one of the definition would be included
in the definitions of ‘‘hedge fund’’ and
‘‘private equity fund,’’ and the role of
the Agencies under the second part was
limited to considering whether and how
to augment the scope of the primary
statutory definition.
As noted above, commenters argued
that this interpretation led to
unintended consequences that were not
consistent with other provisions of
section 13 or the purposes of section 13,
and that other interpretations of the
definition of covered fund were
consistent with both the words and the
purpose of the statute. Also as explained
above, commenters offered multiple
alternative interpretations of the
definition of, the scope of the
prohibition on ownership interests in,
and relationships with, a covered
fund.1681

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The Agencies believe that the
language of section 13(h)(2) can best be
interpreted to provide two alternative
definitions of the entities to be covered
by the statutory terms ‘‘hedge fund’’ and
‘‘private equity fund.’’ Under this
reading, the first part of section 13(h)(2)
contains a base definition that
references the noted exclusions under
the Investment Company Act (the
‘‘default definition’’), while the second
part grants the Agencies the authority to
adopt an alternate definition that is
triggered by agency action (the ‘‘tailored
definition’’). Thus, if the Agencies do
not act by rule, the definition is set by
reference to the Investment Company
Act and the relevant exclusions alone; if
the Agencies act by rule, the definitions
are set by the Agencies under that rule.
As noted above, the Agencies have
determined to exercise the authority
under the second part of the statute to
define ‘‘hedge fund’’ and ‘‘private equity
fund’’ in the final rule.
Relying on the Agencies’ authority to
adopt an alternative, tailored definition
of ‘‘hedge fund’’ and ‘‘private equity
fund,’’ the final rule references funds
that are similar to the funds in the base
alternative provided in the first
alternative definition—that is, an issuer
that would be an investment company
under the Investment Company Act but
for section 3(c)(1) or 3(c)(7) of that Act.
The additions and exclusions from that
definition represent further
determinations by the Agencies
regarding the scope of that definition
that were made in the course of a
rulemaking conducted in accordance
with section 13(b)(2) of the BHC Act.
The Agencies believe that this reading
of the statutory provision is consistent
with the purpose of section 13. That
purpose appears to be to limit the
involvement of banking entities in highrisk proprietary trading, as well as their
investment in, sponsorship of, and other
connections with, entities that engage in
investment activities for the benefit of
banking entities, institutional investors
and high-net worth individuals.1682
Further, the Agencies believe that the
provision permits them to tailor the
scope of the definition to funds that
engage in the investment activities
contemplated by section 13 (as opposed,
for example, to vehicles that merely
serve to facilitate corporate structures);
doing so allows the Agencies to avoid
the unintended results, some of which
commenters identified, that might
1682 See 156 Cong. Reg. S.5894–5895 (daily ed.
July 15, 2010) (statement of Sen. Merkley).

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follow from a definition that is
inappropriately imprecise.1683
The Agencies also note that nothing
in the structure or history of the DoddFrank Act suggests that the definition of
hedge fund and private equity fund was
intended to necessitate a fundamental
restructuring of banking entities by
disallowing investments in common
corporate vehicles such as intermediate
holding companies, joint operating
companies, acquisition vehicles and
similar entities that do not engage in the
types of investment activities
contemplated by section 13. Moreover,
other provisions of the Dodd-Frank Act
and existing banking laws and
regulations would be undermined or
vitiated by a reading that restricts
investments in these types of corporate
vehicles and structures.1684
Based on the interpretive and policy
considerations raised by commenters,
the language of section 13(h)(2), and the
language, structure, and purpose of the
Dodd-Frank Act, the Agencies have
adopted a tailored definition of covered
fund in the final rule that covers issuers
1683 The Agencies believe that the choice of the
tailored definition is supported by the legislative
history that suggests that Congress may have
foreSeen that its base definition could lead to
unintended results and might be overly broad, too
narrow, or otherwise off the mark. Part two of the
statutory definition was not originally included in
the bill reported by the Senate Committee on April
30, 2010. While the addition of part two did not
receive specific comment, Rep. Frank, a co-sponsor
and principal architect of the Dodd-Frank Act,
noted that the default definition ‘‘could technically
apply to lots of corporate structures, and not just
the hedge funds and private equity funds’’ and
confirmed that ‘‘[w]e do not want these overdone.’’
See 156 Cong. Rec. H5226 (daily ed. June 30, 2010)
(statement of Reps. Himes and Frank) (noting intent
that subsidiaries or joint ventures not be included
within the definition of covered fund); 156 Cong.
Rec. S5904–05 (daily ed. July 15, 2010) (statement
of Sens. Boxer and Dodd) (noting broad definition
of hedge fund and private equity fund and
recommending that the Agencies take steps to
ensure definition is reasonably tailored).
1684 For example, the Dodd-Frank Act requires
banking entities to serve as a source of financial
strength to their insured depository institutions and
requires certain banking entities to form
intermediate holding companies to separate their
financial and non-financial activities. See Sections
167, 616(d) & 626 of the Dodd-Frank Act. These
provisions would be severely undermined if the
prohibitions on investments and activities
contained in section 13 were applied to ownership
of intermediate holding companies. For instance, a
bank holding company would not be able to serve
as a source of strength to an intermediate holding
company (or any subsidiary thereof) that is a
covered fund due to the transaction restrictions
contained in section 13(f). See 12 U.S.C. 1851(f). As
another example, the Agencies have made certain
modifications to the final rule to make clear that it
will not affect the resolution authority of the
Federal Deposit Insurance Corporation, including
by excluding from the covered fund definition
issuers formed by or on behalf of the Corporation
for the purpose of facilitating the disposal of assets
acquired in the Corporation’s capacity as
conservator or receiver. See § ll.10(c)(13).

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of the type that would be investment
companies but for section 3(c)(1) or
3(c)(7) of the Investment Company Act
with exclusions for certain specific
types of issuers in order to focus the
covered fund definition on vehicles
used for the investment purposes that
were the target of section 13. The
definition of covered fund under the
final rule also includes certain funds
organized and offered outside of the
United States in order to address foreign
fund structures and certain commodity
pools that might otherwise allow
circumvention of the restrictions of
section 13. The Agencies also expect to
exercise the statutory anti-evasion
authority provided in section 13(e) of
the BHC Act and other prudential
authorities in order to address instances
of evasion.1685
As discussed above, an alternative
approach to defining a covered fund
would be to reference fund
characteristics. Commenters arguing for
a characteristics-based approach stated
that it would more precisely tailor the
final rule to the intent of section 13 and
limit the potential for undue burden on
banking entities. A characteristics-based
definition, however, could be less
effective than the approach taken in the
final rule as a means to prohibit banking
entities, either directly or indirectly,
from engaging in the covered fund
activities limited or proscribed by
section 13. A characteristics-based
approach also could require more
analysis by banking entities to apply
those characteristics to every potential
covered fund on a case-by-case basis,
and create greater opportunity for
evasion. As discussed below, the
Agencies have sought to address some
of the concerns raised by commenters
suggesting a characteristics-based
approach by tailoring the definition of
covered fund to provide exclusions for
certain entities that rely on section
3(c)(1) or 3(c)(7) of the Investment
Company Act and otherwise would be
treated as covered funds.
Some commenters discussed the
potential cost to banking entities to
analyze the covered fund status of
certain entities if the Agencies were to

define the term covered fund by
reference to sections 3(c)(1) and 3(c)(7),
arguing that this analysis would be
costly.1686 A characteristics-based
approach could mitigate the costs
associated with an investment company
analysis but, depending on the
characteristics, could result in
additional compliance costs in some
cases to the extent banking entities
would be required to implement
policies and procedures to prevent
potential covered funds from having
characteristics that would bring them
within the covered fund definition.
Furthermore, banking entities may
currently rely on section 3(c)(1) and
3(c)(7) of the Investment Company Act
to avoid registering various entities
under the Investment Company Act, and
the costs to analyze the status of these
entities under a statutory-based
definition of covered fund are generally
already included as part of the fund
formation process and the costs of
determining covered fund status may
thus be mitigated, especially given the
exclusions provided in the final rule.
The entities excluded from the
definition of covered fund are described
in detail in section (c) below.
1. Foreign Covered Funds
In order to prevent evasion of the
prohibition and purposes of section 13,
the proposal included within the
definition of covered fund any issuer
organized or offered outside of the
United States (‘‘foreign covered fund’’)
that would be a covered fund were it
organized or offered in the United
States.1687
Commenters expressed concern that
the proposed treatment of foreign
covered funds was overly broad,
exceeded the Agencies’ statutory
authority, was not consistent with
principles of national treatment, and
violated international treaties.1688
Commenters expressed concern about
the difficulties of applying Investment
Company Act concepts to foreign funds
that are structured to comply with
1686 See,

e.g., SIFMA et al. (Covered Funds) (Feb.

2012).
proposed rule § ll.10(b)(1)(iii).
SIFMA et al. (Covered Funds) (Feb.
2012); BNY Mellon et al.; BlackRock; ABA
(Keating); AFTI; AFG; ICI Global; Ass’n. of
Institutional Investors (Feb. 2012); ICI (Feb. 2012);
SSgA (Feb. 2012); State Street (Feb. 2012); JPMC;
BoA; Goldman (Covered Funds); Bank of Montreal
et al. (Jan. 2012); AGC; Cadwalader (on behalf of
Thai Banks); ALFI; BVI; EBF; British Bankers
Ass’n.; French ACP; AFME et al.; F&C; IIF; ICSA;
IMA; EFAMA; UKRCBC; AIMA; AFMA; Australian
Bankers Ass’n. (Feb. 2012); Allen & Overy (on
behalf of Foreign Bank Group); IFIC; Allen & Overy
(on behalf of Canadian Banks); RBC; French
Treasury et al.; Hong Kong Inv. Funds Ass’n.; TCW;
Govt. of Japan/Bank of Japan.
1687 See
1688 See

1685 As

discussed in Part IV.C.1 of this
regarding the
compliance program requirements of the final rule,
the Agencies will consider information maintained
and provided by banking entities under the
compliance program mandate to help monitor
potential evasions of the prohibitions and
restrictions of section 13. Additionally and
consistent with the statute, the final rule permits
the Agencies to jointly determine to include within
the definition of covered fund any fund excluded
from that definition. The Agencies expect that this
authority may be used to help address situations of
evasion.

SUPPLEMENTARY INFORMATION

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regulatory schemes under local laws
outside the United States. They also
argued that it would be burdensome and
costly to require foreign banking entities
to interpret and apply U.S. securities
laws to foreign structures that are
designed primarily to be offered and
sold outside the United States.1689
Commenters also contended that foreign
mutual fund equivalents, such as retail
Undertakings for Collective Investments
in Transferable Securities
(‘‘UCITS’’),1690 would be treated as
covered funds under the proposal even
though they generally are similar to U.S.
registered investment companies, which
are not covered funds, meaning that
under the proposal the scope of foreign
funds captured was broader than the
scope of domestic funds.1691 These
commenters argued that a foreign fund
organized and offered outside of the
United States should not be treated as
a covered fund simply because the
foreign fund may (or could) rely on the
exclusion under section 3(c)(1) or 3(c)(7)
of the Investment Company Act were it
to be offered in the United States.1692
Some commenters argued that the
proposal did not clearly identify which
foreign funds would be covered, thereby
creating uncertainty about the scope of
funds to which section 13 would
apply.1693 Several commenters argued
that the proposal’s foreign covered fund
definition could be read to include a
foreign fund, even if its securities were
never offered and sold to U.S. persons,
1689 See JPMC; See also Cadwalader (on behalf of
Thai Banks); Cadwalader (on behalf of Singapore
Banks); Ass’n. of Banks in Malaysia; Govt. of Japan/
Bank of Japan.
1690 UCITS are public limited companies that,
under a series of directives issued by the EU
Commission, coordinate distribution and
management of unit trusts or collective investment
schemes in financial instruments on a cross-border
basis throughout the European Union on the basis
of the authorization of a single member state.
1691 See Allen & Overy (on behalf of Foreign Bank
Group); ABA (Keating); AFG; AFTI; BoA; French
Banking Fed’n.; SIFMA et al. (Covered Funds) (Feb.
2012); See also BNY Mellon et al.; BlackRock; ICI
Global; Ass’n. of Institutional Investors (Feb. 2012);
ICI (Feb. 2012); SSgA (Feb. 2012); State Street (Feb.
2012); JPMC; BoA; Goldman (Covered Funds); Bank
of Montreal et al. (Jan. 2012); AGC; Cadwalader (on
behalf of Thai Banks); ALFI; BVI; EBF; British
Bankers Ass’n.; French ACP; AFME et al.; F&C; IIF;
ICSA; IMA; EFAMA; UKRCBC; AIMA; AFMA;
Australian Bankers Ass’n. (Feb. 2012); Allen &
Overy (on behalf of Foreign Bank Group); IFIC;
Allen & Overy (on behalf of Canadian Banks); RBC;
French Treasury et al.; Hong Kong Inv. Funds
Ass’n.; HSBC Life; ICSA Ass’n. of Banks in
Malaysia (arguing that foreign banking organization
would have to determine how a fund would be
regulated under U.S. law before making
investments in funds in their home markets).
1692 See Allen & Overy (on behalf of Foreign Bank
Group); ABA (Keating); SSgA (Feb. 2012); BoA;
Goldman (Covered Funds).
1693 See Australian Bankers Ass’n. (Feb. 2012);
BlackRock.

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because the fund could theoretically be
offered in the United States in reliance
on section 3(c)(1) or 3(c)(7).1694
Commenters argued that the definition
of foreign covered fund should be
tailored.1695 Some commenters argued
that foreign funds that are not made
available for sale in the U.S. or actively
marketed to U.S. investors should be
specifically excluded from the
definition of covered fund.1696 Several
other commenters supported narrowing
the definition of foreign covered fund to
those foreign funds with characteristics
similar to domestic hedge funds or
private equity funds.1697
After considering the comments in
light of the statutory provisions and
purpose of section 13, the Agencies
have modified the final rule to more
effectively tailor the scope of foreign
funds that would be covered funds
under the rule and better implement the
language and purpose of section 13. As
noted above, section 13 of the BHC Act
applies to the global operations of U.S.
banking entities, and one of the
purposes of section 13 is to reduce the
risk to the U.S. financial system of
activities with and investments in
covered funds. The Agencies proposed
to include foreign funds within the
definition of covered fund in order to
more effectively accomplish the purpose
of section 13. In particular, the Agencies
were concerned that a definition of
covered fund that did not include
foreign funds would allow U.S. banking
entities to be exposed to risks and
engage in covered fund activities
outside the United States that are
specifically prohibited in the United
States. This result would undermine
section 13 and pose risks to U.S.
banking entities and the stability of the
U.S. financial system that section 13
was designed to prevent.
At the same time, section 13 includes
other provisions that explicitly limit its
extra-territorial application to the
1694 See BlackRock; SIFMA et al. (Covered Funds)
(Feb. 2012); JPMC; ABA (Keating); IIB/EBF. These
commenters argued that the proposed definition of
a covered fund could result in virtually every
foreign fund being considered a covered fund,
regardless of whether the fund is similar to a hedge
fund or private equity fund.
1695 See, e.g., AGC; Ass’n. of Institutional
Investors (Feb. 2012); ABA (Keating); Goldman
(Covered Funds); BoA; GE (Feb. 2012); Japanese
Bankers Ass’n.; EBF.
1696 See Australian Bankers Ass’n. (Feb. 2012);
AFG; BNY Mellon et al.; BlackRock; Goldman
(Covered Funds); IIB/EBF.
1697 See SIFMA et al. (Covered Funds) (Feb.
2012); JPMC; Goldman (Covered Funds); Credit
Suisse (Williams); ABA (Keating); IIB/EBF;
Barclays; BoA; GE (Feb. 2012) (discussing the
uncertainty with respect to foreign-based loan and
securitization programs and whether they would be
deemed covered funds).

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activities of foreign banks outside the
United States. As explained below,
section 13 specifically exempts certain
activities in covered funds conducted by
foreign banking entities solely outside of
the United States.
Based on these considerations and the
information provided by commenters,
the Agencies have revised the definition
of covered fund in the final rule to
include certain foreign funds under
certain circumstances. The final rule
provides that a foreign fund is included
within the definition of covered fund
only for any banking entity that is, or is
controlled directly or indirectly by a
banking entity that is, located in or
organized or established under the laws
of the United States or of any State.
Under this definition a foreign fund
becomes a covered fund only with
respect to the U.S. banking entity (or
foreign affiliate of a U.S. banking entity)
that acts as a sponsor to the foreign fund
or has an ownership interest in the
foreign fund. Under the rule, a foreign
fund is any entity that: (i) is organized
or established outside the United States
and the ownership interests of which
are offered and sold solely outside the
United States; (ii) is, or holds itself out
as being, an entity or arrangement that
raises money from investors primarily
for the purpose of investing in securities
for resale or other disposition or
otherwise trading in securities; and (iii)
has as its sponsor the U.S. banking
entity (or an affiliate thereof) or has
issued an ownership interest that is
owned directly or indirectly by the U.S.
banking entity (or an affiliate
thereof).1698 A foreign fund therefore
may be a covered fund with respect to
the U.S. banking entity that sponsors the
fund, but not be a covered fund with
respect to a foreign bank that invests in
the fund solely outside the United
States.
This approach is designed to include
within the definition of covered fund
only foreign entities that would pose
risks to U.S. banking entities of the type
section 13 was designed to address. The
Agencies note that any foreign fund,
including a foreign fund sponsored or
owned by a foreign banking entity, that
is offered or sold in the United States in
reliance on the exclusions in section
3(c)(1) or 3(c)(7) of the Investment
Company Act would be included in the
definition of covered fund under
§ ll.10(b)(1)(i) of the final rule unless
it meets the requirements of an
exclusion from that definition as
discussed below.1699 Thus, the rule is
final rule § ll.10(b)(1)(iii).
also Goodwin, Procter & Hoar LLP, SEC
Staff No-Action Letter (Feb. 28, 1997); Touche
1698 See
1699 See

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designed to provide parity—and no
competitive advantages or
disadvantages—between U.S. and nonU.S. funds sold within the United
States.
To further ensure that this approach
to foreign funds is consistent with the
scope of coverage applied within the
United States, the final rule excludes
from the definition of covered fund any
foreign issuer that, were it subject to
U.S. securities laws, would be able to
rely on an exclusion or exemption from
the definition of investment company
other than the exclusions contained in
section 3(c)(1) or 3(c)(7) of the
Investment Company Act.1700
As explained below, the final rule
also contains an exclusion for foreign
public funds.1701 This is designed to
prevent the extension of the definition
of covered fund from including foreign
funds that are similar to U.S. registered
investment companies, which are by
statute not covered by section 13.

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2. Commodity Pools
Under the proposal, the Agencies
proposed to use their authority to
expand the definition of covered fund to
include a commodity pool as defined in
section 1a(10) of the Commodity
Exchange Act.1702 A 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.1703 The Agencies proposed to
include commodity pools in the
definition of covered fund because some
commodity pools are managed and
structured in a manner similar to a
covered fund.
Some commenters objected to this
expansion of the definition of covered
fund as beyond the scope of section 13.
Commenters argued that covering
commodity pools would extend section
13 of the BHC Act to any entity that
Remnant & Co., SEC Staff No-Action Letter (Aug.
27, 1984).
1700 See final rule § ll.10(b)(2). Because any
issuer that offers its securities under the U.S.
securities laws that may rely on an exclusion or
exemption from the definition of investment
company other than the exclusions contained in
section 3(c)(1) or 3(c)(7) of the Investment Company
Act would not be a covered fund, this exclusion is
designed to provide equivalent treatment for foreign
covered funds.
1701 See § ll.10(c)(1).
1702 See proposal rule § ll.10(b)(1)(ii).
1703 Commodity interests include: (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) leveraged
transaction authorized under section 23 of the
Commodity Exchange Act. See Joint Proposal, 76
FR 68,897 n.224 and accompanying text.

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engages in a single commodity, futures
or swap transaction, including entities
that share few, if any, of the
characteristics or risk associated with
private equity funds or hedge funds.1704
For example, some commenters argued
that many non-bank businesses that are
not investment companies but that
hedge risks using commodity interests
would be treated as covered funds if all
commodity pools were covered.1705 In
addition, registered mutual funds,
pension funds, and many investment
companies that rely on exclusions or
exceptions other than section 3(c)(1) or
3(c)(7) of the Investment Company Act
would be covered as commodity pools.
Commenters argued that the CFTC has
ample authority to regulate the activities
of commodity pools and commodity
pool operators, and nothing in section
13 indicates that Congress intended
section 13 to govern commodity pool
activities or investments in commodity
pools.1706 Commenters also argued that
expanding the definition of covered
fund to include commodity pools would
have the unintended consequence of
limiting all covered transactions
between a banking entity sponsor or
investor in a commodity pool and the
commodity pool itself.1707 If a
commercial end user is a commodity
pool for example, this restriction could
limit access to credit for that entity.
Commenters that opposed the
proposal’s inclusion of commodity
pools generally asserted that, if
commodity pools were nonetheless
included as covered funds under the
final rule, the definition of commodity
pool should be modified so that it
would include only those pools that
engage ‘‘primarily’’ or ‘‘principally’’ in
commodities trading and exhibit
characteristics similar to those of
conventional hedge funds and private
equity funds.1708 Other commenters
urged the Agencies to incorporate the
exemptions from the commodity pool
operator registration requirements under
1704 See, e.g., ABA (Keating) (citing See, e.g.,
CFTC Interpretative Letter No. 86–22, Comm. Fut.
L. Rep. (CCH) ¶ 23,280 (Sept. 19, 1986)); SIFMA et
al. (Covered Funds) (Feb. 2012); ICI (Feb. 2012);
BlackRock; Goldman (Covered Funds); Wells Fargo
(Covered Funds); BoA; EFAMA; TCW; ISDA (Feb.
2012); Arnold & Porter; BNY Mellon et al.; SSgA
(Feb. 2012); State Street (Feb. 2012); Credit Suisse
(Williams); RMA; IIB/EBF.
1705 See Goldman (Covered Funds); TCW;
IIB/EBF.
1706 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); ICI (Feb. 2012); BlackRock.
1707 See, e.g., BoA.
1708 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); Goldman (Covered Funds); BlackRock; Wells
Fargo (Covered Funds); BNY Mellon, et al.; SSgA
(Feb. 2012); State Street (Feb. 2012); Credit Suisse
(Williams); ABA (Keating); FIA; IIB/EBF; BoA.

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5673

the Commodity Exchange Act (such as
rule 4.13(a)(4)).1709
Some commenters supported
including commodity pools within the
definition of covered fund,1710 with
some suggesting that this approach
would be consistent with the goals of
the statute.1711 One commenter asserted
that including commodity pools would
be necessary to prevent banking entities
from indirectly engaging in prohibited
proprietary trading through commodity
pools.1712 Another commenter asserted
that the inclusion of commodity pools
was advisable because the CFTC has in
the past viewed many commodity pools
as similar to hedge funds.1713
After carefully considering these
comments, the Agencies have
determined not to include all
commodity pools as covered funds as
proposed. Instead, and taking into
account commenters’ concerns, the
Agencies have taken a more tailored
approach that is designed to more
accurately identify those commodity
pools that are similar to issuers that
would be investment companies as
defined the Investment Company Act of
1940 but for section 3(c)(1) or 3(c)(7) of
that Act, consistent with section
13(h)(2) of the BHC Act.
Under the final rule, as a threshold
matter, a collective investment vehicle
must determine whether it is a
‘‘commodity pool’’ as that term is
defined in section 1a(10) of the
Commodity Exchange Act.1714 The
Agencies note that collective investment
vehicles need to make this
determination for purposes of
complying with the Commodity
Exchange Act regardless of whether
commodity pools are covered funds.
Under section 1a(10), a commodity pool
is ‘‘any investment trust, syndicate, or
similar form of enterprise operated for
the purpose of trading commodity
interests.’’ 1715 If a collective investment
1709 See

Credit Suisse (Williams).
AFR et al. (Feb. 2012); Alfred Brock;
Occupy; Sens. Merkley & Levin (Feb. 2012).
1711 See Sens. Merkley & Levin (Feb. 2012);
Occupy; AFR et al. (Feb. 2012); Alfred Brock.
1712 See Sens. Merkley & Levin (Feb. 2012).
1713 See Occupy.
1714 See 7 U.S.C. 1a(10).
1715 Id. The CFTC and its divisions have provided
interpretative guidance with respect to the meaning
of the definition of commodity pool. See, e.g., 46
FR 26004, 26005 (May 8, 1981) (adopting the
CFTC’s regulatory definition of commodity pool in
17 CFR 4.10(d), which is substantively identical to
the definition in section 1a(10) of the Commodity
Exchange Act); 77 FR 11252, 11258 (Feb. 24, 2012)
(explaining the need for swaps to be included in the
de minimis exclusion and exemption in 17 CFR 4.5
and 4.13); CFTC Staff Letter 12–13 (Oct. 11, 2012)
(providing interpretative guidance to equity real
estate investment trusts); and CFTC Staff Letters
1710 See

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vehicle meets that definition, the
commodity pool would be considered a
covered fund provided it meets one of
two alternative tests and does not also
qualify for an exclusion from the
covered fund definition (e.g., the
exclusion for registered investment
companies).
First, a commodity pool will be a
covered fund if it is an ‘‘exempt pool’’
under section 4.7(a)(1)(iii) of the CFTC’s
regulations,1716 meaning that it is a
commodity pool for which a registered
commodity pool operator has elected to
claim the exemption provided by
section 4.7 of the CFTC’s regulations.
The Agencies believe that such
commodity pools are appropriately
considered covered funds because, like
funds that rely on section 3(c)(1) or
3(c)(7), these commodity pools sell their
participation units in restricted offerings
that are not registered under the
Securities Act of 1933 and are offered
only to investors who meet certain
heightened qualification standards, as
discussed above.1717 The Agencies
therefore have determined that they
properly are considered ‘‘such similar
funds’’ as specified in section 13(h)(2) of
the BHC Act.
Alternatively, a commodity pool for
which exempt pool status under section
4.7 of the CFTC’s regulations has not
been elected may also be a covered fund
if the pool features certain elements that
make the pool substantively similar to
exempt pools under section 4.7. The
Agencies are including the alternative
definition of commodity pools that are
covered funds because, if the Agencies
had included only pools for which
exempt pool status had been elected,
covered fund status for pools in which
banking entities are invested could
easily be avoided merely by not electing
exempt pool status under section 4.7.
The following is a description of the
elements of a pool that would cause a
pool that is not an exempt pool under
section 4.7 to be a covered fund.
The first element is that a commodity
pool operator for the pool is registered
pursuant to the Commodity Exchange
Act in connection with the operation of
that commodity pool. This element is
present for all pools that are exempt
Nos. 12–14 (Oct. 11, 2012) and 12–45 (Dec. 7, 2012)
(providing interpretative relief that certain
securitization vehicles are not commodity pools).
1716 17 CFR 4.7(a)(1)(iii).
1717 Although section 3(c)(1) itself does not limit
the types of investors who may invest in a fund
relying on that exclusion, section 3(c)(1) provides
that the fund may not conduct a public offering. A
fund relying on section 3(c)(1) therefore must offer
and sell its interests in offerings that are not
registered under the Securities Act of 1933, which
offerings generally are limited to persons who meet
certain qualification standards.

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pools under section 4.7 because exempt
pool status can only be elected by
registered commodity pool operators.
This element excludes from the
definition of covered fund an entity that
is a commodity pool, but for which the
pool operator has been either exempted
from registration as a commodity pool
operator or excluded from the definition
of commodity pool operator under the
CFTC’s regulations or pursuant to a noaction letter issued by CFTC staff.1718
The second element under the
alternative definition is that
substantially all of the commodity
pool’s participation units are owned
only by qualified eligible persons under
section 4.7(a)(2) and (a)(3).1719 This
element is consistent with the
requirement under section 4.7 that
exempt pool status can only be claimed
if the participation units in the pool are
only offered or sold to qualified eligible
persons.1720 Moreover, the inclusion of
this element aligns the elements of the
alternative test with features that define
funds that rely on sections 3(c)(1) and
3(c)(7) of the Investment Company Act
of 1940.
The assessment as to whether the
commodity pool in question satisfies
this condition must be made at the time
that the banking entity is required to
make the following determinations:
Whether it can obtain new participation
units in the commodity pool, whether it
can retain previously purchased
participation units in the commodity
pool, and whether it can act as the
commodity pool’s sponsor. The
Agencies believe this to be appropriate
because it would require the banking
entity to consider current information
regarding the commodity pool and its
participants rather than assess the
composition of the pool’s participants
over time even though its investments
in or relationships with the pool do not
change, which could be difficult
depending upon the length of time that
the pool has been in operation and the
1718 See, e.g., CFTC regulations 3.10(c) and 4.13
and CFTC Staff Letters Nos. 12–37 (Nov. 29, 2012)
(relief from registration for operators of certain
types of family office pools), 12–40 (Dec. 4, 2012)
(relief from registration for operators of business
development companies that meet certain
conditions) and 12–44 (Dec. 7, 2012) (relief from
registration for operators of mortgage real estate
investment trusts that meet certain conditions). See
also supra note 1715.
1719 17 CFR 4.7(a)(2) and (a)(3).
1720 Although section 4.7 requires that all
participation units be owned by qualified eligible
persons, this element of the final rule has been
modified to include pools for which ‘‘substantially
all’’ participation units are owned by qualified
eligible persons to prevent avoidance of covered
fund status by distributing a small number of
participation units to persons who are not qualified
eligible persons.

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records available at the time of
determination.
Finally, the third element under the
alternative definition is that the
commodity pool participation units
have not been publicly offered to
persons other than qualified eligible
persons. Consistent with CFTC
regulations addressing the meaning of
‘‘offer’’ in the context of the CFTC’s
regulations, the term ‘‘offer’’ as used in
§ ll.10(b)(1)(ii)(B) ‘‘has the same
meaning as in contract law, such that,
if accepted the terms of the offer would
form a binding contract.’’ 1721 This
aspect of the alternative definition is
intended to limit the ability for
commodity pools to avoid classification
as covered funds through an offer, either
in the past or currently ongoing, to nonqualified eligible persons ‘‘in name
only’’ where there is no actual offer to
non-qualified eligible persons.
Accordingly, unless the pool operator
can show that the pool’s participation
units have been actively and publicly
offered to non-affiliated parties that are
not qualified eligible persons whereby
such non-qualified eligible persons
could in fact purchase a participation
unit in the commodity pool, a pool that
features the other elements listed in the
alternative definition would be a
covered fund. Such a showing will not
turn solely on whether the commodity
pool has filed a registration statement to
offer its participation units under the
Securities Act of 1933 or whether the
commodity pool operator has prepared
a disclosure document consistent with
the provisions of section 4.24 of the
CFTC’s regulations.1722 Rather, the pool
operator would need to show that a
reasonably active effort, based on the
facts and circumstances, has been
undertaken by brokers and other sales
personnel to publicly offer the pool’s
participation units to non-affiliated
parties that are not qualified eligible
persons.
In taking this more tailored approach
to commodity pools that will be covered
funds, the Agencies are more closely
aligning the types of commodity pools
that will be covered funds under the
final rule with section 13’s definition of
a hedge fund and private equity fund by
reference to section 3(c)(1) or section
3(c)(7), and addressing concerns of
commenters that the proposal was
1721 See 77 FR 9734, 9741 (Feb. 17, 2012)
(describing the meaning of the term ‘‘offer’’ in the
context of the business conduct standards for swap
dealers and major swap participants with
counterparties adopted by the CFTC). The term
‘‘offered’’ as used in this section of the final rule
is not intended to denote an ‘‘offer’’ for purposes
of the Securities Act of 1933.
1722 17 CFR 4.24 (2013).

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overly broad and would lead to
outcomes inconsistent with the words,
structure, and purpose of section 13.1723
The Agencies believe that the types of
commodity pools described above
generally are similar to funds that rely
on section 3(c)(1) and 3(c)(7) in that,
like funds that rely on section 3(c)(1) or
3(c)(7), these commodity pools may be
owned only by investors who meet
certain heightened qualification
standards, as discussed above.1724
Further, the Agencies believe that the
final rule’s identification of the
elements of a commodity pool that is a
covered fund are clearly established and
readily ascertainable such that once it is
determined whether an entity is a
commodity pool, an assessment that is
already necessary to comply with the
Commodity Exchange Act, then the
further determination of whether an
entity that is a commodity pool is also
a covered fund can be made based on
readily ascertainable information.
In adopting this approach, the
Agencies also are utilizing the current
regulatory structure promulgated by the
CFTC under the CEA. As the CFTC
regulates commodity pools, commodity
pool operators, and commodity trading
advisors that advise commodity pools,
the Agencies believe that it is beneficial
to utilize an already established set of
rules, regulations, and guidance. The
Agencies considered alternative
approaches provided by the
commenters, but have adopted the
approach taken in the final rule for the
reasons discussed above and because
the Agencies believe that the final rule,
by incorporating concepts with which
commodity pools and their operators are
familiar, more clearly delineates the
commodity pools that are covered
funds.1725
The Agencies believe that the final
rule’s tailored approach to commodity
pools includes in the definition of
covered fund commodity pools that are
1723 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); BlackRock; AHIC; Sen. Carper et al.; Rep.
Garrett et al.
1724 Funds relying on section 3(c)(7) must be
owned exclusively by qualified purchasers, as
defined in the Investment Company Act. The
Agencies note in this regard that section 4.7 of the
CFTC’s regulations use substantially the same
definition of a qualified purchaser in defining the
term qualified eligible person.
1725 Operators of commodity pools currently must
consider whether they are required to register with
the CFTC as commodity pool operators, and
whether the pools have the characteristics that
would make it possible for the operator to claim an
exemption under section 4.7. These concepts thus
should be familiar to commodity pools and their
operators, and including these concepts in the final
rule should allow banking entities more easily to
determine if a particular commodity pools is a
covered fund than if the Agencies were to develop
new concepts solely for purposes of the final rule.

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similar to funds that rely on section
3(c)(1) and 3(c)(7). The Agencies also
note in this regard that a commodity
pool that would be a covered fund even
under this tailored approach will not be
a covered fund if the pool also qualifies
for an exclusion from the covered fund
definition, including the exclusion for
registered investments companies.
Accordingly, this approach excludes
from covered funds entities like
commercial end users and registered
investment companies, whose activities
do not implicate the concerns section 13
was designed to address. Rather, the
final rule limits the commodity pools
that will be included as covered funds
to those that are similar to other covered
funds except that they are not generally
subject to the Investment Company Act
of 1940 due to the instruments in which
they invest. For all of these reasons, the
Agencies believe that the final rule’s
approach to commodity pools addresses
both the Agencies’ concerns about the
potential for evasion and commenters’
concerns about the breadth of the
proposed rule, and provides that the
commodity pools captured as covered
funds are ‘‘such similar funds,’’
consistent with section 13(h)(2) of the
BHC Act.
The Agencies acknowledge that as a
result of including certain commodity
pools in the definition of covered fund,
the prohibitions under section 13(f) and
§ ll.14 may result in certain structural
changes in the industry. The Agencies
note that these changes (e.g., bankaffiliated FCMs may not be able to lend
money in certain clearing transactions
to affiliated commodity pools that are
covered funds) may result in certain
changes in the way related entities do
business with each other. However, the
Agencies believe that because the
industry is competitive with a
significant number of alternative nonaffiliate competitors, the changes would
not result in a less competitive
landscape for investors in commodity
pools.
3. Entities Regulated Under the
Investment Company Act
The proposed rule did not specifically
include registered investment
companies (including mutual funds) or
business development companies
within the definition of covered
fund.1726 As explained above, the
statute references funds that rely on
section 3(c)(1) or 3(c)(7) of the
Investment Company Act. Registered
investment companies and business
development companies do not rely on
either section 3(c)(1) or 3(c)(7) of the
1726 See

PO 00000

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Frm 00141

Fmt 4701

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5675

Investment Company Act and are
instead registered or regulated in
accordance with the Investment
Company Act.
Many commenters argued that
registered investment companies and
business development companies would
be treated as covered funds under the
proposed definition if commodity pools
are treated as covered funds.1727 A few
commenters argued that the final rule
should specifically provide that all SECregistered funds are excluded from the
definition of covered fund (and the
definition of banking entity) to avoid
any uncertainty about whether section
13 applies to these types of funds.1728
Commenters also requested that the
final rule exclude from the definition of
covered fund entities formed to
establish registered investment
companies during the seeding period.
These commenters contended that,
during the early stages of forming and
seeding a registered investment
company, an entity relying on section
3(c)(1) or (3)(c)(7) may be created to
facilitate the development of a track
record for the registered investment
company so that it may be marketed to
unaffiliated investors.1729
The Agencies did not intend to
include registered investment
companies and business development
companies as covered funds under the
proposal. Section 13’s definition of
private equity fund and hedge fund by
reference to section 3(c)(1) and 3(c)(7) of
the Investment Company Act appears to
reflect Congress’ concerns about
banking entities’ exposure to and
relationships with investment funds
that explicitly are excluded from SEC
regulation as investment companies.
The Agencies do not believe it would be
appropriate to treat as a covered fund
registered investment companies and
business development companies,
which are regulated by the SEC as
investment companies. The Agencies
believe that the proposed rule’s
inclusion of commodity pools would
have resulted in some registered
investment companies and business
development companies being covered
1727 See, e.g., Arnold & Porter; BoA; Goldman
(Covered Funds); ICI (Feb. 2012); Putnam; TCW;
Vanguard. According to these commenters, a
registered investment company may use security or
commodity futures, swaps, or other commodity
interests in various ways to manage its investment
portfolio and be swept into the broad definition of
‘‘commodity pool’’ contained in the Commodity
Exchange Act.
1728 See Arnold & Porter; Goldman (Covered
Funds); See also SIFMA et al. (Covered Funds)
(Feb. 2012); SIFMA et al. (Mar. 2012); ABA
(Keating); BoA; ICI (Feb. 2012); JPMC; (requesting
clarification that registered investment companies
are not banking entities); TCW.
1729 See ICI (Feb. 2012); TCW.

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funds, a result the Agencies did not
intend. The Agencies, in addition to
narrowing the commodity pools that
will be included as covered funds as
discussed above, have also modified the
final rule to exclude SEC-registered
investment companies and business
development companies from the
definition of covered fund.1730
The Agencies also recognize that an
entity that becomes a registered
investment company or business
development company might, during its
seeding period, rely on section 3(c)(1) or
3(c)(7). The Agencies have determined
to exclude these seeding vehicles from
the covered fund definition for the same
reasons the Agencies determined to
exclude entities that are operating as
registered investment companies or
business development companies as
discussed in more detail below in Part
IV.B.1.c.12 of this SUPPLEMENTARY
INFORMATION.
The Agencies also understand that
registered investment companies may
establish and hold subsidiary entities
that rely on section 3(c)(1) or 3(c)(7) in
order to trade in various financial
instruments for the registered
investment company parent. If a
registered investment company were
itself a banking entity, section 13 and
the final rule would prohibit the
registered investment company from
sponsoring or investing in such an
investment subsidiary. But a registered
investment company would only itself
be a banking entity if it is an affiliate of
an insured depository institution. As
explained in the proposal, a registered
investment company, such as a mutual
fund or exchange traded fund, or an
entity that has made an effective
election to be regulated as a business
development company, would not be an
affiliate of a banking entity for purposes
of section 13 of that Act solely by virtue
of being advised, or organized,
sponsored and managed by a banking
entity in accordance with the BHC Act
(including section 13) and the Board’s
Regulation Y.1731
Under the BHC Act, an entity
(including a registered investment
company) would generally be
considered an affiliate of a banking
entity, and therefore a banking entity
itself, if it controls, is controlled by, or
is under common control with an
insured depository institution.1732
Pursuant to the BHC Act, a company
controls another company if: (i) The
company directly or indirectly or acting
final rule § ll.10(c)(12).
Joint Proposal, 76 FR 68,856.
1732 See final rule § ll.2(a) (defining ‘‘affiliate’’
for purposes of the final rule).
1730 See
1731 See

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through one or more other persons
owns, controls, or has power to vote 25
per cent or more of any class of voting
securities of the company; (ii) the
company controls in any manner the
election of a majority of the directors of
trustees of the other company; or (iii)
the Board determines, after notice and
opportunity for hearing, that the
company directly or indirectly exercises
a controlling influence over the
management or policies of the
company.1733
The Board’s regulations and orders
have long recognized that a bank
holding company may organize,
sponsor, and manage a mutual fund
such as a registered investment
company, including by serving as
investment adviser to registered
investment company, without
controlling the registered investment
company for purposes of the BHC
Act.1734 For example, the Board has
permitted a bank holding company to
own up to 5 percent of the voting shares
of a registered investment company for
which the bank holding company
provides investment advisory,
administrative, and other services, and
has a number of director and officer
interlocks, without finding that the bank
holding company controls the fund.1735
The Board has also permitted a bank
holding company to own less than 25
percent of the voting shares of a
registered investment company and
provide similar services without finding
that the bank holding company controls
the fund, so long as the fund limits its
investments to those permissible for the
holding company to make itself.1736
1733 See

12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
e.g., 12 CFR 211.10(a)(11);
225.28(b)(6)(i); 225.86(b)(3); Unicredito, 86 Fed.
Res. Bull. 825 (2000); Societe Generale, 84 Fed. Res.
Bull. 680 (1998); Commerzbank AG, 83 Fed. Res.
Bull. 678 (1997); The Governor and Company of the
Bank of Ireland, 82 Fed. Res. Bull. 1129 (1996);
Mellon Bank Corp., 79 Fed. Res. Bull. 626 (1993);
Bayerische Vereinsbank AG, 73 Fed. Res. Bull. 155
(1987).
1735 See, e.g., Societe Generale, 84 Fed. Res. Bull.
680 (1998) (finding that a bank holding company
does not control a mutual fund for which it holds
up to 5 percent of the voting shares and also
provides investment advisory, administrative and
other services, has directors or employees who
comprise less than 25 percent of the board of
directors of the fund (including the chairman of the
board), and has three senior officer interlocks and
a number of junior officer interlocks).
1736 See letter dated June 24, 1999, to H. Rodgin
Cohen, Esq., Sullivan & Cromwell (First Union
Corp.), from Jennifer J. Johnson, Secretary of the
Board of Governors of the Federal Reserve System
(finding that a bank holding company does not
control a mutual fund for which it provides
investment advisory and other services and that
complies with the limitations of section 4(c)(7) of
the BHC Act (12 U.S.C. 1843(c)(7)), so long as (i)
the bank holding company reduces its interest in
the fund to less than 25 percent of the fund’s voting
1734 See,

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The BHC Act, as amended by the
Gramm-Leach-Bliley Act, and the
Board’s Regulation Y authorize a bank
holding company that qualifies as a
financial holding company to engage in
a broader set of activities, and to have
a broader range of relationships or
investments with entities, than bank
holding companies.1737 For instance, a
financial holding company may engage
in, or acquire shares of any company
engaged in, any activity that is financial
in nature or incidental to such financial
activity, including any activity that a
bank holding company is permitted to
engage in or acquire by regulation or
order.1738 In light of the foregoing, for
purposes of section 13 of the BHC Act
a financial holding company may own
more than 5 percent (and less than 25
percent) of the voting shares of a
registered investment company for
which the holding company provides
investment advisory, administrative,
and other services and has a number of
director and officer interlocks, without
controlling the fund for purposes of the
BHC Act.1739
So long as a bank holding company or
financial holding company complies
with these limitations, it would not,
absent other facts and circumstances,
control a registered investment
company and the registered investment
company for purposes of section 13 (and
any subsidiary thereof) would not itself
be a banking entity subject to the
restrictions of section 13 of the BHC Act
and any final implementing rules
(unless the registered investment
company itself otherwise controls an
insured depository institution). Also
consistent with the Board’s precedent
regarding bank holding company
control of and relationships with funds,
a seeding vehicle that will become a
registered investment company or SECregulated business development
shares after a six-month period, and (ii) a majority
of the fund’s directors are independent of the bank
holding company and the bank holding company
cannot select a majority of the board) (‘‘First Union
Letter’’); H.R. Rep. No. 106–434 at 153 (1999) (Conf.
Rep.) (noting that the Act permits a financial
holding company to sponsor and distribute all types
of mutual funds and investment companies); See
also 12 U.S.C. 1843(k)(1), (6).
1737 See, e.g., H.R. Rep. No. 106–434 at 153 (1999)
(Conf. Rep.) (noting that the Act permits a financial
holding company to sponsor and distribute all types
of mutual funds and investment companies).
1738 See 12 U.S.C. 1843(k)(1); 12 CFR 225.86.
1739 See First Union Letter (June 24, 1999); See
also 12 CFR 225.86(b)(3) (authorizing a financial
holding company to organize, sponsor, and manage
a mutual fund so long as (i) the fund does not
exercise managerial control over the entities in
which the fund invests, and (ii) the financial
holding company reduces its ownership in the
fund, if any, to less than 25 percent of the equity
of the fund within one year of sponsoring the fund
or such additional period as the Board permits).

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
company would not itself be viewed as
violating the requirements of section 13
during the seeding period so long as the
banking entity that establishes the
seeding vehicle operates the vehicle
pursuant to a written plan, developed in
accordance with the banking entity’s
compliance program, that reflects the
banking entity’s determination that the
vehicle will become a registered
investment company or SEC-regulated
business development company within
the time period provided by section
13(d)(4) and § ll.12 for seeding a
covered fund.1740

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c. Entities Excluded From Definition of
Covered Fund
As noted above, the final rule
excludes a number of entities from the
definition of covered fund.1741 As
discussed in more detail below, these
exclusions more effectively tailor the
definition of covered fund to those types
of entities that section 13 was designed
to focus on. The exclusions thus are
designed to provide certainty, mitigate
compliance costs and other burdens,
and address the potential over-breadth
of the covered fund definition and
related requirements without such
exclusions by permitting banking
entities to invest in and have other
relationships with entities that do not
relate to the statutory purpose of section
13. These exclusions, described in more
detail below, take account of
information provided by many
commenters regarding entities that
would likely be included within the
proposed definition of a covered fund,
but that are not traditionally thought of
as hedge funds or private equity
funds.1742 Finally, the Agencies note
that providing exclusions from the
covered fund definition, rather than
providing permitted activity exemptions
as proposed in some cases, aligns the
final rule with the statute in applying
the restrictions imposed by section 13(f)
on transactions with covered funds only
to transactions with issuers that are
defined as covered funds and thus raise
1740 See final rule §§ ll.10(c)(12) and ll.20(e).
Under the final rule, these Seeding vehicles also
must comply with the limitations on leverage under
the Investment Company Act that apply to
registered investment companies and SEC-regulated
business development companies. See final rule
§ ll.10(c)(12).
1741 See final rule § ll.10(c).
1742 See 156 Cong. Rec. H5226 (daily ed. June 30,
2010) (statement of Reps. Himes and Frank) (noting
intent that subsidiaries or joint ventures not be
included within the definition of covered fund);
156 Cong. Rec. S5904–05 (daily ed. July 15, 2010)
(statement of Sens. Boxer and Dodd) (noting broad
definition of hedge fund and private equity fund
and recommending that the Agencies take steps to
ensure definition is reasonably tailored); See also
FSOC study at 61–63.

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the concerns section 13 was designed to
address.
The Agencies recognize, however,
that the final rule’s definition of covered
fund does not include certain pooled
investment vehicles. For example, the
definition of covered fund excludes
business development companies,
entities that rely on section 3(c)(5)(C),
3(c)(3), or 3(c)(11) of the Investment
Company Act, and certain foreign
public funds that are subject to homecountry regulation. The Agencies expect
that the types of pooled investment
vehicles sponsored by the financial
services industry will continue to
evolve, including in response to the
final rule, and the Agencies will be
monitoring this evolution to determine
whether excluding these and other types
of entities remains appropriate. The
Agencies will also monitor use of the
exclusions for attempts to evade the
requirements of section 13 and intend to
use their authority where appropriate to
prevent evasions of the rule.
1. Foreign Public Funds
As discussed above, under the
proposal a covered fund was defined to
include the foreign equivalent of any
covered fund in order to address the
potential for circumvention. Many
commenters argued that the proposed
definition could capture non-U.S.
public retail funds, such as UCITS.1743
These commenters contended that nonU.S. public retail funds should be
excluded from the definition of covered
fund because they are regulated in their
home jurisdiction; commenters noted
that similar funds registered in the
United States, such as mutual funds, are
not covered funds.1744
Some commenters were concerned
that the proposed definition could
inadvertently capture exchange-traded
funds trading in foreign
jurisdictions,1745 separate accounts set
1743 As discussed above, the proposed rule
generally included in the covered fund definition
a foreign fund that, were it organized or offered
under the laws of the United States or offered to
U.S. residents, would meet the definition of a
domestic covered fund (i.e., would need to rely
section 3(c)(1) or 3(c)(7) of the Investment Company
Act). Many commenters argued that this definition
is too broad and could include as covered funds
various types of foreign funds, like UCITS, that
commenters argued should not be included. See,
e.g., JPMC; BlackRock.
1744 See SIFMA et al. (Covered Funds) (Feb.
2012); Hong Kong Inv. Funds Ass’n.; UBS; ICI
Global; BlackRock; TCW; State Street (Feb. 2012);
SSgA (Feb. 2012); IAA; JPMC; Goldman (Covered
Funds); BoA; Credit Suisse (Williams); BNY
Mellon, et al.; Union Asset; EFAMA; BVI; IRSG,
SEB; IIB/EBF; GE (Feb. 2012) (commenting on the
overbreadth of the definition because of the effect
on foreign issuers of asset-backed securities); Allen
& Overy (on behalf of Foreign Bank Group).
1745 See BlackRock; Vanguard.

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5677

up to fund foreign pension plans,1746
non-U.S. issuers of asset-backed
securities,1747 and non-U.S. regulated
funds specifically designed for
institutional investors.1748 Commenters
also provided several potential effects of
capturing foreign public funds under
the covered fund definition: U.S.
banking entities would incur
unnecessary and substantial costs to
rebrand and restructure their non-U.S.
regulated funds,1749 banking entities
could be eliminated from the potential
pool of counterparties, thereby affecting
pricing and efficiency,1750 U.S. banking
entities may exit the UCITS market and
lose competitiveness,1751 the growth of
mutual fund formation in foreign
countries could be limited,1752 and
market liquidity in foreign jurisdictions
could be impaired.1753
Some commenters supported
excluding any foreign public fund that
is organized or formed under non-U.S.
law, authorized for public sale in the
jurisdiction in which it is organized or
formed, and regulated as a public
investment company in that
jurisdiction.1754 In light of the
proposal’s broad definition of covered
fund, some commenters recommended
explicitly excluding non-U.S. regulated
funds based on characteristics to
distinguish the foreign funds that
should be treated as covered funds.1755
Several commenters recommended
excluding non-U.S. funds based upon
whether the funds are subject to a
regulatory framework comparable to
that which is imposed on SEC-registered
funds;1756 one commenter specifically
identified European UCITS, Canadian
mutual funds, Australian unit trusts,
and Japanese investment trusts as
examples of regulated funds to be
excluded.1757
To address these concerns, the final
rule generally excludes from the
definition of covered fund any issuer
1746 See

BlackRock.
ASF (Feb. 2012).
1748 See Union Asset; EFAMA; BVI.
1749 See Goldman (Covered Funds).
1750 See AFMA.
1751 See BoA.
1752 See BVI.
1753 See Goldman (Covered Funds).
See AFMA.
See BoA.
1754 See ICI Global; ICI (Feb. 2012); SSgA (Feb.
2012); BNY Mellon et al.
1755 See UBS; ICI Global; ICI (Feb. 2012); Allen &
Overy (on behalf of Foreign Bank Group); T. Rowe
Price; HSBC Life; Union Asset; EFAMA; BVI; EBF;
Hong Kong Inv. Funds Ass’n.; IMA; Ass’n. of
Institutional Investors (Feb. 2012); Katten (on behalf
of Int’l Clients); Credit Suisse (Williams).
1756 See T. Rowe Price; Credit Suisse (Williams);
SSgA (Feb. 2012); BNY Mellon et al.
1757 See T. Rowe Price.
1747 See

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that is organized or established outside
of the United States and the ownership
interests of which are authorized to be
offered and sold to retail investors in the
issuer’s home jurisdiction and are sold
predominantly through one or more
public offerings outside of the United
States.1758 Foreign funds that meet these
requirements will not be covered funds,
except that an additional condition
applies to U.S. banking entities1759 with
respect to the foreign public funds they
sponsor. The foreign public fund
exclusion is only available to a U.S.
banking entity with respect to a foreign
fund sponsored by the U.S. banking
entity if, in addition to the requirements
discussed above, the fund’s ownership
interests are sold predominantly to
persons other than the sponsoring
banking entity, affiliates of the issuer
and the sponsoring banking entity, and
employees and directors of such
entities.
For purposes of this exclusion, the
Agencies note that the reference to retail
investors, while not defined, should be
construed to refer to members of the
general public who do not possess the
level of sophistication and investment
experience typically found among
institutional investors, professional
investors or high net worth investors
who may be permitted to invest in
complex investments or private
placements in various jurisdictions.
Retail investors would therefore be
expected to be entitled to the full
protection of securities laws in the
home jurisdiction of the fund, and the
Agencies would expect a fund
authorized to sell ownership interests to
such retail investors to be of a type that
is more similar to a U.S. registered
investment company rather than to a
U.S. covered fund.
In order to help maintain this
distinction and to avoid circumstances
that could result in an evasion of section
13 and the final rule, the ownership
interests of the fund must be sold
predominantly in one or more public
offerings outside of the United States to
qualify for the exclusion. Given this
restriction, a U.S. banking entity
therefore could not rely on this
exclusion to set up a foreign public fund
for the purpose of selling a significant
amount of ownership interests in the
final rule § ll.10(c)(1).
the discussion of this condition
generally refers to U.S. banking entities for ease of
reading, the condition also applies to foreign
affiliates of a U.S. banking entity. See final rule
§ ll.10(c)(1)(ii) (applying this limitation ‘‘[w]ith
respect to a banking entity that is, or is controlled
directly or indirectly by a banking entity that is,
located in or organized under the laws of the United
States or of any State and any issuer for which such
banking entity acts as sponsor’’).
1758 See

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fund through one or more offerings
conducted on an unregistered basis
(whether in a foreign jurisdiction or in
the United States). The Agencies
generally expect that an offering is made
predominantly outside of the United
States if 85 percent or more of the fund’s
interests are sold to investors that are
not residents of the United States.
The requirements that a foreign public
fund both be authorized for sale to retail
investors and sold predominantly in
public offerings outside of the United
States are based in part on the Agencies’
view that foreign funds that meet these
requirements generally will be
sufficiently similar to U.S. registered
investment companies such that it is
appropriate to exclude these foreign
funds from the covered fund definition.
A foreign fund authorized for sale to
retail investors that is also publicly
offered may, for example, provide
greater information than funds that are
sold through private offerings like funds
that rely on section 3(c)(1) or 3(c)(7).
Such foreign funds also may be subject
to various restrictions, as deemed
appropriate by foreign regulators in light
of local conditions and practices, that
exceed those applicable to privately
offered funds. Foreign regulators may
apply these or other enhanced
restrictions or other requirements to
funds that are offered on a broad basis
to the general public for the protection
of investors in those jurisdictions.
A foreign fund that purports to
publicly offer its shares but in fact offers
them on a more limited basis, however,
may be less likely to resemble a
registered investment company in these
and other respects. In order to limit the
foreign public fund exclusion to funds
that publicly offer their shares on a
sufficiently broad basis, the final rule
defines the term ‘‘public offering’’ for
purposes of this exclusion to mean a
‘‘distribution’’ (as defined in § ll
.4(a)(3) of subpart B) of securities in any
jurisdiction outside the United States to
investors, including retail investors,
provided that (i) the distribution
complies with all applicable
requirements in the jurisdiction in
which such distribution is being made;
(ii) the distribution does not restrict
availability to investors having a
minimum level of net worth or net
investment assets; and (iii) the issuer
has filed or submitted, with the
appropriate regulatory authority in such
jurisdiction, offering disclosure
documents that are publicly
available.1760
1760 See final rule
§ ll.10(c)(1)(iii).

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Under the final rule, therefore, a
foreign fund’s distribution would not be
a public offering for purposes of the
foreign public fund exclusion if the
distribution imposes investor
restrictions based on a required
minimum level of net worth or net
investment assets. This would not be
affected by any suitability requirements
that may be imposed under applicable
local law. In addition, the final rule
requires that, in connection with a
public offering by a foreign public fund,
the offering disclosure documents must
be ‘‘publicly available.’’ This
requirement will provide assurance
regarding the transparency for such an
offering and will generally be satisfied
where the documents are made
accessible to all persons in such
jurisdiction. Disclosure documents may
be made publicly available in a variety
of means, such as through a public filing
with a regulatory agency or through a
Web site that provides broad
accessibility to persons in such
jurisdiction.
In addition and as discussed above,
the final rule also places an additional
condition on a U.S. banking entity’s
ability to rely on the foreign public fund
exclusion with respect to the foreign
public funds it sponsors. For a U.S.
banking entity to rely on the foreign
public fund exclusion with respect to a
foreign public fund it sponsors, the
ownership interests in the fund must be
sold predominantly to persons other
than the sponsoring U.S. banking entity
and certain persons connected to that
banking entity. Consistent with the
Agencies’ view concerning whether a
foreign public fund has been sold
predominantly outside of the United
States, the Agencies generally expect
that a foreign public fund will satisfy
this additional condition if 85 percent
or more of the fund’s interests are sold
to persons other than the sponsoring
U.S. banking entity and certain persons
connected to that banking entity.
This additional condition reflects the
Agencies’ view that the foreign public
fund exclusion is designed to treat
foreign public funds consistently with
similar U.S. funds and to limit the
extraterritorial application of section 13
of the BHC Act, including by permitting
U.S. banking entities and their foreign
affiliates to carry on traditional asset
management businesses outside of the
United States. The exclusion is not
intended to permit a U.S. banking entity
to establish a foreign fund for the
purpose of investing in the fund as a
means of avoiding the restrictions
imposed by section 13. Permitting a U.S.
banking entity to invest in a foreign
public fund under this exclusion only

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when that fund is sold predominantly to
persons other than the sponsoring U.S.
banking entity and certain persons
connected to that banking entity permits
U.S. banking entities to continue their
asset management businesses outside of
the United States while also limiting the
opportunity for evasion of section 13 as
discussed below.
This additional condition only
applies to U.S. banking entities with
respect to the foreign public funds they
sponsor because the Agencies believe
that a foreign public fund sponsored by
a U.S. banking entity may present
heightened risks of evasion. Absent the
additional condition, a U.S. banking
entity could establish a foreign public
fund for the purpose of itself investing
substantially in that fund and, through
the fund, making investments that the
banking entity could not make directly
under section 13. The Agencies believe
it is less likely that a U.S. banking entity
effectively could evade section 13 by
investing in third-party foreign public
funds that the banking entity does not
sponsor. In those cases it is less likely
that the U.S. banking entity would be
able to control the investments of the
fund, and the fund thus likely would be
a less effective means for the banking
entity to engage in proprietary trading
through the fund. The Agencies
therefore have declined to apply this
additional condition with respect to any
foreign public fund in which a U.S.
banking entity invests but does not act
as sponsor.
The Agencies note that the foreign
public fund exclusion is not intended to
permit a banking entity to sponsor a
foreign fund for the purpose of selling
ownership interests to any banking
entity (affiliated or unaffiliated) that is,
or is controlled directly or indirectly by
a banking entity that is, located in or
organized under the laws of the United
States or of any State (or to a limited
group of such banking entities). The
Agencies intend to monitor banking
entities’ investments in foreign public
funds to ensure that banking entities do
not use the exclusion for foreign public
funds in a manner that functions as an
evasion of section 13 in this or any other
way. The Agencies expect that one area
of focus for such monitoring would be
significant investments in a foreign
public fund, including a fund that is
unaffiliated with any banking entity
located in or organized under the laws
of the United States or of any State,
where such investments represent a
substantial percentage of the ownership
interests in such fund.
In order to conduct this monitoring
more effectively, the Agencies also are
adopting certain documentation

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requirements concerning U.S. banking
entities’ investments in foreign public
funds, as discussed in more detail below
in Part IV.C.1 of this SUPPLEMENTARY
INFORMATION. Under the final rule, a U.S.
banking entity with more than $10
billion in total consolidated assets will
be required to document its investments
in foreign public funds, broken out by
each foreign public fund and each
foreign jurisdiction in which any foreign
public fund is organized, if the U.S.
banking entity and its affiliates’
ownership interests in foreign public
funds exceed $50 million at the end of
two or more consecutive calendar
quarters. This requirement thus is
tailored to apply only to U.S. banking
entities above a certain size that also
have substantial investments in foreign
public funds.1761 The Agencies believe
this approach appropriately balances
the Agencies’ evasion concerns and the
burdens that documentation
requirements impose.
For all of the reasons discussed above,
the Agencies believe that the final rule’s
approach to foreign public funds is
consistent with the final rule’s
exclusion of registered or otherwise
exempt (without reliance on the
exemptions in section 3(c)(1) or 3(c)(7))
funds in the United States. It also limits
the extraterritorial application of section
13 of the BHC Act and reduces the
potential economic and other burdens
commenters argued would result for
banking entities. The Agencies believe
that this exclusion represents an
appropriate balancing of considerations
that should not significantly increase
the risks to the U.S. financial system
that section 13 was designed to limit.
2. Wholly-Owned Subsidiaries
Under the proposed rule, a banking
entity would have been permitted to
invest in or sponsor a wholly-owned
subsidiary that relies on the exclusion
contained in section 3(c)(1) or 3(c)(7) of
the Investment Company Act to avoid
being an investment company under
that Act if the subsidiary was carried on
the balance sheet of its parent and was
engaged principally in performing bona
fide liquidity management activities.1762
Commenters argued that, instead of
providing a permitted activity
exemption for banking entities to invest
in or sponsor certain wholly-owned
subsidiaries as proposed, all whollyowned subsidiaries should be excluded
from the definition of covered fund
under the final rule because whollyowned subsidiaries are typically used
final rule § ll.20(e).
proposed rule § ll.14(a)(2)(iv); Joint
Proposal, 76 FR 68,913.
1761 See
1762 See

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for organizational convenience and
generally do not have the
characteristics, risks, or purpose of a
hedge fund or private equity fund,
which involves unaffiliated investors
owning interests in the structure for the
purpose of sharing in the profits and
losses from investment activities.1763
Commenters explained that publicly
traded companies often establish
wholly-owned intermediate companies
for the purpose of holding securities of
operating entities or other corporate
vehicles necessary to the business of the
entity. Because these intermediate
companies invest entirely (or
substantially) in the securities of other
entities, these intermediate companies
may be investment companies for
purposes of the Investment Company
Act but for the exclusion provided by
section 3(c)(1) or 3(c)(7) of the
Investment Company Act.1764
Commenters contended that requiring
banking entities to divest their interests
in wholly-owned subsidiaries and cease
certain intercompany transactions
would have a material adverse effect on
the safety, soundness, efficiency and
stability of the U.S. and global financial
systems, which could in turn have a
material adverse effect on the wider
economy in terms of reduced credit,
increased unemployment and reduced
output.1765 Commenters also argued that
an exclusion for wholly-owned
subsidiaries is necessary in order to
avoid a conflict with other important
requirements in the Dodd-Frank Act.
For example, commenters alleged that
including wholly-owned subsidiaries
within the definition of covered fund for
purposes of section 13 would create a
conflict with the requirement that a
banking entity that is a bank holding
company serve as a source of strength to
its subsidiaries because the prohibition
in section 13(f) on transactions between
a banking entity and covered funds
owned or sponsored by the banking
entity would effectively prohibit the
banking entity from providing financial
resources to wholly-owned intermediate
holding companies and their
subsidiaries.1766 Other commenters
argued that banking entities would bear
extensive compliance costs and
operational burdens and likely would be
1763 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012), JPMC; Goldman (Covered Funds), NAIB et
al.; GE (Feb. 2012); BoA; Chamber (Feb. 2012);
Wells Fargo (Covered Funds); ABA (Keating); Ass’n.
of Institutional Investors (Feb. 2012); Credit Suisse
(Williams); Rep. Himes; BOK.
1764 See 15 U.S.C. 80a–3(a)(1)(A) & (C).
1765 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012).
1766 See SIFMA et al. (Covered Funds) (Feb.
2012); BoA; Rep. Himes.

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restricted from structuring themselves
effectively.1767
Commenters proposed several
alternatives to address these concerns.
For instance, commenters recommended
that the final rule exclude all whollyowned subsidiaries from the definition
of covered fund.1768 Commenters also
urged that the final rule include
ownership interests held by employees
of a banking entity with any ownership
interests held directly by the banking
entity for purposes of qualifying for any
exclusion granted by the rule for
wholly-owned subsidiaries.1769 Another
commenter recommended the exclusion
of subsidiaries, wholly owned or not,
that engage in bona fide liquidity
management.1770
In light of these comments and
consistent with the purposes of section
13 and the terms of the Dodd-Frank Act
as discussed in more detail above, the
Agencies have revised the final rule to
exclude wholly-owned subsidiaries
from the definition of covered fund,
including those not engaged in liquidity
management.1771 A wholly-owned
subsidiary, as defined in the final rule,
is an entity, all of the outstanding
ownership interests of which are owned
directly or indirectly by the banking
entity (or an affiliate thereof), except
that (i) up to five percent of the entity’s
ownership interests may be owned by
directors, employees, and certain former
directors and employees of the banking
entity (or an affiliate thereof); and (ii)
within the five percent ownership
interests described in clause (i), up to
0.5 percent of the entity’s outstanding
ownership interests may be held by a
third party if the ownership interest is
held by the third party for the purpose
of establishing corporate separateness or
addressing bankruptcy, insolvency, or
similar concerns.1772
Although the final rule includes
ownership interests held by certain
former directors and employees for
1767 See,

e.g., Goldman (Covered Funds); BoA.
Rep. Himes; Fin. Services Roundtable
(June 14, 2011); SIFMA et al. (Covered Funds) (Feb.
2012); BOK; Chamber (Feb. 2012); ABA (Keating);
GE (Feb. 2012); Wells Fargo (Covered Funds);
Goldman (Covered Funds); Ass’n. of Institutional
Investors (Feb. 2012); BoA; NAIB et al.
1769 See Wells Fargo (Covered Funds); Credit
Suisse (Williams).
1770 See Credit Suisse (Williams).
1771 Although not a condition of the exclusion,
banking entities may use wholly-owned
subsidiaries to engage in bona fide liquidity
management. As discussed below, however, a
wholly-owned subsidiary is itself a banking entity,
and thus is subject to all of the requirements that
apply to banking entities, including the
requirements applicable to a banking entity’s
liquidity management activities under
§ ll.3(d)(3).
1772 See final rule § ll.10(c)(2).

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1768 See

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purposes of qualifying for the exclusion,
the exclusion requires that an interest
held by a former (or current) director or
employee must actually be held by that
person (or by the banking entity) and
must have been acquired while
employed by or in the service of the
banking entity. For example, if a former
employee subsequently transfers his/her
interest to a third party (other than to
immediate family members of the
employee or through intestacy of the
employee), then the ownership interest
would no longer be held by the banking
entity or persons whose ownership
interests may be aggregated with
interests held by the banking entity for
purposes of the exclusion for whollyowned subsidiaries under the final rule.
The final rule also permits up to 0.5
percent of the ownership interest of a
wholly-owned subsidiary to be held by
a third party if the interest is held by the
third party for the purpose of
establishing corporate separateness or
addressing bankruptcy, insolvency, or
similar concerns, and the ownership
interest is included when calculating
the five percent cap on employee and
director ownership. The Agencies
understand that it is often important, or
in certain circumstances required, under
the laws of various jurisdictions for a
parent company to establish corporate
separation of a subsidiary through the
issuance of a small amount of
ownership interest to a third party.
The Agencies believe that permitting
limited employee and director
ownership of a vehicle and
accommodating the foreign law
requirements discussed above is
consistent with a vehicle’s treatment as
a wholly-owned subsidiary. Under the
final rule, the banking entity (or an
affiliate thereof) will control the vehicle
because it must, as principal, own at
least 95% of the vehicle.1773 These
conditions are designed to exclude from
the covered fund definition vehicles
that are formed for corporate and
organizational convenience, as
discussed above, and that thus do not
engage in the investment activities
prohibited by section 13. The exclusion
also should reduce the disruption to the
operations of banking entities that
commenters asserted would result from
the proposed rule.1774
1773 Cf. Section 2(a)(43) of the Investment
Company Act (defining a ‘‘wholly-owned
subsidiary’’ of a person to mean ‘‘a company 95 per
centum or more of the outstanding voting securities
of which are owned by such person, or by a
company which, within the meaning of this
paragraph, is a wholly-owned subsidiary of such
person’’).
1774 The Agencies also note that depositors for
asset-backed securities offerings are important to

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Importantly, the Agencies note that a
wholly-owned subsidiary of a banking
entity—although excluded from the
definition of covered fund—still would
itself be a banking entity, and therefore
remain subject to the prohibitions and
other provisions of section 13 of the
BHC Act and the final rule.1775
Accordingly, a wholly-owned
subsidiary of a banking entity would
remain subject to the restrictions of
section 13 and the final rule (including
the ban on proprietary trading) and may
not engage in activity in violation of the
prohibitions of section 13 and the final
rule.
3. Joint Ventures
The proposed rule would have
permitted a banking entity to invest in
or manage a joint venture between the
banking entity and any other person,
provided that the joint venture was an
operating company and did not engage
in any activity or any investment not
permitted under the proposed rule. As
noted in the proposal, many joint
ventures rely on the exclusion
contained in section 3(c)(1) or 3(c)(7) of
the Investment Company Act.1776 Joint
ventures are a common form of
business, especially for firms seeking to
enter new lines of business or new
markets, or seeking to share
complementary business expertise.
Commenters supported this aspect of
the proposal and argued that joint
ventures do not share the same
characteristics as a hedge fund or
private equity fund. However, they
expressed concern that joint ventures
were defined too narrowly under the
proposal because the exclusion was
limited to joint ventures that were
operating companies.1777 Some
the process of securitization. See, e.g., ASF (July
2012) (noting that a depositor, as used in a
securitization structure, is an entity that generally
acts only as a conduit to transfer the loans from the
originating bank to the issuing entity for the
purpose of facilitating a securitization transaction
and engages in no discretionary investment or
securities issuance activities). See also, Rule 191
under the Securities Act of 1933 (17 CFR 230.191)
(depositor as issuer for registered asset-backed
securities offerings). Commenters raised a question
about the treatment of depositors under the
Investment Company Act, and therefore, whether
they would technically fall within the definition of
covered fund. See ASF (July 2012); GE (Aug. 2012).
For purposes of the covered fund prohibitions, the
Agencies note that depositors may fall within the
wholly-owned subsidiary exclusion from the
covered fund definition.
1775 See 12 U.S.C. 1851(h)(1) (defining banking
entity to include any affiliate or subsidiary of a
banking entity).
1776 See Joint Proposal, 76 FR 68,913.
1777 See, e.g., ABA (Keating); Chamber (Feb.
2012); SIFMA et al. (Covered Funds) (Feb. 2012);
GE (Aug. 2012); Goldman (Covered Funds); NAIB
et al.; Rep Himes; Sen. Bennet; See also 156 Cong

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commenters criticized the lack of
guidance regarding the meaning of
operating company.1778 One commenter
proposed defining operating company
as any company engaged in activities
that are permissible for a financial
holding company under sections 3 or 4
of the BHC Act, other than a company
engaged exclusively in investing in
securities of other companies for resale
or other disposition.1779
Another commenter argued that joint
ventures are often used to share risk
from non-performing loans, credit card
receivables, consumer loans,
commercial real estate loans or
automobile loans.1780 According to this
commenter, these joint ventures, while
not generally viewed as operating
companies, promote safety and
soundness by allowing a banking entity
to limit the size of its exposure to
permissible investments or to more
efficiently transfer the risk of existing
assets to a small number of partners.
Commenters stated that banking entities
often employ similar types of nonoperating company joint ventures to
engage in merchant banking activities or
other permissible banking activities, and
that the final rule should not prevent a
banking entity from sharing the risk of
a portfolio company investment with
third parties.1781 A number of
commenters argued that treating joint
ventures as covered funds would create
the same inconsistencies with other
provisions and principles embodied in
the Dodd-Frank Act noted for whollyowned subsidiaries, were they to be
treated as covered funds.1782 Several
commenters argued that the proposed
exemption, as drafted, was unworkable
because it did not appear to provide an
exception to the intercompany
limitations on transactions under
section 13(f), which prohibits
transactions between a banking entity
and a related covered fund.1783
Commenters proposed several
alternatives to address these issues.
Several commenters recommended that
the final rule eliminate the operating
Rec. H5226 (daily ed. June 30, 2010) (statement of
Rep. Himes).
1778 See, e.g., ABA (Keating); NAIB et al.; GE
(Aug. 2012); Chamber (Feb. 2012); SIFMA et al.
(Covered Funds) (Feb. 2012); Wells Fargo (Covered
Funds); Credit Suisse (Williams); Goldman
(Covered Funds).
1779 See SIFMA et al. (Covered Funds) (Feb.
2012).
1780 See Goldman (Covered Funds).
1781 See ABA (Keating); SIFMA et al. (Covered
Funds) (Feb. 2012).
1782 See SIFMA et al. (Covered Funds) (Feb.
2012); Goldman (Covered Funds); ABA (Keating);
Chamber (Feb. 2012).
1783 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); Goldman (Covered Funds); ABA (Keating);
GE (Feb. 2012); Chamber (Feb. 2012).

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company condition under the proposed
exemption.1784 Other commenters
recommended excluding joint ventures
that have an unspecified but limited
number of partners (such as five or
fewer joint venture partners).1785 One
commenter recommended excluding all
‘‘controlled joint ventures’’ but did not
provide an explanation of how to define
that term.1786 Another commenter
suggested defining a joint venture in one
of the following ways: (1) Any company
with a limited number of co-venturers
that is managed pursuant to a
shareholders’ agreement, as opposed to
managed by a general partner; 1787 or (2)
a joint venture in which: (a) There are
a limited number of unaffiliated
partners; (b) the parties operate the
venture on a joint basis or in proportion
to their relative ownership, including
pursuant to a shareholders’ agreement;
(c) material decisions are made by one
party (for example, a general partner);
and (d) the joint venture does not
engage in any activity or investment not
permitted under section 13, other than
activities or investments incidental to
its permissible business.1788
In response to commenter concerns,
the final rule excludes joint ventures
from the definition of covered fund with
some modifications from the proposal to
more clearly identify entities that are
excluded. Under the final rule, a joint
venture is excluded from the definition
of covered fund if the joint venture is
between the banking entity or any of its
affiliates and no more than 10
unaffiliated co-venturers, is in the
business of engaging in activities that
are permissible for the banking entity
other than investing in securities for
resale or other disposition, and is not,
and does not hold itself out as being, an
entity or arrangement that raises money
from investors primarily for the purpose
of investing in securities for resale or
other disposition or otherwise trading in
securities.1789 Banking entities,
therefore, will continue to be able to
share the risk and cost of financing their
banking activities through these types of
entities which, as noted by commenters
as discussed above, may allow banking
entities to more efficiently manage the
risk of their operations.
1784 See SIFMA et al. (Covered Funds) (Feb.
2012); ABA (Keating); Credit Suisse (Williams).
1785 See SIFMA et al. (Covered Funds) (Feb.
2012); Credit Suisse (Williams); GE (Feb. 2012).
1786 See Goldman (Covered Funds).
1787 See ABA (Keating); Credit Suisse (Williams);
SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA
et al. (Mar. 2012); See also GE (Feb. 2012); NAIB
et al.
1788 See Goldman (Covered Funds).
1789 See final rule § ll.10(c)(3).

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The Agencies have specified a limit
on the number of joint venture partners
at the request of many commenters that
suggested such a limit be added (though
typically without suggesting the specific
number of partners). The Agencies
believe that a limit of 10 partners allows
flexibility in structuring larger business
ventures without involving such a large
number of partners as to suggest the
venture is in reality a hedge fund or
private equity fund established for
investment purposes. The Agencies will
monitor joint ventures—and other
excluded entities—to ensure that they
are not used by banking entities to
evade the provisions of section 13.
The final rule’s requirement that a
joint venture not be an entity or
arrangement that raises money from
investors primarily for the purpose of
investing in securities for resale or other
disposition or otherwise trading in
securities prevents a banking entity
from relying on this exclusion to evade
section 13 of the BHC Act by owning or
sponsoring what is or will become a
covered fund. Consistent with this
restriction and to prevent evasion of
section 13, a banking entity may not use
a joint venture to engage in merchant
banking activities because that involves
acquiring or retaining shares, assets, or
ownership interests for the purpose of
ultimate resale or disposition of the
investment.1790
As with wholly-owned subsidiaries, if
a banking entity owns 25 percent or
more of the voting securities of the joint
venture or otherwise controls an entity
that qualifies for the joint venture
exclusion, the joint venture would then
itself be a banking entity and would
remain subject to the restrictions of
section 13 and the final rule (including
the ban on proprietary trading).
The Agencies note that the statute
defines banking entity to include not
only insured depository institutions and
bank holding companies, but also their
affiliates. In the context of a company
that owns an insured depository
institution but is not a bank holding
company or savings and loan holding
company, the insured depository
institution’s affiliates may engage in
commercial activities impermissible for
banks and bank holding companies.
However, section 13 of the BHC Act and
the final rule do not authorize a banking
entity to engage in otherwise
impermissible activities. Because of
this, the scope of activities in which a
joint venture may engage under the final
rule will depend on the status and
identity of its co-venturers. For instance,
a joint venture between a bank holding
1790 See

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company and unaffiliated companies
may not engage in commercial activities
impermissible for a bank holding
company.
4. Acquisition Vehicles
Similar to wholly-owned subsidiaries
and joint ventures, the proposed rule
would have permitted a banking entity
to invest in or sponsor an acquisition
vehicle provided that the sole purpose
and effect of the acquisition vehicle was
to effectuate a transaction involving the
acquisition or merger of an entity with
or into the banking entity or one of its
affiliates. As noted in the proposal,
banking entities often form corporate
vehicles for the purpose of
accomplishing a corporate merger or
asset acquisition.1791 Because of the way
they are structured, acquisition vehicles
may rely on section 3(c)(1) or 3(c)(7) of
the Investment Company Act.1792
Commenters supported the exclusion
of acquisition vehicles from the
restrictions governing covered funds,
and argued that acquisition vehicles do
not share the same characteristics as a
hedge fund or private equity fund.1793
However, similar to concerns articulated
above with respect to wholly-owned
subsidiaries and joint ventures,
commenters argued that the proposed
rule, as drafted, left uncertain how other
provisions of section 13 would apply to
these vehicles.1794
In light of the comments, the final
rule has been modified to exclude
acquisition vehicles from the definition
of covered fund, rather than provide a
permitted activity exemption for
banking entities to invest in or sponsor
the vehicles, so long as the vehicle is
formed solely for the purpose of
engaging in a bona fide merger or
acquisition transaction and the vehicle
exists only for such period as necessary
to effectuate the transaction.1795 The
final rule thus reflects modifications
from the exemption for acquisition
vehicles in the proposal, which was
available for acquisition vehicles where
the sole purpose and effect of the entity
was to effectuate a transaction involving
the acquisition or merger of one entity
with or into the banking entity.1796 The
1791 Cf.

Joint Proposal, 76 FR 68,897.
Joint Proposal, 76 FR 68,913; SIFMA et
al. (Covered Funds) (Feb. 2012).
1793 See, e.g., JPMC; SIFMA et al. (Covered Funds)
(Feb. 2012); GE (Feb. 2012); Sen. Bennet; Sen.
Carper et al.
1794 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); JPMC; GE (Feb. 2012).
1795 See final rule § ll.10(c)(4).
1796 The proposed rule contained an exemption
for investments in acquisition vehicles, provided
that the ‘‘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

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1792 See

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Agencies modified the conditions in the
final rule, as discussed above, to more
clearly reflect the limited activities in
which an excluded acquisition vehicle
may engage and to exclude acquisition
vehicles from the definition of covered
fund, rather than only permit banking
entities to invest in or sponsor them
pursuant to an exemption.
The Agencies also note that an
acquisition vehicle that survives a
transaction would likely be excluded
from the definition of covered fund
under the separate exclusion for either
joint ventures or wholly-owned
subsidiaries described above. An
acquisition vehicle that is controlled by
a banking entity would be a banking
entity itself and would be subject to the
restrictions of section 13 and the final
rule that apply to a banking entity.
5. Foreign Pension or Retirement Funds
Under the proposed rule, a foreign
pension plan that relied on section
3(c)(1) or 3(c)(7) of the Investment
Company Act to avoid being an
investment company (or that was a
commodity pool), would have been a
covered fund. Commenters argued that
including pension funds within the
definition of covered fund would
produce many unexpected results for
pension plans as well as plan
participants.1797
Commenters generally argued that
foreign pension or retirement funds are
established by a foreign company or
foreign sovereign for the purpose of
providing a specific group of foreign
persons with income during retirement
or when they reach a certain age or meet
certain predetermined criteria and are
typically eligible for preferential tax
treatment, and are not formed for the
same purposes as hedge funds or private
equity funds.1798 Commenters argued
that the definition of covered fund
should not include certain foreign
pension or retirement funds, including
managed investment arrangements and
covered banking entity or one of its affiliates.’’ See
proposed rule § ll.14(a)(2)(ii). The final rule
excludes an acquisition vehicle, which is defined
as an issuer that is ‘‘[f]ormed solely for the purpose
of engaging in a bona fide merger or acquisition
transaction’’ and that ‘‘exists only for such period
as necessary to effectuate the transaction.’’ See final
rule § ll.10(c)(4).
1797 As explained above, commenters also argued
that a foreign pension plan should not be
considered a banking entity if the plan is sponsored
by a banking entity or is established for the benefit
of employees of the banking entity. If deemed a
banking entity, the pension plan could become
subject to the limits on section 13 on investing in
covered funds. See Allen & Overy (on behalf of
Canadian Banks); Arnold & Porter; Credit Suisse
(Williams). The final rule addresses these
comments with the exclusions described above.
1798 See, e.g., Allen & Overy (on behalf of
Canadian Banks).

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wrap platforms, such as so-called
‘‘superannuation funds,’’ that are
managed by foreign banks as part of
providing retirement or pension
schemes to foreign citizens pursuant to
foreign law and are generally not
available for sale to U.S. citizens.
Commenters asserted that many foreign
banking entities act as sponsor to and
organize and offer foreign pension funds
abroad as part of a foreign sovereign
program to provide retirement, pension,
or similar benefits to its citizens or
workforce.1799 These commenters
contended that a foreign pension plan
might itself rely on the exclusion in
section 3(c)(1) or 3(c)(7) in order to
avoid being an investment company if it
is offered to citizens of the foreign
sovereign present in the United
States.1800
Several commenters argued that
foreign pension and retirement plans
should be excluded from the definition
of covered fund on the same basis as
U.S. pension and retirement funds that
are ERISA-qualified funds that rely on
the exclusion from the definition of
investment company provided under
section 3(c)(11) of the Investment
Company Act.1801 Commenters alleged
that without an exclusion for foreign
pension or retirement funds, section 13
of the BHC Act would have an extraterritorial effect on pension or
retirement benefits abroad that would be
severe and beyond what was
contemplated by section 13 of the BHC
Act.
In light of comments received on the
proposal, the final rule excludes from
the definition of covered fund a plan,
fund, or program providing pension,
retirement, or similar benefits that is: (i)
Organized and administered outside of
the United States; (ii) a broad-based
plan for employees or citizens that is
subject to regulation as a pension,
retirement, or similar plan under the
laws of the jurisdiction in which the
plan, fund, or program is organized and
administered; and (iii) established for
the benefit of citizens or residents of one
or more foreign sovereign or any
political subdivision thereof.1802 This is
similar to the treatment provided to U.S.
pension funds by virtue of the exclusion
from the definition of investment
company under the Investment
Company Act for certain broad-based
1799 See Allen & Overy (on behalf of Canadian
Banks); Arnold & Porter; UBS; Hong Kong Inv.
Funds Ass’n.
1800 See Allen & Overy (on behalf of Canadian
Banks); Arnold & Porter; UBS; Hong Kong Inv.
Funds Ass’n.; Credit Suisse (Williams).
1801 See Arnold & Porter; UBS; Hong Kong Inv.
Funds Ass’n.; Credit Suisse (Williams).
1802 See final rule § ll.10(c)(5).

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employee benefit plans provided by
section 3(c)(11) of that Act. The
exclusion from the covered fund
definition for foreign plans would be
available for bona fide plans established
for the benefit of employees or citizens
outside the U.S. even if some of the
beneficiaries of the fund reside in the
U.S. or subsequently become U.S.
residents.
The Agencies believe this exclusion is
appropriate in order to facilitate parallel
treatment of domestic and foreign
pension and retirement funds to the
extent possible and to assist in ensuring
that section 13 of the BHC Act does not
apply to foreign pension, retirement, or
similar benefits programs.1803

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6. Insurance Company Separate
Accounts
Under the proposed rule, insurance
company separate accounts would have
been covered funds to the extent that
the separate accounts relied on section
3(c)(1) or 3(c)(7). Such reliance would
generally occur in circumstances where
policies funded by the separate account
are distributed in an unregistered
securities offering solely to qualified
purchasers or on a limited basis to
accredited investors. While the
proposed rule did not generally exclude
insurance company separate accounts
from the definition of covered fund, the
proposed rule did provide a limited
exemption for investing in or acting as
sponsor to separate accounts that were
used for the purpose of allowing a
banking entity to purchase bank owned
life insurance (‘‘BOLI’’), subject to
certain restrictions.1804
Various state or foreign laws allow
regulated insurance companies to create
separate accounts that are generally not
separate legal entities but represent a
segregated pool of assets on the balance
sheet of the insurance company that
support a specific policy claim on the
insurance company. These accounts
have assets and obligations that are
separate from the general account of the
insurance company. Insurance
companies often utilize these separate
accounts to allow policyholders of
variable annuity and variable life
insurance to allocate premium amounts
1803 Additionally and as discussed above, the
prohibitions of section 13 and the final rule do not
apply to an ownership interest that is acquired or
retained by a banking entity through a deferred
compensation, stock-bonus, profit-sharing, or
pension plan of the banking entity that is
established and administered in accordance with
the law of the United States or a foreign sovereign,
if the ownership interest is held or controlled
directly or indirectly by a banking entity as trustee
for the benefit of persons who are or were
employees of the banking entity.
1804 See proposed rule § ll.14(a)(1).

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for the purpose of engaging in various
investment strategies that are tailored to
the requirements of the individual
policyholder. The policyholder, and not
the insurance company, primarily
benefits from the results of investments
in the separate account. These separate
accounts are generally investment
companies for purposes of the
Investment Company Act, unless an
exclusion from that definition is
applicable,1805 and, as noted above, may
rely on the exclusion contained in
section 3(c)(1) or 3(c)(7) of the
Investment Company Act.
While most commenters supported
the proposal’s recognition that interests
in BOLI separate accounts should be
permitted, commenters generally argued
that the final rule should also provide
a broader exclusion from the definition
of covered fund for all insurance
company separate accounts.
Commenters argued that covering
separate accounts could lead to
unintended consequences and was
inconsistent with the statutory
recognition that the business of
insurance should continue to be
accommodated.1806 These commenters
argued that covering separate accounts
within the definition of covered fund
would disrupt a substantial portion of
customer-driven insurance or retirement
planning activity and pose a burden on
insurance companies and holders of
insurance policies funded by separate
accounts, a result commenters alleged
Congress did not intend.1807
In response to commenter concerns
and in order to more appropriately
accommodate the business of insurance
in a regulated insurance company, the
final rule excludes an insurance
company separate account from the
definition of covered fund under certain
circumstances. To prevent this
exclusion from being used to evade the
restrictions on investments and
sponsorship of covered funds by a
banking entity, the final rule provides
that no banking entity other than the
insurance company that establishes the
separate account may participate in the
account’s profits and losses.1808 In this
manner, the final rule appropriately
accommodates the business of insurance
by permitting an insurance company
1805 See In re The Prudential Ins. Co. of Am., 41
S.E.C. 335, 345 (1963), aff’d, The Prudential Ins. Co.
of Am. v. SEC, 326 F.2d 383 (3d Cir.), cert. denied,
377 U.S. 953 (1964).
1806 See ACLI (Jan. 2012); Nationwide; Sutherland
(on behalf of Comm. of Annuity Insurers); See also
STANY.
1807 See ACLI (Jan. 2012); Nationwide; Sutherland
(on behalf of Comm. of Annuity Insurers); See also
STANY.
1808 See final rule § ll.10(c)(6).

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5683

that is a banking entity to continue to
provide its customers with a variety of
insurance products through separate
account structures in accordance with
applicable insurance laws while
protecting against the use of separate
accounts as a means by which banking
entities might take a proprietary or
beneficial interest in an account that
engages in prohibited proprietary
trading and thereby evade the
requirements of section 13 of the BHC
Act. The exclusion of insurance
company separate accounts from the
definition of covered fund therefore is
designed to reduce the potential burden
of the final rule on insurance companies
and holders of insurance policies
funded by separate accounts while also
continuing to prohibit banking entities
from taking ownership interests in, and
sponsoring or having certain
relationships with, entities that engage
in investment and trading activities
prohibited by section 13.
7. Bank Owned Life Insurance Separate
Accounts
As explained above, bank owned life
insurance (‘‘BOLI’’) is generally offered
through a separate account held by an
insurance company. In recognition of
the fact that banking entities have for
many years invested in life insurance
policies that covered key employees, in
accordance with supervisory policies
established by the Federal banking
agencies, the proposal contained a
provision that would permit banking
entities to invest in and sponsor BOLI
separate accounts.1809
Many commenters supported the
exemption in the proposal for BOLI
separate accounts, arguing that
permitting this kind of activity was
appropriate and consistent with safety
and soundness as well as financial
stability.1810 Conversely, one
commenter objected to the proposed
rule’s exemption for investments in
BOLI separate accounts, contending that
such an exemption did not promote and
protect the safety and soundness of
banking entities or the financial stability
of the United States.1811
After considering comments received
on the proposal, the final rule excludes
BOLI separate accounts from the
definition of covered fund but maintains
the substance of the conditions from the
proposal designed to ensure that BOLI
investments are not conducted in a
manner that raises the concerns that
proposed rule § ll.14(a)(1).
ACLI (Jan. 2012); Mass. Mutual; Jones of
Northwestern; AALU; BBVA; BoA; Chris Barnard;
Clark Consulting (Feb. 7, 2012); Clark Consulting
(Feb. 13, 2012); Gagnon of GW Financial.
1811 See Occupy.
1809 See
1810 See

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section 13 of the BHC Act was designed
to address. In particular, in order for a
separate account to qualify for the BOLI
exclusion from the definition of covered
fund, the final rule requires that the
separate account be used solely for the
purpose of allowing one or more
banking entities (which by definition
includes their affiliates) to purchase a
life insurance policy for which such
banking entity(ies) is a beneficiary.1812
Additionally, if the banking entity is
relying on this exclusion, the banking
entity that purchases the insurance
policy (i) must not control the
investment decisions regarding the
underlying assets or holdings of the
separate account,1813 and (ii) must
participate in the profits and losses of
the separate account in compliance with
applicable supervisory guidance
regarding BOLI.1814
When made in the normal course,
investments by banking entities in BOLI
separate accounts do not involve the
types of speculative risks section 13 of
the BHC Act was designed to address.
Rather, these accounts permit the
banking entity to effectively hedge and
cover costs of providing benefits to
employees through insurance policies
related to key employees. Moreover,
applying the prohibitions of section 13
to investments in these accounts would
eliminate an investment that helps
banking entities to efficiently reduce
their costs of providing employee
benefits, and therefore potentially
introduce a burden to banking entities
that would not further the statutory
purpose of section 13. The Agencies
expect this exclusion to be used by
banking entities in a manner consistent
with safety and soundness.
8. Exclusion for Loan Securitizations
and Definition of Loan

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a. Definition of Loan
The proposal defined the term ‘‘loan’’
for purposes of the restrictions on
proprietary trading and the covered
funds provisions and, as discussed in
more detail below, provided an
exemption for loan securitizations in
two separate sections of the proposed
rule. As proposed, loan was defined as
‘‘any loan, lease, extension of credit, or
secured or unsecured receivable.’’ 1815
The definition of loan in the proposed
rule was expansive, and included a
broad array of loans and similar credit
final rule § ll.10(c)(7).
requirement is not intended to preclude
a banking entity from purchasing a life insurance
policy from an affiliated insurance company.
1814 See, e.g., Bank Owned Life Insurance,
Interagency Statement on the Purchase and Risk
Management of Life Insurance (Dec. 7, 2004).
1815 See proposed rule § ll.2(q).
1812 See

1813 This

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transactions, but did not include any
asset-backed security issued in
connection with a loan securitization or
otherwise backed by loans.
Some commenters requested that the
Agencies narrow the proposed
definition of ‘‘loan.’’ 1816 One of these
commenters was concerned that the
proposed definition could apply to any
banking activity and argued that the
definition of loan for purposes of the
final rule should not include
securities.1817 Another commenter,
citing a statement made by Senator
Merkley, asserted that Congress did not
intend the rule of construction for the
sale and securitization of loans in
section 13(g)(2) to include ‘‘loans that
become financial instruments traded to
capture the change in their market
value.’’ 1818
Other commenters requested that the
Agencies expand the proposed
definition of ‘‘loan’’ to capture many
traditional extensions of credit that the
proposal would otherwise exclude.1819
Examples of traditional credit
extensions that commenters requested
be specifically included within the
definition of ‘‘loan’’ included loan
participations,1820 variable funding
notes or certificates,1821 note purchase
1816 See AFR et al. (Feb. 2012); Occupy; Public
Citizen.
1817 See Public Citizen. This commenter argued
that the loan definition should be limited to the
plain meaning of the term ‘‘loan’’ and noted that a
loan is not a security. Id.
1818 See Occupy (citing 156 Cong. Rec. S5895
(daily ed. July 15, 2010)).
1819 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); Credit Suisse (Williams);
GE (Feb. 2012); Goldman (Covered Funds); ICI (Feb.
2012); Japanese Bankers Ass’n.; JPMC; LSTA (Feb.
2012); RBC; SIFMA et al. (Covered Funds) (Feb.
2012); SIFMA (Securitization) (Feb. 2012). One
individual commenter supported the proposed
definition of loan. See Alfred Brock. For example,
one commenter requested that definition of ‘‘loan’’
be revised to include ‘‘(i) any loan, lease (including
any lease residual), extension [of] credit, or secured
or unsecured receivables, (ii) any note, bond or
security collateralized and payable from pools of
loans, leases (including Lease residuals), extensions
of credit or secured or unsecured receivables, and
(iii) any contractual rights arising from, or security
interests or liens, assets, property guarantees,
insurance policies, letters of credit, or supporting
obligations underlying or relating to any of the
foregoing.’’ See RBC. Another commenter requested
that the definition of ‘‘loan’’ be revised to include
‘‘any type of credit extension (including bonds,
other [banking entity-eligible] debt securities, assetbacked securities [as defined in their letter],
variable funding notes and securities lending
agreements, repurchase agreements, reverse
repurchase agreements and other similar extensions
of credit) that a banking entity could hold or deal
in.’’ See SIFMA (Securitization) (Feb. 2012).
1820 See JPMC.
1821 See ASF (Feb. 2012); Credit Suisse
(Williams); JPMC (arguing that such notes operate
in economic substance as loans); SIFMA
(Securitization) (Feb. 2012).

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facilities,1822 certain forms of revolving
credit lines,1823 corporate bonds,1824
municipal securities,1825 securities
lending agreements and reverse
repurchase agreements,1826 auto lease
securitizations,1827 and any other type
of credit extension that banking entities
traditionally have been permitted to
issue under their lending authority.1828
The definition of ‘‘loan’’ in the final
rule applies both in the context of the
proprietary trading restrictions as well
as in determining the scope of the
exclusion of loan securitizations and
asset-backed commercial paper conduits
from the definition of covered fund. The
final rule modifies the proposed
definition and defines ‘‘loan’’ as ‘‘any
loan, lease, extension of credit, or
secured or unsecured receivable that is
not a security or derivative.’’ 1829 The
definition of loan in the final rule
specifically excludes loans that are
securities or derivatives because trading
in these instruments is expressly
included in the statute’s definition of
proprietary trading.1830 In addition, the
Agencies believe these instruments, if
not excluded from the definition of
loan, could be used to circumvent the
restrictions on proprietary trading.
The definition of loan in the final rule
excludes loans that are securities or
derivatives, including securities or
derivatives of or based on such
instruments. The definition of ‘‘loan’’
1822 See ASF (Feb. 2012). This commenter
asserted that a note purchase facility is negotiated
by the asset-backed commercial paper conduit and
allows the asset-backed commercial paper conduit
to purchase asset-backed securities issued by an
intermediate special purpose vehicle and backed by
loans or asset-backed securities backed by loans. Id.
1823 See ASF (Feb. 2012).
1824 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); Credit Suisse (Williams);
JPMC.
1825 See ASF (Feb. 2012). This commenter argued
that certain municipal securities may be ABS,
including revenue bonds that involve the issuance
of senior and subordinate bonds. Id.
1826 See Credit Suisse (Williams); SIFMA
(Securitization) (Feb. 2012).
1827 See SIFMA (Securitization) (Feb. 2012). This
commenter contended that because securitization
transactions have been viewed by the Agencies and
courts as ‘legally transparent’ (i.e., as simply
another way for banking entities to buy and sell the
loans or other assets underlying such securities),
auto lease securitizations supported by a beneficial
interest in a titling trust should be treated as
securitizations of the underlying auto leases and
should fall within the loan securitization
exemption. This commenter also argued that if the
definition of ‘‘loan’’ is not expanded to include
securities, then banking entities could not act as
sponsors for auto lease securitizations (including
resecuritizations) supported by a beneficial interest
in a titling trust.
1828 See Credit Suisse (Williams); Goldman
(Covered Funds); SIFMA et al. (Covered Funds)
(Feb. 2012); SIFMA (Securitization) (Feb. 2012).
1829 See final rule § ll.2(s).
1830 12 U.S.C. 1851(h)(4).

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does not specify the type, nature or
structure of loans included within the
definition, other than by excluding
securities and derivatives. In addition,
the definition of loan does not limit the
scope of parties that may be lenders or
borrowers for purposes of the definition.
The Agencies note that the parties’
characterization of an instrument as a
loan is not dispositive of its treatment
under the federal securities laws or
federal laws applicable to derivatives.
The determination of whether a loan is
a security or a derivative for purposes of
the loan definition is based on the
federal securities laws and the
Commodity Exchange Act. Whether a
loan is a ‘‘note’’ or ‘‘evidence of
indebtedness’’ and therefore a security
under the federal securities laws will
depend on the particular facts and
circumstances, including the economic
terms of the loan.1831 For example,
loans that are structured to provide
payments or returns based on, or tied to,
the performance of an asset, index or
commodity or provide synthetic
exposure to the credit of an underlying
borrower or an underlying security or
index may be securities or derivatives
depending on their terms and the
circumstances of their creation, use, and
distribution.1832 Regardless of whether a
party characterizes the instrument as a
loan, these kinds of instruments, which
may be called ‘‘structured loans,’’ must
be evaluated based on the standards
associated with evaluating derivatives
and securities in order to prevent
evasion of the restrictions on
proprietary trading and ownership
interests in covered funds.

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b. Loan Securitizations
An exemption for loan securitizations
was contained in two separate sections
of the proposed rule. The first, in
section ll.13(a), was proposed as part
of ‘‘other permitted covered fund
activities and investments.’’ The second,
in § ll.14(d), was proposed as part of
‘‘covered fund activities determined to
be permissible.’’ These proposed
provisions would have acted in concert
to permit a banking entity to acquire
and retain an ownership interest in, or
act as sponsor to, a loan securitization
regardless of the relationship that the
1831 See 15 U.S.C. 77b(a)(1) and 15 U.S.C.
78c(a)(10); Reves v. Ernst & Young, 494 U.S. 56
(1990); Trust Company of Louisiana v. N.N.P. Inc.,
104 F.3d 1478 (5th Cir. 1997); Pollack v. Laidlaw
Holdings, 27 F.3d 808 (2d Cir. 1994); but See
Marine Bank v. Weaver, 455 U.S. 551 (1982) ; Banco
Espanol de Credito v. Security Pacific National
Bank, 973 F.2d 51 (2d Cir. 1992); Bass v. Janney
Montgomery Scott, Inc., 210 F.3d 577 (6th Cir.
2000); Piaubert v. Sefrioui, 2000 WL 194140 (9th
Cir. 2000).
1832 Id.

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banking entity had with the
securitization. The Agencies have
evaluated all comments received on
securitizations. These sections of the
proposed rule were intended to
implement the rule of construction
contained in 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 Board to sell
or securitize loans in a manner that is
otherwise permitted by law.1833 The
language of the proposed exemption for
loan securitizations would have
permitted 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 were solely comprised of: (i)
Loans (as defined); (ii) 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 rights or
assets and (B) are used for hedging
purposes with respect to the
securitization structure.1834 The
proposed rule in § ll.13(d) was
further augmented by the proposed rule
in § ll.14(a)(2) so that a banking
entity would be permitted to purchase
loan securitizations and engage in the
sale and securitization of loans. This
was accomplished through the
authorization in proposed section
ll.14(a)(2) of a banking entity’s
acquisition or retention of an ownership
interest in such securitization vehicles
that the banking entity did not organize
and offer, or for which it did not act as
sponsor, provided that the assets or
holdings of such vehicles were solely
comprised of the instruments or
obligations identified in the proposed
exemption.
The proposed rules would have
allowed 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 be a covered fund
for purposes of the proposed rules) that
the banking entity organized and
offered, or acted as sponsor to, without
being subject to the ownership and
sponsor limitations contained in the
proposed rule.1835 As noted in the
proposing release, the Agencies
recognized that by defining ‘‘covered
fund’’ broadly, and, in particular, by
reference to sections 3(c)(1) and 3(c)(7)
1833 See

12 U.S.C. 1851(g)(2).
proposed rule § ll.13(d); Joint
Proposal, 76 FR 68,912.
1835 Id.
1834 See

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5685

of the Investment Company Act,
securitization vehicles may be affected
by the restrictions and requirements of
the proposed rule. The Agencies
attempted to mitigate the potential
adverse impact on the securitization
market by excluding loan securitizations
from the restrictions on sponsoring or
acquiring and retaining ownership
interests in covered funds, consistent
with the rule of construction contained
in section 13(g)(2) of the BHC Act.1836
As a result, under the proposal, loan
securitizations would not be limited or
restricted because banking entities
would be able to find investors or
buyers for their loans or loan
securitizations. The proposing release
included several requests for comment
on the proposed loan securitization
exemption and the application of the
covered fund prohibitions to
securitizations.
Some commenters supported a
narrow exemption for loan
securitizations and in some cases
suggested that the proposed exemption
could be narrowed even further. For
example, one commenter argued that
the definition of ‘‘loan’’ for purposes of
the exemption could include any
extension of credit and any banking
activity.1837 Also, in response to the
proposing release,1838 some commenters
suggested that any exemption for
securitizations should seek to prevent
evasion of the covered fund prohibitions
by issuers with ‘‘hedge-fund or private
equity fund-like characteristics’’ or
issuers with ‘‘hidden proprietary trading
operations.’’ 1839
On the other hand, many commenters
believed that the proposed exemption
1836 See

Joint Proposal, 76 FR 68,931.
e.g., Public Citizen. This commenter
argued that any exemption should prevent evasion,
should ensure that each exempted securitization
reduces risk and should be designed to only serve
client needs. A different commenter recommended
a safe harbor available only to a particular prespecified, transparent and standardized
securitization structure, where Agencies would
need to justify why the specified structure protects
against the systemic risks associated with
securitization. See AFR (Nov. 2012).
1838 See Request for Comment No. 231 in the
Proposing Release (noting that many issuers of
asset-backed 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) and requesting comment on how to
prevent hedge funds or private equity funds from
structuring around an exemption for asset-backed
securities from the covered fund prohibitions).
1839 See, e.g., AFR et al. (Feb. 2012); Occupy;
Public Citizen. But See Credit Suisse (Williams)
(arguing it would be difficult to use the typical
structure and operation of securitizations to avoid
the prohibition on proprietary trading because the
structures are not set up to engage in the kind of
proprietary trading about which Congress was
concerned).
1837 See,

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from the covered fund prohibitions for
loan securitizations should be expanded
to cover securitizations generally and
not just loan securitizations. These
commenters provided various
arguments for their request to exempt all
securitizations from the covered fund
prohibitions, including that the
regulation of securitizations was
addressed in other areas of the DoddFrank Act,1840 that securitization is
essentially a lending activity,1841 and
that securitizations have ‘‘long been
recognized as permissible activities for
banking entities.’’ 1842
Commenters recommending a broader
exclusion for securitizations also
provided a wide variety of specific
suggestions or concerns. Some
commenters suggested that permissible
assets for a loan securitization include
assets other than loans acquired in the
course of collecting a debt previously
contracted, restructuring a loan, during
a loan work out or during the
disposition of a loan or other similar
situation.1843 Commenters noted that,
for example, rules 2a–7 and 3a–7 under
the Investment Company Act define
eligible assets for a securitization as not
only including financial assets but also
‘‘any rights or other assets designed to
assure the servicing or timely
distribution of proceeds to security
holders.’’ 1844 Commenters requested
that various additional rights or assets
be added to the list of permissible assets
held by a loan securitization such as
cash and cash accounts,1845 cash
equivalents,1846 and various other high
quality short term investments, liquidity
agreements or credit enhancements,
certain beneficial interests in titling
trusts used in lease securitizations or
lease residuals.1847 One commenter
1840 See AFME et al.; Ass’n. of German Banks;
Cleary Glottlieb; Credit Suisse (Williams); GE (Feb.
2012); IIB/EBF; RBC; SIFMA (Securitization) (Feb.
2012).
1841 See, e.g., Credit Suisse (Williams).
1842 See Credit Suisse (Williams); JPMC. These
commenters cited the sponsoring of asset-backed
commercial paper conduits as an example of
permissible bank securitization activity.
1843 See Allen & Overy (on behalf of Foreign Bank
Group); Credit Suisse (Williams); JPMC.
1844 See GE (Feb. 2012); GE (Aug. 2012); ICI (Feb.
2012).
1845 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); Cleary Gottlieb; Credit
Suisse (Williams) (including cash that did not arise
directly from the underlying loans); JPMC; LSTA
(Feb. 2012); LSTA (July 2012); RBC; SIFMA
(Securitization) (Feb. 2012).
1846 See Cleary Gottlieb; Credit Suisse (Williams).
1847 See JPMC (requesting high quality, highly
liquid investments, including Treasury securities
and highly rated commercial paper); LSTA (Feb.
2012); LSTA (July 2012) (requesting short-term
highly liquid investments such as obligations
backed by the full faith and credit of the United
States, deposits insured by the Federal Deposit

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suggested that a loan securitization be
permitted to include ‘‘any contractual
rights arising from or supporting
obligations underlying or relating to the
loans.’’ 1848
Others requested that loan
securitizations also be permitted to hold
repurchase agreements or unlimited
amounts of various forms of securities,
including municipal securities, assetbacked securities, credit-linked notes,
trust certificates and ‘‘equity likerights.’’ 1849 Some commenters
requested that loan securitizations be
permitted to hold a limited amount of
certain rights such as securities.1850
Commenters also had suggestions about
the types of derivatives that an
exempted securitization vehicle be
permitted to hold.1851 For example, one
industry association requested that the
loan securitization exemption include
securitizations where up to 10 percent
of the assets are held in the form of
synthetic risk exposure that references
‘‘loans that could otherwise be held
directly’’ under the proposal in order to
Insurance Corporation, various obligations of U.S.
financial institutions and investments in money
market funds); ASF (Feb. 2012); Commercial Real
Estate Fin. Council; RBC (requesting short-term,
high quality investments); Allen & Overy (on behalf
of Foreign Bank Group) (requesting short-term
eligible investments); Credit Suisse (Williams)
(requesting government guaranteed securities,
money market funds and other highly credit-worthy
and liquid investments); Cleary Gottlieb (requesting
money-market interests; SIFMA (Securitization)
(Feb. 2012) (requesting associated investments
which are customarily employed in securitization
transactions). One commenter further noted that
such investments are required by securitization
documents. See Commercial Real Estate Fin.
Council.
1848 RBC. This commenter argued that the loan
securitization exemptions as proposed would not
permit ‘‘traditional securitizations and
securitizations with the characteristics of traditional
securitizations’’ and ‘‘would effectively eliminate a
substantial portion of the very securitization
activities carried on by banks that the [loan
securitization exemptions] are designed to
preserve.’’
1849 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); Credit Suisse (Williams);
GE (Feb. 2012); JPMC; RBC; SIFMA et al. (Covered
Funds) (Feb. 2012); SIFMA (Securitization) (Feb.
2012).
1850 See, e.g., ASF (Feb. 2012); Cleary Gottlieb;
LSTA (Feb. 2012). LSTA (Feb. 2012) specifically
requested that entities issuing collateralized loan
obligations that are primarily backed by loans or
loan participations also be permitted to hold a
limited amount of corporate credit obligations. This
commenter provided recommendations about such
limitations—if the amount of such corporate credit
obligations exceeded 10 percent, a CLO would not
be able to purchase any assets other than senior,
secured syndicated loans and temporary
investments (as defined in the letter). If the amount
of such assets exceeded 30 percent, the entity
should not be able to purchase any assets other than
loans.
1851 See AFME et al.; Allen & Overy (on behalf of
Foreign Bank Group); Credit Suisse (Williams);
Japanese Bankers Ass’n.; LSTA (Feb. 2012); SIFMA
(Securitization) (Feb. 2012).

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achieve risk diversification.1852 This
commenter stated its belief that the rule
of construction requires that synthetic
exposures be permitted because they are
used in certain types of loan
securitizations.
In addition to requests that specific
types of underlying assets be permitted
under the loan securitization
exemption, the Agencies also received
comments about specific types of asset
classes or structures. Some commenters
suggested certain asset classes or
structures should be an excluded
securitization from the covered fund
prohibitions including insurance-linked
securities, collateralized loan
obligations, tender option bonds, assetbacked commercial paper conduits
(ABCP conduits), resecuritizations of
asset-backed securities, and corporate
debt re-packagings.1853 In some cases,
commenters believed that the Agencies
should use their authority under section
13(d)(1)(J) of the BHC Act to exempt
these types of vehicles. Some
commenters identified other vehicles
such as credit funds and issuers of
covered bonds that they believed should
be excluded from the covered fund
prohibitions.1854 On the other hand, the
Agencies also received comment letters
that argued that certain securitizations
should not be exempted from the
covered fund prohibitions, including
resecuritizations, CDO-squared, and
CDO-cubed securitizations because of
concern about their complexity and lack
of reliable performance data or ability to
value those securities.1855
Because a loan securitization could
still be a covered fund, several
commenters expressed concern that the
proposed loan securitization exemption,
as drafted, did not exempt loan
securitizations from the prohibitions of
1852 See ASF (Feb. 2012). Permissible synthetic
exposure would include ‘‘credit default swaps, total
return swaps or other agreements referencing
corporate loans or corporate bonds pursuant to
which the issuer is the seller of credit protection or
otherwise ‘long’ the credit exposure of the reference
corporate loan or bond, and receives a yield derived
from the yield on the reference corporate loan or
bond.’’
1853 See AFME et al.; ASF (July 2012); GE (Aug.
2012); Capital Group; Goldman (Covered Funds);
LSTA (Feb. 2012); SIFMA et al. (Covered Funds)
(Feb. 2012).
1854 See Goldman (Covered Funds) (requesting
exclusion for credit funds). AFME et al. (requesting
exclusion for covered bonds); FSA (Apr. 2012)
(requesting exclusion for covered bonds); UKRCBC
(requesting exclusion for covered bonds).
1855 See Sens. Merkley & Levin (Feb. 2012). These
commenters argued that there should be increased
capital charges in line with the complexity of a
securitization and using the ‘‘high risk asset
limitations on permitted activities to bar any
securitization by a bank from using complex
structures, re-securitization techniques, synthetic
features, or other elements that may increase risk or
make a risk analysis less reliable.’’

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section 13(f) of the BHC Act. As a result,
one commenter noted that the proposed
loan securitization exemptions would
not have their intended result of
excluding loan securitizations from the
BHC Act restrictions applicable to
covered funds.1856
Certain securitization transactions
may involve the issuance of an
intermediate asset-backed security that
supports the asset-backed securities that
are issued to investors, such as in auto
lease securitizations and ABCP
conduits. Commenters suggested that
the Agencies should look through
intermediate securitizations to the assets
that support the intermediate assetbacked security to determine if those
assets would satisfy the definition of
‘‘loan’’ for purposes of the loan
securitization exemption. If those assets
are loans, these commenters suggested
that the entire securitization transaction
should be deemed a loan securitization,
even if the assets supporting the assetbacked securities issued to investors are
not loans.1857 However, some
commenters argued that each step in a
multi-step securitization should be
viewed separately to ensure compliance
with the specific restrictions in the
proposal because otherwise a multi-step
securitization could include
impermissible assets.1858 Some
commenters also raised question about
whether depositors would fall within
the definition of ‘‘investment company’’
under the Investment Company Act and,
therefore, may fall within the proposed
definition of covered fund.1859
After considering carefully the
comments received on sections of the
1856 See AFME et al.; SIFMA (May 2012) (arguing
that because of the narrowness of the proposed
exemption and because it would not exempt
securitizations from prohibitions on covered
transactions imposed by section 13(f), the rule as
proposed ‘‘will effectively prevent banking entities
from sponsoring and owning a large variety of assetbacked securities, in contravention of the rule of
construction.’’)
1857 See AFME et al.; ASF (Feb. 2012); SIFMA
(Securitization) (Feb. 2012).
1858 See Occupy; Public Citizen. Occupy
contended that the structured security issued in a
multi-step securitization can hide underlying risks
under layers of structured complexity. See Occupy.
Public Citizen argued that prohibiting such activity
would ensure that securitizations do not become
proprietary trading vehicles for banking entities that
are effectively off-balance sheet. See Public Citizen.
See infra Part IV.B.1.c.8.b.iv. of this SUPPLEMENTARY
INFORMATION.
1859 A depositor, as used in a securitization
structure, is an entity that generally acts only as a
conduit to transfer the loans from the originating
bank to the issuing entity for the purpose of
facilitating a securitization transaction and engages
in no discretionary investment or securities
issuance activities. See ASF (July 2012); GE (Aug.
2012). For purposes of this rule, the Agencies
believe the wholly owned subsidiary exclusion is
available for depositors. See supra note 1774.

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proposed rule, the Agencies have
determined to adopt a single section in
the final provision relating to loan
securitizations that would exclude loan
securitizations that meet certain criteria
contained in the rule from the definition
of covered fund. The rule, as adopted,
takes into account comments received
on each of the conditions specified in
the two loan securitization sections of
the proposed provisions and has
adopted those conditions with some
clarifying changes from the proposed
language. In addition, in response to
comments, as discussed more fully
below, the Agencies are adopting
additional exclusions from the
definition of covered fund for certain
types of vehicles if they are backed by
the same types of assets as the assets
that are permitted to be held in the loan
securitization exclusion. These
additional exclusions are tailored to
vehicles that are very similar to loan
securitizations but have particular
structural issues, which are described in
more detail below.
In light of the comments received on
the proposal, the final rule was revised
to exclude from the definition of
covered fund an issuing entity of assetbacked securities, as defined in Section
3(a)(79) of the Exchange Act,1860 if the
underlying assets or holdings are
comprised solely of: (A) loans, (B) any
rights or other assets (i) designed to
assure the servicing or timely
distribution of proceeds to security
holders or (ii) related or incidental to
purchasing or otherwise acquiring, and
holding the loans, (C) certain interest
rate or foreign exchange derivatives, and
(D) certain special units of beneficial
interests and collateral certificates
(together, ‘‘loan securitizations’’).1861 In
addition, as discussed below, the
Agencies are adopting specific
exclusions for certain vehicles that issue
short term asset-backed securities and
for pools of assets that are part of
covered bond transactions which pools
also meet the conditions delineated
above.1862
1860 15 U.S.C. 78c(a)(79). This definition was
added by Section 941 of the Dodd-Frank Act.
1861 See final rule § ll.10(c)(8). Consistent with
the proposal, certain securitizations, regardless of
asset composition, would not be considered
covered funds because the securitization issuer is
deemed not to be an investment company under
Investment Company Act exclusions other than
section 3(c)(1) or 3(c)(7) of the Investment Company
Act. For example, this would include issuers that
meet the requirements of section 3(c)(5) or rule 3a–
7 of the Investment Company Act, and the assetbacked securities of such issuers may be offered in
transactions registered under the Securities Act.
1862 As discussed below, the Agencies are
adopting an exclusion from the definition of
covered funds for the pools of assets that are
involved in the covered bond financings. Although

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Although commenters argued that
various types of assets should be
included within the definition of loan or
otherwise permitted to be held under
the loan securitization exclusion, the
loan securitization exclusion in the final
rule has not been expanded to be a
broad exclusion for all securitization
vehicles. Although one commenter
suggested that any securitization is
essentially a lending activity,1863 the
Agencies believe such an expansion of
the exclusion would not be consistent
with the rule of construction in section
13(g)(2) of the BHC Act, which
specifically refers to the ‘‘sale and
securitization of loans.’’ The Agencies
believe that a broad definition of loan
and therefore a broad exemption for
transactions that are structured as
securitizations of pooled financial assets
could undermine the restrictions
Congress intended to impose on banking
entities’ covered fund activities, which
could enable market participants to use
securitization structures to engage in
activities that otherwise are constrained
for covered funds. The Agencies believe
the purpose underlying section 13 is not
to expand the scope of assets in an
excluded loan securitization beyond
loans as defined in the final rule and the
other assets that the Agencies are
specifically permitting in a loan
securitization.
While not expanding the permitted
assets under the loan securitization
exclusion, the Agencies have made
modifications in response to
commenters to ensure that the
provisions of the final rule
appropriately accommodate the need, in
administering a loan securitization
transaction on an ongoing basis, to hold
various assets other than the loans that
support the asset-backed securities.
Moreover, the Agencies do not believe
that the assets permitted under the loan
securitization need to be narrowed
further to prevent evasion and hidden
proprietary trading as requested by
certain commenters because the
Agencies believe that the potential for
evasion has been adequately addressed
through modifications to the definition
of loan and more specific limitations on
the types of securities and derivatives
permitted in an excluded loan
securitization. The Agencies have
revised the scope of the loan
securitization exclusion to
accommodate existing market practice
for securitizations as discussed by
the cover pools must satisfy the same criteria as the
excluded loan securitizations, a separate exclusion
is needed because the securities involved in the
covered bond issuance are not asset-backed
securities.
1863 See, e.g., Credit Suisse (Williams).

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commenters while limiting the
availability of the exclusion for these
particular types of securitization
transactions to issuers of asset-backed
securities supported by loans.
The Agencies are not adopting
specific exclusions for other
securitization vehicles identified by
commenters, including insurance-linked
securities, collateralized loan
obligations, and corporate debt repackagings.1864 The Agencies believe
that providing such exclusions would
not be consistent with the rule of
construction in section 13(g)(2)of the
BHC Act, which specifically refers to
the ‘‘sale and securitization of loans.’’
These other types of securitization
vehicles referenced by commenters are
used to securitize exposures to
instruments which are not included in
the definition of loan as adopted by the
final rule. Moreover, the Agencies note
in response to commenters that
resecuritizations of asset-backed
securities and CDO-squared and CDOcubed securitizations could be used as
a means of evading the prohibition on
the investment in the ownership
interests of covered funds.
As with the proposed rules, the
Agencies are excluding certain loan
securitizations from the definition of
covered fund and therefore the
prohibitions applicable to banking
entities’ involvement in covered funds
in order to implement Congressional
intent expressed in the rule of
construction in section 13(g)(2) of the
BHC Act.1865 The Agencies believe that,
as reflected in the rule of construction,
the continued ability of banking entities
to participate in loan securitizations is
important to enable banks of all sizes to
be able to continue to provide financing
to loan borrowers at competitive prices.
Loan securitizations provide an
important avenue for banking entities to
obtain investor financing for existing
loans, which allows such banks greater
capacity to continuously provide
financing and lending to their
customers. The Agencies also believe
that loan securitizations that meet the
conditions of the rule as adopted do not
raise the same types of concerns as other
types of securitization vehicles that
could be used to circumvent the
restrictions on proprietary trading and
1864 Commenters’ concerns regarding credit funds
are discussed below in Part IV.B.1.d.6. of this
SUPPLEMENTARY INFORMATION.
1865 As discussed below, the Agencies are
excluding those loan securitizations that hold only
loans (and certain other assets identified in the final
rule), consistent with the rule of construction in
section 13(g)(2) of the BHC Act.

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prohibitions in section 13(f) of the BHC
Act.
Under the rule as adopted, loan
securitizations that meet the conditions
of the rule as adopted are excluded from
the definition of covered fund and,
consequently, banking entities are not
restricted as to their ownership of such
entities or their ongoing relationships
with such entities by the final rule. As
the Agencies stated in the proposal,
permitting banking entities to acquire or
retain an ownership interest in these
loan securitizations will allow for 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 the
continued availability of funding to
individuals and small businesses, as
well as provide an efficient allocation of
capital and sharing of risk. The
Agencies believe that excluding these
loan securitizations from the definition
of covered fund is consistent with the
terms and the purpose of section 13 of
the BHC Act, including the rule of
construction regarding loan
securitizations.1866
i. Loans
The first condition of the loan
securitization exclusion from the
definition of covered fund is that the
underlying assets or holdings are
comprised of loans. In the proposal,
‘‘loan’’ was a defined term for purposes
of the restrictions on proprietary trading
and the covered funds provisions. As
proposed, a loan was defined as a loan,
lease, extension of credit, or secured or
unsecured receivable.1867 The definition
of loan in the proposed rule was
expansive, and included a broad array
of loans and similar credit transactions,
but did not include any asset-backed
security that is issued in connection
with a loan securitization or otherwise
backed by loans.
As discussed above under ‘‘Definition
of Loan,’’ the Agencies received
comments regarding the loan definition
in the securitization context. In
particular, one commenter, citing a
statement made by Senator Merkley,
argued that Congress did not intend the
loan securitization exemption to include
‘‘loans that become financial
instruments traded to capture the
change in their market value.’’ 1868
1866 The Agencies note that the loan securitization
and other securitization exclusions apply only to
the definition of covered fund, and therefore the
covered fund-related provisions of the rule, and not
to its prohibition on proprietary trading. The
Agencies recognize that trading in loans is not
subject to the proprietary trading restrictions.
1867 See proposed rule § ll.2(q).
1868 See Occupy (citing 156 Cong. Rec. S5895
(daily ed. July 15, 2010)).

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The Agencies, after considering
carefully the comments received, have
adopted a definition of loan that is
revised from the proposed definition.
The final rule defines ‘‘loan’’ as ‘‘any
loan, lease, extension of credit, or
secured or unsecured receivable that is
not a security or derivative.’’ 1869 The
definition of loan in the final rule
specifically excludes loans that are
securities or derivatives because trading
in these instruments is expressly
included in the statute’s definition of
proprietary trading.1870 In addition, the
Agencies believe these instruments, if
not excluded from the definition of
loan, could be used to circumvent the
restrictions on proprietary trading.
Further, for purposes of the loan
securitization exclusion, the loan
securitization must own the loan
directly; a synthetic exposure to a loan,
such as through holding a derivative,
such as a credit default swap, will not
satisfy the conditions for the loan
securitization exclusion.1871 As such, a
securitization that owns a tranche of
another loan securitization is not itself
a loan securitization, even if the
ownership of such tranche by a banking
entity would otherwise be permissible
under the final rule.
As discussed above under ‘‘Definition
of Loan,’’ the definition of loan in the
final rule has not been expanded as
requested by some commenters but has
been clarified in some respects in
response to comments. The final rule
explicitly excludes securities or
derivatives.1872 In addition, the
definition of loan has not been modified
to include repurchase agreements or
reverse repurchase agreements
regardless of the character of the
underlying asset. The Agencies are
concerned that parties, under the guise
of a ‘‘loan’’ might instead create
instruments that provide the same
exposures to securities and derivatives
that otherwise are prohibited by section
13 and might attempt to use the loan
securitization exclusion to acquire
ownership interests in covered funds
holding those types of instruments,
§ ll.2(r).
U.S.C. 1851(h)(4).
1871 Under the final provision, the issuing entity
for the SUBIs and collateral certificate may rely on
the loan securitization exclusion because of the
separate provisions allowing such a holding.
1872 The determination of whether an instrument
falls outside the definition of loan because it is a
security or a derivative is based on the federal
securities laws and the Commodity Exchange Act.
Whether a loan, lease, extension of credit, or
secured or unsecured receivable is a note or
evidence of indebtedness that is defined as a
security under the federal securities laws will
depend on the particular facts and circumstances,
including the economic terms of the transaction.
See supra note 1831 and accompanying text.
1869 See
1870 12

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counter to the terms and the purpose of
section 13 of the BHC Act. As the
Agencies have noted previously, the
rules relating to covered funds and to
proprietary trading are not intended to
interfere with traditional lending
practices or with securitizations of loans
generated as a result of such activities.
Although the Agencies have revised the
definition of loan in response to
commenters’ concerns as discussed
above, the Agencies are not adopting a
separate definition of loan for
securitization transactions as requested
by commenters. The Agencies believe
that the definition of loan adopted in
the final rule appropriately
encompasses the financial instruments
that result from lending money to
customers.
ii. Contractual Rights or Assets
Under the proposed loan
securitization definition, a covered fund
that is an issuer of asset-backed
securities would have been permitted to
hold contractual rights or assets directly
arising from those loans supporting the
asset-backed securities.1873 The
proposal did not identify or describe
such contractual rights or assets.
Commenters requested that the
Agencies expand the list of contractual
rights and assets that an issuer of assetbacked securities would be permitted to
hold under the proposed loan
securitization exemption.1874 Examples
of the additional rights and assets
requested by commenters include cash
and cash accounts; 1875 cash
equivalents; 1876 liquidity agreements,
proposed rule § ll.13(d).
Allen & Overy (on behalf of Foreign Bank
Group); AFME et al.; ASF (Feb. 2012); Cleary
Gottlieb; Credit Suisse (Williams); Commercial Real
Estate Fin. Council; GE (Feb. 2012); GE (Aug. 2012);
ICI (Feb. 2012); Japanese Bankers Ass’n.; JPMC;
LSTA (Feb. 2012); LSTA (July 2012); RBC; SIFMA
et al. (Covered Funds) (Feb. 2012); SIFMA
(Securitization) (Feb. 2012); Vanguard.
1875 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); Cleary Gottlieb; Credit
Suisse (Williams).
1876 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); Cleary Gottlieb; Credit
Suisse (Williams); Commercial Real Estate Fin.
Council; JPMC; LSTA (Feb. 2012); LSTA (July
2012); RBC; SIFMA (Securitization) (Feb. 2012).
Commenters requested inclusion of the following
examples of cash equivalents: government
guaranteed securities, money market funds, and
‘‘other highly credit-worthy and liquid
investments’’ (Credit Suisse (Williams)); and high
quality, highly liquid investments, including
Treasury securities and highly rated commercial
paper (JPMC). In addition, LSTA (Feb. 2012)
requested inclusion of the following: (i) Short-term
highly liquid investments; (ii) direct obligations of,
and obligations fully guaranteed as to full and
timely payment by, the United States (or by any
agency thereof to the extent such obligations are
backed by the full faith and credit of the United
States); (iii) demand deposits, time deposits or
certificates of deposit that are fully insured by the
1873 See

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1874 See

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including asset purchase agreements,
program support facilities and support
commitments; 1877 credit
enhancements; 1878 asset-backed
securities; 1879 municipal securities; 1880
repurchase agreements; 1881 creditFederal Deposit Insurance Corporation; (iv)
corporate, non-extendable commercial paper; (v)
notes that are payable on demand or bankers’
acceptances issued by regulated U.S. financial
institutions; (vi) investments in money market
funds or other regulated investment companies;
time deposits having maturities of not more than 90
days; (vii) repurchase obligations with respect to
direct obligations and guaranteed obligations of the
U.S. entered into with a regulated U.S. financial
institution; and (viii) other investments with a
maturity one year or less, with the requirement that
each of the investments listed have, at the time of
the securitization’s investment or contractual
commitment to invest therein, a rating of the
highest required investment category.
1877 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); GE (Feb. 2012); JPMC;
RBC; SIFMA (Securitization) (Feb. 2012).
1878 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); GE (Feb. 2012); JPMC;
RBC; SIFMA (Securitization) (Feb. 2012). For
example, SIFMA (Securitization) (Feb. 2012)
requested inclusion of third party credit
enhancements such as guarantees and letters of
credit. Commenters requested inclusion of the
following examples of credit enhancements: (i)
External credit support of borrower obligations
under such loans, including a credit support
facilities, third party or parent guarantee, insurance
policy, letter of credit or other contractual
commitment to make payments or perform other
obligations of the borrower under the loans (ASF
(Feb. 2012)); and (ii) property guarantees, insurance
policies, letters of credit, or supporting obligations
underlying or relating to any of the loans (RBC).
1879 See Allen & Overy (on behalf of Foreign Bank
Group); AFME et al.; ASF (Feb. 2012); Credit Suisse
(Williams); GE (Feb. 2012); GE (Aug. 2012); ICI
(Feb. 2012); JPMC; RBC; SIFMA et al. (Covered
Funds) (Feb. 2012); SIFMA (Securitization) (Feb.
2012). Commenters requested inclusion of the
following examples of asset-backed securities: (i)
SUBI certificates (beneficial interests in titling
trusts typically used in lease securitizations) (AFME
et al.; ASF (Feb. 2012); GE (Aug. 2012); SIFMA
(Securitization) (Feb. 2012)); (ii) ownership
interests and bonds issued by CLOs (JPMC); a broad
array of receivables that support asset-backed
commercial paper (ICI (Feb. 2012)); certain notes,
certificates or other instruments backed by loans or
financial assets that are negotiated by the
purchasing asset-backed commercial paper conduit
(ASF (Feb. 2012); GE (Feb. 2012)); municipal
securities that are technically ABS, including
revenue bonds that involve the issuance of senior
and subordinate bonds (ASF (Feb. 2012));
ownership interests in credit funds (as defined in
their letter) (SIFMA et al. (Covered Funds) (Feb.
2012)); any note, bond or security collateralized and
payable from pools of loans, leases (including lease
residuals), extensions of credit or secured or
unsecured receivables (RBC); asset-backed
securities issued by intermediate vehicles in a
securitization collateralized predominantly by loans
and financial assets, and other similar instruments
(Credit Suisse (Williams)); and asset-backed
securities backed by loans or receivables that are
originated by or owned by the sponsor of such
securitization or which are issued by an entity that
is organized under the direction of the same
sponsor as the issuer of the covered fund (ASF (Feb.
2012)).
1880 See ICI (Feb. 2012); Vanguard.
1881 See Credit Suisse (Williams); SIFMA
(Securitization) (Feb. 2012).

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5689

linked notes; 1882 trust certificates; 1883
lease residuals; 1884 debt securities; 1885
and derivatives.1886 As an alternative,
commenters requested that an issuer of
asset-backed securities be permitted to
hold under the proposed loan
securitization exemption certain of such
additional rights and/or assets up to a
threshold, such as a specified
percentage of the assets of such covered
fund.1887
In response to comments, the final
rule modifies the loan securitization
exclusion from the proposal to identify
the types of contractual rights or assets
directly arising from those loans
supporting the asset-backed securities
that a loan securitization relying on
such exclusion may hold. Under the
final rule, a loan securitization which is
eligible for the loan securitization
exclusion may hold contractual rights or
assets (i) designed to assure the
servicing or timely distribution of
proceeds to security holders or (ii)
related or incidental to purchasing or
otherwise acquiring, and holding the
loans (‘‘servicing assets’’).1888 The
servicing assets are permissible in an
excluded loan securitization transaction
only to the extent that they arise from
the structure of the loan securitization
or from the loans supporting a loan
securitization. If such servicing assets
are sold and securitized in a separate
transaction, they will not qualify as
1882 See Allen & Overy (on behalf of Foreign Bank
Group).
1883 See Credit Suisse (Williams).
1884 See ASF (Feb. 2012); GE (Feb. 2012); GE
(Aug. 2012); RBC.
1885 See GE (Aug. 2012).
1886 See Allen & Overy (on behalf of Foreign Bank
Group); Credit Suisse (Williams); Japanese Bankers
Ass’n.; LSTA (Feb. 2012); SIFMA (Securitization)
(Feb. 2012). Commenters requested inclusion of the
following examples of derivatives: (i) Credit
derivatives (without explanation) as a means of
diversifying the portfolio (Japanese Bankers
Association); (ii) synthetic securities that reference
corporate credits or other debt (Credit Suisse
(Covered Fund)); (iii) credit instruments or other
obligations that the banking entity could originate
or invest or deal in directly, including tranched or
untranched credit linked notes exposed to the
credit risk of such reference assets through a credit
default swap or other credit derivative entered into
by the related ABS Issuer (SIFMA (Securitization)
(Feb. 2012)); (iv) any derivatives structured as part
of the securitization of loans (without explanation)
(Allen & Overy (on behalf of Foreign Bank Group));
(v) hedge agreements (Credit Suisse (Williams));
and (vi) any derivative, including a credit default
swap, as and to the extent a banking entity could
use such derivative in managing its own investment
portfolio (SIFMA (Securitization) (Feb. 2012)).
1887 See ASF (Feb. 2012); Cleary Gottlieb; Credit
Suisse (Williams); GE (Feb. 2012); GE (Aug. 2012);
LSTA (Feb. 2012); LSTA (July 2012).
1888 See final rule § ll.10(c)(8)(i)(B). The use of
the term ‘‘servicing assets’’ is not meant to imply
that servicing assets are limited to those contractual
rights or assets related to the servicer and the
performance of the servicer’s obligations.

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permissible holdings for the loan
securitization exclusion.1889
In adopting this approach, the
Agencies considered commenters’
concerns and determined to revise the
condition to be more consistent with the
definition and treatment of servicing
assets in other asset-backed
securitization regulations, such as the
exemption from the definition of
‘‘investment company’’ under rule 3a–7
promulgated under the Investment
Company Act.1890
Although the Agencies have revised
the proposal in response to commenters’
concerns, the final rule does not permit
a loan securitization to hold as servicing
assets a number of instruments
specifically requested by commenters
whether in their entirety or as a
percentage of the pool. Under the final
rule, servicing assets do not include
securities or derivatives other than as
specified in the rule.
Under the final rule, a loan
securitization which is eligible for the
loan securitization exclusion may hold
securities if those securities fall into one
of three categories.1891 First, such loan
securitizations may hold securities that
are cash equivalents. For purposes of
the exclusion for loan securitizations,
the Agencies interpret ‘‘cash
equivalents’’ to mean high quality,
highly liquid short term investments
whose maturity corresponds to the
securitization’s expected or potential
need for funds and whose currency
corresponds to either the underlying
loans or the asset-backed securities.1892
Depending on the specific funding
needs of a particular securitization,
‘‘cash equivalents’’ might include
deposits insured by the Federal Deposit
Insurance Corporation, certificates of
deposit issued by a regulated U.S.
financial institution, obligations backed
by the full faith and credit of the United
States, investments in registered money
market funds, and commercial
1889 For example, under the final rule, mortgage
insurance policies supporting the mortgages in a
loan securitization are servicing assets permissible
for purposes of § ll.10(c)(8)(i)(B). However, a
separate securitization of the payments on those
mortgage insurance policies would not qualify for
the loan securitization exclusion.
1890 The Agencies believe that for purposes of the
final rule, in the context of securitization, such
related or incidental assets in a loan securitization
should support or further, and therefore, be
secondary to the loans held by the securitization
vehicle.
1891 See final rule § ll.10(c)(8)(iii).
1892 If either the loans supporting the loan
securitization or the asset-backed securities issued
by the loan securitization are denominated in a
foreign currency, for purposes of the exclusion a
loan securitization would be permitted to hold
foreign currency, cash equivalents denominated in
foreign currency and foreign exchange derivatives
that comply with § ll.10(c)(8)(iv).

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paper.1893 Second, such loan
securitizations may hold securities
received in lieu of debts previously
contracted with respect to the loans
supporting the asset-backed securities.
Finally, such loan securitizations may
hold securities that qualify as SUBIs or
collateral certificates subject to the
provisions set forth in the rule for such
intermediate asset-backed securities.
The Agencies have specifically
limited the types of securities held as
eligible assets in a loan securitization
that may be excluded from the
definition of covered fund under the
final rule, even in limited amounts, in
order to assure that the types of
securities are cash equivalents or
otherwise related to the loan
securitization and to prevent the
possible misuse of the loan
securitization exclusion to circumvent
the restrictions on proprietary trading,
investments in covered funds and
prohibitions in section 13(f) of the BHC
Act.1894 The Agencies believe that types
of securities other than those
specifically included in the final rule
could be misused in such manner,
because without limitations on the types
of securities in which an excluded loan
securitization may invest, a banking
entity could structure an excluded loan
securitization with provisions to engage
in activities that are outside the scope
of the definition of loan as adopted and
also to engage in impermissible
proprietary trading. Further, the
Agencies do not believe that the use of
thresholds with respect to such other
types of securities as an alternative is
appropriate because similarly, such a
securitization would then involve a
securitization of non-loan assets,
outside the scope of what the Agencies
believe the rule of construction was
intended to cover. By placing
restrictions on the securities permitted
to be held by an excluded loan
securitization, the potential for evasion
is reduced. Loan securitizations are
intended, as contemplated by the rule of
construction, to permit banks to
continue to engage in securitizations of
loans. Including all types of securities
within the scope of permitted assets in
an excluded loan securitization would
expand the exclusion beyond the scope
of the definition of loan in the final rule
1893 Servicing assets should not introduce
significant additional risks to the transaction,
including foreign currency risk or maturity risk. For
instance, funds on deposit in an account that is
swept on a monthly basis should not be invested
in securities that mature in 90 days.
1894 Commenters expressed concerns about the
use of securitization vehicles for evasion. See, e.g.,
AFR et al. (Feb. 2012); Occupy; Public Citizen.

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that is intended to implement the rule
of construction.
iii. Derivatives
Under the proposed loan
securitization definition, an exempted
loan securitization would be permitted
to hold interest rate or foreign exchange
derivatives that materially relate to the
terms of any loans supporting the assetbacked securities and any contractual
rights or assets directly arising from
such loans so long as such derivatives
are used for hedging purposes with
respect to the securitization
structure.1895 The Agencies indicated in
the proposing release that the proposed
loan securitization definition would not
allow an exempted loan securitization
to use credit default swaps.1896
Commenters criticized the proposed
limitations on the use of derivatives
included in the proposed loan
securitization definition.1897 In
particular, one commenter indicated
that the use of credit derivatives such as
credit default swaps is important in loan
securitizations to provide diversification
of assets.1898 Another commenter noted
the use of such instruments to manage
risks with respect to corporate loan and
debt books by accessing capital from a
broad group of capital markets investors
and facilitates making markets.1899 In
contrast, two commenters generally
supported the limitations on the use of
derivatives under the proposed loan
securitization definition and indicated
that excluding credit default swaps from
the loan securitization definition was
appropriate.1900
1895 See

Joint Proposal, 76 FR 68,912.

1896 Id.
1897 See

AFME et al.; Allen & Overy (on behalf of
Foreign Bank Group); ASF (Feb. 2012) (requesting
that an excluded loan securitization be permitted to
hold up to 10% of its assets in the form of synthetic
risk exposure to loans); Credit Suisse (Williams);
Japanese Bankers Ass’n.; LSTA (Feb. 2012) (for
CLOs); SIFMA (Securitization) (Feb. 2012).
1898 See Japanese Bankers Ass’n. This commenter
indicated that credit derivatives are important in
securitizations to provide diversification when the
desired mix of assets cannot be achieved.
1899 See ASF (Feb. 2012). This commenter argued
that for some loan securitizations, investors may
Seek a broader pool of credit exposures than the
bank has available or can obtain to securitize in
order to achieve risk diversification.
1900 See AFR et al. (Feb. 2012); Public Citizen.
One of these commenters stated that the credit
default exclusion was appropriate because
‘‘synthetic securitizations and resecuritizations
were a key contributor to financial contagion during
the crisis.’’ See AFR et al. (Feb. 2012). Another
commenter argued that the loan securitization
definition should not permit the use of derivatives.
See Occupy. This commenter argued that covered
funds should only be permitted to engage in
hedging activity in accordance with the proposed
exemption for hedging activity. This commenter
also argued that the inclusion of derivatives in the
loan securitization definition exceeded the
Agencies’ statutory authority. Id. Two senators

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With respect to the use of derivatives,
the Agencies are adopting the loan
securitization exclusion substantially as
proposed with certain modifications to
reflect a restructuring of this provision
in order to more closely align the
permissible uses of derivatives under
the loan securitization exclusion with
the loans, the asset-backed securities, or
the contractual rights and other assets
that a loan securitization relying on the
loan securitization exclusion may hold.
As adopted, for a loan securitization to
be eligible for the loan securitization
exclusion, the loan securitization may
hold only interest rate or foreign
exchange derivatives that meet the
following requirements: (i) The written
terms of the derivatives directly relate to
either the loans or the asset-backed
securities that such loan securitization
may hold under the other provisions of
the loan securitization exclusion; and
(ii) the derivatives reduce interest rate
and/or foreign exchange risk with
respect to risks related to either such
loans, the asset-backed securities or the
contractual rights or other assets that a
loan securitization may hold.1901
The first requirement that the written
terms of the derivatives ‘‘directly relate’’
to either the loans or the asset-based
securities themselves is intended to
quantitatively and qualitatively limit the
use of derivatives permitted under the
loan securitization exclusion.1902 The
Agencies would expect that neither the
total notional amount of directly related
interest rate derivatives nor the total
notional amount of directly related
foreign exchange derivatives would
exceed the greater of either the
outstanding principal balance of the
loans supporting the asset-backed
securities or the outstanding principal
balance of the asset-backed
securities.1903 Moreover, under the loan
securitization exclusion, the type of
derivatives must be related to the types
of risks associated with the underlying
assets and may not be derivatives
designed to supplement income based
on general economic scenarios, income
management or unrelated risks.
indicated that ‘‘complex securitizations’’ including
those with ‘‘synthetic features’’ and ‘‘embedded
derivatives’’ should not be allowed to rely on the
exclusion for loan securitizations. See Sens.
Merkley & Levin (Feb. 2012).
1901 See final rule § ll.10(c)(8)(iv).
1902 Under the final rule, the Agencies expect that
a loan securitization relying on the loan
securitization exclusion would not have a
significant amount of interest rate and foreign
exchange derivatives with respect to risks arising
from contractual rights or other assets.
1903 For example, a $100 million securitization
cannot be hedged using an interest rate hedge with
a notional amount of $200 million.

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The second requirement that
derivatives reduce the interest rate and/
or foreign exchange risks related to
either such loans, contractual rights or
other assets, or such asset-backed
securities is intended to permit the use
of derivatives to hedge interest rate and/
or foreign exchange risks that result
from a mismatch between the loans and
the asset-backed securities.1904
The Agencies believe that the
statutory rule of construction should be
implemented in a manner that does not
limit or restrict the sale and
securitization of loans. The Agencies
further believe that the sale and
securitization of credit exposures other
than ‘‘loans’’ as defined in the rule, such
as through securities or derivatives,
could be abused. The derivatives that
may be held in a loan securitization for
purposes of the exclusion may not be
used for speculative purposes.
Consistent with the proposal, the loan
securitization exclusion does not permit
a loan securitization relying on such
exclusion to hold credit default swaps
or other types of derivatives whether or
not they are related either to the
underlying loans or the asset-backed
securities.1905 Under the final rule, a
synthetic securitization in which the
asset-backed securities are supported by
cash flow from derivatives, such as
credit default swaps and total return
swaps, would not be permitted to rely
on the loan securitization exclusion
because such derivatives are excluded
from the final rule’s definition of loan
specifically, as a derivative. Similarly, a
loan securitization that relies on the
loan securitization exclusion would not
be permitted to hold a credit default
swap or total return swap that
references a loan that is held by the loan
securitization. Under the final rule as
adopted, an excluded loan
securitization would not be able to hold
derivatives that would relate to risks to
counterparties or issuers of the
underlying assets referenced by these
derivatives because the operation of
derivatives, such as these, that expand
potential exposures beyond the loans
1904 The derivatives permitted in a securitization
that may rely on the loan securitization exclusion
would permit a securitization to hedge the risk
resulting from differences between the income
received by the issuing entity and the amounts due
under the terms of the asset-backed securities. For
example, fixed rate loans could support floating rate
asset-backed securities; loans with an interest rate
determined by reference to the Prime Rate could
support asset-backed securities with an interest rate
determined by reference to LIBOR; or Eurodenominated loans could support U.S. Dollardenominated asset-backed securities.
1905 Loan securitizations excluded from the
covered fund definition may only hold certain
directly related derivatives as specified in
§ ll.11(c)(8)(iv) and as discussed in this Part.

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5691

and other assets, would not in the
Agencies’ view be consistent with the
limited exclusion contained in the rule
of construction under section 13(g)(2) of
the BHC Act, and could be used to
circumvent the restrictions on
proprietary trading and prohibitions in
section 13(f) of the BHC Act. The
Agencies believe that the use of
derivatives by an issuing entity for
asset-backed securities that is excluded
from the definition of covered fund
under the loan securitization exclusion
should be narrowly tailored to hedging
activities that reduce the interest rate
and/or foreign exchange risks directly
related to the asset-backed securities or
the loans supporting the asset-backed
securities because the use of derivatives
for purposes other than reducing
interest rate risk and foreign exchange
risks would introduce credit risk
without necessarily relating to or
involving a reduction of interest rate
risk or foreign exchange risk.
On the other hand, while the
Agencies are not expanding the types of
permitted derivatives to be held in a
loan securitization, the Agencies in the
final rule are not restricting the use of
all derivatives under the loan
securitization exclusion as requested by
certain commenters. The Agencies
believe that a loan securitization that is
excluded from the definition of covered
fund should be allowed to engage in
activities that reduce interest rate and
foreign exchange risk because the
hedging of such risks is consistent with
the prudent risk management of interest
rate and currency risk in a loan portfolio
while at the same time avoiding the
potential for additional risk arising from
other types of derivatives.1906 The
Agencies do not believe that the
exemption for hedging activity
applicable to market making and
underwriting under the final rule is the
appropriate measure for permitted
derivatives in a loan securitization that
would be excluded from definition of
covered fund 1907 because the hedging
exemptions for market making and
underwriting are not tailored to the
hedging requirements of a securitization
transaction.1908 The Agencies also do
not believe that they lack the statutory
authority to permit a loan securitization
1906 See AFR et al. (Feb. 2012); Occupy; Public
Citizen.
1907 See Occupy. This commenter argued that
covered funds should only be permitted to engage
in hedging activity in accordance with the proposed
exemption for hedging activity.
1908 For example, a banking entity may hold an
ownership interest in a covered fund in order to
hedge employee compensation risks. Because
securitizations do not have employees, such a
hedging exemption would not be applicable to a
securitization structure.

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relying on the loan securitization
exclusion to use derivatives, as
suggested by one commenter,1909
because the Agencies believe that the
permitted derivatives relate directly to
loans that are permitted and have
limited the quality and quantity of
derivatives that an excluded loan
securitization is permitted to hold
directly to the reduction of risks that
result from the loans and the loan
securitization.
While loan securitizations that
include non-loan assets are not
excluded from the definition of covered
fund, banking entities are not prohibited
from owning interests or sponsoring
these covered funds under the final rule.
Under the final rule, these
securitizations would be covered funds,
and banking entities engaged with these
covered funds would be subject to the
limitations on ownership interests and
relationships with these covered funds
imposed by section 13 of the BHC Act.

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iv. SUBIs and Collateral Certificates
Commenters also argued that, under
the proposed exemption for loan
securitizations, securitizations that are
backed by certain intermediate assetbacked securities would not satisfy the
conditions for the exemption and
therefore would be subject to the
covered fund prohibitions.1910 For
example, commenters noted that, in a
securitization of leases with respect to
equipment where a titling trust is used
to hold ownership of the equipment, a
titling trust will typically own the
equipment and the right to payment on
the leases, and then will issue a security
or other instrument, often referred to as
a special unit of beneficial interest
(SUBI), that represents an ownership
interest in the titling trust to the
securitization issuer.1911 As another
example, certain securitizations
frequently use a master trust structure
allowing the trust to issue more than
one series of asset-backed security
collectively backed by a common
revolving pool of assets. In such a
structure, a master trust may hold assets
(such as loans) and issue a collateral
certificate supported by those assets to
an issuing trust that issues asset-backed
securities to investors. The assets held
by the master trust are typically a pool
of revolving accounts that may be paid
in full each month (e.g., credit card
receivables) or a revolving pool of short1909 See

Occupy.
AFME et al.; Allen & Overy (on behalf of
Foreign Bank Group); ASF (Feb. 2012); Credit
Suisse (Williams); GE (Aug. 2012); PNC; RBC;
SIFMA (Securitization)
(Feb. 2012).
1911 See SIFMA (Securitization) (Feb. 2012).
1910 See

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term loans that are replaced with new
loans as they mature (e.g., floor plan
loans).1912 One commenter opposed the
inclusion of securitizations backed by
intermediate asset-backed securities,
arguing that each step should be viewed
separately to ensure compliance to
prevent the inclusion of impermissible
assets such as prohibited
derivatives.1913
In response to comments, the
Agencies are modifying the proposal to
provide that a securitization backed by
certain intermediate asset-backed
securities will qualify for the loan
securitization exclusion. The Agencies
recognize that securitization structures
that use these types of intermediate
asset-backed securities are essentially
loan securitization transactions, because
the intermediate asset-backed securities
in the asset pool are created solely for
the purpose of facilitating a
securitization 1914 and once created, are
issued directly into a securitization
vehicle rather than to any third party
investor.
Under the final rule, a loan
securitization that is excluded from the
definition of covered fund may include
SUBIs or collateral certificates, provided
that four conditions are met.1915 First,
the special purpose vehicle issuing the
SUBI or collateral certificate itself must
meet the conditions of the loan
securitization exclusion, as adopted in
the final rule.1916 Under this provision,
for example, the special purpose
vehicle, in addition to the issuing entity,
may hold an interest rate or foreign
exchange derivative or other assets only
if the derivative or asset is permitted to
be held in accordance with the
requirements for derivatives in respect
of the loan securitization exclusion.
Second, the SUBI or collateral certificate
must be used for the sole purpose of
transferring economic risks and benefits
of the loans (and other permissible
assets) 1917 to the issuing entity for the
securitization and may not directly or
indirectly transfer any interest in any
other economic or financial exposures.
Third, the SUBI or collateral certificate
1912 See, e.g., ASF (Feb. 2012). UK RMBS master
trusts also use a master trust structure. See AFME
et al.; ASF (Feb. 2012); SIFMA (Securitization) (Feb.
2012).
1913 See Occupy.
1914 The use of SUBIs, for example, allows the
sponsor to avoid administrative expenses in
retitling the physical property underlying the
leases.
1915 See final rule § ll.10(c)(8)(v).
1916 The provision will allow for the existing
practice of a master trust to hold a collateral
certificate issued by a legacy master trust.
1917 This would include a collateral certificate
issued by a legacy master trust that meets the
requirements of the loan securitization exclusion.

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must be created solely to satisfy legal
requirements or otherwise facilitate the
structuring of the loan securitization.
Fourth, the special purpose vehicle
issuing the SUBI or collateral certificate
and the issuing entity for the excluded
loan securitization transaction must be
established under the direction of the
same entity that initiated the loan
securitization transaction. The Agencies
believe that the fourth condition will
ensure that the resecuritizations of
asset-backed securities purchased in the
secondary market, which the Agencies
do not believe would constitute a loan
securitization, will not be able to use
these special provisions tailored only
for transactions utilizing SUBIs and
collateral certificates in order to fall
within the loan securitization exclusion.
The Agencies believe that these
conditions provide that only
securitizations backed by SUBIs and
collateral certificates involving loans—
and not other types of securities or other
types of assets—will be able to use the
loan securitization exclusion. These
conditions are intended to assure that
for purposes of the loan securitization
exclusion that only SUBI and collateral
certificates that essentially represent the
underlying loans are included
consistent with the terms and the
purpose of section 13 of the BHC Act,
while also not adversely affecting
securitization of ‘‘loans’’ as defined in
the final rule.1918 The Agencies believe
that the limitation of the types of assetbacked securities permitted in an
excluded loan securitization (only
SUBIs and collateral certificates) and
the restrictions placed on those SUBIs
and collateral certificates that are
permitted in an excluded loan
securitization will avoid loan
securitizations that contain other types
of assets from being excluded from the
definition of covered fund.
v. Impermissible Assets
As discussed above, commenters on
the loan securitization proposals argued
that various types of assets should be
included within the definition of loan or
otherwise permitted to be held by the
loan securitization that would be
entitled to rely on the proposed
exemptions.
After considering comments, the
Agencies have determined to retain the
narrower scope of the permitted assets
in a loan securitization that is eligible
for the loan securitization exclusion.
1918 See, e.g., rule 190 under the Securities Act.
See also, e.g., ASF (Feb. 2012) (noting that certain
rules under the Securities Act and staff
interpretations have carved out SUBIs and collateral
certificates from certain disclosure and other
requirements).

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The Agencies have revised the language
regarding loan securitizations from the
proposal to specify certain types of
assets or holdings that a loan
securitization would not be able to hold
if it were eligible to rely on the
exclusion from the definition of covered
fund for loan securitizations.1919 The
Agencies recognize that securitization
structures vary significantly and,
accordingly, the loan securitization
exclusion as adopted in the final rule
accommodates a wider range of
securitization practices. The Agencies
believe that these limitations provide
that only securitizations backed by
loans—and not securities, derivatives or
other types of assets—will be able to use
the loan securitization exclusion
consistent with the terms and the
purpose of section 13 of the BHC
Act.1920 The Agencies believe that the
limitation of the types of assets
permitted in an excluded loan
securitization will avoid loan
securitizations that contain other types
of assets from being excluded from the
definition of covered fund.
Under the final rule, in order to be
excluded from the definition of covered
fund, a loan securitization may not hold
(i) a security, including an asset-backed
security, or an interest in an equity or
debt security (unless specifically
permitted, such as with respect to a
SUBI or collateral certificate as
described above), (ii) a derivative other
than an interest rate or foreign exchange
derivative that meets the requirements
described above,1921 or (iii) a
commodity forward contract.1922 The
Agencies have determined that a loan
securitization relying on the loan
securitization exclusion may not
include a commodity forward contract
because a commodity forward contract
is not a loan.1923
final rule § ll.10(c)(8)(ii).
Agencies discuss earlier in this Part the
permissible assets an excluded loan securitization
may hold and the Agencies’ belief that excluding
loan securitizations as defined in the final rule is
consistent with the terms and the purpose of
section 13 of the BHC Act, including the rule of
construction in section 13(g)(2). See, e.g., supra
note 1866 and accompanying and following text.
1921 See final rule § ll.10(c)(8)(iv); See also 7
U.S.C. 27(a)–(b).
1922 See the discussion above in Part IV.B.1.c.8 of
this SUPPLEMENTARY INFORMATION.
1923 For a discussion of commodity forward
contracts, See Further Definition of ‘‘Swap,’’
‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap
Agreement;’’ Mixed Swaps; Security-Based Swap
Agreement Recordkeeping, 77 FR 48208 (Aug. 13,
2012) (Release Nos. 33–9338 and 34–67453, July 18,
2012).
1919 See

9. Asset-Backed Commercial Paper
Conduits
Under the proposed rule, certain
securitization vehicles, including ABCP
conduits, would not have been covered
by the loan securitization exclusion and,
therefore, would have been deemed to
be a covered fund.1924 ABCP is a type
of liability that is typically issued by a
special purpose vehicle (commonly
referred to as a ‘‘conduit’’) sponsored by
a financial institution or other entity.
The short term asset-backed securities
issued by the conduit are supported by
a managed pool of assets, which may
change over the life of the entity.
Depending on the type of ABCP
conduit, the securitized assets
ultimately supporting the short term
asset-backed securities may consist of a
wide range of assets including
automobile loans, commercial loans,
trade receivables, credit card
receivables, student loans, and other
loans in addition to asset-backed
securities supported by such assets. The
term of ABCP typically is short, and the
liabilities are ‘‘rolled’’ (i.e., replaced or
refinanced) at regular intervals. Thus,
ABCP conduits generally fund longerterm assets with shorter-term
liabilities.1925 In this regard, in the
proposing release, the Agencies
requested comment on the proposed
rule’s definition of ‘‘covered fund’’ with
respect to asset-backed securities and/or
securitization vehicles 1926 and received
numerous comments requesting a
variety of exemptions for ABCP
conduits.1927
A number of commenters requested
that the final rule exclude ABCP
conduits from the definition of covered
fund 1928 or that the Agencies use their
authority under section 13(d)(1)(J) of the
BHC Act 1929 to similar effect.1930 One
commenter argued that ABCP conduits
do not have the characteristics of a
private equity fund or hedge fund,1931
even though they typically rely on the
exemptions set forth in section 3(c)(1) or

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1920 The

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proposed rule § ll.13(d).
investment vehicles (‘‘SIVs’’) and
securities arbitrage ABCP programs both purchase
securities (rather than receivables and loans). SIVs
typically lack liquidity facilities covering all of
these liabilities issued by the SIV, while securities
arbitrage ABCP programs typically have such
liquidity coverage, though the terms are more
limited than those of the ABCP conduits eligible for
the exclusion pursuant to the final rule.
1926 See Joint Proposal, 76 FR 68,899.
1927 See, e.g., ASF (Feb. 2012); BoA; Capital
Group; Eaton Vance; Fidelity; ICI (Feb. 2012);
Japanese Bankers Ass’n.; PNC; RBC.
1928 See, e.g., ICI (Feb. 2012); PNC et al.; SIFMA
(May 2012).
1929 See 12 U.S.C. 1851(d)(1)(J).
1930 See ICI (Feb. 2012).
1931 See PNC.
1924 See

1925 Structured

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5693

3(c)(7) of the Investment Company Act.
Another commenter argued that the
proposed rule’s definition of covered
fund would negatively impact assetbacked securitizations (including ABCP
conduits), and suggested that the
Agencies define covered funds, in part,
as those that both (i) rely on section
3(c)(1) or 3(c)(7) of the Investment
Company Act and (ii) have the
traditional characteristics of private
equity funds or hedge funds.1932
Another commenter stated that the rule
of construction set forth in section
13(g)(2) of the BHC Act 1933 is a clear
indication that section 13 of the BHC
Act was not intended to apply to
securitization vehicles such as ABCP
conduits.1934 Another commenter stated
that the lending that occurs through
ABCP conduits is the type of activity
that Congress and the Executive Branch
have urged banks to expand in order to
support economic growth and job
creation,1935 while another commenter
stated that ABCP conduits provide low
cost, reliable financing for registered
investment companies, which poses
little risk to the safety and soundness of
banks because federal law requires
registered investment companies to
maintain prescribed asset coverage in
connection with borrowings.1936
Two commenters contended that,
while certain issuers of asset-backed
securities may rely on section 3(c)(5) of
the Investment Company Act or rule
3a–7 thereunder, and, therefore, not be
brought under the proposed rule’s
definition of covered fund, ABCP
conduits typically cannot rely on this
section or rule either because to do so
would be too restrictive (in the case of
section 3(c)(5)) or because they cannot
meet the rule’s requirements.1937
One commenter, employing ABCP
conduits as an example, stated that
failing to exempt securitization vehicles
from the covered fund prohibitions
would preclude banking entities from
engaging in activities that have long
been recognized as permissible
activities for banking entities and that
are vital to the normal functioning of the
securitization markets, and will have a
significant and negative impact on the
securitization markets and on the ability
of banking entities and other companies
to provide credit to their customers.1938
This commenter further stated that
ABCP conduits are an efficient and
1932 See

Barclays.
12 U.S.C. 1851(g)(2).
1934 See ICI (Feb. 2012).
1935 See Credit Suisse (Williams).
1936 See Eaton Vance.
1937 See RBC; ASF (Feb. 2012).
1938 See Credit Suisse (Williams).
1933 See

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attractive way for banking entities to
lend their own credit-worthiness to
expand the pool of possible lenders
willing to finance key economic activity
while maintaining a low cost of funding
for consumers, and because of the
liquidity support provided by the
sponsoring banking entity, the
sponsoring banking entity to the ABCP
conduit has full exposure to the assets
acquired by or securing the amounts
lent by the ABCP conduit and the
banking entity subjects those assets and
the obligors to the same analysis as it
would engage in if the bank were
lending directly against those assets.1939
Another commenter stated that the
provision of credit to companies to
finance receivables through ABCP
conduits is an area of traditional
banking activity that should be
distinguished from the type of high-risk,
conflict-ridden financial activities that
Congress sought to restrict under section
13 of the BHC Act.1940
To this end, commenters proposed
several means to exclude ABCP
conduits from the proposed rule’s
restrictions and requirements, including
an expansion of the loan securitization
exemption to treat two-step
securitization transactions as a single
loan securitization,1941 a separate
exclusion for ABCP conduits,1942 an
expansion of the definition of loan,1943

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1939 Id.
1940 See ICI (Feb. 2012). This commenter
emphasized the importance of the ABCP conduit
market to money market funds, noting that as of
November 2011, taxable money market funds held
$126 billion of the $348.1 billion of securities
issued by ABCP conduits outstanding, which
represented approximately 5.4% of taxable money
market funds’ total assets. Another commenter
noted that approximately $66.7 billion of
automobile loans and leases, $52.1 billion of
student loans, $22.3 billion of credit card charges,
$49.4 billion of loans to commercial borrowers and
$50.7 billion of trade receivables were financed by
the U.S. ABCP conduit market as of October 31,
2011, and that the total outstanding amount of
securities sold by ABCP conduits in the U.S. market
was $344.5 billion as of January 18, 2012. See ASF
(Feb. 2012).
1941 See AFME et al.; Allen & Overy (on behalf of
Foreign Bank Group); ASF (Feb. 2012); PNC; SIFMA
(Securitization) (Feb. 2012).
1942 See ASF (Feb. 2012); Capital Group (alleging
that ABCP does not pose the risks that the rule is
meant to combat); GE (Feb. 2012). One commenter
proposed an exemption for ABCP conduits that
included a requirement of 100% liquidity support
from a regulated, affiliated entity, and such
liquidity support may be conditional or
unconditional. See RBC.
1943 See Credit Suisse (Williams) (alleging that
ABCP conduits acquire ownership of loans
indirectly through the purchase of variable funding
notes, trust certificates, asset-backed securities,
repurchase agreements and other instruments that
may be considered securities, all of which
economically are consistent with providing funding
or extensions of credit to customers); ICI (Feb. 2012)
(requesting that the definition of loan include the
broad array of receivables that back ABCP).

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or as part of a broad exclusion for all
issuers of asset-backed securities.1944 In
order to allow ABCP conduits to qualify
as loan securitizations, commenters
suggested that the loan securitization
exclusion should permit a limited
amount of securities purchased in the
secondary market.1945 Commenters also
proposed changes to the permissible
assets such as allowing a loan
securitization to hold liquidity and
support commitments, asset-backed
securities and certain financial assets in
addition to loans that by their terms
convert to cash within a finite period of
time.1946 Another commenter argued
that the loan securitization exemption
should allow banking entities to
sponsor, control, and invest in ABCP
conduits that facilitate the securitization
of customer loans and receivables.1947
In contrast, one commenter supported
the restriction of the loan securitization
exemption to the plain meaning of what
constitutes a loan and advocated that
the Agencies not include ABCP
conduits under the exemption.1948
In addition to the effect the proposed
rule’s definition of covered fund would
have on ABCP conduits, commenters
also noted that section 13(f) of the BHC
Act 1949 would prohibit certain
transactions between a banking entity
sponsor and a covered fund
securitization.1950 Two commenters
requested a specific exemption from
§ ll.16 of the proposed rule for ABCP
conduits based on the interpretation
that the proposed rule subjects covered
funds exempted under the loan
securitization exemption or other
1944 See AFME et al.; SIFMA (Securitization)
(Feb. 2012).
1945 See ASF (Feb. 2012) (requesting that ABCP
conduits be permitted to own asset-backed
securities purchased on the secondary market only
if the aggregate principal amount of such securities
does not exceed 5% of the aggregate principal or
face amount of all assets held by the ABCP conduit
in order to diversify their asset base and avoid the
negative consequences of divestiture of such assets);
RBC (requesting that loan securitizations be
permitted to hold cash equivalents and assets, other
than loans, which, by their terms, convert to cash
within a finite period of time so long as such assets
comprise no more than 10% of their total assets
based on book value).
1946 See ASF (Feb. 2012) (arguing that the loans,
receivables, leases, or other assets purchased by the
ABCP conduit might have fit the definition of loan
in the proposed rules but for the proposal’s express
assertion that the definition of loan does not
include any asset-backed security that is issued in
connection with a loan securitization or otherwise
backed by loans). See Joint Proposal, 76 FR 68,865;
GE (Feb. 2012); RBC.
1947 See PNC.
1948 See Public Citizen.
1949 See 12 U.S.C. 1851(f); See also § ll.16 of
the proposed rule.
1950 See, e.g., Allen & Overy (on behalf of Foreign
Bank Group); Credit Suisse (Williams); Fidelity; IIB/
EBF; JPMC; PNC; RBC; SIFMA (Securitization) (Feb.
2012).

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exemptions to § ll.16.1951
Commenters argued that without
liquidity and credit support, ABCP
conduits are not viable,1952 cannot
effectively operate,1953 could not
function,1954 or would not be
marketable.1955 One commenter argued
that prohibiting a banking entity from
providing liquidity facilities to ABCP
conduits is tantamount to requiring the
banking entity to wind down the
operation of such ABCP conduits.1956
In response to the comments received
and in light of the rule of construction
contained in section 13(g)(2) of the BHC
Act, the Agencies have determined in
the final rule to exclude from the
definition of covered fund an ABCP
conduit that is a ‘‘qualifying assetbacked commercial paper conduit’’ as
defined in the final rule is excluded
from the definition of covered fund.1957
Under the final rule, a qualifying
asset-backed commercial paper conduit
is an ABCP conduit that holds only (i)
loans or other assets that would be
permissible in a loan securitization 1958
and (ii) asset-backed securities that are
supported solely by assets permissible
for a loan securitization and are
acquired by the conduit as part of an
initial issuance directly from the issuer
or directly from an underwriter engaged
in the distribution of the securities.1959
In addition, a qualifying asset-backed
commercial paper conduit must issue
only asset-backed securities, comprising
of a residual and securities with a term
of 397 days or less and in addition, a
‘‘regulated liquidity provider,’’ as
defined in the final rule, must provide
a legally binding commitment to
provide full and unconditional liquidity
coverage with respect to all the
outstanding short term asset-backed
1951 See

ICI (Feb. 2012); Fidelity.
JPMC.
1953 See ASF (Mar. 2012).
1954 See Allen & Overy (on behalf of Foreign Bank
Group).
1955 See ASF (Feb. 2012); Fidelity.
1956 See ASF (Mar. 2012).
1957 See final rule § ll.10(c)(9)(i). The rule of
construction contained in section 13(g)(2) of the
BHC Act 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 Board to sell or
securitize loans in a manner that is otherwise
permitted by law. As noted above and explained
below, a qualifying asset-backed commercial paper
conduit under the final rule is an ABCP conduit
that holds only (i) loans or other assets that would
be permissible in a loan securitization and (ii) assetbacked securities that are supported solely by assets
permissible for a loan securitization and are
acquired by the conduit as part of an initial
issuance directly from the issuer or directly from an
underwriter engaged in the distribution of the
securities.
1958 See final rule § ll.10(c)(8).
1959 See final rule § ll.10(c)(9)(i)(B).
1952 See

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securities issued by the qualifying assetbacked commercial paper conduit in the
event that funds are required to redeem
the maturing securities.1960
Under the final rule, a regulated
liquidity provider is (i) a depository
institution as defined in section 3 of the
Federal Deposit Insurance Act; 1961 (ii) a
bank holding company or a subsidiary
thereof; 1962 (iii) a savings and loan
holding company,1963 provided all or
substantially all of the holding
company’s activities are permissible for
a financial holding company,1964 or a
subsidiary thereof; (iv) a foreign bank
whose home country supervisor as
defined in section 211.21 of the Federal
Reserve Board’s Regulation K 1965 has
adopted capital standards consistent
with the Capital Accord of the Basel
Committee on Banking Supervision, as
amended, and that is subject to such
standards, or a subsidiary thereof or (v)
a sovereign nation.1966 In order for a
sovereign nation to qualify as a
regulated liquidity provider, the
liquidity provided must be
unconditionally guaranteed by the
sovereign, which would include its
departments and ministries, including
the central bank.
In this regard, under the final rule, the
exclusion from the definition of covered
fund in respect of ABCP conduits is
only available to an issuer of short-term
asset-backed securities supported by
loans and certain asset-backed securities
supported by loans that were issued or
initially sold to the ABCP conduit, and
the short term asset-backed securities
issued by the ABCP conduit are
supported by a liquidity facility that
provides 100 percent liquidity coverage
from a regulated liquidity provider. The
exclusion, therefore, is not available to
ABCP conduits that lack 100 percent
liquidity coverage. The liquidity
coverage may be provided in the form
of a lending facility, an asset purchase
agreement, a repurchase agreement, or
similar arrangement and 100 percent
liquidity coverage means that, in the
event the qualifying asset-backed
commercial paper conduit is unable for
any reason to repay maturing assetbacked securities issued by the issuing
entity, the total amount for which the
regulated liquidity provider may be
obligated is equal to 100 percent of the
amount of asset-backed securities
outstanding plus accrued and unpaid
final rule § ll.10(c)(9)(ii) and (iii).
12 U.S.C. 1813.
1962 See 12 U.S.C. 1841.
1963 See 12 U.S.C. 1467a.
1964 See 12 U.S. C. 1843(k).
1965 See 12 CFR 211.21.
1966 See final rule § ll.10(c)(9)(iii).
1960 See
1961 See

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interest. In addition, amounts due
pursuant to the required liquidity
coverage may not be subject to the credit
performance of the asset-backed
securities held by the qualifying assetbacked commercial paper conduit or
reduced by the amount of credit support
provided to the qualifying asset-backed
commercial paper conduit. Under the
final rule, liquidity coverage that only
funds an amount determined by
reference to the amount of performing
loans, receivables, or asset-backed
securities will not be permitted to
satisfy the liquidity requirement for a
qualifying asset-backed commercial
paper conduit.
As discussed above, the final rule
defines a qualifying asset-backed
commercial paper conduit as having
certain elements. First, a qualifying
asset-backed commercial paper conduit
must issue only a residual interest and
short-term asset-backed securities. This
requirement distinguishes ABCP
conduits from covered funds that issue
partnership interests and mitigates the
potential that a qualifying ABCP
conduit would be used for evasion of
the covered fund prohibitions. The
Agencies chose a maximum term of 397
days for these securities because this
time frame corresponds to the maximum
maturity of securities allowed to be
purchased by money market funds
under Rule 2a–7 of the Investment
Company Act.
Second, the asset-backed securities
issued by the ABCP conduit must be
supported only by loans and certain
asset-backed securities that meet the
requirements of the loan securitization
exclusion. By placing restrictions on the
assets permitted to be held by an
excluded loan securitization, the
potential for evasion of the covered fund
prohibitions is reduced. The exclusion
for qualifying ABCP conduits is
intended, as contemplated by the rule of
construction in section 13(g)(2) of the
BHC Act, to permit banks to continue to
engage in securitizations of loans.
Including all types of securities and
other assets within the scope of
permitted assets in a qualifying ABCP
conduit, as with loan securitizations,
would expand the exclusion beyond the
scope of the definition of loan in the
final rule that is intended to implement
the rule of construction.
Third, the asset-backed securities
supporting a qualifying asset-backed
commercial paper conduit must be
purchased as part of the initial issuance
of such asset-backed securities. Assetbacked securities purchased by an
ABCP conduit in the secondary market
will not be permitted because such a
purchase would not be part of an initial

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5695

issuance and the banking entity that
established and manages the ABCP
conduit would not have participated in
the negotiation of the terms of such
asset-backed securities. Without a more
direct connection between the banking
entity and the ABCP conduit, the
purchase of such asset-backed securities
in the secondary market would resemble
investments in securities.
Fourth, under the final rule, the ABCP
conduit exclusion will not be available
to ABCP conduits that lack 100 percent
liquidity coverage. The Agencies believe
that the 100 percent liquidity coverage
requirement distinguishes the conduits
eligible for the exemption, which
sometimes hold and securitize a
customer’s loans through an intervening
special-purpose vehicle instead of
holding the loans directly, and are
supported by a 100 percent liquidity
guarantee, from other types of conduits
with partial liquidity guarantees (such
as structured investment vehicles) that
have sometimes been operated by
banking entities for the purpose of
financing portfolios of securities
acquired or retained as part of their
activities in the securities markets.
The Agencies recognize that ABCP
conduits that do not satisfy the elements
of the ABCP conduit exclusion may be
covered funds and therefore would be
subject to section 13(f) of the BHC
Act.1967 As a result of section 13(f) of
the BHC Act, which prohibits certain
transactions between banking entities
and a covered fund securitization that
the banking entity sponsors or for which
it provides investment management
services, the banking entity would be
prohibited from providing liquidity
support for the ABCP conduit.
Similarly, while some commenters
requested that the loan securitization
exclusion permit the holding of a
limited amount of securities purchased
in the secondary market, the final rule
does not provide for this in the context
of ABCP conduits. The Agencies believe
that the limitations on the types of
securities that a qualifying asset-backed
commercial paper conduit may invest in
are needed to avoid the possibility that
a banking entity could use a qualifying
asset-backed commercial paper conduit
to securitize non-loan assets or to
engage in proprietary trading of such
securities prohibited under the final
rule. Thus this limitation reduces the
potential for evasion of the covered fund
provisions of section 13 of the BHC Act.
In developing the exclusion from the
definition of covered fund for qualifying
asset-backed commercial paper conduits
1967 See 12 U.S.C. 1851(f); See also § ll.16 of
the proposed rule.

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in the final rule, the Agencies
considered the factors set forth in
sections 13(g)(2) and 13(h)(2) of the BHC
Act. The final rule includes conditions
designed to ensure that an ABCP
conduit established and managed by a
banking entity serves as a means of
facilitating that banking entity’s loan
securitization activity rather than
financing that banking entity’s capital
market investments. The final rule
distinguishes between qualifying assetbacked commercial paper conduits and
other ABCP conduits in order to adhere
to the tenets of section 13 of the BHC
Act while accommodating the market
practices discussed by the commenters
by facilitating reasonable access to
credit by consumers and businesses
through the issuance of ABCP backed by
consumer and business receivables. As
discussed above, the Agencies
understand that some existing ABCP
conduits may need to be restructured to
conform to the requirements of the
ABCP conduit exclusion.
To the extent that the definition of
covered fund, the loan securitization
exclusion and the ABCP conduit
exclusion do not eliminate the
applicability of the final rule provisions
to certain covered funds, there may be
adverse effects on the provision of
capital to customers,1968 to
securitization markets,1969 and to the
creation of new securitization products
to meet investor demands that Congress
may not have contemplated. 1970
However, financial institutions that are
not banking entities and therefore are
not subject to the restrictions on
ownership can continue to engage in
activities relating to securitization,
including those securitizations that fall
under the definition of covered fund.
Furthermore, new securitizations may
be structured so as to qualify for the
loan securitization exclusion or other
exclusions under the final rule. For
these reasons, the impact on
securitizations that are not excluded
under the final rule may be mitigated.
The Agencies believe that the final
rule excludes from the definition of
covered fund typical structures used in
the most common loan securitizations
representing a significant majority of the
current securitization market, such as
residential mortgages, commercial
mortgages, student loans, credit card
receivables, auto loans, auto leases and
1968 See,

e.g., ASF (Feb. 2012).
Credit Suisse (Williams) (employing
ABCP conduits as an example); ASF (Feb. 2012)
(describing the constriction of the market for assetbacked securities if banking entities are restricted
from owning debt classes of new asset backed
securities).
1970 See RBC; ASF (Feb. 2012).
1969 See

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equipment leases. Additionally, the
Agencies believe that esoteric asset
classes supported by loans may also be
able to rely on the loan securitization
exclusion, such as time share loans,
container leases and servicer advances.
10. Covered Bonds
Several commenters called for
covered bond structures to be excluded
from the definition of covered fund.1971
They indicated that the proposed rule
may interfere with and restrict non-U.S.
banks’ ability to establish or issue
covered bonds. As described by several
commenters, covered bonds are full
recourse debt instruments typically
issued by a non-U.S. entity that are fully
secured or ‘‘covered’’ by a pool of highquality collateral (e.g., residential or
commercial mortgage loans or public
sector loans).1972 Certain of these
covered bond structures utilize a special
purpose vehicle (‘‘SPV’’) that holds a
collateral pool. As such, under the
proposed rule, an SPV could be a
covered fund that relies on the
exclusion in section 3(c)(1) or 3(c)(7) of
the Investment Company Act.
According to one commenter, the
majority of covered bonds are issued
under specific legislative frameworks
which define permitted characteristics
for covered bond issuances, including
the kinds and quality of collateral that
may be included in cover pools, the
specific legal framework for issuance of
covered bonds, and the procedures for
resolution in the event that the issuer
becomes insolvent.1973 Some
commenters expressed concern about
the possibility that certain covered bond
structures could fall within the
definition of covered fund, as proposed.
In particular, commenters expressed
concern about covered bond structures
in the United Kingdom that also would
be relevant in principle with respect to
covered bond structures used in other
European Union (‘‘EU’’) jurisdictions
(e.g., the Netherlands and Italy) and
certain non-EU jurisdictions (e.g.,
Canada, Australia, and New
Zealand).1974 Another commenter
1971 See

Allen & Overy (on behalf of Foreign Bank
Group); UKRCBC; FSA (Apr. 2012); ASF (Feb.
2012).
1972 See AFME et al.; Allen & Overy (on behalf of
Foreign Bank Group); ASF (Feb. 2012); FSA (Apr.
2012); UKRCBC.
1973 See UKRCBC. For example, a commenter
indicated that in the European Union, Article 52(4)
of the EU UCITS Directive sets out the defining
characteristics of covered bonds, and this directive
is implemented by specific legislative frameworks.
1974 See UKRCBC; FSA (Apr. 2012). One
commenter argued that there are two main models
used for covered bond structures in Europe—the
integrated model (where the collateral pool
continues to be owned directly by the bank issuer
and is segregated by special legislation) and the

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indicated that covered bonds issued by
certain French entities that hold a
revolving pool of loans may be impacted
by the proposed rule.1975
Certain commenters argued that in
order to achieve the intended economic
effect of providing recourse to both the
bank issuing covered bonds and to the
collateral pool, the issuing bank may
enter into a number of agreements with
the SPV that holds the collateral. This
includes transactions where the bank
takes on credit exposure to the SPV
(e.g., through derivatives and securities
lending, provision of loans, and/or
investments in securities of the
SPV).1976 The issuing bank typically
also provides asset and liability
management services to the SPV and
may also repurchase certain assets from
the SPV.1977 Commenters also
contended that under certain legislative
frameworks, the SPV issues the covered
bonds and holds the collateral, and a
sponsoring bank lends money to the
SPV.1978 According to commenters, the
broad definition of covered fund in the
proposed rule could capture an SPV that
holds the collateral, so transactions
between an SPV and the issuing bank or
sponsor bank may be prohibited.1979
These commenters argued that
including covered bond structures in
the definition of covered fund is
inconsistent with the legislative intent
of the rule, would have a negative and
disproportionate effect on foreign banks,
markets and economies and would give
rise to potential conflicts with such
foreign legislative frameworks.1980
According to certain commenters,
SPVs whose sole function is as part of
an offering of covered bonds should be
excluded from the definition of covered
fund in the final rule. These
commenters provided that the proposed
rule was not clear on whether these
SPVs, which effectively function as
collateral devices for the covered bond,
would be excluded from the definition
of covered fund.1981 One commenter
indicated that the key concern was
primarily due to the wide definition of
structured model (where the pool is transferred to
a special purpose vehicle and is segregated by
operation of legal principles). See UKRCBC.
1975 See Allen & Overy (on behalf of Foreign Bank
Group).
1976 See FSA (Apr. 2012).
1977 See UKRCBC.
1978 See Allen & Overy (on behalf of Foreign Bank
Group).
1979 See Allen & Overy (on behalf of Foreign Bank
Group); UKRCBC; FSA (Apr. 2012).
1980 See Allen & Overy (on behalf of Foreign Bank
Group); UKRCBC; FSA (Apr. 2012); ASF (Feb.
2012); AFME et al. For a discussion of possible
economic effects, See FSA (Feb. 2012); UKRCBC;
Allen & Overy (on behalf of Foreign Bank Group).
1981 See ASF (Feb. 2012); AFME et al.; UKRCBC.

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covered fund in the proposed rule.1982
Other commenters indicated that the
final rule should not apply to covered
bond transactions because they are not
traditionally recognized or regulated as
asset-backed securities transactions, and
they are not the type of transactions that
the rule was intended to address.1983
As a result of comments received on
covered bond vehicles, the final rule
specifically excludes from the definition
of covered fund certain entities that own
or hold a dynamic or fixed pool of assets
that covers the payment obligations of
covered bonds. In order to qualify for
the exclusion, the assets or holdings in
the cover pool must satisfy the
conditions in the loan securitization
exclusion, except for the requirement
that the securities they issue are assetbacked securities (the ‘‘permitted cover
pool’’).1984 The Agencies believe this
approach is consistent with the rule of
construction contained in section
13(g)(2) of the BHC Act. The rule of
construction in section 13(g)(2) of the
BHC Act specifically refers to the ‘‘sale
and securitization of loans’’ and the
Agencies would not want a banking
entity to use an excluded cover pool to
engage in proprietary trading of such
securities prohibited under the final
rule. The Agencies believe this
restriction reduces the potential for
evasion of the final rule.
By placing restrictions on the assets
permitted to be held by a cover pool, the
potential for evasion of the covered fund
prohibitions is reduced. The exclusion
for cover pools is intended, as
contemplated by the rule of
construction in section 13(g)(2) of the
BHC Act, to permit banking entities to
continue to engage in lending activities
and the financing those lending
activities. Including all types of
securities and other assets within the
scope of permitted assets in a cover
pools would expand the exclusion
beyond the scope of the definition of
loan in the final rule that is intended to
implement the rule of construction.
Additionally, because the exclusion for
cover pools is only available to foreign
banking organizations, allowing such
cover pools to hold securities would
provide unequal treatment of covered
bonds as compared to a loan
securitization sponsored by a U.S.
banking entity.
Under the definition of covered bond
in the final rule, the debt obligation may
be issued directly by a foreign banking
organization or by an entity that owns
a permitted cover pool. In both cases,
1982 See

UKRCBC.
e.g., AFME et al.
1984 See final rule § ll.10(c)(10).
1983 See,

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the payment obligations of the debt
obligation must be fully and
unconditionally guaranteed. If the debt
obligation is issued by a foreign banking
organization, such debt obligation will
be a ‘‘covered bond’’ under the final rule
if the payment obligations are fully and
unconditionally guaranteed by an entity
that owns a permitted cover pool.1985 If
the debt obligation is issued by an entity
that owns a permitted cover pool, such
debt obligation will be a ‘‘covered
bond’’ under the final rule if (i) the
payment obligations are fully and
unconditionally guaranteed by a foreign
banking organization and (ii) the issuer
of the debt obligation is a wholly-owned
subsidiary (as defined) by such foreign
banking organization.1986 Thus, under
the final rule, a covered bond structure
in which an entity holds the cover pool
and issues securities that are fully and
unconditionally guaranteed by a foreign
banking organization may also be able to
rely on the loan securitization exclusion
if it meets all of the requirements of that
exclusion.
The Agencies recognize that many
covered bond programs may involve
foreign covered bond programs (and
their related cover pools) that are
permitted by their respective laws to
own residential mortgage-backed
securities and other non-loan assets. As
a result, the exclusion for covered bonds
in the final rule may not be available to
many of the existing cover pools that
support outstanding covered bonds. The
Agencies recognize that this approach
may not exclude all foreign covered
bond programs. Although certain
commenters argued that including
covered bond structures in the
definition of covered fund is
inconsistent with the legislative intent
of the rule,1987 the Agencies believe that
the exclusion for qualifying covered
bonds, including the limitations on the
types of securities that a loan
securitization can hold, is consistent
with the rule of construction contained
in section 13(g)(2) of the BHC Act and
appropriate for the reasons discussed
directly above and under ‘‘Definition of
Loan.’’ The Agencies also recognize that
commenters argued that including
covered bonds as covered funds could
have a negative and disproportionate
effect on foreign banks, markets and
final rule § ll.10(c)(10)(ii)(A).
final rule § ll.10(c)(10)(ii)(B). As
discussed above in the section describing the
wholly-owned subsidiary exclusion from the
definition of covered fund, the Agencies are
permitting 0.5 of a wholly-owned subsidiary to be
owned by an unaffiliated party for the purpose of
establishing corporate separateness or addressing
bankruptcy, insolvency, or similar concerns.
1987 See supra note 1980 and accompanying text.
1985 See
1986 See

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5697

economies and would give rise to
potential conflicts with such foreign
legislative frameworks.1988 The
Agencies note that, although they do not
know the composition of the cover
pools, the Agencies believe that foreign
banking organizations should be able to
look at the composition of their cover
pools to evaluate how to meet the
requirements of the exclusion—and thus
to avoid or mitigate the adverse effects
commenters asserted would occur—as
they determine appropriate.
11. Certain Permissible Public Welfare
and Similar Funds
Section 13(d)(1)(E) of the BHC Act
permits a banking entity to make and
retain: (i) investments in one or more
small business investment companies
(‘‘SBICs’’), as defined in section 103(3)
of the Small Business Investment Act of
1958 (SBA) (15 U.S.C. 662) 1989; (ii)
investments that are designed primarily
to promote the public welfare, of the
type permitted under paragraph (11) of
section 5136 of the Revised Statutes of
the United States (12 U.S.C. 24); and
(iii) investments that are qualified
rehabilitation expenditures with respect
to a qualified rehabilitated building or
certified historic structure, as such
terms are defined in section 47 of the
Internal Revenue Code of 1986 or a
similar State historic tax credit
program.1990 The proposed rule
permitted banking entities to invest in
and act as sponsor 1991 to these entities,
but did not explicitly exclude them
from the definition of covered fund.1992
Commenters generally supported the
proposed exemption for investments in
and sponsorship of funds designed to
promote the public welfare, SBICs, and
other tax credit funds given the valuable
funding and assistance these
investments provide in facilitating
community and economic priorities and
1988 Id.
1989 The Agencies note that section 13(d)(1)(E) of
the BHC Act incorrectly provides that the term
‘‘small business investment company’’ is defined in
section 102 of the SBA, while the definition is in
fact contained in section 103(3) of the SBA as
codified at 15 U.S.C. 662. The statute includes the
correct citation to 15 U.S.C. 662. The Agencies are
correcting this technical error in the final rule by
updating the reference to section 102 to section
103(3).
1990 See 12 U.S.C. 1851(d)(1)(E).
1991 The proposal implemented a proposed
determination by the Agencies under 13(d)(1)(J)
‘‘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.’’ Joint Proposal, 76 FR 68,908 n.292.
1992 See proposed rule § ll.13(a).

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the role these investments play in the
ability of banking entities, especially
community and regional banks, to
achieve their financial and Community
Reinvestment Act (‘‘CRA’’) goals.
However, commenters raised some
issues with respect to the proposed
exemption and sought clarification on
its application to specific
investments.1993 Of primary concern to
commenters was the impact of the
prohibition in section 13(f) of the BHC
Act on the ability of a banking entity
sponsoring a tax credit fund or its
affiliate to guarantee certain obligations
of the fund in order to provide
assurance to investors that the
investment has been properly structured
to enable the investor to receive the tax
benefits on which the investment are
sold.1994 Some commenters noted that
failure to address this issue in the final
rule would damage a large segment of
this market and therefore urged the
Agencies to exempt these investments
from the application of section 13(f) or,
in the alternative, from the definition of
covered fund.1995
In addition, commenters requested
clarification that specific types of public
welfare, SBIC, and other tax credit
investments would be eligible for the
exemption, including Low Income
Housing Tax Credits, Renewable Energy
Tax Credits, New Markets Tax Credits,
and Rural Business Investment
Companies.1996 One commenter
requested that applicants for an SBIC
license that have received permission
from the Small Business Administration
to file a formal SBIC license application
be viewed the same as an SBIC.1997
Other commenters sought coverage of
investments in non-SBIC funds that
provide capital to small and middlemarket companies,1998 investments in
any state administered tax credit
program,1999 and investments outside
the United States that are of the type
permitted under paragraph (11) of
section 5136 of the Revised Statutes of
the United States (12 U.S.C. 24).2000
1993 See Novogradac (LIHTC); Novogradac
(NMTC); Novogradac (RETC); PNC; Raymond
James; SIFMA et al. (Covered Funds) (Feb. 2012);
SBIA.
1994 See AHIC; Novogradac (LIHTC); Novogradac
(NMTC); Novogradac (RETC); SBIA; Union Bank;
U.S. Bancorp.
1995 See ABA (Keating); Lone Star; Novogradac
(LIHTC); Novogradac (NMTC); Novogradac (RETC);
SVB; U.S. Bancorp.
1996 See NCHSA; SBIA; Novogradac (LIHTC);
Novogradac (NMTC); Novogradac (RETC).
1997 See SBIA; See also SEC Rule 3c-2.
1998 See ABA (Keating); PNC.
1999 See USAA.
2000 See JPMC; SIFMA et al. (Covered Funds)
(Feb. 2012).

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In light of the comments received, the
final rule excludes from the definition
of covered fund an issuer that is an SBIC
(or that has received from the Small
Business Administration notice to
proceed to qualify for a license as an
SBIC, which notice or license has not
been revoked) or the business of which
is to make investments that are: (i)
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 (ii) qualified
rehabilitation expenditures with respect
to a qualified rehabilitated building or
certified historic structure, as such
terms are defined in section 47 of the
Internal Revenue Code of 1986 or a
similar State historic tax credit
program.2001
By excluding SBICs and other public
interest funds from the definition of
covered fund—rather than provide a
permitted activity exemption as
proposed—the Agencies addressed
commenters’ concerns regarding the
burdens imposed by section 13(f). The
Agencies believe that excluding these
investments from the definition of
covered fund addresses the issues many
commenters raised with respect to the
application of section 13(f) of the BHC
Act, and gives effect to the statutory
exemption of these investments in a
way that appropriately facilitates
national community and economic
development objectives. The Agencies
believe that permitting a banking entity
to sponsor and invest in these types of
public interest entities will result in
banking entities being able to provide
valuable expertise and services to these
entities and to provide funding and
assistance to small businesses and lowand moderate-income communities. The
Agencies believe that providing the
exclusion will also allow banking
entities to continue to provide capital to
community-improving projects and in
some instances promote capital
formation.
2001 See final rule § ll.10(c)(11). This provision
would cover any issuer that engages in the business
of making tax credit investments (e.g., Low Income
Housing Tax Credit, New Markets Tax Credit,
Renewable Energy Tax Credit, Rural Business
Investment Company) that are either designed to
promote the public welfare of the type permitted
under 12 U.S.C. 24(Eleventh) or are qualified
rehabilitation expenditures with respect to a
qualified rehabilitated building or certified historic
structure, as provided for under § ll.10(c)(11).

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12. Registered Investment Companies
and Excluded Entities
The proposed rule did not specifically
include registered investment
companies (including mutual funds) or
business development companies
within the definition of covered
fund.2002 As explained above, the
statute references funds that rely on
section 3(c)(1) or 3(c)(7) of the
Investment Company Act. Registered
investment companies and business
development companies do not rely on
either section 3(c)(1) or 3(c)(7) of the
Investment Company Act and are
instead registered or regulated in
accordance with the Investment
Company Act.
Many commenters argued that
registered investment companies and
business development companies would
be treated as covered funds under the
proposed definition if commodity pools
are treated as covered funds.2003 A few
commenters argued that the final rule
should specifically provide that all SECregistered funds are excluded from the
definition of covered fund (and the
definition of banking entity) to avoid
any uncertainty about whether section
13 applies to these types of funds.2004
Commenters also requested that the
final rule exclude from the definition of
covered fund entities formed to
establish registered investment
companies during the seeding period.
These commenters contended that,
during the early stages of forming and
seeding a registered investment
company, an entity relying on section
3(c)(1) or (3)(c)(7) may be created to
facilitate the development of a track
record for the registered investment
company so that it may be marketed to
unaffiliated investors.2005
Section 13’s definition of private
equity fund and hedge fund by reference
to section 3(c)(1) and 3(c)(7) of the
Investment Company Act appears to
reflect Congress’ concerns about
banking entities’ exposure to and
relationships with investment funds
that explicitly are excluded from SEC
proposed rule § ll.10(b)(1).
e.g., Arnold & Porter; BoA; Goldman
(Covered Funds); ICI (Feb. 2012); Putnam; TCW;
Vanguard. According to these commenters, a
registered investment company may use security or
commodity futures, swaps, or other commodity
interests in various ways to manage its investment
portfolio and be swept into the broad definition of
‘‘commodity pool’’ contained in the Commodity
Exchange Act.
2004 See Arnold & Porter; Goldman (Covered
Funds); See also SIFMA et al. (Covered Funds)
(Feb. 2012); SIFMA et al. (Mar. 2012); ABA
(Keating); BoA; ICI (Feb. 2012); JPMC (requesting
clarification that registered investment companies
are not banking entities); TCW.
2005 See ICI (Feb. 2012); TCW.
2002 See

2003 See,

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regulation as investment companies.
The Agencies do not believe it would be
appropriate to treat as a covered fund
registered investment companies and
business development companies,
which are regulated by the SEC as
investment companies. The Agencies
believe that the proposed rule’s
inclusion of commodity pools would
have resulted in some registered
investment companies and business
development companies being covered
funds, a result the Agencies did not
intend. The Agencies, in addition to
narrowing the commodity pools that
will be included as covered funds as
discussed above, have also modified the
final rule to exclude SEC-registered
investment companies and business
development companies from the
definition of covered fund.2006
The Agencies also recognize that an
entity that becomes a registered
investment company or business
development company might, during its
seeding period, rely on section 3(c)(1) or
3(c)(7). The Agencies have determined
to exclude these seeding vehicles from
the covered fund definition for the same
reasons the Agencies determined to
exclude entities that are operating as
registered investment companies or
business development companies as
discussed above.
In order to prevent banking entities
from purporting to use this exclusion for
vehicles that the banking entity does not
reasonably expect to become a
registered investment company or
business development company, the
exclusion is available only with respect
to a vehicle that the banking entity
operates (i) pursuant to a written plan,
developed in accordance with the
banking entity’s compliance program,
that reflects the banking entity’s
determination that the vehicle will
become a registered investment
company or business development
company within the time period
provided by the final rule for seeding a
covered fund; (ii) consistently with the
leverage requirements under the
Investment Company Act of 1940 that
are applicable to registered investment
companies and SEC-regulated business
development companies.2007 A banking
entity that seeds a covered fund for any
purpose other than to register it as an
investment company or establish a
business development company must
comply with the requirements of section
13(d)(1)(G) of the BHC Act and § ll.11
of the final rule as described above. The
Agencies will monitor this seeding
final rule § ll.10(c)(12).
final rule §§ ll.10(c)(12)(i);
10(c)(12)(iii); ll.20(e).
2006 See
2007 See

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activity for attempts to use this
exclusion to evade the requirements
governing the ownership of and
relationships with covered funds under
section 13 of the BHC Act and the final
rule.2008
13. Other Excluded Entities
Section 13(h)(2) permits the Agencies
to include similar funds within the
definition of covered fund, but the
proposal did not contain a process for
excluding from the definition of covered
fund other entities that do not engage in
the investment activities contemplated
by section 13. Many commenters argued
that the breadth of entities that may be
required to rely on the exclusions in
section 3(c)(1) or 3(c)(7) of the
Investment Company Act could result in
additional unidentified entities
becoming subject to the definition of
covered fund.2009 In order to ensure that
the final rule effectively addresses the
full scope of entities that may
inadvertently be included within the
definition of covered fund, a number of
commenters urged that the final rule
include a mechanism to exclude other
entities from the term ‘‘covered fund’’
by rule or order if the Agencies
determine such an exclusion is
appropriate.2010
As evidenced by the extensive
comments discussed above identifying
the many types of corporate structures
and other vehicles (not just investment
funds) that rely on sections 3(c)(1) and
3(c)(7) but do not engage in investment
activities of the type contemplated by
section 13, the scope of an overly broad
definition of covered fund may impose
significant burdens on banking entities
that are in conflict with the purposes of
section 13 of the BHC Act. In response
to commenters’ concerns and to address
the potential that the final rule’s
definition of covered fund might
encompass entities that do not engage in
the investment activities contemplated
by section 13, the final rule includes a
provision that provides that the
Agencies may jointly determine to
exclude an issuer from the definition of
covered fund if the exclusion is
2008 The Agencies also note that banking entities
with more than $10 billion in total consolidated
assets as reported on December 31 of the previous
two calendar years must maintain records that
include, among other things, documentation of the
exclusions or exemptions other than sections 3(c)(1)
and 3(c)(7) of the Investment Company Act of 1940
relied on by each fund sponsored by the banking
entity in determining that such fund is not a
covered fund. See final rule § ll.20(e).
2009 See also FSOC study.
2010 See SIFMA et al. (Covered Funds) (Feb.
2012); Credit Suisse (Williams); GE (Feb. 2012).

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consistent with the purposes of section
13 of the BHC Act.2011
As noted above, the statute permits
the Agencies to act by rule to modify the
definition of covered fund. After issuing
the proposed rule and receiving
comment on it, the final rule provides
that the Agencies may act jointly to
provide an exclusion.2012 The Agencies
are working to establish a process
within which to evaluate requests for
exclusions and expect to provide
additional guidance on this matter as
the Agencies gain experience with the
final rule.2013 As a result, the definition
of covered fund would remain unified
and consistent. The final rule also
provides that a determination by the
Agencies to exclude an entity from the
definition of covered fund will be
promptly made public in order to
ensure that both banking entities and
the public may understand what entities
are and are not included within the
definition of covered fund.
d. Entities Not Specifically Excluded
From the Definition of Covered Fund
In addition to the entities identified
above which are excluded from the
definition of covered fund under the
final rule, commenters argued that a
number of other entities such as
financial market utilities, venture
capital funds, credit funds, cash
management vehicles or cash collateral
pools may also be an investment
company but for the exclusion
contained in section 3(c)(1) or 3(c)(7) of
the Investment Company Act and
requested that these entities expressly
be excluded from the final rule’s
definition of covered fund. The
Agencies have considered carefully the
comments received on each of these
entities but, for the reasons explained
below, have declined to provide a
separate exclusion for them from the
definition of covered fund at this time.
As discussed below, some of these
entities are not covered funds for
various reasons or may, with relatively
little cost, conform to the terms of an
exclusion or exemption from the
definition of covered fund. As noted
above, to the extent that one of these
entities qualifies for one or more of the
final rule § ll.10(c)(14).
discussed above, the Agencies also may
determine jointly that an entity excluded from the
definition of covered fund under § ll.10(c) is in
fact a covered fund, and consequently banking
entities’ investments in and transactions with such
fund would be subject to limitations and/or
divestiture. The Agencies intend to utilize this
authority to monitor for and address, as
appropriate, instances of evasion. See, e.g., 12
U.S.C. 1851(e)(2).
2013 A joint determination specified under
§ ll.10(c)(14) may take a variety of forms.
2011 See
2012 As

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other exclusions from the definition of
covered fund, that entity would not be
a covered fund under the final rule. Any
entity that would be a covered fund
would still be able to rely on the
conformance period in order to come
into compliance with the requirements
of section 13 and the final rule.
A number of commenters requested
that certain existing covered funds be
either excluded from the definition of
covered fund or grandfathered and not
be subject to the limitations of section
13 of the BHC Act.2014 The Agencies
note, however, that section 13
specifically addresses a banking entity’s
preexisting investments in covered
funds by providing a conformance
period, which banking entities may use
to bring their activities and investments
into compliance with the requirements
of section 13 and the final rule. To the
extent that section 13 could be
interpreted to permit the Agencies to
take a different approach, despite
addressing banking entities’ preexisting
covered fund investments directly, the
Agencies believe it would be
inconsistent with the purposes of
section 13 to permit banking entities to
continue to hold ownership interests in
covered funds beyond the conformance
period provided by the statute. Section
13’s prohibition on banking entities’
investments in and relationships with
covered funds and the requirement that
banking entities divest or conform these
investments appear to reflect the
statutory purpose that banking entities
be limited in their ability to continue to
be exposed to these investments outside
of the statutorily-provided conformance
period. The Agencies believe that
permitting banking entities to hold
ownership interests indefinitely beyond
the conformance period provided by the
statute appears inconsistent with this
purpose.
1. Financial Market Utilities
Several commenters contended that
financial market utilities (‘‘FMUs’’)
could be covered funds because they
might rely on section 3(c)(1) or 3(c)(7)
for an exclusion from the definition of
investment company under the
Investment Company Act and may not
qualify for an alternative exemption.2015
These commenters argued that banking
entities have long been investors in
domestic and foreign FMUs, such as
securities clearing agencies, derivatives
clearing organizations, securities
exchanges, derivatives boards of trade
2014 See, e.g., PNC; SVB; SIFMA (Securitization)
(Feb. 2012); AFME et al.; BoA. See also, e.g., Credit
Suisse (Williams).
2015 See SIFMA et al. (Covered Funds) (Feb.
2012); Credit Suisse (Williams).

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and alternative trading systems. These
commenters expressed concern that,
unless FMUs are expressly excluded
from the definition of covered fund,
banking entities could be prohibited
from entering into any new covered
transactions with related FMUs and
would be required to divest their
investments in FMUs, thereby
disrupting the operations of those FMUs
and financial markets generally.
After carefully considering
commenters’ concerns, the Agencies
believe that FMUs are not investment
vehicles of the type section 13 of the
BHC Act was designed to address, but
rather entities that generally engage in
other activities, including acting as
central counterparties that reduce
counterparty risk in clearing and
settlement activities. Congress
recognized, in the Payment, Clearing,
and Settlement Supervision Act of 2010
(title VIII of the Dodd–Frank Act),2016
that properly designed, operated, and
supervised financial market utilities as
defined in that Act mitigate systemic
risk and promote financial stability.2017
However, the Agencies have not
provided an exclusion from the covered
fund definition for FMUs because these
kinds of entities do not generally appear
to rely on section 3(c)(1) or 3(c)(7) of the
Investment Company Act, and therefore
do not appear to need an exclusion. For
example, section 3(b)(1) of the
Investment Company Act excludes from
the definition of investment company—
and thus from the definition of a
covered fund—entities primarily
engaged in a business other than that of
an investment company.2018 If an FMU
is primarily engaged in a business other
than those that would make it an
investment company, for example, if the
FMU is primarily engaged in
transferring, clearing, or settling
payments, securities, or other financial
transactions among or between financial
institutions,2019 the FMU could rely on
the exclusion to the definition of
investment company provided by
section 3(b)(1) and would not need to
rely on section 3(c)(1) or 3(c)(7) and, as
such, would not be a covered fund.
2. Cash Collateral Pools
Some commenters expressed concern
that cash collateral pools, which are part
2016 12

USC 5461 et seq.
id.
2018 Section 3(b)(1) of the Investment Company
Act excludes from the definition of investment
company ‘‘[a]ny issuer primarily engaged, directly
or through a wholly-owned subsidiary or
subsidiaries, in a business or businesses other than
that of investing, reinvesting, owning, holding, or
trading in securities.’’
2019 See 12 U.S.C. 1562(6); 12 CFR Part 234.
2017 See

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of securities lending programs, could be
included in the definition of covered
fund.2020 According to these
commenters, banking entities, including
bank custodians acting as lending agent
for customer’s securities lending
activities, typically manage these pools
as fiduciaries for their customers.2021
These commenters argued that collateral
pools are part of a banks’ traditional
custody and advisory services and have
been an integral part of any lending
agent’s role (whether custodial or noncustodial) for years.2022
Cash collateral pools are typically
formed when, as part of a securities
lending program, a customer of a bank
authorizes the bank to take securities
from the customer’s account and lend
them in the open market. The agent
bank then lends those securities and
receives collateral in return from the
borrower; a securities lending customer
of a bank typically elects to have cash
collateral provided by a borrower
pooled by the agent bank with other
cash collateral provided to other
clients.2023 These investment pools may
exist in the form of trusts, partnerships,
limited liability companies, or separate
accounts maintained by more than one
party and these structures may rely on
sections 3(c)(1) and 3(c)(7) of the
Investment Company Act to avoid being
an investment company.2024 While their
ownership interest may be nominal in
amount, the agent banks may hold a
general partnership, limited liability
company membership or trustee interest
in the cash collateral pool.2025 As part
of these arrangements, custodian banks
routinely offer borrower default
indemnifications to the securities lender
in a securities lending transactions.
Commenters raised concerns that
these indemnification agreements could
be considered a covered transaction
prohibited by section 13(f) of the BHC
Act.2026 Since some cash collateral
2020 See RMA; State Street (Feb. 2012); See also
BNY Mellon et al.
2021 See RMA; State Street (Feb. 2012).
2022 See RMA; BNY Mellon et al. (citing
Comptroller’s Handbook: Custody Services (Jan.
2002)).
2023 See RMA.
2024 See RMA.
2025 See RMA.
2026 See State Street; RMA. Commenters also
argued that as part of offering pooled cash collateral
management, agent banks have traditionally
provided short-term extensions of credit and
contractual income and settlement services to
lending clients and cash collateral pools to facilitate
trade settlement and related cash collateral
investment activities. See RMA. One commenter
further argued that if banks are required to
‘‘outsource’’ cash collateral pools and/or the related
short-term credit services provided to the pools,
‘‘participation in securities lending programs would
only be cost effective for the largest lending clients’’

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pools are established outside of the
United States, commenters requested
that the final rule permit banking
entities to have interests in and
relationships with both U.S. and nonU.S. cash collateral pools.2027 These
commenters suggested that cash
collateral pools be excluded from the
definition of covered fund or, in the
alternative, that the Agencies make clear
that cash collateral pools managed by
agent banks qualify for the exemption in
§ ll.11 of the proposed rule for
organizing and offering a covered fund
and that the prime brokerage exemption
from the restrictions of section 13(f)
would permit the indemnification and
income or settlement services agent
banks typically provide to the pools.2028
These commenters also suggested that
the Agencies use their authority under
section 13(d)(1)(J) to provide an
exemption for banking entities to
continue to have interests in and
provide services to these types of
pools.2029
After carefully considering comments
received, the final rule does not provide
a specific exclusion from the definition
of covered fund for cash collateral
pools. The Agencies have determined to
provide specific exclusions for entities
that do not function as investment
funds, consistent with the intent of
section 13’s restrictions, or in response
to other unique considerations (e.g., to
provide consistent treatment for certain
foreign and domestic pension plans).
These considerations do not support a
separate exclusion for cash collateral
pools.
The Agencies note, however, that
some cash collateral pools may not be
covered funds because they rely on an
exclusion from the definition of
investment company other than those
contained in section 3(c)(1) or 3(c)(7) of
the Investment Company Act.2030
Banking entities may determine to
register cash collateral pools with the
SEC as investment companies or to
and, as a result, ‘‘many small and intermediate
securities lending clients would be denied the
incremental revenue securities lending can
provide’’; ‘‘securities lending programs could lose
significant diversification in lending clients,
lendable assets, borrowers and agent banks’’; and,
as a result of lost revenues, ‘‘the actual costs of []
custodial or other services provided to clients that
no longer participate in lending would increase.’’
Id.
2027 See RMA.
2028 See RMA.
2029 See RMA.
2030 For instance, the Agencies understand that a
banking entity may set up a cash collateral pool in
reliance on the exclusion contained in section
3(c)(3) of the Investment Company Act, or may be
able to structure these pools as SEC-registered
money market funds operated in accordance with
rule 2a–7 under the Investment Company Act.

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operate them as separate accounts to
exclude the pools from the covered fund
definition or, if the pools remain
covered funds, to organize and offer
them in compliance with the
requirements of § ll.11 of the final
rule.
In response to comments received on
the proposal, the Agencies note that the
provision of a borrower default
indemnification by a banking entity to
a lending client in connection with
securities lending transactions involving
a covered fund is not a covered
transaction subject to 13(f) or a
guarantee of the performance or
obligations of a covered fund prohibited
under § ll.11 of the final rule. Those
restrictions apply to transactions with
the covered fund or guarantees of the
covered fund’s performance. Borrower
default indemnifications are provided to
the bank’s securities lending customer,
not to the cash collateral pool.
3. Pass-through REITS
Some banking entities may issue real
estate investment trust (‘‘REIT’’)
preferred securities to the public
directly from a subsidiary that qualifies
for the exclusion in section 3(c)(5) or
section 3(c)(6) of the Investment
Company Act. These entities would not
be considered a ‘‘covered fund’’ because
they may rely on an exclusion from the
definition of an investment company
other than the exclusion in section
3(c)(1) or 3(c)(7) of the Investment
Company Act.2031 However, in order to
meet the demands of customers and
avoid undesirable tax consequences,
some banking entities structure their
REIT offerings by using a passive, passthrough statutory trust between the
banking entity and the REIT to issue
REIT preferred securities to the
public.2032 Because the pass-through
trust holds the preferred securities of
the underlying REIT (which would itself
not be a covered fund), as well as
provides administrative and ministerial
functions for the REIT (including
passing through dividends from the
underlying REIT), the pass-through trust
may not itself rely on the exclusion
contained in section 3(c)(5) or 3(c)(6)
and, thus, typically relies on section
3(c)(1) or 3(c)(7).2033
Some commenters urged the Agencies
to provide an exclusion for pass-through
REITS from the definition of covered
fund.2034 These commenters argued that
because the pass-through trust exists as
a corporate convenience as part of
2031 See

PNC.
PNC.
2033 See ABA (Keating); PNC.
2034 See ABA (Keating); PNC.
2032 See

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issuing REIT preferred securities to the
banking entity and its customers, it is
not the type of entity that the covered
fund prohibition in section 13 of the
BHC Act was intended to address. These
commenters also argued that passthrough REITs enable banking entities to
offer preferable tax treatment to holders
of the REIT preferred securities and that
if pass-through REITs were included as
covered funds, because of the
limitations on covered transactions
contained in section 13(f), the minority
interests in the preferred securities
issued by the REIT would no longer be
able to be included in a banking entity’s
tier 1 capital, thereby negatively
impacting the safety and soundness of
the banking entity.2035
The Agencies are not providing a
specific exclusion from the definition of
covered fund for pass-through REITs
because the Agencies are concerned that
such an exclusion could enable banking
entities to structure non-loan
securitization transactions using a passthrough entity in a manner inconsistent
with the final rule’s treatment of similar
vehicles that invest in securities.
Furthermore, banking entities have
alternative manners in which they may
issue or hold REIT preferred securities,
including through REITs directly, which
do not raise the same concerns about
evasion.2036
4. Municipal Securities Tender Option
Bond Transactions
The Agencies received a number of
comments addressing how the final rule
should treat municipal securities tender
option bond vehicles. A number of
commenters argued that issuers of
municipal securities tender option
bonds would fall under the definition of
covered fund in the proposed rule
because these issuers typically rely on
the exclusion contained in section
2035 See PNC; ABA (Keating). These commenters
argued that most REIT preferred securities contain
a conditional exchange provision that allows the
primary regulator to direct that the preferred
securities be automatically exchanged for preferred
shares of the bank or parent BHC upon occurrence
of a conditional exchange event. Because this
arrangement involves the purchase of securities
issued by an affiliate or the purchase of assets, it
would be prohibited under section 13(f) of the BHC
Act if the pass-through REIT were a covered fund.
2036 The Agencies recognize that banking entities
may have relied on pass-through REIT structures to
issue preferred securities in the past and
prohibiting such transactions may pose
inefficiencies. Furthermore, it may not be possible
to unwind or conform past issuances without
significant effort by the banking entity and
negotiation with the holders of the preferred
securities. As noted above, in these circumstances,
section 13 provides a conformance period which
banking entities may take advantage of in order to
bring their activities and investments into
compliance with the requirements of section 13 and
the final rule.

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3(c)(1) or 3(c)(7) of the Investment
Company Act.2037 According to
commenters, a typical tender option
bond transaction consists of the deposit
of a single issue of highly-rated, longterm municipal bonds in a trust and the
issuance by the trust of two classes of
securities: A floating rate, puttable
security (the ‘‘floaters’’), and an inverse
floating rate security (the ‘‘residual’’)
with no tranching involved. According
to commenters, the holders of the
floaters have the right, generally on a
daily or weekly basis, to put the floaters
for purchase at par. The put right is
supported by a liquidity facility
delivered by a highly-rated provider (in
many cases, the banking entity
sponsoring the trust) and allows the
floaters to be treated as a short-term
security. The floaters are in large part
purchased and held by money market
mutual funds. The residual is held by a
longer-term investor (in many cases the
banking entity sponsoring the trust, or
an insurance company, mutual fund, or
hedge fund). According to commenters,
the residual investors take all of the
market and structural risk related to the
tender option bonds structure, with the
investors in floaters taking only limited,
well-defined insolvency and default
risks associated with the underlying
municipal bonds generally equivalent to
the risks associated with investing in
the municipal bonds directly. According
to commenters, the structure of tender
option bond transactions is governed by
certain provisions of the Internal
Revenue Code in order to preserve the
tax-exempt treatment of the underlying
municipal securities.
Many commenters requested a
specific exclusion for municipal tender
option bond vehicles from the definition
of a covered fund.2038 These
commenters argued that, without an
exclusion from the definition of covered
fund, banking entities would be
prohibited from owning or sponsoring
tender option bonds and from providing
credit enhancement, liquidity support,
remarketing, and other services required
in connection with a tender option bond
program.2039 Commenters argued that
2037 See, e.g., Ashurst; SIFMA (Municipal
Securities) (Feb. 2012); Citigroup (Jan. 2012);
Cadwalader (Municipal Securities); Vanguard; ICI
(Feb. 2012); ASF (Feb. 2012); Fidelity; Wells Fargo
(Covered Funds). Commenters also noted that
tender option bond programs as currently
structured may not meet the requirements of section
3(a)(5) of the Investment Company Act or rule 3a7 thereunder, or any other exclusion or exemption
under the Investment Company Act. See Ashurst;
RBC; ASF (Feb. 2012).
2038 See, e.g., ASF (Feb. 2012); BDA (Feb. 2012);
Eaton Vance; Fidelity; ICI (Feb. 2012); RBC; SIFMA
(Municipal Securities) (Feb. 2012); SIFMA (May
2012); State Street (Feb. 2012); Vanguard.
2039 See Ashurst; ASF (Feb. 2012).

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tender option bond vehicles should be
excluded because section 13(d)(1)(A) of
the BHC Act already allows banking
entities to own and dispose of
municipal securities directly,2040 tender
option bonds are economically similar
to repurchase agreements, which are
expressly excluded from the proprietary
trading restrictions of the proposed rule,
and, because they are safe and low risk
are similar to the types of transactions
that the proposed rule would have
exempted.2041 Commenters also argued
that tender option bonds are different
from other covered funds that rely on
the exclusion contained in section
3(c)(1) or 3(c)(7) of the Investment
Company Act 2042 and play an important
role in the municipal bond markets.2043
Commenters requested that the
Agencies use their authority under
section 13(d)(1)(J) of the BHC Act to
exclude tender option bonds because
they argued that tender option bonds
promote the safety and soundness of
banking entities and the financial
stability of the United States by
providing for a deeper, richer pool of
potential investors, a larger and more
liquid market for municipal securities
that results in lower borrowing costs for
municipalities and other issuers of
municipal securities, and greater
efficiency and risk diversification.2044
Commenters also suggested a number of
other ways to exclude tender option
bonds, including defining ownership
interest to exclude any interest in a
tender option bond transaction; 2045
defining banking entity to exclude
tender option bond issuers; 2046
expanding the loan securitization
exclusion to include tender option bond
issuers; 2047 and revising the definition
of sponsor to exclude sponsors of tender
2040 See ASF (Feb. 2012); SIFMA (Municipal
Securities) (Feb. 13, 2012); Citigroup (Jan. 2012).
See also Cadwalader (Municipal Securities)
(alleging that the legislative history of section 13 of
the BHC Act suggests that the exemption relating
to municipal securities should not be construed to
apply only to the section of the rule pertaining to
the proprietary trading prohibitions); BDA (Feb.
2012) (arguing that any fund or trust the assets of
which are entirely invested in any of the obligations
that are excluded from the proprietary trading
prohibitions should also be excluded from the
definition of covered fund).
2041 See, e.g., Ashurst; Cadwalader (Municipal
Securities); Eaton Vance; Nuveen Asset Mgmt.;
SIFMA (Municipal Securities) (Feb. 13, 2012); State
Street (Feb. 2012); Vanguard; Wells Fargo (Covered
Funds); Citigroup (Jan. 2012).
2042 See, e.g., ASF (Feb. 2012); State Street (Feb.
2012); Citigroup (Jan. 2012); Vanguard; Wells Fargo
(Covered Funds); Cadwalader (Municipal
Securities); Ashurst.
2043 See Cadwalader (Municipal Securities); ICI
(Feb. 2012); Ashurst; ASF (Feb. 2012).
2044 See Cadwalader (Municipal Securities).
2045 See RBC.
2046 See ICI (Feb. 2012).
2047 See ASF (Feb. 2012).

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option bond vehicles.2048 One
commenter urged the Commission to
consider amending the exemption under
rule 3a–7 under the Investment
Company Act or providing formal
guidance regarding the status of tender
option bond programs.2049 In addition,
some commenters requested an
exclusion for tender option bond
transactions from the provisions of
section 13(f) of the BHC Act.2050
After carefully considering the
comments received, the final rule does
not provide a specific exclusion from
the definition of covered fund or from
the prohibitions and requirements of the
final rule for tender option bond
vehicles.2051 The Agencies have
determined to provide specific
exclusions for entities that they believe
fall within the rule of construction
contained in section 13(g)(2) of the BHC
Act, which expressly relates to the sale
and securitization of loans,2052 do not
function as investment funds, consistent
with the intent of section 13’s
restrictions, or in response to other
unique considerations. The Agencies do
not believe that these considerations
support a separate exclusion for tender
option bond vehicles, which have
municipal securities as underlying
assets and not loans.
The Agencies recognize commenters’
concerns about the treatment of tender
option bonds under the final rule, as
discussed above. However, as there is
no corresponding rule of construction in
section 13 of the BHC Act for financial
instruments other than loans, the
Agencies do not believe that the
resecuritization of municipal debt
instruments should be treated
differently than the resecuritization of
other debt instruments.2053
Notwithstanding the statutory treatment
of municipal securities for purposes of
the proprietary trading restrictions, the
Agencies also do not believe that tender
option bond vehicles fall within the rule
2048 See

RBC.
Ashurst.
2050 See, e.g., RBC; ASF (Mar. 2012); ASF (Feb.
2012).
2051 The Agencies received a variety of requests
requesting specific treatment of tender option bond
transactions. See, e.g., supra notes 2045–2050. As
discussed above, the Agencies believe that, in light
of the comments received, tender option bond
vehicles do not fall within the rule of construction
contained in section 13(g)(2) of the BHC Act and,
as a result, the final rule does not provide such
treatment.
2052 See 12 U.S.C. 1851(g)(2).
2053 For these same reasons, and based on the
definitions of sponsor and banking entity in section
13, the Agencies have not modified those
definitions in the final rule to exclude sponsors of
tender options bonds and tender bond issuers,
respectively, as some commenters requested. See
supra notes 2046 and 2048 and accompanying text.
2049 See

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of construction contained in section
13(g)(2) of the BHC Act, because, in
light of commenters’ descriptions of
these vehicles, tender option bond
vehicles are more in the nature of other
types of bond repackaging
securitizations and other non-excluded
securitization vehicles.2054 The final
rule, however, does not prevent a
banking entity from owning or
otherwise participating in a tender
option bond vehicle; it requires that
these activities be conducted in the
same manner as with other covered
funds.
In this regard, under the final rule, a
banking entity would need to evaluate
whether a tender option bond vehicle is
a covered fund as defined in the final
rule. If a tender option bond vehicle is
a covered fund and an exclusion from
that definition is not available, then
banking entities sponsoring such a
vehicle will be subject to the
prohibitions in § ll.14 of the final rule
and the provisions of section 13(f) of the
BHC Act.2055
As tender option bond vehicles are
considered issuers of asset-backed
securities subject to the risk retention
requirements of section 15G of the
Exchange Act, banking entities may look
to the provisions of the final rule
governing the limits applicable to
banking entities’ interests in and
relationships with those funds. Under
the final rule, as in the statute, a
banking entity that conducts the
activities described in section 13(f) of
the BHC Act is subject to the restrictions
on transactions with a tender option
bond vehicle, including guaranteeing or
insuring the performance of the tender
option bond vehicle, contained in
section 13(f) of the BHC Act. As a result,
a banking entity is not permitted to
provide credit enhancement, liquidity
support, and other similar services if it
serves in a capacity covered by section
13(f) with the tender option bond
2054 Commenters also argued that to the extent
tender option bond programs are not excluded from
the definition of covered fund, the definition of
ownership interest should exclude any interest in
a tender option bond program (See RBC) or that
where a third party owns the residual, the banking
entity should not be treated as having an ownership
interest, even when it owns a small interest for tax
purposes or becomes the owner through liquidity or
remarketing agreements (See Cadwalader
(Municipal Securities)). The definition of
ownership interest in the final rule focuses on the
attributes of the interest, as discussed below, and
not the particular type of covered fund involved.
The Agencies are not providing separate definitions
of or exclusions from the ownership interest
definition based on the type of vehicle or financing
involved. See infra note 2098 and preceding and
following text. Banking entities will need to
evaluate whether the interests they may acquire are
ownership interests as defined under the final rule.
2055 See 12 U.S.C. 1851(f).

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program.2056 An unaffiliated third party
may provide such services if it does not
have a relationship with the tender
option bond vehicle that triggers
application of section 13(f). The extent
to which the final rule causes a
disruption to the securitization of, and
market for, municipal tender option
bonds may also affect the economic
burden and effects on the municipal
bond market and its participants,
including money market mutual
funds 2057 and issuers of municipal
securities. The Agencies recognize that
a potential economic burden may be an
increase in financing costs to
municipalities as a result of a decrease
in demand for the types of municipal
securities customarily included in
municipal tender option bond
vehicles 2058 and therefore potential
effects on the depth and liquidity of the
market for certain types of municipal
securities.2059
5. Venture Capital Funds
Some private equity funds that make
investments in early-stage start-up
companies or other companies with
significant growth potential (‘‘venture
capital funds’’) would be investment
companies but for the exclusion
contained in section 3(c)(1) or 3(c)(7) of
the Investment Company Act. Venture
capital funds would therefore qualify as
a covered fund under the proposal. The
proposal specifically requested
comment on whether venture capital
funds should be excluded from the
definition of ‘‘covered fund.’’
Some commenters argued that venture
capital funds should be treated
differently than other covered funds and
excluded from the definition. These
commenters argued that, unlike
conventional hedge funds and private
equity funds, venture capital funds do
not possess high leverage and do not
engage in risky trading activities of the
type section 13 of the BHC Act was
designed to address.2060 These
commenters contended that investments
and relationships by banking entities in
venture capital funds would be
consistent with safety and soundness;
2056 As discussed above, while commenters
requested treatment of municipal tender option
bond vehicles that would cause section 13(f) of the
BHC Act not to apply to them, the final rule does
not exclude these vehicles from the definition of
covered fund or the prohibitions relating to covered
funds. As a result, section 13(f) of the BHC Act will
apply to a banking entity that is sponsoring a tender
option bond vehicle.
2057 See ASF (Feb. 2012); Nuveen Asset Mgmt.
2058 See Ashurst.
2059 See Eaton Vance.
2060 See SVB; NVCA; Rep. Eshoo; Sen. Boxer;
Rep. Goodlatte; Rep. Schweikert; Rep. Speier; Rep.
Honda; Rep. Lofgren; Rep. Peters et. al.

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5703

provide important funding and
expertise and other services to start-up
companies; and provide positive
benefits to employment, GDP, growth,
and innovation.2061 These commenters
argued that restricting banking entities’
ability to invest in or sponsor venture
capital funds would have a negative
impact on companies and the U.S.
economy generally.2062 Some
commenters asserted that bank
investments in venture capital funds are
important to the success of venture
capital,2063 with some citing a
consulting firm’s data indicating that
approximately 7 percent of all venture
capital is provided by banks.2064 One
commenter argued, therefore, that
‘‘preventing banks from investing in
venture thus could depress U.S. GDP by
roughly 1.5% (or $215 billion annually)
and eliminate nearly 1% of all U.S.
private sector employment over the long
term,’’ and the funding gap that would
result if banks could not invest in
venture capital funds would not be met
by other market participants if bank
investments in venture capital were
restricted.2065 Several commenters
recommended that venture capital funds
be excluded if they: (i) Do not
fundamentally engage in proprietary
trading; (ii) do not use leverage to
increase investment returns; and (iii)
typically invest in high-growth start-up
companies as compared to more mature
publicly traded companies.2066
Conversely, one commenter alleged
that there was no credible way to
exclude venture capital funds without
providing a means to circumvent the
requirements of section 13 and the final
rule.2067 Another commenter argued
that venture capital funds do in fact
engage in risky activities and that,
instead of making investments in
venture capital funds, banking entities
may directly extend credit to start-up
2061 See,

e.g., NVCA; SVB; Scale.
e.g., SVB; Scale; Sen. Boxer; SIFMA et
al. (Covered Funds) (Feb. 2012) (citing a colloquy
between Sen. Dodd and Sen. Boxer supporting an
exemption for venture capital funds (156 Cong. Rec.
H5226 (daily ed., June 30, 2010)).
2063 See River Cities; Scale. See also Sofinnova;
Canaan (Young); Canaan (Ahrens); Canaan (Kamra);
Mohr Davidow; ATV; BlueRun; Westly; Charles
River; Flybridge; SVB.
2064 See, e.g., SVB.
2065 See SVB.
2066 See, e.g., SVB (arguing that the definition of
‘‘venture capital fund’’ in section 203(l)–1 of the
Investment Advisers Act and the SEC’s Form PF
reporting requirements for investment advisers to
private funds would be instructive for defining an
exclusion for venture capital funds for purposes of
section 13 of the BHC Act).
2067 See Occupy.
2062 See,

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companies in a safe and sound
manner.2068
The final rule does not provide an
exclusion for venture capital funds. The
Agencies believe that the statutory
language of section 13 does not support
providing an exclusion for venture
capital funds from the definition of
covered fund. Congress explicitly
recognized and treated venture capital
funds as a subset of private equity funds
in various parts of the Dodd-Frank Act
and accorded distinct treatment for
venture capital fund advisers by
exempting them from registration
requirements under the Investment
Advisers Act.2069 This indicates that
Congress knew how to distinguish
venture capital funds from other types
of private equity funds when it desired
to do so.2070 No such distinction
appears in section 13 of the BHC Act.
Because Congress chose to distinguish
between private equity and venture
capital in one part of the Dodd-Frank
Act, but chose not to do so for purposes
of section 13, the Agencies believe it is
appropriate to follow this Congressional
determination.
In addition to the language of the
statute, it appears to the Agencies that
the activities and risk profiles for
banking entities regarding sponsorship
of, and investment in, venture capital
funds and private equity funds are not
readily distinguishable. Many key
structural and operational
characteristics of venture capital funds
are substantially similar to those of
hedge funds and private equity funds,
thereby making it difficult to define
venture capital funds in a manner that
would not provide banking entities with
an opportunity to evade the restrictions
of section 13 of the BHC Act.
For instance, in addition to relying on
the same exemptions under the
Securities Act,2071 venture capital
2068 See

Sens. Merkley & Levin (Feb. 2012).
S. Rep. No. 111–176, at 71–3 (2010) (‘‘S.
Rep. No. 111–176’’); H. Rep. No. 111–517, at 866
(2010) (‘‘H. Rep. No. 111–517’’). H. Rep. No. 111–
517 contains the conference report accompanying
the version of H.R. 4173 that was debated in
conference. See S. Rep. No. 111–176, at 74 (‘‘The
Committee believes that venture capital funds, a
subset of private investment funds specializing in
long-term equity investment in small or start-up
businesses, do not present the same risks as the
large private funds whose advisers are required to
register with the SEC under this title.’’). Compare
Restoring American Financial Stability Act of 2010,
S. 3217, 111th Cong. § 408 (2010) (as passed by the
Senate) with The Wall Street Reform and Consumer
Protection Act of 2009, H.R. 4173, 111th Cong.
(2009) (as passed by the House) (‘‘H.R. 4173’’) and
Dodd-Frank Act (2010).
2070 But See Rep. Honda.
2071 These funds all typically offer their shares on
an unregistered basis in reliance on section 4(a)(2)
of the Securities Act of 1933 or Regulation D
thereunder.

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funds, private equity funds and hedge
funds all rely on the exclusion in
section 3(c)(1) or 3(c)(7) from the
definition of investment company under
the Investment Company Act. Moreover,
like private equity funds, venture
capital funds pool funds from multiple
investors and invest those funds in
interests of portfolio companies for the
purpose of profiting from the resale of
those interests. Indeed, funds that are
called ‘‘venture capital funds’’ may
invest in the very same entities and to
the same extent as do funds that call
themselves private equity funds.
Venture capital funds, like private
equity funds, also typically charge
incentive compensation to fund
investors based on the price
appreciation achieved on the
investments held by the fund and
provide a return of principal plus gains
at specific times during the limited life
of the fund. Not including venture
capital funds in the definition of
covered fund, therefore, could allow
banking entities, either directly or
indirectly, to engage in the type of
activities section 13 was designed to
address.
While the final rule does not provide
a separate exclusion for venture capital
funds from the definition of covered
fund, the Agencies recognize that
certain venture capital investments by
banking entities provide capital and
funding to nascent or early-stage
companies and small businesses and
also may provide these companies
expertise and other services.2072 Other
provisions of the final rule or the statute
may facilitate, or at least not impede,
other forms of investing that may
provide the same or similar benefits. For
example, in addition to permitting a
banking entity to organize and offer a
covered fund in section 13(d)(1)(G),
section 13 of the BHC Act does not
prohibit a banking entity, to the extent
otherwise permitted under applicable
law, from making a venture capital-style
investment in a company or business so
long as that investment is not through
or in a covered fund, such as through a
direct investment made pursuant to
2072 As noted above, some commenters quantified
the importance of banking entities to the provision
of venture capital by providing information
indicating that approximately 7 percent of all
venture capital is provided by banks. See, e.g., SVB
(citing The Venture Capital Industry: A Preqin
Special Report, published by Preqin, Ltd. (Oct.
2010)). The 7% estimate commenters identified
includes information on investors based in North
America, Europe, and Asia; thus, although
potentially indicative of the extent of venture
capital investing by banking entities in venture
capital funds, the estimate does not specifically
address the proportion of investment by banking
entities in venture capital funds that are covered
funds, as those terms are defined in the final rule.

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merchant banking authority 2073 or
through business development
companies which are not covered funds
and, like venture capital funds, often
invest in small, early-stage
companies.2074
Thus, to the extent that banking
entities are required to reduce their
investments in venture capital funds,
certain of these investments may be
redirected to the types of entities in
which venture capital funds invest
through alternative means. To the extent
that banking entities may reduce their
investments in venture capital funds
that are covered funds, the potential
funding gap for venture capital funds
may also be offset, in whole or in part,
by investments from firms that are not
banking entities and thus not subject to
section 13’s restrictions.
6. Credit Funds
Several commenters requested that
the final rule explicitly exclude from the
definition of covered fund entities that
are generally formed as partnerships
with third-party capital and invest in
loans or make loans or otherwise extend
the type of credit that banks are
authorized to undertake on their own
balance sheet (‘‘credit funds’’).2075 Two
commenters contended that the
language of section 13(g)(2) indicates
that Congress did not intend section 13
of the BHC Act to limit a banking
entity’s ability to extend credit.2076
They argued that lending is a
fundamental banking activity, whether
accomplished through direct loans or
through a fund structure. These
commenters argued that credit funds
functioned like syndicated loans that
enable borrowers to secure credit during
periods of market distress and reduce
the concentration of risk for both
individual banking entities and the
banking system as a whole.
Commenters suggested different
approaches for excluding credit funds
from the definition of covered fund. One
commenter recommended excluding an
entity that would otherwise be a
covered fund if more than 50 percent of
its assets consist of loans.2077 Another
2073 See

12 U.S.C. 1843(k)(4)(H); 12 CFR 225.170

et seq.
2074 See 15 U.S.C. 80a–54. Companies that have
elected to be treated as a business development
company are subject to limits under the Investment
Company Act, including: (i) Limits on how much
debt the business development company may incur;
(ii) prohibitions on certain affiliated transactions;
(iii) regulation and examination by the SEC; and (iv)
registration and filing requirements.
2075 See, e.g., Goldman (Covered Funds); ABA
(Keating); Credit Suisse (Williams); Comm. on
Capital Markets Regulation; Chamber (Feb. 2012).
2076 See ABA (Keating); Goldman (Covered
Funds).
2077 See Credit Suisse (Williams).

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commenter proposed defining a credit
fund as an entity that met a number of
criteria designed to ensure the entity
only held loans or otherwise engaged in
prudent lending activity.2078 Another
commenter requested that the Agencies
use their authority under section
13(d)(1)(J) to permit a banking entity to
sponsor, invest in, or enter into covered
transactions with related credit funds
that are covered funds.2079
The Agencies, however, are unable
effectively to distinguish credit funds
from other types of private equity funds
or hedge funds in a manner that would
give effect to the language and purpose
of section 13 and not raise concerns
about banking entities being able to
evade the requirements of section 13.
Moreover, the Agencies also believe that
the final rule largely addresses
commenters’ concerns in other ways
because some credit funds may be able
to rely on another exclusion from the
definition of covered fund in the final
rule such as the exclusion for joint
ventures or the exclusion, discussed
above, for loan securitizations. To the
extent that a credit fund may rely on
another exclusion from the definition of
covered fund, it would not be a covered
fund under section 13 of the BHC Act.
7. Employee Securities Companies
Several commenters argued that
employee securities companies
(‘‘ESCs’’) should be explicitly excluded
from the definition of covered fund.2080
One commenter alleged that, though
many ESCs could qualify for the
exemption in section 6(b) of the
Investment Company Act, they often opt
to rely on section 3(c)(1) or 3(c)(7)
instead due to the fact that the section
6(b) exemption is available only upon
application to the SEC.2081 According to
this commenter, the limitations
contained in section 13 on employee
investments and intercompany
transactions with covered funds would
severely limit the ability of a banking
2078 See

Goldman (Covered Funds).
SIFMA et al. (Covered Funds) (Feb.
2012); See also. ABA (Keating); Chamber (Feb.
2012).
2080 See, e.g., ABA (Keating), Credit Suisse
(Williams), Arnold & Porter (as it relates to
commodity pools). Section 2(a)(13) of the
Investment Company Act generally defines an ESC
as ‘‘any investment company or similar issuer all
of the outstanding securities of which (other than
short-term paper) are beneficially owned’’ by
employees and certain related persons (e.g.,
employees’ immediate family members).
2081 Section 6(b) of the Investment Company Act
provides, in part, that ‘‘[u]pon application by any
employees’ security company, the Commission
shall by order exempt such company from the
provisions of this title and of the rules and
regulations hereunder, if and to the extent that such
exemption is consistent with the protection of
investors.’’

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entity to design competitive employee
compensation arrangements.2082 This
commenter also argued that an
exclusion should be provided for any
investment vehicle that satisfies the
definition of an ESC under section
2(a)(13) of the Investment Company Act.
After considering carefully the
comments received on the proposed
rule, the final rule does not provide a
specific exclusion for ESCs because the
Agencies believe that these vehicles
may avoid being a covered fund by
either complying with the conditions of
another exclusion from the definition of
covered fund or seeking and receiving
an exemption available under section
6(b) of the Investment Company Act. As
such, the Agencies believe a banking
entity has a reasonable alternative to
design competitive employee
compensation arrangements. The
Agencies recognize that preparing an
application under section 6(b) of the
Investment Company Act or modifying
an ESC’s activities to meet the terms of
another exclusion from the covered
fund definition is not without costs, but
have determined to provide specific
exclusions for entities that do not
function as investment funds, consistent
with the purpose of section 13, or in
response to other unique considerations
(e.g., to provide consistent treatment for
certain foreign and domestic pension
plans). These considerations do not
support a separate exclusion for ESCs.
The Agencies also note that nonqualified plans are not exempt from the
Investment Company Act under 3(c)(11)
and thus would be covered funds if they
are operating in reliance on section
3(c)(1) or 3(c)(7) of the Investment
Company Act. Some of these nonqualified plans may be formed as
employees’ securities companies,
however, and could qualify for an
exemption under section 6(b) of the
Investment Company Act for employees’
securities companies as discussed
above.
e. Definition of ‘‘Ownership Interest’’
The proposed rule defined
‘‘ownership interest’’ in a covered fund
to mean 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, as well as any derivative of
such an interest.2083 This definition
focused on the attributes of the interest
2082 See
2083 See

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proposed rule § ll.10(b)(3).

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5705

and whether it provided a banking
entity with economic exposure to the
profits and losses of the covered fund,
rather than its form. The proposal thus
would also have included a debt
security or other interest in a covered
fund as an ownership interest if it
exhibited 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).2084 As
described further below, the proposed
rule excluded carried interest (termed
‘‘restricted profit interest’’ in the final
rule) from the definition of ownership
interest.
Many commenters argued that the
proposed definition of ownership
interest was too broad and urged
excluding one or more types of interests
from the definition. A number of
commenters raised concerns regarding
the difficulty of applying the ownership
interest definition to securitization
structures and questioned whether the
definition of ownership interest might
apply to a debt security issued by, or a
debt interest in, a covered fund that has
some characteristics similar to an equity
or other ownership interest.2085 One
commenter argued that the ownership
interest definition should not include
debt instruments with equity features
unless the Agencies determine with
respect to a particular debt instrument,
after appropriate notice and opportunity
for hearing, that the equity features are
so pervasive that the debt instrument is
the functional equivalent of an equity
interest or partnership interest and was
structured to evade the prohibitions and
2084 See

Joint Proposal, 76 FR 68,897.
AFME et al.; AFR et al. (Feb. 2012); ASF
(Feb. 2012); BoA; Cadwalader (Municipal
Securities); Credit Suisse (Williams); Deutsche Bank
(Repackaging Transactions); Occupy; RBC; SIFMA
et al. (Covered Funds) (Feb. 2012); SIFMA
(Securitization) (Feb. 2012); TCW. For example,
securitization structures generally provide that
either the most senior or the most junior tranche
notes have controlling voting rights. One
commenter argued that under the proposed
ownership interest definition, a banking entity
could be deemed to have an ownership interest in
an entity it does not own or sponsor simply due to
its obtaining voting rights. See ASF (Feb. 2012). As
a further example, one commenter alleged that
securitization structures generally are not viewed as
providing economic exposure to the profits and
losses of the issuer in the same manner as equity
interests in hedge funds and private equity funds.
This commenter argued that the ownership interest
definition should include only those interests that
permit the banking entity to share without limit in
the profits and losses or that earn a return that is
based on the performance of the underlying assets.
See SIFMA (Securitization) (Feb. 2012).
2085 See

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restrictions in the proposal.2086 Several
commenters argued that the Agencies
should explicitly exclude certain debt
instruments with equity features from
the ownership interest definition.2087
Finally, certain commenters argued that,
because the application of the
ownership interest definition to
securitization structures was
problematic, alternative regulatory
treatment was appropriate.2088
One commenter expressed concern
over the proposal’s inclusion of
‘‘derivatives’’ of ownership interests in
the definition of ownership interest and
recommended certain derivative
interests of ownership interests in hedge
funds and private equity funds not be
2086 See

SIFMA et al. (Covered Funds) (Feb.

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2012).
2087 See AFME et al.; ASF (Feb. 2012); BoA;
Cadwalader (Municipal Securities); RBC; SIFMA
(Securitization) (Feb. 2012). These commenters
argued that the ownership interest definition
should not include tender option bond programs
and other debt asset-backed securities. Two of these
commenters argued that debt asset-backed
securities should not be viewed as ownership
interests because: (i) They are not typically viewed
as having economic exposure to profits and losses
of an ABS Issuer; (ii) they have a limited life,
periodic fixed or fluctuating cumulative payments,
and are senior to equity of the issuer should the
issuer fail; (iii) they do not have perpetual life with
broad voting rights, appreciation in the market
value of the issuer and non-cumulative dividends,
and subordination to the claims of debt holders if
the issuer fails; and (iv) their limited voting rights
(such as the rights to replace a servicer or manager)
and such rights are protective in nature and similar
to voting rights that accompany securities
traditionally classified by the Agencies as debt
securities (including securities formally structured
as equity). See AFME et al.; SIFMA (Securitization)
(Feb. 2012). One of these commenters argued that
the ownership interest definition should be limited
to those interests that share in the profits or losses
of the relevant entity on an unlimited basis or that
otherwise earn a return that is specifically based
upon the performance of the underlying assets
because the senior tranche in an asset-based
securities transaction often has substantial voting
rights and banking entities should not be penalized
for requiring or otherwise obtaining voting rights
that protect their interests. This commenter also
expressed the view that banking entities should not
be restricted from owning debt classes of new assetbacked securities because ‘‘doing so would
substantially constrict the market for asset-backed
securities.’’ See ASF (Feb. 2012).
2088 See AFR et al. (Feb. 2012); Credit Suisse
(Williams); Occupy. One of these commenters
argued that any general statement about what
instruments would be considered an ‘‘ownership
interest’’ for purposes of securitization structures
would be problematic and easy to evade because
transaction documents underlying securitization
structures are not standardized. This commenter
suggested as an alternative using a safe harbor for
standardized, pre-specified securitization
structures. See AFR et al. (Feb. 2012). Another of
these commenters argued that ‘‘it is difficult to
characterize holders of ABS securities in most
securitization structures as having ‘ownership
interests’ in any common understanding of the
term’’ and the concept of ownership interest is a
‘‘poor fit for the securitization market, underscoring
the benefits of excluding securitization issuers from
the definition of covered fund entirely.’’ See Credit
Suisse (Williams).

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included within the definition of
ownership interest.2089 This commenter
also recommended that the Agencies
expressly exclude from the definition of
ownership interest lending
arrangements with a covered fund that
contain protective covenants linking the
interest rate on the loan to the profits of
the borrowing fund.2090
As discussed in detail below, the
Agencies are adopting the definition of
‘‘ownership interest’’ largely as
proposed but clarifying the scope of that
definition, including with respect to the
inclusion of interests that are linked to
profits and losses of a covered fund and
the exclusion for a restricted profit
interest in a covered fund.2091 The
definition is centered on equity
interests, partnership interests,
membership interests, trust certificates,
and similar interests, and would not
generally cover typical extensions of
credit the terms of which provide for
payment of stated principal and interest
calculated at a fixed rate or at a floating
rate based on an index or interbank rate.
However, as under the proposal, to the
extent that a debt security or other
interest in a covered fund exhibits
specified characteristics that are similar
to those of equity or other ownership
interests (e.g., provides the holder with
the ability to participate in the election
or removal of a party with investment
discretion, 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 instrument would be
an ownership interest under the final
rule.
In response to commenters and in
order to provide clarity about the types
of interests that would be considered
within the scope of ownership interest,
the Agencies have revised the definition
of ‘‘ownership interest’’ to define the
term more clearly. The Agencies are not
explicitly excluding or including debt
securities, instruments or interests with
2089 See

Credit Suisse (Williams).
Credit Suisse (Williams) (arguing that
such arrangements are a fundamental part of a
bank’s lending activities).
2091 See final rule § ll.10(d)(6). The concept of
a restricted profit share was referred to as ‘‘carried
interest’’ in the proposed rule, a term that is often
used as a generic reference to performance-based
allocations or compensation. The Agencies have
instead used the term ‘‘restricted profit interest’’ in
the final rule to avoid any confusion that could
result from using a term that is also used in other
contexts. The final rule focuses only on whether a
profit interest is excluded from the definition of
ownership interest under section 13, and the final
rule does not address in any way the treatment of
such profit interests under other laws, including
under Federal income tax law.
2090 See

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equity features as requested by some
commenters, but are instead identifying
certain specific characteristics that
would cause a particular interest,
regardless of the name or legal form of
that interest, to be included within the
definition of ownership interest. The
Agencies believe that this elaboration on
the characteristics of an ownership
interest will enable parties, including
securitization structures, to more easily
analyze whether their interest is an
ownership interest, regardless of the
type of legal entity or the name of the
particular interest.
As adopted, the final rule provides
that an ownership interest would be any
interest in or security issued by a
covered fund that exhibits any of the
following features or characteristics on
a current, future, or contingent
basis: 2092
• Has the right to participate in the
selection or removal of a general
partner, managing member, member of
the board of directors or trustees,
investment manager, investment
adviser, or commodity trading advisor
of the covered fund. For purposes of the
rule, this would not include the rights
of a creditor to exercise remedies upon
the occurrence of an event of default or
similar rights arising due to an
acceleration event;
• has the right under the terms of the
interest to receive a share of the income,
gains or profits of the covered fund.
This would apply regardless of whether
the right is pro rata with other owners
or holders of interests; 2093
• has the right to receive the
underlying assets of the covered fund,
after all other interests have been
redeemed and/or paid in full
(commonly known as the ‘‘residual’’ in
securitizations). For purposes of the
rule, this would not include the rights
of a creditor to exercise remedies upon
the occurrence of an event of default or
similar rights arising due to an
acceleration event;
• has the right to receive all or a
portion of excess spread (the positive
difference, if any, between the aggregate
interest payments received from the
underlying assets of the covered fund
and the aggregate interest paid to the
2092 Each of these factors are designed to clarify
the interests identified in the proposed definition
of ownership interest as noted above.
2093 This characteristic exists for both multi-class
and single-class covered funds. In the context of an
entity that issues shares, this right could cover, for
example, common shares, as well as preferred
shares the dividend payments of which are
determined by reference to the performance of the
covered fund.

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holders of other outstanding
interests); 2094
• provides that the amounts payable
by the covered fund with respect to the
interest could, under the terms of the
interest, be reduced based on losses
arising from the underlying assets of the
covered fund, such as allocation of
losses, write-downs or charge-offs of the
outstanding principal balance, or
reductions in the amount of interest due
and payable on the interest; 2095
• receives income on a pass-through
basis from the covered fund, or has a
rate of return that is determined by
reference to the performance of the
underlying assets of the covered
fund.2096 This provision would not
include an interest that is entitled to
receive dividend amounts calculated at
a fixed or at a floating rate based on an
index or interbank rate such as LIBOR;
or
• any synthetic right to have, receive
or be allocated any of the rights above.
This provision would not permit
banking entities to obtain synthetic or
derivative exposure to any of the
characteristics identified above in order
to avoid being considered to have an
ownership interest in the covered fund.
This definition of ‘‘ownership
interest’’ is intended to address
commenters’ concerns regarding the
applicability of the ownership interest
definition to different types of interests.
The Agencies believe defining
‘‘ownership interest’’ in this way will
allow existing as well as potential
holders of interests in covered funds,
including securitizations, to effectively
determine whether they have an
ownership interest. As an example, this
definition would include preferred
stock, as well as a lending arrangement
with a covered fund in which the
interest or other payments are
calculated by reference to the profits of
the fund. As a contrasting example, the
Agencies believe that a loan that
provides for a step-up in interest rate
margin when a covered fund has fallen
below or breached a NAV trigger or
2094 The reference to ‘‘all or a portion of excess
spread’’ is meant to include within the definition
of ownership interest the right to receive any excess
spread which remains after the excess spread is
used to pay expenses, maintain credit enhancement
such as overcollateralization or is otherwise
reduced.
2095 This characteristic does not refer to any
reduction in the stated claim to principal or interest
of a holder of an interest that occurs either as a
result of a bona fide subsequent renegotiation of the
terms of an interest or as a result of a bankruptcy,
insolvency, or similar proceeding.
2096 This provision is not intended to encompass
derivative transactions entered into in connection
with typical prime brokerage activities of banking
entities. However, the activities of banking entities
are subject to the anti-evasion provisions.

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other negotiated covenant would not
generally be an ownership interest.
Banking entities will be expected to
evaluate the specific terms of their
interests to determine whether any of
the specified characteristics exist. In
this manner, the Agencies believe that
the definition of ownership interest in
the final rule is clearer than under the
proposal and thus should be less
burdensome for banking entities in their
determination of whether certain rights
would cause an interest to be an
ownership interest for purposes of
compliance with the rule.
As indicated above, many
commenters on securitizations under
the proposed rule made arguments
regarding the difficulty of applying the
proposal’s definition of ownership
interest to securitization structures,
contending that the definition should
not include debt instruments with
equity features, or that the final rule
should provide a safe harbor under
which the use of a standardized, prespecified securitization structure would
not give rise to an ownership
interest.2097 The Agencies are not
adopting a separate definition of
ownership interest for securitization
transactions, providing for differing
treatment of financial instruments, or
providing a safe harbor as requested by
some commenters. The revised
definition of ownership interest will
apply regardless of the type of legal
entity or the name or legal form of the
particular interest. The determination of
whether an interest is an ownership
interest under the final rule will depend
on the features and characteristics of the
particular interest, including the rights
the particular interest provides its
holder, including not only voting rights
but also the right to receive a share of
the income, gains, or profits of a covered
fund, the right to receive a residual, the
right to receive excess spread, and any
synthetic or derivative that would
provide similar rights. While some
commenters argued that securities
issued in asset-backed securities
transactions and by tender option bond
issuers should not be viewed as
ownership interests due to the nature of
the securities issued or the possible lack
of exposure to profits and losses,2098 the
Agencies do not believe that the type of
covered fund involved or the type of
security issued is an appropriate basis
for determining whether there is an
ownership interest for purposes of the
restrictions contained in section
13(a)(1)(B) of the BHC Act. The
Agencies believe that making
2097 See
2098 See

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supra note 2087.

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5707

distinctions in the definition of
ownership interest based on the type of
entity or the type of security, in which
many of the same rights exist as for
other types of ownership interests,
would not be consistent with the
statutory restrictions on ownership.
Similarly, while some commenters
argued that including a safe harbor for
standardized securitization structures
would be more effective in identifying
an ownership interest in securitizations,
the Agencies believe that the type of
interest and the rights associated with
the interest are more appropriate to
determine whether an interest is an
ownership interest and is necessary to
avoid potential evasion of the
ownership restrictions contained in
section 13 of the BHC Act.
The Agencies understand that the
definition of ownership interest in the
final rule may include interests in a
covered fund that might not be
considered an ownership interest or
equity interest in other contexts. For
instance, it may include loans with an
interest rate determined by reference to
the performance of a covered fund or
senior debt interests issued in a
securitization. While the definition of
ownership interest may affect the ability
of a banking entity to hold such
interests, whether existing or in the
future, the Agencies believe that the
definition of ownership interest as
adopted in the final rule is more
effective in preventing possible evasion
of section 13 by capturing interests that
may be characterized as debt but confer
benefits of ownership, including voting
rights and/or the ability to participate in
profits or losses of the covered fund.
The definition of ownership interest
in the final rule, like the proposed rule,
includes derivatives of the interests
described above. Derivatives of
ownership interests provide holders
with economic exposure to the profits
and losses of the covered fund or an
ability to earn a return based on the
performance of the fund’s underlying
holdings or investments in a manner
substantially similar to an ownership
interest. The Agencies believe the final
rule’s approach appropriately addresses
the statutory purpose to limit a banking
entity’s economic exposure to covered
funds, irrespective of the legal form,
name, or issuer of that ownership
interest.
As noted above, the proposed
definition of ownership interest did not
include carried interest (termed
‘‘restricted profit interest’’ in the final
rule). The proposal recognized that
many banking entities that serve as
investment adviser or provide other
services to a covered fund are routinely

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compensated for services they provide
to the fund through receipt of carried
interest. As a result, the proposed rule
provided that an ownership interest
with respect to a covered fund did 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) served
as investment manager, investment
adviser, or commodity trading advisor,
so long as certain enumerated
conditions were met.2099
The enumerated conditions contained
in the proposal were designed to narrow
the scope of the exclusion of carried
interest from the definition of
‘‘ownership interest’’ so as to
distinguish between an investor’s
economic risks and a service provider’s
performance-based compensation. This
was designed to limit the ability of a
banking entity to structure carried
interest in a manner that would evade
section 13’s restriction on the amount of
ownership interests a banking entity
may have as an investment in a covered
fund.
Commenters disagreed over whether
the definition of ownership interest
should exclude carried interest. For
instance, some commenters did not
support excluding carried interest from
the definition of ownership interest,
arguing that such an exclusion was too
permissive and inconsistent with the
statute because, for instance, carried
interest derives its value in part by
tracking gains on price movements of
investments by the fund.2100 One
commenter argued that, despite the fact
that carried interest is typically
provided as compensation for services
provided to a fund, carried interest is a
form of investment and therefore should
be included as an ownership
interest.2101 Another commenter argued
that permitting banking entities to hold
an unrestricted amount of carried
interest could create an indirect and
undesirable link between prohibited
proprietary trading and covered fund
activities.2102 These commenters also
argued that treating carried interest as
compensation for providing services
would be inconsistent with the manner
in which carried interest is treated for
tax purposes.2103
Other commenters, however,
supported excluding carried interest
from the definition of an ownership

interest and argued the exclusion was
consistent with the words and purpose
of section 13.2104 One commenter
argued that carried interest is readily
distinguished from an investment in a
covered fund because carried interest
normally does not expose a banking
entity to a covered fund’s losses (other
than in limited instances such as when
a ‘‘clawback’’ provision is triggered).2105
Another commenter argued that
permitting a banking entity to receive
carried interest without being subject to
the requirements of section 13 regarding
ownership interests better aligns the
interest of the investment manager with
that of the fund and its investors.2106
Another commenter supported
expanding the definition of carried
interest to include an interest received
by a banking entity in return for
qualifying services (e.g., lending,
placement, distribution, or equity
financing) provided to the investment
manager of the fund, but not directly
provided to the fund itself.2107
The proposal established four criteria
that must be met in order for carried
interest to be excluded from the
definition of ownership interest. First,
the proposal required that carried
interest have the sole purpose and effect
of permitting the banking entity or an
employee thereof to share in the covered
fund’s profits as performance
compensation for services provided to
the fund. While most commenters did
not object to this criterion, one
commenter argued that the wording of
this approach would appear to prohibit
an employee of the banking entity from
retaining a carried interest after the
employee has changed employment.2108
This commenter argued that the
determination of the carried interest’s
purpose should be made only at the
time the interest is granted, thereby
enabling an employee to retain the
carried interest if and when the
employee no longer provides
investment management, investment
advisory, or similar services to the fund
or is no longer employed at the banking
entity.
Second, the proposal required that
carried interest, once allocated, be
distributed to the banking entity
promptly after it is earned or, if not so
distributed, not share in the subsequent
profits and losses of the covered fund.
One commenter urged the Agencies to
allow the ‘‘reserve’’ portion of carried

proposed rule § ll.10(b)(3)(ii).
e.g., Occupy; AFR et al. (Feb. 2012).
2101 See Public Citizens; See also Occupy.
2102 See AFR et al. (Feb. 2012).
2103 See Occupy; Public Citizens; AFR et al. (Feb.
2012).

2104 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); TCW; Credit Suisse (Williams); SVB.
2105 See Credit Suisse (Williams).
2106 See TCW.
2107 See Credit Suisse (Williams).
2108 See TCW.

2099 See

2100 See,

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interest that for tax purposes is allocated
to the investment manager or
investment adviser, but invested
alongside the fund and not formally
allocated or distributed by the fund, also
to qualify for the exclusion as carried
interest.2109 This commenter also
suggested that this criterion should not
affect the common European structure
in which allocated carried interest may
share in the subsequent losses, but not
the profits, of the fund.
Third, under the proposal a banking
entity (including its affiliates or
employees) was not permitted to
provide funds to the covered fund in
connection with receiving a carried
interest. The proposal specifically
requested comment on whether the
exemption for carried interest, including
this requirement, was consistent with
the current tax treatment and
requirements of carried interest
arrangements.2110 Commenters urged
the Agencies to relax or amend this
criterion so that banking entities,
including their affiliates and employees,
whether directly or indirectly through a
fund vehicle, would be permitted to
make minimal capital contributions to
the fund (typically less than 1 percent)
in connection with the receipt of carried
interest to the extent that such
contributions provide the basis for
treating the interest as carried interest
for tax purposes.2111 However, these
commenters supported the proposal’s
requirement that any amount
contributed by a banking entity in
connection with receiving a carried
interest should be aggregated with the
banking entity’s ownership interests for
purposes of the 3 percent investment
limits.
Fourth, the proposal provided that
carried interest may not be transferable
by the banking entity (or the affiliate,
subsidiary or employee thereof) except
to another affiliate or subsidiary of the
banking entity. Commenters generally
urged removing the proposal’s
limitations on transferability and
argued, among other things, that this
criterion could prevent a banking entity
(or its affiliate or employee) from
transferring the carried interest in
connection with selling or otherwise
transferring the provision of advisory or
other services that gave rise to the
carried interest.2112 Similarly, one
commenter argued that the final rule
should not require carried interest to be
2109 See

Credit Suisse (Williams).
Proposal, 76 FR 68,899.
2111 See TCW; SIFMA (Covered Funds) (Feb.
2012); Credit Suisse (Williams).
2112 See ASF (Feb. 2012); See also Credit Suisse
(Williams); SVB.
2110 Joint

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re-characterized as an ownership
interest if it is transferred among
employees, family members of
employees or to estate planning vehicles
upon an employee’s death.2113
After considering carefully comments
received on the proposal, the Agencies
have determined to retain in the final
rule the exclusion from the definition of
‘‘ownership interest’’ for a restricted
profit interest (termed ‘‘carried interest’’
in the proposed rule2114) largely as
provided in the proposed rule. The final
rule, like the proposal, recognizes that
banking entities that serve as investment
adviser or provide other services to a
covered fund are routinely compensated
for such services through receipt of a
restricted profit interest. The final rule,
also like the proposal, generally
excludes restricted profit interest from
the definition of ownership interest
subject to conditions designed to
distinguish restricted profit interest,
which serves as a form of compensation,
from an investment in the fund
prohibited (or limited) by section 13. As
explained in detail below, the definition
of restricted profit interest in the final
rule has been modified from the
proposal in several aspects to respond to
commenters’ concerns and to more
effectively capture the types of
compensation that is often granted in
exchange for services provided to a
fund. However, like the proposal, the
final rule continues to contain a number
of requirements designed to ensure that
restricted profit interest functions as
compensation for providing certain
services to a covered fund and does not
permit a banking entity to evade the
investment limitations or other
requirements of section 13.
Under the final rule, restricted profit
interest is defined to include an interest
held by an entity (or employee or former
employee thereof) that serves as
investment manager, investment
adviser, commodity trading advisor, or
other service provider so long as:
(i) The sole purpose and effect of the
interest is to allow the entity (or an employee
or former employee thereof) to share in the
profits of the covered fund as performance
compensation for the investment
management, investment advisory,
commodity trading advisory, or other
services provided to the covered fund by the
entity (or employee or former employee
thereof), provided that the entity (or
employee or former employee thereof) may
be obligated under the terms of such interest
to return profits previously received;
(ii) all such profit, once allocated, is
distributed to the entity (or employee or
former employee thereof) promptly after
2113 See
2114 See

TCW.
supra note 2091 and accompanying text.

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being earned or, if not so distributed, is
retained by the covered fund for the sole
purpose of establishing a reserve amount to
satisfy contractual obligations with respect to
subsequent losses of the covered fund and
such undistributed profit of the entity (or
employee or former employee thereof) does
not share in subsequent investment gains of
the covered fund;
(iii) any amounts invested in the covered
fund, including any amounts paid by the
entity (or employee or former employee
thereof) in connection with obtaining the
restricted profit interest, are within the
investment limitations of § ll.12; and
(iv) the interest is not transferable by the
entity (or employee or former employee
thereof) except to an affiliate thereof (or an
employee of the banking entity or affiliate),
to immediate family members, or through the
intestacy of the employee or former
employee, or in connection with a sale of the
business that gave rise to the restricted profit
interest by the entity (or employee or former
employee thereof) to an unaffiliated party
that provides investment management,
investment advisory, commodity trading
advisory, or other services to the fund.2115

The final rule, like the proposal, permits
any entity (or the affiliate or employee
thereof) to receive or hold restricted
profit interest if the entity (or the
affiliate or employee thereof) serves as
investment manager, investment
adviser, commodity trading advisor, or
other service provider to the covered
fund. For example, an entity that
provides services to the covered fund in
a capacity as sub-adviser or placement
agent would be eligible to receive or
hold restricted profit interest.
As requested by commenters, the first
condition in the final rule, in contrast to
the proposal, permits an employee or
former employee to retain a restricted
profit interest after a change in
employment status so long as the
restricted profit interest was originally
received as compensation for qualifying
services provided to the covered fund.
Also in response to issues raised by
commenters, the second condition in
the final rule has been modified to
permit so-called ‘‘clawback’’ features
whereby restricted profit interest that
has been provided to an investment
manager, investment adviser,
commodity trading advisor, or similar
service provider may be taken back if
certain subsequent events occur, such as
if the fund fails to achieve a specified
preferred rate of return or if liabilities or
subsequent losses are incurred by the
fund. Under these circumstances, the
Agencies believe it is appropriate to
allow the allocated but undistributed
profits to be clawed back from the
service provider’s performance
compensation, and the final rule has
2115 See

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5709

been amended to allow this practice.
The final rule makes clear, however,
that the undistributed profits may only
be held in the fund in connection with
such a clawback arrangement.
Undistributed profits that remain in the
covered fund after they have been
allocated without connection to such an
arrangement would be deemed to be an
investment in the fund and would be an
ownership interest under the final rule.
Importantly, the final rule also retains
the limitation in the proposal that
undistributed profit may not share in
subsequent investment gains of the
covered fund. This limitation (together
with the limited circumstances under
which the undistributed profit may be
retained in the fund) appears necessary
in order to distinguish restricted profit
interest, which functions as
performance compensation and is not
intended to be a form of investment,
from an ownership interest, which is
designed to be an investment. The
Agencies believe that this approach
achieves an appropriate balance
between accommodating receipt of
restricted profit interest, including such
amounts held in ‘‘reserve,’’ 2116 and
limiting the ability of a banking entity
to evade the investment limitations of
section 13. The Agencies expect to
review restricted profit interests to
ensure banking entities do not use the
exclusion for restricted profit interest in
a manner that functions as an evasion of
section 13.
As noted above, the Agencies
understand that entities that provide
investment management, investment
advisory, commodity trading advisory
or other services to a covered fund may,
in connection with receiving restricted
profit interest, be required to hold a
small amount of ownership interests in
a fund to provide the basis for desired
tax treatment of restricted profit interest.
Accordingly, the third condition of the
final rule allows an entity that provides
qualifying services to a fund to
contribute funds to, and have an
ownership interest in, the fund in
connection with receiving restricted
profit interest. As under the proposal,
the amount of the contribution must be
counted toward the investment limits
under section 13(d)(4) and § ll.12 of
the final rule. This would include
attribution to the banking entity of sums
invested by employees in connection
with obtaining a restricted profit
interest. Thus, the final rule permits a
2116 The Agencies believe that this addresses a
commenter’s concern regarding the ‘‘reserve’’
portion of carried interest discussed above; however
such amounts may not share in subsequent
investment gains of the covered fund for the reasons
also discussed above.

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banking entity that provides investment
management, investment advisory, or
commodity trading advisory services to
have both an ownership interest in, and
receive restricted profit interest from,
the covered fund, so long as the
aggregate of the sums invested in all
ownership interests acquired or retained
by the banking entity (including a
general partnership interest), either in
connection with receiving the restricted
profit interest or as an investment, are
within the investment limitations in
section 13(d)(4) and § ll.12 of the
final rule. The Agencies believe this
more appropriately implements the
requirements of section 13 of the BHC
Act by permitting banking entities to
continue to provide customer-driven
investment management services
through organizing and offering covered
funds, while also abiding by the
investment limitations of section 13.
In response to comments, the fourth
condition of the final rule permits the
transfer of a restricted profit interest in
connection with a sale to an unaffiliated
party that provides investment
management, investment advisory,
commodity trading advisory, or other
services to the fund. In response to
comments, the final rule also permits
the transfer of a restricted profit interest
to immediate family members of the
banking entity’s employees or former
employees that provide investment
management, investment advisory,
commodity trading advisory, or other
services to the covered fund, or in
connection with the death of such
employee. Also in response to
comments, the final rule permits the
transfer of a restricted profit interest to
an affiliate or employee that provides
investment management, investment
advisory, commodity trading advisory,
or other services to the covered fund.
However, the final rule, like the
proposed rule, would treat a restricted
profit interest as an ownership interest
if the restricted profit interest is
otherwise transferable. This remaining
restriction recognizes that a freely
transferable restricted profit interest has
the same economic benefits as an
ownership interest and is essential to
differentiating a restricted profit interest
from an ownership interest.
f. Definition of ‘‘Resident of the United
States’’
Section 13(d)(1)(I) of the BHC Act
provides that a foreign banking entity
may acquire or retain an ownership
interest in or act as sponsor to a covered
fund, but only if that activity is
conducted according to the
requirements of the statute, including
that no ownership interest in the

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covered fund is offered for sale or sold
to a ‘‘resident of the United States.’’ The
statute does not define this term.
Under the proposed rule, the term
‘‘resident of the United States’’ was used
in the context of the exemptions for
covered trading and covered fund
activities. As proposed, the definition of
resident of the United States was
similar, but not identical, to the SEC’s
definition of U.S. person in Regulation
S, which governs offerings of securities
outside of the United States.2117 The
Agencies proposed this approach in
order to promote consistency and
understanding among market
participants that have experience
with the concept from the SEC’s
Regulation S.
Some commenters supported the
proposed definition of resident of the
United States.2118 One commenter
suggested that the proposed rule defined
resident of the United States too broadly
and inappropriately precluded
investments in U.S. funds by foreign
banking entities.2119
Other commenters generally argued
that the final rule should adopt the
definition of ‘‘U.S. person’’ under the
SEC’s Regulation S without the
modifications in the proposed rule.2120
According to many commenters, market
participants are familiar with and rely
upon the body of law interpreting U.S.
Person under Regulation S.2121 They
argued that, to the extent that the
definitions of ‘‘resident of the United
States’’ under section 13 and ‘‘U.S.
person’’ under Regulation S differ, this
would create unnecessary uncertainty
and increase compliance burdens
associated with monitoring multiple
definitions.2122 Other commenters urged
the Agencies not to depart from the
treatment of international parties and
organizations (e.g., the International
Monetary Fund and the World Bank)
under the SEC’s Regulation S.2123
Many commenters contended that,
because the definition of resident of the
United States in the proposal was
2117 See proposed rule § ll.2(t); 17 CFR
230.901–230.905.
2118 See, e.g., Occupy.
2119 See Sens. Merkley & Levin (Feb. 2012) (citing
156 Cong. Rec. S5897 (daily ed. July 15, 2010)
(statement of Sen. Merkley)).
2120 See, e.g., Union Asset; EFAMA; BVI; AFME
et al.; IIB/EBF; Credit Suisse (Williams); Hong Kong
Inv. Funds Ass’n.; PEGCC; UBS; Allen & Overy (on
behalf of Canadian Banks); Allen & Overy (on behalf
of Foreign Bank Group); AFG.
2121 See PEGCC; Allen & Overy (on behalf of
Canadian Banks); Allen & Overy (on behalf of
Foreign Bank Group); ICI (Feb. 2012); Credit Suisse
(Williams).
2122 See IIB/EBF; Credit Suisse (Williams); ICI
(Feb. 2012); ICI Global; PEGCC.
2123 See IIB/EBF; ICI Global; Credit Suisse
(Williams).

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generally broader than the definition of
U.S. person under Regulation S, many
additional types of persons, entities and
investors would be deemed residents of
the United States for purposes of the
foreign activity exemptions.
Commenters argued that this would
limit the potential for foreign banking
entities to effectively use those
statutorily provided exemptions. A few
commenters noted that using a
definition in the foreign fund exemption
that differs from the definition in
Regulation S loses the advantage of
using a term that is already understood
by market participants and that avoids
confusion and limits compliance
costs.2124
Other commenters suggested that
defining resident of the United States as
proposed presented problems for
investment funds managed by U.S.
investment advisers, even those without
U.S. investors.2125 Some commenters
argued that, under the proposed
definition, a foreign fund managed by a
U.S. investment adviser or sub-adviser
that is not otherwise subject to section
13 might be deemed a resident of the
United States, thereby disqualifying the
fund from relying on the foreign funds
exemption, a result inconsistent with
the purpose of section 13 and the
statutory exemption in section
13(d)(1)(I).2126
Commenters also argued that the
proposed definition raised issues for
compensation plans of international
organizations that are subject to section
13 of the BHC Act. Several commenters
argued that U.S. employees of a foreign
banking entity should not be considered
residents of the United States if they
invest in a non-U.S. covered fund
pursuant to a bona fide employee
investment, retirement or compensation
program.2127 The Agencies have
carefully considered the comments
received on the definition of resident of
the United States, and have determined
to modify the final rule as discussed
below. The term ‘‘resident of the United
States’’ is not defined in the statute and
is used by the statute to clarify when
2124 See Allen & Overy (on behalf of Foreign Bank
Group); IIB/EBF; PEGCC; Union Asset.
2125 See, e.g., MFA; TCW.
2126 See AFG; BVI. See also MFA; TCW.
Similarly, these commenters argued that although
treated as a non-U.S. person under Regulation S, a
non-U.S. fund organized as a trust in accordance
with local law with a limited number of U.S.
investors would have been a resident of the United
States. Under the proposal, this foreign fund could
not invest in another foreign covered fund Seeking
to rely on the exemption for covered fund activities
or investments that occur solely outside of the
United States.
2127 See IIB/EBF; Credit Suisse (Williams); UBS;
JPMC.

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
foreign activity or investment of a
foreign banking entity qualifies for the
foreign funds exemption in section
13(d)(1)(I). The purpose of this
exemption is to enable foreign banking
entities to continue to engage in foreign
funds activities and investments that do
not have a sufficient nexus to the United
States so as to present risk to U.S.
investors or the U.S. financial
system.2128 The purpose of Regulation S
is to provide a safe harbor from the
registration provisions under the
Securities Act for offerings that take
place outside of the United States.2129
The Agencies believe that, because
the covered funds provisions of the final
rule involve sponsoring covered funds
and offering and selling securities
issued by funds (as compared to
counterparty transactional
relationships), the securities law
framework reflected in Regulation S
would most effectively achieve the
purpose of the foreign funds exemption.
As noted by commenters and discussed
above, market participants are familiar
with and rely upon the body of law
interpreting U.S. Person under
Regulation S, and differing definitions
under section 13 and Regulation S could
create uncertainty and increase
compliance burdens associated with
monitoring multiple definitions. The
Agencies therefore have defined the
term ‘‘resident of the United States’’ in
the final rule to mean a ‘‘U.S. person’’
as defined in Regulation S.2130
In addition, as explained in detail
below in Part IV.B.4.b.3. of this
SUPPLEMENTARY INFORMATION, the final
rule provides that an ownership interest
is offered for sale or sold to a resident
of the United States if it is sold in an
offering that ‘‘targets’’ residents of the
United States.2131 As explained in more
detail in that section, this approach is
consistent with Regulation S.

sroberts on DSK5SPTVN1PROD with RULES

g. Definition of ‘‘Sponsor’’
Section 13(h)(5) of the BHC Act
defines ‘‘sponsor’’ to mean: (i) Serving
as a general partner, managing member,
or trustee of a covered fund; (ii) in any
manner selecting or controlling (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) sharing with a
covered fund, for corporate, marketing,
promotional, or other purposes, the
same name or a variation of the same
2128 See 156 Cong. Reg. S.5894–5895 (daily ed.
July 15, 2010) (statement of Sen. Merkley).
2129 Offers and Sales, Securities Act Release No.
6863 (Apr. 24, 1990), 55 FR 18,306 (May 2, 1990).
2130 See final rule § ll.10(d)(8).
2131 See infra Part IV.B.4.b.3.

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name.2132 Sponsor is a key definition
because it defines, in part, the scope of
activities to which the prohibition in
section 13(a)(1) applies.2133
Under the proposal, the term sponsor
would have been defined largely as in
the statute.2134 Nearly all commenters
who addressed the definition of sponsor
argued that the definition was too broad
and suggested various ways to narrow or
limit the definition.2135 Commenters
generally expressed concerns that a
sponsor to a covered fund became
subject to the restrictions of section
13(f), limiting the relationships of the
banking entity with the covered fund.
Commenters argued this would prevent
banking entities from providing many
customary services to covered funds.2136
The proposal excluded from the
definition of ‘‘trustee’’ as used in the
term sponsor 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
(‘‘ERISA’’) (29 U.S.C. 1103(a)(1)).2137 On
the other hand, the proposal provided
that any banking entity that directs a
directed trustee, or that possesses
authority and discretion to manage and
control the assets of a covered fund for
which a directed trustee serves as
trustee, would be considered a trustee of
the covered fund.
Commenters generally supported the
exception for directed trustees in the
proposed rule but argued that the
exception was too narrow because it
only referred to directed trustees under
section 403(a)(1) of the ERISA and did
not include other similar custodial or
administrative arrangements that may
not meet those requirements or be
subject to ERISA.2138 These commenters
2132 See

12 U.S.C. 1851(h)(5).
12 U.S.C. 1851(a)(1).
2134 See proposed rule ll.10(b)(5).
2135 A number of comments received regarding
the definition of sponsor relate to securitization
structures and are addressed below. There also were
a few comments urging that insurance companies
not be considered to sponsor their separate
accounts. See Sutherland (on behalf of Comm. of
Annuity Insurers); Nationwide. The Agencies
believe these concerns should be addressed by the
exclusion of separate accounts from the definition
of covered fund, as discussed in Part IV.B.1.c.6. of
this SUPPLEMENTARY INFORMATION.
2136 See, e.g., ASF (Feb. 2012); BNY Mellon et al.;
Credit Suisse (Williams).
2137 See proposed rule § ll.10(b)(6); See also 29
U.S.C. 1103(a)(1).
2138 See, e.g., Arnold & Porter; Ass’n. of Global
Custodians; BNY Mellon et al.; SIFMA et al.
(Covered Funds) (Feb. 2012); State Street (Feb.
2012); See also Fin. Services Roundtable (June 14,
2011) (recommending the definition of directed
trustee under the Board’s Regulation R be used,
which defines directed trustee to mean ‘‘a trustee
that does not exercise investment discretion with
respect to the account’’).
2133 See

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5711

argued that banking entities that serve
as trustees or custodians of covered
funds may provide a limited range of
ministerial services or exercise limited
fiduciary duties that, while not subject
to ERISA or beyond those permitted for
a directed trustee under ERISA,
nevertheless do not involve the exercise
of investment discretion or control over
the operations of the covered fund in
the same manner as a general partner or
managing member. Some of these
commenters advocated defining
‘‘directed trustee’’ more expansively to
include any situation in which a
banking entity serves solely in a
directed, fiduciary, or administrative
role where a third-party and not the
banking entity exercises investment
discretion.
In particular, some commenters also
argued that a trustee should not be
viewed as having investment discretion,
and therefore should not be treated as a
sponsor, if it possesses only the
authority to terminate an investment
adviser to a covered fund and to appoint
another unaffiliated investment adviser
in order to fulfill a demonstrable legal
or contractual obligation of the trustee,
or the formal but unexercised power to
make investment decisions for a covered
fund in circumstances where one or
more unaffiliated investment advisers
have been appointed to manage fund
assets. Some commenters argued in
favor of excluding trustees serving
under non-U.S. trust arrangements
pursuant to which they may have legal
or contractual authority to, but in fact
do not, exercise investment discretion
(i.e., the entity has the formal authority
to appoint an investment adviser to a
trust but does so only in extraordinary
circumstances such as appointing a
successor investment adviser).2139
A few commenters requested
confirmation that a banking entity
acting as a custodian should not be
considered a sponsor of a covered
fund.2140 One commenter argued that
traditional client trust accounts for
which a bank serves as discretionary
trustee should not, by implication,
themselves become ‘‘covered funds’’
that are ‘‘sponsored’’ by the bank.2141
2139 See BNY Mellon et al. (providing proposed
rule text or suggesting in the alternative
clarification regarding the phrase ‘‘exercise
investment discretion’’ in the final rule preamble);
Ass’n. of Global Custodians; ICI Global; State Street
(Feb. 2012).
2140 See Ass’n. of Global Custodians; SIFMA et al.
(Covered Funds) (Feb. 2012); ABA (Keating); AFG;
AFTI; BNY Mellon et al.; EFAMA; IMA; State Street
(Feb. 2012).
2141 See Arnold & Porter. To the extent that a
client trust account would not be an investment
company but for the exclusion contained in section

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sroberts on DSK5SPTVN1PROD with RULES

One commenter argued that any
person performing similar functions to a
directed trustee (such as a fund
management company established
under Irish law), regardless of its formal
title or position, also should be
excluded if the person does not exercise
investment discretion.2142 Some
commenters argued more generally for
an exclusion from the definition of
trustee (and therefore from the
definition of sponsor) for entities that
act as service providers (such as
custodians, trustees, or administrators)
to non-U.S. regulated funds, arguing
that European laws already impose
significant obligations on entities
serving in these roles.2143
Under both section 13 of the BHC Act
and the proposal, the definition of
sponsor also included the ability to
select or control (or to have employees,
officers, directors, or agents who
constitute) a majority of the directors,
trustees or management of a covered
fund. Some commenters argued that an
entity should not be treated as a sponsor
of a covered fund when it selects a
majority of the initial directors, trustees
or management of a covered fund that
are independent of the banking entity,
so long as the banking entity may not
remove or replace the directors, trustees,
or management and directors are
subsequently either chosen by others or
self-perpetuating.2144 One of these
commenters argued similarly that a
banking entity should not be deemed to
sponsor a covered fund if it selects an
independent general partner, managing
member or trustee of a new fund, so
long as the general partner, managing
member or trustee may not be
terminated and replaced by the banking
entity.2145 Commenters argued that
initial selection of these parties was
inherently part of, and necessary to
allow, the formation of a covered fund
and would not provide a banking entity
with ongoing control over the fund to a
degree that the banking entity should be
considered to be a sponsor.
The statute and proposed rule also
defined the term sponsor to include an
3(c)(1) or 3(c)(7) of the Investment Company Act,
such as the exclusion for common trust funds under
section 3(c)(3) of that Act, it would not be a covered
fund regardless of whether a banking entity acts as
trustee.
2142 See BNY Mellon et al.
2143 See EFAMA; F&C; IRSG; Union Asset.
2144 See SIFMA et al. (Covered Funds) (Feb. 2012)
(recommending the Agencies adopt independence
guidelines similar to the FDIC’s guidelines for
determining whether audit committee members of
insured depository institutions are ‘‘independent’’
of management); Credit Suisse (Williams).
2145 See Credit Suisse (Williams) (arguing that
such an approach would be consistent with the
existing BHC Act concept of control with respect to
funds).

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entity that shares, for corporate,
marketing, promotional, or other
purposes, the same name or a variation
of the same name, with a covered fund.
One commenter argued in favor of a
narrower interpretation of this statutory
provision.2146 This commenter argued
that a covered fund should be permitted
to share the name of the asset manager
that advises the fund without the asset
manager becoming a sponsor so long as
the asset manager does not share the
same name as an affiliated insured
depository institution or the ultimate
parent of an affiliated insured
depository institution.2147 Another
commenter argued that the proposal
would put U.S. banking entities at a
competitive disadvantage relative to
non-banking entities and foreign
banks.2148 These commenters argued
that the costs of rebranding covered
funds or an asset manager would far
outweigh any potential benefit in terms
of reducing the risk that a banking entity
may be pressured to ‘‘bail out’’ a
covered fund with a name similar to its
investment manager.2149 One
commenter also requested clarification
that the name sharing prohibition does
not apply in the context of offering
documents that carry the names of the
manager, sponsor, distributor, as well as
the name of the fund itself.2150 This
commenter also advocated that, because
of the costs associated with changing a
fund name, the Agencies give specific
guidance regarding how similar a name
may be so as not to be a ‘‘variation of
the same name’’ for purposes of the
definition of sponsor and the activities
permitted under section 13(d)(1)(G) and
§ ll.11 of the rule.
The Agencies have carefully
considered comments received in light
of the terms of the statute. Section
13(h)(5) of the BHC Act specifically
defines the term ‘‘sponsor’’ for purposes
of section 13. The Agencies recognize
that the broad definition of sponsor in
the statute will result in some of the
effects commenters identified, as
discussed above.
2146 A number of comments were also received
regarding the restriction on name sharing that is one
of the requirements of section 13(d)(1)(G) and
§ ll.11 of the proposed rule. These comments are
discussed in Part IV.B.2.a.5. of this SUPPLEMENTARY
INFORMATION.
2147 See Credit Suisse (Williams); See also ABA
(Keating); BlackRock; Goldman (Covered Funds);
SIFMA et al. (Covered Funds) (Feb. 2012); TCW
(proposing similarly to limit the name-sharing
restriction to the insured depository institution in
context of section 13(d)(1)(G)).
2148 See Goldman (Covered Funds).
2149 See Credit Suisse (Williams); See also
Goldman (Covered Funds).
2150 See Credit Suisse (Williams).

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The final rule generally retains the
definition of ‘‘sponsor’’ in the statute
and the proposed rule, although with
certain modifications and clarifications
to respond to comments received
regarding the exclusion for ‘‘directed
trustees.’’ As in the proposed rule, the
definition of sponsor in the final rule
covers an entity that (i) serves as general
partner, managing member, or trustee of
a covered fund, or that serves as a
commodity pool operator of a covered
fund as defined in § ll.10(b)(1)(ii) of
the final rule, (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, for
corporate, marketing, promotional, or
other purposes, the same name or a
variation of the same name.2151
While commenters urged the
Agencies to provide an exemption from
the definition of sponsor for a banking
entity that selects the initial directors,
trustees, or management of a fund,2152
the final rule has not been modified in
this manner because the initial selection
of the directors, trustees or management
of a fund is an action characteristic of
a sponsor and is essential to the creation
of a covered fund. The Agencies note,
however, that the statute and the final
rule allow banking entities to sponsor
covered funds, including selecting the
initial board of directors, trustees and
management, so long as the banking
entity observes certain requirements and
conforms any initial investment in the
covered fund to the limits in the statute
and regulation during the relevant
conformance period as discussed in Part
IV.B.3.b. of this SUPPLEMENTARY
INFORMATION.2153 Moreover, a banking
entity that does not continue to select or
control a majority of the board of
directors would not be considered to be
a sponsor under this part of the
definition once that role or control
terminates. In the case of a covered fund
that will have a self-perpetuating board
2151 See final rule § ll.10(d)(9). Some
commenters asserted that custodians and service
providers should not treated as sponsors under the
final rule. The Agencies note, however, that a
banking entity is not a sponsor under the final rule
unless it serves in one or more of the capacities
specified in the definition; controls or makes up the
fund’s board of directors or management as
described in the final rule; or shares the same name
or a variation of the same name with the fund as
described in the final rule. See, e.g., supra note
2151 and accompanying text. See also infra note
2155.
2152 See supra note 2144 and accompanying text.
2153 Similarly, a banking entity may share the
same name or a variation of the same name with
a covered fund so long as the banking entity does
not organize and offer the covered fund in
accordance with section 13(d)(1)(G) and § ll.11.

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sroberts on DSK5SPTVN1PROD with RULES

of directors or a board selected by the
fund’s shareholders, this would not be
considered to have occurred until the
board has held its first re-selection of
directors or first shareholder vote on
directors without selection or control by
the banking entity.
As explained below, the Agencies
believe that, in context, the term trustee
in the definition of the term sponsor
refers to a trustee with investment
discretion. Consistent with this view,
commenters urged the Agencies to
exclude from the definition of sponsor
certain trustees and parties commenters
asserted acted in a similar capacity, as
discussed above.2154 The final rule
therefore has been modified to exclude
from the definition of trustee: (i) a
trustee that does not exercise
investment discretion with respect to a
covered fund, including a trustee that is
subject to the direction of an
unaffiliated named fiduciary who is not
a trustee pursuant to section 403(a)(1) of
the Employee’s Retirement Income
Security Act (29 U.S.C. 1103(a)(1)); or
(ii) a trustee that is subject to fiduciary
standards imposed under foreign law
that are substantially equivalent to those
described in paragraph (i).2155 Under
the final rule, a trustee would be
excluded if the trustee does not have
any investment discretion, but is
required to ensure that the underlying
assets are appropriately segregated for
the benefit of the trust. Similarly, a
trustee would be excluded if the trustee
has no investment discretion but is
authorized to replace an investment
adviser with an unaffiliated party when
the investment adviser resigns. With
respect to an issuing entity of assetbacked securities and as explained
below, a directed trustee excluded from
the definition of sponsor would include
a person that conducts their actions
solely in accordance with directions
prepared by an unaffiliated party.
The Agencies believe that this
exclusion is appropriate because the
relevant prong of the definition of
sponsor (i.e., serving as general partner,
managing member, or trustee) specifies
entities that have the ongoing ability to
exercise control over a fund; directed
trustees excluded from definition of
sponsor in the final rule do not appear
to have this ability and thus do not
2154 See, e.g., supra notes 2138–2139 and
accompanying text. See also supra note 2151.
2155 See final rule § ll.10(d)(10). With respect to
the concept of a ‘‘directed trustee’’ under foreign
law, commenters generally requested changes only
if non-U.S. mutual fund equivalents were not
excluded from the definition of covered fund. As
discussed above, the final rule explicitly excludes
foreign public funds from the definition of covered
fund, which should address these commenters
concerns. See final rule § ll.10(c)(1).

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appear to be the type of entity that this
prong of the definition of sponsor was
intended to capture. If a trustee were
itself to assume the role of investment
adviser, or have the ability to exercise
investment discretion with respect to
the covered fund, the trustee would not
qualify for this exclusion. The final rule
does not include within the definition
of sponsor custodians or administrators
of covered funds unless they otherwise
meet the definitional qualifications set
forth in section 13 and the final rule.
The definition of sponsor will
continue to cover entities that share the
same name or variation of the same
name of a covered fund for corporate,
marketing, promotional, or other
purposes, consistent with the definition
of sponsor in section 13(h)(5). The
Agencies recognize that some
commenters urged the Agencies to
modify this aspect of the definition of
sponsor, and that the name-sharing
prohibition included in the definition of
sponsor (and in the conditions for the
organize and offer exemption) will
require some banking entities to rebrand
their covered funds, which may prove
expensive and will limit the extent to
which banking entities may continue to
benefit from brand equity they have
developed.2156 The costs a banking
entity would incur to rebrand its
covered funds would depend on the
cost to rebrand the banking entity’s
current funds, as well as the banking
entity’s ability to attract new investor
capital to its current and future covered
funds. The total burden per banking
entity, therefore, would depend on the
brand equity as well as the number of
covered funds that share a similar
name.2157 One commenter argued that,
as a result, banking entities subject to
section 13 may be at a competitive
disadvantage to other firms that are not
subject to these or similar
restrictions.2158 The Agencies believe
that the final rule addresses some
commenters’ concerns to an extent by
adopting a more tailored definition of
covered, including a focused definition
of foreign funds that will be covered
funds and an exclusion for foreign
public funds.2159 In addition, to the
extent that a banking entity would
otherwise come under pressure for
reputational reasons to directly or
2156 See supra notes 2146–2150 and
accompanying text.
2157 See infra note 2159.
2158 See supra note 2148 and accompanying text.
2159 For example, one commenter argued that it
would need to rebrand approximately 500
established funds under the rule proposal if the
final rule was not modified to exclude established
and regulated funds in foreign jurisdictions. See
Goldman (Covered Funds).

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5713

indirectly assist a covered fund under
distress that bears the banking entity’s
name, the name-sharing prohibition
could reduce the risk to the banking
entity this assistance could pose.
B. Definition of Sponsor With Respect to
Securitizations
Commenters on the definition of
sponsor in the context of securitization
vehicles generally argued that the
proposed definition of sponsor was too
broad and requested clarification that
various roles that banking entities might
serve within a securitization structure
would be excluded from the definition
of sponsor, including servicers; 2160
backup servicers and master
servicers; 2161 collateral agents and
administrators; 2162 custodians; 2163
indenture trustees; 2164 underwriters,
distributors, placement agents; 2165
arrangers, structuring agents; 2166
originators, depositors, securitizers; 2167
‘‘sponsors’’ under the SEC’s Regulation
AB; 2168 administrative agents; 2169 and
securities administrators and
remarketing agents.2170 Commenters
argued that these parties should not be
included in the definition of sponsor
because such parties have clearly
defined and extremely limited authority
and discretion,2171 do not have the right
to control the decision-making and
operational functions of the issuer,2172
2160 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); Credit Suisse (Williams);
SIFMA (Securitization) (Feb. 2012); Wells Fargo
(Covered Funds). One of these commenters argued
that servicers will not have the right to control the
decision-making and operational functions of the
issuer. See SIFMA (Securitization) (Feb. 2012).
Another commenter stated that servicers do not
have the authority to select assets or make
investment decisions on behalf of investors. See
PNC.
2161 See ASF (Feb. 2012).
2162 Id.
2163 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012).
2164 Id.
2165 See Cleary Gottlieb; Credit Suisse (Williams);
SIFMA (Securitization) (Feb. 2012); Wells Fargo
(Covered Funds). One of these commentators
argued that placement agents and underwriters will
not have the right to control the decision-making
and operational functions of the issuer. See SIFMA
(Securitization) (Feb. 2012).
2166 See Cleary Gottlieb (‘‘party that structures the
asset-backed securities’’); SIFMA (Securitization)
(Feb. 2012).
2167 See Credit Suisse (Williams); Wells Fargo
(Covered Funds).
2168 See SIFMA (Securitization) (Feb. 2012)
(arguing that Regulation AB sponsors will not have
the right to control the decision-making and
operational functions of the issuer after they deposit
the assets).
2169 See Credit Suisse (Williams).
2170 See ASF (Feb. 2012); Wells Fargo (Covered
Funds).
2171 See Allen & Overy (on behalf of Foreign Bank
Group).
2172 See SIFMA (Securitization) (Feb. 2012).

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and would not have ‘‘control’’ under
BHC Act control precedent.2173
Conversely, one commentator supported
defining sponsor under the proposed
rule to include the Regulation AB
sponsor, the servicer and the investment
manager.2174 Commenters also made
arguments regarding the potential
detrimental effects to securitization and
credit markets if banking entities are
prohibited from acting as sponsors of
securitizations.2175
Commenters disagreed as to whether
or not a sponsor under the final rule
should include a party with any
investment discretion, some investment
discretion or complete investment
discretion. Some commenters argued
that certain parties should not be
considered a sponsor because they were
not an investment advisor or did not
have investment discretion.2176 Other
commenters argued that an entity
should not be considered a sponsor
even though it has limited investment
discretion,2177 while others argued that
2173 See

Credit Suisse (Williams).
Occupy.
2175 See ASF (Feb. 2012); Credit Suisse
(Williams).
2176 See ASF (Feb. 2012) (arguing that service
providers, including trustees, custodians, collateral
agents, servicers, master servicers, backup servicers,
securities administrators, remarketing agents and
collateral administrators, should not be considered
the sponsor or investment manager of a fund under
section 13 of the BHC Act because they have roles
that are principally ministerial in nature and do not
generally involve investment discretion or
management and control activities); PNC (arguing
that a banking entity should not be deemed a
sponsor simply by serving as underwriter,
distributor, placement agent, originator, depositor,
investment adviser, servicer, administrative agent,
securitizer or similar role because these parties do
not have the authority to select assets or make
investment decisions on behalf of investors).
2177 See Allen & Overy (on behalf of Foreign Bank
Group); ASF (Feb. 2012); SIFMA (Securitization)
(Feb. 2012). One commenter argued that the limited
discretion that a servicer, trustee or custodian may
have to either invest funds within certain
parameters, liquidate assets following a default on
the asset or the securitization default, or mitigate
losses subject to a servicing standard, should not be
considered a sponsor because these entities do not
exercise the level of management and control
exercised by the general partner or managing
member of a hedge fund or private equity fund.
Another commenter argued that to the extent that
any of these parties exercises discretion, such
discretion (A) involves decisions made after another
party defaults (e.g., post-event of default collateral
sale), (B) prescribed by the transaction documents
(e.g., choosing among a limited number of eligible
investments) and (C) governed by standards of care
(e.g., the servicing standards). See ASF (Feb. 2012).
Another commenter requested clarification that the
exclusion of trustees that do not exercise
investment discretion would also cover trustees that
(A) direct investment of amounts in accordance
with the applicable transaction documents, (B) act
as servicer pending the appointment of a successor
or (C) liquidate collateral. See SIFMA
(Securitization) (Feb. 2012). One commenter argued
that the definition of sponsor should not include an
investment manager unless the investment manager

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investment advisers and parties with
investment discretion should not be
included in the definition of
sponsor.2178
After considering comments received
and the language and purpose of section
13, the Agencies have determined not to
adopt a separate definition of sponsor
for issuers of covered funds that are
issuers of an asset-backed security. As
described above and consistent with the
statute, the definition of sponsor only
includes parties that: (i) Serve as a
general partner, managing member, or
trustee (other than a directed trustee) of
a covered fund; (ii) have the right to
select or control a majority of the
directors, trustees, or management of a
covered fund; or (iii) share with a
covered fund, for corporate, marketing,
promotional, or other purposes, the
same name or a variation of the same
name. If the parties that commenters
described do not serve in those
capacities for a covered fund, do not
have those rights with respect to a
covered fund or do not share a name
with a covered fund, such parties would
not be a sponsor for purposes of the
final rule, and, therefore, they would
not be subject to the restrictions
applicable to the sponsor of a covered
fund, including the restrictions
contained in section 13(f).2179
Additionally, the Agencies believe
that the exclusion of loan securitizations
from the definition of covered fund
under the final rule addresses many of
the commenters’ concerns about the
sponsor definition because this
exclusion limits the types of
securitizations that are covered funds
and subject to the final rule. Similarly,
the exclusion of certain ABCP conduits
from the definition of covered fund will
mean that the restrictions under section
13(f) will not apply to qualifying assetbacked commercial paper conduits.
As with any other covered fund under
the final rule, the term sponsor would
(A) serves in one of the capacities designated in the
definition of sponsor and can be replaced at the
discretion of one or more entities serving in such
capacity or with or without cause by the security
holders or (B) has the ‘‘discretion to acquire or
dispose of assets in the securitization for the
primary purpose of recognizing gains or decreasing
losses resulting from market value changes.’’ Id.
2178 See Credit Suisse (Williams); SIFMA
(Securitization) (Feb. 2012); TCW (arguing that the
investment manager is typically unaffiliated with
the general partner or equivalent of such fund, does
not control the board of directors, is not responsible
for the operations or books and records of the fund
and generally does not perform any other
significant function for the fund, such as acting as
transfer agent).
2179 As discussed above, commenters argued that
that various roles that banking entities might serve
within a securitization structure should be
excluded from the definition of sponsor. See supra
notes 2160–2170 and accompanying text.

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include a trustee that has the right to
exercise any investment discretion for
the securitization. For issuers of assetbacked securities, this would generally
not include a trustee that executes
decision-making, including investment
of funds prior to the occurrence of an
event of default, solely according to the
provisions of a written contract or at the
written direction of an unaffiliated
party. In addition, under the rule as
adopted a trustee with investment
discretion may avoid characterization as
a sponsor if it irrevocably delegates all
of its investment discretion to another
unaffiliated party with respect to the
covered fund. The Agencies believe that
these considerations regarding when a
trustee is a sponsor responds to
commenters’ concerns regarding the
roles of trustees in securitizations.2180
2. Section ll.11: Activities Permitted
in Connection With Organizing and
Offering a Covered Fund
Section 13(d)(1)(G) of the BHC Act
permits a banking entity to make
investments in and sponsor covered
funds within certain limits in
connection with organizing and offering
the covered fund.2181 Section ll.11 of
the final rule implements this statutory
exemption, and includes several
changes from the proposed rule in
response to concerns raised by
commenters as described in detail
below.2182
a. Scope of Exemption
Section ll.11 of the proposed rule
described the conditions that must be
met in order to qualify for the
exemption provided by section
13(d)(1)(G) for covered fund activities
conducted in connection with
organizing and offering a covered
fund.2183 These conditions generally
mirrored section 13(d)(1)(G) of the
statute, and included: (i) The banking
entity must provide bona fide trust,
fiduciary, investment advisory, or
commodity trading advisory
services; 2184 (ii) the covered fund must
2180 The Agencies also note that, while the
entities commenters identified may not fall into the
definition of sponsor, the ability of a banking entity
to acquire and retain an interest in a securitization
that is a covered fund will depend on whether it
conducts its activity in a manner permitted under
one of the exemptions contained in section 13(d)(1)
of the BHC Act, such as the exemption for
organizing and offering a covered fund.
2181 156 Cong. Rec. S5889 (daily ed. July 15, 2010)
(statement of Sen. Hagan) (arguing that section 13
permits a banking entity to engage in a certain level
of traditional asset management business).
2182 See final rule § ll.11; proposed rule
§ ll.11.
2183 See proposed rule §§ ll.11(a)–(h).
2184 While section 13(d)(1)(G) of the BHC Act
does not explicitly mention ‘‘commodity trading

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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 banking
entity may not acquire or retain an
ownership interest in the covered fund
except in accordance with the
limitations on amounts and value of
those interests as permitted under
subpart C of the proposed rule; (iv) the
banking entity must comply with the
restrictions governing relationships with
covered funds under § ll.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, may not share the same name
or a variation of the same name with the
banking entity (or an affiliate or
subsidiary thereof), and 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; (viii) the
banking entity must 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 § ll.11(h) of the
proposed rule; and (ix) the banking
entity must 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.2185
Commenters raised concern that the
proposed rule could be read to extend
advisory services,’’ the Agencies proposed to treat
commodity trading advisory services in the same
way as investment advisory services because the
proposed rule would have included commodity
pools within the definition of ‘‘covered fund.’’ One
commenter argued that a covered banking entity
should not be permitted to qualify for the
exemption in section 13(d)(1)(G) based on
providing commodity trading advisory services. See
Occupy. The Agencies believe that commodity
trading advisors provide services to commodity
pools that are similar to the services an investment
adviser provides to a hedge fund or private equity
fund. Because certain commodity pools are
included within the definition of covered fund,
banking entities may organize and offer these
commodity pools as a means of providing these
services to customers.
2185 See proposed rule §§ ll.11(a)–(h).

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the prohibition on covered fund
activities beyond the scope intended by
the statute.2186 Because the proposed
exemption was applicable to banking
entities engaged in ‘‘organizing and
offering’’ a covered fund, commenters
were concerned that the proposed rule
might be interpreted to prohibit a
banking entity from engaging in
activities that are part of organizing and
offering a covered fund but that are not
prohibited under the covered fund
prohibition. In this regard, commenters
contended that the activity of
‘‘organizing and offering’’ a covered
fund would include serving as
investment adviser, distributor, broker,
and other activities not prohibited by
section 13 of the BHC Act and not
involving the acquisition or retention of
an ownership interest in or sponsorship
of a covered fund as those terms are
defined in section 13.2187
The Agencies have modified the final
rule to address this concern, which
reflects a reading of the proposal not
intended by the Agencies. Section
13(d)(1)(G) of the BHC Act by its terms
provides an exemption from section
13(a) of the BHC Act, which prohibits a
banking entity from acquiring or
retaining an equity, partnership or other
ownership interest in or sponsoring a
covered fund. To the extent that an
activity is not prohibited by section
13(a), no exemption to that statutory
prohibition is needed to conduct that
activity. However, it is common for
prohibited and non-prohibited activities
to be conducted together in connection
with offering and organizing a covered
fund. For example, an entity that
provides investment advisory services
to a covered fund (an activity not itself
prohibited by section 13(a)(1)(B) of the
BHC Act) often acquires an ownership
interest in a covered fund and/or
appoints a majority of management of
the covered fund (which is included in
the definition of sponsor under the
statute), both of which are covered by
the statutory prohibition in section
13(a)(1)(B). In that case, the banking
entity may engage in the prohibited
activity as part of organizing and
offering a covered fund only if the
prohibited activity is conducted in
accordance with the requirements in the
exemption in section 13(d)(1)(G) or
some other exemption.
The final rule reflects this view in that
it permits a banking entity to invest in
or sponsor a covered fund in connection
with organizing and offering the fund,
which may involve activities that are
not prohibited by section 13. Under the

final rule, a banking entity that serves as
an investment adviser to a covered fund
(including a sub-adviser), for example,
may permissibly invest in the covered
fund to the extent the banking entity
complies with the requirements of
section 13(d)(1)(G) of the Act. An entity
that serves only as investment adviser,
without making any investment or
conducting any activity covered by the
prohibition in section 13(a), would not
be covered by the prohibition in section
13(a) and thus would not need to rely
on section 13(d)(1)(G) and § ll.11 of
the final rule to conduct that investment
advisory activity.
As described in more detail below, a
number of commenters expressed
concern about applying the
requirements of section 13(d)(1)(G) and
the final rule outside of the United
States, including with respect to foreign
public funds organized and offered by
foreign banking entities, particularly in
situations where requirements in foreign
jurisdictions may conflict with the
requirements of section 13 of the BHC
Act and implementing regulations.2188
The Agencies believe that many of the
concerns raised with respect to applying
section 13(d)(1)(G) and the proposed
rule outside the United States have been
addressed through the revised definition
of covered fund described above and
revisions to the exemption provided for
activities conducted solely outside the
United States. In particular, the revised
definition of covered fund makes clear
that a foreign fund offered outside the
United States is only a covered fund
under specified circumstances with
respect to a banking entity that is, or is
controlled directly or indirectly by a
banking entity that is, located in or
organized or established under the laws
of the United States or of any State.2189
Furthermore, foreign public funds are
excluded from the definition of covered
fund in the final rule.2190 Consequently,
a foreign banking entity may invest in
or organize and offer a variety of funds
outside of the United States without
becoming subject to the requirements of
section 13(d)(1)(G) and § ll.11 of the
final rule, such as the name-sharing
restriction or limitations on director and
employee investments.
1. Fiduciary Services
In order to qualify for the exemption
for activities related to organizing and
offering a covered fund, section
13(d)(1)(G) generally requires that a
banking entity provide bona fide trust,
fiduciary, investment advisory, or
2188 See,

2186 See,

e.g., Arnold & Porter.
2187 See Arnold & Porter; F&C.

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5715

e.g., EFAMA; ICI Global; JPMC.
final rule § ll.10(b)(1)(iii).
2190 See final rule § ll.10(c)(1).
2189 See

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commodity trading advisory services,
that the covered fund be organized and
offered in connection with providing
these services, and that the banking
entity providing those services offer the
covered fund only to persons that are
customers of those services of the
banking entity.2191 These requirements
were largely mirrored in the proposed
rule. 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.2192
As noted in the proposal, section
13(d)(1)(G)(ii) of the BHC Act does not
explicitly require that the customer
relationship be pre-existing.
Accordingly, the Agencies explained in
the proposal that the customer
relationship 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
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 requirement is consistent with
the manner in which these services are
provided by banking entities. The
proposed rule also required that a
banking entity relying on the authority
contained in § ll.11 adopt a credible
plan or similar documentation outlining
how the banking entity intended to
provide advisory or similar services to
its customers through organizing and
offering such fund.
Several commenters indicated
support for this customer requirement
and, in particular, the Agencies’ view
that the customer relationship need not
be a preexisting one.2193 A few
commenters contended that the statute
required that a banking entity have a
pre-existing customer relationship, and
may not solicit investors outside of its
existing asset management
customers.2194 One of these commenters
argued that this would place banking
entities at a competitive disadvantage
compared to investment advisers that
are not banking entities (and thus not
subject to the requirements of section 13
and the final rule), but argued that this
is a necessary result of section 13.2195

The final rule adopts the language
largely as proposed, and the Agencies
continue to believe that the customer
relationship required under section
13(d)(1)(G) and the final rule 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 manifestation of the
provision by the banking entity of bona
fide trust, fiduciary, investment
advisory, or commodity trading
advisory services to the customer.2196
The final rule requires that a covered
fund be organized and offered pursuant
to a written plan or similar
documentation outlining how the
banking entity (or an affiliate thereof)
intends to provide advisory or similar
services to its customers through
organizing and offering the fund. As
part of this requirement, the plan must
be credible and indicate that the
banking entity has conducted
reasonable analysis to show that the
fund is organized and offered for the
purpose of providing bona fide trust,
fiduciary, investment advisory, or
commodity trading advisory services to
customers of the banking entity (or an
affiliate thereof) and not to evade the
restrictions of section 13 of the BHC
Act.
The language of the final rule also
adopts the statutory requirements (and
modifications related to commodity
pools as discussed above) that the
banking entity provide bona fide trust,
fiduciary, investment advisory, or
commodity trading advisory services,
and that the covered fund be organized
and offered only in connection with the
provision of those services. 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.2197
Historically, banking entities have used
covered funds as a method of providing
these services to customers in a manner
that is both cost efficient for the
customer and allows customers to
benefit from access to advice and
services that might not otherwise be
available to them. These benefits apply
to long-established customers as well as
individuals or entities that have no preexisting relationship with the banking

2191 See 12 U.S.C. 1851(d)(1)(G)(i); proposed rule
§ ll.11(a).
2192 See 156 Cong. Rec. at S5897 (daily ed. July
15, 2010) (statement of Sen. Merkley).
2193 See Ass’n of Institutional Investors (Feb.
2012); SIFMA et al. (Covered Funds) (Feb. 2012);
JPMC.
2194 See Sens. Merkley & Levin (Feb. 2012); AFR
et al. (Feb. 2012); Occupy; Public Citizen.
2195 See Sens. Merkley & Levin.

2196 See final rule § ll.11(a)(1)–(2). See Part
IV.B.2.b. below for a discussion of these
requirements in the context of a banking entity that
organizes and offers a covered fund that is an
issuing entity of asset-backed securities.
2197 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. Part 362 (with
respect to a state non-member bank).

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entity but choose to obtain the benefit
of trust, fiduciary, investment advisory,
or commodity trading advisory services
through participation in the covered
fund. Covered funds also allow
customers to gauge the historical record
of the banking entity in providing these
services by reviewing the funds’ past
performance.
The statute does not require that a
covered fund be offered only to preexisting customers of the banking entity,
and the Agencies believe that imposing
such a requirement would not improve
the quality of the trust, fiduciary,
investment advisory, or commodity
trading advisory service, enhance the
safety and soundness of the banking
entity, or reduce the risks to the
customers or the banking entity. In each
case, the banking entity provides trust,
fiduciary or advisory services to a
covered fund for the benefit of the
banking entity’s customers, and the
statute recognizes that organizing and
offering a covered fund is a legitimate
method for providing that service. In
addition, the banking entity must abide
by all the statutory and prudential
requirements imposed by section 13 and
the entity’s supervisors on the provision
of those services. The Agencies do not
believe that a pre-existing customer
relationship requirement would be
meaningful because it could easily be
satisfied by a prospective customer
seeking to invest in a covered fund by
first establishing an account with a
banking entity or purchasing another
product (e.g., a brokerage account or
shares of a mutual fund).
2. 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 as an
investment.2198 Both the proposed rule
and the final rule implement this
provision by requiring that a banking
entity limit its investments in a covered
fund that the banking entity organizes
and offers as provided in § ll.12.2199
Comments received on investment
limitations in the proposed rule, and
modifications made to the final rule
implementing these limitations, are
described in Part IV.B.3. below.
3. Compliance With Section 13(f) of the
BHC Act
Section ll.11(d) of the proposed
rule required that the banking entity
comply with the limitations on
2198 See
2199 See

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
relationships with covered funds
imposed by section 13(f) of the BHC
Act.2200 The final rule adopts this
requirement and provides that the
banking entity (and its affiliates) must
comply with the requirements of
§ ll.14. Section 13(f) of the BHC Act
prohibits certain transactions or
relationships that would be covered by
section 23A of the Federal Reserve Act,
and provides that any permitted
transaction is subject to section 23B of
the Federal Reserve Act, in each
instance as if such banking entity were
a member bank and such covered fund
were an affiliate thereof.2201 These
limitations apply in several contexts,
and are contained in § ll.14 of the
final rule, discussed in detail below in
Part IV.B.5.

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4. No Guarantees or Insurance of Fund
Performance
Section ll.11(e) of the proposed
rule prohibited a banking entity that
organizes and offers a covered fund
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.2202
This prong implemented section
13(d)(1)(G)(iv) of the BHC Act and was
intended to prevent a banking entity
from engaging in bailouts of a covered
fund in which the banking entity has an
interest.2203
There were only a few comments
received on this aspect of the proposal.
One commenter supported the
restriction on guarantees as effective
and consistent with the statute.2204
One commenter argued that the final
rule should not prohibit borrower
default indemnification services (i.e.,
the guarantee of collateral sufficiency
upon a securities borrower’s default)
provided to lending clients by agent
banks in connection with securities
lending transactions involving a covered
fund.2205 This commenter argued that
borrower default indemnification
services guarantee only the deficit
between the mark to market value of
cash collateral received and the amount
of any borrower default, and are
therefore different from and more
limited than the type of general
2200 12 U.S.C. 1851(d)(1)(G)(iv); proposed rule
§ ll.11(d).
2201 See Part IV.B.5. below. The comments
received on section 13(f) and § ll.16 of the
proposed rule are described below.
2202 12 U.S.C. 1851(d)(1)(G)(v); proposed rule
§ ll.11(e).
2203 See 156 Cong. Rec. S5897 (daily ed. July 15,
2010) (statement of Sen. Merkley).
2204 See Occupy.
2205 See RMA.

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investment performance or obligation
guarantee that section 13 was designed
to prevent.
The Agencies believe that the statute
does not permit either full or partial
guarantees of the obligations of a
covered fund that the banking entity
organizes and offers. Accordingly, the
final rule, like the proposed rule,
continues to mirror the statutory
restriction on direct or indirect
guarantees of the obligations or
performance of a covered fund by a
banking entity in connection with
reliance on the exemption provided in
section 13(d)(1)(G) of the BHC Act.
However, in response to comments
received on the proposal, the Agencies
note that the provision of a borrower
default indemnification by a banking
entity to a lending client in connection
with securities lending transactions
involving a covered fund is not
prohibited. This type of indemnification
is not a guarantee of the performance or
obligations of a covered fund because it
represents a guarantee to the customer
or borrower of the obligation of the
counterparty to perform and not a
guarantee of the performance or
underlying obligations of the covered
fund. The requirement of the final rule
that a banking entity and its affiliates
not guarantee the obligations or
performance of a covered fund that it
organizes and offers therefore does not
prohibit a banking entity from providing
borrower default indemnifications to
customers.
5. Limitation on Name Sharing With a
Covered Fund
Section ll.11(f) of the proposed rule
prohibited the covered fund from
sharing the same name or a variation of
the same name with the banking entity
that relies on the exemption in section
13(d)(1)(G) of the BHC Act.2206 The
proposed rule also prohibited the
covered fund from using the word
‘‘bank’’ in its name.2207
The name-sharing restriction was one
of the most commented upon aspects of
§ ll.11. A number of commenters on
this section expressed the view that the
name-sharing restriction in section
13(d)(1)(G)(vi) of the BHC Act and the
proposed rule was too strict. In
particular, a number of commenters
2206 12 U.S.C. 1851(d)(1)(G)(vi); proposed rule
§ ll.11(f).
2207 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).

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5717

argued that the name-sharing restriction
should allow an asset manager to share
its name with a sponsored covered fund
so long as the covered fund does not
share the name of the insured
depository institution or its affiliated
holding company or use the word
‘‘bank.’’ 2208
Commenters argued that the namesharing restriction as proposed would
impose significant business and
branding burdens on the industry
without providing incremental benefit
to the public.2209 These commenters
argued that it would be unduly
burdensome and costly for funds
currently affiliated with banking entities
or managers that are themselves banking
entities to change the name of their
affiliated funds and that many of these
funds have developed a reputation in
the marketplace based on the current
name of the fund and/or fund manager.
Some of these commenters argued that
the name-sharing restriction would
place asset managers and funds
affiliated with banking entities at a
competitive disadvantage to other asset
managers and funds.2210
A few commenters argued that the
rationale for the name-sharing
restriction (i.e., to discourage bailing out
funds) was already addressed under
other restrictions of section 13(d)(1)(G)
and the proposed rule that prohibit a
banking entity from, directly or
indirectly, guaranteeing, assuming or
otherwise insuring the obligations or
performance of the covered fund or of
any covered fund in which such
covered fund invested and that require
disclosure that investments in the
covered fund are not insured by the
Federal Deposit Insurance
Corporation.2211 These commenters
questioned the necessity for the namesharing restriction when a prohibition
on bailing out funds is already in place
and where there is disclosure that
investors bear the risk of loss in the
fund. Some of these commenters
contended it was unlikely that investors
in a covered fund with an SECregistered investment adviser that has a
name unrelated to the name of an
insured depository institution would be
2208 See ABA (Keating); Ass’n of Institutional
Investors (Feb. 2012); Blackrock; EFAMA; SIFMA et
al. (Covered Funds) (Feb. 2012); TCW; Katten (on
behalf of Int’l Clients); Union Asset.
2209 See, e.g., ABA (Keating); Ass’n of
Institutional Investors (Feb. 2012); Blackrock; See
also SVB; Katten (on behalf of Int’l Clients); SIFMA
et al. (Covered Funds) (Feb. 2012); UBS.
2210 See Ass’n of Institutional Investors (Feb.
2012); Katten (on behalf of Int’l Clients); SIFMA et
al. (Covered Funds) (Feb. 2012).
2211 See Ass’n of Institutional Investors (Feb.
2012); SIFMA et al. (Covered Funds) (Feb. 2012); T.
Rowe Price; TCW.

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misled to believe that the fund would be
backed in any way by a related insured
depository institution or the Federal
Deposit Insurance Corporation.2212 One
of these commenters argued that the
name-sharing restriction should not
apply to organizations where insured
depository institutions represent a de
minimis component of the
organization’s operations.2213
Other commenters recommended that
the name-sharing restriction not be
applied to covered funds that rely on
the exemption for covered fund
activities and investments that occur
solely outside of the United States.2214
A few commenters expressed concern
that the name-sharing restriction could
be incompatible with regulatory
requirements in certain foreign
jurisdictions that a covered fund’s name
must indicate the fund’s connection
with the fund sponsor.2215 One
commenter argued that it is common
practice in Germany to disclose the
designation of the sponsoring
investment manager in the fund name in
order to provide transparency to
investors, while a few commenters
contended that European jurisdictions,
including the U.K., require an
authorized fund to have a name
representative of the authorized
investment manager to avoid misleading
fund investors.2216 Commenters also
argued that the name-sharing restriction
was inconsistent with the laws of
Ireland and Hong Kong.2217 Certain
commenters argued that the impact of
the name-sharing restriction would be
particularly unfair to non-U.S. retail
funds like European UCITS if such
funds are not allowed to use the name
of the bank while U.S. mutual funds
would not be subject to the same
restriction.2218
By contrast, some commenters
supported the name-sharing restriction.
For example, one commenter indicated
that the use of the word ‘‘bank’’ or a
shared name in the fund’s name was
already strongly discouraged by prior
guidance.2219 Another commenter
2212 See

TCW; Union Asset.
T. Rowe Price.
2214 See, e.g., UBS.
2215 See Credit Suisse (Williams); EFAMA; JPMC;
Katten (on behalf of Int’l Clients); Union Asset; IAA;
ICI Global; UBS; SIFMA et al. (Covered Funds) (Feb.
2012) (citing Directive 2004/39/EC of the European
Parliament and Council).
2216 See BVI; EFAMA; JPMC; UBS; Union Asset;
ICI Global; IAA.
2217 See UBS; Union Asset; ICI Global.
2218 See, e.g., AFG; ICI Global; JPMC.
2219 See Arnold & Porter (citing SEC Division of
Investment Management, Letter to Registrants (May
13, 1993); Memorandum to SEC Chairman Breeden
from Division of Investment Management (May 6,
1993); FDIC, Board, OCC, OTS, Interagency

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2213 See

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supported the name-sharing restriction
but argued it did not go far enough
because it did not apply to funds that a
banking entity was permissibly allowed
to sponsor and invest in under other
provisions of section 13.2220 According
to this commenter, covered funds
permitted under other exemptions
should not be allowed to share the same
name with the banking entity.2221
After carefully considering comments
and the express terms of the statute, the
final rule includes the name-sharing
restriction as proposed.2222 The namesharing restriction is imposed by the
statute and prohibits a banking entity
from sharing the same name or variation
of the same name with a covered fund.
The statute also defines the scope of the
prohibition by defining the term
‘‘banking entity’’ to generally include
any affiliate or subsidiary of an insured
depository institution or any company
that controls an insured depository
institution.2223
However, the Agencies believe that
many of the concerns raised by
commenters with respect to this
provision should be addressed through
the revised definition of covered fund in
the final rule, and modifications to the
exemption for covered fund activities
and investments that occur solely
outside of the United States.2224 For
example, as discussed in greater detail
above in Part IV.B.1.c.1., foreign public
funds sold outside the United States are
excluded from the definition of covered
fund.2225 In addition, pursuant to the
definition of covered fund in the final
rule, a foreign fund only becomes a
covered fund with respect to a U.S.
banking entity (including a foreign
affiliate of that U.S. banking entity) that
acts as sponsor to, or has an ownership
interest in, the fund. Moreover,
numerous funds operate successfully
with names that differ from the name of
the fund sponsor or adviser.
The Agencies recognize, however,
that the statutory name-sharing
restriction may affect some entities that
will be covered funds and that cannot
rely on another permitted activity
exemption under section 13(d)(1) and
the final rule. The name-sharing
restriction may result in certain costs
Statement on Retail Sales of Non-Deposit
Investment Products (Feb. 14, 1994)).
2220 See Occupy the SEC at 165.
2221 See id.
2222 See final rule § ll.11(f).
2223 See 12 U.S.C. 1851(d)(1)(G)(vi) & (h)(1).
2224 For example, one commenter alleged that it
would need to rebrand approximately 500
established funds if the final rule was not modified
to exclude established and regulated funds in
foreign jurisdictions. See Goldman (Covered
Funds).
2225 See final rule §§ ll.10(b)(1)(ii) & (c)(1).

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and other economic burdens for banking
entities that advise these funds, as
discussed in greater detail in Part
IV.B.1.g. above.2226 However, as the
Agencies also note above, to the extent
that the restriction results in a banking
entity not otherwise coming under
pressure for reputational reasons to
directly or indirectly assist a covered
fund under distress that shares the
banking entity’s name, the name-sharing
prohibition could reduce the risk to the
banking entity that this assistance might
pose. The Agencies also expect that the
conformance period, both for
compliance with section 13 of the BHC
Act generally and for funds that are
illiquid funds, should be sufficient to
allow covered funds to take the steps
necessary to comply with the namesharing restriction in the statute and
final rule.
6. Limitation on Ownership by Directors
and Employees
Section ll.11(g) of the proposed
rule implemented section
13(d)(1)(G)(vii) of the BHC Act. That
statutory 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.2227 This allows an individual
employed by a banking entity, who also
acts as fund manager or adviser (for
example), to acquire or retain an
ownership interest in a covered fund
that aligns the manager or adviser’s
incentives with those of the banking
entity’s customers.2228
One commenter argued that only
employees or directors who provide
investment advisory services should be
allowed to make an investment in the
fund and that the rule should not allow
employees or directors who provide
other, unspecified services to invest in
a fund.2229 This commenter argued that
the proposed rule would allow nonadviser banking entity employees who
have no need to maintain ‘‘skin in the
game’’ to earn profit on the fund’s
performance. According to another
commenter, fiduciary clients of banking
organizations often are less interested in
whether the fund manager or other
service providers have money in the
fund than whether the client’s own
account manager, and those individuals
2226 See

Part IV.B.1.g.
12 U.S.C. 1851(d)(1)(G)(vii); proposed
rule § ll.11(g).
2228 See 156 Cong. Rec. S5897 (daily ed. July 15,
2010) (statement of Sen. Merkley).
2229 See Occupy.
2227 See

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above him/her who are responsible for
investment decisions, have allocated his
or her own assets in the same way and
into the same general asset classes and
funds as the client’s fiduciary account is
being allocated.2230
The more prevalent view among
commenters was that the proposed rule
should be revised and expanded to
permit investments in a sponsored fund
by a broader group of banking entity
directors, officers, and employees,
directly or indirectly through employee
benefit programs or trust and fiduciary
accounts, regardless of whether the
individual provides services to the
covered fund.2231 Some commenters
argued that narrowly limiting
permissible director and employee
investments could put asset managers
affiliated with an insured depository
institution at a competitive
disadvantage relative to managers that
are not affiliated with an insured
depository institution,2232 as well as
make it more difficult for banking
entities to offer their U.S. and non-U.S.
employees similar choices in retirement
plans.2233
Two commenters urged that the
supervisors of a fund’s portfolio
managers or investment advisers should
be permitted to invest.2234 These
commenters also argued that
individuals who provide support
services to the fund, including
administrative, oversight and risk
management, legal compliance,
regulatory, product structuring, deal
sourcing and origination, deal
evaluation and diligence, investor
relations, sales and marketing, tax,
accounting, valuation and other
operational support services, should be
permitted to invest in the fund. These
commenters also requested confirmation
that any director, including an
individual serving on the board or
investment committee of a fund or its
manager, should be permitted to
invest.2235 Another commenter argued
that employees and directors should be
permitted to make their own individual
investment decisions independently
without regard to whether they provide
services to the covered fund.2236 One
commenter contended that a
2230 See

Arnold & Porter.
Arnold & Porter; BOK, Credit Suisse
(Williams); Fin. Services Roundtable (Jun. 14,
2011); PEGCC; T. Rowe Price.
2232 See Credit Suisse (Williams).
2233 See T. Rowe Price.
2234 See Credit Suisse (Williams); Fin. Services
Roundtable (Jun. 14, 2011).
2235 See Credit Suisse (Williams); Fin. Services
Roundtable (Jun. 14, 2011).
2236 See BOK (citing proposed rule at § ll.17);
Arnold & Porter.

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2231 See

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grandfathering approach is necessary to
address situations where a pre-existing
covered fund already has investments
from directors and employees who do
not directly provide services to the fund
because the fund may be unable to force
those individuals out of the fund.2237
A number of commenters argued that,
if defined too narrowly, this restriction
may conflict with the laws of other
jurisdictions that require advisers
and/or their directors and employees to
invest in the funds they manage.2238 For
example, several commenters argued
that this requirement will directly
conflict with the European Alternative
Investment Fund Managers
Directive.2239 Two commenters
contended that certain jurisdictions,
including the Netherlands, require
directors and other personnel of fund
managers to hold fund units or shares of
funds managed by the fund manager as
part of their pensions.2240
The final rule retains the requirement
limiting the ownership of a covered
fund by directors and employees of a
banking entity (or an affiliate thereof)
relying on the exemption in section
13(d)(1)(G) of the BHC Act.2241 This
limitation is imposed by statute on
banking entities that rely on this
exemption. If a director or employee
does not provide services to the fund,
they may not invest in that fund. As in
the statute, the final rule allows
employees who provide services to the
fund other than investment advisory
services to invest in the fund. Under the
final rule, directors or employees who
provide investment advice or
investment management services to the
fund may invest in that fund. Similarly,
directors or employees who provide
services that enable the provision of
investment advice or investment
management, such as oversight and risk
management, deal origination, due
diligence, administrative or other
support services, may also invest in the
fund. In response to comments, the final
rule has been modified to make clear
that a former director or employee may
retain an interest in a covered fund if
the director or employee acquired the
interest while serving as a director or
employee of the banking entity and
providing investment advisory or other
services to the covered fund.
2237 See

SVB.
EFAMA; BVI; IAA; ICI Global; JPMC;
Union Asset.
2239 See Annex II para. 1(m). Directive 2011/61/
EU of the European Parliament and the Council of
8 June 2011 on Alternative Investment Fund
Managers.
2240 See EFAMA; Union Asset.
2241 See final rule § ll.11(g).
2238 See

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5719

The Agencies believe that many of the
concerns raised by commenters
regarding the effects of this limitation
on foreign funds are addressed through
the scope of foreign funds that will be
covered funds, and revisions to the
exemption provided for covered fund
activities and investments that occur
solely outside of the United States.
Moreover, the final rule excludes
foreign public funds and broad-based
foreign pension funds from the
definition of covered fund and they are
thus not subject to the restrictions of
section 13 or the final rule.2242
Section 13 clearly contemplates
investments by certain employees and
directors of the banking entity.2243
However, the Agencies continue to
believe that certain 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 the final rule. In order to
address this concern, the final rule
attributes an ownership interest in a
covered fund acquired or retained by a
director or employee to a banking entity
for purposes of the investment limits in
section 13(d)(4) under certain
circumstances. This attribution is
discussed in detail below in Part
IV.B.3.f.
7. Disclosure Requirements
Section ll.11(h) of the proposed
rule required that, in connection with
organizing and offering a covered fund,
the banking entity clearly and
conspicuously disclose, in writing, to
prospective and actual investors in the
covered fund that any losses in the
covered fund will be borne solely by
investors in the covered fund and not by
the banking entity and its affiliates or
subsidiaries; and that the banking
entity’s and its affiliates’ or subsidiaries’
losses in the 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. In addition, the proposed rule
required that a banking entity disclose,
in writing: (i) That each investor should
read the fund offering documents before
investing in 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
2242 See final rule §§ ll.10(c)(1) and
ll.10(c)(5).
2243 See 12 U.S.C. 1851(d)(1)(G)(vii).

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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. The proposed rule
also required banking entities to comply
with any additional rules of the
appropriate Agency designed to ensure
that losses in any covered fund are
borne solely by the investors in the
covered fund and not by the banking
entity.2244 In proposing the rule, the
Agencies indicated that a banking entity
may satisfy these disclosure
requirements by making the required
disclosures in the covered fund’s
offering documents.2245
A few commenters supported the
disclosure requirement as effective and
consistent with the statute.2246 One
commenter stated that the disclosures
required in section 13(d)(1)(G)(viii) of
the Act and the proposed rule are
consistent with disclosures in the
banking agencies’ February 1994
‘‘Interagency Statement on Retail Sales
of Non-deposit Investment Products’’
and other FINRA and SEC guidance.2247
One commenter suggested that the rule
include a requirement that the
disclosures be issued in plain
English.2248
Another commenter argued that the
Agencies should revise the disclosure
requirements under the proposal so that
offering materials of non-U.S. funds
provided to non-U.S. investors outside
the United States need not include the
specified disclosures nor refer to the
FDIC or other specific U.S. agencies.2249
This commenter argued that a non-U.S.
person investing in a non-U.S. fund
offered or sponsored by a non-U.S.
banking entity has no expectation that
the fund or its interests would be
insured by the FDIC. The Agencies
believe this concern is addressed
through the revised definition of
covered fund, which generally provides
that a foreign fund offered outside of the
United States will only be a covered
fund with respect to a U.S. banking
entity (including a foreign affiliate of the
2244 12 U.S.C. 1851(d)(1)(G)(viii); proposed rule
§ ll.11(h).
2245 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.
2246 See, e.g., Occupy.
2247 See Arnold& Porter.
2248 See Occupy.
2249 See Katten (on behalf of Int’l Clients).

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U.S. banking entity) that acts as sponsor
to, or invests in, the fund.2250
The final rule adopts the proposed
disclosure requirements substantially as
proposed. As explained above, these
disclosures are largely required by the
statute.2251 The proposed requirement
to disclose that ownership interests in a
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) is not expressly
required by the statute. However,
section 13(d)(1)(G)(iii) permits the
Agencies to impose additional rules
designed to ensure that losses in a
covered fund are borne solely by
investors in the fund and not by a
banking entity. The Agencies believe
that requiring a banking entity to make
this disclosure as part of organizing and
offering a covered fund furthers this
purpose by removing the potential for
misperception that a covered fund
sponsored by a banking entity (which by
definition must be affiliated with a
depository institution insured by the
FDIC) is guaranteed by that insured
institution or the FDIC. Moreover, as
noted above, this disclosure is already
commonly provided by banking entities.
b. Organizing and Offering an Issuing
Entity of Asset-Backed Securities
To the extent that an issuing entity of
asset-backed securities is a covered
fund, the investment limitations
contained in section 13(d)(4) of the BHC
Act also would limit the ability of a
banking entity to acquire or retain an
investment in that issuer. Section 941 of
the Dodd-Frank Act added a new
section 15G of the Exchange Act (15
U.S.C. 78o–11) which requires a
banking entity to retain and maintain a
certain minimum interest in certain
asset-backed securities.2252 In order to
give effect to this separate requirement
under the Dodd-Frank Act,
§ ll.14(a)(2) of the proposed rule
permitted a banking entity that is a
‘‘securitizer’’ or ‘‘originator’’ under the
provisions of that Act to acquire or
retain an ownership interest in an issuer
of asset-backed securities, in an amount
(or value of economic interest) required
to comply with the minimum
requirements of section 15G of the
final rule § ll.10(b)(1)(iii).
12 U.S.C. 1851(d)(1)(G)(viii).
2252 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
24,090 (Apr. 29, 2011). Those agencies recently
issued a re-proposal of the risk-retention
requirements. See Credit Risk Retention, 78 FR
57,928 (Sept. 20, 2013).
2250 See
2251 See

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Exchange Act and any implementing
regulations issued thereunder.2253 The
proposal also permitted a banking entity
to act as sponsor to the securitization.
Commenters expressed a variety of
views on the treatment of interests in
securitizations held under risk retention
pursuant to the proposed rule. Some
commenters argued that the proposal
was effective as written and represented
a reasonable way to reconcile the two
sections of the Dodd-Frank Act
consistent with the risk-reducing
objective of section 13 of the BHC
Act.2254 Other commenters also
supported the proposal’s recognition
that banking entities may be required to
hold a certain amount of risk in a
securitization that would also be a
covered fund, but argued that the
proposed exemption was too
narrow.2255
After carefully considering the
comments received on the proposal, as
well as the language and purpose of
section 13 of the BHC Act, the final rule
provides an exemption that permits a
banking entity to organize and offer a
covered fund that is an issuing entity of
asset-backed securities.2256 The
Agencies have determined to provide
this exemption in order to address the
unique circumstances and ownership
structures presented by
securitizations.2257 Under the final rule,
a banking entity may permissibly
organize and offer a covered fund that
is an issuing entity of asset-backed
securities so long as the banking entity
(and its affiliates) comply with all of the
requirements of § ll.11(a)(3) through
(a)(8).2258 As discussed above, the
requirements of § ll.11(a)(3) through
ll.11(a)(8) are that: (i) The banking
entity and its affiliates do not acquire or
retain an ownership interest in the
covered fund except as permitted under
§ ll.12 of the final rule; 2259 (ii) the
2253 See
2254 See

proposed rule § ll.14(a)(2)(iii).
Sens. Merkley & Levin (Feb. 2012); Alfred

Brock.
2255 See, e.g., AFME et al.; SIFMA (Securitization)
(Feb. 2012); JPMC; BoA.
2256 See final rule § ll.11(b).
2257 As used in this Supplementary Information,
the term ‘‘securitization’’ means a transaction or
series of transactions that result in the issuance of
asset-backed securities.
2258 See final rule § ll.11(b) (providing the
requirements for a banking entity that is organizing
and offering a covered fund that is an issuing entity
of asset-backed securities by reference to the
requirements of § ll.11(a), as discussed above).
2259 As explained in detail below in Part IV.B.3.
addressing the limitations on investments in
covered funds by a banking entity, the final rule
permits a banking entity to acquire and retain
ownership interests in a covered fund in order to
comply with section 15G of the Exchange Act (15
U.S.C.78o–11) in an amount that does not exceed
the amount required to comply with the banking
entity’s chosen method of compliance under section

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banking entity and its affiliates comply
with the requirements of § ll.14 of the
final rule; (iii) the banking entity and its
affiliates do not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests; (iv)
the covered fund, for corporate,
marketing, promotional, or other
purposes, does not share the same name
or variation of the same name with the
banking entity (or an affiliate thereof)
and does not use the word ‘‘bank’’ in its
name; (v) no director or employee of the
banking entity (or an affiliate thereof)
takes or retains an ownership interest in
the covered fund except under the
limited circumstances noted in the final
rule; and (vi) the banking entity
complies with the disclosure
requirements regarding covered funds in
the final rule.
The Agencies believe that the
requirements of the exemption for
organizing and offering a covered fund
that is an issuing entity of asset-backed
securities, which are in most aspects
consistent with the exemption for
organizing and offering a covered fund
in section 13(d)(1)(G), provide
limitations on a banking entity’s
securitization activities involving
covered funds that are consistent with
the limitations imposed with respect to
organizing and offering a covered fund
that is not an issuing entity of assetbacked securities. For instance, a
banking entity may not share the same
name as a covered fund that is an
issuing entity of asset-backed securities
and is prohibited from guaranteeing or
otherwise ‘‘bailing out’’ a covered fund
that is an issuing entity of asset-backed
securities, including being required to
comply with section 13(f) of the BHC
Act regarding covered transactions with
the covered fund. Furthermore, like a
banking entity’s investment in any
covered fund, the final rule limits the
ability of a banking entity to invest in
a covered fund that is an issuing entity
of asset-backed securities unless it
meets the requirements of § ll.12.
Unlike many other covered funds, the
Agencies understand that banking
entities might not act in a fiduciary
capacity when they organize and offer a
covered fund that is a securitization
vehicle. For instance, as part of
organizing and offering a securitization
vehicle, one or more parties may
typically organize and initiate the
securitization by selling or transferring
assets, either directly or indirectly, to an
issuing entity of asset-backed securities.
15G and the implementing regulations issued
thereunder.

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An entity that provides these services
typically does so as a service to provide
investors and the entity’s customers
with the ability to invest in the assets in
a manner and to a degree that they may
otherwise be unable to do. In order to
identify certain activities that would be
included as organizing and offering a
securitization, the final rule provides
that organizing and offering an issuing
entity of asset-backed securities means
acting as the securitizer, as that term is
used in section 15G(a)(3) of the
Exchange Act, for the issuer, or
acquiring or retaining an ownership
interest in the issuer in compliance with
the implementing regulations issued
under section 15G of that Act.
The final rule reflects, as discussed
above, that one or more parties that
organize and offer an issuing entity of
asset-backed securities may not provide
any of the services identified in
§ ll.11(a)(1). In this case the banking
entity is not required to comply with
§ ll.11(a)(1) or (a)(2). Section
ll.11(b) of the final rule is designed
to address situations where, as
discussed above, a banking entity does
not act in a fiduciary capacity when it
organizes and offers a covered fund that
is a securitization vehicle. With respect
to any securitization vehicle that retains
a collateral manager for investment
advice regarding the assets of the
securitization vehicle, such a collateral
manager would be required to comply
with all of the provisions of § ll.11(a)
to acquire and retain an ownership
interest in such securitization vehicle.
The final rule therefore both identifies
certain activities that would be included
as organizing and offering a
securitization and modifies the
requirements of § ll.11 to reflect
differences between securitizations and
other types of covered funds, as
discussed above. The Agencies believe,
therefore, that the final rule
appropriately addresses the type of
activity that is usually associated with
organizing and offering a securitization
and also comports with the manner in
which Congress chose to define the type
of parties engaged in activities that
merit special attention related to issuing
entities of asset-backed securities in
another part of the Dodd-Frank Act.
The Agencies have determined to
provide this exemption by using their
authority in section 13(d)(1)(J) of the
BHC Act and believe that this
exemption promotes and protects the
safety and soundness of banking entities
and the financial stability of the United
States. Many companies and other
entities utilize securitization
transactions to efficiently manage,
allocate and distribute risks throughout

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5721

the markets in a manner consistent with
meeting the demands of their investors.
Companies also utilize securitizations in
order to help provide liquidity to certain
asset classes or portions of the market
that, absent this liquidity, may
experience decreased liquidity and
increased costs of funding. For instance,
if banking entities were not permitted to
organize and offer a securitization, the
Agencies believe this would result in
increased costs of funding or credit for
many businesses of all sizes that are
engaged in activities that section 13 of
the BHC Act was not designed to
address. Additionally, this exemption
enables banking entities to acquire and
retain ownership interests in a covered
fund to comply with section 15G of the
Exchange Act, which requires certain
parties to a securitization transaction to
retain a minimum amount of risk in a
securitization, a requirement not
applicable to covered funds that are not
securitizations. The Agencies therefore
have determined that this exemption
will promote and protect the safety and
soundness of banking entities and the
financial stability of the United States
by facilitating the benefits
securitizations can provide as discussed
above, and also by enabling banking
entities to comply with section 15G of
the Exchange Act.
The Agencies believe it would not be
consistent with the safety and
soundness of banking entities or the
financial stability of the United States to
prevent banking entities from acquiring
or retaining ownership interests in
securitizations as part of the permitted
activity of organizing and offering
securitizations or from meeting any
applicable requirements related to
securitizations, including those imposed
under section 15G of the Exchange Act.
The Agencies note that the exemption
for organizing and offering a
securitization does not relieve banking
entities of any requirements that they
may be subject to with respect to their
investments in or relationships with a
securitization, such as any applicable
requirements regarding conflicts of
interest relating to certain
securitizations under section 27B of the
Securities Act of 1933.
c. Underwriting and Market Making for
a Covered Fund
Section 13(d)(1)(B) permits a banking
entity to purchase and sell securities
and other instruments described in
13(h)(4) in connection with certain
underwriting or market making-related
activities.2260 The proposal did not
2260 See

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discuss how this exemption applied in
the context of underwriting or market
making of ownership interests in
covered funds.
Commenters argued that the scope of
the permitted activities under sections
13(d)(1)(B), (D) and (F), which
respectively set out permitted activities
of underwriting and market makingrelated activities, activities on behalf of
customers, and activities by a regulated
insurance company, apply to all of the
activities prohibited under section 13(a),
whether those activities would involve
proprietary trading or ownership of or
acting as a sponsor to covered funds.2261
Commenters argued that the statutory
exemption for underwriting and market
making-related activities is applicable to
both proprietary trading and covered
fund activities, and recommended that
the final rule allow banking entities to
hold ownership interests and other
securities of covered funds for the
purpose of underwriting and engaging
in market making-related activities.2262
Commenters noted that many structured
finance vehicles rely on sections 3(c)(1)
and 3(c)(7) of the Investment Company
Act, and argued that, without a market
making exemption for securities of
covered funds, banking entities would
be unable to engage in customer-driven
underwriting and market making
activity with respect to securities issued
by entities such as collateralized loan
obligation issuers and non-U.S.
exchange-traded funds.2263
After careful review of the comments
in light of the statutory provisions, the
final rule has been modified to provide
a covered fund specific provision for
underwriting and market making-related
activities of ownership interests in
covered funds. These underwriting and
market making activities are within the
scope of permitted activities under the
final rule so long as:

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• The banking entity conducts the
activities in accordance with the
requirements of § ll.4(a) or § ll.4(b),
respectively;
2261 See Cleary Gottlieb et al.; JPMC; Credit Suisse
(Williams).
2262 See BoA; Cleary Gottlieb; Credit Suisse
(Williams); SIFMA et al. (Covered Funds) (Feb.
2012); See also Deutsche Bank (Fund-Linked
Products); SIFMA (Securitization) (Feb. 2012).
Other commenters argued that application of
Section 13(f) of the BHC Act would prohibit the
underwriting and market making by a banking
entity of the securities of a covered fund that such
banking entity sponsors, organizes and offers or
provides investment management advice or services
because Section 13(f) of the BHC Act prohibits the
purchase of securities by a banking entity from such
a covered fund. See, e.g., ASF (Feb. 2012); Cleary
Gottlieb; Credit Suisse (Williams); SIFMA
(Securitization) (Feb. 2012); FSA (Feb. 2012).
2263 See JPMC; Cleary Gottlieb.

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• With respect to any banking entity (or an
affiliate thereof) that: Acts as a sponsor,
investment adviser or commodity trading
advisor to a particular covered fund or
otherwise acquires and retains an ownership
interest in such covered fund in reliance on
§ ll.11(a); acquires and retains an
ownership interest in such covered fund and
is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act, or is
acquiring and retaining an ownership interest
in such covered fund in compliance with
section 15G of that Act and the implementing
regulations issued thereunder each as
permitted by § ll.11(b); or, directly or
indirectly, guarantees, assumes, or otherwise
insures the obligations or performance of the
covered fund or of any covered fund in
which such fund invests, then in each such
case any ownership interests acquired or
retained by the banking entity and its
affiliates in connection with underwriting
and market making related activities for that
particular covered fund are included in the
calculation of ownership interests permitted
to be held by the banking entity and its
affiliates under the limitations of § ll
.12(a)(2)(ii) and § ll.12(d); and
• With respect to any banking entity, the
aggregate value of all ownership interests of
the banking entity and its affiliates in all
covered funds acquired and retained under
§ ll.11, including all covered funds in
which the banking entity holds an ownership
interest in connection with underwriting and
market making related activities under § ll
.11(c), are included in the calculation of all
ownership interests under § ll.12(a)(2)(iii)
and § ll.12(d).2264

The Agencies believe that providing a
separate provision relating to permitted
underwriting and market making-related
activities for ownership interests in
covered funds is supported by section
13(d)(1)(B) of the BHC Act.2265 The
exemption for underwriting and market
making-related activities under section
13(d)(1)(B), by its terms, is a statutorily
permitted activity and exemption from
the prohibitions in section 13(a),
whether on proprietary trading or on
covered fund activities. Applying the
statutory exemption in this manner
accommodates the capital raising
activities of covered funds and other
issuers in accordance with the
underwriting and market making
provisions under the statute.
The final rule provides that a banking
entity must include any ownership
interests that it acquires or retains in
connection with underwriting and
market making-related activities for a
particular covered fund for purposes of
the per-fund limitation under § ll
final rule § l.11(c).
discussion of the implementation of
section 13(d)(1)(D) and (F) with regard to the final
rule’s limitations on covered fund investments and
activities is provided in the section that relates to
permitted covered fund interests and activities by
a regulated insurance company and § ll.13(c) of
the final rule.
2264 See
2265 A

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.12(a)(2)(ii) if the banking entity: (i) Acts
as a sponsor, investment adviser or
commodity trading advisor to the
covered fund; (ii) otherwise acquires
and retains an ownership interest in the
covered fund as permitted under § ll
.11(a); (iii) acquires and retains an
ownership interest in the covered fund
and is either a securitizer, as that term
is used in section 15G(a)(3) of the
Exchange Act, or is acquiring and
retaining an ownership interest in the
covered fund in compliance with
section 15G of that Act and the
implementing regulations issued
thereunder each as permitted by § ll
.11(b); or (iv) directly or indirectly
guarantees, assumes, or otherwise
insures the obligations or performance
of the covered fund or of any covered
fund in which such fund invests. This
is designed to prevent any unintended
expansion of ownership of covered
funds by banking entities that are
subject to the per fund limitations under
§ ll.12.
These banking entities will have a
limited ability to engage in underwriting
or market making-related activities for a
covered fund for which the banking
entity’s investments are subject to the
per-fund limitations in § ll.12 as
discussed above. Such a banking entity
will have more flexibility to underwrite
and make a market in the ownership
interests of such a covered fund in
connection with organizing and offering
the covered fund during the fund’s
seeding period, since during the seeding
period a banking entity may own in
excess of three percent of the covered
fund, subject to the other requirements
in § ll.12.
The final rule also provides that all
banking entities that engage in
underwriting and market-making related
activities in covered funds are required
to include the aggregate value of all
ownership interests of the banking
entity in all covered funds acquired and
retained under § ll.11, including in
connection with underwriting and
market making-related activities under
§ ll.11(c), in the calculation of the
aggregate covered fund ownership
interest limitations under § ll
.12(a)(2)(iii) (and make the associated
deduction from tier one capital for
purposes of calculating compliance with
applicable regulatory capital
requirements).2266
Some commenters asked that the
Agencies permit banking entities to
engage in market making and
underwriting in non-sponsored covered
fund interests.2267 The final rule permits
2266 See
2267 See

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final rule § ll.11(c)(3).
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a banking entity that does not hold an
ownership interest in the covered fund
in reliance on §§ ll.11(a) or ll.11(b)
of the final rule, is not a sponsor of the
covered fund, is not an investment
adviser or commodity trading advisor to
the covered fund, and 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 fund
invests to rely on the market-making
and underwriting exemption in § ll
.11(c) provided that the banking entity
meets all of the requirements of that
exemption. These conditions include
the aggregate funds limitation and the
capital deduction contained in § ll.12
after including all ownership interest
held by the banking entity and its
affiliates under § ll.11, including
ownership interests acquired or retained
under the exemption for underwriting
and market making-related activities in
§ ll.11(c). In accordance with section
13(d)(1) of the BHC Act, the Agencies
have determined that these restrictions
on reliance on the market-making and
underwriting exemption provided by
section 13(d)(1)(B) are appropriate to
address the purposes of section 13 of the
BHC Act, which is aimed at assuring
that banking entities do not bail-out a
covered fund and maintain sufficient
capital against the risks of ownership of
covered funds. The Agencies note,
however, that the guarantee restriction
is not intended to prevent a banking
entity from entering into arrangements
with a covered fund that are not entered
into for the purpose of guaranteeing the
obligations or performance of the
covered fund. For example, this
restriction is not intended to prohibit a
banking entity from entering into or
providing liquidity facilities or letters of
credit for covered funds; however, it
would apply to arrangements such as a
put of the ownership interest in the
covered fund to the banking entity. The
determination of whether an
arrangement would fall within this
guarantee restriction would depend on
the facts and circumstances.
The Agencies emphasize that any
banking entity that engages in
underwriting or market making-related
activities in covered funds must comply
with all of the conditions applicable to
such activity as set forth in section §§ l
l.4(a) and ll.4(b).2268 Thus, holdings
of a single covered fund would be
subject to limitations on risk as well as
length of holding period, among other
applicable limitations and requirements.
These requirements are designed
specifically to address a banking entity’s
2268 See

final rule § ll.11(c)(1).

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underwriting and market making-related
activities and to prohibit holding
exposures in excess of reasonably
expected near term demand of clients,
customers and counterparties.
3. Section ll.12: Permitted Investment
in a Covered Fund
a. Proposed Rule
Section ll.12 of the proposed rule
implemented section 13(d)(4) of the
BHC Act and described the limited
circumstances under which a banking
entity may acquire or retain an
ownership interest in a covered fund
that the banking entity (which includes
its subsidiaries and affiliates) organizes
and offers.2269 Section 13(d)(4)(A) 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 for the
purpose of: (i) establishing the 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 fund, subject to several
limitations. Section 13(d)(4)(B) of the
BHC Act requires that investments by a
banking entity in a covered fund must,
not later than one year after the date of
establishment of the fund, be reduced to
an amount that is not more than three
percent of the total outstanding
ownership interests of the fund.
Consistent with the statute, § .ll12 of
the proposal provided that, after
expiration of the seeding period, a
banking entity’s investment in a single
covered fund may not represent more
than three percent of the total
outstanding ownership interests in the
covered fund (the ‘‘per-fund
limitation’’).2270 In addition, as
provided in the statute, the proposal
provided that the total amount invested
by a banking entity in all covered funds
may not exceed three percent of the tier
1 capital of the banking entity (the
‘‘aggregate funds limitation’’).2271
b. Duration of Seeding Period for New
Covered Funds
Commenters argued that it is essential
to serving their customers efficiently
that a banking entity be permitted to
acquire and retain an ownership interest
in a covered fund that it organizes and
offers as a de minimis investment or for
the purpose of establishing the fund. A
number of commenters contended that a
U.S.C. 1851(d)(4); proposed rule § ll.12.
proposed rule
§§ ll.12(a)(1)(i);ll.12(a)(2)(i)(A) and (B);
ll.12(b).
2271 See id. at §§ ll.12(a)(1)(ii); ll.12(a)(2)(ii);
ll.12(c).
2269 12

2270 See

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banking entity typically invests a
limited amount of its own capital in a
fund (‘‘seed capital’’) as part of
organizing the fund to produce
investment performance as a record of
the fund’s investment strategy (‘‘track
record’’).2272 Once a track record for the
fund is established, the banking entity
markets the fund to unaffiliated
investors.
Commenters argued that the one-year
seeding period provided in the
proposed rule would be too short to
establish a track record for many types
of covered funds. Commenters argued
that the duration of the track record
investors typically demand before
investing in a new fund depends on a
number of factors (e.g., the type of fund,
investment strategy, and potential
investors). According to commenters, an
inability to demonstrate a track record
over multiple years may reduce the
allocation of capital by investors who
are unable to gain an understanding of
the investment strategy, risk profile, and
potential performance of the fund.2273
Commenters provided alternative
suggestions regarding how to define the
start of the seeding period for purposes
of applying the statutory exception for
investments during the seeding period.
For example, two commenters
recommended that the Agencies treat a
private equity fund as being established
on the date on which the fund begins its
asset-acquisition phase and is closed to
new investors, and a hedge fund as
established on the date on which the
fund has reached its target amount of
funding and begins investing according
to the fund’s stated investment
objectives.2274 Another commenter
suggested that the permitted seeding
period begin on the date on which thirdparty investors are first admitted to the
fund.2275
Several commenters expressed
concern that the per-fund limitation
could be subject to evasion unless the
Agencies require that the seeding period
begin at the time funds are first invested
2272 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012); SSgA (Feb. 2012); T. Rowe Price; Credit
Suisse (Williams); Allen & Overy (on behalf of
Canadian Banks);TCW.
2273 See et al. (Covered Funds) (Feb. 2012); See
also Ass’n of Institutional Investors (Feb. 2012);
Bank of Montreal et al. (Jan. 2012); Allen & Overy
(on behalf of Canadian Banks); Credit Suisse
(Williams); Japanese Bankers Ass’n; SSgA (Feb.
2012); T. Rowe Price; Union Asset. One commenter
argued that this limitation would constrain
portfolio composition of a covered fund due to an
inability of a fund to raise sufficient capital to make
larger investments. See Credit Suisse (Williams).
2274 See AFG; Union Asset.
2275 See SIFMA (Mar. 2012); See also Credit
Suisse (Williams).

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by the banking entity in the fund.2276
Some of these commenters suggested
the Agencies impose a dollar cap of $10
million on the seed capital that a
banking entity may provide to a newly
organized covered fund in addition to
the statutory limits based on the amount
of the fund’s shares and the amount of
the banking entity’s tier 1 capital.2277
These commenters argued that an
explicit quantitative limit better
accounted for the size of some banking
entities, which otherwise made the
potential amount of capital placed in
covered funds quite large.2278
The Agencies have considered
carefully the comments on the proposal
and have made several modifications to
the final rule to more clearly explain
how the limitations apply during the
seeding period. The final rule continues
to provide that a banking entity may
invest in a covered fund that it
organizes and offers either in
connection with establishing the fund,
or as a de minimis investment.2279
Importantly, the statute does not permit
a banking entity to invest in a covered
fund unless the banking entity organizes
or offers the covered fund or qualifies
for another exemption. As explained
more fully in the discussion of § ll.11
above, a wide variety of activities are
encompassed in organizing and offering
a covered fund. Under the statute,
which generally prohibits investments
in covered funds, a banking entity may
invest in a covered fund under the
exemptions provided in section 13(d)(1)
of the BHC Act, including section
13(d)(1)(G) and the provisions of section
13(d)(4), only if the banking entity
engages in one or more of these
permitted activities with regard to that
covered fund and complies with all
applicable limitations under the final
rule regarding investments in a covered
fund.
As noted above, the statute allows a
banking entity to acquire and hold all of
the ownership interests in a covered
fund for the purpose of establishing the
fund and providing the fund with
sufficient initial equity for investment to
permit the fund to attract unaffiliated
investors.2280 However, the statute also
imposes a limit on the duration of an
investment made in connection with
seeding a covered fund. At the end of
that period, the investment must
conform to the limits on de minimis
2276 See AFR et al. (Feb. 2012); Occupy; Public
Citizen; Sens. Merkley & Levin (Feb. 2012).
2277 See Occupy; Sens. Merkley & Levin (Feb.
2012); See also 156 Cong. Rec. S5897 (daily ed. July
15, 2010) (statement of Sen. Merkley).
2278 See, e.g., Public Citizen.
2279 See final rule § ll.12(a)(1).
2280 12 U.S.C. 1851(d)(4).

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investments set by the statute. In
keeping with the terms of the statute,
the final rule, like the proposal, allows
banking entities a seeding period of oneyear for all covered funds. The statute
also allows the Board to extend that
period, upon an application by a
banking entity, for two additional years
if the Board finds an extension to be
consistent with safety and soundness
and in the public interest.2281 As
explained below, the final rule, like the
proposal, incorporates this process and
sets forth the factors the Board will
consider when determining whether to
allow an extended seeding period. The
Board and the Agencies will monitor
these extension requests to ensure that
banking entities do not seek extensions
for the purpose of evading the
restrictions on covered funds or to
engage in prohibited proprietary
trading.
As noted above, the proposal did not
specify ‘‘date of establishment,’’ and
commenters suggested a variety of dates
that could serve as the date of
establishment for purposes of
determining the duration of the seeding
period and the per-fund limitations on
ownership interests in a covered
fund.2282 After considering comments
received on the proposal, the Agencies
have modified the final rule to include
a definition of ‘‘date of establishment’’
for a covered fund. In general, the date
of establishment is the date on which an
investment adviser or similar party
begins to make investments that execute
an investment or trading strategy for the
covered fund. The Agencies perceive
the act of making investments to execute
an investment or trading strategy as
demonstrating that the fund has begun
its existence and is no longer simply a
plan or proposal. In order to account for
the unique circumstances and manner
in which securitizations are established,
for a covered fund that is an issuing
entity of asset-backed securities, the
date of establishment under the final
rule is the date on which the assets are
initially transferred into the issuing
entity of the asset-backed securities.
This is the date that the entity is formed
and the securities are generally sold
around this time. The Agencies believe
this is the appropriate time for the date
of establishment for securitizations
because this is the date that the
securitization risks are transferred to the
owners of the securitization vehicle.
Once the assets have been transferred,
the securitization has been established
2281 See

id. at 1851(d)(4)(C).
SIFMA et al. (Mar. 2012); Credit Suisse
(Williams); EFAMA: Hong Kong Inv. Funds Ass’n;
AFG; Union Asset.
2282 See

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and securities of the issuer may
typically be priced in support of
organizing and offering the issuer.
Setting a later time, such as when the
fund becomes fully subscribed or the
assets have been fully assembled, could
permit a banking entity to engage in
prohibited proprietary trading under the
guise of waiting for investors that may
never materialize.2283
The statute also requires a banking
entity to actively seek unaffiliated
investors to reduce or dilute the entity’s
ownership interest to the amount
permitted under the statute. This
requirement is included in the final
rule, and underscores the nature of
covered fund activities under section
13(d)(1)(G) as a method to provide
investment advisory, trust and fiduciary
services to customers rather than allow
the banking entity to engage in
prohibited proprietary trading. To
effectuate the requirements of the
statute, under the final rule, banking
entities that organize and offer a covered
fund must develop and document a plan
for offering shares in the covered fund
to other investors and conforming the
banking entity’s investments to the de
minimis limits to help monitor and
ensure compliance with this
requirement.
While certain commenters requested
that the final rule include a quantitative
dollar limit on the amount of funds a
banking entity may use to organize and
offer a covered fund, the Agencies have
declined to add this limitation in the
final rule. This type of limit is not
required by statute. Moreover, the
Agencies believe that imposing a strict
dollar limit may not adequately permit
banking entities to employ trading or
investment strategies that will attract
unaffiliated investors, thereby
precluding banking entities from
meeting the demands of customers
contrary to the purpose of section 13.
c. Limitations on Investments in a
Single Covered Fund (‘‘Per-Fund
Limitation’’)
Section 13(d)(4)(B) imposes limits on
the amount of ownership interest a
banking entity may have in any single
covered fund at the end of the one year
period (subject to limited extension)
after the date of establishment of the
fund (the ‘‘seeding period’’). In
recognition of the fact that a covered
2283 Importantly, the statute recognizes that a
banking entity may need more than the automatic
one-year Seeding period to build a track record and/
or market its interests to unaffiliated investors;
therefore, a banking entity may apply for an
extension of the Seeding period as provided in l
l.12(e) of the final rule as discussed below in Part
IV.B.3.h.

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fund may have multiple classes or types
of ownership interests with different
characteristics or values, the proposal
required that a banking entity apply the
limits to both the total value of and total
amount of the banking entity’s
ownership interest in a covered fund.
The proposed rule required a banking
entity to calculate the per-fund
limitation using two methods. First, a
banking entity was required to calculate
the value of its investments and capital
contributions made with respect to any
ownership interest in a single covered
fund as a percentage of the value of all
investments and capital contributions
made by all persons in that covered
fund. Second, a banking entity was
required to determine the total number
of ownership interests held by the
banking entity in a single covered fund
as a percentage of the total number of
ownership interests held by all persons
in that covered fund.2284 Both
calculations were required to be done
without regard to committed funds not
yet called for investment. The proposed
rule also required the banking entity to
calculate the value and amount of its
ownership interest in each covered fund
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.2285 These
calculations were designed to ensure
that the banking entity’s investment in
a covered fund could not result in more
than three percent of the losses of the
covered fund being allocated to the
banking entity’s investment.2286
Commenters did not generally object
to calculating the per-fund limitation
based on both number and value of
ownership interests. Several
commenters urged the Agencies to allow
a banking entity to value its investment
in a covered fund based on the
acquisition cost of the investment,
instead of fair market value,
notwithstanding the manner in which
the covered fund accounts for or values
investments for its shareholders
generally.2287 One commenter suggested
that the Agencies allow a banking entity
to choose between acquisition cost and
fair value so long as the chosen
valuation method is applied
consistently to both the numerator and
denominator when calculating the perfund limitation.2288
proposed rule § ll.12(b)(2).
proposed rule § ll.12(b)(4).
2286 See Joint Proposal, 76 FR 68,904.
2287 See ABA (Keating); BoA; Arnold & Porter;
BOK; Scale; SVB.
2288 See ABA (Keating) (alleging that this is
similar to the SEC’s approach to the definition of
2284 See
2285 See

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To the extent that an issuer of an
asset-backed security is a covered fund,
the investment limitations contained in
section 13(d)(4) of the BHC Act also
would limit the ability of a banking
entity to acquire or retain an investment
in that issuer. Section 941 of the DoddFrank Act added a new section 15G of
the Exchange Act (15 U.S.C. 78o–11)
which requires certain parties to a
securitization transaction, including
banking entities, to retain and maintain
a certain minimum interest in certain
issuers or asset-backed securities.2289 In
order to give effect to this separate
requirement under the Dodd-Frank Act,
§ ll.14(a)(2) of the proposed rule
permitted a banking entity that is a
‘‘securitizer’’ or ‘‘originator’’ under that
provisions of the Act to acquire or retain
an ownership interest in an issuer of
asset-backed securities, in an amount (or
value of economic interest) required to
comply with the minimum
requirements of section 15G of the
Exchange Act and any implementing
regulations issued thereunder.2290 The
proposal also permitted a banking entity
to act as sponsor to the securitization.
Commenters expressed a variety of
views on the treatment of interests in
securitizations held under risk retention
pursuant to the proposed rule. Some
commenters argued that the proposal
was effective as written and represented
a reasonable way to reconcile the two
sections of the Dodd-Frank Act
consistent with the risk-reducing
objective of section 13 of the BHC
Act.2291 Other commenters also
supported the proposal’s recognition
that banking entities may be required to
hold a certain amount of risk in a
securitization that would also be a
covered fund, but argued that the
proposed exemption was too
narrow.2292 Some commenters argued
that the exemption should be broadened
to permit a banking entity to hold in
excess of the minimum amount required
under section 15G of the Exchange Act
instead of allowing only the minimum
amount required by that section.2293
venture capital fund for the purposes of being
exempt from investment advisor registration).
2289 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
24,090 (Apr. 29, 2011). Those agencies recently
issued a re-proposal of the risk-retention
requirements. See Credit Risk Retention, 78 FR
57,928 (Sept. 20, 2013).
2290 See proposed rule § ll.14(a)(2)(iii).
2291 See Sens. Merkley & Levin (Feb. 2012); Alfred
Brock.
2292 See, e.g., AFME et al.; SIFMA (Securitization)
(Feb. 2012); JPMC; BoA.
2293 See AFME et al.; SIFMA (Securitization)
(Feb. 2012); JPMC; BoA.

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5725

One commenter requested that the final
rule permit a banking entity to hold an
amount of risk in a securitization that is
commensurate with what investors
demand rather than the minimum
required by section 15G.2294 Some
commenters argued that banking entities
may be subject to similar generally
applicable requirements to hold risk in
securitizations under foreign law, such
as Article 122a of the Capital
Requirements Directive issued by the
European Union, and that the final rule
should permit banking entities to
comply with these foreign legal
requirements.2295
Conversely, a few commenters
objected to the proposed rule’s
exemption for risk-retention as unclear
and argued that if the exemption was
retained, the Agencies should provide
that any amounts held by a banking
entity in a securitization that exceed the
minimum required to satisfy section
15G of the Exchange Act should count
towards the aggregate funds limitation
of the banking entity.2296 One
commenter argued that the final rule
should impose higher capital charges for
interests held in these securitizations
due to concerns that securitizations
involve heightened risks due to the
complexity of their ownership
structure.2297
The Agencies have carefully
considered the comments received and
are adopting the calculation
requirements for the per-fund limitation
as proposed with several modifications,
including modifications designed to
address the unique characteristics and
ownership structure of securitizations.
The final rule, like the proposal,
requires that a banking entity calculate
its per-fund investment limit in covered
funds that are not issuing entities of
asset-backed securities based on both
the value of its investments and capital
contributions in and to each covered
fund and the total number of ownership
interests it has in each covered fund. A
banking entity’s investment (including
investments by its affiliates) may not
exceed either three percent of the value
of the covered fund or three percent of
the number of ownership interests in
the covered fund at the end of the
seeding period. The Agencies continue
to believe that requiring the per-fund
limitation to be calculated based on
these two measures best effectuates the
terms and purpose of the per-fund
2294 See

BoA.
AFME et al.; Allen & Overy (on behalf of
Foreign Bank Group); SIFMA (Securitization) (Feb.
2012);BoA.
2296 See Occupy.
2297 See Sens. Merkley & Levin (Feb. 2012).
2295 See

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limitation in the statute. Together, these
measures ensure that a banking entity’s
exposure to and ownership of each
covered fund is limited. Each measure
alone could provide a distorted view of
the banking entity’s ownership interest
and could be more easily manipulated,
for example by issuing ownership
interests with high value or special
governance provisions. As discussed in
more detail below, the final rule
contains a separate method for
calculating the value of investments in
issuing entities of asset-backed
securities due to the fact that these
entities do not have a single class of
security and thus, the valuation of the
ownership interests cannot be made on
a per interest or single class basis.
The per-fund limitation on ownership
interests must be measured against the
total ownership interests of the covered
fund, as defined in § ll.10 of the final
rule and as discussed above in Part
IV.B.1.e. In determining the amount of
ownership interests held by the banking
entity and its affiliates, the banking
entity must include an ownership
interest permitted under §§ ll.4 and
ll.11 of the final rule.2298
Additionally, any banking entity that
acts as underwriter or market-maker for
ownership interests of a covered fund
must do so in compliance with the
limitations of §§ ll.4(a) and ll.4(b)
of the final rule, including the limits on
the amount, types, and risk of the
underwriting position or market-maker
inventory as well as in compliance with
the per-fund limitation, as applicable,
and the aggregate funds limitations and
capital deduction in the final rule. The
Agencies expect to monitor these
activities to ensure that a banking entity
does not engage in underwriting or
market making-related activity in a
manner that is inconsistent with the
limitations of the statute and the final
rule.2299
2298 As discussed above in Part IV.B.2.c., the perfund limitation does not apply to ownership
interests held by a banking entity that acts as
market maker or underwriter in accordance with
§ ll.11(c) of the final rule, so long as the banking
entity does not also organize and offer, or act as
sponsor, investment adviser or commodity trading
advisor to, the fund, or, with respect to ownership
interests in issuing entities of asset-backed
securities, is not a securitizer who continues to own
ownership interests or is not an entity that holds
ownership interests in compliance with Section
15G of the Exchange Act and the implementing
regulations adopted thereunder; however, the
banking entity that is acting as market maker or
underwriter that is not subject to the per-fund
limitation must still comply with the other
requirements set forth in §§ ll.4(a) and ll.4(b),
respectively, and any other applicable requirements
set out in § ll.11(c).
2299 The Agencies note that if a banking entity
acts as investment adviser or commodity trading
advisor to a covered fund and shares the same name

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The final rule requires that the value
of the ownership interests and
contributions made by a banking entity
in each covered fund (that is not an
issuing entity of an asset-backed
security) be the fair market value of the
interest or contribution. The Agencies
have determined to use fair market
value as the measurement of value for
the per-fund value limitation in order to
ensure comparability with the
investments made in the covered fund
by others and limit the potential that the
valuation measure can be manipulated
(for example by altering the percentage
of gains and losses that are associated
with a particular ownership interest). A
banking entity should determine fair
market value for purposes of the final
rule, including the calculation of both
the per-fund and aggregate funds
limitations, in a manner that is
consistent with its determination of the
fair market value of its assets for
financial statement purposes and that
fair market value would be determined
in a manner consistent with the
valuations reported by the relevant
covered fund unless the banking entity
determines otherwise for purposes of its
financial statements and documents the
reason for any disparity. If fair market
value cannot be determined, then the
value shall be the historical cost basis of
all investments and capital
contributions made by the banking
entity to the covered fund. The final
rule also requires that, once a valuation
method is chosen, the banking entity
calculate the value of its investments
and the investments of all others in the
covered fund for purposes of the perfund limitation in the same manner and
according to the same standards.2300
This approach is intended to ensure
that, for purposes of calculating the perfund limitation, a banking entity does
not calculate its investment in a covered
fund in a manner more favorable to the
banking entity than the method used by
the covered fund for valuing the
investments made by others. Under the
final rule and as explained in more
detail below, any ownership interest
acquired or retained by an employee or
director of the banking entity is
attributed to the banking entity for
purposes of the per-fund limitation if
the banking entity financed the
or variation of the same name with the fund, then
that banking entity would be a sponsor and
therefore subject to the limitations of section 13(f).
2300 In the context of securitizations, the final rule
similarly provides that the valuation methodology
used to calculate the fair market value of the
ownership interests must be the same for both the
ownership interests held by a banking entity and
the ownership interests held by all other investors
in the covered fund in the same manner and
according to the same standards.

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purchase of the ownership interest.
Additionally, any amount contributed
or paid by a banking entity or its
employee to obtain an ownership
interest in connection with obtaining
the restricted profit interest must be
included in calculating compliance with
the per-fund and aggregate funds
limitations (See Part IV.B.1.e.
above).2301
In determining the per-fund limitation
for purposes of § ll.12 of the final
rule, the banking entity should use the
same methodology for valuing its
investments and capital contributions as
the banking entity uses to prepare its
financial statements and regulatory
reports.2302 In particular, the fair market
value of a banking entity’s investments
and any capital contributions made to a
covered fund should be the same for
purposes of § ll.12 of the final rule as
reported on the banking entity’s
financial statements and regulatory
reports. Similarly, if fair market value of
all investments in and capital
contributions cannot be determined for
purposes of § ll.12 of the final rule,
then the banking entity should use the
same methodology to calculate the
historical cost basis of the investments
and any capital contributions as the
banking entity uses to prepare its
financial statements and regulatory
reports. The Agencies will review
carefully the methodology that a
banking entity uses to calculate the
value of its investments in and capital
contributions made to covered funds as
part of the process to monitor
compliance with the final rule.
The Agencies expect that for the
majority of covered funds, the party that
organizes and offers the fund or
otherwise exercises control over the
fund will provide a standard
methodology for valuing interests in the
fund. However, the Agencies
understand that for some covered funds,
including issuing entities of asset
backed securities, there may be multiple
parties that organize and offer the fund
that each utilize a different methodology
or standard for calculating the value of
ownership interests of the fund. Going
forward, the Agencies expect that in
these circumstances the parties that
organize and offer the covered fund will
work together or select a responsible
party to determine a single standard by
2301 See

Part IV.B.1.e.
example, a depository institution or bank
holding company should use the same methodology
as used in the Report of Condition and Income (Call
Report) for depository institutions and the
Consolidated Financial Statements for Holding
Companies (FR Y–9C) for bank holding companies,
respectively.
2302 For

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which all ownership interests in the
covered fund will be valued.
One commenter suggested the
Agencies count both invested funds and
committed funds not yet called for
investment towards the per-fund
limitation.2303 This commenter argued
that a banking entity has already
contractually allocated committed-yetuncalled funds to the covered fund and
that depositors face a risk of loss for
such funds if the covered fund fails.
The final rule, like the proposal, does
not count committed-yet-uncalled funds
towards the per-fund limitation; instead,
it counts funds once they are invested.
This approach reflects the fact that these
funds may never be called while at the
same time ensuring that the banking
entity must comply with the per-fund
limitation once the funds are called. The
Agencies note that a banking entity is
prohibited from guaranteeing or bailing
out a covered fund that the banking
entity or one of its affiliates organizes
and offers by the terms of the statute
and the final rule and, accordingly,
would not be permitted to provide
committed funds to a covered fund in a
manner inconsistent with the
limitations in the statute and final rule.
After carefully considering the
comments received on the proposal, as
well as the language and purpose of
section 13 of the BHC Act, the final rule
provides that, for purposes of applying
the per-fund limitation to an investment
in a covered fund that is an issuing
entity of an asset-backed security, the
ownership interest held by the banking
entity and its affiliates generally may
not exceed three percent of the fair
market value of the ownership interests
of the fund as measured in accordance
with § ll.12(b)(3), unless a greater
percentage is retained by the banking
entity and its affiliates in compliance
with the requirements of section 15G of
the Exchange Act and the implementing
regulations issued thereunder, in which
case the investment by the banking
entity and its affiliates in the covered
fund may not exceed the amount,
number, or value of ownership interests
of the fund required under section 15G
of the Exchange Act and the
implementing regulations issued
thereunder. A banking entity may rely
on any of the options available to it in
order to meet the requirements of
section 15G, but for purposes of section
13 of the BHC Act and this rule, the
amount held by the banking entity may
not exceed the amount required under
the chosen option. Under the final rule,
if a banking entity’s investment in a
covered fund is held pursuant to the
2303 See

Occupy.

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requirements of section 15G of the
Exchange Act, the banking entity must
calculate the amount and value of its
ownership interest for purposes of the
per-fund limitation as of the date and
according to the same valuation
methodology applicable pursuant to the
requirements of that section and the
implementing regulations issued
thereunder.
While the amount retained in
compliance with section 15G of the
Exchange Act and the implementing
regulations issued thereunder may
permit a banking entity to own more
than three percent of the ownership
interests in a securitization that is a
covered fund, this approach is
appropriate to reconcile the competing
policies of section 13 of the BHC Act
and section 15G of the Exchange Act
which requires that a securitizer of
certain securitizations retain a
minimum of five percent of the risk of
the securitization. Congress enacted
these two apparently conflicting
provisions in the same Act, and the
Agencies believe the more specific
section regarding risk retention in
securitizations was intended to prevail
over the more general restriction on
ownership of covered funds (which
applies to a broader range of entities).
The Agencies believe that the risk
limitation goals of section 13 of the BHC
Act are met by satisfying the minimum
requirement of an applicable option
under section 15G of the Exchange Act
as the maximum initial investment
limit, and applying the other limitations
discussed in this section governing
aggregate investment in covered funds
and capital deductions.
As under the proposal, if a banking
entity does not have a minimum risk
retention requirement, that banking
entity would remain subject to the
limitations of section 13(d)(4) of the
BHC Act and § ll.12 on the amount of
ownership interests it may hold in an
issuing entity of asset-backed securities.
A banking entity may not combine the
amounts under these provisions to
acquire or retain ownership interests in
a securitization that exceed the
aggregate permissible amounts.
Some commenters requested that the
Agencies coordinate implementation of
any exemption for risk-retention
requirements under section 13 of the
BHC Act with the issuance of rules
implementing section 15G of the
Exchange Act. The Agencies note that
rules implementing section 15G have
been proposed but not yet finalized, but
the Agencies will review the interaction
between the rules promulgated under
section 13 of the BHC Act and section
15G of the Exchange Act once the rules

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5727

under section 15G are finalized.
Regardless of any action that may be
taken regarding rules implementing
section 15G, the final rule permits
banking entities to own ownership
interests in and sponsor covered funds
as discussed above.
Some commenters also requested that
the final rule provide an exemption to
permit banking entities to comply with
any risk retention requirement imposed
under foreign law that is similar to
section 15G of the Exchange Act. The
Agencies are not revising the rule to
permit banking entities to own
ownership interests required to be
retained pursuant to risk retention-type
requirements under foreign law. The
Agencies are providing the exemption
for the required ownership arising from
the risk retention provisions under
section 15G of the Exchange Act in
order to reconcile the requirements
under the Dodd-Frank Act applicable to
ownership of securitization interests;
however, the Agencies do not believe at
this time that such reconciliation is
appropriate with respect to foreign law
risk retention-type requirements and
those requirements should not prevail
over the purpose of section 13 of the
BHC Act to reduce banking entities’
exposure to risks from investments in
covered funds.
The Agencies also note that the
definition of covered fund has been
modified to exclude certain foreign
public funds and also any foreign fund
that is not owned or sponsored by a U.S.
banking entity. Moreover, the final rule
permits foreign banking entities to
engage in covered fund activities and
investments that occur solely outside of
the United States without regard to the
investment limitations of section
13(d)(4) of the BHC Act and § ll.12 of
the final rule, which may include
retaining risk in a securitization to the
extent required under foreign law. In
these manners, the final rule permits
foreign banking entities to comply with
requirements under foreign law that
govern their securitization activities or
investments abroad. However, as noted
above, section 13 of the BHC Act applies
to the global operations of U.S. banking
entities and, as such, U.S. banking
entities’ investments in foreign
securitizations that are covered funds
would remain subject to the investment
limitations of section 13(d)(4) and
§ ll.12 of the final rule.
The proposed rule provided that a
banking entity must comply with both
measures of the per-fund limitation at
all times. The preamble to the proposal
explained that the Agencies expected a
banking entity to calculate its per-fund
limitation no less frequently than the

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frequency with which the fund performs
such calculation or issues or redeems
interests, and in no case less frequently
than quarterly.2304
Several commenters requested that
the Agencies modify the frequency of
this calculation and monitoring
requirement to a standard quarterly
basis.2305 These commenters argued
that, although some covered funds may
provide daily liquidation and
redemption rights to investors,
monitoring the per-fund limitation on a
continuous basis would be costly and
burdensome and would not provide a
significant offsetting benefit.
The Agencies continue to believe that
for covered funds other than issuing
entities of asset-backed securities the
per-fund limitations apply to
investments in covered funds at all
times following the end of the seeding
period. However, to relieve burden and
costs, while also setting a minimum
recordkeeping standard, the final rule
has been modified to require that a
banking entity calculate the amount and
value of its ownership interests in
covered funds other than issuing
entities of asset-backed securities
quarterly.2306 The Agencies believe that
this change will assist in reducing
unnecessary costs and burdens in
connection with calculating the perfund limitation, particularly for smaller
banking entities, and will also facilitate
consistency with the calculation for the
aggregate funds limitation (which is also
determined on a quarterly basis).
Nevertheless, should a banking entity
become aware that it has exceeded the
per-fund limitation for a given fund at
any time, the Agencies expect the
banking entity to take steps to ensure
that the banking entity complies
promptly with the per-fund
limitation.2307
The Agencies have also modified the
timing and methodology of the per-fund
limitation as it applies to securitizations
to address the unique circumstances
and ownership structure presented by
securitizations, which typically wind
down over time. Unlike many other
covered funds, securitizations do not
generally experience increases in the
amount of investors or value of
ownership interests during the life of
2304 See proposed rule § ll.12(b); Joint
Proposal, 76 FR 68,904.
2305 See, e.g., ABA (Keating); Credit Suisse
(Williams); JPMC.
2306 See final rule § l.12(b)(2)(i) and (ii). For
covered funds that are an issuing entity of assetbacked securities, recalculation of the banking
entity’s permitted ownership for purposes of the
per-fund limitation is not required unless the
covered fund sells additional securities.
2307 See 12 U.S.C. 1851(d)(4)(B)(ii)(I).

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the securitization; rather, they generally
experience only a contraction of the
investor base and reduction in the total
outstanding value of ownership
interests on an aggregate basis, and may
do so at different rates under the terms
of the transaction agreements, meaning
that the percentage of ownership
represented by a particular ownership
interest may increase as the fund
amortizes but without the banking
entity adding any funds. The manner in
which securitizations are organized and
offered, as well as the amortization of
securitizations, differs from many other
covered funds; section 15G of the
Exchange Act also requires that certain
parties to securitization transactions,
which may include banking entities,
retain a minimum amount of risk in a
securitization, a requirement not
applicable to covered funds that are not
securitizations. Therefore, for purposes
of calculating a banking entity’s perfund limitation with respect to a
securitization, the calculation of the perfund limitation shall be based on
whether section 15G applies and the
implementing regulations are effective.
In the case of an ownership interest in
an issuing entity of an asset-backed
security that is subject to section 15G of
the Exchange Act and for which
effective implementing regulations have
been issued, the calculation of the perfund limitation shall be made as of the
date and pursuant to the methodology
applicable pursuant to the requirements
of section 15G of the Exchange Act and
the implementing regulations issued.
For securitizations executed after the
effective date of the final rule and prior
to the adoption and implementation of
the rules promulgated under section
15G of the Exchange Act and for
securitizations for which a fair valuation
calculation is not required by the
implementing rules promulgated under
section 15G of the Exchange Act, the per
fund limitation is calculated as of the
date on which the assets are initially
transferred into the issuing entity of the
asset-backed securities or such earlier
date on which the transferred assets
have been valued for purposes of
transfer to the covered fund.2308 This
calculation for issuers of asset backed
securities is only required to be
2308 In addition, although some commenters
requested that banking entities be able to hold more
than the minimum required by section 15G, the
Agencies are not revising the per fund limitation in
that manner. One of the purposes of section 13 of
the BHC Act is to reduce banking entities’ exposure
to risks from investments in covered funds, and the
Agencies believe at this time that permitting
banking entities to retain risk exposure to the
covered fund in excess of the minimum required to
be retained would contradict the purposes of
section 13 of the BHC Act.

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performed once on the date noted
above, and thereafter only upon the date
on which the price of additional
securities of the covered fund to be sold
to third parties is determined.
As noted above, the per-fund
limitations for ownership interests in
issuing entities of asset-backed
securities are calculated based only on
the value of the ownership interest in
relation to the value of all ownership
interests in the issuing entity of the
asset-backed security and are not
calculated on a class by class, or tranche
by tranche basis. For purposes of the
valuation, the aggregate value of all the
assets that are transferred to the issuing
entity of the asset-backed securities, and
any assets otherwise held by the issuing
entity, are determined based on the
valuation methodology used for
determining the value of the assets for
financial statement purposes. This
valuation will be the value of the
ownership interests in the issuing entity
for purposes of the calculation. A
banking entity will need to determine
its percentage ownership in the issuing
entity based on the its contributions to
the entity in relation to the
contributions of all parties and after
taking into account the value of any
residual interest in the issuing entity. In
addition, for purposes of the final rule,
the asset valuation is as of the date of
establishment (the date of the asset
transfer to the issuing entity of the assetbacked securities).
d. Limitation on Aggregate Permitted
Investments in all Covered Funds
(‘‘Aggregate Funds Limitation’’)
In addition to the per-fund limitation,
section 13(d)(4) of the BHC Act provides
that the aggregate of a banking entity’s
investments in all covered funds may
not exceed three percent of the tier 1
capital of the banking entity (referred to
above as the ‘‘aggregate funds
limitation’’).2309 To implement this
limitation, the proposed rule required a
banking entity to determine the
aggregate value of the banking entity’s
investments in covered funds by
calculating the sum of the value of each
investment in a covered fund, as
determined in accordance with
applicable accounting standards. This
amount was then measured as a
percentage of the tier 1 capital of the
banking entity for purposes of
determining compliance with the
aggregate funds limitation. For purposes
of applying the limit, a banking entity
that is subject to regulatory capital
requirements was required under the
proposed rule to measure tier 1 capital
2309 See

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in accordance with those regulatory
capital requirements; a banking entity
that is not a subsidiary of a reporting
banking entity and that is not itself
required to report capital in accordance
with the risk-based capital rules of a
Federal banking agency was required by
the proposed rule to calculate its tier 1
capital based on the total amount of
shareholders’ equity of the top-tier
entity as of the last day of the most
recent calendar quarter, as determined
under applicable accounting standards.
Commenters expressed a variety of
views regarding the aggregate funds
limitation. One commenter argued that
basing the aggregate funds limitation on
the size of tier 1 capital of a banking
entity provides an advantage to the
largest institutions with large absolute
capital bases and disadvantages smaller
banks that are well capitalized but have
a smaller absolute capital base.2310 This
commenter urged the Agencies to
permit all banking entities to invest in
covered funds in an amount that is, in
the aggregate, the greater of $1 billion
(subject to prudential investment
limitations and safety and soundness
concerns), or three percent of tier 1
capital.2311
In contrast, other commenters urged
the Agencies to decrease the statutory
limit in order to prevent the largest
banking entities from investing amounts
that, while within the statutory limit,
could be very large in absolute
terms.2312 One commenter argued that a
loss of three percent of tier 1 capital
would be a material loss reflected in a
change in stock price.2313 Another
commenter suggested the Agencies
consider whether the investment
supports a large flow of management
fees linked to market volatility or has
significant embedded leverage.2314
Some commenters argued that the
final rule should calculate the value of
covered fund investments based on
acquisition cost instead of fair market
value.2315 These commenters argued
that using fair value to calculate the
aggregate funds limitation penalizes
banking entities for organizing and
investing in successful funds and,
conversely, would allow banking
entities to increase investments in
unsuccessful funds (the value of which
would decline relative to the capital of
the banking entity).
In contrast, another commenter
argued that valuation of a covered fund
2310 See

ABA (Abernathy).
e.g., ABA (Abernathy).
2312 See AFR et al. (Feb. 2012); Public Citizen.
2313 See Public Citizen.
2314 See AFR et al. (Feb. 2012).
2315 See ABA(Keating); BoA; Arnold & Porter;
BOK; Scale; SVB.
2311 See,

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investment should include any mark-tomarket increase in a banking entity’s
aggregate investments in order to keep
pace with increases in the capital of the
banking entity.2316
Some commenters discussing the
frequency of the calculation of the
aggregate funds limitation supported
determining the aggregate funds
limitation on the last day of each
calendar quarter as required in the
proposal.2317 Other commenters argued
that the statute requires compliance at
all times rather than periodic
calculations of compliance.2318
After consideration of the comments
in light of the statutory provisions, the
Agencies have adopted the requirements
for calculating the aggregate funds
limitation as proposed with several
modifications as explained below.
Under the final rule, the aggregate value
is the sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest in each covered
fund (together with any amounts paid
by the entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § ll.10(d)(6)(ii)),
as measured on a historical cost basis.
This aggregate value is measured against
the total applicable tier 1 capital for the
banking entity as explained below.
For purposes of determining the
aggregate funds limitation, the final rule
requires that the value of investments
made by a banking entity be calculated
on a historical cost basis. This approach
limits the aggregate amount of funds a
banking entity may provide to covered
funds as a percentage of the banking
entity’s capital as required by statute. At
the same time, this approach does not
permit a banking entity to increase its
exposure to covered funds in the event
any investment in a particular covered
fund declines in value as a result of the
fund’s investment activities. Permitting
a banking entity to increase its aggregate
investments as covered funds lose value
would permit the banking entity both to
increase its exposure to covered funds at
the same time the covered funds it
already owns are losing value and to
effectively bail-out investors by
providing additional capital to troubled
covered funds. Neither of these actions
is consistent with the purposes of
section 13 of the BHC Act. Moreover
and as explained below, because the
final rule requires that the banking
entity deduct from the entity’s capital
the greater of historical cost (plus
earnings) or fair market value of its
2316 See

Occupy.
ABA (Keating).
2318 See AFR et al. (Feb. 2012); Occupy.
2317 See

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5729

investments in covered funds, the
deduction accounts for any profits
resulting from investments in covered
funds.
Historical cost basis means, with
respect to a banking entity’s ownership
interest in a covered fund, the sum of all
amounts paid or contributed by the
banking entity to a covered fund in
connection with acquiring or retaining
an ownership interest (together with any
amounts paid by the entity (or employee
thereof) in connection with obtaining a
restricted profit interest)), less any
amounts received as a redemption, sale
or distribution of such ownership
interest or restricted profit interest.
Under the final rule, any reduction of
the historical cost would not generally
include gains or losses, fees, income,
expenses or similar items. However, as
noted above, the final rule also requires
that a banking entity deduct any
earnings from its tier 1 capital even if it
values its ownership interests in a
covered fund pursuant to historical cost.
The concern expressed by
commenters that the aggregate funds
limitation should account for increases
in the fair market value of covered funds
is addressed in other ways under the
final rule. In particular, the final rule
requires that for purposes of calculating
compliance with regulatory capital
requirements the banking entity deduct
from the entity’s capital the greater of
fair market value (or historical cost plus
earnings) of its investment in each
covered fund; thus, profits resulting
from investments in covered funds will
not inflate the capital of the banking
entity for regulatory compliance
purposes. Moreover, as explained above,
the per-fund limitation is generally
based on fair market value, which
maintains the relative level of a banking
entity’s investment in each covered
fund.
As noted above, the aggregate funds
limitation applies to all investments by
a banking entity in a covered fund that
the banking entity or an affiliate thereof
holds under §§ ll.4 and ll.11 of the
final rule. The limitation would also
apply to investments by a banking entity
made or held during the seeding period
as part of organizing and offering a
covered fund, including ownership
interests held in order to satisfy the
requirements of section 15G of the
Exchange Act, as well as ownership
interests held by a banking entity in the
capacity of acting as underwriter or
market-maker.
As under the proposal, this
calculation must be made as of the last
day of each calendar quarter, consistent
with when tier 1 capital is reported by
banking entities to the Agencies.

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Because compliance with the aggregate
funds limitations is calculated based on
tier 1 capital, the Agencies believe it is
more appropriate to require the
calculation to be performed on the same
schedule as tier 1 capital is reported.
While the aggregate funds limitation
must be calculated on a quarterly basis,
the Agencies expect banking entities to
monitor investments in covered funds
regularly and remain in compliance
with the limitations on covered fund
investments throughout the quarter. The
Agencies intend, through their
respective supervisory processes, to
monitor covered fund investment
activity to ensure that a banking entity
is not attempting to evade the
requirements of section 13.
The Agencies recognize that banks
with large absolute capital bases will be
able to place a greater amount of capital
in covered funds compared to banks
with small absolute capital bases.
However, the amount of risk exposure to
a covered fund, despite their different
investment strategies, will be relatively
similar across banking entities, which is
consistent with the language and risklimiting purpose of section 13.
e. Capital Treatment of an Investment in
a Covered Fund
Section 13(d)(4)(B)(iii) of the BHC Act
provides that, for purposes of
determining compliance with applicable
capital standards under section 13(d)(3)
of that Act, the aggregate amount of
outstanding investments by a banking
entity under section 13(d)(4), including
retained earnings, must be deducted
from the assets and tangible equity of
the banking entity, and the amount of
the deduction must increase
commensurate with the leverage of the
covered fund.2319 Section 13(d)(3)
authorizes the Agencies, by rule, to
impose additional capital requirements
and quantitative limitations, including
diversification requirements on any of
the activities permitted under section 13
of the BHC Act if the Agencies
determine that such additional capital
and quantitative limitations are
appropriate to protect the safety and
soundness of banking entities engaged
in such activities.2320
The proposed rule implemented the
capital deduction provided for under
section 13(d)(4)(B)(iii) of the BHC Act
by requiring a banking entity to deduct
the aggregate fair value of its
investments in covered funds, including
any attributed profits, from tier 1
capital. As in the statute, the proposed
rule applied the capital deduction to
2319 See
2320 Id.

12 U.S.C. 1851(d)(4)(B)(iii).
at 1851(d)(3).

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ownership interests in covered funds
held as an investment by a banking
entity pursuant to the provisions of
section 13(d)(4) of the BHC Act, and not
to ownership interests acquired under
other permitted authorities, such as a
risk-mitigating hedge under section 13
of the BHC Act. The proposed rule
required the deduction to be calculated
consistent with the method for
calculating other deductions under the
applicable risk-based capital rules. The
proposed rule did not otherwise adopt
additional capital requirements and
quantitative limitations under section
13(d)(3) of the BHC Act.
Some commenters supported the
proposed dollar-for-dollar deduction
from tier 1 capital of a banking entity’s
aggregate investments in covered funds
and asserted it is consistent with the
statute.2321 One of these commenters
urged the Agencies to rely on their
authority under section 13(d)(3) of the
BHC Act to apply the capital deduction
to other permitted ownership interests
in covered funds to protect the safety
and soundness of the banking entity.2322
In contrast, other commenters urged the
Agencies to eliminate the capital
deduction for investments in covered
funds and questioned the Agencies’
statutory authority to impose the capital
deduction.2323 These commenters
argued that the statute does not
authorize or require the Agencies to
require banking entities to deduct their
investments in covered funds for
purposes of calculating capital pursuant
to the applicable capital rules.
According to these commenters, section
13 only requires deductions for
purposes of determining compliance
with applicable capital standards under
section 13 and argued the Agencies did
not make the necessary safety and
soundness findings under section
13(d)(3) to impose additional capital
requirements on any activities permitted
under section 13(d)(1).2324 One
commenter urged the Agencies to make
any capital adjustment as part of the
banking agencies’ broader efforts to
implement the Basel III capital
framework.2325 Another commenter
urged the Agencies to apply the capital
deduction only for purposes of
determining a banking entity’s
compliance with the aggregate funds
limitation and not for other regulatory
capital purposes.2326 This commenter
2321 See

Occupy.
Occupy.
2323 See ABA (Keating); BNY Mellon et al.; PNC;
SIFMA et al. (Covered Funds) (Feb. 2012); SVB.
2324 See, e.g., SIFMA et al. (Covered Funds) (Feb.
2012).
2325 Id.
2326 See ABA (Keating).
2322 See

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also argued that a capital deduction is
normally not required for assets
reflected on a bank’s consolidated
balance sheet, and that the Agencies
should not require a deduction for a
covered fund investment that is not
consolidated with the banking entity for
financial reporting purposes under
GAAP.2327 Some commenters urged the
Agencies to apply the capital deduction
only to a banking entity’s investment in
a covered fund that the banking entity
organizes and offers and not to
ownership interests otherwise permitted
to be held under section 13 of the BHC
Act.2328
Several commenters addressed the
manner for valuing an investment
subject to the deduction. One
commenter urged the Agencies to
permit a banking entity to calculate the
deduction based on the acquisition cost,
instead of the fair market value, of the
banking entity’s ownership interest in
the covered fund.2329 This commenter
emphasized that valuing the investment
at fair market value would penalize a
banking entity if the covered fund
performs well by reducing the amount
of capital available for additional
covered fund investments but reduce
the capital charge against troubled
investments. One commenter argued
that the Agencies did not perform an
appropriate cost-benefit analysis of the
deduction in the proposed rules.2330
Other commenters sought clarification
on how the capital deduction would
apply to a foreign banking organization.
Several commenters argued that the
capital deduction should not apply to a
foreign banking entity that calculates its
tier 1 capital under the standards of its
home country.2331 These commenters
argued that imposing a capital
deduction requirement on foreign banks
would not be consistent with past
practices on the application of U.S. riskbased capital requirements to foreign
banking organizations.
The Agencies have carefully
considered the comments in light of the
statutory provisions requiring a capital
deduction. The statute requires that the
aggregate amount of outstanding
investments by a banking entity,
including retained earnings, be
deducted from the assets and tangible
equity of the banking entity.2332 This
requirement is independent of the
minimum regulatory capital
2327 See

ABA (Keating); See also letter from PNC.
Arnold & Porter; SVB.
2329 See SIFMA et al. (Covered Funds) (Feb.
2012).
2330 Id.
2331 See IIB/EBF.
2332 See 12 U.S.C. 1851(d)(4)(B)(iii).
2328 See

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
requirements in the final capital rule
published by the Federal Banking
agencies in 2013 (‘‘regulatory capital
rule’’).2333
The Federal Banking agencies
recognize that the regulatory capital rule
imposes risk weights and deductions
that do not correspond to the deduction
for covered fund investments imposed
by section 13 of the BHC Act. The
Federal Banking agencies intend to
review the interaction between the
requirements of this rule and the
requirements of the regulatory capital
rule and expect to propose steps to
reconcile the two rules.
At the same time, the Agencies
believe that the dollar-for-dollar
deduction of the fair market value of a
banking entity’s investment in a covered
fund is appropriate to protect the safety
and soundness of the banking entity, as
provided in section 13(d) of the BHC
Act. This approach ensures that a
banking entity can withstand the failure
of a covered fund without causing the
banking entity to breach the minimum
regulatory capital requirements.
Consistent with the language and
purpose of section 13 of the BHC Act,
this deduction will help provide that a
banking entity has sufficient capital to
absorb losses that may occur from
covered fund investments without
endangering the safety and soundness of
the banking entity or the financial
stability of the United States.
Accordingly, under the final rule, a
banking entity must, for purposes of
determining compliance with applicable
regulatory capital requirements, deduct
the greater of (i) the sum of all amounts
paid or contributed by the banking
entity in connection with acquiring or
retaining an ownership interest
(together with any amounts paid by the
entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § ll.10(b)(6)(ii)),
on a historical cost basis, including
earnings or (ii) the fair market value of
the sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest (together with any
amounts paid by the entity (or employee
thereof) in connection with obtaining a
restricted profit interest under
§ ll.10(b)(6)(ii)), if the banking entity
accounts for the profits (or losses) of the
fund investment in its financial
statements.2334 This deduction must be
2333 See 78 FR 62,018, 62,072 (Oct. 11, 2013)
(Board/OCC/FDIC Basel III Final Rule); 78 FR
55,340, 55,391 (Sept. 10, 2013) (FDIC Basel III
interim final rule).
2334 See 12 CFR part 208, subpart D and
appendixes A, B, E, and F; 12 CFR part 217 (to be
codified), and 12 CFR part 225, appendixes A, D,

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made whenever the banking entity
calculates its tier 1 capital, either
quarterly or at such other time at which
the appropriate Federal banking agency
may request such a calculation.
Requiring a banking entity to deduct the
greater of historical cost or fair market
value of all covered fund investments
made by a banking entity from the
entity’s tier 1 capital should result in an
appropriate deduction that is consistent
with the manner in which the banking
entity accounts for its covered fund
investments. For instance, if a banking
entity accounts for its investments in
covered funds using fair market value,
then any changes in the fair market
value of the banking entity’s investment
in a covered fund should similarly be
reflected in the banking entity’s tier 1
capital. Thus, this deduction should not
unduly penalize banking entities for
making successful investments or allow
more investments in troubled covered
funds.
The final rule does not require a
foreign banking entity that makes a
covered fund investment in the United
States, either directly or through a
branch or agency, to deduct the
aggregate value of the investment from
the foreign bank’s tier 1 capital
calculated under applicable home
country standards. However, any U.S.
subsidiary of a foreign banking entity
that is required to calculate tier 1 capital
under U.S. risk based capital regulations
must deduct the aggregate value of
investment held through that subsidiary
from its tier 1 capital.
While some commenters requested
that additional capital charges be
imposed on banking entity’s interests in
securitizations, the Agencies have
declined to do so at this time. Under the
final rule, the banking entity must
deduct the value of its investment in a
securitization that is a covered fund
from its tier 1 capital for purposes of
determining compliance with the
applicable regulatory capital
requirements. This requirement already
requires the banking entity to adjust its
capital for the possibility of losses on
the full amount of its investment. The
Agencies do not believe that it is
appropriate to impose additional capital
charges on these securitizations because
it would act as a disincentive to retain
risk in securitizations for which the
banking entity acts as issuer or sponsor,
a result that would contradict the
purpose of section 15G of the Exchange
Act. Additionally and as noted in the
proposal, permitting a banking entity to
retain the minimum level of economic
E, and G; See also 12 CFR 240.15c3–1 (net capital
requirements for brokers or dealers).

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5731

interest and risk in a securitization will
incent banking entities to engage in
more careful and prudent underwriting
and evaluation of the risks and
obligations that may accompany assetbacked securitizations, which would
promote and protect the safety and
soundness of banking entities and the
financial stability of the United States.
The Agencies have also declined to
impose additional quantitative
limitations or diversification
requirements on covered fund
investments at this time. The Agencies
believe that the per-fund and aggregate
funds limitations, as well as the capital
deduction required by the rule, acting
together with the other limitations on
covered fund activities, establish an
appropriate framework for ensuring that
the covered fund investments and
activities of banking entities are
conducted in a manner that is safe and
sound and consistent with financial
stability. The Agencies will continue to
monitor these activities and investments
to determine whether other limitations
are appropriate over time.
f. Attribution of Ownership Interests to
a Banking Entity
The proposed rule attributed an
ownership interest to a banking entity
based on whether or not the banking
entity held the interest through a
controlled entity. The proposed rule
required that any ownership interest
held by any entity that is controlled,
directly or indirectly, by a banking
entity be included in the amount and
value of the banking entity’s permitted
investments in a single covered fund.
The proposed rule required that the pro
rata share of any ownership interest
held by any covered fund that is not
controlled 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, be included in the amount and
value of the banking entity’s permitted
investments in a single covered fund.
Many commenters expressed
concerns regarding the proposed
attribution requirements.2335 These
commenters argued that the proposed
pro rata attribution requirements are not
required or permitted by the statute,
have unintended and inconsistent
consequences for covered fund
investments, impose heavy compliance
costs on banking entities, and would
impede the ability of funds sponsored
by banking entities to invest in thirdparty funds for the benefit of clients.
2335 See ABA (Keating); Arnold & Porter; SIFMA
et al. (Covered Funds) (Feb. 2012); SSgA (Feb.
2012).

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Some commenters argued that the costs
and complexity of determining whether
a banking entity ‘‘controls’’ another
banking entity under the BHC Act and
the Board’s precedent are high and
urged the Agencies to adopt a simpler
test.2336 For example, some commenters
urged that shares of a company be
attributed to a banking entity only when
the banking entity maintains ownership
of 25 percent or more of voting shares
of the company.2337
Several commenters maintained that
applying the attribution requirements to
fund-of-funds structures and parallel or
master-feeder structures would be
unworkable.2338 Commenters contended
that the proposed attribution rules could
result in a banking entity calculating the
per-fund limitation in a way that
exceeds the banking entity’s actual loss
exposure if the attribution rule for
controlled investments is interpreted to
require that 100 percent of all
investments made by controlled entities
be attributed to the banking entity.2339
In addition, several commenters
argued that the pro rata attribution of
investments held through noncontrolled structures is not consistent
with the Board’s rules and practices for
purposes of the activity and investment
limits in other sections of the BHC Act.
Commenters also maintained that this
pro rata attribution for non-controlled
entities would be impracticable because
a banking entity has only a limited
ability to monitor, direct, or restrain
investments of a covered fund that it
does not control.2340
Conversely, one commenter
supported the pro rata attribution
requirement in the proposal. This
commenter argued that this requirement
reduced opportunities for evasion
2336 See SIFMA et al. (Covered Funds) (Feb.
2012); BlackRock; Arnold & Porter.
2337 See ABA (Keating); Arnold & Porter.
2338 See BoA; SIFMA et al. (Covered Funds) (Feb.
2012); SSgA (Feb. 2012). These commenters argued
that banking entities traditionally utilize a fund-offunds structure to offer customers the opportunity
to invest indirectly in a portfolio of other funds
(including some funds sponsored and managed by
one or more third parties) and that these structures
provide customers with certain risk-mitigating
benefits and allow customers to gain exposure to a
diverse portfolio without having to satisfy the
minimum investment requirements of each fund
directly. They also argued that parallel and feeder
entities are established for a variety of client-driven
reasons, including to accommodate tax needs of
clients and that these entities should be viewed as
a single investment program in which the master
fund holds and manages investments in portfolio
assets and the feeder fund typically makes no
investments other than in the master fund.
2339 See SIFMA et al. (Covered Funds) (Feb.
2012); BoA; Arnold & Porter; SSgA (Feb. 2012).
2340 See SIFMA et al. (Covered Funds) (Feb.
2012).

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through subsidiaries, affiliates or related
entities.2341
The final rule has been modified in
light of the comments. Under the final
rule, a banking entity must account for
an investment in a covered fund for
purposes of the per-fund and aggregate
funds limitations only if the investment
is made by the banking entity or another
entity controlled by the banking entity.
Accordingly, the final rule does not
generally require that a banking entity
include the pro rata share of any
ownership interest held by any entity
that is not controlled by the banking
entity, and thus reduces the potential
compliance costs of the final rule. The
Agencies believe that this concept of
attribution is more consistent with how
the Board has historically applied the
concept of ‘‘control’’ under the BHC Act
for purposes of determining whether a
company subject to that Act is engaged
in an activity or whether to attribute an
investment to that company.
Furthermore, because a banking entity
does not control a non-affiliate and
typically has less access to information
about the holdings of a non-affiliate, this
change is unlikely to present
opportunity for circumvention of the
per-fund and aggregate funds
limitations. The Agencies will monitor
these limitations for practices that
appear to be attempts to circumvent
them.2342
Whether a banking entity controls
another entity under the BHC Act may
vary depending on the type of entity in
question. As noted above in Part
IV.B.1.b.3., the Board’s regulations and
orders have long recognized that the
concept of control is different for funds
than for operating companies.2343 In
contrast to the proposal, the final rule
incorporates these different concepts of
control in part by providing that, for
purposes of section 13 of the BHC Act
and the final rule, a registered
investment company, SEC-regulated
business development company, and a
foreign public fund as described in
§ ll.10(c)(1) of the final rule will not
be considered to be an affiliate of the
banking entity if the banking entity
owns, controls, or holds with the power
to vote less than 25 percent of the voting
shares of the company or fund, and
provides investment advisory,
2341 See

Occupy.
Agencies note that other provisions of
the BHC Act and Savings and Loan Holding
Company Act would prohibit a banking entity that
is a bank holding company or savings and loan
holding company from acquiring 5 percent or more
of a covered fund that is itself a bank holding
company or a savings and loan holding company,
respectively, without regulatory approval. See 12
U.S.C. 1842(a); 12 U.S.C. 1467a(e).
2343 See, e.g., First Union Letter.
2342 The

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commodity trading advisory,
administrative, and other services to the
company or fund only in a manner that
complies with other limitations under
applicable regulation, order, or other
authority.2344
In response to commenter concerns
regarding the workability of the
proposed rule, the final rule has been
modified to address how ownership
interests would be attributed to a
banking entity when those interests are
held in a fund-of-funds or multi-tiered
fund structures. For instance, banking
entities may use a variety of structures
to satisfy operational needs or meet the
investment needs of customers of their
trust, fiduciary, investment advisory or
commodity trading advisory services.
First, except as explained for
purposes of calculating a banking
entity’s permitted investment in multitier fund structures, the final rule does
not generally attribute to a banking
entity ownership interests held by a
covered fund so long as the banking
entity’s investment in the covered fund
meets the per-fund limitation in the
final rule.2345 Absent unusual
circumstances or structures, a banking
entity would not control a covered fund
in which the banking entity has an
ownership interest that conforms to the
per-fund and aggregate funds limitations
contained in the final rule. Thus, the
interests held by that covered fund
would not be attributed to the banking
entity for the reasons discussed above.
The final rule also explains how the
investment limitations apply to
investments of a banking entity in
multi-tier fund structures. The Agencies
believe that master-feeder fund
structures typically constitute a single
investment program in which the master
fund holds and manages investments
and the feeder funds typically make no
investments other than in the master
fund and exist as a convenience for
customers of the trust, fiduciary,
investment advisory, or commodity
trading advisory services of the banking
entity. Similarly, trust, fiduciary, or
advisory customers of a banking entity
may desire to obtain diversified
exposure to a variety of funds or
investments through investing in a
fund-of-funds structure that the banking
entity organizes and offers.
In order to meet the demands of these
customers, the final rule provides that if
the principal investment strategy of a
covered fund (the ‘‘feeder fund’’) is to
invest substantially all of its assets in
another single covered fund (the
‘‘master fund’’), then for purposes of the
2344 Id.

See final rule § ll.12(b)(1)(ii).
final rule § ll.12(b)(1)(iii).

2345 See

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
per-fund limitation the banking entity’s
permitted investment shall be measured
only at the master fund. However, in
order to appropriately capture the
banking entity’s amount of investment
in the master fund, a banking entity
must include in this calculation any
investment held by the banking entity in
the master fund, as well as the banking
entity’s pro-rata share of any ownership
interest of the master fund that is held
through the feeder fund.2346
Similarly, regarding fund-of-funds
structures, the final rule provides that if
a banking entity organizes and offers a
covered fund pursuant to § ll.11 for
the purpose of investing in other
covered funds (a ‘‘fund of funds’’) and
that fund of funds itself invests in
another covered fund that the banking
entity organizes and offers, then the
banking entity’s permitted investment
in that other covered fund shall include
any investment held by the banking
entity in that other fund, as well as the
banking entity’s pro-rata share of any
ownership interest of the other fund that
is held through the fund of funds. The
banking entity’s investment in the fund
of funds must also meet the investment
limitations contained in § ll.12. In
these manners, the final rule permit a
banking entity to meet the demands of
customers of their trust, fiduciary, or
advisory services while also limiting the
ability of a banking entity to be exposed
to more than the amount of risk of a
covered fund contemplated by section
13.
As described above in the discussion
of organizing and offering a covered
fund, other provisions of section 13
contemplate investments by employees
and directors of the banking entity that
provide qualifying services to a covered
fund.2347 The Agencies recognized in
the proposal that employee and director
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 in
a covered fund.2348 In order to address
this concern, the proposal attributed an
ownership interest in a covered fund
acquired or retained by a director or
employee to the person’s employing
banking entity if the banking entity
either extends credit for the purposes of
allowing the director or employee to
acquire the ownership interest,
guaranteed the director or employee’s
purchase, or guarantees the director or

employee against loss on the
investment.
One commenter supported the way
the proposal addressed evasion
concerns by attributing an ownership
interest in a covered fund acquired or
retained by a director or employee to a
banking entity.2349 A different
commenter urged the Agencies to
attribute any employee investments in a
covered fund to the banking entity itself,
regardless of the source of funds.2350
Another commenter argued that the
statute prohibits a banking entity from
guaranteeing an investment by an
employee or director.2351
After considering the comments and
the language of the statute, the Agencies
have determined to retain the
requirement that all director or
employee investments in a covered fund
be attributed to the banking entity for
purposes of the per-fund limitation and
the aggregate funds limitation whenever
the banking entity provides the
employee or director funding for the
purpose of acquiring the ownership
interest. Specifically, under the final
rule, an investment by a director or
employee of a banking entity who
acquires an ownership interest in his or
her personal capacity in a covered fund
sponsored by the banking entity will be
attributed to the banking entity if the
banking entity, directly or indirectly,
extends financing for the purpose of
enabling the director or employee to
acquire the ownership interest in the
fund and the financing is used to
acquire such ownership interest in the
covered fund.2352 It is also important to
note that the statute prohibits a banking
entity from guaranteeing the obligations
or performance of a covered fund in
which it acts as investment adviser,
investment manager or sponsor, or
organizes and offers.2353
As discussed above in the definition
of ownership interest, the final rule also
attributes to the banking entity any
amounts contributed by an employee or
director when made in order to receive
a restricted profit interest, whether or
not funded or guaranteed by the banking
entity. This approach ensures that all
funding provided by the banking
entity—whether directly or through its
employees or directors—and all
exposures of the banking entity—
whether directly or through a guarantee
provided to or on behalf of an employee
or director—is counted against the
2349 See

Ass’n. of Institutional Investors (Feb.

2012).
final rule § ll.12(b)(34).
12 U.S.C. 1851(d)(1)(G)(vii); final rule
§ ll.11(g).
2348 See Joint Proposal, 76 FR 68,902.
2346 See

2350 See

2347 See

2351 See

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Occupy.
Arnold & Porter.
2352 See final rule § ll.12(b)(1)(iv).
2353 See 12 U.S.C. 1851(f)(1).

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5733

limits on exposure contained in the
statute and final rule. At the same time,
this approach recognizes that employees
and directors may use their own
resources, not protected by the banking
entity, to invest in a covered fund.
Employees of investment advisers in
particular often invest their own
resources in covered funds they advise,
both by choice and as a method to align
their personal financial interests with
those of other investors in the covered
fund. So long as these investments are
truly with personal resources, and are
not funded by the banking entity, these
personal investments would not expose
the banking entity to loss and would not
be attributed by the final rule to the
banking entity. This approach is also
consistent with the terms of the statute,
which expressly contemplates
investments by directors or employees
of a banking entity in their individual
capacity.2354
The Agencies intend to monitor
investments by directors and employees
of a banking entity to ensure that
employee ownership interests are not
used to circumvent the per-fund and
aggregate funds limitations in section
13. Among the factors the Agencies will
consider, in addition to financing and
guarantee arrangements, are whether the
benefits of the acquisition and retention,
such as dividends, inure to the benefit
of the director or employee and not the
banking entity; the voting or control of
the ownership interests is subject to the
direction of, or otherwise controlled by,
the banking entity; and the employee or
director, rather than the banking entity,
determines whether the employee or
director should make the investment.
The proposed rule contained a
provision intended to curb potential
evasion of the per-fund limitation and
aggregate limitation through parallel
investments by banking entities that
were not otherwise subject to section 13
of the BHC Act. Specifically, the
proposed rule provided that, to the
extent that a banking entity is
contractually obligated to 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 must be
included in the calculation of a banking
entity’s per-fund limitation.
Several commenters objected to this
requirement and argued that it was not
consistent with the statute. These
commenters argued that section 13 of
2354 See

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the BHC Act restricts a banking entity’s
investments in covered funds, and not
direct investments by a banking entity
in individual companies under other
authorities, such as the merchant
banking investment authority in section
4(k)(4)(H) of the BHC Act.2355 Some
commenters argued that prohibiting or
limiting direct investments could cause
a conflict between a banking entity’s
fiduciary duty to its clients to manage
their covered fund investments and the
banking entity’s duty to its shareholders
to pursue legitimate merchant banking
investments.2356 Some commenters
urged the Agencies not to attribute any
parallel co-investment alongside a
covered fund to a banking entity unless
there is a pattern of evasion, and some
requested that there be prior notice and
an opportunity for a hearing to
determine whether such a pattern has
occurred.2357 Another commenter
recommended the Agencies provide a
safe harbor for situations where a bank
trustee is acting on behalf of
customers.2358
In contrast, other commenters
contended that the risks of direct
investments, such as those made under
merchant banking authority, are similar
to those of many investments in covered
funds. These commenters urged the
Agencies to restrict direct investments
in the underlying holdings or assets of
a covered fund in the same manner as
direct investments in covered funds.2359
After carefully considering the
comments and the language of the
statute, the Agencies have determined
not to adopt the proposed prohibition
on parallel investments in the final rule.
As illustrated by commenters, banking
entities rely on a number of investment
authorities and structures to meet the
needs of their clients and make
investments under a variety of
authorities that are not coordinated with
investments made by covered funds
owned or advised by the banking entity.
The Agencies believe that many
investments made by banking entities
are made for the purpose of serving the
legitimate needs of customers and
shareholders, and not for the purpose of
circumventing the per-fund and
aggregate funds limitations in section
13.
Nevertheless, the Agencies continue
to believe that the potential for evasion
2355 See 12 U.S.C. 1843(k)(4)(H); 12 CFR 225.170
et seq. See ABA (Keating); BoA; BOK; SIFMA et al.
(Covered Funds) (Feb. 2012); SVB.
2356 See ABA (Keating).
2357 See BOK; SVB; ABA (Keating); BoA; SIFMA
et al. (Covered Funds) (Feb. 2012).
2358 See BOK.
2359 See Public Citizen; Sens. Merkley & Levin
(Feb. 2012).

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of these limitations may be present
where a banking entity coordinates its
direct investment decisions with the
investments of covered funds that it
owns or sponsors. For instance, the
Agencies understand that it is relatively
common for the sponsor of a covered
fund in connection with a privately
negotiated investment to offer investors
co-investment opportunities when the
general partner or investment manager
for the covered fund determines that the
covered fund does not have sufficient
capital available to make the entire
investment in the target portfolio
company or determines that it would
not be suitable for the covered fund to
take the entire available investment. In
such circumstances, a banking entity
that sponsors the covered fund should
not itself make any additional side by
side co-investment with the covered
fund in a privately negotiated
investment unless the value of such coinvestment is less than 3% of the value
of the total amount co-invested by other
investors in such investment. Further, if
the co-investment is made through a coinvestment vehicle that is itself a
covered fund (a ‘‘co-investment fund’’),
the sum of the banking entity’s
ownership interests in the coinvestment fund and the related covered
fund should not exceed 3% of the sum
of the ownership interests held by all
investors in the co-investment fund and
related covered fund. Finally, the
Agencies note that if a banking entity
makes investments side by side in
substantially the same positions as the
covered fund, then the value of such
investments shall be included for
purposes of determining the value of the
banking entity’s investment in the
covered fund.
g. Calculation of Tier 1 Capital
The proposal explained that tier 1
capital is a banking law concept that, in
the United States, is 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 clarified that for purposes of the
aggregate funds limitation in § ll.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’’) needed to use 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.

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The proposal also recognizes that 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
§ ll.12(c) of the proposed rule, the
proposed rule clarified how the
aggregate funds limitation should 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 was 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.2360 For a banking entity that
was not itself required to report tier 1
capital but was a subsidiary of a
reporting banking entity that is a
depository institution (e.g., a subsidiary
of a national bank), the aggregate funds
limitation was the amount of tier 1
capital reported by such depository
institution.2361 For a banking entity that
was not itself required to report tier 1
capital but was 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 was the
amount of tier 1 capital reported by the
top-tier affiliate of such banking entity
that holds and reports tier 1 capital
under the proposal.2362
Commenters did not generally object
to the proposed approach for
determining the applicable tier 1 capital
for banking entities. One commenter
advocated calculating the aggregate
funds limitation based on the tier 1
capital of the banking entity making the
covered fund investment instead of the
tier 1 capital of the consolidated
banking entity.2363 In addition, the
commenter urged the Agencies to
require banking entities to divest any
portions of the investment that exceeds
3 percent of that entity’s tier 1 capital.
The final rule provides that any
banking entity that is required to
proposed rule § ll.12(c)(2)(ii)(B)(2).
proposed rule § ll.12(c)(2)(ii)(A).
2362 See proposed rule
§ ll.12(c)(1)(B(2)(ii)(B)(1).
2363 See Occupy.
2360 See
2361 See

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calculate and report tier 1 capital (a
‘‘reporting banking entity’’) must
calculate the aggregate funds limitation
using the tier 1 capital amount reported
by the entity as of the last day of the
most recent calendar quarter as reported
to the relevant Federal banking agency.
A non-depository institution subsidiary
of a reporting banking entity may rely
on the consolidated tier 1 capital of the
reporting banking entity for purposes of
calculating compliance with the
aggregate funds limitation. In the case of
a depository institution that is itself a
reporting banking entity and that is also
a subsidiary or affiliate of a reporting
banking entity, the aggregate of all
investments in covered funds held by
the depository institution (including the
investments by its subsidiaries) may not
exceed three percent of either the tier 1
capital of the depository institution or of
the top-tier reporting banking entity that
controls such depository institution.
The final rule also provides that any
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) may compute
compliance with the aggregate funds
limitations using the amount of tier 1
capital reported by such depository
institution.
Several commenters argued that
foreign banking organizations should be
permitted to use the consolidated tier 1
capital at the top-tier foreign banking
organization level, as calculated under
applicable home country capital
standards, to calculate compliance with
the aggregate funds limitation.2364 One
commenter noted that the tier 1 capital
of a banking entity may fluctuate based
on specific conditions relevant only to
the banking entity, and urged the
Agencies to consider an alternative
measure of capital, although this
commenter did not suggest any
alternative.2365
After considering the comments
received and that purpose and language
of section 13 of the BHC Act, the
Agencies have determined that for
foreign banking organizations, the
aggregate funds limitation would be
based on the consolidated tier 1 capital
of the foreign banking organization, as
calculated under applicable home
country standards. However, a U.S.
bank holding company or U.S. savings
and loan holding company that is
controlled by a foreign banking entity
must separately meet the per-fund and
aggregate funds limitations for each and
all (respectively) covered fund
2364 See
2365 See

Credit Suisse (Williams); IIB/EBF.
Japanese Bankers Ass’n.

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investments made by the U.S. holding
company, based on the tier 1 capital of
the U.S. bank holding company or U.S.
savings and loan holding company. The
Federal banking agencies may revisit
this approach in light of the manner in
which the Board implements the
enhanced prudential standards and
early remediation requirements for
foreign banking organizations and
foreign nonbank financial companies,
including the proposed U.S.
intermediate holding company
requirements under that rule.2366
h. Extension of Time to Divest
Ownership Interest in a Single Fund
The proposed rule provided that the
Board may, upon application by a
banking entity, extend the period of
time that a banking entity may have to
conform an investment to the 3 percent
per-fund limitation. As in the statute,
the proposed rule permitted the Board
to grant up to an additional two years
if the Board finds that an extension
would be consistent with safety and
soundness and not detrimental to the
public interest. The proposal required a
banking entity to submit an application
for extension to the Board, and set forth
the factors that the Board would
consider in reviewing an application for
extension, including a requirement that
the Board consult with the primary
federal supervisory agency for the
banking entity prior to acting on an
application.
Some commenters argued that the
final rule should be modified to extend
automatically the one-year statutory
period for complying with the per-fund
limitation by an additional two years
without application or approval on a
case-by-case basis and to apply the
extended conformance period to the
aggregate funds limitations.2367 Some of
these commenters suggested that
Congress explicitly recognized the need
for a banking entity to have a sufficient
seeding period following establishment
of a fund, and that funds often require
more than one year to attract enough
unaffiliated investors to enable the
sponsoring banking entity to reduce its
ownership interests in the fund to the
level required by section 13(d)(4).
Other commenters argued that the
amount of a banking entity’s own
capital involved in seeding a fund is
typically ‘‘small’’ and suggested that, in
order to prevent banking entities from
2366 See Enhanced Prudential Standards and Early
Remediation Requirements for Foreign Banking
Organizations and Foreign Nonbank Financial
Companies, 77 FR 76,628, 76,637 (Dec. 28, 2012).
2367 See, e.g., SIFMA et al. (Covered Funds)
(Feb. 2012); SSgA (Feb. 2012); TCW; Credit Suisse
(Williams).

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5735

engaging in prohibited proprietary
trading through a fund, the Board
should condition the ability of a
banking entity to qualify for an
extension of the one-year statutory
period on several requirements,
including a requirement that the
banking entity not have provided more
than $10 million in seed capital as part
of establishing the covered fund.2368
The Agencies have carefully
considered comments received on the
proposal and have determined instead
to adopt the process and standards
governing requests for extensions of
time to divest an ownership interest in
a single covered fund largely as
proposed. The Agencies believe that this
approach is consistent with the process
and standards set out under the statute.
As under the proposal, the final rule
requires any banking entity that seeks
an extension of the conformance period
provided for the per-funds limitation to
submit a written request to the Board.
Any such request must be submitted to
the Board at least 90 days prior to the
expiration of the applicable time period
and provide the reasons why the
banking entity believes the extension
should be granted. In addition, the
request must explain the banking
entity’s plan for reducing the permitted
investment in a covered fund through
redemption, sale, dilution or other
methods to the limits imposed by the
final rule. To allow the Board to assess
the factors provided in the statute, the
final rule provides that any extension
request by a banking entity must
address: (i) Whether the investment
would result, directly or indirectly, in a
material exposure by the banking entity
to high-risk assets or high-risk trading
strategies; (ii) the contractual terms
governing the banking entity’s interest
in the covered fund; (iii) the total
exposure of the covered banking entity
to the investment and the risks that
disposing of, or maintaining, the
investment in the covered fund may
pose to the banking entity and the
financial stability of the United States;
(iv) the cost to the banking entity of
divesting or disposing of the investment
within the applicable period; (v)
whether the investment or the
divestiture or conformance of the
investment would involve or result in a
material conflict of interest between the
banking entity and unaffiliated parties,
including clients, customers or
counterparties to which it owes a duty;
(vi) the banking entity’s prior efforts to
reduce through redemption, sale,
dilution, or other methods its ownership
2368 See, e.g., Occupy; Sens. Merkley & Levin
(Feb. 2012).

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interests in the covered fund, including
activities related to the marketing of
interests in such covered fund; (vii)
market conditions; and (viii) any other
factor that the Board believes
appropriate. In contrast to the proposal,
the final rule does not require
information on whether the extension
would pose a threat to safety and
soundness of the covered banking entity
or to financial stability of the United
States. The categories of information in
final rule have been modified in order
to eliminate redundancies.
The final rule continues to permit the
Board to impose conditions on granting
any extension granted 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
otherwise unsound practices, or to
otherwise further the purposes of
section 13 of the BHC Act and the final
rule. In cases where the banking entity
is primarily supervised by another
Agency, the Board will 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
extension of the conformance period.
While some commenters requested that
the Board modify the final rule to
permit a banking entity to have covered
fund investments in excess of the
aggregate funds limitation,2369 the final
rule does not contain such a provision.
As noted in the release for the proposed
rule, the statutory grant of authority to
provide extensions of time to comply
with the investment limits refers
specifically and only to the period for
conforming a seeding investment to the
per-fund limitation.2370
As noted in the proposed rule, the
Agencies recognize the potential for
evasion of the restrictions contained in
section 13 of the BHC Act through
misuse of requests for extension of the
seeding period for covered funds.
Therefore, the Board and the Agencies
will monitor requests for extensions of
the seeding period for activity in
covered funds that is inconsistent with
the requirements of section 13 of the
BHC Act.

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4. Section ll.13: Other Permitted
Covered Fund Activities
a. Permitted Risk-Mitigating Hedging
Activities
Section 13(d)(1)(C) of the BHC Act
provides an exemption for certain risk2369 See
2370 See

ABA (Keating).
12 U.S.C. 1851(d)(4)(C).

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mitigating hedging activities.2371 In the
context of covered fund activities, the
proposed rule implemented this
authority narrowly and permitted a
banking entity to acquire or retain an
ownership interest in a covered fund as
a risk-mitigating hedge only in two
situations: (i) When acting as
intermediary on behalf of a customer
that is not itself a banking entity to
facilitate exposure by the customer to
the profits and losses of the covered
fund; and (ii) with respect to a
compensation arrangement with an
employee of the banking entity that
directly provides investment advisory or
other services to that fund.2372 The
proposed rule imposed specific
requirements on a banking entity
seeking to rely on this exemption.2373
The Agencies received a range of
comments on the proposed riskmitigating hedging exemption for
ownership interests in covered funds.
Some commenters objected to the
limited applicability of the statutory
risk-mitigating hedging exemption in
the covered funds context and urged the
Agencies to allow ownership interests
in covered funds to be used in any
appropriate risk-mitigating hedging.2374
In contrast, other commenters urged the
Agencies to delete one or both of the
risk-mitigating hedging exemptions as
the commenters argued they were
inconsistent with the statute or
otherwise inappropriate.2375
Commenters also argued that a separate
risk-mitigating hedging exemption for
covered funds is unnecessary because
the statute provides a single riskmitigating hedging exemption.2376
Some commenters argued that the
proposed rule would impede banking
entities from offering covered-fund
linked products to customers, including
hedging these products, and would, in
particular, impair the ability of banking
2371 See
2372 See

12 U.S.C. 1851(d)(1)(C).
proposed rule § ll.13(b)(1)(i)(A) and

(B).
2373 These requirements were substantially
similar to the requirements for the risk-mitigating
hedging exemption for trading activities contained
in proposed § ll.5. In addition, proposed § ll
.13(b) also required that: (i) The hedge represent a
substantially similar offsetting exposure to the same
covered fund and in the same amount of ownership
interest in that covered fund arising out of the
transaction to accommodate a specific customer
request or directly connected to the banking entity’s
compensation arrangement with an employee; and
(ii) the banking entity document, at the time the
transaction is executed, the hedging rationale for all
hedging transactions involving an ownership
interest in a covered fund.
2374 See BoA; Credit Suisse (Williams); Deutsche
Bank (Fund-Linked Products); ISDA (Feb. 2012);
SIFMA et al. (Covered Funds) (Feb. 2012).
2375 See AFR et al. (Feb. 2012); Occupy; Public
Citizen; Sens. Merkley & Levin (Feb. 2012).
2376 See BoA.

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entities to hedge the risks of fund-linked
derivatives with fund-linked swaps or
shares of covered funds referenced in
fund-linked products.2377 These
commenters argued this limitation
would increase risks at banking entities
and was inconsistent with the purpose
of the risk-mitigating hedging
exemption. Commenters also proposed
modifying the proposal to permit riskmitigating hedging activities that
facilitate a customer’s exposure to
profits and/or losses of the covered
fund, to permit portfolio or dynamic
hedging strategies involving covered
fund interests, and to eliminate the
proposed condition that a customer
would not itself be a banking entity.2378
Some commenters also urged the
Agencies to grandfather existing riskmitigating hedging activities with
respect to any covered-fund linked
products that comply with the hedging
requirements for proprietary trading
under § ll.5 of the proposed rule.2379
In contrast, other commenters
objected to the exemption for hedging
covered fund-linked products sold to
customers. These commenters asserted
that this activity would authorize
investment in covered funds in a
manner that would not be subject to the
three percent per-fund limitation; 2380 or
would be inconsistent with the statutory
requirement that a banking entity
actively seek additional investors for a
fund.2381
Some commenters urged the Agencies
to expand the hedging exemption to
allow banking entities to invest in
covered funds in order to hedge
obligations relating to deferred
compensation plans for employees who
do not directly provide services to the
covered fund for which the hedge
relates.2382 Another commenter argued
that banking entities should be
permitted to hedge compensation
investment accounts for executive
officers who are not involved in the
management of the investment
accounts.2383 In contrast, other
commenters objected to the hedging
exemption for compensation
arrangements, arguing that it may
increase risk to banking entities,2384 is
2377 See ISDA (Feb. 2012); BoA; Credit Suisse
(Williams); Deutsche Bank (Fund-Linked Products);
ISDA (Feb. 2012); SIFMA et al. (Covered Funds)
(Feb. 2012).
2378 See, e.g., BoA; SIFMA et al. (Covered Funds)
(Feb. 2012); Deutsche Bank (Fund-Linked
Products).
2379 See SIFMA et al. (Covered Funds) (Feb.
2012); BoA.
2380 See Sens. Merkley & Levin (Feb. 2012).
2381 See AFR et al. (Feb. 2012).
2382 See Arnold & Porter.
2383 See BOK.
2384 See Occupy.

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unnecessary,2385 or may provide
banking entities with an opportunity to
evade the limitations on the amount of
ownership interests they may have as an
investment in a covered fund.2386
After review of the comments, the
Agencies believe at this time that
permitting only limited risk-mitigating
hedging activities involving ownership
interests in covered funds is consistent
with the safe and sound conduct of
banking entities, and that increased use
of ownership interests in covered funds
could result in exposure to higher
risks.2387
In particular, the Agencies have
determined that transactions by a
banking entity to act as principal in
providing exposure to the profits and
losses of a covered fund for a customer,
even if hedged by the entity with
ownership interests of the covered fund,
is a high risk strategy that could
threaten the safety and soundness of the
banking entity. These transactions
expose the banking entity to the risk
that the customer will fail to perform,
thereby effectively exposing the banking
entity to the risks of the covered fund.
Furthermore, a customer’s failure to
perform may be concurrent with a
decline in value of the covered fund,
which could expose the banking entity
to additional losses. Accordingly, the
Agencies believe that these transactions
pose a significant potential to expose
banking entities to the same or similar
economic risks that section 13 of the
BHC Act sought to eliminate, and have
not adopted the proposed exemption for
using ownership interests in covered
funds to hedge these types of
transactions in the final rule.
As argued by some commenters,
modifying the proposal to eliminate the
exemption for permitting banking
entities to acquire covered fund
interests in connection with customer
facilitation may impact banking entities
ability to hedge the risks of fund-linked
derivatives through the use of fundlinked swaps or shares of covered funds
referenced by fund-linked products.2388
Some commenters on the proposal
argued that innovation of financial
products may potentially be reduced if
the final rule does not permit this type
of activity related to fund-linked
products.2389 The Agencies recognize
that U.S. banking entities may no longer
be able to participate in offering certain
2385 See

AFR et al. (Feb. 2012); Public Citizen.
Occupy.
2387 See 12 U.S.C. 1851(d)(2).
2388 See ISDA (Feb. 2012); BoA; Credit Suisse
(Williams); Deutsche Bank (Fund-Linked Products);
SIFMA et al. (Covered Funds) (Feb. 2012).
2389 See SIFMA et al. (Covered Funds) (Feb.
2012); Credit Suisse (Williams).
2386 See

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customer facilitation products relating
to covered funds, but believe it is
consistent with the purposes of section
13 to restrict these activities.
The final rule maintains the proposed
exemption for hedging employee
compensation arrangements with
several changes. To ensure that exempt
hedging activities are designed to
reduce one or more specific risks, as
required by section 13(d)(1)(C) of the
BHC Act, the proposed rule required
that permitted hedging activity be
designed to reduce the specific risks to
the banking entity in connection with
and related to its obligations or
liabilities. The final rule permits a
banking entity to acquire or retain an
ownership interest in a covered fund
provided that the ownership interest is
designed to demonstrably reduce or
otherwise significantly mitigate the
specific, identifiable risks to the banking
entity in connection with a
compensation arrangement with an
employee who directly provides
investment advisory or other services to
the covered fund. Under the final rule,
a banking entity may not use as a hedge
ownership interests of a covered fund
for which the employee does not
provide services. The requirement
under the final rule that the hedging
activity be designed to demonstrably
reduce or otherwise significantly
mitigate the specific, identifiable risks
to the banking entity is consistent with
the requirement in § ll.5 of the final
rule, as discussed above in Part IV.A.4.
The final rule permits a banking entity
to hedge its exposures to price and other
risks based on fund performance that
arise from restricted profit interest and
other performance based compensation
arrangements with its investment
managers.
Section 13(a)(2) of the final rule
describes the criteria a banking entity
must meet in order to rely on the riskmitigating hedging exemption for
covered funds. These requirements,
which are based on the requirements for
the risk-mitigating hedging exemption
for trading activities under § ll.5 of
the final rule and which are discussed
in detail above in Part IV.A.4, have been
modified from the proposal to reflect the
more limited scope of this section.2390
In particular, the final rule permits a
banking entity to engage in riskmitigating hedging activities involving
ownership interests in a covered fund
only if the banking entity has
established and implements, maintains
and enforces an internal compliance
program that is reasonably designed to
ensure the covered banking entity’s
2390 See

PO 00000

final rule § ll.13(a)(2).

Frm 00203

Fmt 4701

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5737

compliance with the requirements of the
hedging exemption, including
reasonably designed written policies
and procedures and internal controls
and ongoing monitoring and
authorization procedures, and has
acquired or retained the ownership
interest in accordance with these
written policies, procedures and
internal controls. Furthermore, the
acquisition or retention of an ownership
interest must demonstrably reduce or
otherwise significantly mitigate, at the
inception of the hedge, one or more
specific, identifiable risks arising in
connection with the compensation
arrangement with an employee that
directly provides investment advisory or
other services to the covered fund. The
acquisition or retention also may not, at
the inception of the hedge, result in any
significant new or additional risk that is
not itself hedged contemporaneously in
accordance with the hedging exemption,
and the hedge must be subject to
continuing review, monitoring and
management by the banking entity.
The final rule also permits a banking
entity to engage in risk-mitigating
hedging activities in connection with a
compensation arrangement, subject to
the conditions noted above, only if the
compensation arrangement relates
solely to the covered fund in which the
banking entity or any affiliate thereof
has acquired an ownership interest and
the losses on such ownership interest
are offset by corresponding decreases in
the amounts payable in connection with
the related employee compensation
arrangement.2391
b. Permitted Covered Fund Activities
and Investments Outside of the United
States
Section 13(d)(1)(I) of the BHC Act 2392
permits foreign banking entities to
acquire or retain an ownership interest
in, or act as sponsor to, covered funds,
so long as those activities and
investments occur solely outside the
United States and certain other
conditions are met (the ‘‘foreign fund
final rule § ll.13(a)(2)(iii).
13(d)(1)(I) of the BHC Act permits a
banking entity to acquire or retain an ownership
interest in, or have certain relationships with, a
covered fund notwithstanding the restrictions on
investments in, and relationships with, a covered
fund, if: (i) Such activity or investment is
conducted by a banking entity pursuant to
paragraph (9) or (13) of section 4(c) of the BHC Act;
(ii) the activity occurs solely outside of the United
States; (iii) no ownership interest in such fund is
offered for sale or sold to a resident of the United
States; and (iv) the banking entity is not directly or
indirectly controlled by a banking entity that is
organized under the laws of the United States or of
one or more States. See 12 U.S.C. 1851(d)(1)(I).
2391 See

2392 Section

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exemption’’).2393 As described in the
proposal, the purpose of this statutory
exemption appears to be to limit the
extraterritorial application of the
statutory restrictions on covered fund
activities and investments, while
preserving national treatment and
competitive equality among U.S. and
foreign banking entities within the
United States.2394 The statute does not
explicitly define what is meant by
‘‘solely outside of the United States.’’
The proposed rule allowed foreign
banking entities that met certain
qualifications to engage in covered fund
activities, including owning, organizing
and offering, and sponsoring funds
outside the United States. The proposed
rule defined both the type of foreign
banking entity that is eligible for the
exemption and when an activity or
investment would occur ‘‘solely outside
of the United States.’’ The proposed rule
allowed a qualifying foreign banking
entity to acquire or retain an ownership
interest in, or act as sponsor to, a
covered fund under the exemption only
if no subsidiary, affiliate or employee of
the banking entity that’s incorporated or
physically located in the United States
engaged in offering or selling the
covered fund. The proposed rule also
implemented the statutory requirement
that prohibited an ownership interest in
the covered fund from being offered for
sale or sold to a resident of the United
States.
Commenters generally expressed
support for an exemption to allow
foreign banking entities to conduct
foreign covered fund activities and
make investments outside the United
States.2395 A number of commenters
also expressed concerns that the
proposed foreign fund exemption was
2393 This section’s discussion of the concept
‘‘solely outside of the United States’’ is provided
solely for purposes of the final rule’s
implementation of section 13(d)(1)(I) 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.
2394 See 156 Cong. Rec. S5897 (daily ed. July 15,
2010) (statement of Sen. Merkley). (‘‘Subparagraphs
(H) and (I) recognize rules of international
regulatory comity by permitting foreign banks,
regulated and backed by foreign taxpayers, in the
course of operating outside of the United States to
engage in activities permitted under relevant
foreign law. However, these subparagraphs are not
intended to permit a U.S. banking entity to avoid
the restrictions on proprietary trading simply by
setting up an offshore subsidiary or reincorporating
offshore, and regulators should enforce them
accordingly. In addition, the subparagraphs Seek to
maintain a level playing field by prohibiting a
foreign bank from improperly offering its hedge
fund and private equity fund services to U.S.
persons when such offering could not be made in
the United States.’’).
2395 See, e.g., IIB/EBF; SIFMA et al. (Covered
Funds) (Feb. 2012); See also Occupy.

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too narrow and would not be effective
in permitting foreign banking entities to
engage in covered fund activities and
investments outside of the United
States. For instance, many commenters
argued that several of the proposal’s
restrictions on the exemption were not
required by statute and were
inconsistent with congressional intent
to limit the extraterritorial impact of
section 13 of the BHC Act.2396 These
commenters argued that the foreign
funds exemption should focus on
whether a prohibited activity, such as
sponsoring or investing in a covered
fund, involves principal risk taken or
held by the foreign banking entity that
poses risk to U.S. banking entities or the
financial stability of the United
States.2397 Commenters also argued that
a broader exemption would better
recognize the regulation and
supervision of the home country
supervisor of the foreign banking entity
and of its covered fund activities.2398
Some commenters contended that the
proposal represented an improper
extraterritorial application of U.S. law
that could be found to violate
international treaty obligations of the
United States, such as those under the
North American Free Trade Agreement,
and might result in retaliation by foreign
countries in their treatment of U.S.
banking entities abroad.2399
Commenters also alleged that the
proposal would impose significant
compliance costs on the foreign
operations of foreign banking entities
conducting activity pursuant to this
exemption.2400 These commenters
argued that foreign banking entities
relying on the foreign fund exemption
should not be subject to the compliance
program requirements contained in
Appendix C with respect to their nonU.S. operations.2401
2396 See Ass’n. of German Banks; BVI; Allen &
Overy (on behalf of Canadian Banks); EFAMA; F&C;
HSBC; IIB/EBF; ICSA; PEGCC; Socie´te´ Ge´ne´rale;
Union Asset; Ass’n. of Banks in Malaysia; EBF;
Credit Suisse (Williams); Cadwalader (on behalf of
Thai Banks).
2397 See IIB/EBF; EBF; Allen & Overy (on behalf
of Canadian Banks); Credit Suisse (Williams);
Katten (on behalf of Int’l Clients).
2398 See Credit Suisse (Williams); PEGCC; See
also Commissioner Barnier.
2399 See e.g., Norinchukin; Cadwalader (on behalf
of Thai Banks); Barclays; EBF; Ass’n. of German
Banks; Socie´te´ Ge´ne´rale; Chamber (Feb. 2012).
2400 See BaFin/Deutsche Bundesbank;
Norinchukin; IIF; Allen & Overy (on behalf of
Canadian Banks); ICFR; BoA. As discussed below
in Part IV.C.1, other parts of the final rule address
commenters’ concerns regarding the compliance
burden on foreign banking entities.
2401 See AFG; Ass’n. of German Banks; BVI;
Comm. on Capital Markets Regulation; IIB/EBF;
Japanese Bankers Ass’n.; Norinchukin; Union Asset.
As discussed in greater detail below in Part IV.C.1,
activities and investments of a foreign bank that are

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Several commenters argued that the
restrictions of section 13(f), which limits
transactions between a banking entity
and certain covered funds, would not
apply to activities and investments
made in reliance on the foreign fund
exemption.2402 Some commenters
argued that the Agencies should
grandfather all existing foreign covered
funds and argued that failure to provide
relief for existing relationships could
cause substantial disruption to foreign
covered funds and significantly harm
investors in existing funds without
producing a clear offsetting benefit.2403
In response to comments received on
the proposal, the final rule contains a
number of modifications to more
effectively implement the foreign fund
exemption in light of the language and
purpose of the statute. Importantly, as
explained in the section defining
covered funds, the Agencies also believe
that the more circumscribed definition
of covered fund, including the exclusion
for foreign public funds, should
alleviate many of the concerns raised
and potential burdens identified by
commenters with respect to the funds
activities of foreign banking entities.2404
1. Foreign Banking Entities Eligible for
the Exemption
The statutory language of section
13(d)(1)(I) provides that, in order to be
eligible for the foreign funds exemption,
the banking entity must not be directly
or indirectly controlled by a banking
conducted under the foreign funds exemption are
generally not subject to the specific requirements of
§ ll.20 and Appendices A and B. The U.S.
operations of foreign banking entities are expected
to have policies and procedures in place to ensure
that they conduct activities under this part in full
compliance with this part.
2402 See Australian Bankers Ass’n.; AFMA; Allen
& Overy (on behalf of Foreign Bank Group); British
Bankers’ Ass’n.; F&C; French Banking Fed’n.; IIB/
EBF; Japanese Bankers Ass’n; Katten (on behalf of
Int’l Clients); Union Asset. See also infra Part
IV.B.5.
2403 See BVI; Credit Suisse (Williams); EFAMA;
IIB/EBF; PEGCC; Union Asset. See supra Part II for
a discussion regarding the conformance period.
2404 For instance, many commenters raised
concerns regarding the treatment of foreign public
funds such as UCITS. As discussed in greater detail
above in Part IV.B.1, the definition of covered fund
under the final rule has been modified from the
proposal and tailored to include only the types of
foreign funds that the Agencies believe are intended
to be the focus of the statute (e.g., certain foreign
funds that are established by U.S. banking entities).
Foreign public funds are also excluded from the
definition of covered fund under the final rule. The
modifications in the final rule in part address
commenters’ request that foreign funds be
grandfathered. To the extent that an entity qualifies
for one or more of the exclusions from the
definition of covered fund, that entity would not be
a covered fund under the final rule. Moreover, any
entity that would be a covered fund would still be
able to rely on the conformance period in order to
come into compliance with the requirements of
section 13 and the final rule.

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entity that is organized under the laws
of the United States or of one or more
States. Consistent with this statutory
language, the proposed rule limited the
scope of the exemption to banking
entities that are organized under foreign
law and, as applicable, controlled only
by entities organized under foreign law.
The Agencies did not receive
substantive comment on this aspect of
the proposal related to the foreign fund
exemption, though some commenters
offered suggestions to clarify various
parts of the wording of the scope of the
definition of banking entities that may
qualify for the exemption. The final rule
makes only minor, technical changes to
more fully carry out the purposes of the
statute.
Consistent with the statutory language
and purpose of section 13(d)(1)(I) of the
BHC Act, the final rule provides that the
exemption is available only if the
banking entity is not organized
under 2405 or directly or indirectly
controlled by a banking entity that is
organized under the laws of the United
States or of one or more States. As noted
above, section 13(d)(1)(I) of the BHC Act
specifically provides that its exemption
is available only to a banking entity that
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.2406 Because of
this express statutory requirement, a
foreign subsidiary controlled, directly or
indirectly, by a banking entity organized
under the laws of the United States or
one of its States, and a foreign branch
office of a banking entity organized
under the laws of the United States or
one of the States, may not take
advantage of this exemption.
Like the proposal, the final rule
incorporates the statutory requirement
that the banking entity conduct its
sponsorship or investment activities
pursuant to sections 4(c)(9) or 4(c)(13) of
the BHC Act. The final rule retains the
tests in the proposed rule for
determining when a banking entity
would meet that requirement. The final
rule also provides qualifying criteria for
both a banking entity that is a qualifying
foreign banking organization under the
2405 The final rule clarifies the eligibility
requirements for banking entities Seeking to rely on
the foreign fund exemption. Section 13(d)(1)(I) of
the BHC Act and § ll.13(c)(1)(i) of the proposal
require that a banking entity Seeking to rely on the
foreign fund exemption 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. For clarification purposes, in addition
to the eligibility requirement in Section 13(d)(1)(I)
of the BHC Act and the proposal, the final rule also
expressly requires that the banking entity not itself
be organized under the laws of the United States.
2406 See 12 U.S.C. 1851(d)(1)(I).

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Board’s Regulation K and a banking
entity that is not a foreign banking
organization for purposes of Regulation
K.2407
Section 4(c)(9) of the BHC Act applies
to 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 the
exemption would not be substantially at
variance with the purposes of the BHC
Act and would be in the public
interest.2408 The Board has
implemented section 4(c)(9) as part of
subpart B of the Board’s Regulation
K,2409 which specifies a number of
conditions and requirements that a
foreign banking organization must meet
in order to act pursuant to that
authority.2410 The qualifying conditions
and requirements include, for example,
that the foreign banking organization
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.2411 Under
the final rule a banking entity that is a
qualifying foreign banking organization
for purposes of the Board’s Regulation
K, other than a foreign bank as defined
in section 1(b)(7) of the International
Banking Act of 1978 that is organized
under the laws of any commonwealth,
2407 Section ll.13(b)(2) only addresses when a
transaction 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 to date
applied the general 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)(I) of the BHC Act, are unable to
rely on the foreign funds exemption.
2408 See 12 U.S.C. 1843(c)(9).
2409 See 12 CFR 211.20 et seq.
2410 Some commenters argued that the Board’s
Regulation K contains a number of limitations that
may not be appropriate to include as part of the
requirements of the foreign fund exemption. For
example, subpart B of the Board’s Regulation K
includes various approval requirements and
interstate office location restrictions. See Allen &
Overy (on behalf of Foreign Bank Group); HSBC
Life. The final rule does not retain the proposal’s
requirement that the activity be conducted in
compliance with all of subpart B of the Board’s
Regulation K (12 CFR 211.20 through 211.30).
However, the foreign fund exemption in section
13(d)(1)(I) of the BHC Act and the final rule
operates as an exemption and is not a separate grant
of authority to engage in an otherwise
impermissible activity. To the extent a banking
entity is a foreign banking organization, it remains
subject to the Board’s Regulation K and must, as a
separate matter, comply with any and all applicable
rules and requirements of that regulation.
2411 See 12 CFR 211.23(a), (c), and (e). The
proposed rule only referenced the qualifying test
under section 211.23(a) of the Board’s Regulation K;
however, because there are two other methods by
which a foreign banking organization may meet the
requirements to be considered a qualified foreign
banking organization, the final rule incorporates a
reference to those provisions as well.

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5739

territory, or possession of the United
States, will qualify for the foreign fund
exemption.2412
Section 13 of the BHC Act also
applies to foreign companies that
control a U.S. insured depository
institution but that are not 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 final rule also provides that a foreign
banking entity that is not a foreign
banking organization would be
considered to be conducting activities
‘‘pursuant to section 4(c)(9)’’ for
purposes of the foreign fund
exemption 2413 if the entity, on a fullyconsolidated basis 2414, meets at least
two of three requirements that evaluate
the extent to which the foreign banking
entity’s business is conducted outside
the United States, as measured by
assets, revenues, and income.2415 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), (c), or (e)
of the Board’s Regulation K, except that
the test does not require the foreign
2412 This modification to the definition of foreign
banking organization from the proposed definition
is necessary because, under the International
Banking Act and the Board’s Regulation K,
depository institutions that are located in, or
organized under the laws of a commonwealth,
territory, or possession of the United States, are
foreign banking organizations. However, for
purposes of the Federal securities laws and certain
banking statutes, such as section 2(c)(1) of the BHC
Act and section 3 of the FDI Act, these same entities
are defined to be and treated as domestic entities.
For instance, these entities act as domestic brokerdealers under U.S. securities laws and their
deposits are insured by the FDIC. Because one of
the purposes of section 13 is to protect insured
depository institutions and the U.S. financial
system from the perceived risks of proprietary
trading and covered fund activities, the Agencies
believe that these entities should be considered to
be located within the United States for purposes of
section 13. The final rule includes within the
definition of State any State, the District of
Columbia, the Commonwealth of Puerto Rico,
Guam, American Samoa, the United States Virgin
Islands, and the Commonwealth of the Northern
Mariana Islands.
2413 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.
2414 For clarification purposes, the final rule has
been modified from the proposal to provide that the
requirements for this provision must be met on a
fully-consolidated basis.
2415 See final rule § ll.13(b)(2)(ii)(B). For
purposes of determining whether, on a fully
consolidated basis, it meets the requirements under
§ ll.13(b)(2)(ii)(B), a foreign banking entity that is
not a foreign banking organization should base its
calculation on the consolidated global assets,
revenues, and income of the top-tier affiliate within
the foreign banking entity’s structure.

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entity to demonstrate that more than
half of its banking business is outside
the United States.2416 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 restrictions on covered fund
activities and investments, a result that
the Agencies do not believe was
intended.
2. Activities or Investments Solely
Outside of the United States
As noted above, the proposed rule
adopted a transaction-based approach to
implementing the foreign fund
exemption and focused on the extent to
which the foreign fund transactions
occur within, or are carried out by
personnel, subsidiaries or affiliates
within, the United States. In particular,
§ ll.13(c)(3) of the proposed rule
provided that a transaction or activity be
considered to have occurred solely
outside of the United States only if: (i)
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; (ii) 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 (iii) no ownership interest in such
covered fund is offered for sale or sold
to a resident of the United States.
Commenters suggested that, like the
foreign trading exemption, the foreign
fund exemption should focus on the
location of activities that a banking
entity engages in as principal.2417 These
commenters argued that the location of
sales activities of a fund should not
determine whether a banking entity has
sponsored or acquired an ownership
interest in a covered fund solely outside
of the United States. Commenters also
argued that foreign banking entities
typically locate marketing and sales
personnel for foreign funds in the
United States in order to serve
customers, including those that are not
residents of the United States, and that
the proposal would needlessly force all
covered fund sales activities to shift
outside of the United States. These
2416 See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a),
(c), and (e); final rule § ll.13(b)(2)(ii)(B).
2417 See Credit Suisse (Williams); IIB/EBF; Katten
(on behalf of Int’l Clients).

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commenters alleged that the restrictions
under the proposal would cause foreign
banking entities to relocate their
personnel from the United States to
overseas, diminishing U.S. jobs with no
concomitant benefit.2418
Many commenters requested removal
of the proposal’s prohibition on a U.S.
subsidiary, affiliate, or employee of the
foreign banking entity offering or selling
fund interests in order to qualify for the
foreign fund exemption.2419
Commenters argued that this limitation
was not included in the statute and that
the limited involvement of persons
located in the U.S. in the distribution of
ownership interests in a foreign covered
fund should not, by itself, disqualify the
banking entity from relying on the
foreign fund exemption so long as the
fund is offered only outside the United
States.2420 These commenters argued
that organizing and offering a fund is
not a prohibited activity so long as it is
not accompanied by ownership or
sponsorship of the covered fund. One
commenter urged that the final rule
permit U.S. personnel of a foreign
banking entity to engage in non-selling
activities related to a covered fund,
including acting as investment advisor,
establishing fund vehicles, conducting
back-office functions such as day-to-day
management and deal sourcing tax
structuring, obtaining licenses,
interfacing with regulators, and other
related activities that do not involve
U.S. sales activity.2421
Instead of the proposal’s transactionbased approach to implementing the
foreign fund exemption, many
commenters suggested the final rule
adopt a risk-based approach.2422 These
commenters argued that a risk-based
approach would prohibit or
significantly limit the amount of
financial risk from such activities that
could be transferred to the United States
by the foreign activity of foreign banking
entities in line with the purpose of the
2418 See Allen & Overy (on behalf of Foreign Bank
Group); Ass’n. of German Banks; Credit Suisse
(Williams); IIB/EBF; Socie´te´ Ge´ne´rale; Union Asset.
2419 See Allen & Overy (on behalf of Foreign Bank
Group); Ass’n. of German Banks; Credit Suisse
(Williams); IIB/EBF; Katten (on behalf of Int’l
Clients); TCW; Union Asset.
2420 See IIB/EBF; Socie
´ te´ Ge´ne´rale; TCW; Union
Asset; Credit Suisse (Williams); See also Katten (on
behalf of Int’l Clients) (recommending that, similar
to the SEC’s Regulation S, the final rule provide that
involvement of persons located in the United States
in the distribution of a non-U.S. covered fund’s
securities to potential purchasers outside of the
United States not affect the analysis of whether a
non-U.S. banking entity’s investment or
sponsorship occurs outside the United States).
2421 See Allen & Overy (on behalf of Foreign Bank
Group).
2422 See BaFin/Deutsche Bundesbank; ICSA; IIB/
EBF; EBF; Allen & Overy (on behalf of Canadian
Banks); Credit Suisse (Williams); George Osborne.

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statute.2423 Commenters also contended
that foreign activities of most foreign
banking entities are already subject to
activities limitations, capital
requirements, and other prudential
requirements of their home-country
supervisor(s).2424
In response to commenters’ concerns
and in order to more effectively
implement both the statutory
prohibition as well as the foreign fund
exemption, the final rule has been
modified to better reflect the purpose of
the statute by ensuring that the
principal risks of covered fund
investments and sponsorship by foreign
banking entities permitted under the
foreign funds exemption occur and
remain solely outside of the United
States. One of the principal purposes of
section 13 is to limit the risks that
covered fund investments and activities
pose to the safety and soundness of U.S.
banking entities and the U.S. financial
system. Another purpose of the foreign
fund exemption was to limit the
extraterritorial application of section 13
as it applies to foreign banking entities
subject to section 13.
To accomplish these purposes in light
of the structure and purpose of the
statute and in response to commenters,
the final rule adopts a risk-based
approach rather than a transaction
approach to the foreign fund exemption.
In order to ensure these risks remain
solely outside of the United States, the
final rule also includes several
conditions on the availability of the
foreign fund exemption. Specifically,
the final rule provides that an activity
or investment occurs solely outside the
United States for purposes of the foreign
fund exemption only if:
• The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and it not controlled directly or
indirectly by, a banking entity that is
located in the United States or
established under the laws of the United
States or of any State;
• The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
• The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
2423 See
2424 See

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affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
• No financing for the banking
entity’s ownership or sponsorship is
provided, directly or indirectly, by any
branch or affiliate that is located in the
United States or organized under the
laws of the United States or of any
State.2425
These requirements are designed to
ensure that any foreign banking entity
engaging in activity under the foreign
fund exemption does so in a manner
that ensures the risk and sponsorship of
the activity or investment occurs and
resides solely outside of the United
States.
The final rule has been modified from
the proposal to specifically recognize
that, for purposes of the foreign fund
exemption, a U.S. branch, agency, or
subsidiary of a foreign bank, is located
in the United States; however, a foreign
bank that operates or controls that
branch, agency, or subsidiary is not
considered to be located in the United
States solely by virtue of operation of
the U.S. branch, agency, or
subsidiary.2426 A subsidiary (wherever
located) of a U.S. branch, agency, or
subsidiary of a foreign bank is also
considered itself to be located in the
United States. This provision helps give
effect to the statutory language limiting
the foreign fund exemption to activities
of foreign banking entities that occur
‘‘solely outside of the United States’’ by
clarifying that the U.S. operations of
foreign banking entities may not
sponsor or acquire or retain an
ownership interest in a covered fund as
principal based on this exemption.
Because so-called ‘‘back office’’
activities do not involve sponsoring or
acquiring or retaining an ownership
interest in a covered fund, the final rule
does not impose restrictions on U.S.
personnel of a foreign banking entity
engaging in these activities in
connection with one or more covered
funds. This allows providing
administrative services or similar
functions to the covered fund as an
incident to the activity conducted under
the foreign fund exemption (such as
clearing and settlement, maintaining
and preserving records of the fund,
furnishing statistical and research data,
or providing clerical support for the
fund).
The foreign fund exemption in the
final rule also permits the U.S.
personnel and operations of a foreign
banking entity to act as investment
adviser to a covered fund in certain

circumstances. For instance, the U.S.
personnel of a foreign banking entity
may provide investment advice and
recommend investment selections to the
manager or general partner of a covered
fund so long as that investment advisory
activity in the United States does not
result in the U.S. personnel
participating in the control of the
covered fund or offering or selling an
ownership interest to a resident of the
United States. As explained above, the
final rule also explicitly provides that
acquiring or retaining an ownership
interest does not include acquiring or
retaining an ownership interest in a
covered fund by a banking entity acting
solely as agent, broker, or custodian,
subject to certain conditions, or acting
on behalf of customers as a trustee, or
in a similar fiduciary capacity for a
customer that is not a covered fund, so
long as the activity is conducted for the
account of the customer and the banking
entity and its affiliates do not have or
retain beneficial ownership of the
ownership interest.2427 The final rule
would thus allow a foreign bank to
engage in any of these capacities in the
U.S. without the need to rely on the
foreign fund exemption.
3. Offered for Sale or Sold to a Resident
of the United States
The proposed rule provided that no
ownership interest in the covered fund
be offered for sale or sold to a resident
of the United States, a requirement of
the statute.2428 Numerous commenters
focused on the definition of ‘‘resident of
the United States’’ in the proposed rule
and the manner in which the restriction
on offers and sales to such persons
would interrelate with Regulation S
under the Securities Act of 1933.
Commenters asserted that, since market
participants have long conducted
offerings of foreign funds in reliance on
Regulation S 2429 in order to comply
with U.S. securities law obligations,
these same securities law principles
should be applied to determine whether
a person is a resident of the United
States for purposes of section 13 and the
final rule to determine whether an offer
or sale is made to residents of the
United States.2430
Certain commenters argued that
because of the way the restriction in the
statute and proposed rule was written,
it was unclear whether the restriction on
offering for sale to a resident of the
United States applied to the foreign
banking entity or to any third party that
final rule § ll.10(a)(2).
proposed rule § ll.13(c)(1)(iii).
2429 See 17 CFR 230.901–905.
2430 See IIB/EBF; EFAMA; ICI Global.
2427 See
2428 See

2425 See
2426 See

final rule § ll.13(b)(4).
final rule § ll.13(b)(5).

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5741

establishes a fund.2431 Commenters
argued the prohibition against offers or
sales of ownership interests to residents
of the United States should apply only
to offers and sales of covered funds
organized and offered by the foreign
banking entity but not to covered funds
established by unaffiliated third
parties.2432 These commenters reasoned
that a foreign banking entity should be
permitted to make a passive investment
in a covered fund sponsored and
controlled by an unaffiliated third party
that has U.S. investors as long as the
foreign banking entity does not itself
offer or sell ownership interest in the
covered fund to residents of the United
States.2433 Commenters contended that
this interpretation would be consistent
with section 13’s purpose to prevent
foreign banks from using the foreign
fund exemption to market and sell
covered funds to U.S. investors, while
simultaneously limiting the
extraterritorial impact of section 13.2434
Commenters argued that the proposal’s
foreign fund exemption would
negatively impact U.S. asset managers
unaffiliated with any banking entity
because they would either be forced to
exclude foreign banking entities from
investing in their funds or would need
to ensure that no residents of the United
States hold ownership interests in funds
offered to these entities.2435
Commenters also contended that foreign
banking entities, including sovereign
wealth funds that own or control foreign
banking organizations, invest tens of
billions of dollars in U.S. covered funds
and that if these types of investments
were not permitted under the foreign
fund exemption an important source of
foreign investment in the U.S. could be
eliminated.2436
Commenters argued that an
investment by a foreign banking entity
in a third-party unaffiliated fund does
not pose any risk to a U.S. banking
entity or to the U.S. financial system.
Moreover, commenters argued that a
foreign banking entity that has invested
in a fund sponsored and advised by a
2431 See Cadwalader (on behalf of Thai Banks);
Grosvenor; SIFMA et al. (Covered Funds) (Feb.
2012).
2432 See Ass’n. of German Banks; BAROC;
Cadwalader (on behalf of Thai Banks); Comm. on
Capital Markets Regulation; Credit Suisse
(Williams); IIB/EBF; Japanese Bankers Ass’n.;
Katten (on behalf of Int’l Clients); PEGCC.
2433 See Grosvenor; IIB/EBF; Japanese Bankers
Ass’n.; Katten (on behalf of Int’l Clients); Sens.
Merkley & Levin (Feb.2012); Norinchukin; SIFMA
et al. (Covered Funds) (Feb. 2012).
2434 See BAROC; Credit Suisse (Williams);
Grosvenor; IIB/EBF.
2435 See Comm. on Capital Markets Regulation;
Credit Suisse (Williams); PEGCC.
2436 See SIFMA et al. (Covered Funds) (Feb.
2012); See also Grosvenor; PEGCC.

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third party has no control over
whether—and may have no
knowledge—that the third party has
determined to offer or sell the fund to
U.S. residents.2437
As noted above, one of the purposes
of section 13 is to limit the risk to
banking entities and the financial
system of the United States. Another
purpose of the statute appears to be to
permit foreign banking entities to
engage in foreign activities without
being subject to the restrictions of
section 13 while also ensuring that these
foreign entities do not receive a
competitive advantage over U.S.
banking entities with respect to offering
and selling their covered fund services
in the United States.2438 As such, the
final rule does not prohibit a foreign
banking entity from making an
investment in or sponsoring a foreign
fund. However, a foreign banking entity
would not be permitted under the
foreign fund exemption to invest in, or
engage in the sponsorship of, a U.S. or
foreign covered fund that offers
ownership interests to residents in the
United States unless it does so pursuant
to and subject to the limitations of the
permitted activity exemption for
organizing and offering a covered fund,
for example, which has the same effect
for U.S. banking entities. The final rule
ensures that the risk of the sponsoring
and investing in non-U.S. covered funds
by foreign banking entities remains
outside of the United States and that the
foreign fund exemption does not
advantage foreign banking entities
relative to U.S. banking entities with
respect to providing their covered fund
services in the United States by
prohibiting the offer or sale of
ownership interests in related covered
funds to residents of the United States.
Commenters also argued that foreign
investors in a foreign covered fund
should not be treated as residents of the
United States for purposes of the final
rule if, after purchasing their interest in
the covered fund, they relocate to the
U.S.,2439 or travel to the U.S. on a
temporary basis.2440 Commenters also
argued that non-U.S. investors in a fund
offered by a foreign banking entity
should not be prohibited from
transferring their interests to residents
of the United States in the secondary
2437 See AFG; BAROC; Cadwalader (on behalf of
Thai Banks); Japanese Bankers Ass’n.
2438 See 156 Cong. Rec. S5897 (daily ed. July 15,
2010) (statement of Sen. Merkley).
2439 See IIB/EBF; Katten (on behalf of Int’l
Clients); Union Asset.
2440 See IFIC; See also Allen & Overy (on behalf
of Canadian Banks).

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market.2441 One commenter alleged that,
notwithstanding the reasonable efforts
of foreign banking entities to prevent
residents of the United States from
investing in their foreign covered funds,
investors may find ways to circumvent
and invest in covered funds without
knowledge or assistance from the
foreign banking entity.2442
Certain commenters argued that there
was a substantial risk that foreign funds
offered by foreign banking entities
would not be able to rely on the
exemption due to the presence of a
limited number of investors who are
residents of the United States.2443 A few
commenters suggested that the final rule
should require that, for both related and
unrelated covered funds, a banking
entity need only have a reasonable
belief that an ownership interest in a
covered fund is not offered or sold to
residents of the United States in order
to qualify for the foreign fund
exemption. Commenters argued that
only active targeting or marketing
towards a resident of the United States
by the foreign banking entity should be
prohibited by the final rule, and that the
incidental presence of a limited number
of investors that are residents of the
United States in a foreign covered fund
offered by a foreign banking entity
should not prohibit the foreign banking
entity from relying on the foreign fund
exemption.2444 One commenter argued
that, for certain complex fund structures
(e.g., a structure with a master fund and
multiple feeder funds that investors
invest in or a parallel fund structure
both managed by the same fund
manager), eligibility for the foreign fund
exemption should not be precluded for
a fund with no ownership interests
offered for sale or sold to U.S. residents
even if a related covered fund is offered
to residents of the United States.2445
After considering comments received
on the proposal, the final rule retains
the statutory requirement that no
ownership interest in the covered fund
be offered for sale to a resident of the
United States.2446 The final rule
provides that an ownership interest in a
covered fund is offered for sale or sold
to a resident of the United States for
purposes of the foreign fund exemption
only if it is sold or has been sold
2441 See Ass’n. of German Banks; Credit Suisse
(Williams); IIB/EBF; Katten (on behalf of Int’l
Clients).
2442 See Credit Suisse (Williams).
2443 See BVI; EFAMA; Union Asset.
2444 See AFG; Union Asset; See also BVI; Allen
& Overy (on behalf of Canadian Banks); Katten (on
behalf of Int’l Clients).
2445 See Japanese Bankers Ass’n.
2446 See final rule § ll.13(b)(1)(iii).

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pursuant to an offering that targets
residents of the United States.2447
Absent circumstances otherwise
indicating a nexus with residents of the
United States, the sponsor of a foreign
fund would not be viewed as targeting
U.S. residents for purposes of the
foreign fund exemption if it conducts an
offering directed to residents of one or
more countries other than the United
States; includes in the offering materials
a prominent disclaimer that the
securities are not being offered in the
United States or to residents of the
United States; and includes other
reasonable procedures to restrict access
to offering and subscription materials to
persons that are not residents of the
United States.2448 If ownership interests
that are issued in a foreign offering are
listed on a foreign exchange, secondary
market transactions could be
undertaken by the banking entity
outside the United States in accordance
with Regulation S under the foreign
fund exemption.2449 Foreign banking
entities should use precautions not to
send offering materials into the United
States or conduct discussions with
persons located in the United States
(other than to or with a person known
to be a dealer or other professional
fiduciary acting on behalf of a
discretionary account or similar account
for a person who is not a resident of the
United States).2450 In order to comply
with the rule as adopted, sponsors of
covered funds established outside of the
United States must examine the facts
and circumstances of their particular
offerings and confirm that the offering
does not target residents of the United
States.
With respect to the treatment of multitiered fund structures under the foreign
fund exemption, the Agencies expect
that activities related to certain complex
fund structures should be integrated in
final rule § ll.13(b)(3).
Statement of the Commission Regarding
Use of Internet Web sites to Offer Securities, Solicit
Securities Transactions or Advertise Investment
Services Offshore, Securities Act Release No. 7516
(Mar. 23, 1998). Reliance on these principles only
applies with respect to whether an ownership
interest in a covered fund is offered for sale or sold
to a resident of the United States for purposes of
section 13 of the BHC Act. In addition, reliance
would not be appropriate if a foreign fund engages
in a private placement of ownership interests in the
United States in reliance on Section 4(a)(2) of the
Securities Act of 1933 or Regulation D (17 CFR
230.501–506).
2449 An offer or sale is made in an ‘‘offshore
transaction’’ under Regulation S if, among other
conditions, the transaction is executed in, on or
through the facilities of a ‘‘designated offshore
securities market’’ as described in Regulation S,
which includes a number of foreign stock
exchanges and markets and any others the SEC
designates. See Securities Act rule 902(h).
2450 See Securities Act rule 902(k)(2).
2447 See
2448 See

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order to determine whether an
ownership interest in a covered fund is
offered for sale to a resident of the
United States. For example, a banking
entity may not be able to rely on the
foreign fund exemption to sponsor or
invest in an initial covered fund (that is
offered for sale only overseas and not to
residents of the United States) that is
itself organized or operated for the
purpose of investing in another covered
fund (that is sold pursuant to an offering
that targets U.S. residents) and that is
either organized and offered or is
advised by that banking entity.
4. Definition of ‘‘Resident of the United
States’’
As discussed in greater detail above in
Part IV.B.1, section 13(d)(1)(I) of the
BHC Act provides that a foreign banking
entity may acquire or retain an
ownership interest in or act as sponsor
to a covered fund, but only if that
activity is conducted according to the
requirements of the statute, including
that no ownership interest in the
covered fund is offered for sale or sold
to a ‘‘resident of the United States.’’ As
noted above in Part IV.B.1.f describing
the definition of ‘‘resident of the United
States,’’ the statute does not define this
term.
After carefully considering comments
received, the Agencies have defined the
term ‘‘resident of the United States’’ in
the final rule to mean a ‘‘U.S. person’’
as defined in the SEC’s Regulation S.2451
The Agencies note, however, that it
would not be permissible under the
foreign fund exemption for a foreign
banking entity to facilitate or participate
in the formation of a non-U.S.
investment vehicle for a person or entity
that is itself a U.S. person for the
specific purpose of investing in a
foreign fund. The Agencies believe that
this type of activity would constitute an
evasion of the requirements of section
13 of the BHC Act.

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c. Permitted Covered Fund Interests and
Activities by a Regulated Insurance
Company
As discussed above, section
13(d)(1)(F) of the BHC Act permits a
banking entity that 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, to purchase
or sell a financial instrument subject to
certain conditions.2452 Section
13(d)(1)(D) of the Act permits a banking
entity to purchase or sell a financial
2451 See
2452 See

final rule § ll.10(d)(8).
12 U.S.C. 1851(d)(1)(F).

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instrument on behalf of customers.2453
The proposal implemented these
exemptions with respect to the
proprietary trading activities of
insurance companies by permitting a
banking entity that is an insurance
company to purchase or sell a financial
instrument for the general account of
the insurance company or for a separate
account, in each case subject to certain
restrictions.2454 The proposal did not
apply these exemptions to covered fund
activities or investments.
A number of commenters argued that
section 13 was designed to
accommodate the business of insurance
by exempting both the proprietary
trading and covered fund activities of
insurance companies.2455 These
commenters argued that providing an
exemption for covered fund activities
and investments through both the
general account and separate accounts
of an insurance company was integral to
the business of insurance and that,
absent an exemption from the covered
fund provisions, insurance companies
would lack an effective means to
diversify their holdings and obtain
adequate rates of return in order to
maintain affordable premiums for
customers.2456
Some commenters argued that section
13 of the BHC Act specifically provides
exemptions from both the covered fund
prohibition of section 13(a)(1), and the
prohibition on proprietary trading.2457
Commenters contended that the
exemptions in section 13(d)(1)(F)
(referencing activity in general accounts
of insurance companies) and 13(d)(1)(D)
(referencing activities on behalf of
customers) cross-reference the
instruments described in section
13(h)(4) and not activity described in
section 13(h)(4). On this basis,
commenters argued the statute exempts
both proprietary trading in these
instruments described in section
13(h)(4) and investments in those
instruments (including when those
2453 See
2454 See

12 U.S.C. 1851(d)(1)(D).
proposed rule §§ ll.6(b)(2)(iii);

ll.6(c).
2455 See, e.g., Sutherland (on behalf of Comm. of
Annuity Insurers); ACLI (Jan. 2012); Country Fin. et
al.; Nationwide; NAMIC; Fin. Services Roundtable
(Feb. 3, 2012) (citing FSOC study at 71); HSBC Life;
Chamber (Feb. 2012); Country Fin. et al.; Mutual of
Omaha; See also Rep. McCarthy et al.; Sen. Nelson;
Sen. Hagan; Sens. Brown & Harkin.
2456 See, e.g., Fin. Services Roundtable (Feb. 3,
2012); TIAA–CREF (Feb. 13, 2012); Sutherland (on
behalf of Comm. of Annuity Insurers); USAA (citing
FSOC study at 71); HSBC Life; ACLI; NAMIC;
Nationwide.
2457 See Sutherland (on behalf of Comm. of
Annuity Insurers); Nationwide; See also Rep.
McCarthy et al.; Sens. Brown & Harkin.

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5743

instruments are ownership interests in
covered funds).2458
Alternatively, commenters argued that
the Agencies should use their authority
in section 13(d)(1)(J) of the BHC Act to
provide an exemption for the covered
fund activities and investments of
insurance companies.2459 These
commenters argued that exempting
covered funds activities and
investments of insurance companies
would promote and protect the safety
and soundness of the banking entity and
financial stability of the United States
and provide certain benefits to the U.S.
financial system by allowing insurance
companies to access important asset
classes (for better investment diversity
and returns), provide more diverse
product offerings to customers, better
manage their investment risks through
diversification and more closely
matching the maturity of their assets
and liabilities, contribute liquidity to
capital markets, and support economic
growth through the provision of capital
to entrepreneurs and businesses.2460
Commenters also argued that an
exemption for insurance companies
from the covered fund prohibitions was
necessary to permit insurance
companies that are banking entities to
effectively compete with insurance
companies not affiliated with an insured
depository institution.2461 Commenters
alleged that insurance companies are
already subject to extensive regulation
under state insurance laws that
specifically include provisions designed
to diversify risk among investment
categories, limit exposure to particular
types of asset classes including covered
fund investments, and protect the safety
and soundness of the insurance
company.2462
After careful review of the comments
in light of the statutory provisions, the
final rule has been modified to permit
2458 See, e.g., Fin. Services Roundtable (Feb. 3,
2012); USAA; HSBC Life; Country Fin. et al.;
Sutherland (on behalf of Comm. of Annuity
Insurers); Nationwide (discussing the exemption for
the general account of an insurance company);
ACLI; Nationwide (discussing the exemption for
separate accounts).
2459 See, e.g., Sutherland (on behalf of Comm. of
Annuity Insurers).
2460 See Fin. Services Roundtable (Feb. 3, 2012);
TIAA–CREF (Feb. 13, 2012); USAA; HSBC Life;
ACLI (Jan. 2012); NAMIC; Nationwide.
2461 See, e.g., Nationwide.
2462 See, e.g., ACLI (Jan. 2012); Fin. Services
Roundtable (Feb. 3, 2012); USAA; Chamber (Feb.
2012); Country Fin. et al.; Mutual of Omaha;
NAMIC; Nationwide; Rep. McCarthy et al. See also
156 Cong. Reg. S. 5896 (daily ed. July 15, 2010)
(statement of Sen. Merkley) (arguing that activities
of insurance companies ‘‘are heavily regulated by
State insurance regulators, and in most cases do not
pose the same level of risk as other proprietary
trading’’).

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an insurance company or its affiliate 2463
to acquire or retain an ownership
interest in, or act as sponsor to, a
covered fund for either the general
account of the insurance company or
one or more separate accounts
established by the insurance
company.2464
These activities are only permitted
under the final rule so long as: (1) the
insurance company or its affiliate
acquires and retains the ownership
interest solely for the general account of
the insurance company or for one or
more separate accounts established by
the insurance company; (2) the
acquisition and retention of the
ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which the
insurance company is domiciled; and
(3) the appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and
relevant foreign jurisdictions, as
appropriate, have not jointly
determined, after notice and comment,
that a particular law, regulation, or
written guidance described in
§ ll.13(c)(2) of the final rule is
insufficient to protect the safety and
soundness of the banking entity, or the
financial stability of the United
States.2465
The Agencies believe that exempting
insurance activities and investments
from the covered fund restrictions is
supported by the language of sections
13(d)(1)(D) and (F) of the BHC Act,2466
and more fully carries out Congressional

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2463 Some

commenters urged the Agencies to
provide that an affiliate or subsidiary of an
insurance company could purchase covered funds
for the insurance company’s general account or a
separate account. See e.g., Fin. Services Roundtable
(Feb. 3, 2012); TIAA–CREF (Feb. 13, 2012). The
Agencies note that the final rule provides (as does
the statute) an exemption that permits an insurance
company or its affiliate to acquire and retain an
ownership interest in a covered fund solely for the
insurance’s company general account (or one or
more of its separate account); such an affiliate or
subsidiary also may be a wholly-owned subsidiary,
as defined in the final rule.
2464 The final rule defines the terms ‘‘general
account’’ and ‘‘separate account’’ largely as
proposed, and includes the new defined term
‘‘insurance company,’’ defined as a company that
is organized as an insurance company, primarily
and predominantly engaged in writing insurance or
reinsuring risks underwritten by insurance
companies, subject to supervision as such by a state
insurance regulator or a foreign insurance regulator,
and not operated for the purpose of evading the
provisions of section 13 of the BHC Act. Cf. section
2(a)(17) of the Investment Company Act (defining
the term insurance company).
2465 See final rule § ll.13(c).
2466 See 12 U.S.C. 1851(d)(1)(D), (F).

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intent and the statutory purpose of
appropriately accommodating the
business of insurance within an
insurance company.2467 Section
13(d)(1)(F) of the statute specifically
exempts general accounts of insurance
companies, and, as explained above in
Part IV.A.7, separate accounts are
managed and maintained on behalf of
customers, an activity exempt under
section 13(d)(1)(D) of the statute. By
their terms, these are statutory
exemptions from the prohibitions in
section 13(a), which includes both the
prohibition on proprietary trading and
the prohibition on covered fund
investments and sponsorship. Moreover,
the statutory language of sections
13(d)(1)(D) and 13(d)(1)(F), both crossreference the instruments described in
section 13(h)(4) and not activity
described in section 13(h)(4). These
instruments are ‘‘any security, any
derivative, any contract of sale of a
commodity for future delivery, any
option on any such security, derivative
or contract or any other security or
financial instrument that [the Agencies
determine by rule.]’’ This reference
covers an ownership interest in a
covered fund. The Agencies believe
these exemptions as modified more
fully carry out Congressional intent and
the statutory purpose of appropriately
accommodating the business of
insurance within an insurance
company.2468 Insurance companies are
already subject to a robust regulatory
regime including limitations on their
investment activities.
5. Section ll.14: Limitations on
Relationships With a Covered Fund
Section 13(f) of the BHC Act generally
prohibits a banking entity that, directly
or indirectly, serves as investment
manager, investment 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
entering into a transaction with a
covered fund that would be a covered
transaction as defined in section 23A of
the Federal Reserve Act (‘‘FR Act’’).2469
The statute also provides an exemption
2467 See 12 U.S.C. 1851(b)(1)(F). See also 156
Cong. Reg. S. 5896 (daily ed. July 15, 2010)
(statement of Sen. Merkley) (arguing that ‘‘section
13 of the BHC Act] was never meant to affect the
ordinary business of insurance’’).
2468 See 12 U.S.C. 1851(b)(1)(F). See also 156
Cong. Reg. S. 5896 (daily ed. July 15, 2010)
(statement of Sen. Merkley) (arguing that ‘‘section
13 of the BHC Act] was never meant to affect the
ordinary business of insurance’’).
2469 12 U.S.C. 371c. The Agencies note that this
does not alter the applicability of section 23A of the
FR Act and the Board’s Regulation W to covered
transactions between insured depository
institutions and their affiliates.

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for prime brokerage transactions
between a banking entity and a covered
fund in which a covered fund managed,
sponsored, or advised by that banking
entity has taken an ownership interest.
Section 13(f) subjects any transaction
permitted under section 13(f) of the
BHC Act (including a permitted prime
brokerage transaction) between the
banking entity and covered fund to
section 23B of the FR Act.2470 In
general, section 23B of the FR Act
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 ll.16 of the proposed rule
implemented these provisions.2471
a. Scope of Application
Section 13(f) of the BHC Act and the
related provisions of the proposal were
among the most commented upon
aspects of the covered funds section.
The majority of commenters argued that
the broad definition of ‘‘covered fund’’
under the proposal made the proposed
implementation of section 13(f)
unworkable and disruptive to existing
market practices because it would
prohibit corporate funding transactions
with ordinary corporate entities that do
not engage in hedge fund or private
equity activities.2472 Commenters also
argued that activities that the proposal
appeared to permit as a permitted
activity exemption (e.g., investments in
public welfare funds) would be
prohibited by the restrictions in
13(f) 2473 and that the Agencies should
construe section 13(d)(1)(J) of the BHC
Act as allowing them to permit banking
entities to enter into covered
transactions with a covered fund, if
those activities would promote and
protect the safety and soundness of
banking entities and the financial
stability of the United States.2474
However, many of the comments
discussed above and some of the
economic burdens noted by these
commenters have been addressed by
revisions discussed above in Part IV.B.1
to the definition of covered fund.2475 A
number of these and related comments
are also addressed by portions of the
2470 12

U.S.C. 371c–1.
proposed rule § ll.16.
2472 See, e.g., Allen & Overy (on behalf of Foreign
Bank Group); BoA; Barclays; Credit Suisse
(Williams); Deutsche Bank (Fund-Linked Products);
GE (Feb. 2012); Goldman Sachs (Covered Funds);
ICI Global; ISDA (Feb. 2012); RMA; SIFMA et al.
(Covered Funds) (Feb. 2012).
2473 See SunTrust; AHIC; SBIA.
2474 See SIFMA et al. (Covered Funds) (Feb.
2012).
2475 See final rule § ll.10(b). See supra Part
IV.B.1.
2471 See

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final rule that provide that the
prohibitions of section 13 do not apply
to interests acquired, for example, as
agent, broker, custodian, in satisfaction
of a debt previously contracted, through
a pension fund, or as trustee or fiduciary
(all within the limits defined in the final
rule).
Several commenters argued that
applying the restrictions in section 13(f)
to foreign activities of foreign banking
entities would be inconsistent with the
presumption against extraterritorial
application of U.S. law and principles of
international comity, including
deference to home-country
regulation.2476 For example, one
commenter expressed concern that rules
being developed around custody
obligations in the European Union may
require a prime broker or custodian to
indirectly guarantee assets of a fund,
which would directly conflict with the
prohibition on guarantees in section
13(f) of the BHC Act.2477 As explained
above, the final rule has been modified
to more narrowly focus the scope of the
definition of covered fund as it applies
to foreign funds.2478 These changes
substantially address the issues raised
by commenters regarding the
applicability of section 13(f) of the BHC
Act to foreign funds.
Commenters also raised a number of
other issues. For instance, some
commenters argued that applying
section 13(f) to securitization entities
would in some instances run counter to
the rule of construction contained in
section 13(g)(2) regarding the sale and
securitization of loans.2479 These
commenters recommended that the final
rule, at a minimum, grandfather preexisting relationships between banking
entities and existing securitization
vehicles to reduce the potential effects
of the final rule on agreements and
positions entered into before the
enactment of the statute.2480
2476 See IIB/EBF; Katten (on behalf of Int’l
Clients); EBF; EFAMA; French Banking Fed’n.;
Japanese Bankers Ass’n.
2477 See AIMA.
2478 See final rule § ll.10(b)(1)(ii) & (c)(1). See
supra Part IV.B.1.
2479 Section ll.11(b) of the final rule provides
that for purposes of securitizations, organizing and
offering includes acting as the securitizer. As
discussed in greater detail above in Part IV.B.2.b,
a banking entity that continues to hold interests in
a securitization in reliance on this exemption must
comply with certain requirements, including the
requirements of § ll.14. Accordingly, § ll.14 of
the final rule has also been modified from the
proposal to prohibit a banking entity that continues
to hold an ownership interest in accordance with
§ ll11(b), and its affiliates, from entering into a
covered transaction with a covered fund, subject to
certain exceptions.
2480 See AFME et al.: ASF (Feb. 2012); Ashurst;
BoA; Barclays; Cadwalader (Municipal Securities);
Credit Suisse (Williams); Commercial Real Estate

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One commenter argued that a banking
entity that delegates its responsibility
for acting as sponsor, investment
manager, or investment adviser to an
unaffiliated entity should no longer be
subject to the restrictions of section
13(f).2481 By its terms, section 13(f) of
the BHC Act applies to a banking entity
that, directly or indirectly, serves as
investment manager, investment
adviser, or sponsor to a covered fund (or
that relies on section 13(d)(1)(G) of the
BHC Act in connection with organizing
and offering a covered fund). The
Agencies believe that a banking entity
that delegates its responsibility to act as
sponsor, investment manager, or
investment adviser to an unaffiliated
party would still be subject to the
limitations of section 13(f) if the
banking entity retains the ability to
select, remove, direct, or otherwise exert
control over the sponsor, investment
manager, or investment adviser
designee. In addition, the unaffiliated
party designated as sponsor, investment
manager, or investment adviser would
be subject to the restrictions of section
13(f) if the third party is a banking
entity.
b. Transactions That Would Be a
‘‘Covered Transaction’’
Section 13(f) of the BHC Act prohibits
covered transactions as defined in
section 23A of the FR Act between a
banking entity that serves as investment
manager, investment advisor or sponsor
to a covered fund or that relies on the
exemption in section 13(d)(1)(G) and a
covered fund.2482 A number of
Fin. Council; Deutsche Bank (Fund-Linked
Products); Fidelity; GE (Feb. 2012); Goldman Sachs
(Covered Funds); ICI (Feb. 2012); IIB/EBF; ISDA
(Feb. 2012); JPMC; PNC et al.; PNC; RBC; SIFMA
et al. (Covered Funds) (Feb. 2012); SIFMA
(Securitization) (Feb. 2012); Chamber (Feb. 2012).
These comments are addressed above in Part II
regarding availability of the conformance period
provisions of section 13 of the BHC Act.
2481 See Katten (on behalf of Int’l Clients).
2482 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 Statutes of the
United States (12 U.S.C. 84(b)), with an affiliate, to

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5745

commenters contended that the
definition of ‘‘covered transaction’’ in
section 13(f) of the BHC Act should
incorporate the exemptions available
under section 23A and the Board’s
Regulation W.2483 These commenters
alleged that the statute’s general
reference to section 23A suggests that
the term ‘‘covered transaction’’ should
be construed in light of section 23A as
a whole, including the exemptions in
subsection (d) of that Act and as
implemented in the Board’s Regulation
W.2484 These commenters also argued
that the Board’s authority to interpret
and issue rules pursuant to section 23A
of the FR Act and section 5(b) of the
BHC Act, the general rule-making
authority contained in section 13(b) of
the BHC Act, and the exemptive
authority in section 13(d)(1)(J) all
provide a basis for providing such
exemptions.2485
In particular, commenters argued that
intraday extensions of credit;2486
transactions fully secured by cash or
U.S. government securities;2487
purchases of liquid assets and
marketable securities from covered
funds;2488 and riskless principal
transactions with covered funds all
should be exempt from the restrictions
in section 13(f) of the BHC Act.2489
These commenters argued that
providing an exemption for intraday
extensions of credit in particular was
necessary to allow a banking entity to
continue to provide affiliated covered
funds with standard custody, clearing,
and settlement services that include
intra-day or overnight overdrafts
necessary to facilitate securities
settlement, contractual settlement, predetermined income, or similar custodyrelated transactions. Some commenters
argued that transactions fully secured by
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.
2483 See 12 U.S.C. 371c(d); 12 CFR 223.42; ABA
(Keating); Ass’n. of Institutional Investors (Feb.
2012); BoA; BNY Mellon et al.; Credit Suisse
(Williams); SIFMA et al. (Covered Funds) (Feb.
2012); See also Allen & Overy (on behalf of Foreign
Bank Group).
2484 See ABA (Keating); Ass’n. of Institutional
Investors (Feb. 2012); BoA; BNY Mellon et al.;
SIFMA et al. (Covered Funds) (Feb. 2012).
2485 See BNY Mellon et al.; SIFMA et al. (Covered
Funds) (Feb. 2012); See also Credit Suisse
(Williams).
2486 See ABA (Keating); AFG; Ass’n. of
Institutional Investors (Feb. 2012); BoA; BNY
Mellon et al.; Credit Suisse (Williams); EFAMA;
French Treasury et al.; JPMC; IMA; RMA; SIFMA
et al. (Covered Funds) (Feb. 2012); State Street (Feb.
2012); SSgA (Feb. 2012); Vanguard.
2487 See BoA; Credit Suisse (Williams); SIFMA et
al. (Covered Funds) (Feb. 2012).
2488 See Credit Suisse (Williams).
2489 See, e.g., Credit Suisse (Williams).

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cash or U.S. government securities do
not expose banking entities to
inappropriate risks, are permitted in
unlimited amounts under section 23A,
and should not be entirely prohibited
under the rule.2490 A few commenters
argued that the proposal would prohibit
securities lending transactions and
argued that borrower default
indemnifications by a banking entity in
agency securities lending arrangements
should not be prohibited under section
13(f).2491 Some commenters argued that
a banking entity should be allowed to
accept the shares of a sponsored covered
fund as collateral for a loan to any
person or entity, in particular where the
loan is not for the purpose of purchasing
interests in the covered fund.2492
One commenter argued that no
exceptions should be granted to the
definition of covered transaction, and
financing of covered funds would relate
to greater fund risk.2493 In addition, that
commenter contended that the Agencies
should prohibit a sale of securities by a
banking entity to a covered fund even
though these transactions are not within
the definition of covered transaction for
purposes of section 23A of the FR
Act.2494
The final rule continues to apply the
same definition of covered transaction
as the proposal. Section 13(f) refers to a
covered transaction, as defined in
section 23A of the FR Act. Section 13(f)
of the BHC Act does not incorporate or
reference the exemptions contained in
section 23A of the FR Act or the Board’s
Regulation W. Indeed, the exemptions
for these transactions are not included
in the definition of covered transactions
in section 23A; the exemptions are
instead in a different subsection of
section 23A and provide an exemption
from only some (but not all) of the
provisions of section 23A governing
covered transactions.2495 Therefore, the
final rule does not incorporate the
exemptions in section 23A.
Similarly, the final rule incorporates
the statutory restriction as written,
which provides that a banking entity
that serves in certain specified roles
may not enter into a transaction with a
covered fund that would be a covered
transaction as defined in section 23A of
the FR Act as if the banking entity were
2490 See BoA; Credit Suisse (Williams); SIFMA et
al. (Covered Funds) (Feb. 2012).
2491 See State Street (Feb. 2012); RMA.
2492 See BoA; SIFMA et al. (Covered Funds) (Feb.
2012); See also Katten (on behalf of Int’l Clients).
2493 See Occupy.
2494 See 12 U.S.C. 371c(b)(7); See also 12 U.S.C.
371c–1(a)(2)(B) (including the sale of securities or
other assets to an affiliate as a transaction subject
to section 23B).
2495 See 12 U.S.C. 371c(d).

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a member bank and the covered fund
were an affiliate thereof. There are
certain occasions when the restrictions
of section 23A apply to transactions that
involve a third party other than an
affiliate of a member bank. For example,
section 23A would apply to an
extension of credit by a member bank to
a customer where the extension of credit
is secured by shares of an affiliate. The
Agencies believe that these transactions
between a banking entity and a third
party that is not a covered fund are not
covered by the terms of section 13(f),
which (as discussed above) make
specific reference to transactions by the
banking entity with the covered fund. A
contrary reading would prohibit
securities margin lending, which
Congress has specifically addressed
(and permitted) in other statutes. There
is no indication in the legislative history
that Congress intended section 13(f) to
prohibit margin lending that occurs in
accordance with other specific statutes.
Thus, section 13(f) does not prohibit a
banking entity from extending credit to
a customer secured by shares of a
covered fund (as well as, perhaps, other
securities) held in a margin account.
However, the Agencies expect banking
entities not to structure transactions
with third parties in an attempt to evade
the restrictions on transactions with
covered funds, and the Agencies will
use their supervisory authority to
monitor and restrict transactions that
appear to be evasions of section 13(f).
c. Certain Transactions and
Relationships Permitted
While section 13(f)(1) of the BHC Act
generally prohibits a banking entity
from entering into a transaction with a
related covered fund that would be a
covered transaction as defined under
section 23A of the FR Act, other specific
portions of the statute permit a banking
entity to engage in certain transactions
or relationships with such funds.
1. Permitted Investments and
Ownerships Interests
The proposed rule permitted a
banking entity to acquire or retain an
ownership interest in a covered fund in
accordance with the requirements of
section 13.2496 This was consistent with
the text of section 13(f), which by its
terms is triggered by the presence of
certain ownership interests. This view
also resolved an apparent conflict
between the text of section 13(f) and the
reference in section 13(f) prohibiting
covered transactions under section 23A
of the FR Act, which includes acquiring
2496 See

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or retaining an interest in securities
issued by an affiliate.
Several commenters supported this
aspect of the proposal.2497 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
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. Therefore, the final rule
adopts this provision as proposed.2498
2. Prime Brokerage Transactions
Section 13(f) provides an exception
from the prohibition on covered
transactions with a covered fund for any
prime brokerage transaction with a
covered fund in which a covered fund
managed, sponsored, or advised by a
banking entity has taken an ownership
interest (a ‘‘second-tier fund’’).
However, the statute does not define
prime brokerage transaction. The
proposed rule defined prime brokerage
transaction to include providing one or
more products or services, such as
custody, clearance, securities borrowing
or lending services, trade execution, or
financing, data, operational, and
portfolio management support.2499
A few commenters argued that the
proposed definition of prime brokerage
transaction was overly broad and should
not permit securities lending or
borrowing services. These commenters
argued that securities lending and
borrowing (and certain other services)
could increase leverage by covered
funds and the risk that a banking entity
would bailout these funds.2500
Other commenters argued that the
proposed definition of prime brokerage
transaction was confusing because it
included transactions (such as data or
portfolio management support) that
were not ‘‘covered transactions’’ under
section 23A of the FR Act and thus not
prohibited as an initial matter by section
13(f). These commenters argued that
including otherwise permissible
transactions within the definition of
prime brokerage transaction created
uncertainty about the permissibility of
other transactions or services that are
not expressly covered transactions
2497 See,

e.g., SIFMA et al. (Covered Funds) (Feb.

2012).
2498 The final rule modifies the proposal to clarify
that a banking entity may acquire and retain an
ownership interest in a covered fund by express
reference to the permitted activities described in
§§ ll.11, ll.12 and ll.13.
2499 See proposed rule § ll.10(b)(4).
2500 See, e.g., Occupy; Public Citizen.

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under section 23A of the FR Act and
thus not prohibited under section 13(f).
One commenter proposed defining
prime brokerage transaction as any
‘‘covered transaction’’ entered into by a
banking entity with a covered fund ‘‘for
purposes of custody, clearance,
securities borrowing or lending services,
trade execution and settlement,
financing and related hedging,
intermediation, or a similar
purpose.’’ 2501
A few commenters supported
expanding the definition of prime
brokerage transaction to include any
service or transaction ‘‘related to’’ a
specific list of permissible transactions.
For instance, one commenter argued
that acting as agent in providing
contractual income and settlement
services and intraday and overnight
overdraft protection should expressly be
included within the definition of prime
brokerage transaction.2502 This
commenter also urged that borrower
default indemnification should be
included as a prime brokerage
transaction to the extent it would be a
covered transaction that is prohibited by
section 13(f).2503 Another commenter
recommended that the definition of
prime brokerage transaction expressly
include transactions in commodities,
futures and foreign exchange, as well as
securities, and transactions effected
through OTC derivatives, including,
without limitation, contracts for
differences, various swaps and securitybased swaps, foreign exchange swaps
and forwards and ‘‘FX prime
brokerage.’’ 2504
Based on review of the comments, the
definition of prime brokerage
transaction has been modified in several
ways. For purposes of the final rule,
prime brokerage transaction is defined
to mean any transaction that would be
a covered transaction, as defined in
section 23A(b)(7) of the FR Act (12
U.S.C. 371c(b)(7)), that is provided in
connection with custody, clearance and
settlement, securities borrowing or
lending services, trade execution,
financing, or data, operational, and
administrative support. The definition
of prime brokerage transaction under
the final rule generally recognizes the
same relationships that were considered
when defining prime brokerage
transaction under the proposal,2505
without certain of the modifications
suggested by some commenters that are
discussed above. The Agencies carefully
2501 See

SIFMA et al. (Mar. 2012).
RMA.
2503 See RMA.
2504 See Katten (on behalf of Int’l Clients).
2505 See final rule § ll.10(d)(5).
2502 See

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considered comments received on the
definition of prime brokerage
transaction. As noted above, certain
commenters requested that various
types of transactions be included in or
omitted from the definition. The
Agencies believe it appropriate to
include within the definition of prime
brokerage transaction those transactions
that the Agencies believe generally
constitute the typical type of prime
brokerage transactions provided in the
market. Including this list of
relationships provides clarity and
certainty for transactions that are
commonly considered to be prime
brokerage transactions.
The final rule incorporates within the
definition of prime brokerage
transaction a reference to covered
transactions under section 23A(b)(7) of
the FR Act. This change aligns the final
rules with section 13(f) of the BHC Act
and is designed to eliminate confusion
and provide certainty regarding both the
breath of the prohibition on covered
transactions in section 13(f) and the
scope of the exception for prime
brokerage transactions. Thus, a
transaction or relationship that is not a
covered transaction under section 13(f)
of the BHC Act is not prohibited in the
first instance (unless prohibited
elsewhere in section 13). Within the
category of transactions prohibited by
section 13(f), transactions within the
definition of prime brokerage
transaction are permitted.
Some commenters argued that the
Agencies should provide an exemption
for prime brokerage transactions with a
broader array of funds than the proposal
permitted. For instance, some
commenters argued that the Agencies
should permit a banking entity to enter
into a prime brokerage transaction with
any covered fund or fund structure that
the banking entity organizes and offers
or for which it directly serves as
investment manager, investment
adviser, or sponsor, and should not
limit the exception for prime brokerage
transactions to only a second-tier
covered fund.2506 Conversely, a few
commenters argued that the prime
brokerage exemption should only
permit a banking entity to provide these
services to a third-party fund in order to
ensure that the provision of prime
brokerage services does not give rise to
the same risks that section 13 was
designed more generally to limit.2507
2506 See RMA; Katten (on behalf of Int’l Clients);
EFAMA; See also Hong Kong Inv. Funds Ass’n.;
IMA; Union Asset.
2507 See Sens. Merkley & Levin (Feb. 2012);
Occupy.

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The Agencies note that the statute by
its terms does not restrict prime
brokerage transactions generally. As
noted above, section 13(f)(3)(A) of the
BHC Act provides that a banking entity
may enter into any prime brokerage
transaction with a second-tier fund. The
statute by its terms permits a banking
entity with a relationship to a covered
fund described in section 13(f) to engage
in prime brokerage transactions (that are
covered transactions) only with secondtier funds and does not extend to
covered funds more generally. Neither
the statute nor the final rule limit
covered transactions between a banking
entity and a covered fund for which the
banking entity does not serve as
investment manager, investment
adviser, or sponsor (as defined in
section 13 of the BHC Act) or have an
interest in reliance on section
13(d)(1)(G) of the BHC Act. Under the
statute, the exemption for prime
brokerage transactions is available only
so long as certain enumerated
conditions are satisfied.2508 The
conditions are that (i) the chief
executive officer (or equivalent officer)
of the banking entity certifies in writing
annually that the banking entity does
not, directly or indirectly, guarantee,
assume, or otherwise insure the
obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests, and
(ii) the Board has not determined that
such transaction is inconsistent with the
safe and sound operation and condition
of the banking entity. The proposed rule
incorporated each of these provisions.
The final rule provides that this
certification be made to the appropriate
Federal supervisor for the banking
entity.
A few commenters argued that the
proposal did not adequately address
how the CEO attestation requirement in
section 13(f) would apply to foreign
banking organizations. They argued that
a senior officer with authority for the
U.S. operations of the foreign bank
should be permitted to make the
required attestation.2509
The statute allows the attestation for
purposes of the prime brokerage
exception in section 13(f) of the BHC
Act to be from the chief executive
officer or ‘‘equivalent officer.’’ 2510 In
the case of the U.S. operations of foreign
banking entities, the senior officer of the
foreign banking entity’s U.S. operations
or the chief executive officer of the U.S.
2508 See

12 U.S.C. 1851(f)(3).
proposed rule § ll.16(a)(2)(ii); IIB/EBF;
Credit Suisse (Williams).
2510 See 12 U.S.C. 1851(f)(3)(A)(ii).
2509 See

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banking entity may provide the required
attestation.
d. Restrictions on Transactions With
Any Permitted Covered Fund
Sections 13(f)(2) and 13(f)(3)(B) of the
BHC Act apply section 23B of the FR
Act 2511 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.2512 Section 23B provides that
transactions between a member bank
and an affiliate must be on terms and
under circumstances, including credit
standards, that are substantially the
same or at least as favorable to the
banking entity as those prevailing at the
time for comparable transactions with or
involving 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, non-affiliated companies.2513
Mirroring the statute, the proposal
applied this requirement to transactions
between a banking entity that serves as
investment manager, investment
adviser, or sponsor to a covered fund
and that fund and any other fund
controlled by that fund. It also applied
this condition to a permissible prime
brokerage transaction in which a
banking entity may engage under the
proposal.
Commenters generally did not raise
any issues regarding the proposal’s
implementation of section 13(f)(2) and
13(f)(3)(B). The final rule generally
implements these requirements in the
same manner as the proposal.2514
6. Section ll.15: Other Limitations on
Permitted Covered Fund Activities
Like § ll.8, § ll.17 of the
proposed rule implemented 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 § ll.8
of the proposed rule, § ll.17 provided
2511 12

U.S.C. 371c–1.
proposed rule § ll.16(b).
2513 12 U.S.C. 371c–1(a); 12 CFR 223.51.
2514 See final rule § ll.14(b). As discussed
above, § ll.11(b) of the final rule provides that for
purposes of securitizations, organizing and offering
includes acting as the securitizer. A banking entity
that continues to own interests in a securitization
in reliance on this exemption must comply, among
other things, with the requirements of § ll.14.
Accordingly, § ll.14(b) of the final rule has been
modified to require that a banking entity that
continues to hold an ownership interest in
accordance with § ll.11(b) is subject to section
23B of the Federal Reserve Act, as if such banking
entity were a member bank and the covered fund
were an affiliate.

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2512 See

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that no transaction, class of transactions,
or activity was permissible under
§§ ll.11 through ll.14 and § ll.16
of the proposed rule if the transaction,
class of transactions, or activity would:
(i) involve or result in a material conflict
of interest between the banking entity
and its clients, customers, or
counterparties; (ii) result, directly or
indirectly, in a material exposure by the
banking entity to a high-risk asset or a
high-risk trading strategy; or (iii) pose a
threat to the safety and soundness of the
banking entity or the financial stability
of the United States.
Section ll.17 of the proposed rule
defined ‘‘material conflict of interest,’’
‘‘high-risk assets,’’ and ‘‘high-risk
trading strategies’’ for these purposes in
a fashion identical to the definitions of
the same terms for purposes of § ll.8
of the proposed rule related to
proprietary trading. In the final rule,
other than the permitted activities to
which §§ ll.7 and ll.15 apply,
§§ ll.7 and ll.15 are also identical.
Comments received on the definitions
in these sections, as well as the
treatment of these concepts under the
final rule, are described in detail in Part
IV.A.9 above.
The Agencies also note that some
concerns identified by commenters
regarding the rule’s extraterritorial
application are addressed by
modifications in the final rule to the
definition of a covered fund under
§ ll.10. As noted above, commenters
requested that the Agencies clarify that
the limitations in §§ ll.8 or ll.17 of
the proposed rule apply only to a
foreign banking entity’s U.S. activities
and affiliates.2515 As discussed in
greater detail above in Part IV.B.1, the
final rule has been modified to more
narrowly focus the scope of the
definition of covered fund as it applies
to foreign funds. Pursuant to the
definition of a covered fund in
§ ll.10(b)(1), a foreign fund may be a
covered fund with respect to the U.S.
banking entity that sponsors the fund,
but not be a covered fund with respect
to a foreign bank that invests in the fund
solely outside the United States. Foreign
public funds, as defined in
§ ll.10(c)(1) of the final rule, are also
excluded from the definition of a
covered fund. By excluding foreign
public funds from the definition of
covered fund and by narrowing the
scope of the definition of a covered fund
with respect to foreign funds, the
Agencies have addressed some
commenters’ concerns regarding the
2515 See

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burdens imposed by proposed rule
§ ll.17.
C. Subpart D and Appendices A and B—
Compliance Program, Reporting, and
Violations
Subpart D of the proposed rule
implemented section 13(e)(1) of the
BHC Act and required 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
activities and investments set forth in
section 13 and the proposed rule.
As explained in detail below, in
response to comments on the
compliance program requirements and
Appendix C (Minimum Standards for
Programmatic Compliance) and to
conform to modifications to other
sections of the proposed rule, the
Agencies are adopting a variety of
modifications to Subpart D of the
proposed rule, which 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
proprietary trading activities and
covered fund activities and investments
set forth in section 13 of the BHC Act
and the final rule. As described above,
this compliance program requirement
forms a key part of the 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
proprietary trading activities and
covered fund activities and investments.
The proposal adopted a tiered
approach to implementing the
compliance program mandate, requiring
a banking entity engaged in proprietary
trading activities or covered fund
activities and investments to establish a
compliance program that contained
specific elements and, if the banking
entity’s activities were significant, meet
a number of more detailed minimum
standards. If a banking entity did not
engage in proprietary trading activities
and covered fund activities and
investments, it was required to ensure
that its existing compliance policies and
procedures included measures that were
designed to prevent the banking entity
from becoming engaged in such
activities and making such investments
and to develop and provide for the
required program under § __.20(a) of the
proposed rule prior to engaging in such
activities or making such investments,
but was not otherwise required to meet

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the requirements of subpart D of the
proposed rule.
1. Section __.20: Compliance Program
Mandate

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a. Program Requirement
A number of commenters argued that
the compliance program requirements of
the proposal were overly specific, too
prescriptive and complex to be
workable, and not justified by the costs
and benefits of having a compliance
program.2516 For instance, one
commenter expressed concern that the
complexity of the proposed compliance
regime would undermine compliance
efforts because the requirements were
overlapping, imprecise, and did not
provide sufficient clarity to traders or
banking entities as to what types or
levels of activities would be viewed as
permissible trading.2517 Some
commenters argued that the compliance
program would be challenging to
enforce or administer with any
consistency across different banking
entities and jurisdictions.2518 A few
commenters objected to any attempt to
identify every possible instance of
prohibited proprietary trading in
otherwise permitted activity.2519 By
contrast, some commenters supported
the proposed compliance program as
effective and consistent with the statute
but also suggested a number of ways
that the proposal’s compliance program
could be improved.2520
A few commenters argued that the
proposed compliance program should
be replaced with a more principlesbased framework that provides banking
entities the discretion and flexibility to
customize compliance programs tailored
to the structure and activities of their
organizations.2521 A few commenters
2516 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); Citigroup (Feb. 2012); Wells Fargo (Prop.
Trading); See also Barclays; BlackRock; Chamber
(Dec. 2011); Comm. on Capital Markets Regulation;
Credit Suisse (Williams); FIA; Goldman (Covered
Funds); Investure; NYSE Euronext; RBC; STANY;
Wedbush; See also Northern Trust; Chamber (Feb.
2012).
2517 See Citigroup (Feb. 2012).
2518 See ABA (Abernathy); IIB/EBF; ICFR. While
the Agencies recognize these issues, the Agencies
believe the final rule’s modifications to the
proposal—for example, providing for simplified
programs for smaller, less active banking entities
and increasing the asset threshold that triggers
enhanced compliance requirements—helps balance
enforceability and consistency concerns with
implementing a program that helps to ensure
compliance consistent with section 13(e)(1) of the
BHC Act. See 12 U.S.C. 1851(e)(1).
2519 See, e.g., SIFMA et al. (Prop. Trading) (Feb.
2012); RBC; STANY; See also Barclays.
2520 See AFR (Nov. 2012); Occupy; Sens. Merkley
& Levin (Feb. 2012)
2521 See SIFMA et al. (Prop. Trading) (Feb. 2012);
Wells Fargo (Prop. Trading); See also M&T Bank;
Credit Suisse (Seidel); State Street (Feb. 2012); See
also NYSE Euronext; Stephen Roach.

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argued that building on compliance
regimes that already exist at banking
entities, including risk limits, risk
management systems, board-level
governance protocols, and the level at
which compliance is monitored, would
reduce the costs and complexity of the
proposal while also enabling a robust
compliance mechanism for section
13.2522
Another commenter suggested that
the focus of the compliance program be
on the key goal of reducing risk at
banking entities by requiring each
banking entity to establish a risk
architecture that prescribes a customerfocused business model for market
making-related activities including a
comprehensive set of risk limits that
focuses on servicing customers and
ensuring safety and soundness.2523 This
commenter suggested the proposal’s
compliance requirements be replaced by
a simpler compliance framework that
could be harmonized with the broader
systemic capital and risk management
framework under the Basel accord. This
commenter argued such a framework
would increase transparency as well as
reduce overall complexity and costs of
regulation, and that information
relevant to the compliance
infrastructure, including customer
orientation policies and procedures,
target customer and product lists, trade
histories, and risk limit calibration
methodology and analyses, should all be
made available to examiners.2524
Another commenter urged that the
compliance program could be generally
improved by having a greater focus on
the compensation incentives within the
compliance program of banking
entities.2525
A number of other commenters
requested certain types of banking
entities be specifically excluded from
having to implement the requirements
of the compliance program. For
example, some commenters urged that
the details required in proposed
Appendix C apply only to those banking
entities and business lines within a
banking group that have ‘‘significant’’
covered funds or trading activities and
not apply to an affiliate of a banking
entity that does not engage in the types
of activities section 13 is designed to
address (e.g., an industrial affiliate that
manufactures machinery).2526 One
2522 See Citigroup (Feb. 2012); SIFMA et al. (Prop.
Trading) (Feb. 2012); See also ABA (Abernathy);
Paul Volcker.
2523 See Citigroup (Feb. 2012); See also SIFMA et
al. (Prop. Trading) (Feb. 2012).
2524 See Citigroup (Feb. 2012).
2525 See Occupy.
2526 See, e.g., Credit Suisse (Williams); GE (Feb.
2012); See also NAIB et al.; Chamber (Feb. 2012).

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commenter argued that the final rule
should not impose a compliance
program requirement on a banking
entity that owns 50 percent or less of
another banking entity in order to
ensure the compliance program did not
discourage joint ventures or other
arrangements where a banking entity
does not have actual control over an
affiliate.2527 As discussed in Part
IV.B.4.c. above,2528 other commenters
argued that the reporting and
recordkeeping and compliance
requirements of the rule should not
apply to permitted insurance company
investment activities because insurance
companies are already subject to
comprehensive regulation of the kinds
and amounts of investments they can
make under State or foreign insurance
laws and regulations.2529 However,
another commenter suggested that
insurance company affiliates of banking
entities expressly be made subject to
data collection and reporting
requirements to prevent possible
evasion of the restrictions of section 13
and the final rule using their insurance
affiliates.2530
A few commenters argued that
requiring securitization vehicles to
establish even the minimal
requirements set forth in § __.20(d)
would impose unnecessary costs and
burdens on these entities.2531 By
contrast, another commenter argued
that, because of the perceived risks of
these entities, securitization vehicles
related to a banking entity should be
required to comply fully with the
proposed rule regardless of how such
compliance procedures are funded by
the banking entity.2532
Several commenters urged that
foreign activities of foreign banking
entities, which are already subject to
2527 See GE (Feb. 2012). Under the BHC Act, an
entity would generally be considered an affiliate of
a banking entity, and therefore a banking entity
itself, if it controls, is controlled by, or is under
common control with an insured depository
institution. Pursuant to the BHC Act, a company
controls another company if, for instance, the
company directly or indirectly or acting through
one or more other persons owns, controls, or has
power to vote 25 per cent or more of any class of
voting securities of the company. See 12 U.S.C.
1841(a)(2). The compliance program requirement
applies to all banking entities in order to ensure
their compliance with the final rule.
2528 See Part IV.B.4.c.
2529 See, e.g., ACLI (Jan. 2012); Country Fin. et al.;
NAMIC.
2530 See Sens. Merkley & Levin (Feb. 2012). As
noted above, the compliance program requirement
applies to all banking entities, including insurance
companies that are considered banking entities, in
order to ensure their compliance with the final rule.
2531 See ASF (Feb. 2012); AFME et al.; SIFMA
(Securitization) (Feb. 2012); Commercial Real Estate
Fin. Council.
2532 See Occupy.

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their own prudential regulation under
applicable home country regulation, be
excluded from the compliance program
and argued that to do otherwise would
be an extraterritorial expansion of U.S.
law.2533 These commenters contended
that the compliance program
requirements for foreign banking
entities should, in any event, be
narrowly circumscribed.2534 One
commenter proposed that the foreign
activity of foreign banking entities be
excluded from compliance, reporting
and other obligations where the risk of
the activity is outside of the United
States because those risks do not pose
a threat to U.S. taxpayers.2535 Another
commenter argued that only U.S.
affiliates of foreign banking entities
engaged in proprietary trading and
covered fund activities as principal in
the United States should be required to
institute the compliance and reporting
systems required in the proposal, and
that all foreign affiliates only be
required to have policies and
procedures designed to prevent the
banking entity from engaging in relevant
trading and covered fund activities in
the United States.2536 This commenter
also expressed concern that the
reporting and recordkeeping
requirements could be interpreted to
apply to an entire trading unit, even
trading activities with no U.S. nexus, if
any portion of a trading unit’s activities,
even a single trade, would be required
to rely on the market-making, hedging,
underwriting or U.S. government
security exemptions.2537
Commenters also offered thoughts on
the timeframe within which banking
entities must establish a compliance
program. One commenter urged that
reporting begin immediately,2538 while
another commenter contended that the
effective date provided banking entities
with sufficient time to implement the
proposal’s compliance program.2539
Other commenters, however, argued
2533 See, e.g., Socie
´ te´ Ge´ne´rale; IIB/EBF;
Australian Bankers Ass’n. (Feb. 2012); Banco de
Me´xico; Norinchukin; Cadwalader (on behalf of
Thai Banks); Cadwalader (on behalf of Singapore
Banks); Allen & Overy (on behalf of Canadian
Banks); BAROC; Comm. on Capital Markets
Regulation; Credit Suisse (Williams); EFAMA; Hong
Kong Inv. Funds Ass’n.; HSBC; IIAC; IMA; Katten
(on behalf of Int’l Clients); Ass’n. of Banks in
Malaysia; RBC; Sumitomo Trust; See also AFME et
al.; British Bankers’ Ass’n.; EBF; Commissioner
Barnier; French Banking Fed’n.; UBS; Union Asset.
2534 See, e.g., AFME et al.; IIB/EBF; BaFin/
Deutsche Bundesbank; Credit Suisse (Williams);
HSBC.
2535 See Australian Bankers Ass’n. (Feb. 2012);
See also RBC.
2536 See IIB/EBF.
2537 See IIB/EBF.
2538 See Occupy.
2539 See Alfred Brock.

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that banking entities should have
additional time to establish compliance
programs.2540 Some commenters argued
banking entities should have one-year
from the date of publication of the final
rule to implement their compliance
programs,2541 while others urged that
banking entities have a two-year period
to build compliance systems.2542 One
commenter suggested the Board amend
its conformance rule to provide U.S.
banking entities with an additional year
for implementing the compliance
requirements with respect to their
foreign operations.2543
After considering comments on the
proposal, the final rule retains the
compliance program requirement with a
variety of modifications. In particular,
the modifications are designed to make
the compliance program requirements
clearer and more tailored to the size,
complexity and type of activity
conducted by each banking entity.2544
The Agencies also believe that the
revisions build on the limits, procedures
and elements of risk management
programs that many banking entities
have already developed to monitor and
control the risk of existing trading and
investment activities.2545
The final rule builds on the proposed
rule’s tiered approach by adjusting asset
thresholds and by adding a new
provision allowing a banking entity
with modest covered activities to
customize its compliance program.
Specifically, the final rule allows
banking entities with total assets below
$10 billion to fold compliance measures
into their existing compliance program
2540 See Wells Fargo (Prop. Trading); PNC et al.;
Australian Bankers Ass’n. (Feb. 2012); SIFMA et al.
(Prop.Trading) (Feb. 2012); ABA (Keating); AFME et
al.; BoA; Barclays; SIFMA et al. (Covered Funds)
(Feb. 2012); SIFMA et al. (Mar. 2012); Comm. on
Capital Markets Regulation; Credit Suisse
(Williams); T. Rowe Price; See also Citigroup (Feb.
2012); Socie´te´ Ge´ne´rale; IIB/EBF; Am. Express;
Arnold & Porter; BDA (Mar. 2012).
2541 See Wells Fargo (Prop. Trading); PNC et al.;
Australian Bankers Ass’n. (Feb. 2012); BoA;
Barclays; SIFMA et al. (Covered Funds) (Feb. 2012);
SIFMA et al. (Mar. 2012); Credit Suisse (Seidel); See
also BDA (Mar. 2012).
2542 See SIFMA et al. (Prop.Trading) (Feb. 2012);
ABA (Keating); AFME et al.; GE; Credit Suisse
(Williams); Goldman (Prop. Trading); Morgan
Stanley; RBC; SVB.
2543 See Morgan Stanley.
2544 The Agencies believe these modifications,
such as increasing the threshold that triggers
enhanced compliance standards and allowing
smaller banking entities to customize their
compliance programs, help address concerns that
the proposed requirement was too complex and
unworkable. See, e.g., SIFMA et al. (Prop.Trading)
(Feb. 2012); Citigroup (Feb. 2012); Wells Fargo
(Prop. Trading).
2545 Some commenters argued that the
requirement should build on banking entities’
existing compliance regimes. See Citigroup (Feb.
2012); SIFMA et al. (Prop.Trading) (Feb. 2012); See
also ABA (Abernathy); Paul Volcker.

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in a manner that addresses the types
and amounts of activities the entity
conducts.2546 The proposal did not
contain such a provision. Similar to the
proposal, the final rule requires that a
banking entity that conducts no activity
subject to section 13 of the BHC Act is
not required to develop any compliance
program until it begins conducting
activities subject to section 13.2547 The
final rule further modifies the proposal
by requiring that a banking entity with
total assets greater than $10 billion but
less than $50 billion is generally
required to establish a compliance
program suited to its activities which
includes the six elements described in
the final rule.2548 Additionally, the final
rule requires that the largest and most
active banking entities, with total assets
above $50 billion, or that are subject to
the quantitative measurements
requirement due to the size of their
trading assets and liabilities, adopt an
enhanced compliance program that
addresses the six elements described in
the rule plus a number of more detailed
requirements described in Appendix
B.2549
In response to commenters’ concerns
regarding compliance program burdens
in connection with covered fund
activities and investments, the final rule
is further modified with respect to
thresholds for covered fund activities
and investments. As noted above, this
and the other modifications are
designed to make the compliance
program requirement clearer and more
tailored to the size, complexity and type
of activity conducted by each banking
entity. The final rule, unlike the
proposal, does not require a banking
entity to adopt the enhanced
compliance program if the banking
entity, together with its affiliates and
subsidiaries, invests in the aggregate
final rule § __.20(f)(2).
final rule § __.20(f)(1). In response to a
few commenters, the final rule, unlike § __.20(d) of
the proposed rule, no longer requires a banking
entity include measures that are designed to
prevent such entity from becoming engaged in
covered trading activities or covered fund
investments and activities.
2548 Under the proposal, each banking entity was
required to have a compliance program that
addressed the elements described in the rule, unless
the banking entity did not engage in prohibited
activities or investments, in which case it need only
have existing policies and procedures requiring the
banking entity to develop a compliance program
before engaging in such activities. Further, a
banking entity that has trading assets and liabilities
equal to or greater than $1 billion, or equal to 10%
or more of total assets, would have been subject to
additional standards under the proposed rule. See
proposed rule §§ __.20(a), (c), (d).
2549 Because the Agencies have determined not to
retain proposed Appendix B in the final rule,
proposed Appendix C is now Appendix B under the
final rule.
2546 See
2547 See

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more than $1 billion in covered funds
or if they sponsor or advise covered
funds, the average total assets of which
are equal to or greater than $1 billion.
Banking entities would look to the total
asset thresholds discussed above,
instead of the amount of covered fund
investments and activities, in
determining whether they would be
subject to the enhanced compliance
program requirements. The Agencies
have also modified the compliance
program reporting obligations of foreign
banking entities with respect to their
covered trading and covered fund
activities that are conducted pursuant to
the exemptions contained in §§ __.6(e)
and __.13(b).2550
The final rule also responds to
commenters’ concerns regarding the
timeframe within which a banking
entity must establish and implement the
compliance program required for that
entity under § ll.20. Under the final
rule, each banking entity must establish
the compliance program required for
that entity under § ll.20 as soon as
practicable and in no case later than the
end of the conformance period.2551 The
Agencies expect that during this period
a banking entity will develop and
implement the compliance program
requirements of the final rule as part of
its good-faith efforts to fully conform its
activities and investments to the
requirements of section 13 and the final
rule. As explained below in the
discussion of the enhanced minimum
standards for compliance programs
under Appendix B, the final rule also
requires larger and more active banking
entities to report certain data regarding
2550 See, e.g., Socie
´ te´ Ge´ne´rale; IIB/EBF;
Australian Bankers Ass’n. (Feb. 2012); Banco de
Me´xico; Norinchukin; Cadwalader (on behalf of
Thai Banks); Cadwalader (on behalf of Singapore
Banks); Allen & Overy (on behalf of Canadian
Banks); BAROC; Comm. on Capital Markets
Regulation; Credit Suisse (Williams); EFAMA; Hong
Kong Inv. Funds Ass’n.; HSBC; IIAC; IMA; Katten
(on behalf of Int’l Clients); Ass’n. of Banks in
Malaysia; RBC; Sumitomo Trust; See also AFME et
al.; British Bankers’ Ass’n.; EBF; Commissioner
Barnier; French Banking Fed’n.; UBS; Union Asset.
2551 As discussed in Part II., the Board is
extending the conformance period by one year.
Extension of the conformance period will, among
other things, provide banking entities with
additional time to establish the required
compliance program. The Agencies believe the
extension of the conformance period, as well as the
phased-in approach to implementing the enhanced
compliance program in Appendix B, address certain
commenters’ requests for additional time to
establish a compliance program. See Wells Fargo
(Prop. Trading); PNC et al.; Australian Bankers
Ass’n. (Feb. 2012); SIFMA et al. (Prop.Trading)
(Feb. 2012); ABA (Keating); AFME et al.; BoA;
Barclays; SIFMA et al. (Covered Funds) (Feb. 2012);
SIFMA et al. (Mar. 2012); Comm. on Capital
Markets Regulation; Credit Suisse (Williams); T.
Rowe Price; See also Citigroup (Feb. 2012); Socie´te´
Ge´ne´rale; IIB/EBF; Am. Express; Arnold & Porter;
BDA (Mar. 2012); Morgan Stanley.

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their trading activities. These
requirements have been phased-in to
provide banking entities an opportunity
to develop the necessary systems to
capture and report the relevant data.2552
In addition, as explained below, the
Agencies will consider, after a period to
gain experience with the data, revisiting
these data collections to determine their
usefulness in monitoring the risk and
types of activities conducted by banking
entities.
b. Compliance Program Elements
Section ll.20 of the final rule
specifies six elements that each
compliance program required under that
section must at a minimum contain.
With some minor modifications, these
are the same six elements that were
included in the proposed rule. The
changes reflect modifications made in
requirements and limits in the other
provisions of the rule and, in particular,
acknowledge the importance of trading
and hedging limits, appropriate setting,
monitoring and management review of
trading and hedging limits, strategies,
and activities and investments,
incentive compensation and other
matters.
The six elements specified in
§ ll.20(b) are:
• Written policies and procedures
reasonably designed to document, describe,
monitor and limit trading activities and
covered fund activities and investments
conducted by the banking entity to ensure
that all activities and investments that are
subject to section 13 of the BHC Act and the
rule comply with section 13 of the BHC Act
and the rule; 2553
• A system of internal controls reasonably
designed to monitor compliance with section
13 of the BHC Act and the rule and to
prevent the occurrence of activities or
investments that are prohibited by section 13
of the BHC Act and the rule; 2554
• A management framework that clearly
delineates responsibility and accountability
for compliance with section 13 of the BHC
Act and the rule and includes appropriate
management review of trading limits,
strategies, hedging activities, investments,
incentive compensation and other matters
2552 Commenters provided a wide range of
feedback regarding the timeframe for establishing a
compliance program, from requesting that reporting
begin immediately to requesting two years from the
date of publication of the final rule. See, e.g.,
Occupy; Alfred Brock; Wells Fargo (Prop. Trading);
PNC et al.; SIFMA et al. (Prop.Trading) (Feb. 2012).
The Agencies believe that the final rule’s approach
appropriately balances the desire for effective
regulation with requests for additional time to
establish a compliance program.
2553 This requirement is substantially the same as
the proposed written policies and procedures
requirement. See proposed rule § ll20(b)(1).
2554 This requirement is substantially the same as
the proposed internal controls requirement. See
proposed rule § ll.20(b)(2).

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5751

identified in the rule or by management as
requiring attention; 2555
• Independent testing and audit of the
effectiveness of the compliance program
conducted periodically by qualified
personnel of the banking entity or by a
qualified outside party; 2556
• Training for trading personnel and
managers, as well as other appropriate
personnel, to effectively implement and
enforce the compliance program; 2557 and
• Making and keeping records sufficient to
demonstrate compliance with section 13 of
the BHC Act and the 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.

Under the final rule, these six elements
must be part of the compliance program
of each banking entity with total
consolidated assets greater than $10
billion that engages in activities covered
by section 13 of the BHC Act.
As discussed above, the Agencies
have moved particular elements with
respect to the required compliance
program for the exemptions contained
in § ll.4(a), § ll.4(b), and § ll.5
into the specific requirements of these
exemptions. The Agencies believe this
structure more effectively conveys that
satisfying the requirements of these
exemptions involves specific
compliance measures or, with respect to
underwriting and market making, a
customer-focused business model, as
requested by some commenters.2558
In addition to the generally required
compliance program elements specified
in § ll.20(b), a banking entity relying
on any of these exemptions should
employ the specific compliance tools
specified within the relevant section of
2555 The final rule modifies the proposed
management framework requirement by adding that
the management framework element must include
appropriate management review of trading limits,
strategies, hedging activities, incentive
compensation, and other matters. See final rule
§ ll.20(b)(3). See also proposed rule
§ ll20(b)(3). One commenter suggested that the
compliance program requirement have a greater
focus on compensation incentives. See Citigroup
(Feb. 2012).
2556 The final rule modifies the proposed
independent testing requirement by specifying that
such testing must be done ‘‘periodically.’’ See final
rule § ll.20(b)(4). See also proposed rule
§ ll.20(b)(4). The meaning of ‘‘independent
testing’’ is discussed in more detail below in Part
IV.C.2.e. The reference to ‘‘audit’’ does not mean
that the independent testing must be performed by
a designated auditor, whether internal or external.
2557 The final rule retains the proposed training
requirement. See final rule § ll.20(b)(5). See also
proposed rule § ll.20(b)(5).
2558 One of these commenters suggested the
Agencies adopt a simpler compliance framework
that could be harmonized with the Basel accord.
See Citigroup (Feb. 2012). The Agencies believe the
final framework described above helps address
concerns about streamlining the compliance
program requirement while meeting the statutory
requirement to issue regulations ‘‘in order to insure
compliance’’ with section 13. 12 U.S.C. 1851(e)(1).

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this rule to facilitate compliance with
the applicable exemption and should
appropriately tailor the required
compliance program elements to the
individual trading activities and
strategies of each trading desk on an
ongoing basis. By specifying particular
compliance program-related
requirements in the exemptions, the
Agencies have sought to provide
additional guidance and clarity as to
how a compliance program should be
structured,2559 while at the same time
providing the banking entity with
sufficient discretion to consider the
type, size, scope and complexity of its
activities and business structure in
designing a compliance program to meet
the requirements set forth in
§ ll.20(b).2560
For a banking entity with more than
$10 billion in total consolidated assets,
the compliance program requires
additional documentation with respect
to funds. For example, the banking
entity is required to maintain records
that include documentation of
exclusions or exemptions other than
sections 3(c)(1) and 3(c)(7) of the
Investment Company Act of 1940 relied
on by each fund sponsored by the
banking entity (including all
subsidiaries and affiliate) in
determining that such fund is not a
covered fund.2561 The banking entity is
also required to maintain, with respect
to each fund sponsored by the banking
entity (including all subsidiaries and
affiliates) for which the banking entity
relies on one or more of the exclusions
provided by §§ ll.10(c)(1),
ll.10(c)(5), ll.10(c)(8),
ll.10(c)(9), or ll.10(c)(10) of
2559 One commenter stated that the proposed rule
did not provide sufficient clarity as to what types
or levels of activities would be permissible. See
Citigroup (Feb. 2012).
2560 Some commenters requested a more
principles-based framework that allows banking
entities to customize compliance programs to the
structure and activities of their organizations. See
SIFMA et al. (Prop.Trading) (Feb. 2012); Wells
Fargo (Prop. Trading); See also M&T Bank; Credit
Suisse (Seidel); State Street (Feb. 2012); NYSE
Euronext; Stephen Roach.
2561 See final rule § ll.20(e)(1). As discussed
under § ll.10 regarding entities excluded from
the definition of covered fund, the Agencies
recognize that the final rule’s definition of covered
fund does not include certain pooled investment
vehicles. The Agencies expect that the types of
pooled investment vehicles sponsored by the
financial services industry will continue to evolve,
including in response to the final rule, and the
Agencies will be monitoring this evolution to
determine whether excluding these and other types
of entities remains appropriate. The Agencies will
also monitor use of the exclusions for attempts to
evade the requirements of section 13 and intend to
use their authority where appropriate to prevent
evasions of the rule. The Agencies are adopting this
additional documentation requirement to facilitate
such monitoring activities.

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subpart C, documentation supporting
the banking entity’s determination that
the fund is not a covered fund pursuant
to one or more of those exclusions.2562
If the banking entity operates a seeding
vehicle described in §§ ll.10(c)(12)(i)
or ll.10(c)(12)(iii) of subpart C that
will become a registered investment
company or SEC-regulated business
development company, the compliance
program must also include a written
plan documenting the banking entity’s
determination that the seeding vehicle
will become a registered investment
company or SEC-regulated business
development company; the period of
time during which the vehicle will
operate as a seeding vehicle; and the
banking entity’s plan to market the
vehicle to third-party investors and
convert it into a registered investment
company or SEC-regulated business
development company within the time
period specified in § ll.12(a)(2)(i)(B)
of subpart C.2563 Furthermore, for any
banking entity that is, or is controlled
directly or indirectly by a banking entity
that is, located in or organized under the
laws of the United States or of any State,
if the aggregate amount of ownership
interest in foreign public funds as
described in § ll.10(c)(1) of subpart C
owned by such banking entity
(including ownership interests owned
by any affiliate that is controlled
directly or indirectly by a banking entity
that is located in or organized under the
laws of the United States or of any State)
exceeds $50 million at the end of two
or more consecutive calendar quarters,
beginning with the next succeeding
calendar quarter, such banking entity
must include in its compliance program
documentation the value of the
ownership interests owned by the
banking entity (and such affiliates) in
each foreign public fund and each
jurisdiction in which any such foreign
public fund is organized. Such
calculation must be done at the end of
each calendar quarter and must
continue until the banking entity’s
aggregate amount of ownership interests
in foreign public funds is below $50
million for two consecutive calendar
quarters.2564
2562 See final rule § ll.20(e)(2). The Agencies
are adopting this additional documentation
requirement for the same reasons discussed above
with respect to § ll.20(e)(1).
2563 See final rule § ll.20(e)(3). The rationale for
this additional documentation requirement is
provided under the discussion regarding registered
investment companies and business development
companies in § ll.10.
2564 See final rule § ll.20(e)(4). The rationale for
this additional documentation requirement is
provided under the discussion regarding foreign
public funds in § ll.10. For purposes of this
requirement, a U.S. branch, agency, or subsidiary of

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c. Simplified Programs for Less Active
Banking Entities
The proposed rule provided that the
six elements of the compliance program
required by § ll.20 would apply to all
banking entities engaged in covered
trading activities or covered fund
activities and investments and that the
minimum detailed standards of
Appendix C would apply to only those
banking entities above specified
thresholds. The application of detailed
minimum standards was intended to
reflect the heightened compliance risks
of significant covered trading and
significant covered fund activities and
investments.
The proposed rule provided that a
banking entity with no covered
activities or investments could satisfy
the requirements of § ll.20 if its
existing compliance policies and
procedures were amended to include
measures that were designed to prevent
the banking entity from becoming
engaged in such activities or making
such investments and required the
banking entity to develop and provide
for the required compliance program
prior to engaging in covered activities or
making covered investments.
Several commenters expressed
concern over the requirement in
§ ll.20(d) of the proposed rule that a
banking entity that did not engage in
any covered trading activities or covered
fund activities or investments must
ensure that its existing compliance
policies and procedures include
measures designed to prevent the
banking entity from becoming engaged
in such activities and making such
investments.2565 In particular, some
commenters expressed concern that the
proposal would have a burdensome
impact on community banks and force
community banks to hire specialists to
amend their policies and procedures to
ensure compliance with section 13 and
the final regulations. These commenters
argued that a banking entity should not
be required to amend its compliance
policies and procedures and set up a
monitoring program if the banking
entity does not engage in prohibited
activities.2566
A few commenters argued that the
Agencies should more carefully
a foreign banking entity is located in the United
States; however, the foreign bank that operates or
controls that branch, agency, or subsidiary is not
considered to be located in the United States solely
by virtue of operating or controlling the U.S.
branch, agency, or subsidiary. See final rule
§ ll.20(e)(5).
2565 See, e.g., ICBA; ABA (Keating); Conf. of State
Bank Supervisors; NAIB; Ryan Kamphuis;
Wisconsin Bankers Ass’n.
2566 See, e.g., ICBA; ABA (Keating).

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consider the burden of the compliance
program on smaller institutions that
engage in a modest level of permissible
trading or covered fund activity.2567
One commenter recommended that
smaller banks be given the benefit of the
doubt regarding compliance.2568 For
instance, one commenter recommended
that banking entities with consolidated
assets of $10 billion or less be permitted
to engage in a limited amount of interest
rate swaps and certain other traditional
banking activities without being
required to establish a compliance
program.2569
The Agencies have considered
carefully the comments received and, as
noted above, have modified the rule in
order to limit the implementation,
operational or other burdens or
expenses associated with the
compliance requirements for a banking
entity that engages in no covered
activities or investments. The final rule
permits banking entities that have no
covered activities or investments (other
than covered transactions in obligations
of or guaranteed by the United States or
an agency of the United States and
municipal securities) to satisfy the
compliance program requirements by
establishing the required compliance
program prior to becoming engaged in
such activities or making such
investments. This eliminates the burden
on banking entities that do not engage
in covered activities or investments.
Similarly, § ll.20(f)(2) of the final
rule provides that a banking entity with
total consolidated assets of $10 billion
or less as measured on December 31 of
the previous two years that does engage
in covered activities and investments
may satisfy the requirements of
§ ll.20 by including in its existing
compliance policies and procedures
references to the requirements of section
13 and subpart D as appropriate given
the activities, size, scope and
complexity of the banking entity. 2570
2567 See Sens. Merkley & Levin (Feb. 2012); Conf.
of State Bank Supervisors; Ryan Kamphuis; SVB.
2568 See Sens. Merkley & Levin (Feb. 2012).
2569 See ICBA.
2570 Some commenters asked the Agencies to
consider the burden of the compliance program
requirement on smaller institutions and
recommended that small banks be given the benefit
of the doubt regarding compliance. See Sens.
Merkley & Levin (Feb. 2012); Conf. of State Bank
Supervisors; Ryan Kamphuis; SVB. The Agencies
decline to follow the approach suggested by another
commenter to allow banking entities with assets of
$10 billion or less be permitted to engage in certain
limited activities without having to establish a
compliance program. See ICBA. The Agencies
believe that requiring a banking entity engaged in
covered trading or covered fund activity to establish
a compliance program is a fundamental part of the
multi-faceted approach to implementing section 13
of the BHC Act, which requires the Agencies to

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This could include appropriate
references to the limits on trading
activities permitted in reliance upon
any of the exemptions contained in
§ ll_.4(a), § ll_.4(b) or § ll_.5.
d. Threshold for Application of
Enhanced Minimum Standards
Under the proposed rule, banking
entities with significant covered trading
activities or covered fund activities and
investments were required to establish
an enhanced compliance program in
accordance with Appendix C, which
contained detailed compliance program
requirements. The proposed rule
required a banking entity to implement
the enhanced compliance program
under Appendix C if the banking entity
engaged in covered activities and
investments and either: (i) Has, on a
consolidated basis, 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,
is equal to or greater than $1 billion or
equals 10 percent or more of its total
assets; or (ii) has, on a consolidated
basis, aggregate investments in covered
funds the average value of which (on a
worldwide consolidated basis), as
measured as of the last day of each of
the four prior calendar quarters, is equal
to or greater than $1 billion, or sponsors
and advises one or more covered funds
the 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.
In general, commenters argued that
the activities and investments subject to
section 13 are conducted by only a
small number of the nation’s largest
financial firms and that the compliance
program requirements should be
tailored to target these firms.2571 Some
commenters urged the Agencies to raise
substantially the proposed $1 billion
threshold for trading assets and
liabilities in § ll.20(c)(2) of the
proposal to $10 billion or higher due to
the high costs of implementing the
enhanced compliance program. A few
commenters argued that even if the
threshold were raised to $10 billion, an
overwhelming percentage of trading
assets and liabilities in the banking
industry (approximately 98 percent)
would still remain subject to heightened
implement rules ‘‘to insure compliance with this
section.’’ 12 U.S.C. 1851(e)(1). Further, the Agencies
believe that the final rule’s modification of the
proposal to allow banking entities with total assets
under $10 billion to customize their compliance
programs helps ease the burden of this requirement
on smaller institutions.
2571 See, e.g., Sens. Merkley & Levin (Feb. 2012);
PNC et al.

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compliance requirements included in
Appendix C.2572 Some of these
commenters recommended the
threshold for trading assets for
compliance should be increased to no
less than $10 billion to mitigate the
costs and impact on regional banking
organizations that do not engage
proprietary trading subject to the
prohibition of section 13. These
commenters argued that the compliance
requirements of § ll.20(a)-(b) are
sufficient to ensure that regional
banking organizations have appropriate
compliance programs.2573 One
commenter suggested the threshold for
the enhanced compliance requirement
be increased to $50 billion in combined
trading assets and liabilities.2574 One
commenter also argued that banking
entities required to establish enhanced
compliance programs should no longer
be required to do so if they fall below
the threshold.2575
Commenters also offered a number of
suggestions for modifying the activity
that would be considered in meeting the
thresholds for determining which
compliance program requirements apply
to a banking entity. Several commenters
argued that certain types of trading
assets or fund investments should not
be included for purposes of determining
whether the relevant dollar threshold
triggering the enhanced compliance was
met, particularly those that are not
prohibited activities or investments. For
instance, some commenters urged that
trading in U.S. government obligations
should not count toward the calculation
of whether a banking organization meets
the trading threshold triggering
Appendix C.2576 These commenters also
argued that other positions or
transactions that do not involve
financial instruments and that may
constitute trading assets and liabilities,
such as loans, should be excluded from
the thresholds because exempt activities
should not determine the type of
compliance program a banking entity
must implement.2577 One commenter
urged that foreign exchange swaps and
forwards be excluded from the
definition of a ‘‘derivative’’ and not be
subject to compliance requirements as a
result.2578 Conversely, one commenter
urged that all assets and liabilities
defined as trading assets for purposes of
the Market Risk Capital Rule should be
2572 See

ABA (Keating); M&T Bank; PNC et al.
PNC et al.; M&T Bank; See also ABA
(Abernathy).
2574 See State Street (Feb. 2012).
2575 See ABA (Keating).
2576 See PNC et al.
2577 See PNC et al.
2578 See Northern Trust.
2573 See

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included in the $1 billion standard for
becoming subject to any reporting and
recordkeeping requirements under the
final rule.2579
A few commenters argued that the $1
billion threshold for establishing an
enhanced compliance program should
not include the amount of investments
in, or assets of, funds that are SBICs or
similar funds that contain, SBICs or
other investments specified under
section 13(d)(1)(E) of the BHC Act, such
as investments in and funds that qualify
for low-income housing tax credits, or
New Markets Tax Credits or that qualify
for Federal historic tax credits or similar
state programs.2580 These commenters
argued that each of these types of funds
is expressly permitted by the statute and
that including these investments and
funds in the dollar thresholds that
trigger the programmatic compliance
requirements of Appendix C would
provide a disincentive to banking
entities investing in or sponsoring these
funds, a result inconsistent with
permitting these types of investments.
Similarly, one commenter urged that
investments by a banking entity in, and
assets held by, loan securitizations not
be included in these thresholds because
these activities and investments are
expressly excluded from coverage under
the rule of construction contained in
section 13(g)(2) of the BHC Act
regarding the securitization of loans.2581
Another commenter urged that this
threshold not include investments in, or
assets of, any securitization vehicle that
would be considered a covered fund
because many smaller and regional
banking entities that were not intended
to be subject to Appendix C likely
would exceed the $1 billion threshold if
these assets are included.2582 A few
commenters also argued that, during the
conformance period, investments in,
and relationships with, a covered fund
that a banking entity is required to
terminate or otherwise divest in order to
comply with section 13 should not be
included for purposes of calculating the
compliance thresholds.2583
After considering comments received
on the proposal and in order to
implement a compliance program
requirement that is consistent with the
purpose and language of the statute and
rule while at the same time
appropriately calibrating the associated
resource burden on banking entities, the
final rule applies the enhanced
Occupy.
ABA (Keating); PNC et al.
2581 See PNC et al.
2582 See ASF (Feb. 2012).
2583 See PNC et al.; SIFMA et al. (Covered Funds)
(Feb. 2012).

minimum standards contained in
Appendix B to only those banking
entities with the most significant
covered trading activities or those that
meet a specified threshold of total
consolidated assets. The final rule,
unlike the proposal, does not require a
banking entity to adopt the enhanced
compliance program if the banking
entity, together with its affiliates and
subsidiaries, invest in the aggregate
more than $1 billion in covered funds
or if they sponsor or advise covered
funds, the average total assets of which
are equal to or greater than $1 billion.
Banking entities would look to the total
consolidated asset thresholds, instead of
the amount of covered fund investments
and activities, in determining whether
they would be subject to the enhanced
compliance program requirements. The
Agencies believe that commenters’
concerns about whether certain types of
covered fund investments or activities
(e.g., amounts or relationships held
during the conformance period) are
included for purposes of calculating the
enhanced compliance thresholds are
addressed because under the final rule,
the enhanced compliance thresholds are
based on total consolidated assets and
not the amount of covered fund
investments and activities. Similar to
the proposed rule, which provided that
a banking entity could be subject to the
enhanced compliance program if the
Agency deemed it appropriate, the final
rule’s enhanced compliance program
also could apply if the Agency notifies
the banking entity in writing that it
must satisfy the requirements.2584
Section ll.20 provides that three
categories of banking entities will be
subject to the enhanced minimum
standards contained in Appendix B. The
first category is any banking entity that
engages in proprietary trading and is
required to report metrics regarding its
trading activities to its primary Federal
supervisory agency under the final
rule.2585 This category includes a
banking entity that has, together with its
affiliates and subsidiaries, trading assets
and liabilities that equal or exceed $50
billion based on the average gross sum
of trading assets and liabilities (on a
worldwide consolidated basis and after
excluding trading assets and liabilities
involving obligations of or guaranteed
by the United States or any agency of
the United States) over the previous
consecutive four quarters, as measured
as of the last day of each of the four

2579 See
2580 See

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2584 See proposed rule § ll.20(c)(2)(iii); final
rule § ll.20(c)(3).
2585 Issues related to the threshold for reporting
quantitative measurements are discussed in detail
in Part IV.C.3., below.

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prior calendar quarters. A foreign
banking entity with U.S. operations is
required to adopt an enhanced
compliance program if its total trading
assets and liabilities across all its U.S.
operations equal or exceed $50 billion
(after excluding trading assets and
liabilities involving obligations of or
guaranteed by the U.S. or any agency of
the U.S.). While these banking entities
will be required to begin to report and
record quantitative measurements by
June 30, 2014, they will not be required
to implement an enhanced compliance
program by this date. Instead, as
discussed above, a banking entity must
establish a compliance program as soon
as practicable and in no event later than
the end of the conformance period. As
explained more fully in Part IV.C.3., this
category expands over time to include
any banking entity with trading assets
and liabilities that equal or exceed $10
billion (as measured in the manner
described above). For banking entities
below the $50 billion threshold that
become subject to the quantitative
measurements requirement through the
phased-in approach, they will not
become subject to the enhanced
compliance program until the date they
are required to comply with the
quantitative measurements requirement.
However, these banking entities will be
required to have a compliance program
that meets the requirements of
§ ll.20(b) by the end of the
conformance period. Thus, banking
entities with between $25 billion and
$50 billion trading assets and liabilities
(as described in § ll.20(d)) will be
required to implement an enhanced
compliance program under Appendix B
by April 30, 2016. Similarly, banking
entities with between $10 billion and
$25 billion trading assets and liabilities
will be subject to the requirements of
Appendix B by December 31, 2016.
After considering comments, the
Agencies have increased the trading
asset and liability thresholds triggering
the enhanced compliance program
requirements. The Agencies believe that
banking entities with a significant
amount of trading assets should have
the most detailed programs for ensuring
compliance with the trading and other
requirements of section 13 of the BHC
Act and the final rule. Specifically,
consistent with the thresholds for
reporting and recording quantitative
measurements, the threshold will
initially be $50 billion trading assets
and liabilities and, over time, will be
reduced to $10 billion.2586 As noted by
2586 Some commenters requested raising this
dollar threshold to at least $10 billion. See PNC et
al.; PNC; ABA (Keating). One commenter suggested

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commenters, these thresholds will
continue to capture a significant
percentage of the total trading assets and
liabilities in the banking system, but
will reduce the burdens to smaller, less
complex banking entities.2587 With
respect to this first category, the
Agencies determined, in response to
comments,2588 that the threshold for
proprietary trading should not include
trading assets and liabilities involving
obligations of or guaranteed by the
United States or any agency of the
United States. This approach reduces
the burdens associated with the
enhanced minimum compliance
program on banking entities whose
trading operations consist primarily of
trading U.S. government or agency
obligations, which are generally exempt
from the proprietary trading prohibition
under § ll.6(a)(1)(i). While some
commenters argued that additional
assets or liabilities, such as
securitizations or investments in SBICs,
should be excluded from the
calculation,2589 the Agencies believe
that trading in other assets involves
more complex trading activity and
warrants being included in the
threshold calculation for applying the
enhanced compliance program
requirement.
To balance the increased trading asset
and liability threshold with the goal of
requiring appropriate specificity and
rigor for large and complex banking
organizations’ compliance programs, the
Agencies have determined to also
require an enhanced compliance
program for any banking entity that has
reported total consolidated assets, as of
the previous calendar year-end, of $50
billion or more. Banking entities with
total assets of $50 billion or more are
among the most complex banking
entities and have been found by
Congress to pose sufficient risk to the
financial stability of the United States to
warrant being generally subject to
enhanced prudential standards under
section 165 of the Dodd-Frank Act. With
respect to foreign banking entities, this
threshold is calculated by reference

solely to the aggregate assets of the
foreign banking entity’s U.S. operations,
including its U.S. branches and
agencies. This approach is consistent
with the statute’s focus on the risks
posed by covered trading activities and
investments within the United States
and also responds to commenters’
concerns regarding the level of burden
placed on foreign banking entities with
respect to their foreign operations.2590
The third category includes any
banking entity that is notified by its
primary Federal supervisory Agency in
writing that it must satisfy the
requirements and other standards
contained in Appendix B. By retaining
the flexibility to impose enhanced
compliance requirements on a given
banking entity upon specific notice to
the firm, the Agencies have the ability
to apply additional standards to any
banking entity with a mix, level,
complexity or risk of activities that, in
the judgment of the relevant supervisory
Agency, indicates that the firm should
appropriately have in place an
enhanced compliance program.
Some commenters argued that the
final rule should not require a banking
entity to establish the type of detailed
compliance regime dictated by
Appendix C for both trading and
covered fund activities and investments
simply because the banking entity
engages in one but not the other
activity.2591
To comply with the applicable
compliance program requirements
under § ll.20 and Appendix B of the
final rule, banking entities should
appropriately take into account the type,
size, scope and complexity of their
activities and business structure in
determining the terms, scope and detail
of the compliance program to be
instituted.2592 For example, if all of a
banking entity’s activities subject to the
rule involve covered fund activities or
investments, it would be expected that
the banking entity would have an
appropriate compliance program
governing those activities (including an
enhanced compliance program if

the threshold be increased to $50 billion. See State
Street (Feb. 2012).
2587 See PNC et al.; M&T Bank; See also ABA
(Abernathy); ABA (Keating). The Agencies
recognize that, at the $10 billion threshold, a
significant percentage of the trading assets and
liabilities in the banking industry will remain
subject to the enhanced compliance program
requirement. See PNC.
2588 See PNC et al.
2589 See, e.g., ABA (Keating) (suggesting the
threshold should not include the amount of
investments in or assets of SBICs, or those that
qualify for low-income housing tax credits (LIHTC)
New Markets Tax Credits (NMTC), or Federal
historic tax credits (HTC)); PNC et al. (loans);
Northern Trust.

2590 Several commenters requested that foreign
activities of foreign banking entities be excluded
from the compliance program requirement. See,
e.g., Socie´te´ Ge´ne´rale; IIB/EBF; Australian Bankers
Ass’n. (Feb. 2012); Banco de Mexico; Norinchukin.
One commenter stated the only U.S. affiliates of
foreign banking entities should be required to
institute the proposed reporting and compliance
requirements. See IIB/EBF.
2591 See, e.g., SIFMA et al. (Prop.Trading) (Feb.
2012).
2592 This is generally consistent with the
proposed rule’s compliance program requirement.
See proposed rule § ll.20(a) (requiring that the
banking entity’s compliance program be appropriate
for the size, scope and complexity of activities and
business structure of the banking entity).

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5755

applicable) and it would not be
expected that the banking entity would
construct the same detailed compliance
program under the proprietary trading
provision of the rule. Similarly, if a
banking entity engages only in activities
that are subject to the proprietary
trading provisions of the rule and does
not engage in any covered fund
activities or investments, it would not
be expected that the banking entity
would implement the same detailed
compliance program under the covered
funds section as would be required for
its proprietary trading activities. In each
of these situations, the banking entity
would be expected to put in place
sufficient controls to ensure that an
appropriate compliance program is
established before the banking entity
commences a new covered activity. The
Agencies believe that this treatment is
consistent with the statutory language
regarding internal controls and
recordkeeping to ensure compliance
with section 13 and also reduces
unnecessary costs and burdens
associated with requiring banking
entities to implement compliance
requirements that are not appropriate to
the size, scope and risk of their relevant
activities.
2. Appendix B: Enhanced Minimum
Standards for Compliance Programs
The proposed rule contained an
appendix (Appendix C) which specified
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. The
Agencies 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 for the rule.
As explained above, the Agencies
continue to believe that the inclusion of
specified minimum standards for the
compliance program within the
regulation itself rather than as
accompanying guidance serves to
reinforce the importance of the
compliance program in the
implementation framework for section
13 of the BHC Act. As explained above,
the Agencies believe that large banking
entities and banking entities engaged in
significant trading activities should
establish, maintain and enforce an
enhanced compliance program. The
requirements for an enhanced
compliance program have been
consolidated in Appendix B of the final
rule.

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Similar to the proposed rule, section
I of Appendix B provides that the
enhanced compliance program must:

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• Be reasonably designed to identify,
document, monitor and report the covered
trading and covered fund activities and
investments of the banking entity; identify,
monitor and promptly address the risks of
these covered activities and investments and
potential areas of noncompliance; and
prevent activities or investments prohibited
by, or that do not comply with, section 13 of
the BHC Act and the rule;
• Establish and enforce appropriate limits
on the covered activities and investments of
the banking entity, including limits on the
size, scope, complexity, and risks of the
individual activities or investments
consistent with the requirements of section
13 of the BHC Act and the rule;
• Subject the effectiveness of the
compliance program to periodic independent
review and testing, and ensure that the
entity’s internal audit, corporate compliance
and internal control functions involved in
review and testing are effective and
independent;
• Make senior management, and others as
appropriate, accountable for the effective
implementation of the compliance program,
and ensure that the board of directors and
CEO (or equivalent) of the banking entity
review the effectiveness of the compliance
program; and
• Facilitate supervision and examination
by the Agencies of the banking entity’s
covered trading and covered fund activities
and investments.

The proposed rule included several
definitions within the appendix. In the
final rule, all definitions have been
moved to other sections of the rule or
into Appendix A (governing metrics).
Any banking entity subject to the
enhanced minimum standards
contained in Appendix B may
incorporate existing policies,
procedures and internal controls into
the compliance program required by
Appendix B to the extent that such
existing policies, procedures and
internal controls assist in satisfying the
requirements of Appendix B.
Section II of Appendix B contains two
parts: one that sets forth the enhanced
minimum compliance program
standards applicable to covered trading
activities of a banking entity and one
that sets forth the corresponding
enhanced minimum compliance
program standards with respect to
covered fund activities and investments.
As noted above, if all of a banking
entity’s activities subject to the final
rule involve only covered trading
activities (or only covered fund
activities and investments), it would be
expected that the banking entity would
have an appropriate compliance
program governing those activities
(including an enhanced compliance

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program if applicable) and it would not
be expected that the banking entity
would construct the same detailed
compliance program under the covered
funds (or proprietary trading) provisions
of the rule. As discussed below, the
Agencies have determined not to
include the provisions regarding
enterprise-wide compliance programs.
a. Proprietary Trading Activities
Like the proposed compliance
appendix, section II.A of Appendix B
requires a banking entity subject to the
enhanced minimum standards
contained in Appendix B to establish,
maintain and enforce a compliance
program that includes written policies
and procedures that are appropriate for
the types, size, and complexity of, and
risks associated with, its permitted
trading activities.2593 This portion of
Appendix B requires a banking entity to
devote adequate resources and use
knowledgeable personnel in conducting,
supervising and managing its covered
trading activities, and to promote
consistency, independence and rigor in
implementing its risk controls and
compliance efforts. The compliance
program must be updated with a
frequency sufficient to account for
changes in the activities of the banking
entity, results of independent testing of
the program, identification of
weaknesses in the program and changes
in legal, regulatory or other
requirements.
Similar to the proposed rule, section
II.A of Appendix B requires a banking
entity subject to the Appendix to: (i)
Have written policies and procedures
governing each trading desk that
include a description of certain
information specific to each trading
desk that will delineate its processes,
mission and strategy, risks, limits, types
of clients, customers and counterparties
and its compensation arrangements; (ii)
include a comprehensive description of
the risk management program for the
trading activity of the banking entity, as
well as a description of the governance,
approval, reporting, escalation, review
and other processes that the banking
entity will use to reasonably ensure that
trading activity is conducted in
compliance with section 13 of the BHC
Act and subpart B; (iii) implement and
enforce limits and internal controls for
each trading desk that are reasonably
designed to ensure that trading activity
is conducted in conformance with
section 13 of the BHC Act and subpart
B and with the banking entity’s policies
and procedures, and establish and
enforce risk limits appropriate for the
2593 See

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activity of each trading desk; and (iv) for
any hedging activities that are
conducted in reliance on the exemption
contained in § ll.5, establish,
maintain and enforce policies and
procedures regarding the use of riskmitigating hedging instruments and
strategies that describe the positions,
techniques and strategies that each
trading desk may use, the manner in
which the banking entity will determine
that the risks generated by each trading
desk have been properly and effectively
hedged, the level of the organization at
which hedging activity and management
will occur, the management in which
such hedging strategies will be
monitored and the personnel
responsible for such monitoring, the risk
management processes used to control
unhedged or residual risks, and a
description of the process for
developing, documenting, testing,
approving and reviewing all hedging
positions, techniques and strategies
permitted for each trading desk and for
the banking entity in reliance on
§ ll.5.
To the extent that any of the standards
contained in Appendix B may be
appropriately met by policies and
procedures, internal controls and other
requirements that are common to more
than one trading desk, a banking entity
may satisfy the requirements for the
enhanced minimum standards of the
compliance program by implementing
such common requirements with
respect to any such desks as to which
they are appropriately applicable.2594
To the extent the required elements of
the compliance program apply
differently to different trading desks that
conduct trading in the same financial
instruments, a banking entity must
document the differences and adopt
policies and procedures and implement
internal controls specific to each of the
different trading desks. Overall, the
policies and procedures should provide
the Agencies with a clear,
comprehensive picture of a banking
entity’s covered trading activities that
can be effectively reviewed.
Appendix B also requires that the
banking entity perform robust analysis
and quantitative measurement of its
covered trading activities that is
reasonably designed to ensure that the
trading activity of each trading desk is
consistent with the banking entity’s
compliance program; monitor and assist
in the identification of potential and
actual prohibited proprietary trading
2594 This is consistent with proposed Appendix C,
except that the term ‘‘trading unit’’ from the
proposal has been replaced with the term ‘‘trading
desk.’’ See Joint Proposal, 76 FR 68,965.

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activity; and prevent the occurrence of
prohibited proprietary trading. In
particular, the banking entity must
incorporate into its compliance program
any quantitative measure reported by
the banking entity pursuant to
Appendix A where applicable, and
include at a minimum: (i) Internal
controls and written policies and
procedures reasonably designed to
ensure the accuracy and integrity of the
quantitative measures employed; (ii)
ongoing timely monitoring and review
of calculated quantitative
measurements; (iii) the establishment of
thresholds and trading measures for
each trading desk and heightened
review of any trading activity that is
inconsistent with those thresholds; and
(iv) review, investigation and escalation
with respect to matters that suggest a
reasonable likelihood that a trading desk
has violated any part of section 13 of the
BHC Act or the rule.2595
Where a banking entity is subject to
the reporting requirements of Appendix
A, any additional quantitative
measurements developed and
implemented by the banking entity
under the compliance program
requirement are not required to be
routinely submitted to the relevant
Agency as provided in Appendix A, but
are subject to the recordkeeping
requirements set forth in subpart D,
including the requirement to promptly
produce such records to the relevant
Agency upon request. Where a banking
entity is not subject to the requirements
of Appendix A, that banking entity
would likewise not be required by this
rule to routinely submit these additional
quantitative measurements to the
relevant Agency, but would be subject
to the recordkeeping requirements set
forth in subpart D, including the
requirement to promptly produce such
records to the relevant Agency upon
request.
In addition to the other requirements
that are specific to proprietary trading,
the banking entity’s compliance
program must identify the activities of
each trading desk that will be conducted
in reliance on the exemptions contained
in §§ ll.4 through ll.6, including
an explanation of (i) how and where in
the organization such activity occurs,
and (ii) which exemption is being relied
on and how the activity meets the
specific requirements of such
exemption. For trading activities that
rely on an exemption contained in
§§ ll.4 through § ll.6, the banking
entity’s compliance program should
include an explanation of how, and its
policies, procedures and internal
2595 See

Joint Proposal, 76 FR 68,965.

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controls that demonstrate that, such
trading activities satisfy such exemption
and any other requirements of section
13 of the BHC Act and the final rule that
are applicable to such activities. A
foreign banking entity that engages in
proprietary trading in reliance on the
exemption contained in § ll.6(e) will
be expected to provide information
regarding the compliance program
implemented to ensure compliance with
the requirements of that section,
including compliance by the U.S.
operations of the foreign banking firm,
but will only be expected to provide
trading information regarding activity
conducted within the United States
(absent an indication of activity
conducted or designed to evade the
requirements of section 13 of the BHC
Act of the final rule).2596
In addition, the compliance program
must describe the process for ensuring
that liquidity management activities are
conducted in conformance with the
limits and policies contained in
§ ll.3(d)(3). This includes processes
for ensuring that liquidity management
activities are not conducted for the
purpose of prohibited proprietary
trading.
The banking entity’s compliance
program must be reasonably designed
and established to effectively monitor
and identify for further analysis any
proprietary trading activity that may
indicate potential violations of section
13 of the BHC Act and subpart B and to
prevent violations of section 13 of the
BHC Act and subpart B. The standards
set forth in subpart D direct the banking
entity to include requirements in its
compliance program for documenting
remediation efforts, assessing the extent
to which modification of the
compliance program is warranted and
providing prompt notification to
appropriate management and the board
of directors of material weakness or
significant deficiencies in the
implementation of the compliance
program.
b. Covered Fund Activities or
Investments
Section II.B of Appendix B requires a
banking entity subject to the enhanced
minimum standards contained in
Appendix B to establish, maintain and
enforce a compliance program that
includes written policies and
procedures that are appropriate for the
types, size, complexity and risks of the
covered fund and related activities
conducted and investments made, by
the banking entity.
2596 See AFME et al.; IIB/EBF; BaFin/Deutsche
Bundesbank; Credit Suisse (Seidel); HSBC.

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The enhanced compliance program
requirements for covered funds and
investments focus on: (i) Ensuring that
the compliance program provides a
process for identifying all covered funds
that the banking entity sponsors,
organizes or offers, and covered funds in
which the banking entity invests; (ii)
ensuring that the compliance program
provides a method for identifying all
funds and pools that the banking entity
sponsors or has an interest in and the
type of exemption from the Investment
Company Act or Commodity Exchange
Act (whether or not the fund relies on
section 3(c)(1) or 3(c)(7) of the
Investment Company Act or section 4.7
of the regulations under the Commodity
Exchange Act), and the amount of
ownership interest the banking entity
has in those funds or pools; (iii)
identifying, documenting, and mapping
where any covered fund activities are
permitted to be conducted within the
banking entity; and (iv) including an
explanation of compliance; (v)
describing sponsorship activities related
to covered funds; and (vi) establishing,
maintaining and enforcing internal
controls that are reasonably designed to
ensure that its covered fund activities or
investments comply with the
requirements of section 13 of the BHC
Act and subpart C, and (vii) monitoring
of the banking entity’s investments in
and transactions with any covered
funds.
In addition, the banking entity’s
compliance program must document the
banking entity’s plan for seeking
unaffiliated investors to ensure that any
investment by the banking entity in a
covered fund conforms to the limits
contained in the final rule or that the
covered fund is registered in
compliance with the securities laws
within the conformance period
provided in the final rule. Similarly, the
compliance program must ensure that
the banking entity complies with any
limits on transactions or relationships
with the covered fund contained in the
final rule, including in situations in
which the banking entity is designated
as a sponsor, investment manager,
investment adviser or commodity
trading adviser by another banking
entity.
The banking entity’s compliance
program must be reasonably designed
and established to effectively monitor
and identify for further analysis any
covered fund activity that may indicate
potential violations of section 13 of the
BHC Act and subpart C. The standards
set forth in subpart D require the
banking entity to include requirements
in its compliance program for
documenting remediation efforts,

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assessing the extent to which
modification of the compliance program
is warranted and providing prompt
notification to appropriate management
and the board of directors of material
weakness or significant deficiencies in
the design or implementation of the
compliance program.

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c. Enterprise-Wide Programs
Appendix C in the proposed rule
contained a provision that permitted a
banking entity to establish a compliance
program on an enterprise-wide basis.
Some commenters argued that a less
specific and more flexible compliance
regime would be essential to make the
enterprise-wide compliance structures
contemplated in Appendix C effective
because requiring individualized
policies and procedures for each
business line would diminish the
benefits of enterprise-wide compliance
and prevent consistency of these
policies and procedures within the
banking entity.2597 One of these
commenters recommended the Agencies
provide greater options for developing a
compliance program and not limit a
banking entity to a choice between a
single enterprise-wide program or a
separate program for each subsidiary
engaged in activities covered by the
proposed rule.2598
In contrast, one commenter argued
that any enterprise-wide compliance
program would only be effective if
combined with additional programs at
the trading unit or subsidiary level to
train all employees at a banking
entity.2599 This commenter argued that
each trading unit is different and
suggested that it would be more efficient
to mandate enterprise-wide default
internal controls, but provide each
individual trading unit the flexibility to
tailor these requirements to its own
specific business.2600 This commenter
also urged that Appendix C’s elements
III (internal controls), IV (responsibility
and accountability) and VII
(recordkeeping) should not be imposed
solely at the enterprise-wide level.2601
After considering carefully the
comments on the proposal, the Agencies
have removed the reference to an
enterprise-wide compliance program
from the final rule; however, the
Agencies acknowledge that a banking
entity may establish a compliance
program on an enterprise-wide basis, as
long as the program satisfies the
2597 See SIFMA et al. (Prop.Trading) (Feb. 2012);
Wells Fargo (Prop. Trading).
2598 See Wells Fargo (Prop. Trading).
2599 See Occupy.
2600 See Occupy.
2601 See Occupy.

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requirements of § ll.20 and, where
applicable, Appendix B. A banking
entity may employ common policies
and procedures that are established at
the enterprise-wide level or at a
business-unit level to the extent that
such policies and procedures are
appropriately applicable to more than
one trading desk or activity, as long as
the required elements of Appendix B
and all of the other applicable
compliance-related provisions of the
rule are incorporated in the compliance
program and effectively administered
across trading desks and banking
entities within the consolidated
enterprise or designated business. If a
banking entity establishes an enterprisewide program, like a non-enterprise
wide program, that program will be
subject to supervisory review and
examination by any Agency vested with
rule writing authority under section 13
of the BHC Act with respect to the
compliance program and the activities
or investments of each banking entity
for which the Agency has such
authority.2602 The banking organization
would be expected to provide each
appropriate Agency with 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 rule writing
authority.
For similar reasons, the Agencies have
determined not to adopt some
commenters’ requests that a single
agency be responsible for determining
compliance with section 13.2603 At this
time the Agencies do not believe such
an approach would be consistent with
the statute, which requires each Agency
to adopt a rule for the types of banking
entities under its jurisdiction,2604 or
effective given the different authorities
and expertise of each Agency. The
Agencies expect to continue to
coordinate their supervisory efforts
related to section 13 of the BHC Act and
to share information as appropriate in
order to effectively implement the
requirements of that section and the
final rule.2605
2602 See

12 U.S.C. 1851(b)(2)(B)(i).
Barclays; Goldman (Prop. Trading); BoA;
SIFMA Funds et al. (Prop. Trading) (Feb. 2012);
Comm. on Capital Markets Regulation.
2604 See 12 U.S.C. 1851(b)(2)(B).
2605 Accordingly, the SEC’s and CFTC’s final
rules, unlike the applicable proposals, do not
incorporate by reference the rules and
interpretations of the Federal banking agencies with
respect to covered fund activities or investments.
See SEC proposed rule 255.10(a)(2), Joint Proposal,
76 FR 68,942–68,943, and CFTC proposed rule, 77
FR 8421–8423.
2603 See

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d. Responsibility and Accountability
Section III of Appendix B includes the
enhanced minimum standards for
responsibility and accountability.
Section III contains many of the
provisions contained in the proposed
rule relating to responsibility and
accountability, with certain
modifications.2606 Section III requires a
banking entity to establish, maintain
and enforce both a governance and
management framework to manage its
business and employees with a view to
preventing violations of section 13 of
the BHC Act and the rule. The standards
in Section III focus on four key
constituencies—the board of directors,
the CEO, senior management, and
business line managers. Certain of the
standards contained in the proposed
rule relating to business management
are separately covered by specific
requirements contained in sections II.A
and II.B of Appendix B. Section III
makes it clear that the board of
directors, or similar corporate body, and
the CEO and senior management 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 the firm’s trading
activities and its fund activities and
investments. Senior management must
be made responsible for communicating
and reinforcing the culture of
compliance established by it and the
board of directors, for the actual
implementation and enforcement of the
approved compliance program, and for
taking corrective action where
appropriate.
In response to a question in the
preamble to the proposed rule regarding
whether the chief executive officer or
similar officer of a banking entity
should be required to provide a
certification regarding the compliance
program requirements, a few
commenters urged that the final rule
should not require that the board of
directors or CEO of a banking entity
review or certify the effectiveness of the
compliance program.2607 These
commenters argued that existing
processes developed by large, complex
banking entities for board of director
reporting and governance processes
ensure that compliance programs work
appropriately, and argued that these
protocols would establish appropriate
management and board of directors’
oversight of the section 13 compliance
2606 See

Joint Proposal, 76 FR 68,966.
SIFMA et al. (Prop.Trading) (Feb. 2012);
Wells Fargo (Prop. Trading).
2607 See

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
program.2608 By contrast, several
commenters advocated requiring CEO
attestation regarding compliance with
section 13.2609 One commenter
suggested that the rule require an
annual assessment by management of
the effectiveness of internal controls and
policies and require a public accounting
firm to attest to the accuracy of those
annual assessments.2610
After considering comments received
on the proposal, the Agencies have
determined to include a requirement in
the final rule that a banking entity’s
CEO annually attest in writing to the
appropriate Agency for the banking
entity that the banking entity has in
place processes to establish, maintain,
enforce, review, test and modify the
compliance program established
pursuant to Appendix B and § __.20 of
the rule in a manner reasonably
designed to achieve compliance with
section 13 of the BHC Act and this rule.
Although some commenters stated that
existing protocols of certain banking
entities would establish appropriate
oversight of the rule’s compliance
program,2611 the Agencies believe this
requirement will better help to ensure
that a strong governance framework is
implemented with respect to
compliance with section 13 of the BHC
Act, and that it more directly
underscores the importance of CEO
engagement in the governance and
management framework supporting
compliance with the rule. In the case of
the U.S. operations of a foreign banking
entity, including a U.S. branch or
agency of a foreign banking entity, the
attestation may be provided for the
entire U.S. operations of the foreign
banking entity by the senior
management officer of the U.S.
operations of the foreign banking entity
who is located in the United States.

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e. Independent Testing
Section IV of the Appendix B
includes the enhanced minimum
standards for independent testing,
which are substantially similar to the
proposed independent testing
standards.2612 A banking entity subject
to Appendix B must ensure that
independent testing regarding the
effectiveness of the banking entity’s
compliance program is conducted by a
2608 See SIFMA et al. (Prop.Trading); See also
Wells Fargo (Prop. Trading).
2609 See Occupy; AFR et al. (Feb. 2012); Sens.
Merkley & Levin (Feb. 2012); Public Citizen; Ralph
Saul (Oct. 2011); John Reed; See also BEC et al.
(Oct. 2011); Matthew Richardson.
2610 See Merkley & Levin (Feb. 2012).
2611 See SIFMA et al. (Prop.Trading) (Feb. 2012);
See also Wells Fargo (Prop. Trading).
2612 See Joint Proposal, 76 FR 68,967.

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qualified independent party, such as the
banking entity’s internal audit
department, compliance personnel or
risk managers independent of the
trading desk or other organizational unit
being tested, outside auditors,
consultants, or other qualified
independent parties. If a banking entity
uses internal personnel to conduct the
independent testing, the Agencies
would expect that the banking entity
ensure that the personnel responsible
for the testing are separate from the unit
and functions being tested (e.g., the
personnel do not report to a person who
is directly responsible for the unit or
involved in the functions being tested)
and have knowledge of the requirements
of section 13 and its implementing
rules. Although an external audit is not
required to meet the independent
testing requirement, the Agencies would
expect that, when external auditors are
engaged to review compliance by a
banking entity with laws and
regulations, the banking entity would
give appropriate consideration to the
need to review the compliance program
required under this rule.
While one commenter suggested the
final rule prescribe the precise manner
in which a banking entity must conduct
its compliance testing,2613 the Agencies
believe such a requirement is
unnecessary because the standards in
the final rule will ensure that
independent testing of the effectiveness
of a banking entity’s compliance
program is objective and robust. The
independent testing must examine both
the banking entity’s compliance
program and its actual compliance with
the rule. This testing must include not
only testing of the overall 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 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
2613 One commenter suggested that any
compliance testing under the final rule be
monitored by the Agencies and initially tested by
internal audit personnel of the banking entity who
are subject to a specific licensing and registration
process for section 13 of the BHC Act and
supplemented by an annual independent external
review. See Occupy; See also proposed rule
§ __.20(b)(4). The Agencies believe it would be
unnecessarily burdensome to require particular
licensing and registration processes for internal
auditors that are specific to section 13 of the BHC
Act.

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5759

or matters requiring attention within the
compliance framework.
f. Training
Like the proposed compliance
appendix, Section V of Appendix B
includes the enhanced minimum
standards for training.2614 It requires
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
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-to-day decisions that
support the banking entity’s compliance
with section 13 of the BHC Act and the
rule. 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.
g. Recordkeeping
Section VI of Appendix B contains the
enhanced minimum standards for
recordkeeping which are consistent
with the proposed recordkeeping
standards.2615 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 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 must
include trading records of the trading
units, including trades and positions of
each such unit. Records created and
2614 See
2615 See

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retained under the enhanced
compliance program must also include
documentation of any exemption in the
final rule relied on by the banking entity
to invest in or sponsor a covered fund.
While one commenter requested that
the period for retaining records be
extended from 5 years to 6 years, the
final rule does not make this change.2616
The Agencies believe that 5 years is an
appropriate minimum period for
requiring retention of records to
demonstrate compliance with the final
rule. The final rule allows the Agencies
to require a banking entity to retain
records for a longer period if
appropriate.

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3. Section ll.20(d) and Appendix A:
Reporting and Recordkeeping
Requirements Applicable to Trading
Activities
Section ll.7 of the proposed rule,
which the Agencies proposed to
implement in part section 13(e)(1) of the
BHC Act,2617 required certain banking
entities to comply with the reporting
and recordkeeping requirements
specified in Appendix A of the
proposed rule. In addition, § ll.7
required banking entities to comply
with the recordkeeping requirements in
§ __.20 of the proposed rule, related to
the banking entity’s compliance
program,2618 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.2619
Proposed Appendix A required 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
measurements varied depending on the
scope, type, and size of trading
activities. In addition, proposed
Appendix B contained a detailed
commentary regarding the
characteristics of permitted market
2616 One commenter specifically urged that
records for any type of compliance program be
required to be kept on all hedges, rather than only
those placed at a different level or trading unit as
under the proposal, and that the retention period
for all compliance records be changed from 5 years
to 6 years in line with the statute of limitations on
civil suits for fraud, contracts and collection of debt
in accounts in New York State. See Occupy.
2617 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
ll.20 and Appendix C of the proposed rule also
implemented section 13(e)(1) of the BHC Act.
2618 See Part III.D. of this SUPPLEMENTARY
INFORMATION.
2619 See proposed rule § ll.7.

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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.2620 Under the proposal, a
banking entity was required to comply
with proposed Appendix A’s reporting
and recordkeeping requirements only if
it had, together with its affiliates and
subsidiaries, trading assets and
liabilities the average gross sum of
which (on a worldwide consolidated
basis) was, as measured as of the last
day of each of the four prior calendar
quarters, equal to or greater than $1
billion.2621 The Agencies did not
propose to extend the reporting and
recordkeeping requirements to banking
entities with smaller amounts of trading
activity, as it appeared 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. Approach to Reporting and
Recordkeeping Requirements Under the
Proposal
The proposal explained that the
reporting and recordkeeping
requirements of § ll.7 and Appendix
A of the proposed rule were an
important part of the proposed rule’s
multi-faceted approach to implementing
the prohibition on proprietary trading.
These requirements were 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 required certain
banking entities to calculate and report
detailed quantitative measurements of
their trading activity, by trading unit.
These measurements were meant to
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
required to be reported under the
proposed rule were generally designed
to reflect, and to provide meaningful
information regarding, certain
2620 See supra Part IV.A.3.c.8 (explaining why
Appendix B was removed from the final rule).
2621 See proposed rule § __.7(a).

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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 measured the size and
type of revenues generated, and the
types of risks taken, by a trading unit.
Each of these measurements appeared to
be useful in assessing whether a trading
unit was (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 measured how much revenue was
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 appeared to be useful in
assessing whether a trading unit is
engaged in permitted market makingrelated activity.
However, as noted in the proposal,
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 proposed 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 proposed to take a
heuristic approach to implementation in
this area that recognized 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 noted that,
although a 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

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
proprietary trading from permitted
market making-related activities.2622
Consistent with this heuristic
approach, the proposed rule included a
large number of potential quantitative
measurements on which public
comment was sought, many of which
overlap to some degree in terms of their
informational value. The proposal
explained that not all of these
quantitative measurements may
ultimately be adopted in the final rule,
depending on their relative strengths,
weaknesses, costs, and benefits. The
Agencies noted 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 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 sought comment on whether the
quantitative measurements described in
the proposal were appropriate to use to
help assess compliance with section 13
of the BHC Act.
In addition to the proposed
quantitative measurements, the proposal
explained that 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 § ll.20 of the proposed
rule and Appendix C. The Agencies
noted that the proposed quantitative
measurements in Appendix A were
intended to assist banking entities and
Agencies in monitoring compliance
with the proprietary trading restrictions
and would not necessarily provide all
the data necessary for the banking entity
to establish an effective compliance
program. The Agencies also recognized
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
2622 Joint

2623 See 12 U.S.C. 1851(c)(2); Joint Proposal, 76
FR 68,883.

Proposal, 76 FR 68,883.

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a new entrant to a competitive market).
In all cases, banking entities needed to
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 proposed to utilize the
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.2623 This heuristic, gradual
approach to implementing reporting
requirements for quantitative
measurements was 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 makingrelated activities that provide an
important service to market participants
and the capital markets at large.
In addition, the Agencies requested
comment on the use of 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. The
Agencies did not propose 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 intended to carefully consider
public comments provided on this issue
and to separately determine whether it
would be appropriate to propose,
subsequent to finalizing the current
proposal, such numerical thresholds.
Part III of proposed Appendix A
defined the scope of the reporting
requirements. The proposed rule
adopted a tiered approach that required
banking entities with the most extensive
trading activities to report the largest
number of quantitative measurements,
while banking entities with smaller

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5761

trading activities had fewer or no
reporting requirements. This tiered
approach was 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.
Under the proposal, any banking
entity that had, 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 would be
required the banking entity to furnish
quantitative measurements for all
trading units of the banking entity
engaged in trading activity subject to
§§ ll.4, ll.5, or ll.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 depended on the activity in
which the trading unit was engaged.
First, for the trading units of such a
banking entity that are engaged in
market making-related activity pursuant
to § __.4(b) of the proposed rule,
proposed Appendix A required that a
banking entity furnish seventeen
quantitative measurements.2624 Second,
all trading units of such a banking entity
engaged in trading activity subject to
§§ ll.4(a), ll.5, or ll.6(a) of the
proposed rule were required to report
five quantitative measurements
designed to measure the general risk
and profitability of the trading unit.2625
The Agencies expected that each of
these general types of measurements
would 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, riskmitigated hedging, and trading in
certain government obligations. These
additional measurements applicable
only to trading units engaged in market
making-related activities were designed
to help evaluate the extent to which the
quantitative profile of a trading unit’s
2624 See proposed rule Appendix A.III.A. These
seventeen quantitative measurements are discussed
further below.
2625 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.

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activities is consistent with permissible
market making-related activities.
Under the proposal, any banking
entity that had, 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 would be required to
provide quantitative measurements to
be furnished for trading units that
engaged in market making-related
activity subject to § ll.4(b) of the
proposed rule. Trading units of such
banking entities that engaged in market
making-related activities needed to
report eight quantitative measurements
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.2626 The proposal applied 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. The Agencies noted in the
proposal that a less burdensome
reporting regime, coupled with other
elements of the proposal (e.g., the
compliance program requirement), was
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.
Section III.B of proposed Appendix A
specified the frequency of required
calculation and reporting of quantitative
measurements. Under the proposed
rule, each required quantitative
measurement needed to be calculated
for each trading day. Required
quantitative measurements were
required to 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 required a 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
2626 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.

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of such measurements, for a period of 5
years. This included records for each
trade and position.
b. General Comments on the Proposed
Metrics
A number of commenters were
supportive of metrics. A few
commenters argued that the metrics
could reveal prohibited proprietary
trading activity and be an appropriate
and valuable tool in analyzing
positions.2627 One commenter argued
that metrics are the single most valuable
tool available to the Agencies for
distinguishing between prohibited and
permitted activities and recommended
the compliance program be structured
around metrics.2628 Another commenter
stated that the identification of metrics
is one of the strengths of the proposed
rule and offered great promise for
successful implementation of the
rule.2629 One commenter expressed
support for the metrics and argued that
there would be substantial evasion of
the rule without reporting of these
measurements.2630 Some commenters
proposed a presumption of compliance
so long as trading activity is conducted
in a manner consistent with tailored
quantitative metrics and related specific
thresholds as coordinated and agreed
with the relevant Agency.2631 A few of
commenters suggested that metrics not
be used as a bright-line trigger and
recommended flexibility in the
application of metrics for assessing
market-making activities.2632 Two
commenters supported metrics as part
of a bright lines approach.2633
A number of commenters felt that
some metrics might be more relevant
than others, depending upon the
particular asset class, activity, particular
market, and unique characteristics of
each banking entity.2634 These
commenters advocated an approach
where banking entities and examiners
would determine over time the
usefulness and relevance of particular
metrics.2635 One commenter expressed
2627 See, e.g., Paul Volcker; SIFMA et al.
(Prop.Trading) (Feb. 2012); Invesco; Comm. on
Capital Markets Regulation.
2628 See Goldman (Prop. Trading).
2629 See Sens. Merkley & Levin (Feb. 2012).
2630 See Occupy.
2631 See Barclays; See also BoA; Invesco; ISDA
(Feb. 2012); JPMC; Morgan Stanley; SIFMA et al.
(Prop.Trading) (Feb. 2012).
2632 See SIFMA et al. (Prop.Trading) (Feb. 2012);
Wells Fargo (Prop. Trading); NYSE Euronext; Oliver
Wyman (Feb. 2012); UBS; Western Asset Mgmt.;
Goldman (Prop. Trading); Northern Trust.
2633 See John Reed; Public Citizen.
2634 See Morgan Stanley; SIFMA et al.
(Prop.Trading) (Feb. 2012); Stephen Roach.
2635 See Wells Fargo (Prop. Trading); Morgan
Stanley; SIFMA et al. (Prop.Trading) (Feb. 2012);
Stephen Roach.

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support for the 5 metrics required for
trading in U.S. government
obligations.2636 A number of
commenters recommended that metrics
be tailored to different asset classes and
markets, to avoid the drawbacks of a
one-size-fits-all approach.2637 One
commenter argued that application of
metrics to market-making activities at
different firms may produce very
different results, all of which might
reflect legitimate market-making.2638
Commenters also indicated that not all
metrics are meaningful and calculable
for all trading units and some would be
unnecessarily burdensome.2639
Other commenters did not support the
use of metrics. These commenters
argued that metrics reporting was one
aspect of the complexity of the proposal
that increased the cost and difficulty of
distinguishing market-making from
prohibited proprietary trading.2640 One
commenter argued that banking entities
may avoid legitimate market making
activities that would produce ‘‘worse’’
metrics results.2641
Several commenters expressed
concern that the costs exceeded the
benefits of the required quantitative
metrics in the proposal. In particular,
commenters argued that the 17 metrics
in the proposal calculated at each
trading unit was excessive, would
generate an unmanageable amount of
data, would yield numerous false
positives, and would require the
construction and programming of highly
sophisticated systems that are not
currently employed.2642 A few
commenters suggested that a more
limited set of metrics would reduce
compliance complexity.2643 Some
commenters noted that many of these
metrics have not been historically
reported by banking entities and some
of the metrics would require substantial
resources and investment infrastructure
to produce some of the metrics without
a clear functional purpose.2644
According to other commenters,
however, banking entities currently use
2636 See

UBS.
Goldman (Prop. Trading); Northern Trust;
See also UBS.
2638 See Comm. on Capital Markets Regulation.
2639 See Morgan Stanley; See also ISDA (Feb.
2012).
2640 See ABA (Keating); Barclays; Citigroup (Feb.
2012); ISDA (Feb. 2012); UBS; Oliver Wyman (Feb.
2012); Prof. Duffie; Wellington.
2641 See Oliver Wyman (Feb. 2012).
2642 See BoA (expressing concern about the need
for new systems to distinguish bid-ask spreads from
price appreciation); UBS; Wellington.
2643 See BoA; Barclays; Citigroup (Feb. 2012).
2644 See Credit Suisse (Seidel); Morgan Stanley;
UBS; Wells Fargo (Prop. Trading); Socie´te´ Ge´ne´rale
(arguing that many calculation questions need to be
resolved before banking entities can create
necessary systems to measure metrics).
2637 See

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all or nearly all of the proposed
metrics.2645 One commenter urged that
it would be good to make metrics
consistent with the banking entities’
internal reporting and control
systems.2646 Some commenters argued it
was critical for the Agencies to get the
metrics right,2647 while others indicated
it was unclear how the Agencies could
analyze such information to draw useful
conclusions.2648
Some commenters expressed concern
that metrics were vulnerable to
manipulation and arbitrage.2649 These
commenters generally felt that the
quantitative measurements were only
appropriate for certain liquid and
transparent trading activities but not
meaningful for illiquid markets,
including opaque securities and
derivatives.2650 These commenters also
argued that the vast majority of
proprietary trading would not be
differentiable through analysis of the
data.2651 Other commenters expressed
concern that the use of metrics not
replace regulatory review of actual
specific trading positions held by
banking entities.2652 One commenter
argued that in relying on metrics to be
elaborated upon and discussed in the
examination process, the proposed rule
did not meet the fundamental fair notice
goal of regulation.2653
A few commenters also recommended
creation of a central data repository or
data sharing protocol that would
promote consistency and accountability
in oversight and regulation and
suggested the Office of Financial
Research (‘‘OFR’’) be given access to this
data so that it can provide centralized
analysis and monitoring to identify any
trends that give rise to systemic risk.2654
These commenters generally supported
compliance benefits that would result
from increased public disclosure of
2645 See Occupy; AFR et al. (Feb. 2012); Western
Asset Mgmt.; Public Citizen. For example, one
commenter cited a study finding that 14 out of 17
of the proposed metrics are either in wide use today
or are possible to implement fairly easily using data
already collected for internal risk management and
profit and loss purposes. See AFR et al. (Feb. 2012)
(citing John Lester and Dylan Walsh, ‘‘The Volcker
Rule Ban On Prop Trading: A Step Closer to Reality,
Point of View,’’ Oliver Wyman Company (Oct.
2011)).
2646 See Paul Volcker.
2647 See, e.g., UBS.
2648 See BoA; UBS; Wellington.
2649 See AFR (Nov. 2012); See also Occupy;
Public Citizen.
2650 See Occupy; AFR (Nov. 2012); Wells Fargo
(Prop. Trading).
2651 See Occupy.
2652 See Sens. Merkley & Levin (Feb. 2012).
2653 See ISDA (Feb. 2012) (citing Mason v. Florida
Bar, 208 F.3d 952, 958–59 (11th Cir. 2000)).
2654 See Sens. Merkley & Levin (Feb. 2012); See
also Occupy; Public Citizen.

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banking entities’ trading and funds
activities, including all of their trading
positions, their valuation models, and
their compliance metrics.2655
Some commenters expressed support
for the reporting thresholds contained in
Appendix A.2656 One commenter
suggested that all banking entities that
engage in any trading (regardless of
threshold) report certain metrics.2657
Other commenters supported metrics
reporting, but recommended the
threshold for trading assets and
liabilities be increased from $1 billion to
$10 billion to mitigate any cost and
burden impact on smaller banking
entities.2658 These commenters pointed
out that even if the minimum dollar
threshold were raised to $10 billion, an
overwhelming percentage of trading
assets and liabilities in the banking
industry (approximately 98 percent)
would still remain subject to heightened
compliance requirements including
Appendix A.2659 One commenter
suggested the threshold be raised to $50
billion in combined trading assets and
liabilities.2660
Commenters also offered a number of
suggestions for modifying the activity
that would be considered in meeting the
thresholds for determining which
reporting requirements apply to a
banking entity. Several commenters
argued that certain types of trading
assets or fund investments should not
be included for purposes of determining
whether the relevant dollar threshold
for compliance was met, particularly
those that are not prohibited activities
or investments. For instance, some
commenters urged that trading in U.S.
government obligations should not
count toward the calculation of whether
a banking organization meets the trading
threshold triggering metrics
reporting.2661 These commenters also
argued that other positions or
transactions that do not involve
financial instruments and that may
constitute trading assets and liabilities,
such as loans, should be excluded from
the thresholds because exempt activities
should not determine the type of
compliance program a banking entity
must implement.2662 One commenter
2655 See Sens. Merkley & Levin (Feb. 2012); See
also Public Citizen; John Reed.
2656 See ICBA; Occupy.
2657 See Occupy (suggesting all banking entities
that engage in trading be required to provide VaR
Exceedance, Risk Factor Sensitivities and Risk and
Position Limits).
2658 See PNC et al.; M&T Bank; See also ABA
(Abernathy).
2659 See ABA (Keating); M&T Bank; PNC et al.
2660 See State Street (Feb. 2012).
2661 See PNC et al.
2662 See PNC et al.

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urged that foreign exchange swaps and
forwards be excluded from the
definition of a ‘‘derivative’’ and not be
subject to compliance requirements as a
result.2663 Conversely, one commenter
urged that all assets and liabilities
defined as trading assets for purposes of
the Market Risk Capital Rule should be
included in the $1 billion standard for
becoming subject to any reporting and
record-keeping requirements under the
final rule.2664
A number of commenters argued that
monthly reporting was too frequent
because of the complexity of the process
that surrounds generation of regulatory
reports and suggested that the frequency
of reporting should be quarterly.2665
One commenter supported the reporting
frequency as extremely effective and
said it should not be reduced in any
way.2666
A number of comments were received
on the implementation timeframe for
metrics reporting. Several commenters
urged allowing banking entities the use
of the full conformance period for
creating the systems and processes to
capture and report the quantitative
metrics.2667 Some commenters
suggested that metrics should not be
required to be reported until one year
after adoption of final regulations.2668 A
different commenter suggested that the
Agencies provide a one-year period
during which they determine which
metrics will be employed for different
asset classes and an additional one-year
period during which such metrics could
be reviewed so metrics would be a
required component of a banking
entity’s compliance program no sooner
than 2 years after issuance of the final
rule.2669 Another commenter suggested
that banking entities and regulators use
the first year of the conformance period
to consult with one another and
determine the usefulness and relevance
of individual metrics for different
activities, asset classes, and markets and
the second year of the conformance
period to test the metrics systems to
validate the accuracy and relevance of
metrics that are agreed upon the first
year.2670 One commenter suggested a
subset of metrics be rolled out gradually
2663 See

Northern Trust.
Occupy at 60.
2665 See JPMC; See also Stephen Roach.
2666 See Occupy.
2667 See BoA; Barclays; Citigroup (Feb. 2012);
Goldman (Prop. Trading); JPMC; Morgan Stanley;
SIFMA et al. (Prop.Trading) (Feb. 2012); UBS;
Stephen Roach.
2668 See Credit Suisse (Seidel); JPMC; Wells Fargo
(Prop. Trading).
2669 See BoA.
2670 See Morgan Stanley; See also SIFMA et al.
(Prop.Trading) (Feb. 2012).
2664 See

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across trading units before
implementing the full suite of metrics
that are ultimately adopted or metrics
could be rolled out one trading unit at
a time.2671 Another commenter said the
Agencies should identify key metrics
that are clearly workable across all
ranges of trading activity and most
likely to provide useful data and require
those metrics be implemented first and
require other metrics to be phased in
over time in consultation with the
banking entity’s primary federal
regulator.2672 One commenter supported
the heuristic approach of the proposal
and suggested the Agencies should draw
on resources and comment from the
public and the industry in continuing
the process of developing and building
out metrics.2673
Another commenter requested that
the final rule specify how trading assets
and liabilities should be reported for
savings and loan holding
companies.2674 This commenter
requested clarification that positions
held for hedging or liquidity
management purposes should not count
as trading assets or liabilities for the $5
billion threshold in Appendix A.
Another commenter expressed concern
that derivatives valuation may value
derivatives substantially lower than
their notional exposure and thereby
make high reporting thresholds not
meaningful or reflective of inherent
risk.2675
Many commenters expressed concern
that the smallest trading unit level was
too low a level for collecting metrics
data and suggested the final rule
provide a higher reporting level.2676
These commenters stated that
calculating at too low of a level would
be more likely to generate false
positives 2677 and would be
burdensome, particularly for firms with
large trading operations.2678 In addition,
some commenters indicated that it
would be problematic if the definition
of ‘‘trading unit’’ is applied at a legal
entity level and cannot be applied
across multiple legal entities within the
same affiliate group.2679 By contrast,
two commenters supported the
2671 See

Goldman (Prop. Trading).
Wells Fargo (Prop. Trading).
2673 See AFR et al. (Feb. 2012).
2674 See GE (Feb. 2012).
2675 See Occupy.
2676 See, e.g., BoA; Goldman (Prop.Trading);
JPMC; SIFMA et al. (Prop.Trading) (Feb. 2012);
Morgan Stanley; RBC.
2677 See JPMC; Goldman (Prop.Trading); SIFMA
et al. (Prop.Trading) (Feb. 2012); BoA. See also Sen.
Gillibrand.
2678 See Goldman (Prop.Trading); SIFMA et al.
(Prop.Trading) (Feb. 2012); BoA.
2679 See Goldman (Prop.Trading); SIFMA et al.
(Prop.Trading) (Feb. 2012).

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2672 See

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collection of metrics at the trading desk
level and appropriate levels above the
trading desk.2680 One of these
commenters expressed concern that the
rule allowed for an inappropriately large
trading desk unit that could combine
significantly unrelated trading desks,
which would impede detection of
proprietary trading and supported
measurements at multiple levels of
organization to combat evasion
concerns.
In response to questions in the
proposal about whether the Agencies
should establish numerical thresholds
for some or all of the proposed
quantitative measurements, a number of
commenters expressed opposition to
establishing numerical thresholds for
purposes of the rule,2681 while others
stated that thresholds should be
established over time.2682 In opposition
of thresholds, one commenter expressed
concern that numerical thresholds could
be easily abused and evaded and may
need to be constantly revised and
updated as financial markets evolve.2683
In addition, another commenter stated
that numerical thresholds should not be
imposed because metric levels will
differ by asset class and type of
activity.2684 A few commenters
suggested that numerical thresholds,
based on the specific asset class or
market, would be useful to provide
clarity or consistency about the types of
activity that are permitted under the
rule.2685 Two commenters expressed
support for banking entities establishing
numerical thresholds, in consultation
with the relevant regulator, for different
trading units based on differences
between markets and asset classes.2686
c. Approach of the Final Rule
As explained below, the Agencies
have reduced the number of metrics that
banking entities must report under
Appendix A from the 17 metrics in the
proposal to 7 metrics in the final rule.
The final rule also increases the level of
activity that is required to trigger
mandatory reporting of metrics data and
phases in the reporting requirement
over time.
Under the final rule, a banking entity
engaged in significant trading activity as
defined by § ll.20 must furnish the
following quantitative measurements for
2680 See Sens. Merkley & Levin (Feb. 2012);
Occupy.
2681 See SIFMA et al. (Prop.Trading) (Feb. 2012);
Occupy; Alfred Brock.
2682 See Wellington; Barclays; Goldman (Prop.
Trading); CalPERS; John Reed.
2683 See Occupy.
2684 See SIFMA et al. (Prop.Trading) (Feb. 2012).
2685 See Wellington; CalPERS; John Reed.
2686 See Goldman (Prop. Trading); Barclays.

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each of its trading desks engaged in
covered trading activity calculated in
accordance with Appendix A:
• Risk and Position Limits and Usage;
• Risk Factor Sensitivities;
• Value-at-Risk and Stress VaR;
• Comprehensive Profit and Loss
Attribution;
• Inventory Turnover;
• Inventory Aging; and
• Customer Facing Trade Ratio.
In response to comments, the final
rule raises the threshold for metrics
reporting from the proposal to capture
only firms that engage in significant
trading activity, identified at specified
aggregate trading asset and liability
thresholds, and delays the dates for
reporting metrics through a phased-in
approach based on the size of trading
assets and liabilities.2687 Banking
entities that meet the relevant
thresholds must collect and report
metrics for all trading desks engaged in
covered trading activity beginning on
the dates established in § ll.20 of the
final rule. Specifically, the Agencies
have delayed the reporting of metrics
until June 30, 2014 for the largest
banking entities that, together with their
affiliates and subsidiaries, have trading
assets and liabilities the average gross
sum of which equal or exceed $50
billion on a worldwide consolidated
basis over the previous four calendar
quarters (excluding trading assets and
liabilities involving obligations of or
guaranteed by the United States or any
agency of the United States). Banking
entities with less than $50 billion and
greater than or equal to $25 billion in
trading assets and liabilities and
banking entities with less than $25
billion and greater than or equal to $10
2687 As noted above, a number of commenters
suggested setting a higher threshold than the
proposed $1 billion and $5 billion trading asset and
liability thresholds because even thresholds of $10
billion to $50 billion would capture a significant
percentage of the total trading assets and liabilities
in the banking system. See ABA (Keating); M&T
Bank; PNC et al.; State Street (Feb. 2012). The
Agencies believe that the phase-in approach to the
metrics requirement established in the final rule
should generally address commenters’ concerns
about the implementation timeframe by providing
time for analysis, development of systems (if
needed), and implementation of the quantitative
measurements requirement. See, e.g., BoA;
Barclays; Citigroup (Feb. 2012); Goldman (Prop.
Trading); JPMC; Morgan Stanley; SIFMA et al.
(Prop.Trading) (Feb. 2012); UBS; Stephen Roach;
Credit Suisse (Seidel); Wells Fargo (Prop. Trading).
The Agencies are establishing a phase-in approach,
rather than requiring all banking entities above the
$10 billion threshold to report metrics within the
same timeframe, to strike a balance between the
benefits of receiving data to help monitor
compliance with the rule against the need for time
to assess the effectiveness and usefulness of the
quantitative measurements in practice and for some
firms to develop additional systems for purposes of
this requirement.

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billion in trading assets and liabilities
would also be required to report these
metrics beginning on April 30, 2016,
and December 31, 2016, respectively.
The Agencies believe that these delayed
dates for reporting metrics should allow
firms adequate time to develop systems
to calculate and report the quantitative
metrics. The Agencies will review the
data collected and revise this collection
requirement as appropriate based on a
review of the data collected prior to
September 30, 2015.
Under the final rule, a banking entity
required to report metrics must
calculate any applicable quantitative
measurement for each trading day. Each
banking entity required to report must
report each applicable quantitative
measurement to its primary supervisory
Agency on the reporting schedule
established in § ll.20 unless
otherwise requested by the primary
supervisory Agency for the entity. The
largest banking entities with $50 billion
or greater in trading assets and liabilities
must report the metrics on a monthly
basis. Other banking entities required to
report metrics must do so on a quarterly
basis.2688 All quantitative measurements
for any calendar month must be
reported no later than 10 days after the
end of the calendar month required by
§ ll.20, unless another time is
requested by the primary supervisory
Agency for the entity except for a
preliminary period when reporting will
be required no later than 30 days after
the end of the calendar month. Banking
entities subject to quarterly reporting
will be required to report quantitative
measurements within 30 days of the end
of the quarter, unless another time is
requested by the primary supervisory
Agency for the entity in writing.2689
The Agencies believe that together the
reduced number of metrics, the higher
thresholds for reporting metrics,
delayed reporting dates, and modified
reporting frequency reduce the costs
and burden from the proposal while
allowing collection of data to permit
better monitoring of compliance with
section 13 of the BHC Act. The Agencies
2688 Consistent with certain commenters’
requests, the final rule generally requires less
frequent reporting than was proposed. However, the
Agencies continue to believe that monthly reporting
is appropriate for the largest banking entities above
the $50 billion threshold. More frequent reporting
for these firms is appropriate to allow for more
effective supervision of their large-scale trading
operations. See JPMC; Stephen Roach.
2689 See final rule § ll.20(d)(3). The final rule
includes a shorter period of time for reporting
quantitative measurements after the end of the
relevant period than was proposed for the largest
banking entities. Like the monthly reporting
requirement for these firms, this is intended to
allow for more effective supervision of their largescale trading operations.

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also believe that the delayed dates for
reporting quantitative metrics will
provide banking entities with the time
to develop systems to calculate and
report these metrics. The Agencies are
not applying these 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 banking entities with
lower levels of trading activities, which
represent entities that are typically
small, less complex, and easier to
supervise, would not justify the burden
associated with complying with the
reporting and recordkeeping
requirements of Appendix A.
The final rule defines ‘‘trading desk’’
to replace the concept of ‘‘trading unit’’
in the proposal.2690 Under the final rule,
trading desk means the smallest discrete
unit of organization of a banking entity
that buys or sells financial instruments
for the trading account of the banking
entity or an affiliate thereof. The
Agencies believe that applying
quantitative measurements to 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.
While the Agencies recognize that
applying quantitative measurements at
the trading desk level may result in
some ‘‘noise’’ in the data and false
positives, the Agencies believe it is
necessary to apply the quantitative
measurements at the trading desk level
to enhance consistency with other
provisions of the final rule. For
example, because the requirements of
the market-making exemption apply at
the trading desk level of organization,
the Agencies believe quantitative
measurements used to monitor a
banking entity’s market making-related
activities should also calculated,
reported, and recorded at the trading
desk level. In response to commenters’
concerns that trading desk level
measurements are more likely to
generate false positives, the Agencies
emphasize that quantitative
measurements will not be used as a
dispositive tool for determining
compliance and, rather, will be used to
monitor patterns and identify activity
that may warrant further review.

Like the proposal, the final rule does
not include specific numerical
thresholds. Commenters did not suggest
specific thresholds for particular metrics
or provide data and analysis that would
support particular thresholds.2691 Given
the range of financial instruments and
trading activity covered by the final
rule, as well as potential differences
among banking entities’ organizational
structures, trading strategies, and level
of presence in a particular market, the
Agencies are concerned that numerical
thresholds for specific metrics would
not account for these differences and
could inappropriately constrain
legitimate activity.2692 Further,
mandated thresholds for the metrics
would not recognize the impact
changing market conditions may have
on a given trading desk’s quantitative
measurements. Consistent with two
commenters’ suggested approach,
banking entities will be required to
establish their own numerical
thresholds for quantitative
measurements under the enhanced
compliance program requirement in
Appendix B.2693
d. Proposed Quantitative Measurements
and Comments on Specific Metrics
Section IV of proposed Appendix A
described, in detail, the individual
quantitative measurements that must be
furnished. These measurements were
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,
Inventory Aging, and Customer-facing Trade
Ratio; and
• Payment of fees, commissions, and
spreads measurements—Pay-to-Receive
Spread Ratio.
2691 See

Wellington; CalPERS; John Reed.
SIFMA et al. (Prop.Trading) (Feb. 2012).
2693 See Goldman (Prop. Trading); Barclays. See
also final rule Appendix B.
2692 See

2690 See final rule § ll.3(e)(13); See also supra
Parts IV.A.2.c.1.c.ii. and IV.A.3.c.1.c.i.

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The Agencies proposed these
quantitative measurements because,
taken together, these measurements
appeared 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 were proposed to
identify different aspects and
characteristics of trading activity for the
purpose of helping to identify
prohibited proprietary trading, and the
Agencies stated in the proposal that
they expected that the quantitative
measurements would be most useful for
this purpose when implemented and
reviewed collectively, rather than in
isolation. The Agencies stated in the
proposal that they believed that, in the
aggregate, many banking entities already
collect and review many of these
measurements as part of their risk
management activities, and stated that
they expected that many of the
quantitative measurements proposed
would be readily computed and
monitored at the multiple levels of
organization included in proposed
Appendix A’s definition of ‘‘trading
unit,’’ to which they would apply.
Under the proposal, the first set of
quantitative measurements related to
risk management, and included VaR,
Stress VaR, VaR Exceedance, Risk
Factor Sensitivities, and Risk and
Position Limits. Commenters generally
supported the use of risk-management
metrics as the most important measure
of compliance, indicating that these
metrics could potentially provide useful
supervisory information.2694
In general, commenters supported the
use of the VaR metric.2695 One of these
commenters argued that VaR was not
particularly indicative of proprietary
trading, but could be helpful to reveal
a trading unit’s overall size and risk
profile.2696 Another commenter
indicated that significant, abrupt or
inconsistent changes to VaR may need
to be absorbed by market makers who
absorb large demand and supply shocks
2694 See, e.g., AFR et al. (Feb. 2012); Barclays;
Citigroup (Feb. 2012); Prof. Duffie; Goldman (Prop.
Trading); Invesco; JPMC; Occupy; Public Citizen;
See also BNY Mellon et al. (suggesting the use of
VaR measures for foreign exchange trading activity).
2695 See, e.g., Citigroup (Feb. 2012); Prof. Duffie;
Goldman (Prop. Trading); Invesco; Public Citizen.
2696 See Goldman (Prop. Trading).

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into their inventories.2697 This
commenter contended that the six
largest bank holding companies had
proprietary trading losses that
frequently exceeded their VaR estimates
and the design and supervision of such
risk measures should be revisited.
One commenter argued that the
definition of VaR was not made clear in
the proposal and was missing some
important information regarding
methodology as VaR methodologies
tend to vary among banking entities.2698
This commenter recommended the
development of a standard methodology
by the OFR including a central
repository for historical calculation data
for each asset for the purpose of
ensuring standard calculation across the
industry. This commenter also
expressed concern that VaR calculations
are heavily reliant on the quality of
input data and stated that many markets
are unable to provide sufficient
information such that VaR calculations
are meaningful, including markets for
illiquid products for which accurate
historical price and market information
is sparse and could severely under
represent true potential losses under
VaR calculations.2699
A few commenters expressed concern
about the applicability of VaR when
applied to ALM activities.2700 These
commenters argued that risk
management metrics such as VaR would
not help to distinguish ALM and valid
risk mitigating hedging activities from
prohibited proprietary trading. For
instance, one of these commenters
stated that the proposed reliance on VaR
and Stress VaR to demonstrate bona fide
hedging is misleading for ALM activities
due to the typical accounting
asymmetry in ALM where, for example,
managed liabilities such as deposits are
not marked to market but the
corresponding hedge may be.
One commenter argued that the use of
stress VaR would be important to guard
against excessive risk taking.2701 A few
commenters suggested that additional
guidance be provided for Stress VaR
including linking it to the broader stress
testing regime and based on extreme
conditions that are not based on historic
2697 See

Prof. Duffie.
Occupy.
2699 See Occupy.
2700 See JPMC; State Street (Feb. 2012); See also
BoA; CH/ABASA. For instance, one of these
commenters stated that the proposed reliance on
VaR and Stress VaR to demonstrate bona fide
hedging is misleading for ALM activities due to the
typical accounting asymmetry in ALM where, for
example, managed liabilities such as deposits are
not mark-to-market but the corresponding hedge
may be. See State Street (Feb. 2012).
2701 See Public Citizen.
2698 See

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precedent.2702 These commenters also
argued that a one-day holding period
assumption is inadequate, especially for
less liquid asset classes, and
recommended that stress be measured
over a longer period. One commenter
argued that Stress VaR should be
removed from the list of required
metrics as it is not in regular use for
day-to-day risk management and
provides little relevant information
about the intent or proportionality
between risk assumed and client
demands.2703
A number of commenters requested
that VaR Exceedance be removed from
the list of metrics. These commenters
argued that the primary function of VaR
Exceedance is to analyze the quality of
a VaR model and that VaR backtesting
is already reported to regulators as part
of the supervisory process. These
commenters argued that VaR
Exceedance does not reveal trading
intent or actual risk taken.2704 One
commenter argued that VaR Exceedance
may be useful to the Agencies as an
indicator of the quality of the VaR
measure relative to the profit and loss of
the trading unit but that a more rigorous
back-testing process would serve as a
better analytical tool than VaR
Exceedance to evaluate the quality of
the VaR model result and should be
included as an additional metric.2705
One commenter suggested that riskbased metrics should measure risk as a
function of capital.2706 Another
commenter warned that risk metrics
could be significantly higher during
times of market stress and volatility
than during normal times.2707
A few commenters expressed support
for risk factor sensitivities as useful,
supervisory information.2708 One of
these commenters suggested that risk
factor sensitivities could orient
regulators to a trading unit’s overall size
and risk profile,2709 while another
commenter stated that risk factor
sensitivities would be the most useful
tool for identifying the accumulation of
market risk in different areas of a
banking entity.2710 One commenter
suggested that several risk factor
sensitivity snapshots be taken
throughout the day with an average
2702 See

AFR et al. (Feb. 2012); Public Citizen.
JPMC.
2704 See ABA (Keating); Barclays; Goldman (Prop.
Trading); SIFMA et al. (Prop.Trading) (Feb. 2012);
Wells Fargo (Prop. Trading); UBS.
2705 See Occupy.
2706 See Citigroup (Feb. 2012).
2707 See SIFMA et al. (Prop. Trading) (Feb. 2012).
2708 See Citigroup (Feb. 2012); Prof. Duffie;
Occupy.
2709 See Goldman (Prop. Trading).
2710 See Occupy.
2703 See

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value reported at the end of day.2711
This commenter also recommended that
trading strategies that rely heavily on
models to calculate risk exposures (e.g.,
correlation trading portfolios), should
trigger additional disclosures in risk
factor sensitivity reporting.2712
Commenters also supported risk and
position limits as providing useful,
supervisory information. Several
commenters indicated that these limits
could be helpful to orient regulators to
a trading unit’s overall size and risk
profile.2713 Another commenter
expressed the view risk and position
limits are the most comprehensive
measures of risk taking and incorporate
VaR, Stress VaR, and Risk Factor
Sensitivities.2714 A different commenter
argued it was unclear how position
limits are in fact a quantitative metric
and not a description of a banking
entity’s internal risk policies.2715
After carefully considering the
comments received, the final rule
retains the risk-management metrics
other than VaR Exceedance. The
collection of information regarding Risk
and Position Limits, VaR, Stress VaR,
and Risk Factor Sensitivities is
consistent with the aim of providing a
means of characterizing the overall risk
profile of the trading activities of each
trading desk and evaluating the extent
to which the quantitative profile of a
trading desk’s activities is consistent
with permissible activities. Moreover, a
number of commenters indicated that
the risk management measures would be
effective at achieving these goals.2716
The risk management measure that was
not retained in the final rule, VaR
Exceedance, was considered, in light of
the comments, as not offering significant
additional information on the overall
risk profile and activities of the trading
desk relative to the burden associated
with computing, auditing and reporting
it on an ongoing basis.2717
The risk-management measurements
included in the final rule are widely
used by banking entities to measure and
manage trading risks and activities.2718
VaR, Stress VaR, and Risk Factor
Sensitivities provide internal, modelbased assessments of overall risk, stated
2711 See

Occupy.
Occupy.
2713 See, e.g., Barclays; Citigroup (Feb. 2012);
Prof. Duffie; Goldman (Prop. Trading).
2714 See Barclays.
2715 See Occupy.
2716 See, e.g., AFR et al. (Feb. 2012); Barclays;
Citigroup (Feb. 2012); Prof. Duffie; Goldman (Prop.
Trading); Invesco; JPMC; Occupy; Public Citizen;
See also Northern Trust; State Street (Feb. 2012).
2717 See ABA (Keating); Barclays; Goldman (Prop.
Trading); SIFMA et al. (Prop.Trading) (Feb. 2012);
Wells Fargo (Prop. Trading); UBS.
2718 See Joint Proposal, 76 FR 68,887.

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2712 See

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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.
The provided description and
calculation guidance for each of these
measures is consistent with both current
market practice and regulatory capital
requirements for banks. The final rule
does not provide a prescriptive
definition of each of these
measurements as these measures must
be flexible enough to be tailored to the
specific trading activities of each trading
desk. Supervisory guidance and
comparisons of these measures across
similarly situated trading desks at a
given entity as well as across entities
will be used to ensure that the provided
measurements conform to the
description and calculation guidance
provided in Appendix A. Risk and
Position Limits and Usage provide an
explicit assessment of management’s
expectation of how much risk is
required to perform permitted marketmaking, underwriting and hedging
activities. The final rule requires that
the usage of each risk and position limit
be reported so that the risk taking by
each trading desk can be monitored and
assessed on an ongoing basis.2719
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
allocating capital internally.2720 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 desks and
management’s stated expectations for
such measures may indicate
impermissible proprietary trading, and
may warrant further review. In addition,
indicators of unanticipated or unusual
levels of risk taken, such as breaches of
internal Risk and Position Limits, may
suggest behavior that is inconsistent
with appropriate levels of risk and may
warrant further scrutiny. The limits
required under § ll.4(b)(2)(iii) and
2719 The Agencies believe this clarification
responds to one commenter’s question regarding
how risk and position limits will be used and
assessed for purposes of the rule. See Occupy.
2720 See Joint Proposal, 76 FR 68,887.

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§ ll.5(b)(1)(i) must meet the
applicable requirements under
§ ll.4(b)(2)(iii) and § ll.5(b)(1)(i)
and also must include appropriate
metrics for the trading desk limits
including, at a minimum, the ‘‘Risk
Factor Sensitivities’’ and ‘‘Value-at-Risk
and Stress Value-at-Risk’’ metrics except
to the extent any of the ‘‘Risk Factor
Sensitivities’’ or ‘‘Value-at-Risk and
Stress Value-at-Risk’’ metrics are
demonstrably ineffective for measuring
and monitoring the risks of a trading
desk based on the types of positions
traded by, and risk exposures of, that
desk.
Under the proposal, the second set of
quantitative measurements related to
the source of revenues, and included
Comprehensive Profit and Loss,
Portfolio Profit and Loss, Fee Income,
Spread Profit and Loss, and
Comprehensive Profit and Loss
Attribution. A few commenters
expressed support for Comprehensive
Profit and Loss as a reasonable
contextual metric and contended that
the metric could inform the analysis of
whether market-making revenues are
from customer transactions.2721
As described above, a number of
commenters expressed concern about a
focus on revenues as part of evaluating
market-making.2722 For instance, one
commenter argued that the rule should
not require, even in guidance, that
market making-related permitted
activities be ‘‘designed to generate
revenues from fees, commissions, bidasks spreads or other income,’’ arguing
that this prejudges appropriate results
for revenue metrics and implies that a
bona fide market maker is not permitted
to benefit from revenues from market
movements.2723 One commenter
expressed concern that the source-ofrevenue metrics are subject to
manipulation as these metrics depend
on correctly classifying revenue into
market bid-ask spreads as opposed to
other sources of revenue.2724 One
commenter stated that this metric
should serve as a secondary indication
of risk levels because it could be subject
to manipulation.2725 Another
commenter recommended use of the
sub-metric in Comprehensive P&L
Attribution.2726 A different commenter
recommended the adoption of clearer
metrics to distinguish customer
revenues from revenues from price
2721 See Goldman (Prop.Trading); Japanese
Bankers Ass’n; Occupy; See also Barclays.
2722 See supra Part IV.A.3.c.7.b.
2723 See SIFMA (May 2012).
2724 See AFR (Nov. 2012).
2725 See Occupy.
2726 See Barclays.

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movements.2727 One commenter
indicated that after-the-fact application
of quantitative measurements such as
Comprehensive Profit and Loss may
cause firms to reconsider their
commitment to market making and
recommended that, to the extent this
metric is used, it should be applied
flexibly in light of market conditions
prevailing during the relevant time
period, and as one of many factors
relevant to an overall assessment of
bona fide market making.2728
A few commenters supported
Portfolio Profit and Loss as a reasonable
contextual metric to inform whether
revenues from market-making
transactions are from customer
transactions.2729 However, one of these
commenters argued that this metric
would not necessarily be indicative of
prohibited proprietary trading and
profits may reflect bona fide market
making-related, underwriting, and
hedging activities.2730 Another
commenter argued that this metric
should serve as a secondary indication
of risk levels and may be subject to
manipulation.2731
Some commenters felt that Fee
Income and Expense was a useful
metric.2732 One of these commenters
argued this metric has the potential to
help distinguish permitted activities
from prohibited proprietary trading.2733
Another commenter felt this metric
would be useful in liquid markets that
trade with the convention of fees and
commissions but less useful, but still
indicative, in other markets that use
inter-dealer brokers to conduct clientrelated activities.2734 One commenter
argued that it would be impracticable to
produce Fee Income and Expense data
for foreign exchange trading, which is
predominantly based on bid/offer
spread.2735
A few commenters thought that
Spread P&L could be useful.2736 One of
these commenters argued that Spread
P&L has the potential to help
distinguish permitted activities from
2727 See

Public Citizen.
NYSE Euronext.
2729 See Goldman (Prop. Trading); Japanese
Bankers Ass’n; Occupy.
2730 See Goldman (Prop. Trading).
2731 See Occupy.
2732 See Goldman (Prop. Trading); Japanese
Bankers Ass’n; Occupy.
2733 See Goldman (Prop. Trading). This
commenter urged that fee income and expense
should be considered together with Spread P&L
arguing that these two both measures of customer
revenues and, in practice, may function as
substitutes for each other.
2734 See Occupy.
2735 See Northern Trust.
2736 See, e.g., Goldman (Prop. Trading); JPMC;
UBS.

prohibited proprietary trading.2737 This
commenter suggested that the final rule
remove the proposal’s revenue
requirement as part of market-making
and instead rely on revenue metrics
such as Spread P&L.2738 This
commenter argued, however, that it will
not always be clear how to best
calculate Spread P&L and it would be
critical for the Agencies to be flexible
and work with banking entities to
determine the appropriate proxies for
spreads on an asset-class-by-asset class
and trading desk-by-trading-desk basis.
One commenter contended that the
proposed implementation in the
proposal was more difficult than
necessary and suggested End of Day
Spread Proxy is sufficient. Another
commenter suggested expanding the
flexibility offered in choosing a bid-offer
source to calculate Spread P&L.2739
However, the majority of commenters
recommended removal of Spread P&L as
a metric.2740 These commenters argued
that a meaningful measure for Spread
P&L cannot be calculated in the absence
of a continuous bid-ask spread, making
this metric misleading especially for
illiquid positions and shallow markets.
A few commenters generally
expressed support for the inclusion of
Comprehensive Profit and Loss
Attribution.2741 One of these
commenters stated that this metric was
the most comprehensive metric for
measuring sources of revenue and
included other metrics as sub-metrics,
such as Comprehensive Profit and Loss,
Portfolio Profit and Loss, and Fee
Income and Expense. Another
commenter contended the mention of
‘‘customer spreads’’ and ‘‘bid-ask
spreads’’ was unclear and that both of
these terms should be removed from the
calculation guidance. Other commenters
argued that the benefits of this metric do
not justify the costs of generating a
report of Comprehensive P&L
Attribution on a daily basis.2742 One
commenter urged the Agencies to
ensure that each institution be
permitted to calculate this metric in a

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2728 See

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2737 See

Goldman (Prop. Trading).
Goldman (Prop. Trading); See also Paul
Volcker (supporting a metric considering the extent
to which earnings are generated by pricing spreads
rather than changes in price).
2739 See JPMC; UBS; See also SIFMA et al. (Prop.
Trading) (Feb. 2012).
2740 See ABA et al.; BoA; Barclays; Credit Suisse
(Seidel); Japanese Bankers Ass’n; Northern Trust;
SIFMA et al. (Prop. Trading) (Feb. 2012); Wells
Fargo (Prop.Trading); See also AFR et al. (Feb.
2012); Occupy.
2741 See Barclays; Occupy.
2742 See BOK; Goldman (Prop. Trading); SIFMA et
al. (Prop Trading) (Feb. 2012); Wells Fargo (Prop.
Trading).
2738 See

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way that reflects the institution’s unique
characteristics.2743
After carefully considering the
comments received, the final rule
maintains only a modified version of
Comprehensive P&L Attribution metric
and does not retain the proposed
Comprehensive Profit and Loss,
Portfolio Profit and Loss, Fee Income, or
Spread Profit and Loss metrics. The
final rule also requires volatility of
comprehensive profit and loss to be
reported. As pointed out by a number of
commenters, Comprehensive Profit and
Loss Attribution provides a holistic
attribution of each trading desk’s profit
and loss and contains much of the
information content that is provided by
many of the other metrics, such as Fee
Income and Expense.2744 Accordingly,
the use of Comprehensive Profit and
Loss Attribution in the final rule greatly
simplifies the metric reporting
requirement and reduces burden while
retaining much of the information and
analysis that was provided in the full set
of five metrics that were contained in
the proposal. In addition, in response to
commenters’ concerns about the
burdens of separately identifying
specific revenue sources (e.g., revenues
from bid-ask spreads, revenues from
price appreciation), the Agencies have
modified the focus of the proposed
source of revenue metrics to focus on
when revenues are generated, rather
than the specific sources of revenue.2745
This approach should also help address
one commenter’s concern about the
need for new, sophisticated systems to
differentiate bid-ask spreads from price
appreciation.2746 The utility of this
modified approach is discussed in more
detail in the discussion of the marketmaking exemption.2747 Finally, the
Comprehensive Profit and Loss
Attribution metric will ensure that all
components of a trading desk’s profit
and loss are measured in a consistent
and comprehensive fashion so that each
individual component can be reliably
compared against other components of a
trading desk’s profit and loss without
being considered in isolation or taken
out of context.
This measurement is 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
2743 See

SIFMA et al. (Prop Trading) (Feb. 2012).
Barclays.
JPMC; UBS; SIFMA et al. (Prop Trading)
(Feb. 2012); ABA (Keating); BoA; Barclays; Credit
Suisse (Seidel).
2746 See BoA.
2747 See supra Part IV.A.3.c.7.c.
2744 See
2745 See

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activities seek to generate profits by
providing customers with
intermediation and related services
while, managing, 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.
Under the proposal, the third set of
measurements related 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 Portfolio Profit
and Loss, and Skewness of Portfolio
Profit and Loss and Kurtosis of Portfolio
Profit and Loss.
A few commenters indicated support
for these metrics as appropriate,
contextual metrics.2748 These
commenters indicated that these metrics
may serve to highlight areas requiring
further investigation, since high P&L
volatility may indicate a deviation from
traditional client related activities and
that a well-structured trading operation
should be able to obtain relatively high
ratios of revenue-to-risk (as measured by
various metrics), low volatility, and
relatively high turnover.2749 One
commenter recommended that New
Trades P&L be substituted for Portfolio
P&L for purposes of computing
Volatility of P&L because New Trades
P&L captures customer revenues more
completely and is therefore more useful
for distinguishing market making from
proprietary trading.2750 Another
commenter indicated that Skewness of
Portfolio Profit and Loss and Kurtosis of
Portfolio Profit and Loss incorporates
(and therefore obviates the need for a
separate calculation of) the metric
Volatility of Portfolio Profit and
Loss.2751
One commenter urged that after-thefact application of Comprehensive Profit
and Loss to Volatility Ratio may cause
firms to reconsider their commitment to
2748 See, e.g., Goldman (Prop. Trading); Volcker;
John S. Reed; See also AFR et al. (Feb. 2012); Sen.
Merkley; Occupy; Public Citizen.
2749 See Occupy; Public Citizen; Sen. Merkley.
2750 See Goldman (Prop. Trading) (also suggesting
that New Trades P&L be substituted for Portfolio
P&L in Comprehensive Profit and Loss to Volatility
Ratio and Portfolio Profit and Loss to Volatility
Ratio and Unprofitable Trading Days based on
Comprehensive Profit and Loss and Unprofitable
Trading Days based on Portfolio Profit and Loss).
2751 See Barclays.

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market making and argued that this
metric should be applied flexibly in
light of market conditions prevailing
during the relevant time period and as
one of many factors relevant to an
assessment of overall bona fide market
making.2752 One commenter supported
monitoring Portfolio Profit and Loss to
Volatility Ratio and argued that the
Agencies should establish a clear
pattern of profit and loss results of
individual trading units through
iterative application of the metrics.2753
One commenter expressed support for
Unprofitable Trading Days based on
Comprehensive Profit and Loss and
Unprofitable Trading Days based on
Portfolio Profit and Loss indicating that
these metrics may serve to highlight
areas requiring further investigation,
since a significant number of
unprofitable trading days may indicate
a deviation from traditional clientrelated activities.2754 Another
commenter suggested that these metrics
be removed as they would result in
market makers being less likely to take
client-facing positions due to reluctance
to incur unprofitable trading days that
could indicate the presence of
impermissible activity despite the
utility of such trades in providing
liquidity to customers.2755
One commenter requested including
Skewness of Portfolio Profit and Loss
and Kurtosis of Portfolio Profit and Loss
in the metrics set as the most
comprehensive metric in the revenuerelative-to-risk category making other
metrics unnecessary in this area.2756
Another commenter argued that this
metric would produce inconsistent
results within and across trading units
and would generally not support any
meaningful conclusions regarding the
permissibility or risk of trading
activities.2757
After carefully considering the
comments received, the final rule does
not include any of the proposed
revenue-relative-to-risk measurements.
Each of these measures provides
information that may generally be useful
for characterizing the overall risk profile
of the trading activities of each trading
unit and evaluating the extent to which
the quantitative profile of a trading
unit’s activities is consistent with
permissible trading activities. The broad
information content of these measures,
however, can largely be reproduced
from transformations of information that
2752 See

NYSE Euronext.
2753 See AFR et al. (Feb. 2012).
2754 See Occupy.
2755 See Barclays.
2756 See Barclays.
2757 See Goldman (Prop. Trading).

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will be provided in the Comprehensive
Profit and Loss Attribution and, as
noted above, volatility of
comprehensive profit and loss must be
reported. Analogs to the other metrics
such as Skewness of Portfolio Profit and
Loss and Kurtosis of Portfolio Profit and
Loss can be computed similarly from
information that will be provided in the
Comprehensive Profit and Loss
Attribution. Accordingly, the
information contained in these metrics
is retained in the final rule while the
burden associated with computing,
auditing and reporting these additional
metrics on an ongoing basis has been
eliminated.
Under the proposal, the fourth set of
quantitative measurements related to
customer-facing activity measurements.
These metrics include Inventory Risk
Turnover, Inventory Aging, and
Customer-facing Trade Ratio.
A few commenters supported the
proposal’s Inventory Risk Turnover
metric though some of these
commenters suggested modifications to
the metric.2758 One commenter argued
that this metric could indicate whether
a given trading unit holds risk and
inventory consistently with the asset
class in which such trading unit deals,
the types of trading activity in which
the trading unit engages, and the scale
and scope of the client activity that such
trading unit serves.2759 Another
commenter argued that the final rule
should explicitly state that a trading
unit’s inventory management practices
will be evaluated using this metric.2760
Some commenters expressed the view
that this metric might be useful in the
case of liquid positions but not in the
case of illiquid or difficult-to-hedge
products, which naturally have lower
risk turnover. Others noted support for
this metric tailored on an asset-by-asset
basis.2761
A few commenters requested that the
final rule clarify that this metric will not
be required to be calculated for every
possible Risk Factor Sensitivity
measurement for the applicable
portfolio and that a banking entity and
its regulator should determine one or
two core risk factors per asset classes
with respect to which this metric that
will be calculated to strike a reasonable
balance between costs of calculations
2758 See Goldman (Prop. Trading); Barclays; John
Reed; JPMC; SIFMA et al. (Prop. Trading) (Feb.
2012); Wells Fargo (Prop. Trading).
2759 See Barclays.
2760 See Goldman (Prop. Trading).
2761 See, e.g., Barclays; Goldman (Prop. Trading);
JPMC; John Reed.

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and benefits of this metric.2762 Other
commenters argued the Inventory Risk
Turnover Metric was difficult to
measure, burdensome, and would create
uncertainty for derivatives
counterparties.2763
A few commenters supported the
Inventory Aging metric. One commenter
argued it should be included in the
metrics set to indicate whether a given
trading desk holds risk and inventory
consistently within the asset class in
which such trading desk deals, the type
of trading activity in which the trading
unit engages, and the scale and scope of
the client activity that such trading desk
serves.2764 This commenter suggested
tailoring the metric based on the market
for a particular asset class and market
conditions because aging levels may be
higher in less liquid markets. A number
of commenters argued that application
of the Inventory Aging metric is only
appropriate for cash products and
should not be used for trading units
engaged in transactions in financial
instruments such as derivatives.2765
Another commenter argued that the
Inventory Aging metric is generally not
useful for derivatives, and for nonderivatives it provides essentially
similar information to Inventory Risk
Turnover.2766 One commenter requested
additional guidance on how to calculate
this metric.2767
A few commenters indicated that the
Customer-Facing Trade Ratio could be
helpful in distinguishing prohibited
proprietary trading from market making
and would be more effective than the
proposal’s negative presumption against
interdealer trading to evaluate the
amount of interdealer trading that is
consistent with market making-related
or hedging activity in a particular
business.2768 Some commenters
suggested that the metric could be
improved and argued that the number of
transactions executed over a calculation
period does not provide an adequate
measure for the level of customer-facing
trading because it does not reflect the
size of transactions or the amount of
risk. These commenters suggested
replacing the metric with a more risksensitive metric or defining the ratio so
that it measures notional principal risk

associated with customer transactions
and is appropriately tailored to the
relevant asset class or market.2769
A number of commenters raised
concerns about the definition of
customer for purposes of this metric.
One commenter argued that a failure to
define ‘‘customer’’ to differentiate
between customers and non-customers
would render this metric
meaningless.2770 Another commenter
contended that the metric would be
appropriate as long as banking entities
have the flexibility to determine who is
a customer.2771 One commenter argued
that using a definition of ‘‘customer’’
that is different between the market
making-related activity and the reported
metric could make legitimate market
making-related activity with customers
appear to be prohibited proprietary
trading.2772 This commenter argued that
other dealers and other registered
market participants should be
recognized as customers of the banking
entity. A few commenters contended
that this metric would be burdensome if
it required a banking entity to tag
individual trades as customer or noncustomer.2773 A few commenters argued
that interdealer trading should be
allowed as part of market making and
argued this metric would not provide a
useful measure of customer-facing
activity.2774 Some commenters also
expressed concern about the
implications of such a metric for
hedging activity, which may involve
relatively less customer-facing
activity.2775
After carefully considering the
comments received, the final rule
retains all three of the customer-facing
activity measurements from the
proposal, though each measure has been
modified. A number of commenters
raised issues regarding the complexities
associated with computing the
Inventory Risk Turnover metric. In
particular, as noted above, some
commenters argued that computing the
metric for every reported risk factor
sensitivity would be burdensome and
would not be informative.2776 The
inventory metric required in the final
rule, Inventory Turnover, is applied at

2762 See Goldman (Prop. Trading); JPMC; SIFMA
et al. (Prop. Trading) (Feb. 2012); See also Morgan
Stanley.
2763 See Japanese Bankers Ass’n; SIFMA (Asset
Mgmt.) (Feb. 2012); Morgan Stanley.
2764 See Barclays; See also Invesco.
2765 See Barclays; Goldman (Prop. Trading);
Japanese Bankers Ass’n; Morgan Stanley; SIFMA
(Prop. Trading) (Feb. 2012).
2766 See Goldman (Prop. Trading).
2767 See Socie
´ te´ Ge´ne´rale.
2768 See Goldman (Prop. Trading); See also
Invesco.

2769 See Barclays; Goldman (Prop. Trading);
JPMC; SIFMA (Prop. Trading) (Feb. 2012); UBS.
2770 See Occupy.
2771 See Wells Fargo (Prop. Trading).
2772 See SIFMA (Prop. Trading) (Feb. 2012).
2773 See SIFMA (Prop. Trading) (Feb. 2012); See
also Goldman (Prop Trading).
2774 See Barclays; Japanese Bankers Ass’n; Oliver
Wyman (Dec. 2011); SIFMA (Prop. Trading) (Feb.
2012).
2775 See Barclays; Wells Fargo (Prop. Trading).
2776 See Goldman (Prop. Trading); JPMC; SIFMA
(Prop. Trading) (Feb. 2012).

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the transaction level and not at the risk
factor sensitivity level. Accordingly, for
a given trading desk and calculation
period, e.g., 30 days, there is only one
value of the Inventory Turnover metric
rather than one value for each risk factor
sensitivity that is managed and reported
by the trading desk. In this sense, the
turnover metric required in the final
rule is similar to more traditional and
common measures of inventory
turnover. Moreover, the required
turnover metric is simpler and less
costly to track and record while still
providing banking entities and Agencies
with meaningful information regarding
the extent to which the size and volume
of trading activities are directed at
servicing the demands of customers. In
addition, the description of Inventory
Turnover in the final rule provides
explicit guidance on how to apply the
metric to derivative positions.2777
Inventory Aging provides banking
entities and Agencies with meaningful
information regarding the extent to
which the size and volume of trading
activities are directed at servicing the
demands of customers. In the case of
Inventory Aging, the proposal required
that the aging schedule be organized
according to a specific set of age ranges
(i.e., 0–30 days, 30–60 days, 60–90 days,
90–180 days, 180–360 days, and more
than 360 days). This requirement has
not been adopted in the final rule in
order to provide greater flexibility and
to recognize that specific age ranges that
may be relevant for one asset class may
be less relevant for another asset class.
Also, to address commenters’
uncertainty about how this metric
would apply to derivatives, the final
rule’s description of the Inventory Aging
metric provides guidance on how to
apply the metric to derivative
positions.2778
The Customer Facing Trade Ratio
provides directionally useful
information regarding the extent to
which trading transactions are
conducted with customers. In the case
of the Customer Facing Trade Ratio, the
proposal required that customer trades
be measured on a trade count basis. The
final rule requires that the Customer
Facing Trade Ratio be computed in two
ways. As in the proposal, the metric
must be computed by measuring trades
on a trade count basis. Additionally, as
suggested by some commenters, the
2777 The Agencies believe that this should address
commenters’ uncertainty with respect to how the
Inventory Risk Turnover metric would work for
derivatives. See Japanese Bankers Ass’n; SIFMA
(Asset Mgmt.) (Feb. 2012); Morgan Stanley.
2778 See Barclays; Goldman (Prop.Trading);
Japanese Bankers Ass’n; Morgan Stanley; SIFMA
(Prop. Trading) (Feb. 2012).

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final rule requires that the metric be
computed by measuring trades on a
notional value basis. The value based
approach is required to reflect the fact
noted by some commenters, that a trade
count based measure may not accurately
represent the amount of customer facing
activity if customer trade sizes
systematically differ from the sizes of
non-customer trades. In addition, the
term ‘‘customer’’ for purposes of the
Customer-Facing Trade Ratio is defined
in the same manner as the terms client,
customer, and counterparty used for
purposes of the market-making
exemption. This will ensure that the
information provided by this metric is
useful for purposes of monitoring
compliance with the market-making
exemption.2779
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 was 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 expected that the proposed
Pay-to-Receive Spread Ratio
measurement would 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
desks and management’s stated
expectations for such measures could
indicate impermissible proprietary
trading.
One commenter expressed concern
that after-the-fact application of the Payto-Receive Spread Ratio could cause
firms to reconsider their commitment to
market making. This commenter
suggested that if this measure is used, it
be applied flexibly, in light of market
2779 See

SIFMA (Prop. Trading) (Feb. 2012).

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conditions prevailing during the
relevant time period, and as one of
many factors relevant to an overall
assessment of bona fide market
making.2780 Another commenter
suggested expanding the flexibility
offered in choosing a bid-offer source to
the entire process of calculating Pay-toReceive Spread Ratio.2781 A number of
commenters argued for removing this
metric because its calculation
incorporates the Spread P&L metric.2782
Some of these commenters argued that
the metric requires a trade-by-trade
analysis which would be expensive to
compute and would not provide any
additional information that is not
available from other metrics. One
commenter alleged that this metric was
not calculable by any methodology.2783
The Pay-to-Receive Spread Ratio has
not been retained in the final rule. As
noted by some commenters, the broad
information content of this metric will
largely be captured in the
Comprehensive Profit and Loss
Attribution measurement. In addition,
the Comprehensive Profit and Loss
Attribution will place such factors that
are related to the proposed Pay-toReceive Spread Ratio in context with
other factors that determine total
profitability. Accordingly, factors
relating to the payment of fees,
commissions and spreads will not be
considered in isolation but will be
viewed in a context that is appropriate
to the entirety of the trading desk’s
activities. Finally, using the information
contained in the Comprehensive Profit
and Loss Attribution to holistically
assess the range of factors that
determine overall profitability, rather
than requiring a large number of
separate and distinct measurements,
will reduce the resulting compliance
burden while ensuring an integrated
and holistic approach to assessing the
activities of each trading desk.
Commenters also suggested a number
of additional metrics be added to the
final rule that were not contained in the
proposal. One commenter, who
advocated for an alternative framework
for market making supported by
structural and transactional metrics,
suggested that structural metrics could
include the ratio of salespeople to
traders and the level of resources
devoted to client research and trading
content.2784 Two commenters supported
2780 See

NYSE Euronext.
UBS.
2782 See CH/ABASA; Goldman (Prop.Trading);
Japanese Bankers Ass’n; Occupy; SIFMA
(Prop.Trading) (Feb. 2012); Wells Fargo
(Prop.Trading).
2783 See Morgan Stanley.
2784 See Morgan Stanley.
2781 See

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the use of a counterparty risk exposure
measure, not only to the risk of
counterparty default but also to
potential gains and losses to major
counterparties for each of a list of
systemically important scenarios.2785
One of these commenters suggested that
entity-wide inflation risk assessments be
produced on a daily basis.2786 This
commenter also argued that an
important metric that is missing is a
Liquidity Gap Risk metric that estimates
the price change that occurs following a
sudden disruption in liquidity for a
product, arguing that there needs to be
an industry-wide effort to more
accurately measure and account for the
significant effect that liquidity and
changes in its prevailing level have on
the valuation of each asset.
One commenter argued that the
metrics regime was well-designed for
market-making but lacking in other
areas like hedging. This commenter
recommended the addition of additional
metrics more applicable to other nonmarket making activities like a net profit
metric for hedging.2787 Two commenters
argued that quantitative measurement
for underwriting was not included in
the proposal and stated that in a bona
fide underwriting, unsold balances
should be relatively small so a marker
for potential non-bona fide underwriting
should be recognized if VaR (unhedged
and uncovered) of the unsold balance
that is allocated to a banking entity is
large relative to the expected revenue
measured by the pro rata underwriting
spread.2788
After carefully considering the
comments received, these and other
proposed metrics have not been
included as part of the final rule. One
major concern raised by a range of
commenters was the degree of
complexity and burden that would be
required by the metrics reporting
regime. In light of these comments, the
final rule includes a number of
quantitative measurements that are
expected to provide a means of
characterizing the overall risk profile of
the trading activities of each trading
desk and evaluating the extent to which
the quantitative profile of a trading
desk’s activities is consistent with
permissible trading activities in a cost
effective and efficient manner while
being appropriate for a range of different
trading activities. Moreover, while many
commenters suggested a number of
different alternative metrics, many of
2785 See

Prof. Duffie; Occupy.
Occupy.
2787 See AFR et al. (Feb. 2012).
2788 See AFR et al. (Feb. 2012); See also Public
Citizen.
2786 See

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these alternatives are consistent with
the broad themes, risk management,
sources of revenues, customer facing
activity, that inform the quantitative
measurements that are retained in the
final rule. Finally, banking entities will
be expected to develop their own
metrics, as appropriate, to further
inform and improve their own
monitoring and understanding of their
trading activities. Many of the
alternative metrics that were suggested
by commenters, especially those that
relate to a specific market or type of
instrument, may be used by banking
entities as they develop their own
quantitative measurements.
For each individual quantitative
measurement in the final rule,
Appendix A describes the measurement,
provides general guidance regarding
how the measurement should be
calculated 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
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 Appendix A
and at the trading desk level mandated
by the final rule may require banking
entities to implement new processes to
calculate and furnish the required
data.2789
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 tailored
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
2789 See Credit Suisse (Seidel) ; Morgan Stanley;
UBS; Wells Fargo (Prop. Trading); Socie´te´ Ge´ne´rale;
Occupy; Paul Volcker; AFR et al. (Feb. 2012);
Western Asset Mgmt.; Public Citizen.

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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 desks
across firms.
The Agencies expect to evaluate the
data collected during the compliance
period both for its usefulness as a
barometer of impermissible trading
activity and excessive risk-taking and
for its costs. This evaluation will
consider, among other things, whether
all of the quantitative measurements are
useful for all asset classes and markets,
as well as for all the trading activities
subject to the metrics requirement, or if
further tailoring is warranted.2790 The
Agencies propose to revisit the metrics
and determine, based on a review of the
data collected by September 30, 2015,
whether to modify, retain or replace the
metrics. To allow firms to develop
systems to calculate and report these
metrics, the Agencies have delayed all
reporting of the metrics until July 2014,
phased in the reporting requirements
over a multi-year period, and reduced
the category of banking entities that
must report the metrics to a smaller
number of firms that engage in
significant trading activity. These steps,
combined with the reduction in the
number of metrics required to be
reported, are designed to reduce the cost
and burden associated with compiling
and reporting the metrics while
retaining the usefulness of this data
collection in helping to ensure that
trading activities are conducted in
compliance with section 13 of the BHC
Act and the final rule and in a manner
that monitors, assesses and controls the
risks associated with these activities.
4. Section ll.21: Termination of
Activities or Investments; Authorities
for Violations
Section ll.21 implements section
13(e)(2) of the BHC Act, which
authorizes an Agency to order a banking
entity subject to its jurisdiction to
terminate activities or investments that
violate or function as an evasion of
section 13 of the Act.2791 Section
13(e)(2) further provides that this
paragraph shall not be construed to
limit the inherent authority of any
2790 The Agencies believe this review, along with
the fact that quantitative measurements will not be
used as a dispositive tool for determining
compliance and the removal of many of the
proposed metrics, should help address commenters’
concerns that some of the proposed quantitative
measurements will not be as relevant for certain
asset classes, markets, and activities. See Morgan
Stanley; SIFMA et al. (Prop. Trading); Stephen
Roach.
2791 See 12 U.S.C. 1851(e)(2).

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Federal agency or State regulatory
authority to further restrict any
investments or activities under
otherwise applicable provisions of
law.2792
The proposed rule implemented
section 13(e)(2) in two parts. First,
§ ll.21(a) of the proposal required 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.2793
Second, § ll.21(b) of the proposal
provided that if, after due notice and an
opportunity for hearing, the respective
Agency finds reasonable cause to
believe that any banking entity has
engaged in an activity or made an
investment described in paragraph (a),
the Agency may, by order, direct the
entity to restrict, limit, or terminate the
activity and, as relevant, dispose of the
investment.2794
Several commenters urged the
Agencies to strengthen the authorities
provided for under § ll.21,2795 with
some commenters expressing concern
that the proposed rule does not establish
sufficient enforcement mechanisms and
penalties for violations of the rule’s
requirements.2796 Some commenters
suggested the Agencies add language in
§ ll.21 authorizing the imposition of
automatic and significant financial
penalties—as significant as the potential
gains from illegal proprietary trading—
on traders, supervisors, executives, and
firms for violating section 13 of the BHC
Act and the final rule.2797 These
2792 Id.
2793 See proposed rule § ll.21(a). The proposal
noted that the Agencies included § ll.21(a), in
addition to the provisions of § ll.21(b) of the
proposed rule, to clarify that the requirement to
terminate an activity or, as relevant, dispose of an
investment would be triggered when a banking
entity discovers the violation or evasion, regardless
of whether an Agency order has been issued.
2794 See proposed rule § ll.21(b).
2795 See Sen. Merkley; Better Markets (Feb. 2012);
Occupy; AFR et al. (Feb. 2012); Public Citizen.
2796 See, e.g., BEC et al. (Jan. 2012); John Reed;
Better Markets (Feb. 2012); AFR et al. (Feb. 2012);
Occupy; Sen. Merkley; Public Citizen.
2797 See, e.g., Form Letter Type A; Form Letter
Type B; Sarah McKee; David R. Wilkes; Ben Leet;
Karen Michaelis; Barry Rein; Allan Richardson;
Ronald Gedrim; Susan Pashkoff; Joan Budd; Frances
Vreman; Lisa Kazmier; Michael Wenger; Dyanne
DiRosario; Alexander Clayton; James Ofsink;
Richard Leining (arguing that violators should face

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commenters suggested the Agencies
incorporate reference to the Board’s
authority under section 8 of the BHC
Act into the rule,2798 and others
encouraged the Agencies to rely on their
inherent authority to impose automatic
penalties and fines.2799 A few
commenters stated that traders,
management, and banking entities
should be held responsible for
violations under certain
circumstances.2800 Finally, another
commenter recommended that officers
and directors of a banking entity be
removed from office, be prohibited from
being affiliated with a banking entity,
and be subject to salary clawbacks for
violations of section 13 of the BHC Act
and the final rule.2801
The Agencies note that the authorities
provided for in § ll.21 are not
exclusive. The Agencies have a number
of enforcement tools at their disposal to
carry out their obligations to ensure
compliance with section 13 of the BHC
Act and the final rule, and need not
reference them expressly in § ll.21 in
order to exercise them. Specifically, the
Agencies may rely on their inherent
authorities under otherwise applicable
provisions of banking, securities, and
commodities laws to bring enforcement
actions against banking entities, their
officers and directors, and other
institution-affiliated parties for
violations of law.2802 For example, a
banking entity that violates section 13 of
the BHC Act and the final rule may be
subject to criminal and civil penalties
under section 8 of the BHC Act. Banking
entities may also be subject to formal
enforcement actions under section 8 of
the Federal Deposit Insurance Act
(FDIA), such as cease and desist orders
penalties such as seizure and discharge of the board
and executives); Lee Smith; See also Occupy; Public
Citizen.
2798 See Better Markets (Feb. 2012) (contending
that penalties should include specific
administrative penalties, including monetary
penalties, bars, cease and desist orders,
strengthened penalties for recurring violations, and
sanctioning of employees involved in the violation
and public reporting of such sanctions); AFR et al.
(arguing that section 8 of the BHC Act provides civil
penalties for violations by a company or individual
and criminal penalties for willful violations of the
BHC Act). See also Occupy (requesting the Agencies
provide penalties that are specific to this rule in
addition to the general framework for criminal and
civil penalties in section 8 of the BHC Act).
2799 See Better Markets (Feb. 2012); Occupy; AFR
et al. (Feb. 2012).
2800 See John Reed; Better Markets (Feb. 2012).
See also BEC et al. (Jan. 2012) (arguing that CEOs
and CFOs should be held fully responsible for any
violations of the rule by any employees above the
clerical level); Occupy (recommending that traders
relying on an exemption in the proposed rule be
held personally liable for any losses on trading
positions).
2801 See Occupy.
2802 See 12 U.S.C. 1851(g)(3).

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or civil money penalty actions,2803 or
safety and soundness orders under
section 39 of the FDIA which may be
enforceable through assessment of civil
money penalties and through the federal
court system. In addition, officers,
directors, and other institution-affiliated
parties2804 may be subject to civil
money penalties, prohibition or removal
actions, and personal cease and desist
orders under section 8 of the FDIA.
Submission of late, false, or misleading
reports, including false statements on
compliance with section 13 of the BHC
Act or the final rule, may also result in
actions under applicable securities,
commodities, banking, and criminal
laws, including imposition of civil
money and criminal penalties.2805
Therefore, the final rule is consistent
with the proposal and does not mention
other enforcement actions available to
address violations of section 13 of the
BHC Act and this final rule.
Section 13 of the BHC Act and the
final rule do not limit the reach or
applicability of the antifraud and other
provisions of the federal laws to banking
entities, including, for example, section
17(a) of the Securities Act of 1933 or
section 10(b) and 15(c) of the Exchange
Act and the rules promulgated
thereunder.
One commenter also suggested that
the Agencies use their authority under
section 13(d)(3) of the BHC Act to
impose additional capital requirements
and quantitative limitations on banking
entities for repeat violations of the
prohibition on proprietary trading.2806
The Agencies believe they can rely on
other inherent enforcement authorities
to address repeat violations. The
Agencies note that several other
commenters also requested the Agencies
to exercise their authority under section
13(d)(3).2807 The Agencies do not
believe that it is appropriate to exercise
their authority under this section at this
time, primarily because the capital
treatment of banking entities’ trading
activities is currently being addressed
2803 See, e.g., 12 U.S.C. 1818(i) (authorizing
imposition of civil money penalties up to the
maximum daily amount of $1,000,000 for, among
other things, knowing violations of law or
regulation).
2804 See 12 U.S.C. 1813(u) (defining ‘‘institutionaffiliated party’’).
2805 See, e.g., 12 U.S.C. 164 (authorizing
imposition of civil money penalties for, among
other things, submitting false or misleading reports
or information to the OCC); 18 U.S.C. 1005
(authorizing imposition of fines of not more than
$1,000,000 or imprisonment not more than 30
years, or both, for, among other things, making a
false entry in the books, reports or statements of a
bank with intent to injure, defraud or deceive).
2806 See Better Markets (Feb. 2012).
2807 See Sen. Merkley; Public Citizen; Better
Markets (Feb. 2012); Profs. Admati & Pfleiderer.

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through the Agencies’ risk-based capital
rulemakings.2808 Additionally, the
Agencies believe Congress intended
section 13(d)(3) to serve the prudential
purposes of bolstering the safety and
soundness of individual banking
entities and the wider U.S. financial
system. To the extent commenters
suggested section 13(d)(3) be employed
for a punitive purpose, the Agencies do
not believe the provision was designed
to serve such a purpose nor do the
Agencies believe that would be an
appropriate use of the provision. Thus,
the Agencies believe section 13(d)(3) is
more appropriately employed for the
prudential purposes of bolstering the
safety and soundness of individual
banking entities and the wider financial
stability of the U.S. financial system.
Commenters also urged the Agencies
to clearly delineate in the final rule the
jurisdictional authority of each of the
Agencies to enforce compliance with
section 13 of the BHC Act and the
implementing final rule. A number of
commenters recommended approaches
to coordinating examinations and
enforcement among the Agencies, as
well as to providing interpretive
guidance.2809 For example, some
commenters observed that more than
one Agency would have jurisdiction
over a given banking entity, and
recommended that supervision and
enforcement of the final rule for all
entities within a banking enterprise
remain completely with one Agency.
2810 Further, some commenters
recommended that a single Agency be
appointed to provide interpretations,
supervision, and enforcement of section
13 and the rules thereunder for all
banking entities.2811 Similarly, one
commenter suggested that the Board be
given initial authority to supervise the
implementation of the rule because it is
the primary enforcer of the BHC Act and
the single regulator that can currently
look across a banking group’s entire
global businesses, regardless of legal
entity. This commenter stated that the
Board could then determine whether an
activity should be delegated to one of
2808 See Regulatory Capital Rules: Regulatory
Capital, Implementation of Basel III, Capital
Adequacy, Transition Provisions, Prompt Corrective
Action, Standardized Approach for Risk-weighted
Assets, Market Discipline and Disclosure
Requirements, Advanced Approaches Risk-Based
Capital Rule, and Market Risk Capital Rule; Final
Rule, 78 FR 62,017 (Friday, October 11, 2013).
2809 See SIFMA et al. (Prop. Trading) (Feb. 2012);
JPMC; Barclays; Goldman (Prop. Trading); BoA;
ABA (Keating); Comm. on Capital Market
Regulation; BEC et al.; ISDA (Apr. 2012).
2810 See Barclays (arguing that ideally the
umbrella federal regulator of the enterprise should
take this role); Goldman (Prop. Trading).
2811 See BoA; BEC et al.

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the other Agencies for further
examination or enforcement.2812 In
addition, with respect to interpretive
authority, some commenters indicated
that the Board should be given sole
interpretive authority of the statute and
the rules thereunder.2813 Other
commenters urged the Agencies to
supervise and enforce the rule on a
coordinated basis so as to minimize
duplicative enforcement efforts, reduce
costs, and promote certainty.2814
Section 13(e)(2) mandates that each
Agency enforce compliance of section
13 with respect to a banking entity
‘‘under the respective [A]gency’s
jurisdiction.’’ 2815 This section provides
the Agencies with the authority to order
a banking entity to terminate activities
or investments that violate or function
as an evasion of section 13 of the BHC
Act.2816 Decisions about whether to
issue such orders could be made after
examinations or otherwise. Nothing in
the final rule limits an Agency’s
inherent authority to conduct
examinations or otherwise inspect
banking entities to ensure compliance
with the final rule. Section ll.1 of
each Agency’s proposed rule described
the specific types of banking entities to
which that Agency’s rule applies. The
Agencies acknowledge commenters’
concerns about overlapping
jurisdictional authority. The Agencies
recognize that, on occasion, a banking
entity may be subject to jurisdiction by
more than one Agency. As is customary,
the Agencies plan to coordinate their
examination and enforcement
2812 See

Comm. on Capital Market Regulation.
SIFMA et al. (Prop. Trading) (Feb. 2012);
BoA (recommending that the Board be responsible
for resolving potentially conflicting supervisory
recommendations or matters requiring attention
arising from examinations as well); ISDA (Apr.
2012). See also ABA (Keating) (arguing that the
Agencies should defer to the Board’s sole authority
to interpret provisions of Volcker that intersect with
other statutory provisions subject to the Board’s
jurisdictional authority, such as Super 23A); JPMC
(contending that the Agencies should adopt and
Seek comment on a protocol for supervision and
enforcement that will ensure a given banking entity
will face one set of rules and different banking
entities will face the same set of rules). The
Agencies decline to adopt the commenter’s
suggested approach of deferring to the Board’s sole
interpretive authority with respect to the provisions
of the final rule. The Agencies believe at this time
that such an approach would be neither appropriate
nor effective given the different authorities and
expertise of each Agency. See Part IV.C (discussing
the Agencies’ decision not to adopt some
commenters’ requests that a single agency be
responsible for determining compliance with
section 13).
2814 See SIFMA et al. (Prop. Trading) (Feb. 2012);
BoA (stating that the Agencies should issue one set
of exam findings under these circumstances); ISDA
(Apr. 2012).
2815 See 12 U.S.C. 1851(c)(2).
2816 See 12 U.S.C. 1851(e)(2) (requiring ‘‘due
notice and opportunity for hearing’’).

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2813 See

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proceedings under section 13, to the
extent possible and practicable, so as to
limit duplicative actions and undue
costs and burdens for banking
entities.2817
The Agencies are adopting § ll.21
substantially as proposed. Accordingly,
§ ll.21(a) of the final rule provides
that any banking entity that engages in
an activity or makes an investment in
violation of section 13 of the BHC Act
or the final rule or acts in a manner that
functions as an evasion of the
requirements of section 13 of the BHC
Act or the final rule, including through
an abuse of any activity or investment
permitted or expressly excluded by the
terms of the final rule, or otherwise
violates the restrictions and
requirements of section 13 of the BHC
Act or the final rule, shall, upon
discovery, promptly terminate the
activity and, as relevant, dispose of the
investment. This provision allows the
Agencies to enforce the rule’s
prohibitions against proprietary trading
and sponsoring or owning interests in
covered funds regardless of how
banking entities classify their actions,
while also providing banking entities
the freedom to legitimately engage in
those banking activities which are
outside the scope of the statute.
V. Administrative Law Matters
A. Use of Plain Language
Section 722 of the Gramm-Leach
Bliley Act (Pub. L. 106–102, 113 Stat.
1338, 1471, 12 U.S.C. 4809) requires the
Federal banking agencies to use plain
language in all proposed and final rules
published after January 1, 2000. The
OCC, Board and FDIC invited comment
on whether the proposed rule was
written plainly and clearly, or whether
there were ways the Federal banking
agencies could make the rule easier to
understand. The Federal banking
agencies received no comments on these
matters and believe that the final rule is
written plainly and clearly.
B. Paperwork Reduction Act Analysis
Certain provisions of the final rule
contain ‘‘collection of information’’
requirements within the meaning of the
Paperwork Reduction Act (PRA) of 1995
(44 U.S.C. 3501–3521). In accordance
with the requirements of the PRA, the
Agencies may not conduct or sponsor,
and a respondent is not required to
respond to, an information collection
2817 See 12 U.S.C. 1844 (establishing
jurisdictional boundaries for regulation of bank
holding companies); See also 12 U.S.C. 1828a
(antievasion statute empowering OCC, FDIC, and
the Board to impose restrictions on relationships or
transactions between banks and their subsidiaries
and affiliates).

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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
final rule, to the extent they apply to
insured financial institutions that are
not under a holding company, have
been submitted to OMB for review and
approval by the OCC and FDIC under
section 3507(d) of the PRA and
§ 1320.11 of OMB’s implementing
regulations (5 CFR part 1320). The
Board reviewed the final rule under the
authority delegated to the Board by
OMB.
PRA Submission to OMB
The Board will submit information
collection burden estimates to OMB and
the submission will include burden for
Federal Reserve-supervised institutions,
as well as burden for OCC-, FDIC-,
SEC-, and CFTC-supervised institutions
under a holding company. The OCC and
the FDIC will take burden for banking
entities that are not under a holding
company.
The FDIC and OCC submitted these
information collection estimates to OMB
at the proposed rule stage as well. OMB
filed comments instructing the OCC and
FDIC to examine public comment in
response to the notice of proposed
rulemaking and include in the
supporting statement of the next
Information Collection Request (ICR), to
be submitted to OMB at the final rule
stage, a description of how the OCC and
FDIC have responded to any public
comments in response to the ICR.
Provisions Requiring PRA Clearance
The final rule contains requirements
subject to the PRA. The reporting
requirements are found in §§ ll.12(e)
and ll.20(d); the recordkeeping
requirements are found in §§ ll
.3(d)(3), ll.4(b)(3)(i)(A), ll.5(c),
ll.11(a)(2), and ll.20(b)-(f); and the
disclosure requirements are found in
§ ll.11(a)(8)(i). The recordkeeping
burden for §§ ll.4(a)(2)(iii), ll
.4(b)(2)(iii), ll.5(b)(1), ll.5(b)(2)(i),
ll.5(b)(2)(iv), ll.13(a)(2)(i), and l
l.13(a)(2)(ii)(A) is accounted for in
§ ll.20(b); the recordkeeping burden
for Appendix B is accounted for in § l
l.20(c); the reporting and
recordkeeping burden for Appendix A is
accounted for in § ll.20(d); and the
recordkeeping burden for §§ ll
.10(c)(12)(i) and ll.10(c)(12)(iii) is
accounted for in § ll.20(e). These
information collection requirements
would implement section 619 of the
Dodd-Frank Act, as mentioned in the
Abstract below. The respondent/

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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 [the
Agency] on request.
Comments Received on PRA
Of the comments received in response
to the proposed rule, three specifically
referenced the PRA.2818 They were
received from five industry trade groups
and focused on the analysis of the
regulatory burden imposed by
regulation. They referenced the PRA
burden as an example of the
significance of the burden imposed by
the regulation but did not address
burden in the context of the PRA. A
number of other comments addressed
reporting and recordkeeping
requirements and the utility of the
information to be collected outside the
context of the PRA. As a result of these
and other comments, the Agencies made
changes to the rule. These comments are
discussed throughout the release.

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Proposed Information Collection
Title of Information Collection:
Reporting, Recordkeeping, and
Disclosure Requirements Associated
with Proprietary Trading and Certain
Interests in and Relationships with
Covered Funds.
Frequency of Response: Annual,
monthly, quarterly, 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, U.S. branches or agencies
of foreign banks, 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.
2818 See BoA (acknowledging that the Agencies
performed an analysis of the information costs as
required by the Paperwork Reduction Act); SIFMA
et al. (Covered Funds) (Feb. 2012) (noting that the
Agencies conducted a limited cost/benefit analysis
of the information requirements of the proposed
rules under the PRA); Chamber (Nov. 2013) (noting
that the burden estimates for the proposed rule
stand at almost 6,600,000 hours per year).

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OCC: National banks, federal savings
associations, federal savings banks not
under a holding company, and their
respective subsidiaries, and their
affiliates not under a holding company,
and U.S. branches or agencies of foreign
banks. 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: Insured 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 and their branches and
agencies.
Abstract:
Section 619 of the Dodd-Frank 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. As noted above, the final
rule contains requirements subject to
the PRA. The Agencies believe that the
reporting, recordkeeping, and disclosure
requirements associated with the rule
will permit banking entities and the
Agencies to enforce compliance with
section 13 of the BHC Act and the final
rule and to identify, monitor and limit
risks of activities permitted under
section 13, particularly involving
banking entities posing the greatest risk
to financial stability. Compliance with
the information collections would be
mandatory. As noted above, a number of
commenters addressed reporting and
recordkeeping requirements and the
utility of the information to be collected
outside the context of the PRA. As a
result of these comments, the Agencies
made changes to the rule, which are
discussed throughout the release. The
final burden estimates take these
changes into account and reflect the
anticipated burden under the final rules.
As discussed in the release, in brief, the
purpose for the recordkeeping,
disclosure, and reporting requirements
contained within the rule is to facilitate
compliance with section 13 of the BHC
and implementing rules.

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5775

Section-by-Section Analysis
PRA Reporting Requirements
Section ll.12(e) states that, upon
application by a banking entity, the
Board may extend the period of time to
meet the requirements on ownership
limitations in 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 (1) be
submitted to the Board at least 90 days
prior to expiration, (2) provide the
reasons for application including
information that addresses the factors in
paragraph (e)(2) of § ll.12, and (3)
explain the banking entity’s plan for
reducing the permitted investment in a
covered fund through redemption, sale,
dilution or other methods.
Section ll.20(d) provides that a
banking entity engaged in proprietary
trading activity must comply with the
reporting requirements described in
Appendix A, if (1) the banking entity
has, together with its affiliates and
subsidiaries, trading assets and
liabilities the average gross sum of
which over the previous consecutive
four quarters, as measured as of the last
day of each of the four prior calendar
quarters, equals or exceeds the
established threshold; (2) in the case of
a foreign banking entity, the average
gross sum of the trading assets and
liabilities of the combined U.S.
operations of the foreign banking entity
(including all subsidiaries, affiliates,
branches and agencies of the foreign
banking entity operating, located or
organized in the United States and
excluding trading assets and liabilities
involving obligations of or guaranteed
by the United States or any agency of
the United States) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the established threshold; or (3)
the appropriate agency notifies the
banking entity in writing that it must
satisfy the reporting requirements
contained in Appendix A of this part.
The threshold for reporting is $50
billion beginning on June 30, 2014; $25
billion beginning on April 30, 2016; and
$10 billion beginning on December 31,
2016. Unless the appropriate agency
notifies the banking entity in writing
that it must report on a different basis,
a banking entity with $50 billion or
more in trading assets and liabilities
shall report the information required by
Appendix A for each calendar month
within 30 days of the end of the relevant
calendar month; beginning with
information for the month of January

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2015, such information shall be reported
within 10 days of the end of that
calendar month. Any other banking
entity subject to Appendix A shall
report the information required by
Appendix A for each calendar quarter
within 30 days of the end of that
calendar quarter unless the appropriate
agency notifies the banking entity in
writing that it must report on a different
basis. Appendix A requires banking
entities to furnish the following
quantitative measurements for each
trading desk of the banking entity: (1)
risk and position limits and usage; (2)
risk factor sensitivities; (3) Value-at-Risk
and stress VaR; (4) comprehensive profit
and loss attribution; (5) inventory
turnover; (6) inventory aging; and (7)
customer facing trade ratio.
Recordkeeping Requirements
Section ll.3(d)(3) specifies that
proprietary trading does not include any
purchase or sale of a security by a
banking entity for the purpose of
liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that (1) specifically contemplates and
authorizes the particular securities to be
used for liquidity management
purposes, the amount, types, and risks
of these securities that are consistent
with liquidity management, and the
liquidity circumstances in which the
particular securities may or must be
used; (2) requires that any purchase or
sale of securities contemplated and
authorized by the plan be principally for
the purpose of managing the liquidity of
the banking entity, and not for the
purpose of short-term resale, benefitting
from actual or expected short-term price
movements, realizing short-term
arbitrage profits, or hedging a position
taken for such short-term purposes; (3)
requires that any securities purchased or
sold for liquidity management purposes
be highly liquid and limited to
securities the market, credit and other
risks of which the banking entity does
not reasonably expect to give rise to
appreciable profits or losses as a result
of short-term price movements; (4)
limits any securities purchased or sold
for liquidity management purposes,
together with any other instruments
purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan; (5) includes
written policies and procedures,
internal controls, analysis and
independent testing to ensure that the

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purchase and sale of securities that are
not permitted under § ll.6(a) or (b) of
this part are for the purpose of liquidity
management and in accordance with the
liquidity management plan described in
this paragraph; and (6) is consistent
with the appropriate agency’s
supervisory requirements, guidance and
expectations regarding liquidity
management.
Section ll.4(b)(3)(i)(A) provides
that a trading desk or other
organizational unit of another entity
with more than $50 billion in trading
assets and liabilities is not a client,
customer, or counterparty unless the
trading desk documents how and why a
particular trading desk or other
organizational unit of the entity should
be treated as a client, customer, or
counterparty of the trading desk for
purposes of § ll.4(b). This
modification responds to comments
received on the proposal regarding the
definition of client, customer, or
counterparty for purposes of the market
making exemption.
Section ll.5(c) requires
documentation for any purchase or sale
of a financial instrument for riskmitigating hedging purposes that is: (1)
not established by the specific trading
desk establishing the underlying
positions, contracts, or other holdings
the risks of which the hedging activity
is designed to reduce; (2) established by
the specific trading desk establishing or
responsible for the underlying positions,
contracts, or other holdings but that is
not specifically identified in the trading
desk’s written policies and procedures;
or (3) established to hedge aggregated
positions across two or more trading
desks. In connection with any purchase
or sale that meets these specified
circumstances, a banking entity must, at
a minimum and contemporaneously
with the purchase or sale, document (1)
the specific, identifiable risk(s) of the
identified positions, contracts, or other
holdings of the banking entity that the
purchase or sale is designed to reduce;
(2) the specific risk-mitigating strategy
that the purchase or sale is designed to
fulfill; and (3) the trading desks or other
business unit that is establishing and
responsible for the hedge. The banking
entity must also create and retain
records sufficient to demonstrate
compliance with this section for at least
5 years in a form that allows the banking
entity to promptly produce such records
to the appropriate agency on request, or
such longer period as required under
other law or this part.
Section ll.11(a)(2) requires that
covered funds generally must be
organized and offered only in
connection with the provision of bona

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fide trust, fiduciary, investment
advisory, or commodity trading
advisory services and only to persons
that are customers of such services of
the banking entity, pursuant to a written
plan or similar documentation outlining
how the banking entity intends to
provide advisory or other similar
services to its customers through
organizing and offering the covered
fund.
Section ll.20(b) specifies the
contents of the compliance program for
a banking entity with total consolidated
assets of $10 billion or more. It includes:
(1) written policies and procedures
reasonably designed to document,
describe, monitor and limit trading
activities, including setting and
monitoring required limits set out in
§ ll.4 and § ll.5 and activities and
investments with respect to a covered
fund (including those permitted under
§§ ll.3 through ll.6 or §§ ll.11
through ll.14) to ensure that all
activities and investments conducted by
the banking entity that are subject to
section 13 of the BHC Act and this part
comply with section 13 of the BHC Act
and applicable regulations; (2) a system
of internal controls reasonably designed
to monitor compliance with section 13
of the BHC Act and this part and to
prevent the occurrence of activities or
investments that are prohibited by
section 13 of the BHC Act and
applicable regulations; (3) a
management framework that clearly
delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and this part
and includes appropriate management
review of trading limits, strategies,
hedging activities, investments,
incentive compensation and other
matters identified in this part or by
management as requiring attention; (4)
independent testing and audit of the
effectiveness of the compliance program
conducted periodically by qualified
personnel of the banking entity or by a
qualified outside party; (5) training for
trading personnel and managers, as well
as other appropriate personnel, to
effectively implement and enforce the
compliance program; and (6) records
sufficient to demonstrate compliance
with section 13 of the BHC Act and
applicable regulations, which a banking
entity must promptly provide to the
[Agency] upon request and retain for a
period of no less than 5 years or such
longer period as required by [Agency].
Section ll.20(c) specifies that the
compliance program of a banking entity
must satisfy the requirements and other
standards contained in Appendix B, if
(1) the banking entity engages in
proprietary trading permitted under

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subpart B and is required to comply
with the reporting requirements of
§ ll.20(d); (2) the banking entity has
reported total consolidated assets as of
the previous calendar year end of $50
billion or more or, in the case of a
foreign banking entity, has total U.S.
assets as of the previous calendar year
end of $50 billion or more (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States); or (3) the [Agency]
notifies the banking entity in writing
that it must satisfy the requirements and
other standards contained in Appendix
B. Appendix B provides enhanced
minimum standards for compliance
programs for banking entities that meet
the thresholds in § ll.20(c) as
described above. These include the
establishment, maintenance, and
enforcement of the enhanced
compliance program and meeting the
minimum written policies and
procedures, internal controls,
management framework, independent
testing, training, and recordkeeping. The
program must: (1) be reasonably
designed to identify, document, monitor
and report the permitted trading and
covered fund activities and investments;
identify, monitor and promptly address
the risk of these covered activities and
investments and potential areas of
noncompliance; and prevent activities
or investments prohibited by, or that do
not comply with, section 13 of the BHC
Act and this part; (2) establish and
enforce appropriate limits on covered
activities and investments, including
limits on size, scope, complexity, and
risks of individual activities or
investments consistent with the
requirements of section 13 of the BHC
Act and this part; (3) subject the
effectiveness of the compliance program
to periodic independent review and
testing, and ensure that internal audit,
corporate compliance and internal
control functions involved in review
and testing are effective and
independent; (4) make senior
management and others accountable for
effective implementation of compliance
program and ensure that board of
directors and chief executive officer (or
equivalent) of the banking entity review
effectiveness of the compliance
program; and (5) facilitate supervision
and examination by Agencies of
permitted trading and covered fund
activities and investments.
Section ll.20(d) provides that
certain banking entities engaged in
certain proprietary trading activities
must comply with the reporting
requirements described in Appendix A.

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A banking entity must also, for any
quantitative measurement furnished to
the appropriate agency pursuant to
§ ll.20(d) and Appendix A, create and
maintain records documenting the
preparation and content of these reports,
as well as such information as is
necessary to permit the appropriate
agency to verify the accuracy of such
reports, for a period of 5 years from the
end of the calendar year for which the
measurement was taken.
Section ll.20(e) specifies additional
documentation required for covered
funds. Any banking entity that has more
than $10 billion in total consolidated
assets as reported on December 31 of the
previous two calendar years shall
maintain records that include: (1)
documentation of the exclusions or
exemptions other than sections 3(c)(1)
and 3(c)(7) of the Investment Company
Act of 1940 relied on by each fund
sponsored by the banking entity
(including all subsidiaries and affiliates)
in determining that such fund is not a
covered fund; (2) for each fund
sponsored by the banking entity
(including all subsidiaries and affiliates)
for which the banking entity relies on
one or more of the exclusions from the
definition of covered fund provided by
§§ ll.10(c)(1),ll.10(c)(5),
ll.10(c)(8), ll.10(c)(9), or
ll.10(c)(10) of subpart C,
documentation supporting the banking
entity’s determination that the fund is
not a covered fund pursuant to one or
more of those exclusions; (3) for each
seeding vehicle described in
§§ ll.10(c)(12)(i) or ll.10(c)(12)(iii)
of subpart C that will become a
registered investment company or SECregulated business development
company, a written plan documenting
the banking entity’s determination that
the seeding vehicle will become a
registered investment company or SECregulated business development
company; the period of time during
which the vehicle will operate as a
seeding vehicle; and the banking
entity’s plan to market the vehicle to
third-party investors and convert it into
a registered investment company or
SEC-regulated business development
company within the time period
specified in § ll.12(a)(2)(i)(B) of
subpart C; and (4) for any banking entity
that is, or is controlled directly or
indirectly by a banking entity that is,
located in or organized under the laws
of the United States or of any State, if
the aggregate amount of ownership
interests in foreign public funds that are
described in § ll.10(c)(1) of subpart C
owned by such banking entity
(including ownership interests owned

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by any affiliate that is controlled
directly or indirectly by a banking entity
that is located in or organized under the
laws of the United States or of any State)
exceeds $50 million at the end of two
or more consecutive calendar quarters,
beginning with the next succeeding
calendar quarter, documentation of the
value of the ownership interests owned
by the banking entity (and such
affiliates) in each foreign public fund
and each jurisdiction in which any such
foreign public fund is organized,
calculated as of the end of each calendar
quarter, which documentation must
continue until the banking entity’s
aggregate amount of ownership interests
in foreign public funds is below $50
million for two consecutive calendar
quarters.
Section ll.20(f)(1) applies to
banking entities with no covered
activities. A banking entity that does not
engage in activities or investments
pursuant to subpart B or subpart C
(other than trading activities permitted
pursuant to § ll.6(a) of subpart B) may
satisfy the requirements of this section
by establishing the required compliance
program prior to becoming engaged in
such activities or making such
investments (other than trading
activities permitted pursuant to
§ ll.6(a) of subpart B).
Section ll.20(f)(2) applies to
banking entities with modest activities.
A banking entity with total consolidated
assets of $10 billion or less as reported
on December 31 of the previous two
calendar years that engages in activities
or investments pursuant to subpart B or
subpart C of this part (other than trading
activities permitted under section
ll.6(a)) may satisfy the requirements
of this section by including in its
existing compliance policies and
procedures appropriate references to the
requirements of section 13 and this part
and adjustments as appropriate given
the activities, size, scope and
complexity of the banking entity.
Disclosure Requirements
Section ll.11(a)(8)(i) requires that a
banking entity must 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 banking entity]; therefore, [the
banking entity’s] losses in [such covered
fund] will be limited to losses
attributable to the ownership interests
in the covered fund held by [the
banking entity] in its capacity as
investor in the [covered fund] or as

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beneficiary of a restricted profit interest
held by [the banking entity]’’; (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 banking entity and its affiliates
and employees in sponsoring or
providing any services to the covered
fund.
PRA Burden Estimates
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.
Estimated PRA Burden per Response:
Reporting Burden
§ ll.12(e)—20 hours (Initial set up
50 hours).
§ ll.20(d)—2 hours (Initial setup 6
hours).
PRA Recordkeeping Burden
§ ll.3(d)(3)—1 hour (Initial setup 3
hours).
§ ll.4(b)(3)(i)(A)—2 hours.
§ ll.5(c)—100 hours (Initial setup
50 hours).
§ ll.11(a)(2)—10 hours.
§ ll.20(b)—265 hours (Initial setup
795 hours).
§ ll.20(c)—1,200 hours (Initial
setup 3,600 hours).
§ ll.20(d)—440 hours for entities
with $50 billion or more in trading
assets/liabilities; 350 hours for entities
with $10 to $50 billion in trading assets/
liabilities.
§ ll.20(e)—200 hours.
§ ll.20(f)(1)—8 hours.
§ ll.20(f)(2)—40 (Initial setup 100
hours).
PRA Disclosure Burden
§ ll.11(a)(8)(i)—0.1 hours.

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Board
Number of respondents: 5,027.
Total estimated annual burden:
2,336,190 hours (968,488 hours for
initial setup and 1,367,702 hours for
ongoing compliance).
FDIC
Number of respondents: 797.
Total estimated annual burden:
28,234 hours (14,165 hours for initial
setup and 14,069 hours for ongoing
compliance).

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OCC
Number of respondents: 381.
Total estimated annual burden:
28,016 hours (14,386 hours for initial
setup and 13,630 hours for ongoing
compliance).
C. Regulatory Flexibility Act Analysis
In general, section 4 of the Regulatory
Flexibility Act (5 U.S.C. 604) (RFA)
requires an agency to prepare a final
regulatory flexibility analysis (FRFA) for
a final rule unless the agency certifies
that the rule will not, if promulgated,
have a significant economic impact on
a substantial number of small entities
(defined as of July 22, 2013, to include
banking entities with total assets of $500
million or less (‘‘small banking
entities’’).2819 Pursuant to section 605(b)
of the RFA, a FRFA is not required if an
agency certifies that the final rule will
not have a significant economic impact
on a substantial number of small
entities. The Agencies have considered
the potential economic impact of the
final rule on small banking entities in
accordance with the RFA. The Agencies
believe that the final rule will not have
a significant economic impact on a
substantial number of small banking
entities for the reasons described below.
The Agencies previously considered
the impact of the proposed rule for
purposes of the RFA and concluded that
the proposed rule would not appear to
have a significant economic impact on
a substantial number of small banking
entities. In support of this conclusion,
the proposed rule, among other things,
noted that the thresholds for the metrics
reporting requirements under § l.7 and
Appendix A and for the enhanced and
core compliance program requirements
under § l.20 and Appendix C of the
proposed rule would not capture small
banking entities.2820
The Agencies received several
comments on the impact of the
proposed rule on small entities.
Commenters argued that the Agencies
incorrectly concluded that the proposed
rule would not have a significant
economic impact on a substantial
number of small entities.2821
Commenters asserted that the proposed
rule would have a significant economic
impact on numerous small non-banking
entities by restricting their access to a
variety of products and services,
2819 See 13 CFR 121.201; See also 13 CFR
121.103(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).
2820 See Joint Proposal, 76 FR 68,938–68,939.
2821 See BoA; SIFMA et al. (Covered Funds) (Feb.
2012); Chamber (Feb. 2012); ABA (Keating).

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including covered fund-linked products
for investment and hedging purposes
and underwriting and market-making
related services.2822
The Agencies have carefully
considered these comments in
developing a final rule. To minimize
burden on small banking entities,
section ll.20(f)(1) of the final rule
provides that a banking entity that does
not engage in covered trading activities
(other than trading in U.S. government
or agency obligations, obligations of
specified government sponsored
entities, and state and municipal
obligations) or covered fund activities
and investments need only establish a
compliance program prior to becoming
engaged in such activities or making
such investments. In addition, to
minimize the burden on small banking
entities, a banking entity with total
consolidated assets of $10 billion or less
that engages in covered trading
activities and/or covered fund activities
may satisfy the requirements of the final
rule by including in its existing
compliance policies and procedures
appropriate references to the
requirements of section 13 and the final
rule and adjustments as appropriate
given the activities, size, scope and
complexity of the banking entity. Only
those banking entities with total assets
of greater than $10 billion will need to
adopt more detailed or enhanced
compliance requirements under the
final rule. (For purposes of the
enhanced compliance program in
Appendix B of the final rule, the
threshold for banking entities is total
consolidated assets of $50 billion or
more.) Accordingly, the compliance
requirements under the final rule do not
have a significant economic impact on
a substantial number of small banking
entities.
Likewise, the final rule raises the
threshold for metrics reporting from the
proposed rule to capture only firms that
engage in significant trading activities.
Specifically, the metrics reporting
requirements under § l.20 and
Appendix A of the final rule apply only
to banking entities with average trading
assets and liabilities on a consolidated,
worldwide basis for the preceding year
equal to or greater than $10 billion.
Accordingly, the metrics reporting
requirements under the final rule do not
impact small banking entities.
Moreover, the Agencies have revised
the definition of covered fund in the
final rule to address many of the
concerns raised by commenters
regarding the unintended consequences
2822 See SIFMA et al. (Covered Funds) (Feb.
2012); Chamber (Feb. 2012).

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of the proposed definition.2823 The
definition of covered fund under the
final rule contains a number of
exclusions for entities that may rely on
exclusions from the Investment
Company Act of 1940 contained in
section 3(c)(1) or 3(c)(7) of that Act but
that are not engaged in investment
activities of the type contemplated by
section 13 of the BHC Act. These
include, for example, exclusions for
wholly owned subsidiaries, joint
ventures, acquisition vehicles,
insurance company separate accounts,
registered investments companies, and
public welfare investment funds. The
Agencies believe that these changes will
further minimize the burden for small
banking entities such as those that may
use wholly owned subsidiaries for
organizational convenience or make
public welfare investments to achieve
their financial and Community
Reinvestment Act goals.
Finally, in response to commenters’
assertion that the proposed rule would
have had a significant economic impact
on numerous small non-banking entities
by restricting their access to a variety of
products and services,2824 the Agencies
note that the RFA does not require the
Agencies to consider the impact of the
final rule, including its indirect
economic effects, on small entities that
are not subject to the requirements of
the final rule.2825
For the reasons stated above, the OCC,
FDIC, SEC, and CFTC certify, for the
banking entities subject to each such
Agency’s jurisdiction, that the final rule
will not result in a significant economic
impact on a substantial number of small
entities. In light of the foregoing, the
Board does not believe, for the banking
entities subject to the Board’s
jurisdiction, that the final rule would
have a significant economic impact on
a substantial number of small entities.
2823 See

Part IV.B.1. of this SUPPLEMENTARY

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INFORMATION.
2824 See SIFMA et al. (Covered Funds) (Feb.
2012); Chamber (Feb. 2012).
2825 See e.g., In Mid-Tex Electric Cooperative v.
FERC, 773 F.2d 327 (D.C. Cir. 1985); United
Distribution Cos. v. FERC, 88 F.3d 1105, 1170 (D.C.
Cir. 1996); Cement Kiln Recycling Coalition v. EPA,
255 F.3d 855 (D.C. Cir. 2001). Commenters relied
on Aeronautical Repair Station Association v.
Federal Aviation Administration, 494 F.3d 161
(D.C. Cir 2007) to argue that the Agencies must
consider the indirect economic effects of the final
rule on small non-banking entities. This case is
inapposite, however, because there the agency’s
own rulemaking release expressly stated that the
rule imposed responsibilities directly on certain
small business contractors. The court reaffirmed its
prior holdings that the RFA limits its application to
small entities ‘‘which will be subject to the
proposed regulation—that is, those small entities to
which the proposed rule will apply.’’ Id. at 176
(emphasis and internal quotations omitted).

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D. OCC Unfunded Mandates Reform Act
of 1995 Determination
The Unfunded Mandates Reform Act
of 1995, Public Law 104–4 (2 U.S.C.
1532) (UMRA) requires a Federal agency
to 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 (adjusted annually for inflation)
in any one year. If a budgetary impact
statement is required, Section 205 of the
UMRA also requires an agency to
identify and consider a reasonable
number of regulatory alternatives before
promulgating a rule.
The OCC previously determined that
the proposed rule would not impose any
Federal mandates resulting in
expenditures by State, local, and tribal
governments, in the aggregate, or by the
private sector of $100 million or more
(adjusted annually for inflation) in any
one year. Several commenters argued
that the OCC failed to consider all
relevant expenditures and that that the
proposed rule should have qualified as
a significant regulatory action under
UMRA.2826
The OCC has carefully considered
these comments in completing its
UMRA analysis of the final rule. The
OCC has determined that the final rule
qualifies as a significant regulatory
action under the UMRA because its
Federal mandates may result in
expenditures by the private sector in
excess of $100 million or more (adjusted
annually for inflation) in any one year.
Text of Common Rule
PART [ll] PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
Subpart A Authority and Definitions
Sec.
ll.1 Authority, purpose, scope, and
relationship to other authorities
[Reserved].
ll.2 Definitions.
Subpart B Proprietary Trading
ll.3 Prohibition on proprietary trading.
ll.4 Permitted underwriting and market
making-related activities.
ll.5 Permitted risk-mitigating hedging
activities.
ll.6 Other permitted proprietary trading
activities.
ll.7 Limitations on permitted proprietary
trading activities.
ll.8 [Reserved]
ll.9 [Reserved]
2826 See BoA; SIFMA et al. (Covered Funds);
Chamber.

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Subpart C Covered Fund Activities and
Investments
ll.10 Prohibition on acquiring or
retaining an ownership interest in and
having certain relationships with a
covered fund.
ll.11 Permitted organizing and offering,
underwriting, and market making with
respect to a covered fund.
ll.12 Permitted investment in a covered
fund.
ll.13 Other permitted covered fund
activities and investments.
ll.14 Limitations on relationships with a
covered fund.
ll.15 Other limitations on permitted
covered fund activities and investments.
ll.16 [Reserved]
ll.17 [Reserved]
ll.18 [Reserved]
ll.19 [Reserved]
Subpart D Compliance Program
Requirement; Violations
ll.20 Program for compliance; reporting.
ll.21 Termination of activities or
investments; penalties for violations.
Appendix A Reporting and Recordkeeping
Requirements for Covered Trading
Activities
Appendix B Enhanced Minimum Standards
for Compliance Programs

Subpart A—Authority and Definitions
§ ll.1 Authority, purpose, scope, and
relationship to other authorities [Reserved]
§ ll.2

Definitions.

Unless otherwise specified, for
purposes of this part:
(a) Affiliate has the same meaning as
in section 2(k) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(k)).
(b) Bank holding company has the
same meaning as in section 2 of the
Bank Holding Company Act of 1956 (12
U.S.C. 1841).
(c) Banking entity. (1) Except as
provided in paragraph (c)(2) of this
section, banking entity means:
(i) Any insured depository institution;
(ii) Any company that controls an
insured depository institution;
(iii) Any company that is treated as a
bank holding company for purposes of
section 8 of the International Banking
Act of 1978 (12 U.S.C. 3106); and
(iv) Any affiliate or subsidiary of any
entity described in paragraphs (c)(1)(i),
(ii), or (iii) of this section.
(2) Banking entity does not include:
(i) A covered fund that is not itself a
banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under
the authority contained in section
4(k)(4)(H) or (I) of the BHC Act (12
U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small
business investment company, as

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defined in section 103(3) of the Small
Business Investment Act of 1958 (15
U.S.C. 662), so long as the portfolio
company or portfolio concern is not
itself a banking entity under paragraphs
(c)(1)(i), (ii), or (iii) of this section; or
(iii) The FDIC acting in its corporate
capacity or as conservator or receiver
under the Federal Deposit Insurance Act
or Title II of the Dodd-Frank Wall Street
Reform and Consumer Protection Act.
(d) Board means the Board of
Governors of the Federal Reserve
System.
(e) CFTC means the Commodity
Futures Trading Commission.
(f) Dealer has the same meaning as in
section 3(a)(5) of the Exchange Act (15
U.S.C. 78c(a)(5)).
(g) Depository institution has the same
meaning as in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)).
(h) Derivative. (1) Except as provided
in paragraph (h)(2) of this section,
derivative means:
(i) Any swap, as that term is defined
in section 1a(47) of the Commodity
Exchange Act (7 U.S.C. 1a(47)), or
security-based swap, as that term is
defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68));
(ii) Any purchase or sale of a
commodity, that is not an excluded
commodity, for deferred shipment or
delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as
that term is defined in section 1a(24) of
the Commodity Exchange Act (7 U.S.C.
1a(24)) or foreign exchange swap (as
that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C.
1a(25));
(iv) Any agreement, contract, or
transaction in foreign currency
described in section 2(c)(2)(C)(i) of the
Commodity Exchange Act (7 U.S.C.
2(c)(2)(C)(i));
(v) Any agreement, contract, or
transaction in a commodity other than
foreign currency described in section
2(c)(2)(D)(i) of the Commodity Exchange
Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under
section 19 of the Commodity Exchange
Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or
other agreement, contract, or transaction
that the CFTC and SEC have further
defined by joint regulation,
interpretation, guidance, or other action
as not within the definition of swap, as
that term is defined in section 1a(47) of
the Commodity Exchange Act (7 U.S.C.
1a(47)), or security-based swap, as that
term is defined in section 3(a)(68) of the
Exchange Act (15 U.S.C. 78c(a)(68)); or

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(ii) Any identified banking product, as
defined in section 402(b) of the Legal
Certainty for Bank Products Act of 2000
(7 U.S.C. 27(b)), that is subject to section
403(a) of that Act (7 U.S.C. 27a(a)).
(i) Employee includes a member of the
immediate family of the employee.
(j) Exchange Act means the Securities
Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(k) Excluded commodity has the same
meaning as in section 1a(19) of the
Commodity Exchange Act (7 U.S.C.
1a(19)).
(l) FDIC means the Federal Deposit
Insurance Corporation.
(m) Federal banking agencies means
the Board, the Office of the Comptroller
of the Currency, and the FDIC.
(n) Foreign banking organization has
the same meaning as in section
211.21(o) of the Board’s Regulation K
(12 CFR 211.21(o)), but does not include
a foreign bank, as defined in section
1(b)(7) of the International Banking Act
of 1978 (12 U.S.C. 3101(7)), that is
organized under the laws of the
Commonwealth of Puerto Rico, Guam,
American Samoa, the United States
Virgin Islands, or the Commonwealth of
the Northern Mariana Islands.
(o) Foreign insurance regulator means
the insurance commissioner, or a
similar official or agency, of any country
other than the United States that is
engaged in the supervision of insurance
companies under foreign insurance law.
(p) General account means all of the
assets of an insurance company except
those allocated to one or more separate
accounts.
(q) Insurance company means a
company that is organized as an
insurance company, primarily and
predominantly engaged in writing
insurance or reinsuring risks
underwritten by insurance companies,
subject to supervision as such by a state
insurance regulator or a foreign
insurance regulator, and not operated
for the purpose of evading the
provisions of section 13 of the BHC Act
(12 U.S.C. 1851).
(r) Insured depository institution 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 an
insured depository institution that is
described in section 2(c)(2)(D) of the
BHC Act (12 U.S.C. 1841(c)(2)(D)).
(s) Loan means any loan, lease,
extension of credit, or secured or
unsecured receivable that is not a
security or derivative.
(t) Primary financial regulatory
agency has the same meaning as in
section 2(12) of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act (12 U.S.C. 5301(12)).

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(u) Purchase includes any contract to
buy, purchase, or otherwise acquire. For
security futures products, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a commodity future, purchase
includes any contract, agreement, or
transaction for future delivery. With
respect to a derivative, purchase
includes the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(v) Qualifying foreign banking
organization means a foreign banking
organization that qualifies as such under
section 211.23(a), (c) or (e) of the
Board’s Regulation K (12 CFR 211.23(a),
(c), or (e)).
(w) SEC means the Securities and
Exchange Commission.
(x) Sale and sell each include any
contract to sell or otherwise dispose of.
For security futures products, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a commodity future, such
terms include any contract, agreement,
or transaction for future delivery. With
respect to a derivative, such terms
include the execution, termination
(prior to its scheduled maturity date),
assignment, exchange, or similar
transfer or conveyance of, or
extinguishing of rights or obligations
under, a derivative, as the context may
require.
(y) Security has the meaning specified
in section 3(a)(10) of the Exchange Act
(15 U.S.C. 78c(a)(10)).
(z) Security-based swap dealer has the
same meaning as in section 3(a)(71) of
the Exchange Act (15 U.S.C. 78c(a)(71)).
(aa) Security future has the meaning
specified in section 3(a)(55) of the
Exchange Act (15 U.S.C. 78c(a)(55)).
(bb) Separate account means an
account established and maintained by
an insurance company in connection
with one or more insurance contracts to
hold assets that are legally segregated
from the insurance company’s other
assets, under which income, gains, and
losses, whether or not realized, from
assets allocated to such account, are, in
accordance with the applicable contract,
credited to or charged against such
account without regard to other income,
gains, or losses of the insurance
company.
(cc) State means any State, the District
of Columbia, the Commonwealth of
Puerto Rico, Guam, American Samoa,
the United States Virgin Islands, and the
Commonwealth of the Northern Mariana
Islands.

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(dd) Subsidiary has the same meaning
as in section 2(d) of the Bank Holding
Company Act of 1956 (12 U.S.C.
1841(d)).
(ee) State insurance regulator means
the insurance commissioner, or a
similar official or agency, of a State that
is engaged in the supervision of
insurance companies under State
insurance law.
(ff) Swap dealer has the same meaning
as in section 1(a)(49) of the Commodity
Exchange Act (7 U.S.C. 1a(49)).
Subpart B—Proprietary Trading

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§ ___.3

Prohibition on proprietary trading.

(a) Prohibition. Except as otherwise
provided in this subpart, a banking
entity may not engage in proprietary
trading. Proprietary trading means
engaging as principal for the trading
account of the banking entity in any
purchase or sale of one or more
financial instruments.
(b) Definition of trading account. (1)
Trading account means any account that
is used by a banking entity to:
(i) Purchase or sell one or more
financial instruments principally for the
purpose of:
(A) Short-term resale;
(B) Benefitting from actual or
expected short-term price movements;
(C) Realizing short-term arbitrage
profits; or
(D) Hedging one or more positions
resulting from the purchases or sales of
financial instruments described in
paragraphs (b)(1)(i)(A), (B), or (C) of this
section;
(ii) Purchase or sell one or more
financial instruments that are both
market risk capital rule covered
positions and trading positions (or
hedges of other market risk capital rule
covered positions), if the banking entity,
or any affiliate of the banking entity, is
an insured depository institution, bank
holding company, or savings and loan
holding company, and calculates riskbased capital ratios under the market
risk capital rule; or
(iii) Purchase or sell one or more
financial instruments for any purpose, if
the banking entity:
(A) Is licensed or registered, or is
required to be licensed or registered, to
engage in the business of a dealer, swap
dealer, or security-based swap dealer, to
the extent the instrument is purchased
or sold in connection with the activities
that require the banking entity to be
licensed or registered as such; or
(B) Is engaged in the business of a
dealer, swap dealer, or security-based
swap dealer outside of the United
States, to the extent the instrument is
purchased or sold in connection with
the activities of such business.

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(2) Rebuttable presumption for certain
purchases and sales. The purchase (or
sale) of a financial instrument by a
banking entity shall be presumed to be
for the trading account of the banking
entity under paragraph (b)(1)(i) of this
section if the banking entity holds the
financial instrument for fewer than sixty
days or substantially transfers the risk of
the financial instrument within sixty
days of the purchase (or sale), unless the
banking entity can demonstrate, based
on all relevant facts and circumstances,
that the banking entity did not purchase
(or sell) the financial instrument
principally for any of the purposes
described in paragraph (b)(1)(i) of this
section.
(c) Financial instrument. (1) Financial
instrument means:
(i) A security, including an option on
a security;
(ii) A derivative, including an option
on a derivative; or
(iii) A contract of sale of a commodity
for future delivery, or option on a
contract of sale of a commodity for
future delivery.
(2) A financial instrument does not
include:
(i) A loan;
(ii) A commodity that is not:
(A) An excluded commodity (other
than foreign exchange or currency);
(B) A derivative;
(C) A contract of sale of a commodity
for future delivery; or
(D) An option on a contract of sale of
a commodity for future delivery; or
(iii) Foreign exchange or currency.
(d) Proprietary trading. Proprietary
trading does not include:
(1) Any purchase or sale of one or
more financial instruments by a banking
entity that arises under a repurchase or
reverse repurchase agreement pursuant
to which the banking entity has
simultaneously agreed, in writing, to
both purchase and sell a stated asset, at
stated prices, and on stated dates or on
demand with the same counterparty;
(2) Any purchase or sale of one or
more financial instruments by a banking
entity that arises under a transaction in
which the banking entity lends or
borrows a security temporarily to or
from another party pursuant to a written
securities lending agreement under
which the lender retains the economic
interests of an owner of such security,
and has the right to terminate the
transaction and to recall the loaned
security on terms agreed by the parties;
(3) Any purchase or sale of a security
by a banking entity for the purpose of
liquidity management in accordance
with a documented liquidity
management plan of the banking entity
that:

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5781

(i) Specifically contemplates and
authorizes the particular securities to be
used for liquidity management
purposes, the amount, types, and risks
of these securities that are consistent
with liquidity management, and the
liquidity circumstances in which the
particular securities may or must be
used;
(ii) Requires that any purchase or sale
of securities contemplated and
authorized by the plan be principally for
the purpose of managing the liquidity of
the banking entity, and not for the
purpose of short-term resale, benefitting
from actual or expected short-term price
movements, realizing short-term
arbitrage profits, or hedging a position
taken for such short-term purposes;
(iii) Requires that any securities
purchased or sold for liquidity
management purposes be highly liquid
and limited to securities the market,
credit, and other risks of which the
banking entity does not reasonably
expect to give rise to appreciable profits
or losses as a result of short-term price
movements;
(iv) Limits any securities purchased or
sold for liquidity management purposes,
together with any other instruments
purchased or sold for such purposes, to
an amount that is consistent with the
banking entity’s near-term funding
needs, including deviations from
normal operations of the banking entity
or any affiliate thereof, as estimated and
documented pursuant to methods
specified in the plan;
(v) Includes written policies and
procedures, internal controls, analysis,
and independent testing to ensure that
the purchase and sale of securities that
are not permitted under §§ ll.6(a) or
(b) of this subpart are for the purpose of
liquidity management and in
accordance with the liquidity
management plan described in
paragraph (d)(3) of this section; and
(vi) Is consistent with [Agency]’s
supervisory requirements, guidance,
and expectations regarding liquidity
management;
(4) Any purchase or sale of one or
more financial instruments by a banking
entity that is a derivatives clearing
organization or a clearing agency in
connection with clearing financial
instruments;
(5) Any excluded clearing activities
by a banking entity that is a member of
a clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(6) Any purchase or sale of one or
more financial instruments by a banking
entity, so long as:

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(i) The purchase (or sale) satisfies an
existing delivery obligation of the
banking entity or its customers,
including to prevent or close out a
failure to deliver, in connection with
delivery, clearing, or settlement activity;
or
(ii) The purchase (or sale) satisfies an
obligation of the banking entity in
connection with a judicial,
administrative, self-regulatory
organization, or arbitration proceeding;
(7) Any purchase or sale of one or
more financial instruments by a banking
entity that is acting solely as agent,
broker, or custodian;
(8) Any purchase or sale of one or
more financial instruments by a banking
entity through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity that is
established and administered in
accordance with the law of the United
States or a foreign sovereign, if the
purchase or sale is made directly or
indirectly by the banking entity as
trustee for the benefit of persons who
are or were employees of the banking
entity; or
(9) Any purchase or sale of one or
more financial instruments by a banking
entity in the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the financial instrument
as soon as practicable, and in no event
may the banking entity retain such
instrument for longer than such period
permitted by the [Agency].
(e) Definition of other terms related to
proprietary trading. For purposes of this
subpart:
(1) Anonymous means that each party
to a purchase or sale is unaware of the
identity of the other party(ies) to the
purchase or sale.
(2) Clearing agency has the same
meaning as in section 3(a)(23) of the
Exchange Act (15 U.S.C. 78c(a)(23)).
(3) Commodity has the same meaning
as in section 1a(9) of the Commodity
Exchange Act (7 U.S.C. 1a(9)), except
that a commodity does not include any
security;
(4) Contract of sale of a commodity
for future delivery means a contract of
sale (as that term is defined in section
1a(13) of the Commodity Exchange Act
(7 U.S.C. 1a(13)) for future delivery (as
that term is defined in section 1a(27) of
the Commodity Exchange Act (7 U.S.C.
1a(27))).
(5) Derivatives clearing organization
means:
(i) A derivatives clearing organization
registered under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1);

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(ii) A derivatives clearing organization
that, pursuant to CFTC regulation, is
exempt from the registration
requirements under section 5b of the
Commodity Exchange Act (7 U.S.C. 7a–
1); or
(iii) A foreign derivatives clearing
organization that, pursuant to CFTC
regulation, is permitted to clear for a
foreign board of trade that is registered
with the CFTC.
(6) Exchange, unless the context
otherwise requires, means any
designated contract market, swap
execution facility, or foreign board of
trade registered with the CFTC, or, for
purposes of securities or security-based
swaps, an exchange, as defined under
section 3(a)(1) of the Exchange Act (15
U.S.C. 78c(a)(1)), or security-based swap
execution facility, as defined under
section 3(a)(77) of the Exchange Act (15
U.S.C. 78c(a)(77)).
(7) Excluded clearing activities means:
(i) With respect to customer
transactions cleared on a derivatives
clearing organization, a clearing agency,
or a designated financial market utility,
any purchase or sale necessary to
correct trading errors made by or on
behalf of a customer provided that such
purchase or sale is conducted in
accordance with, for transactions
cleared on a derivatives clearing
organization, the Commodity Exchange
Act, CFTC regulations, and the rules or
procedures of the derivatives clearing
organization, or, for transactions cleared
on a clearing agency, the rules or
procedures of the clearing agency, or,
for transactions cleared on a designated
financial market utility that is neither a
derivatives clearing organization nor a
clearing agency, the rules or procedures
of the designated financial market
utility;
(ii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a customer
provided that such purchase or sale is
conducted in accordance with, for
transactions cleared on a derivatives
clearing organization, the Commodity
Exchange Act, CFTC regulations, and
the rules or procedures of the
derivatives clearing organization, or, for
transactions cleared on a clearing
agency, the rules or procedures of the
clearing agency, or, for transactions
cleared on a designated financial market
utility that is neither a derivatives
clearing organization nor a clearing
agency, the rules or procedures of the
designated financial market utility;
(iii) Any purchase or sale in
connection with and related to the
management of a default or threatened
imminent default of a member of a

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clearing agency, a member of a
derivatives clearing organization, or a
member of a designated financial market
utility;
(iv) Any purchase or sale in
connection with and related to the
management of the default or threatened
default of a clearing agency, a
derivatives clearing organization, or a
designated financial market utility; and
(v) Any purchase or sale that is
required by the rules or procedures of a
clearing agency, a derivatives clearing
organization, or a designated financial
market utility to mitigate the risk to the
clearing agency, derivatives clearing
organization, or designated financial
market utility that would result from the
clearing by a member of security-based
swaps that reference the member or an
affiliate of the member.
(8) Designated financial market utility
has the same meaning as in section
803(4) of the Dodd-Frank Act (12 U.S.C.
5462(4)).
(9) Issuer has the same meaning as in
section 2(a)(4) of the Securities Act of
1933 (15 U.S.C. 77b(a)(4)).
(10) Market risk capital rule covered
position and trading position means a
financial instrument that is both a
covered position and a trading position,
as those terms are respectively defined:
(i) In the case of a banking entity that
is a bank holding company, savings and
loan holding company, or insured
depository institution, under the market
risk capital rule that is applicable to the
banking entity; and
(ii) In the case of a banking entity that
is affiliated with a bank holding
company or savings and loan holding
company, other than a banking entity to
which a market risk capital rule is
applicable, under the market risk capital
rule that is applicable to the affiliated
bank holding company or savings and
loan holding company.
(11) Market risk capital rule means
the market risk capital rule that is
contained in subpart F of 12 CFR part
3, 12 CFR parts 208 and 225, or 12 CFR
part 324, as applicable.
(12) Municipal security means a
security that is a direct obligation of or
issued by, or an obligation guaranteed as
to principal or interest by, a State or any
political subdivision thereof, or any
agency or instrumentality of a State or
any political subdivision thereof, or any
municipal corporate instrumentality of
one or more States or political
subdivisions thereof.
(13) Trading desk means the smallest
discrete unit of organization of a
banking entity that purchases or sells
financial instruments for the trading
account of the banking entity or an
affiliate thereof.

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§ ___.4 Permitted underwriting and market
making-related activities.

(a) Underwriting activities—(1)
Permitted underwriting activities. The
prohibition contained in § __.3(a) does
not apply to a banking entity’s
underwriting activities conducted in
accordance with this paragraph (a).
(2) Requirements. The underwriting
activities of a banking entity are
permitted under paragraph (a)(1) of this
section only if:
(i) The banking entity is acting as an
underwriter for a distribution of
securities and the trading desk’s
underwriting position is related to such
distribution;
(ii) The amount and type of the
securities in the trading desk’s
underwriting position are designed not
to exceed the reasonably expected near
term demands of clients, customers, or
counterparties, and reasonable efforts
are made to sell or otherwise reduce the
underwriting position within a
reasonable period, taking into account
the liquidity, maturity, and depth of the
market for the relevant type of security;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (a)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The products, instruments or
exposures each trading desk may
purchase, sell, or manage as part of its
underwriting activities;
(B) Limits for each trading desk, based
on the nature and amount of the trading
desk’s underwriting activities, including
the reasonably expected near term
demands of clients, customers, or
counterparties, on the:
(1) Amount, types, and risk of its
underwriting position;
(2) Level of exposures to relevant risk
factors arising from its underwriting
position; and
(3) Period of time a security may be
held;
(C) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(D) Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis of the
basis for any temporary or permanent
increase to a trading desk’s limit(s), and
independent review of such
demonstrable analysis and approval;

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(iv) The compensation arrangements
of persons performing the activities
described in this paragraph (a) are
designed not to reward or incentivize
prohibited proprietary trading; and
(v) The banking entity is licensed or
registered to engage in the activity
described in this paragraph (a) in
accordance with applicable law.
(3) Definition of distribution. For
purposes of this paragraph (a), a
distribution of securities means:
(i) An offering of securities, whether
or not subject to registration under the
Securities Act of 1933, that is
distinguished from ordinary trading
transactions by the presence of special
selling efforts and selling methods; or
(ii) An offering of securities made
pursuant to an effective registration
statement under the Securities Act of
1933.
(4) Definition of underwriter. For
purposes of this paragraph (a),
underwriter means:
(i) A person who has agreed with an
issuer or selling security holder to:
(A) Purchase securities from the
issuer or selling security holder for
distribution;
(B) Engage in a distribution of
securities for or on behalf of the issuer
or selling security holder; or
(C) Manage a distribution of securities
for or on behalf of the issuer or selling
security holder; or
(ii) A person who has agreed to
participate or is participating in a
distribution of such securities for or on
behalf of the issuer or selling security
holder.
(5) Definition of selling security
holder. For purposes of this paragraph
(a), selling security holder means any
person, other than an issuer, on whose
behalf a distribution is made.
(6) Definition of underwriting
position. For purposes of this paragraph
(a), underwriting position means the
long or short positions in one or more
securities held by a banking entity or its
affiliate, and managed by a particular
trading desk, in connection with a
particular distribution of securities for
which such banking entity or affiliate is
acting as an underwriter.
(7) Definition of client, customer, and
counterparty. For purposes of this
paragraph (a), the terms client,
customer, and counterparty, on a
collective or individual basis, refer to
market participants that may transact
with the banking entity in connection
with a particular distribution for which
the banking entity is acting as
underwriter.
(b) Market making-related activities—
(1) Permitted market making-related
activities. The prohibition contained in

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5783

§ ll.3(a) does not apply to a banking
entity’s market making-related activities
conducted in accordance with this
paragraph (b).
(2) Requirements. The market makingrelated activities of a banking entity are
permitted under paragraph (b)(1) of this
section only if:
(i) The trading desk that establishes
and manages the financial exposure
routinely stands ready to purchase and
sell one or more types of financial
instruments related to its financial
exposure and is willing and available to
quote, purchase and sell, or otherwise
enter into long and short positions in
those types of financial instruments for
its own account, in commercially
reasonable amounts and throughout
market cycles on a basis appropriate for
the liquidity, maturity, and depth of the
market for the relevant types of financial
instruments;
(ii) The amount, types, and risks of
the financial instruments in the trading
desk’s market-maker inventory are
designed not to exceed, on an ongoing
basis, the reasonably expected near term
demands of clients, customers, or
counterparties, based on:
(A) The liquidity, maturity, and depth
of the market for the relevant types of
financial instrument(s); and
(B) Demonstrable analysis of
historical customer demand, current
inventory of financial instruments, and
market and other factors regarding the
amount, types, and risks, of or
associated with financial instruments in
which the trading desk makes a market,
including through block trades;
(iii) The banking entity has
established and implements, maintains,
and enforces an internal compliance
program required by subpart D of this
part that is reasonably designed to
ensure the banking entity’s compliance
with the requirements of paragraph (b)
of this section, including reasonably
designed written policies and
procedures, internal controls, analysis
and independent testing identifying and
addressing:
(A) The financial instruments each
trading desk stands ready to purchase
and sell in accordance with paragraph
(b)(2)(i) of this section;
(B) The actions the trading desk will
take to demonstrably reduce or
otherwise significantly mitigate
promptly the risks of its financial
exposure consistent with the limits
required under paragraph (b)(2)(iii)(C) of
this section; the products, instruments,
and exposures each trading desk may
use for risk management purposes; the
techniques and strategies each trading
desk may use to manage the risks of its
market making-related activities and

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inventory; and the process, strategies,
and personnel responsible for ensuring
that the actions taken by the trading
desk to mitigate these risks are and
continue to be effective;
(C) Limits for each trading desk, based
on the nature and amount of the trading
desk’s market making-related activities,
that address the factors prescribed by
paragraph (b)(2)(ii) of this section, on:
(1) The amount, types, and risks of its
market-maker inventory;
(2) The amount, types, and risks of the
products, instruments, and exposures
the trading desk may use for risk
management purposes;
(3) The level of exposures to relevant
risk factors arising from its financial
exposure; and
(4) The period of time a financial
instrument may be held;
(D) Internal controls and ongoing
monitoring and analysis of each trading
desk’s compliance with its limits; and
(E) Authorization procedures,
including escalation procedures that
require review and approval of any
trade that would exceed a trading desk’s
limit(s), demonstrable analysis that the
basis for any temporary or permanent
increase to a trading desk’s limit(s) is
consistent with the requirements of this
paragraph (b), and independent review
of such demonstrable analysis and
approval;
(iv) To the extent that any limit
identified pursuant to paragraph
(b)(2)(iii)(C) of this section is exceeded,
the trading desk takes action to bring the
trading desk into compliance with the
limits as promptly as possible after the
limit is exceeded;
(v) The compensation arrangements of
persons performing the activities
described in this paragraph (b) are
designed not to reward or incentivize
prohibited proprietary trading; and
(vi) The banking entity is licensed or
registered to engage in activity
described in this paragraph (b) in
accordance with applicable law.
(3) Definition of client, customer, and
counterparty. For purposes of paragraph
(b) of this section, the terms client,
customer, and counterparty, on a
collective or individual basis refer to
market participants that make use of the
banking entity’s market making-related
services by obtaining such services,
responding to quotations, or entering
into a continuing relationship with
respect to such services, provided that:
(i) A trading desk or other
organizational unit of another banking
entity is not a client, customer, or
counterparty of the trading desk if that
other entity has trading assets and
liabilities of $50 billion or more as

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measured in accordance with
§ ll.20(d)(1) of subpart D, unless:
(A) The trading desk documents how
and why a particular trading desk or
other organizational unit of the entity
should be treated as a client, customer,
or counterparty of the trading desk for
purposes of paragraph (b)(2) of this
section; or
(B) The purchase or sale by the
trading desk is conducted anonymously
on an exchange or similar trading
facility that permits trading on behalf of
a broad range of market participants.
(4) Definition of financial exposure.
For purposes of this paragraph (b),
financial exposure means the aggregate
risks of one or more financial
instruments and any associated loans,
commodities, or foreign exchange or
currency, held by a banking entity or its
affiliate and managed by a particular
trading desk as part of the trading desk’s
market making-related activities.
(5) Definition of market-maker
inventory. For the purposes of this
paragraph (b), market-maker inventory
means all of the positions in the
financial instruments for which the
trading desk stands ready to make a
market in accordance with paragraph
(b)(2)(i) of this section, that are managed
by the trading desk, including the
trading desk’s open positions or
exposures arising from open
transactions.
§ ll.5 Permitted risk-mitigating hedging
activities.

(a) Permitted risk-mitigating hedging
activities. The prohibition contained in
§ ll.3(a) does not apply to the riskmitigating hedging activities of a
banking entity in connection with and
related to individual or aggregated
positions, contracts, or other holdings of
the banking entity and designed to
reduce the specific risks to the banking
entity in connection with and related to
such positions, contracts, or other
holdings.
(b) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under paragraph (a) of this
section only if:
(1) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(i) Reasonably designed written
policies and procedures regarding the
positions, techniques and strategies that
may be used for hedging, including
documentation indicating what
positions, contracts or other holdings a
particular trading desk may use in its

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risk-mitigating hedging activities, as
well as position and aging limits with
respect to such positions, contracts or
other holdings;
(ii) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(iii) The conduct of analysis,
including correlation analysis, and
independent testing designed to ensure
that the positions, techniques and
strategies that may be used for hedging
may reasonably be expected to
demonstrably reduce or otherwise
significantly mitigate the specific,
identifiable risk(s) being hedged, and
such correlation analysis demonstrates
that the hedging activity demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risk(s)
being hedged;
(2) The risk-mitigating hedging
activity:
(i) Is conducted in accordance with
the written policies, procedures, and
internal controls required under this
section;
(ii) At the inception of the hedging
activity, including, without limitation,
any adjustments to the hedging activity,
is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks, including market risk,
counterparty or other credit risk,
currency or foreign exchange risk,
interest rate risk, commodity price risk,
basis risk, or similar risks, arising in
connection with and related to
identified positions, contracts, or other
holdings of the banking entity, based
upon the facts and circumstances of the
identified underlying and hedging
positions, contracts or other holdings
and the risks and liquidity thereof;
(iii) Does not give rise, at the
inception of the hedge, to any
significant new or additional risk that is
not itself hedged contemporaneously in
accordance with this section;
(iv) Is subject to continuing review,
monitoring and management by the
banking entity that:
(A) Is consistent with the written
hedging policies and procedures
required under paragraph (b)(1) of this
section;
(B) Is designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates the specific, identifiable risks
that develop over time from the riskmitigating hedging activities undertaken
under this section and the underlying
positions, contracts, and other holdings
of the banking entity, based upon the
facts and circumstances of the

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underlying and hedging positions,
contracts and other holdings of the
banking entity and the risks and
liquidity thereof; and
(C) Requires ongoing recalibration of
the hedging activity by the banking
entity to ensure that the hedging activity
satisfies the requirements set out in
paragraph (b)(2) of this section and is
not prohibited proprietary trading; and
(3) The compensation arrangements of
persons performing risk-mitigating
hedging activities are designed not to
reward or incentivize prohibited
proprietary trading.
(c) Documentation requirement—(1) A
banking entity must comply with the
requirements of paragraphs (c)(2) and
(3) of this section with respect to any
purchase or sale of financial
instruments made in reliance on this
section for risk-mitigating hedging
purposes that is:
(i) Not established by the specific
trading desk establishing or responsible
for the underlying positions, contracts,
or other holdings the risks of which the
hedging activity is designed to reduce;
(ii) Established by the specific trading
desk establishing or responsible for the
underlying positions, contracts, or other
holdings the risks of which the
purchases or sales are designed to
reduce, but that is effected through a
financial instrument, exposure,
technique, or strategy that is not
specifically identified in the trading
desk’s written policies and procedures
established under paragraph (b)(1) of
this section or under
§ ll.4(b)(2)(iii)(B) of this subpart as a
product, instrument, exposure,
technique, or strategy such trading desk
may use for hedging; or
(iii) Established to hedge aggregated
positions across two or more trading
desks.
(2) In connection with any purchase
or sale identified in paragraph (c)(1) of
this section, a banking entity must, at a
minimum, and contemporaneously with
the purchase or sale, document:
(i) The specific, identifiable risk(s) of
the identified positions, contracts, or
other holdings of the banking entity that
the purchase or sale is designed to
reduce;
(ii) The specific risk-mitigating
strategy that the purchase or sale is
designed to fulfill; and
(iii) The trading desk or other
business unit that is establishing and
responsible for the hedge.
(3) A banking entity must create and
retain records sufficient to demonstrate
compliance with the requirements of
this paragraph (c) for a period that is no
less than five years in a form that allows
the banking entity to promptly produce

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such records to [Agency] on request, or
such longer period as required under
other law or this part.
§ ll.6 Other permitted proprietary
trading activities.

(a) Permitted trading in domestic
government obligations. The prohibition
contained in § ll.3(a) does not apply
to the purchase or sale by a banking
entity of a financial instrument that is:
(1) An obligation of, or issued or
guaranteed by, the United States;
(2) An obligation, participation, or
other instrument of, or issued or
guaranteed by, an agency of the United
States, the Government National
Mortgage Association, the Federal
National Mortgage Association, the
Federal Home Loan Mortgage
Corporation, a Federal Home Loan
Bank, the Federal Agricultural Mortgage
Corporation or a Farm Credit System
institution chartered under and subject
to the provisions of the Farm Credit Act
of 1971 (12 U.S.C. 2001 et seq.);
(3) An obligation of any State or any
political subdivision thereof, including
any municipal security; or
(4) An obligation of the FDIC, or any
entity formed by or on behalf of the
FDIC for purpose of facilitating the
disposal of assets acquired or held by
the FDIC in its corporate capacity or as
conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(b) Permitted trading in foreign
government obligations—(1) Affiliates of
foreign banking entities in the United
States. The prohibition contained in
§ ll.3(a) does not apply to the
purchase or sale of a financial
instrument that is an obligation of, or
issued or guaranteed by, a foreign
sovereign (including any multinational
central bank of which the foreign
sovereign is a member), or any agency
or political subdivision of such foreign
sovereign, by a banking entity, so long
as:
(i) The banking entity is organized
under or is directly or indirectly
controlled by a banking entity that is
organized under the laws of a foreign
sovereign and is not directly or
indirectly controlled by a top-tier
banking entity that is organized under
the laws of the United States;
(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign banking entity
referred to in paragraph (b)(1)(i) of this
section is organized (including any
multinational central bank of which the
foreign sovereign is a member), or any

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5785

agency or political subdivision of that
foreign sovereign; and
(iii) The purchase or sale as principal
is not made by an insured depository
institution.
(2) Foreign affiliates of a U.S. banking
entity. The prohibition contained in
§ ll.3(a) does not apply to the
purchase or sale of a financial
instrument that is an obligation of, or
issued or guaranteed by, a foreign
sovereign (including any multinational
central bank of which the foreign
sovereign is a member), or any agency
or political subdivision of that foreign
sovereign, by a foreign entity that is
owned or controlled by a banking entity
organized or established under the laws
of the United States or any State, so long
as:
(i) The foreign entity is a foreign bank,
as defined in section 211.2(j) of the
Board’s Regulation K (12 CFR 211.2(j)),
or is regulated by the foreign sovereign
as a securities dealer;
(ii) The financial instrument is an
obligation of, or issued or guaranteed
by, the foreign sovereign under the laws
of which the foreign entity is organized
(including any multinational central
bank of which the foreign sovereign is
a member), or any agency or political
subdivision of that foreign sovereign;
and
(iii) The financial instrument is
owned by the foreign entity and is not
financed by an affiliate that is located in
the United States or organized under the
laws of the United States or of any State.
(c) Permitted trading on behalf of
customers—(1) Fiduciary transactions.
The prohibition contained in § ll.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
entity acting as trustee or in a similar
fiduciary capacity, so long as:
(i) The transaction is conducted for
the account of, or on behalf of, a
customer; and
(ii) The banking entity does not have
or retain beneficial ownership of the
financial instruments.
(2) Riskless principal transactions.
The prohibition contained in § ll.3(a)
does not apply to the purchase or sale
of financial instruments by a banking
entity acting as riskless principal in a
transaction in which the banking entity,
after receiving an order to purchase (or
sell) a financial instrument from a
customer, purchases (or sells) the
financial instrument for its own account
to offset a contemporaneous sale to (or
purchase from) the customer.
(d) Permitted trading by a regulated
insurance company. The prohibition
contained in § ll.3(a) does not apply
to the purchase or sale of financial
instruments by a banking entity that is

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an insurance company or an affiliate of
an insurance company if:
(1) The insurance company or its
affiliate purchases or sells the financial
instruments solely for:
(i) The general account of the
insurance company; or
(ii) A separate account established by
the insurance company;
(2) The purchase or sale is conducted
in compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (d)(2) of this
section is insufficient to protect the
safety and soundness of the covered
banking entity, or the financial stability
of the United States.
(e) Permitted trading activities of
foreign banking entities. (1) The
prohibition contained in § ll.3(a) does
not apply to the purchase or sale of
financial instruments by a banking
entity if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of any
State;
(ii) The purchase or sale by the
banking entity is made pursuant to
paragraph (9) or (13) of section 4(c) of
the BHC Act; and
(iii) The purchase or sale meets the
requirements of paragraph (e)(3) of this
section.
(2) A purchase or sale of financial
instruments by a banking entity is made
pursuant to paragraph (9) or (13) of
section 4(c) of the BHC Act for purposes
of paragraph (e)(1)(ii) of this section
only if:
(i) The purchase or sale is conducted
in accordance with the requirements of
paragraph (e) of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of section
211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of any State and the banking

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entity, on a fully-consolidated basis,
meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues
derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
income derived from the business of the
banking entity in the United States.
(3) A purchase or sale by a banking
entity is permitted for purposes of this
paragraph (e) if:
(i) The banking entity engaging as
principal in the purchase or sale
(including any personnel of the banking
entity or its affiliate that arrange,
negotiate or execute such purchase or
sale) is not located in the United States
or organized under the laws of the
United States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to purchase or sell as principal
is not located in the United States or
organized under the laws of the United
States or of any State;
(iii) The purchase or sale, including
any transaction arising from riskmitigating hedging related to the
instruments purchased or sold, is not
accounted for as principal directly or on
a consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State;
(iv) No financing for the banking
entity’s purchases or sales is provided,
directly or indirectly, by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(v) The purchase or sale is not
conducted with or through any U.S.
entity, other than:
(A) A purchase or sale with the
foreign operations of a U.S. entity if no
personnel of such U.S. entity that are
located in the United States are
involved in the arrangement,
negotiation, or execution of such
purchase or sale;
(B) A purchase or sale with an
unaffiliated market intermediary acting
as principal, provided the purchase or
sale is promptly cleared and settled
through a clearing agency or derivatives
clearing organization acting as a central
counterparty; or
(C) A purchase or sale through an
unaffiliated market intermediary acting
as agent, provided the purchase or sale

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is conducted anonymously on an
exchange or similar trading facility and
is promptly cleared and settled through
a clearing agency or derivatives clearing
organization acting as a central
counterparty.
(4) For purposes of this paragraph (e),
a U.S. entity is any entity that is, or is
controlled by, or is acting on behalf of,
or at the direction of, any other entity
that is, located in the United States or
organized under the laws of the United
States or of any State.
(5) For purposes of this paragraph (e),
a U.S. branch, agency, or subsidiary of
a foreign banking entity is considered to
be located in the United States;
however, the foreign bank that operates
or controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(6) For purposes of this paragraph (e),
unaffiliated market intermediary means
an unaffiliated entity, acting as an
intermediary, that is:
(i) A broker or dealer registered with
the SEC under section 15 of the
Exchange Act or exempt from
registration or excluded from regulation
as such;
(ii) A swap dealer registered with the
CFTC under section 4s of the
Commodity Exchange Act or exempt
from registration or excluded from
regulation as such;
(iii) A security-based swap dealer
registered with the SEC under section
15F of the Exchange Act or exempt from
registration or excluded from regulation
as such; or
(iv) A futures commission merchant
registered with the CFTC under section
4f of the Commodity Exchange Act or
exempt from registration or excluded
from regulation as such.
§ ll.7 Limitations on permitted
proprietary trading activities.

(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ ll.4 through
ll.6 if the transaction, class of
transactions, or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,

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a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with
respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.

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(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
§ ll.8

[Reserved]

§ ll.9

[Reserved]

Subpart C—Covered Funds Activities
and Investments
§ ll.10 Prohibition on acquiring or
retaining an ownership interest in and
having certain relationships with a covered
fund.

(a) Prohibition. (1) Except as
otherwise provided in this subpart, a
banking entity may not, as principal,
directly or indirectly, acquire or retain
any ownership interest in or sponsor a
covered fund.
(2) Paragraph (a)(1) of this section
does not include acquiring or retaining
an ownership interest in a covered fund
by a banking entity:
(i) Acting solely as agent, broker, or
custodian, so long as;
(A) The activity is conducted for the
account of, or on behalf of, a customer;
and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest;
(ii) Through a deferred compensation,
stock-bonus, profit-sharing, or pension
plan of the banking entity (or an affiliate
thereof) that is established and
administered in accordance with the
law of the United States or a foreign
sovereign, if the ownership interest is
held or controlled directly or indirectly
by the banking entity as trustee for the
benefit of persons who are or were
employees of the banking entity (or an
affiliate thereof);
(iii) In the ordinary course of
collecting a debt previously contracted
in good faith, provided that the banking
entity divests the ownership interest as
soon as practicable, and in no event may
the banking entity retain such
ownership interest for longer than such
period permitted by the [Agency]; or
(iv) On behalf of customers as trustee
or in a similar fiduciary capacity for a
customer that is not a covered fund, so
long as:
(A) The activity is conducted for the
account of, or on behalf of, the
customer; and
(B) The banking entity and its
affiliates do not have or retain beneficial
ownership of such ownership interest.
(b) Definition of covered fund. (1)
Except as provided in paragraph (c) of
this section, covered fund means:

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(i) An issuer that would be an
investment company, as defined in the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.), but for section
3(c)(1) or 3(c)(7) of that Act (15 U.S.C.
80a–3(c)(1) or (7));
(ii) Any commodity pool under
section 1a(10) of the Commodity
Exchange Act (7 U.S.C. 1a(10)) for
which:
(A) The commodity pool operator has
claimed an exemption under 17 CFR
4.7; or
(B)(1) A commodity pool operator is
registered with the CFTC as a
commodity pool operator in connection
with the operation of the commodity
pool;
(2) Substantially all participation
units of the commodity pool are owned
by qualified eligible persons under 17
CFR 4.7(a)(2) and (3); and
(3) Participation units of the
commodity pool have not been publicly
offered to persons who are not qualified
eligible persons under 17 CFR 4.7(a)(2)
and (3); or
(iii) For any banking entity that is, or
is controlled directly or indirectly by a
banking entity that is, located in or
organized under the laws of the United
States or of any State, an entity that:
(A) Is organized or established outside
the United States and the ownership
interests of which are offered and sold
solely outside the United States;
(B) Is, or holds itself out as being, an
entity or arrangement that raises money
from investors primarily for the purpose
of investing in securities for resale or
other disposition or otherwise trading in
securities; and
(C)(1) Has as its sponsor that banking
entity (or an affiliate thereof); or
(2) Has issued an ownership interest
that is owned directly or indirectly by
that banking entity (or an affiliate
thereof).
(2) An issuer shall not be deemed to
be a covered fund under paragraph
(b)(1)(iii) of this section if, were the
issuer subject to U.S. securities laws, the
issuer could rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act.
(3) For purposes of paragraph
(b)(1)(iii) of this section, a U.S. branch,
agency, or subsidiary of a foreign
banking entity is located in the United
States; however, the foreign bank that
operates or controls that branch, agency,
or subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.

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(c) Notwithstanding paragraph (b) of
this section, unless the appropriate
Federal banking agencies, the SEC, and
the CFTC jointly determine otherwise, a
covered fund does not include:
(1) Foreign public funds. (i) Subject to
paragraphs (ii) and (iii) below, an issuer
that:
(A) Is organized or established outside
of the United States;
(B) Is authorized to offer and sell
ownership interests to retail investors in
the issuer’s home jurisdiction; and
(C) Sells ownership interests
predominantly through one or more
public offerings outside of the United
States.
(ii) With respect to a banking entity
that is, or is controlled directly or
indirectly by a banking entity that is,
located in or organized under the laws
of the United States or of any State and
any issuer for which such banking
entity acts as sponsor, the sponsoring
banking entity may not rely on the
exemption in paragraph (c)(1)(i) of this
section for such issuer unless ownership
interests in the issuer are sold
predominantly to persons other than:
(A) Such sponsoring banking entity;
(B) Such issuer;
(C) Affiliates of such sponsoring
banking entity or such issuer; and
(D) Directors and employees of such
entities.
(iii) For purposes of paragraph
(c)(1)(i)(C) of this section, the term
‘‘public offering’’ means a distribution
(as defined in § ll.4(a)(3) of subpart B)
of securities in any jurisdiction outside
the United States to investors, including
retail investors, provided that:
(A) The distribution complies with all
applicable requirements in the
jurisdiction in which such distribution
is being made;
(B) The distribution does not restrict
availability to investors having a
minimum level of net worth or net
investment assets; and
(C) The issuer has filed or submitted,
with the appropriate regulatory
authority in such jurisdiction, offering
disclosure documents that are publicly
available.
(2) Wholly-owned subsidiaries. An
entity, all of the outstanding ownership
interests of which are owned directly or
indirectly by the banking entity (or an
affiliate thereof), except that:
(i) Up to five percent of the entity’s
outstanding ownership interests, less
any amounts outstanding under
paragraph (c)(2)(ii) of this section, may
be held by employees or directors of the
banking entity or such affiliate
(including former employees or
directors if their ownership interest was

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acquired while employed by or in the
service of the banking entity); and
(ii) Up to 0.5 percent of the entity’s
outstanding ownership interests may be
held by a third party if the ownership
interest is acquired or retained by the
third party for the purpose of
establishing corporate separateness or
addressing bankruptcy, insolvency, or
similar concerns.
(3) Joint ventures. A joint venture
between a banking entity or any of its
affiliates and one or more unaffiliated
persons, provided that the joint venture:
(i) Is comprised of no more than 10
unaffiliated co-venturers;
(ii) Is in the business of engaging in
activities that are permissible for the
banking entity or affiliate, other than
investing in securities for resale or other
disposition; and
(iii) Is not, and does not hold itself out
as being, an entity or arrangement that
raises money from investors primarily
for the purpose of investing in securities
for resale or other disposition or
otherwise trading in securities.
(4) Acquisition vehicles. An issuer:
(i) Formed solely for the purpose of
engaging in a bona fide merger or
acquisition transaction; and
(ii) That exists only for such period as
necessary to effectuate the transaction.
(5) Foreign pension or retirement
funds. A plan, fund, or program
providing pension, retirement, or
similar benefits that is:
(i) Organized and administered
outside the United States;
(ii) A broad-based plan for employees
or citizens that is subject to regulation
as a pension, retirement, or similar plan
under the laws of the jurisdiction in
which the plan, fund, or program is
organized and administered; and
(iii) Established for the benefit of
citizens or residents of one or more
foreign sovereigns or any political
subdivision thereof.
(6) Insurance company separate
accounts. A separate account, provided
that no banking entity other than the
insurance company participates in the
account’s profits and losses.
(7) Bank owned life insurance. A
separate account that is used solely for
the purpose of allowing one or more
banking entities to purchase a life
insurance policy for which the banking
entity or entities is beneficiary,
provided that no banking entity that
purchases the policy:
(i) Controls the investment decisions
regarding the underlying assets or
holdings of the separate account; or
(ii) Participates in the profits and
losses of the separate account other than
in compliance with applicable
supervisory guidance regarding bank
owned life insurance.

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(8) Loan securitizations. (i) Scope. An
issuing entity for asset-backed securities
that satisfies all the conditions of this
paragraph (c)(8) and the assets or
holdings of which are comprised solely
of:
(A) Loans as defined in § ll.2(s) of
subpart A;
(B) Rights or other assets designed to
assure the servicing or timely
distribution of proceeds to holders of
such securities and rights or other assets
that are related or incidental to
purchasing or otherwise acquiring and
holding the loans, provided that each
asset meets the requirements of
paragraph (c)(8)(iii) of this section;
(C) Interest rate or foreign exchange
derivatives that meet the requirements
of paragraph (c)(8)(iv) of this section;
and
(D) Special units of beneficial interest
and collateral certificates that meet the
requirements of paragraph (c)(8)(v) of
this section.
(ii) Impermissible assets. For purposes
of this paragraph (c)(8), the assets or
holdings of the issuing entity shall not
include any of the following:
(A) A security, including an assetbacked security, or an interest in an
equity or debt security other than as
permitted in paragraph (c)(8)(iii) of this
section;
(B) A derivative, other than a
derivative that meets the requirements
of paragraph (c)(8)(iv) of this section; or
(C) A commodity forward contract.
(iii) Permitted securities.
Notwithstanding paragraph (c)(8)(ii)(A)
of this section, the issuing entity may
hold securities if those securities are:
(A) Cash equivalents for purposes of
the rights and assets in paragraph
(c)(8)(i)(B) of this section; or
(B) Securities received in lieu of debts
previously contracted with respect to
the loans supporting the asset-backed
securities.
(iv) Derivatives. The holdings of
derivatives by the issuing entity shall be
limited to interest rate or foreign
exchange derivatives that satisfy all of
the following conditions:
(A) The written terms of the
derivative directly relate to the loans,
the asset-backed securities, or the
contractual rights of other assets
described in paragraph (c)(8)(i)(B) of
this section; and
(B) The derivatives reduce the interest
rate and/or foreign exchange risks
related to the loans, the asset-backed
securities, or the contractual rights or
other assets described in paragraph
(c)(8)(i)(B) of this section.
(v) Special units of beneficial interest
and collateral certificates. The assets or
holdings of the issuing entity may

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include collateral certificates and
special units of beneficial interest
issued by a special purpose vehicle,
provided that:
(A) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate meets
the requirements in this paragraph
(c)(8);
(B) The special unit of beneficial
interest or collateral certificate is used
for the sole purpose of transferring to
the issuing entity for the loan
securitization the economic risks and
benefits of the assets that are
permissible for loan securitizations
under this paragraph (c)(8) and does not
directly or indirectly transfer any
interest in any other economic or
financial exposure;
(C) The special unit of beneficial
interest or collateral certificate is
created solely to satisfy legal
requirements or otherwise facilitate the
structuring of the loan securitization;
and
(D) The special purpose vehicle that
issues the special unit of beneficial
interest or collateral certificate and the
issuing entity are established under the
direction of the same entity that
initiated the loan securitization.
(9) Qualifying asset-backed
commercial paper conduits. (i) An
issuing entity for asset-backed
commercial paper that satisfies all of the
following requirements:
(A) The asset-backed commercial
paper conduit holds only:
(1) Loans and other assets permissible
for a loan securitization under
paragraph (c)(8)(i) of this section; and
(2) Asset-backed securities supported
solely by assets that are permissible for
loan securitizations under paragraph
(c)(8)(i) of this section and acquired by
the asset-backed commercial paper
conduit as part of an initial issuance
either directly from the issuing entity of
the asset-backed securities or directly
from an underwriter in the distribution
of the asset-backed securities;
(B) The asset-backed commercial
paper conduit issues only asset-backed
securities, comprised of a residual
interest and securities with a legal
maturity of 397 days or less; and
(C) A regulated liquidity provider has
entered into a legally binding
commitment to provide full and
unconditional liquidity coverage with
respect to all of the outstanding assetbacked securities issued by the assetbacked commercial paper conduit (other
than any residual interest) in the event
that funds are required to redeem
maturing asset-backed securities.

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(ii) For purposes of this paragraph
(c)(9), a regulated liquidity provider
means:
(A) A depository institution, as
defined in section 3(c) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c));
(B) A bank holding company, as
defined in section 2(a) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1841(a)), or a subsidiary thereof;
(C) A savings and loan holding
company, as defined in section 10a of
the Home Owners’ Loan Act (12 U.S.C.
1467a), provided all or substantially all
of the holding company’s activities are
permissible for a financial holding
company under section 4(k) of the Bank
Holding Company Act of 1956 (12
U.S.C. 1843(k)), or a subsidiary thereof;
(D) A foreign bank whose home
country supervisor, as defined in
§ 211.21(q) of the Board’s Regulation K
(12 CFR 211.21(q)), has adopted capital
standards consistent with the Capital
Accord for the Basel Committee on
banking Supervision, as amended, and
that is subject to such standards, or a
subsidiary thereof; or
(E) The United States or a foreign
sovereign.
(10) Qualifying covered bonds—(i)
Scope. An entity owning or holding a
dynamic or fixed pool of loans or other
assets as provided in paragraph (c)(8) of
this section for the benefit of the holders
of covered bonds, provided that the
assets in the pool are comprised solely
of assets that meet the conditions in
paragraph (c)(8)(i) of this section.
(ii) Covered bond. For purposes of this
paragraph (c)(10), a covered bond
means:
(A) A debt obligation issued by an
entity that meets the definition of
foreign banking organization, the
payment obligations of which are fully
and unconditionally guaranteed by an
entity that meets the conditions set forth
in paragraph (c)(10)(i) of this section; or
(B) A debt obligation of an entity that
meets the conditions set forth in
paragraph (c)(10)(i) of this section,
provided that the payment obligations
are fully and unconditionally
guaranteed by an entity that meets the
definition of foreign banking
organization and the entity is a whollyowned subsidiary, as defined in
paragraph (c)(2) of this section, of such
foreign banking organization.
(11) SBICs and public welfare
investment funds. An issuer:
(i) That is a small business investment
company, as defined in section 103(3) of
the Small Business Investment Act of
1958 (15 U.S.C. 662), or that has
received from the Small Business
Administration notice to proceed to

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5789

qualify for a license as a small business
investment company, which notice or
license has not been revoked; or
(ii) The business of which is to make
investments that are:
(A) Designed primarily to promote the
public welfare, of the type permitted
under paragraph (11) of section 5136 of
the Revised Statutes of the United States
(12 U.S.C. 24), including the welfare of
low- and moderate-income communities
or families (such as providing housing,
services, or jobs); or
(B) Qualified rehabilitation
expenditures with respect to a qualified
rehabilitated building or certified
historic structure, as such terms are
defined in section 47 of the Internal
Revenue Code of 1986 or a similar State
historic tax credit program.
(12) Registered investment companies
and excluded entities. An issuer:
(i) That is registered as an investment
company under section 8 of the
Investment Company Act of 1940 (15
U.S.C. 80a–8), or that is formed and
operated pursuant to a written plan to
become a registered investment
company as described in § ll.20(e)(3)
of subpart D and that complies with the
requirements of section 18 of the
Investment Company Act of 1940 (15
U.S.C. 80a–18);
(ii) That may rely on an exclusion or
exemption from the definition of
‘‘investment company’’ under the
Investment Company Act of 1940 (15
U.S.C. 80a–1 et seq.) other than the
exclusions contained in section 3(c)(1)
and 3(c)(7) of that Act; or
(iii) That has elected to be regulated
as a business development company
pursuant to section 54(a) of that Act (15
U.S.C. 80a–53) and has not withdrawn
its election, or that is formed and
operated pursuant to a written plan to
become a business development
company as described in § ll.20(e)(3)
of subpart D and that complies with the
requirements of section 61 of the
Investment Company Act of 1940 (15
U.S.C. 80a–60).
(13) Issuers in conjunction with the
FDIC’s receivership or conservatorship
operations. An issuer that is an entity
formed by or on behalf of the FDIC for
the purpose of facilitating the disposal
of assets acquired in the FDIC’s capacity
as conservator or receiver under the
Federal Deposit Insurance Act or Title II
of the Dodd-Frank Wall Street Reform
and Consumer Protection Act.
(14) Other excluded issuers. (i) Any
issuer that the appropriate Federal
banking agencies, the SEC, and the
CFTC jointly determine the exclusion of
which is consistent with the purposes of
section 13 of the BHC Act.

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(ii) A determination made under
paragraph (c)(14)(i) of this section will
be promptly made public.
(d) Definition of other terms related to
covered funds. For purposes of this
subpart:
(1) Applicable accounting standards
means U.S. generally accepted
accounting principles, or such other
accounting standards applicable to a
banking entity that the [Agency]
determines are appropriate and that the
banking entity uses in the ordinary
course of its business in preparing its
consolidated financial statements.
(2) Asset-backed security has the
meaning specified in Section 3(a)(79) of
the Exchange Act (15 U.S.C. 78c(a)(79).
(3) Director has the same meaning as
provided in section 215.2(d)(1) of the
Board’s Regulation O (12 CFR
215.2(d)(1)).
(4) Issuer has the same meaning as in
section 2(a)(22) of the Investment
Company Act of 1940 (15 U.S.C. 80a–
2(a)(22)).
(5) Issuing entity means with respect
to asset-backed securities the special
purpose vehicle that owns or holds the
pool assets underlying asset-backed
securities and in whose name the assetbacked securities supported or serviced
by the pool assets are issued.
(6) Ownership interest—(i) Ownership
interest means any equity, partnership,
or other similar interest. An ‘‘other
similar interest’’ means an interest that:
(A) Has the right to participate in the
selection or removal of a general
partner, managing member, member of
the board of directors or trustees,
investment manager, investment
adviser, or commodity trading advisor
of the covered fund (excluding the
rights of a creditor to exercise remedies
upon the occurrence of an event of
default or an acceleration event);
(B) Has the right under the terms of
the interest to receive a share of the
income, gains or profits of the covered
fund;
(C) Has the right to receive the
underlying assets of the covered fund
after all other interests have been
redeemed and/or paid in full (excluding
the rights of a creditor to exercise
remedies upon the occurrence of an
event of default or an acceleration
event);
(D) Has the right to receive all or a
portion of excess spread (the positive
difference, if any, between the aggregate
interest payments received from the
underlying assets of the covered fund
and the aggregate interest paid to the
holders of other outstanding interests);
(E) Provides under the terms of the
interest that the amounts payable by the
covered fund with respect to the interest

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could be reduced based on losses arising
from the underlying assets of the
covered fund, such as allocation of
losses, write-downs or charge-offs of the
outstanding principal balance, or
reductions in the amount of interest due
and payable on the interest;
(F) Receives income on a pass-through
basis from the covered fund, or has a
rate of return that is determined by
reference to the performance of the
underlying assets of the covered fund;
or
(G) Any synthetic right to have,
receive, or be allocated any of the rights
in paragraphs (d)(6)(i)(A) through (F) of
this section.
(ii) Ownership interest does not
include: Restricted profit interest. An
interest held by an entity (or an
employee or former employee thereof)
in a covered fund for which the entity
(or employee thereof) serves as
investment manager, investment
adviser, commodity trading advisor, or
other service provider so long as:
(A) The sole purpose and effect of the
interest is to allow the entity (or
employee or former employee thereof)
to share in the profits of the covered
fund as performance compensation for
the investment management, investment
advisory, commodity trading advisory,
or other services provided to the
covered fund by the entity (or employee
or former employee thereof), provided
that the entity (or employee or former
employee thereof) may be obligated
under the terms of such interest to
return profits previously received;
(B) All such profit, once allocated, is
distributed to the entity (or employee or
former employee thereof) promptly after
being earned or, if not so distributed, is
retained by the covered fund for the sole
purpose of establishing a reserve
amount to satisfy contractual obligations
with respect to subsequent losses of the
covered fund and such undistributed
profit of the entity (or employee or
former employee thereof) does not share
in the subsequent investment gains of
the covered fund;
(C) Any amounts invested in the
covered fund, including any amounts
paid by the entity (or employee or
former employee thereof) in connection
with obtaining the restricted profit
interest, are within the limits of
§ ll.12 of this subpart; and
(D) The interest is not transferable by
the entity (or employee or former
employee thereof) except to an affiliate
thereof (or an employee of the banking
entity or affiliate), to immediate family
members, or through the intestacy, of
the employee or former employee, or in
connection with a sale of the business
that gave rise to the restricted profit

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interest by the entity (or employee or
former employee thereof) to an
unaffiliated party that provides
investment management, investment
advisory, commodity trading advisory,
or other services to the fund.
(7) Prime brokerage transaction means
any transaction that would be a covered
transaction, as defined in section
23A(b)(7) of the Federal Reserve Act (12
U.S.C. 371c(b)(7)), that is provided in
connection with custody, clearance and
settlement, securities borrowing or
lending services, trade execution,
financing, or data, operational, and
administrative support.
(8) Resident of the United States
means a person that is a ‘‘U.S. person’’
as defined in rule 902(k) of the SEC’s
Regulation S (17 CFR 230.902(k)).
(9) Sponsor means, with respect to a
covered fund:
(i) To serve as a general partner,
managing member, or trustee of a
covered fund, or to serve as a
commodity pool operator with respect
to a covered fund as defined in (b)(1)(ii)
of this section;
(ii) In any manner to select or to
control (or to have employees, officers,
or directors, or agents who constitute) a
majority of the directors, trustees, or
management of a covered fund; or
(iii) To share with a covered fund, for
corporate, marketing, promotional, or
other purposes, the same name or a
variation of the same name.
(10) Trustee. (i) For purposes of
paragraph (d)(9) of this section and
§ ll.11 of subpart C, a trustee does not
include:
(A) A trustee that does not exercise
investment discretion with respect to a
covered fund, including a trustee that is
subject to the direction of an
unaffiliated named fiduciary who is not
a trustee pursuant to section 403(a)(1) of
the Employee’s Retirement Income
Security Act (29 U.S.C. 1103(a)(1)); or
(B) A trustee that is subject to
fiduciary standards imposed under
foreign law that are substantially
equivalent to those described in
paragraph (d)(10)(i)(A) of this section;
(ii) Any entity that directs a person
described in paragraph (d)(10)(i) of this
section, or that possesses authority and
discretion to manage and control the
investment decisions of a covered fund
for which such person serves as trustee,
shall be considered to be a trustee of
such covered fund.
§ ll.11 Permitted organizing and
offering, underwriting, and market making
with respect to a covered fund.

(a) Organizing and offering a covered
fund in general. Notwithstanding § ll
.10(a) of this subpart, a banking entity

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is not prohibited from acquiring or
retaining an ownership interest in, or
acting as sponsor to, a covered fund in
connection with, directly or indirectly,
organizing and offering a covered fund,
including serving as a general partner,
managing member, trustee, or
commodity pool operator of the covered
fund and in any manner selecting or
controlling (or having employees,
officers, directors, or agents who
constitute) a majority of the directors,
trustees, or management of the covered
fund, including any necessary expenses
for the foregoing, only if:
(1) The banking entity (or an affiliate
thereof) provides bona fide trust,
fiduciary, investment advisory, or
commodity trading advisory services;
(2) The covered fund is organized and
offered only in connection with the
provision of bona fide trust, fiduciary,
investment advisory, or commodity
trading advisory services and only to
persons that are customers of such
services of the banking entity (or an
affiliate thereof), pursuant to a written
plan or similar documentation outlining
how the banking entity or such affiliate
intends to provide advisory or similar
services to its customers through
organizing and offering such fund;
(3) The banking entity and its
affiliates do not acquire or retain an
ownership interest in the covered fund
except as permitted under § ll.12 of
this subpart;
(4) The banking entity and its
affiliates comply with the requirements
of § ll.14 of this subpart;
(5) The banking entity and its
affiliates do not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests;
(6) The covered fund, for corporate,
marketing, promotional, or other
purposes:
(i) Does not share the same name or
a variation of the same name with the
banking entity (or an affiliate thereof);
and
(ii) Does not use the word ‘‘bank’’ in
its name;
(7) No director or employee of the
banking entity (or an affiliate thereof)
takes or retains an ownership interest in
the covered fund, except for any
director or employee of the banking
entity or such affiliate who is directly
engaged in providing investment
advisory, commodity trading advisory,
or other services to the covered fund at
the time the director or employee takes
the ownership interest; and
(8) The banking entity:
(i) Clearly and conspicuously
discloses, in writing, to any prospective

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and actual investor in the covered fund
(such as through disclosure in the
covered fund’s offering documents):
(A) That ‘‘any losses in [such covered
fund] will be borne solely by investors
in [the covered fund] and not by [the
banking entity] or its affiliates;
therefore, [the banking entity’s] losses in
[such covered fund] will be limited to
losses attributable to the ownership
interests in the covered fund held by
[the banking entity] and any affiliate in
its capacity as investor in the [covered
fund] or as beneficiary of a restricted
profit interest held by [the banking
entity] or any affiliate’’;
(B) That such investor should read the
fund offering documents before
investing in the covered fund;
(C) That the ‘‘ownership interests in
the covered fund are not insured by the
FDIC, and are not deposits, obligations
of, or endorsed or guaranteed in any
way, by any banking entity’’ (unless that
happens to be the case); and
(D) The role of the banking entity and
its affiliates and employees in
sponsoring or providing any services to
the covered fund; and
(ii) Complies with any additional
rules of the appropriate Federal banking
agencies, the SEC, or the CFTC, as
provided in section 13(b)(2) of the BHC
Act, designed to ensure that losses in
such covered fund are borne solely by
investors in the covered fund and not by
the covered banking entity and its
affiliates.
(b) Organizing and offering an issuing
entity of asset-backed securities. (1)
Notwithstanding § ll.10(a) of this
subpart, a banking entity is not
prohibited from acquiring or retaining
an ownership interest in, or acting as
sponsor to, a covered fund that is an
issuing entity of asset-backed securities
in connection with, directly or
indirectly, organizing and offering that
issuing entity, so long as the banking
entity and its affiliates comply with all
of the requirements of paragraph (a)(3)
through (8) of this section.
(2) For purposes of this paragraph (b),
organizing and offering a covered fund
that is an issuing entity of asset-backed
securities means acting as the
securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)) of the issuing
entity, or acquiring or retaining an
ownership interest in the issuing entity
as required by section 15G of that Act
(15 U.S.C.78o–11) and the
implementing regulations issued
thereunder.
(c) Underwriting and market making
in ownership interests of a covered
fund. The prohibition contained in
§ ll.10(a) of this subpart does not

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5791

apply to a banking entity’s underwriting
activities or market making-related
activities involving a covered fund so
long as:
(1) Those activities are conducted in
accordance with the requirements of
§ ll.4(a) or § ll.4(b) of subpart B,
respectively;
(2) With respect to any banking entity
(or any affiliate thereof) that: Acts as a
sponsor, investment adviser or
commodity trading advisor to a
particular covered fund or otherwise
acquires and retains an ownership
interest in such covered fund in reliance
on paragraph (a) of this section; acquires
and retains an ownership interest in
such covered fund and is either a
securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act
(15 U.S.C. 78o–11(a)(3)), or is acquiring
and retaining an ownership interest in
such covered fund in compliance with
section 15G of that Act (15 U.S.C.78o–
11) and the implementing regulations
issued thereunder each as permitted by
paragraph (b) of this section; or, directly
or indirectly, guarantees, assumes, or
otherwise insures the obligations or
performance of the covered fund or of
any covered fund in which such fund
invests, then in each such case any
ownership interests acquired or retained
by the banking entity and its affiliates in
connection with underwriting and
market making related activities for that
particular covered fund are included in
the calculation of ownership interests
permitted to be held by the banking
entity and its affiliates under the
limitations of § ll.12(a)(2)(ii) and
§ ll.12(d) of this subpart; and
(3) With respect to any banking entity,
the aggregate value of all ownership
interests of the banking entity and its
affiliates in all covered funds acquired
and retained under § ll.11 of this
subpart, including all covered funds in
which the banking entity holds an
ownership interest in connection with
underwriting and market making related
activities permitted under this
paragraph (c), are included in the
calculation of all ownership interests
under § ll.12(a)(2)(iii) and
§ ll.12(d) of this subpart.
§ ll.12 Permitted investment in a
covered fund.

(a) Authority and limitations on
permitted investments in covered funds.
(1) Notwithstanding the prohibition
contained in § ll.10(a) of this subpart,
a banking entity may acquire and retain
an ownership interest in a covered fund
that the banking entity or an affiliate
thereof organizes and offers pursuant to
§ ll.11, for the purposes of:

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(i) Establishment. Establishing the
fund and providing the fund with
sufficient initial equity for investment to
permit the fund to attract unaffiliated
investors, subject to the limits contained
in paragraphs (a)(2)(i) and (iii) of this
section; or
(ii) De minimis investment. Making
and retaining an investment in the
covered fund subject to the limits
contained in paragraphs (a)(2)(ii) and
(iii) of this section.
(2) Investment limits—(i) Seeding
period. With respect to an investment in
any covered fund made or held
pursuant to paragraph (a)(1)(i) of this
section, the banking entity and its
affiliates:
(A) Must actively seek unaffiliated
investors to reduce, through
redemption, sale, dilution, or other
methods, the aggregate amount of all
ownership interests of the banking
entity in the covered fund to the amount
permitted in paragraph (a)(2)(i)(B) of
this section; and
(B) Must, no later than 1 year after the
date of establishment of the fund (or
such longer period as may be provided
by the Board pursuant to paragraph (e)
of this section), conform its ownership
interest in the covered fund to the limits
in paragraph (a)(2)(ii) of this section;
(ii) Per-fund limits. (A) Except as
provided in paragraph (a)(2)(ii)(B) of
this section, an investment by a banking
entity and its affiliates in any covered
fund made or held pursuant to
paragraph (a)(1)(ii) of this section may
not exceed 3 percent of the total number
or value of the outstanding ownership
interests of the fund.
(B) An investment by a banking entity
and its affiliates in a covered fund that
is an issuing entity of asset-backed
securities may not exceed 3 percent of
the total fair market value of the
ownership interests of the fund
measured in accordance with paragraph
(b)(3) of this section, unless a greater
percentage is retained by the banking
entity and its affiliates in compliance
with the requirements of section 15G of
the Exchange Act (15 U.S.C. 78o–11)
and the implementing regulations
issued thereunder, in which case the
investment by the banking entity and its
affiliates in the covered fund may not
exceed the amount, number, or value of
ownership interests of the fund required
under section 15G of the Exchange Act
and the implementing regulations
issued thereunder.
(iii) Aggregate limit. The aggregate
value of all ownership interests of the
banking entity and its affiliates in all
covered funds acquired or retained
under this section may not exceed 3
percent of the tier 1 capital of the

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banking entity, as provided under
paragraph (c) of this section, and shall
be calculated as of the last day of each
calendar quarter.
(iv) Date of establishment. For
purposes of this section, the date of
establishment of a covered fund shall
be:
(A) In general. The date on which the
investment adviser or similar entity to
the covered fund begins making
investments pursuant to the written
investment strategy for the fund;
(B) Issuing entities of asset-backed
securities. In the case of an issuing
entity of asset-backed securities, the
date on which the assets are initially
transferred into the issuing entity of
asset-backed securities.
(b) Rules of construction—(1)
Attribution of ownership interests to a
covered banking entity. (i) For purposes
of paragraph (a)(2) of this section, the
amount and value of a banking entity’s
permitted investment in any single
covered fund shall include any
ownership interest held under § ___.12
directly by the banking entity, including
any affiliate of the banking entity.
(ii) Treatment of registered investment
companies, SEC-regulated business
development companies and foreign
public funds. For purposes of paragraph
(b)(1)(i) of this section, a registered
investment company, SEC-regulated
business development companies or
foreign public fund as described in
§ ___.10(c)(1) of this subpart will not be
considered to be an affiliate of the
banking entity so long as the banking
entity:
(A) Does not own, control, or hold
with the power to vote 25 percent or
more of the voting shares of the
company or fund; and
(B) Provides investment advisory,
commodity trading advisory,
administrative, and other services to the
company or fund in compliance with
the limitations under applicable
regulation, order, or other authority.
(iii) Covered funds. For purposes of
paragraph (b)(1)(i) of this section, a
covered fund will not be considered to
be an affiliate of a banking entity so long
as the covered fund is held in
compliance with the requirements of
this subpart.
(iv) Treatment of employee and
director investments financed by the
banking entity. For purposes of
paragraph (b)(1)(i) of this section, an
investment by a director or employee of
a banking entity who acquires an
ownership interest in his or her
personal capacity in a covered fund
sponsored by the banking entity will be
attributed to the banking entity if the
banking entity, directly or indirectly,

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extends financing for the purpose of
enabling the director or employee to
acquire the ownership interest in the
fund and the financing is used to
acquire such ownership interest in the
covered fund.
(2) Calculation of permitted
ownership interests in a single covered
fund. Except as provided in paragraph
(b)(3) or (4), for purposes of determining
whether an investment in a single
covered fund complies with the
restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and
(a)(2)(ii)(A) of this section:
(i) The aggregate number of the
outstanding ownership interests held by
the banking entity shall be the total
number of ownership interests held
under this section by the banking entity
in a covered fund divided by the total
number of ownership interests held by
all entities in that covered fund, as of
the last day of each calendar quarter
(both measured without regard to
committed funds not yet called for
investment);
(ii) The aggregate value of the
outstanding ownership interests held by
the banking entity shall be the aggregate
fair market value of all investments in
and capital contributions made to the
covered fund by the banking entity,
divided by the value of all investments
in and capital contributions made to
that covered fund by all entities, as of
the last day of each calendar quarter (all
measured without regard to committed
funds not yet called for investment). If
fair market value cannot be determined,
then the value shall be the historical
cost basis of all investments in and
contributions made by the banking
entity to the covered fund;
(iii) For purposes of the calculation
under paragraph (b)(2)(ii) of this section,
once a valuation methodology is chosen,
the banking entity must calculate the
value of its investment and the
investments of all others in the covered
fund in the same manner and according
to the same standards.
(3) Issuing entities of asset-backed
securities. In the case of an ownership
interest in an issuing entity of assetbacked securities, for purposes of
determining whether an investment in a
single covered fund complies with the
restrictions on ownership interests
under paragraphs (a)(2)(i)(B) and
(a)(2)(ii)(B) of this section:
(i) For securitizations subject to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11), the
calculations shall be made as of the date
and according to the valuation
methodology applicable pursuant to the
requirements of section 15G of the
Exchange Act (15 U.S.C. 78o–11) and

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the implementing regulations issued
thereunder; or
(ii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the calculations shall be
made as of the date of establishment as
defined in paragraph (a)(2)(iv)(B) of this
section or such earlier date on which
the transferred assets have been valued
for purposes of transfer to the covered
fund, and thereafter only upon the date
on which additional securities of the
issuing entity of asset-backed securities
are priced for purposes of the sales of
ownership interests to unaffiliated
investors.
(iii) For securitization transactions
completed prior to the compliance date
of such implementing regulations (or as
to which such implementing regulations
do not apply), the aggregate value of the
outstanding ownership interests in the
covered fund shall be the fair market
value of the assets transferred to the
issuing entity of the securitization and
any other assets otherwise held by the
issuing entity at such time, determined
in a manner that is consistent with its
determination of the fair market value of
those assets for financial statement
purposes.
(iv) For purposes of the calculation
under paragraph (b)(3)(iii) of this
section, the valuation methodology used
to calculate the fair market value of the
ownership interests must be the same
for both the ownership interests held by
a banking entity and the ownership
interests held by all others in the
covered fund in the same manner and
according to the same standards.
(4) Multi-tier fund investments—(i)
Master-feeder fund investments. If the
principal investment strategy of a
covered fund (the ‘‘feeder fund’’) is to
invest substantially all of its assets in
another single covered fund (the
‘‘master fund’’), then for purposes of the
investment limitations in paragraphs
(a)(2)(i)(B) and (a)(2)(ii) of this section,
the banking entity’s permitted
investment in such funds shall be
measured only by reference to the value
of the master fund. The banking entity’s
permitted investment in the master fund
shall include any investment by the
banking entity in the master fund, as
well as the banking entity’s pro-rata
share of any ownership interest of the
master fund that is held through the
feeder fund; and
(ii) Fund-of-funds investments. If a
banking entity organizes and offers a
covered fund pursuant to § __.11 of this
subpart for the purpose of investing in
other covered funds (a ‘‘fund of funds’’)
and that fund of funds itself invests in

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another covered fund that the banking
entity is permitted to own, then the
banking entity’s permitted investment
in that other fund shall include any
investment by the banking entity in that
other fund, as well as the banking
entity’s pro-rata share of any ownership
interest of the fund that is held through
the fund of funds. The investment of the
banking entity may not represent more
than 3 percent of the amount or value
of any single covered fund.
(c) Aggregate permitted investments
in all covered funds. (1) For purposes of
paragraph (a)(2)(iii) of this section, the
aggregate value of all ownership
interests held by a banking entity shall
be the sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest in covered funds
(together with any amounts paid by the
entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § ___.10(d)(6)(ii) of
this subpart), on a historical cost basis.
(2) Calculation of tier 1 capital. For
purposes of paragraph (a)(2)(iii) of this
section:
(i) Entities that are required to hold
and report tier 1 capital. If a banking
entity is required to calculate and report
tier 1 capital, the banking entity’s tier 1
capital shall be equal to the amount of
tier 1 capital of the banking entity as of
the last day of the most recent calendar
quarter, as reported to its primary
financial regulatory agency; and
(ii) If a banking entity is not required
to calculate and report tier 1 capital, the
banking entity’s tier 1 capital shall be
determined to be equal to:
(A) In the case of a banking entity that
is controlled, directly or indirectly, by a
depository institution that calculates
and reports tier 1 capital, be equal to the
amount of tier 1 capital reported by
such controlling depository institution
in the manner described in paragraph
(c)(2)(i) of this section;
(B) In the case of a banking entity that
is not controlled, directly or indirectly,
by a depository institution that
calculates and reports tier 1 capital:
(1) Bank holding company
subsidiaries. If the banking entity is a
subsidiary of a bank holding company
or company that is treated as a bank
holding company, be equal to the
amount of tier 1 capital reported by the
top-tier affiliate of such covered banking
entity that calculates and reports tier 1
capital in the manner described in
paragraph (c)(2)(i) of this section; and
(2) Other holding companies and any
subsidiary or affiliate thereof. If the
banking entity is not a subsidiary of a
bank holding company or a company
that is treated as a bank holding

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5793

company, be equal to the total amount
of shareholders’ equity of the top-tier
affiliate within such organization as of
the last day of the most recent calendar
quarter that has ended, as determined
under applicable accounting standards.
(iii) Treatment of foreign banking
entities—(A) Foreign banking entities.
Except as provided in paragraph
(c)(2)(iii)(B) of this section, with respect
to a banking entity that is not itself, and
is not controlled directly or indirectly
by, a banking entity that is located or
organized under the laws of the United
States or of any State, the tier 1 capital
of the banking entity shall be the
consolidated tier 1 capital of the entity
as calculated under applicable home
country standards.
(B) U.S. affiliates of foreign banking
entities. With respect to a banking entity
that is located or organized under the
laws of the United States or of any State
and is controlled by a foreign banking
entity identified under paragraph
(c)(2)(iii)(A) of this section, the banking
entity’s tier 1 capital shall be as
calculated under paragraphs (c)(2)(i) or
(ii) of this section.
(d) Capital treatment for a permitted
investment in a covered fund. For
purposes of calculating compliance with
the applicable regulatory capital
requirements, a banking entity shall
deduct from the banking entity’s tier 1
capital (as determined under paragraph
(c)(2) of this section) the greater of:
(1) The sum of all amounts paid or
contributed by the banking entity in
connection with acquiring or retaining
an ownership interest (together with any
amounts paid by the entity (or employee
thereof) in connection with obtaining a
restricted profit interest under
§ ___.10(d)(6)(ii) of subpart C), on a
historical cost basis, plus any earnings
received; and
(2) The fair market value of the
banking entity’s ownership interests in
the covered fund as determined under
paragraph (b)(2)(ii) or (b)(3) of this
section (together with any amounts paid
by the entity (or employee thereof) in
connection with obtaining a restricted
profit interest under § ___.10(d)(6)(ii) of
subpart C), if the banking entity
accounts for the profits (or losses) of the
fund investment in its financial
statements.
(e) Extension of time to divest an
ownership interest. (1) Upon application
by a banking entity, the Board may
extend the period under paragraph
(a)(2)(i) of this section for up to 2
additional years if the Board finds that
an extension would be consistent with
safety and soundness and not
detrimental to the public interest. An
application for extension must:

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(i) Be submitted to the Board at least
90 days prior to the expiration of the
applicable time period;
(ii) Provide the reasons for
application, including information that
addresses the factors in paragraph (e)(2)
of this section; and
(iii) Explain the banking entity’s plan
for reducing the permitted investment
in a covered fund through redemption,
sale, dilution or other methods as
required in paragraph (a)(2) of this
section.
(2) Factors governing Board
determinations. In reviewing any
application under paragraph (e)(1) of
this section, the Board may consider all
the facts and circumstances related to
the permitted investment in a covered
fund, including:
(i) Whether the investment would
result, directly or indirectly, in a
material exposure by the banking entity
to high-risk assets or high-risk trading
strategies;
(ii) The contractual terms governing
the banking entity’s interest in the
covered fund;
(iii) The date on which the covered
fund is expected to have attracted
sufficient investments from investors
unaffiliated with the banking entity to
enable the banking entity to comply
with the limitations in paragraph
(a)(2)(i) of this section;
(iv) The total exposure of the covered
banking entity to the investment and the
risks that disposing of, or maintaining,
the investment in the covered fund may
pose to the banking entity and the
financial stability of the United States;
(v) The cost to the banking entity of
divesting or disposing of the investment
within the applicable period;
(vi) Whether the investment or the
divestiture or conformance of the
investment would involve or result in a
material conflict of interest between the
banking entity and unaffiliated parties,
including clients, customers or
counterparties to which it owes a duty;
(vi) The banking entity’s prior efforts
to reduce through redemption, sale,
dilution, or other methods its ownership
interests in the covered fund, including
activities related to the marketing of
interests in such covered fund;
(viii) Market conditions; and
(ix) Any other factor that the Board
believes appropriate.
(3) Authority to impose restrictions on
activities or investment during any
extension period. The Board may
impose such conditions on any
extension approved under paragraph
(e)(1) of this section as the Board
determines are necessary or appropriate
to protect the safety and soundness of
the banking entity or the financial

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stability of the United States, address
material conflicts of interest or other
unsound banking practices, or otherwise
further the purposes of section 13 of the
BHC Act and this part.
(4) Consultation. In the case of a
banking entity that is primarily
regulated by another Federal banking
agency, the SEC, or the CFTC, the Board
will consult with such agency prior to
acting on an application by the banking
entity for an extension under paragraph
(e)(1) of this section.
§ __.13 Other permitted covered fund
activities and investments.

(a) Permitted risk-mitigating hedging
activities. (1) The prohibition contained
in § ___.10(a) of this subpart does not
apply with respect to an ownership
interest in a covered fund acquired or
retained by a banking entity that is
designed to demonstrably reduce or
otherwise significantly mitigate the
specific, identifiable risks to the banking
entity in connection with a
compensation arrangement with an
employee of the banking entity or an
affiliate thereof that directly provides
investment advisory, commodity trading
advisory or other services to the covered
fund.
(2) Requirements. The risk-mitigating
hedging activities of a banking entity are
permitted under this paragraph (a) only
if:
(i) The banking entity has established
and implements, maintains and enforces
an internal compliance program
required by subpart D of this part that
is reasonably designed to ensure the
banking entity’s compliance with the
requirements of this section, including:
(A) Reasonably designed written
policies and procedures; and
(B) Internal controls and ongoing
monitoring, management, and
authorization procedures, including
relevant escalation procedures; and
(ii) The acquisition or retention of the
ownership interest:
(A) Is made in accordance with the
written policies, procedures and
internal controls required under this
section;
(B) At the inception of the hedge, is
designed to reduce or otherwise
significantly mitigate and demonstrably
reduces or otherwise significantly
mitigates one or more specific,
identifiable risks arising in connection
with the compensation arrangement
with the employee that directly
provides investment advisory,
commodity trading advisory, or other
services to the covered fund;
(C) Does not give rise, at the inception
of the hedge, to any significant new or
additional risk that is not itself hedged

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contemporaneously in accordance with
this section; and
(D) Is subject to continuing review,
monitoring and management by the
banking entity.
(iii) The compensation arrangement
relates solely to the covered fund in
which the banking entity or any affiliate
has acquired an ownership interest
pursuant to this paragraph and such
compensation arrangement provides
that any losses incurred by the banking
entity on such ownership interest will
be offset by corresponding decreases in
amounts payable under such
compensation arrangement.
(b) Certain permitted covered fund
activities and investments outside of the
United States. (1) The prohibition
contained in § __.10(a) of this subpart
does not apply to the acquisition or
retention of any ownership interest in,
or the sponsorship of, a covered fund by
a banking entity only if:
(i) The banking entity is not organized
or directly or indirectly controlled by a
banking entity that is organized under
the laws of the United States or of one
or more States;
(ii) The activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act;
(iii) No ownership interest in the
covered fund is offered for sale or sold
to a resident of the United States; and
(iv) The activity or investment occurs
solely outside of the United States.
(2) An activity or investment by the
banking entity is pursuant to paragraph
(9) or (13) of section 4(c) of the BHC Act
for purposes of paragraph (b)(1)(ii) of
this section only if:
(i) The activity or investment is
conducted in accordance with the
requirements of this section; and
(ii)(A) With respect to a banking
entity that is a foreign banking
organization, the banking entity meets
the qualifying foreign banking
organization requirements of section
211.23(a), (c) or (e) of the Board’s
Regulation K (12 CFR 211.23(a), (c) or
(e)), as applicable; or
(B) With respect to a banking entity
that is not a foreign banking
organization, the banking entity is not
organized under the laws of the United
States or of one or more States and the
banking entity, on a fully-consolidated
basis, meets at least two of the following
requirements:
(1) Total assets of the banking entity
held outside of the United States exceed
total assets of the banking entity held in
the United States;
(2) Total revenues derived from the
business of the banking entity outside of
the United States exceed total revenues

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derived from the business of the
banking entity in the United States; or
(3) Total net income derived from the
business of the banking entity outside of
the United States exceeds total net
income derived from the business of the
banking entity in the United States.
(3) An ownership interest in a covered
fund is not offered for sale or sold to a
resident of the United States for
purposes of paragraph (b)(1)(iii) of this
section only if it is sold or has been sold
pursuant to an offering that does not
target residents of the United States.
(4) An activity or investment occurs
solely outside of the United States for
purposes of paragraph (b)(1)(iv) of this
section only if:
(i) The banking entity acting as
sponsor, or engaging as principal in the
acquisition or retention of an ownership
interest in the covered fund, is not itself,
and is not controlled directly or
indirectly by, a banking entity that is
located in the United States or
organized under the laws of the United
States or of any State;
(ii) The banking entity (including
relevant personnel) that makes the
decision to acquire or retain the
ownership interest or act as sponsor to
the covered fund is not located in the
United States or organized under the
laws of the United States or of any State;
(iii) The investment or sponsorship,
including any transaction arising from
risk-mitigating hedging related to an
ownership interest, is not accounted for
as principal directly or indirectly on a
consolidated basis by any branch or
affiliate that is located in the United
States or organized under the laws of
the United States or of any State; and
(iv) No financing for the banking
entity’s ownership or sponsorship is
provided, directly or indirectly, by any
branch or affiliate that is located in the
United States or organized under the
laws of the United States or of any State.
(5) For purposes of this section, a U.S.
branch, agency, or subsidiary of a
foreign bank, or any subsidiary thereof,
is located in the United States; however,
a foreign bank of which that branch,
agency, or subsidiary is a part is not
considered to be located in the United
States solely by virtue of operation of
the U.S. branch, agency, or subsidiary.
(c) Permitted covered fund interests
and activities by a regulated insurance
company. The prohibition contained in
§ __.10(a) of this subpart does not apply
to the acquisition or retention by an
insurance company, or an affiliate
thereof, of any ownership interest in, or
the sponsorship of, a covered fund only
if:
(1) The insurance company or its
affiliate acquires and retains the

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ownership interest solely for the general
account of the insurance company or for
one or more separate accounts
established by the insurance company;
(2) The acquisition and retention of
the ownership interest is conducted in
compliance with, and subject to, the
insurance company investment laws,
regulations, and written guidance of the
State or jurisdiction in which such
insurance company is domiciled; and
(3) The appropriate Federal banking
agencies, after consultation with the
Financial Stability Oversight Council
and the relevant insurance
commissioners of the States and foreign
jurisdictions, as appropriate, have not
jointly determined, after notice and
comment, that a particular law,
regulation, or written guidance
described in paragraph (c)(2) of this
section is insufficient to protect the
safety and soundness of the banking
entity, or the financial stability of the
United States.
§ __.14 Limitations on relationships with a
covered fund.

(a) Relationships with a covered fund.
(1) Except as provided for in paragraph
(a)(2) of this section, no banking entity
that serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, that
organizes and offers a covered fund
pursuant to § __.11 of this subpart, or
that continues to hold an ownership
interest in accordance with § __.11(b) of
this subpart, and no affiliate of such
entity, may enter into a transaction with
the covered fund, or with any other
covered fund that is controlled by such
covered fund, that would be a covered
transaction as defined in section 23A of
the Federal Reserve Act (12 U.S.C.
371c(b)(7)), as if such banking entity
and the affiliate thereof were a member
bank and the covered fund were an
affiliate thereof.
(2) Notwithstanding paragraph (a)(1)
of this section, a banking entity may:
(i) Acquire and retain any ownership
interest in a covered fund in accordance
with the requirements of § __.11, § __.12,
or § __.13 of this subpart; and
(ii) Enter into any prime brokerage
transaction with any covered fund in
which a covered fund managed,
sponsored, or advised by such banking
entity (or an affiliate thereof) has taken
an ownership interest, if:
(A) The banking entity is in
compliance with each of the limitations
set forth in § __.11 of this subpart with
respect to a covered fund organized and
offered by such banking entity (or an
affiliate thereof);

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5795

(B) The chief executive officer (or
equivalent officer) of the banking entity
certifies in writing annually to [Agency]
(with a duty to update the certification
if the information in the certification
materially changes) that the banking
entity does not, directly or indirectly,
guarantee, assume, or otherwise insure
the obligations or performance of the
covered fund or of any covered fund in
which such covered fund invests; and
(C) The Board has not determined that
such transaction is inconsistent with the
safe and sound operation and condition
of the banking entity.
(b) Restrictions on transactions with
covered funds. A banking entity that
serves, directly or indirectly, as the
investment manager, investment
adviser, commodity trading advisor, or
sponsor to a covered fund, or that
organizes and offers a covered fund
pursuant to § __.11 of this subpart, or
that continues to hold an ownership
interest in accordance with § __.11(b) of
this subpart, shall be subject to section
23B of the Federal Reserve Act (12
U.S.C. 371c–1), as if such banking entity
were a member bank and such covered
fund were an affiliate thereof.
(c) Restrictions on prime brokerage
transactions. A prime brokerage
transaction permitted under paragraph
(a)(2)(ii) of this section shall be subject
to section 23B of the Federal Reserve
Act (12 U.S.C. 371c–1) as if the
counterparty were an affiliate of the
banking entity.
§ __.15 Other limitations on permitted
covered fund activities.

(a) No transaction, class of
transactions, or activity may be deemed
permissible under §§ __.11 through __
.13 of this subpart if the transaction,
class of transactions, or activity would:
(1) Involve or result in a material
conflict of interest between the banking
entity and its clients, customers, or
counterparties;
(2) Result, directly or indirectly, in a
material exposure by the banking entity
to a high-risk asset or a high-risk trading
strategy; or
(3) Pose a threat to the safety and
soundness of the banking entity or to
the financial stability of the United
States.
(b) Definition of material conflict of
interest. (1) For purposes of this section,
a material conflict of interest between a
banking entity and its clients,
customers, or counterparties exists if the
banking entity engages in any
transaction, class of transactions, or
activity that would involve or result in
the banking entity’s interests being
materially adverse to the interests of its
client, customer, or counterparty with

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respect to such transaction, class of
transactions, or activity, and the
banking entity has not taken at least one
of the actions in paragraph (b)(2) of this
section.
(2) Prior to effecting the specific
transaction or class or type of
transactions, or engaging in the specific
activity, the banking entity:
(i) Timely and effective disclosure. (A)
Has made clear, timely, and effective
disclosure of the conflict of interest,
together with other necessary
information, in reasonable detail and in
a manner sufficient to permit a
reasonable client, customer, or
counterparty to meaningfully
understand the conflict of interest; and
(B) Such disclosure is made in a
manner that provides the client,
customer, or counterparty the
opportunity to negate, or substantially
mitigate, any materially adverse effect
on the client, customer, or counterparty
created by the conflict of interest; or
(ii) Information barriers. Has
established, maintained, and enforced
information barriers that are
memorialized in written policies and
procedures, such as physical separation
of personnel, or functions, or limitations
on types of activity, that are reasonably
designed, taking into consideration the
nature of the banking entity’s business,
to prevent the conflict of interest from
involving or resulting in a materially
adverse effect on a client, customer, or
counterparty. A banking entity may not
rely on such information barriers if, in
the case of any specific transaction,
class or type of transactions or activity,
the banking entity knows or should
reasonably know that, notwithstanding
the banking entity’s establishment of
information barriers, the conflict of
interest may involve or result in a
materially adverse effect on a client,
customer, or counterparty.
(c) Definition of high-risk asset and
high-risk trading strategy. For purposes
of this section:
(1) High-risk asset means an asset or
group of related assets that would, if
held by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.
(2) High-risk trading strategy means a
trading strategy that would, if engaged
in by a banking entity, significantly
increase the likelihood that the banking
entity would incur a substantial
financial loss or would pose a threat to
the financial stability of the United
States.

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§ ll.16

[Reserved]

§ ll.17

[Reserved]

§ ll.18

[Reserved]

§ ll.19

[Reserved]

Subpart D—Compliance Program
Requirement; Violations
§ ll.20 Program for compliance;
reporting

(a) Program requirement. Each
banking entity shall develop and
provide for the continued
administration of a compliance program
reasonably designed to ensure and
monitor compliance with the
prohibitions and restrictions on
proprietary trading and covered fund
activities and investments set forth in
section 13 of the BHC Act and this part.
The terms, scope and detail of the
compliance program shall be
appropriate for the types, size, scope
and complexity of activities and
business structure of the banking entity.
(b) Contents of compliance program.
Except as provided in paragraph (f) of
this section, the compliance program
required by paragraph (a) of this section,
at a minimum, shall include:
(1) Written policies and procedures
reasonably designed to document,
describe, monitor and limit trading
activities subject to subpart B (including
those permitted under §§ ll.3 to
ll.6 of subpart B), including setting,
monitoring and managing required
limits set out in § ll4 and § ll5, and
activities and investments with respect
to a covered fund subject to subpart C
(including those permitted under
§§ ll.11 through ll.14 of subpart C)
conducted by the banking entity to
ensure that all activities and
investments conducted by the banking
entity that are subject to section 13 of
the BHC Act and this part comply with
section 13 of the BHC Act and this part;
(2) A system of internal controls
reasonably designed to monitor
compliance with section 13 of the BHC
Act and this part and to prevent the
occurrence of activities or investments
that are prohibited by section 13 of the
BHC Act and this part;
(3) A management framework that
clearly delineates responsibility and
accountability for compliance with
section 13 of the BHC Act and this part
and includes appropriate management
review of trading limits, strategies,
hedging activities, investments,
incentive compensation and other
matters identified in this part or by
management as requiring attention;
(4) Independent testing and audit of
the effectiveness of the compliance

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program conducted periodically by
qualified personnel of the banking
entity or by a qualified outside party;
(5) Training for trading personnel and
managers, as well as other appropriate
personnel, to effectively implement and
enforce the compliance program; and
(6) Records sufficient to demonstrate
compliance with section 13 of the BHC
Act and this part, which a banking
entity must promptly provide to
[Agency] upon request and retain for a
period of no less than 5 years or such
longer period as required by [Agency].
(c) Additional standards. In addition
to the requirements in paragraph (b) of
this section, the compliance program of
a banking entity must satisfy the
requirements and other standards
contained in Appendix B, if:
(1) The banking entity engages in
proprietary trading permitted under
subpart B and is required to comply
with the reporting requirements of
paragraph (d) of this section;
(2) The banking entity has reported
total consolidated assets as of the
previous calendar year end of $50
billion or more or, in the case of a
foreign banking entity, has total U.S.
assets as of the previous calendar year
end of $50 billion or more (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity
operating, located or organized in the
United States); or
(3) [Agency] notifies the banking
entity in writing that it must satisfy the
requirements and other standards
contained in Appendix B to this part.
(d) Reporting requirements under
Appendix A to this part. (1) A banking
entity engaged in proprietary trading
activity permitted under subpart B shall
comply with the reporting requirements
described in Appendix A, if:
(i) The banking entity (other than a
foreign banking entity as provided in
paragraph (d)(1)(ii) of this section) has,
together with its affiliates and
subsidiaries, trading assets and
liabilities (excluding trading assets and
liabilities involving obligations of or
guaranteed by the United States or any
agency of the United States) the average
gross sum of which (on a worldwide
consolidated basis) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section;
(ii) In the case of a foreign banking
entity, the average gross sum of the
trading assets and liabilities of the
combined U.S. operations of the foreign
banking entity (including all
subsidiaries, affiliates, branches and
agencies of the foreign banking entity

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operating, located or organized in the
United States and excluding trading
assets and liabilities involving
obligations of or guaranteed by the
United States or any agency of the
United States) over the previous
consecutive four quarters, as measured
as of the last day of each of the four
prior calendar quarters, equals or
exceeds the threshold established in
paragraph (d)(2) of this section; or
(iii) [Agency] notifies the banking
entity in writing that it must satisfy the
reporting requirements contained in
Appendix A.
(2) The threshold for reporting under
paragraph (d)(1) of this section shall be
$50 billion beginning on June 30, 2014;
$25 billion beginning on April 30, 2016;
and $10 billion beginning on December
31, 2016.
(3) Frequency of reporting: Unless
[Agency] notifies the banking entity in
writing that it must report on a different
basis, a banking entity with $50 billion
or more in trading assets and liabilities
(as calculated in accordance with
paragraph (d)(1) of this section) shall
report the information required by
Appendix A for each calendar month
within 30 days of the end of the relevant
calendar month; beginning with
information for the month of January
2015, such information shall be reported
within 10 days of the end of each
calendar month. Any other banking
entity subject to Appendix A shall
report the information required by
Appendix A for each calendar quarter
within 30 days of the end of that
calendar quarter unless [Agency]
notifies the banking entity in writing
that it must report on a different basis.
(e) Additional documentation for
covered funds. Any banking entity that
has more than $10 billion in total
consolidated assets as reported on
December 31 of the previous two
calendar years shall maintain records
that include:
(1) Documentation of the exclusions
or exemptions other than sections
3(c)(1) and 3(c)(7) of the Investment
Company Act of 1940 relied on by each
fund sponsored by the banking entity
(including all subsidiaries and affiliates)
in determining that such fund is not a
covered fund;
(2) For each fund sponsored by the
banking entity (including all
subsidiaries and affiliates) for which the
banking entity relies on one or more of
the exclusions from the definition of
covered fund provided by
§§ ll.10(c)(1),ll.10(c)(5),
ll.10(c)(8), ll.10(c)(9), or
ll.10(c)(10) of subpart C,
documentation supporting the banking
entity’s determination that the fund is

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not a covered fund pursuant to one or
more of those exclusions;
(3) For each seeding vehicle described
in § ll.10(c)(12)(i) or (iii) of subpart C
that will become a registered investment
company or SEC-regulated business
development company, a written plan
documenting the banking entity’s
determination that the seeding vehicle
will become a registered investment
company or SEC-regulated business
development company; the period of
time during which the vehicle will
operate as a seeding vehicle; and the
banking entity’s plan to market the
vehicle to third-party investors and
convert it into a registered investment
company or SEC-regulated business
development company within the time
period specified in § ll.12(a)(2)(i)(B)
of subpart C;
(4) For any banking entity that is, or
is controlled directly or indirectly by a
banking entity that is, located in or
organized under the laws of the United
States or of any State, if the aggregate
amount of ownership interests in
foreign public funds that are described
in § ll.10(c)(1) of subpart C owned by
such banking entity (including
ownership interests owned by any
affiliate that is controlled directly or
indirectly by a banking entity that is
located in or organized under the laws
of the United States or of any State)
exceeds $50 million at the end of two
or more consecutive calendar quarters,
beginning with the next succeeding
calendar quarter, documentation of the
value of the ownership interests owned
by the banking entity (and such
affiliates) in each foreign public fund
and each jurisdiction in which any such
foreign public fund is organized,
calculated as of the end of each calendar
quarter, which documentation must
continue until the banking entity’s
aggregate amount of ownership interests
in foreign public funds is below $50
million for two consecutive calendar
quarters; and
(5) For purposes of paragraph (e)(4) of
this section, a U.S. branch, agency, or
subsidiary of a foreign banking entity is
located in the United States; however,
the foreign bank that operates or
controls that branch, agency, or
subsidiary is not considered to be
located in the United States solely by
virtue of operating or controlling the
U.S. branch, agency, or subsidiary.
(f) Simplified programs for less active
banking entities—(1) Banking entities
with no covered activities. A banking
entity that does not engage in activities
or investments pursuant to subpart B or
subpart C (other than trading activities
permitted pursuant to § ll.6(a) of
subpart B) may satisfy the requirements

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of this section by establishing the
required compliance program prior to
becoming engaged in such activities or
making such investments (other than
trading activities permitted pursuant to
§ ll.6(a) of subpart B).
(2) Banking entities with modest
activities. A banking entity with total
consolidated assets of $10 billion or less
as reported on December 31 of the
previous two calendar years that
engages in activities or investments
pursuant to subpart B or subpart C
(other than trading activities permitted
under § ll.6(a) of subpart B) may
satisfy the requirements of this section
by including in its existing compliance
policies and procedures appropriate
references to the requirements of section
13 of the BHC Act and this part and
adjustments as appropriate given the
activities, size, scope and complexity of
the banking entity.
§ ll.21 Termination of activities or
investments; penalties for violations.

(a) Any banking entity that engages in
an activity or makes an investment in
violation of section 13 of the BHC Act
or this part, or acts in a manner that
functions as an evasion of the
requirements of section 13 of the BHC
Act or this part, including through an
abuse of any activity or investment
permitted under subparts B or C, or
otherwise violates the restrictions and
requirements of section 13 of the BHC
Act or this part, shall, upon discovery,
promptly terminate the activity and, as
relevant, dispose of the investment.
(b) Whenever [Agency] finds
reasonable cause to believe any banking
entity has engaged in an activity or
made an investment in violation of
section 13 of the BHC Act or this part,
or engaged in any activity or made any
investment that functions as an evasion
of the requirements of section 13 of the
BHC Act or this part, [Agency] may take
any action permitted by law to enforce
compliance with section 13 of the BHC
Act and this part, including directing
the banking entity to restrict, limit, or
terminate any or all activities under this
part and dispose of any investment.
Appendix A to Part ll—Reporting
and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and
recordkeeping requirements that certain
banking entities must satisfy in connection
with the restrictions on proprietary trading
set forth in subpart B (‘‘proprietary trading
restrictions’’). Pursuant to § ll.20(d), this
appendix generally applies to a banking
entity that, together with its affiliates and
subsidiaries, has significant trading assets
and liabilities. These entities are required to

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(i) 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 (ii) create and maintain records
documenting the preparation and content of
these reports. The requirements of this
appendix must be incorporated into the
banking entity’s internal compliance program
under § ll.20 and Appendix B.
b. The purpose of this appendix is to assist
banking entities and [Agency] in:
(i) Better understanding and evaluating the
scope, type, and profile of the banking
entity’s covered trading activities;
(ii) Monitoring the banking entity’s covered
trading activities;
(iii) Identifying covered trading activities
that warrant further review or examination
by the banking entity to verify compliance
with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading
activities of trading desks engaged in market
making-related activities subject to
§ ll.4(b) are consistent with the
requirements governing permitted market
making-related activities;
(v) Evaluating whether the covered trading
activities of trading desks that are engaged in
permitted trading activity subject to
§§ ll.4, ll.5, or ll.6(a)-(b) (i.e.,
underwriting and market making-related
related activity, risk-mitigating hedging, or
trading in certain government obligations) are
consistent with the requirement that such
activity not result, directly or indirectly, in
a material exposure to high-risk assets or
high-risk trading strategies;
(vi) Identifying the profile of particular
covered trading activities of the banking
entity, and the individual trading desks of
the banking entity, to help establish the
appropriate frequency and scope of
examination by [Agency] of such activities;
and
(vii) Assessing and addressing the risks
associated with the banking entity’s covered
trading activities.
c. The quantitative measurements that
must be furnished pursuant to this appendix
are not intended to serve as a dispositive tool
for the identification of permissible or
impermissible activities.
d. In order to allow banking entities and
the Agencies to evaluate the effectiveness of
these metrics, banking entities must collect
and report these metrics for all trading desks
beginning on the dates established in
§ ll.20 of the final rule. The Agencies will
review the data collected and revise this
collection requirement as appropriate based
on a review of the data collected prior to
September 30, 2015.
e. In addition to the quantitative
measurements required in this appendix, a
banking entity may need to develop and
implement other quantitative measurements
in order to effectively monitor its covered
trading activities for compliance with section
13 of the BHC Act and this part and to have
an effective compliance program, as required
by § ll.20 and Appendix B to this part. The
effectiveness of particular quantitative
measurements may differ based on the profile
of the banking entity’s businesses in general

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and, more specifically, of the particular
trading desk, including types of instruments
traded, trading activities and strategies, and
history and experience (e.g., whether the
trading desk is an established, successful
market maker or a new entrant to a
competitive market). In all cases, banking
entities must ensure that they have robust
measures in place to identify and monitor the
risks taken in their trading activities, to
ensure that the activities are within risk
tolerances established by the banking entity,
and to monitor and examine for compliance
with the proprietary trading restrictions in
this part.
f. On an ongoing basis, banking entities
must carefully monitor, review, and evaluate
all furnished quantitative measurements, as
well as any others that they choose to utilize
in order to maintain compliance with section
13 of the BHC Act and this part. All
measurement results that indicate a
heightened risk of impermissible proprietary
trading, including with respect to otherwisepermitted activities under §§ ll.4 through
ll.6(a) and (b), or that result in a material
exposure to high-risk assets or high-risk
trading strategies, must be escalated within
the banking entity for review, further
analysis, explanation to [Agency], and
remediation, where appropriate. The
quantitative measurements discussed in this
appendix should be helpful to banking
entities in identifying and managing the risks
related to their covered trading activities.
II. Definitions
The terms used in this appendix have the
same meanings as set forth in §§ ll.2 and
ll.3. In addition, for purposes of this
appendix, the following definitions apply:
Calculation period means the period of
time for which a particular quantitative
measurement must be calculated.
Comprehensive profit and loss means the
net profit or loss of a trading desk’s material
sources of trading revenue over a specific
period of time, including, for example, any
increase or decrease in the market value of
a trading desk’s holdings, dividend income,
and interest income and expense.
Covered trading activity means trading
conducted by a trading desk under §§ ll.4,
ll.5, ll.6(a), or ll.6(b). A banking
entity may include trading under
§§ ll.3(d), ll.6(c), ll.6(d) or ll.6(e).
Measurement frequency means the
frequency with which a particular
quantitative metric must be calculated and
recorded.
Trading desk means the smallest discrete
unit of organization of a banking entity that
purchases or sells financial instruments for
the trading account of the banking entity or
an affiliate thereof.
III. Reporting and Recordkeeping of
Quantitative Measurements
a. Scope of Required Reporting
General scope. Each banking entity made
subject to this part by § ll.20 must furnish
the following quantitative measurements for
each trading desk of the banking entity,
calculated in accordance with this appendix:
• Risk and Position Limits and Usage;
• Risk Factor Sensitivities;

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• Value-at-Risk and Stress VaR;
• Comprehensive Profit and Loss
Attribution;
• Inventory Turnover;
• Inventory Aging; and
• Customer-Facing Trade Ratio
b. Frequency of Required Calculation and
Reporting
A banking entity must calculate any
applicable quantitative measurement for each
trading day. A banking entity must report
each applicable quantitative measurement to
[Agency] on the reporting schedule
established in § ll.20 unless otherwise
requested by [Agency]. All quantitative
measurements for any calendar month must
be reported within the time period required
by § ll.20.
c. Recordkeeping
A banking entity must, for any quantitative
measurement furnished to [Agency] pursuant
to this appendix and § ll.20(d), 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 from the
end of the calendar year for which the
measurement was taken.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. Risk and Position Limits and Usage
i. Description: For purposes of this
appendix, Risk and Position Limits are the
constraints that define the amount of risk that
a trading desk is permitted to take at a point
in time, as defined by the banking entity for
a specific trading desk. Usage represents the
portion of the trading desk’s limits that are
accounted for by the current activity of the
desk. Risk and position limits and their usage
are key risk management tools used to
control and monitor risk taking and include,
but are not limited, to the limits set out in
§ ll.4 and § ll.5. A number of the
metrics that are described below, including
‘‘Risk Factor Sensitivities’’ and ‘‘Value-atRisk and Stress Value-at-Risk,’’ relate to a
trading desk’s risk and position limits and
are useful in evaluating and setting these
limits in the broader context of the trading
desk’s overall activities, particularly for the
market making activities under § ll.4(b)
and hedging activity under § ll.5.
Accordingly, the limits required under
§ ll.4(b)(2)(iii) and § ll.5(b)(1)(i) must
meet the applicable requirements under
§ ll.4(b)(2)(iii) and § ll.5(b)(1)(i) and
also must include appropriate metrics for the
trading desk limits including, at a minimum,
the ‘‘Risk Factor Sensitivities’’ and ‘‘Value-atRisk and Stress Value-at-Risk’’ metrics except
to the extent any of the ‘‘Risk Factor
Sensitivities’’ or ‘‘Value-at-Risk and Stress
Value-at-Risk’’ metrics are demonstrably
ineffective for measuring and monitoring the
risks of a trading desk based on the types of
positions traded by, and risk exposures of,
that desk.
ii. General Calculation Guidance: Risk and
Position Limits must be reported in the
format used by the banking entity for the
purposes of risk management of each trading

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desk. Risk and Position Limits are often
expressed in terms of risk measures, such as
VaR and Risk Factor Sensitivities, but may
also be expressed in terms of other
observable criteria, such as net open
positions. When criteria other than VaR or
Risk Factor Sensitivities are used to define
the Risk and Position Limits, both the value
of the Risk and Position Limits and the value
of the variables used to assess whether these
limits have been reached must be reported.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
2. Risk Factor Sensitivities
i. Description: For purposes of this
appendix, Risk Factor Sensitivities are
changes in a trading desk’s Comprehensive
Profit and Loss that are expected to occur in
the event of a change in one or more
underlying variables that are significant
sources of the trading desk’s profitability and
risk.
ii. General Calculation Guidance: A
banking entity must report the Risk Factor
Sensitivities that are monitored and managed
as part of the trading desk’s overall risk
management policy. The underlying data and
methods used to compute a trading desk’s
Risk Factor Sensitivities will depend on the
specific function of the trading desk and the
internal risk management models employed.
The number and type of Risk Factor
Sensitivities that are monitored and managed
by a trading desk, and furnished to [Agency],
will depend on the explicit risks assumed by
the trading desk. In general, however,
reported Risk Factor Sensitivities must be
sufficiently granular to account for a
preponderance of the expected price
variation in the trading desk’s holdings.
A. Trading desks must take into account
any relevant factors in calculating Risk Factor
Sensitivities, including, for example, the
following with respect to particular asset
classes:
• Commodity derivative positions: risk
factors with respect to the related
commodities set out in 17 CFR 20.2, the
maturity of the positions, volatility and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), and the maturity profile of
the positions;
• Credit positions: risk factors with respect
to credit spreads that are sufficiently granular
to account for specific credit sectors and
market segments, the maturity profile of the
positions, and risk factors with respect to
interest rates of all relevant maturities;
• Credit-related derivative positions: risk
factor sensitivities, for example credit
spreads, shifts (parallel and non-parallel) in
credit spreads—volatility, and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and the maturity profile of the positions;
• Equity derivative positions: risk factor
sensitivities such as equity positions,
volatility, and/or correlation sensitivities
(expressed in a manner that demonstrates
any significant non-linearities), and the
maturity profile of the positions;
• Equity positions: risk factors for equity
prices and risk factors that differentiate
between important equity market sectors and

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segments, such as a small capitalization
equities and international equities;
• Foreign exchange derivative positions:
risk factors with respect to major currency
pairs and maturities, exposure to interest
rates at relevant maturities, volatility, and/or
correlation sensitivities (expressed in a
manner that demonstrates any significant
non-linearities), as well as the maturity
profile of the positions; and
• Interest rate positions, including interest
rate derivative positions: risk factors with
respect to major interest rate categories and
maturities and volatility and/or correlation
sensitivities (expressed in a manner that
demonstrates any significant non-linearities),
and shifts (parallel and non-parallel) in the
interest rate curve, as well as the maturity
profile of the positions.
B. The methods used by a banking entity
to calculate sensitivities to a common factor
shared by multiple trading desks, such as an
equity price factor, must be applied
consistently across its trading desks so that
the sensitivities can be compared from one
trading desk to another.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Value-at-Risk and Stress Value-at-Risk
i. Description: For purposes of this
appendix, Value-at-Risk (‘‘VaR’’) is the
commonly used percentile measurement of
the risk of future financial loss in the value
of a given set of aggregated positions over a
specified period of time, based on current
market conditions. For purposes of this
appendix, Stress Value-at-Risk (‘‘Stress VaR’’)
is the percentile measurement of the risk of
future financial loss in the value of a given
set of aggregated positions over a specified
period of time, based on market conditions
during a period of significant financial stress.
ii. General Calculation Guidance: Banking
entities must compute and report VaR and
Stress VaR by employing generally accepted
standards and methods of calculation. VaR
should reflect a loss in a trading desk that is
expected to be exceeded less than one
percent of the time over a one-day period.
For those banking entities that are subject to
regulatory capital requirements imposed by a
Federal banking agency, VaR and Stress VaR
must be computed and reported in a manner
that is consistent with such regulatory capital
requirements. In cases where a trading desk
does not have a standalone VaR or Stress VaR
calculation but is part of a larger aggregation
of positions for which a VaR or Stress VaR
calculation is performed, a VaR or Stress VaR
calculation that includes only the trading
desk’s holdings must be performed consistent
with the VaR or Stress VaR model and
methodology used for the larger aggregation
of positions.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this
appendix, Comprehensive Profit and Loss
Attribution is an analysis that attributes the
daily fluctuation in the value of a trading
desk’s positions to various sources. First, the
daily profit and loss of the aggregated

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positions is divided into three categories: (i)
profit and loss attributable to a trading desk’s
existing positions that were also positions
held by the trading desk as of the end of the
prior day (‘‘existing positions’’); (ii) profit
and loss attributable to new positions
resulting from the current day’s trading
activity (‘‘new positions’’); and (iii) residual
profit and loss that cannot be specifically
attributed to existing positions or new
positions. The sum of (i), (ii), and (iii) must
equal the trading desk’s comprehensive profit
and loss at each point in time. In addition,
profit and loss measurements must calculate
volatility of comprehensive profit and loss
(i.e., the standard deviation of the trading
desk’s one-day profit and loss, in dollar
terms) for the reporting period for at least a
30-, 60- and 90-day lag period, from the end
of the reporting period, and any other period
that the banking entity deems necessary to
meet the requirements of the rule.
A. The comprehensive profit and loss
associated with existing positions must
reflect changes in the value of these positions
on the applicable day. The comprehensive
profit and loss from existing positions must
be further attributed, as applicable, to
changes in (i) the specific Risk Factors and
other factors that are monitored and managed
as part of the trading desk’s overall risk
management policies and procedures; and (ii)
any other applicable elements, such as cash
flows, carry, changes in reserves, and the
correction, cancellation, or exercise of a
trade.
B. The comprehensive profit and loss
attributed to new positions must reflect
commissions and fee income or expense and
market gains or losses associated with
transactions executed on the applicable day.
New positions include purchases and sales of
financial instruments and other assets/
liabilities and negotiated amendments to
existing positions. The comprehensive profit
and loss from new positions may be reported
in the aggregate and does not need to be
further attributed to specific sources.
C. The portion of comprehensive profit and
loss that cannot be specifically attributed to
known sources must be allocated to a
residual category identified as an
unexplained portion of the comprehensive
profit and loss. Significant unexplained
profit and loss must be escalated for further
investigation and analysis.
ii. General Calculation Guidance: The
specific categories used by a trading desk in
the attribution analysis and amount of detail
for the analysis should be tailored to the type
and amount of trading activities undertaken
by the trading desk. The new position
attribution must be computed by calculating
the difference between the prices at which
instruments were bought and/or sold and the
prices at which those instruments are marked
to market at the close of business on that day
multiplied by the notional or principal
amount of each purchase or sale. Any fees,
commissions, or other payments received
(paid) that are associated with transactions
executed on that day must be added
(subtracted) from such difference. These
factors must be measured consistently over
time to facilitate historical comparisons.
iii. Calculation Period: One trading day.

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iv. Measurement Frequency: Daily.
c. Customer-Facing Activity Measurements
1. Inventory Turnover
i. Description: For purposes of this
appendix, Inventory Turnover is a ratio that
measures the turnover of a trading desk’s
inventory. The numerator of the ratio is the
absolute value of all transactions over the
reporting period. The denominator of the
ratio is the value of the trading desk’s
inventory at the beginning of the reporting
period.
ii. General Calculation Guidance: For
purposes of this appendix, for derivatives,
other than options and interest rate
derivatives, value means gross notional
value, for options, value means delta
adjusted notional value, and for interest rate
derivatives, value means 10-year bond
equivalent value.
iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.
2. Inventory Aging
i. Description: For purposes of this
appendix, Inventory Aging generally
describes a schedule of the trading desk’s
aggregate assets and liabilities and the
amount of time that those assets and
liabilities have been held. Inventory Aging
should measure the age profile of the trading
desk’s assets and liabilities.
ii. General Calculation Guidance: In
general, Inventory Aging must be computed
using a trading desk’s trading activity data
and must identify the value of a trading
desk’s aggregate assets and liabilities.
Inventory Aging must include two schedules,
an asset-aging schedule and a liability-aging
schedule. Each schedule must record the
value of assets or liabilities held over all
holding periods. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value
and, for interest rate derivatives, value means
10-year bond equivalent value.
iii. Calculation Period: One trading day.
iv. Measurement Frequency: Daily.
3. Customer-Facing Trade Ratio—Trade
Count Based and Value Based
i. Description: For purposes of this
appendix, the Customer-Facing Trade Ratio
is a ratio comparing (i) the transactions
involving a counterparty that is a customer
of the trading desk to (ii) the transactions
involving a counterparty that is not a
customer of the trading desk. A trade count
based ratio must be computed that records
the number of transactions involving a
counterparty that is a customer of the trading
desk and the number of transactions
involving a counterparty that is not a
customer of the trading desk. A value based
ratio must be computed that records the
value of transactions involving a
counterparty that is a customer of the trading
desk and the value of transactions involving
a counterparty that is not a customer of the
trading desk.
ii. General Calculation Guidance: For
purposes of calculating the Customer-Facing
Trade Ratio, a counterparty is considered to
be a customer of the trading desk if the

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counterparty is a market participant that
makes use of the banking entity’s market
making-related services by obtaining such
services, responding to quotations, or
entering into a continuing relationship with
respect to such services. However, a trading
desk or other organizational unit of another
banking entity would not be a client,
customer, or counterparty of the trading desk
if the other entity has trading assets and
liabilities of $50 billion or more as measured
in accordance with § ll.20(d)(1) unless the
trading desk documents how and why a
particular trading desk or other
organizational unit of the entity should be
treated as a client, customer, or counterparty
of the trading desk. Transactions conducted
anonymously on an exchange or similar
trading facility that permits trading on behalf
of a broad range of market participants would
be considered transactions with customers of
the trading desk. For derivatives, other than
options, and interest rate derivatives, value
means gross notional value, for options,
value means delta adjusted notional value,
and for interest rate derivatives, value means
10-year bond equivalent value.
iii. Calculation Period: 30 days, 60 days,
and 90 days.
iv. Measurement Frequency: Daily.

Appendix B to Part ll—Enhanced
Minimum Standards for Compliance
Programs
I. Overview
Section ll.20(c) requires certain banking
entities to establish, maintain, and enforce an
enhanced compliance program that includes
the requirements and standards in this
Appendix as well as the minimum written
policies and procedures, internal controls,
management framework, independent
testing, training, and recordkeeping
provisions outlined in § ll.20. This
Appendix sets forth additional minimum
standards with respect to the establishment,
oversight, maintenance, and enforcement by
these banking entities of an enhanced
internal compliance program for ensuring
and monitoring compliance with the
prohibitions and restrictions on proprietary
trading and covered fund activities and
investments set forth in section 13 of the
BHC Act and this part.
a. This compliance program must:
1. Be reasonably designed to identify,
document, monitor, and report the permitted
trading and covered fund activities and
investments of the banking entity; identify,
monitor and promptly address the risks of
these covered activities and investments and
potential areas of noncompliance; and
prevent activities or investments prohibited
by, or that do not comply with, section 13 of
the BHC Act and this part;
2. Establish and enforce appropriate limits
on the covered activities and investments of
the banking entity, including limits on the
size, scope, complexity, and risks of the
individual activities or investments
consistent with the requirements of section
13 of the BHC Act and this part;
3. Subject the effectiveness of the
compliance program to periodic independent
review and testing, and ensure that the

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entity’s internal audit, corporate compliance
and internal control functions involved in
review and testing are effective and
independent;
4. Make senior management, and others as
appropriate, accountable for the effective
implementation of the compliance program,
and ensure that the board of directors and
chief executive officer (or equivalent) of the
banking entity review the effectiveness of the
compliance program; and
5. Facilitate supervision and examination
by the Agencies of the banking entity’s
permitted trading and covered fund activities
and investments.
II. Enhanced Compliance Program
a. Proprietary Trading Activities. A
banking entity must establish, maintain and
enforce a compliance program that includes
written policies and procedures that are
appropriate for the types, size, and
complexity of, and risks associated with, its
permitted trading activities. The compliance
program may be tailored to the types of
trading activities conducted by the banking
entity, and must include a detailed
description of controls established by the
banking entity to reasonably ensure that its
trading activities are conducted in
accordance with the requirements and
limitations applicable to those trading
activities under section 13 of the BHC Act
and this part, and provide for appropriate
revision of the compliance program before
expansion of the trading activities of the
banking entity. A banking entity must devote
adequate resources and use knowledgeable
personnel in conducting, supervising and
managing its trading activities, and promote
consistency, independence and rigor in
implementing its risk controls and
compliance efforts. The compliance program
must be updated with a frequency sufficient
to account for changes in the activities of the
banking entity, results of independent testing
of the program, identification of weaknesses
in the program, and changes in legal,
regulatory or other requirements.
1. Trading Desks: The banking entity must
have written policies and procedures
governing each trading desk that include a
description of:
i. The process for identifying, authorizing
and documenting financial instruments each
trading desk may purchase or sell, with
separate documentation for market makingrelated activities conducted in reliance on
§ ll.4(b) and for hedging activity
conducted in reliance on § ll.5;
ii. A mapping for each trading desk to the
division, business line, or other
organizational structure that is responsible
for managing and overseeing the trading
desk’s activities;
iii. The mission (i.e., the type of trading
activity, such as market-making, trading in
sovereign debt, etc.) and strategy (i.e.,
methods for conducting authorized trading
activities) of each trading desk;
iv. The activities that the trading desk is
authorized to conduct, including (i)
authorized instruments and products, and (ii)
authorized hedging strategies, techniques and
instruments;
v. The types and amount of risks allocated
by the banking entity to each trading desk to

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implement the mission and strategy of the
trading desk, including an enumeration of
material risks resulting from the activities in
which the trading desk is authorized to
engage (including but not limited to price
risks, such as basis, volatility and correlation
risks, as well as counterparty credit risk).
Risk assessments must take into account both
the risks inherent in the trading activity and
the strength and effectiveness of controls
designed to mitigate those risks;
vi. How the risks allocated to each trading
desk will be measured;
vii. Why the allocated risks levels are
appropriate to the activities authorized for
the trading desk;
viii. The limits on the holding period of,
and the risk associated with, financial
instruments under the responsibility of the
trading desk;
ix. The process for setting new or revised
limits, as well as escalation procedures for
granting exceptions to any limits or to any
policies or procedures governing the desk,
the analysis that will be required to support
revising limits or granting exceptions, and
the process for independently reviewing and
documenting those exceptions and the
underlying analysis;
x. The process for identifying,
documenting and approving new products,
trading strategies, and hedging strategies;
xi. The types of clients, customers, and
counterparties with whom the trading desk
may trade; and
xii. The compensation arrangements,
including incentive arrangements, for
employees associated with the trading desk,
which may not be designed to reward or
incentivize prohibited proprietary trading or
excessive or imprudent risk-taking.
2. Description of risks and risk
management processes: The compliance
program for the banking entity must include
a comprehensive description of the risk
management program for the trading activity
of the banking entity. The compliance
program must also include a description of
the governance, approval, reporting,
escalation, review and other processes the
banking entity will use to reasonably ensure
that trading activity is conducted in
compliance with section 13 of the BHC Act
and this part. Trading activity in similar
financial instruments should be subject to
similar governance, limits, testing, controls,
and review, unless the banking entity
specifically determines to establish different
limits or processes and documents those
differences. Descriptions must include, at a
minimum, the following elements:
i. A description of the supervisory and risk
management structure governing all trading
activity, including a description of processes
for initial and senior-level review of new
products and new strategies;
ii. A description of the process for
developing, documenting, testing, approving
and reviewing all models used for valuing,
identifying and monitoring the risks of
trading activity and related positions,
including the process for periodic
independent testing of the reliability and
accuracy of those models;
iii. A description of the process for
developing, documenting, testing, approving

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and reviewing the limits established for each
trading desk;
iv. A description of the process by which
a security may be purchased or sold pursuant
to the liquidity management plan, including
the process for authorizing and monitoring
such activity to ensure compliance with the
banking entity’s liquidity management plan
and the restrictions on liquidity management
activities in this part;
v. A description of the management review
process, including escalation procedures, for
approving any temporary exceptions or
permanent adjustments to limits on the
activities, positions, strategies, or risks
associated with each trading desk; and
vi. The role of the audit, compliance, risk
management and other relevant units for
conducting independent testing of trading
and hedging activities, techniques and
strategies.
3. Authorized risks, instruments, and
products. The banking entity must
implement and enforce limits and internal
controls for each trading desk that are
reasonably designed to ensure that trading
activity is conducted in conformance with
section 13 of the BHC Act and this part and
with the banking entity’s written policies and
procedures. The banking entity must
establish and enforce risk limits appropriate
for the activity of each trading desk. These
limits should be based on probabilistic and
non-probabilistic measures of potential loss
(e.g., Value-at-Risk and notional exposure,
respectively), and measured under normal
and stress market conditions. At a minimum,
these internal controls must monitor,
establish and enforce limits on:
i. The financial instruments (including, at
a minimum, by type and exposure) that the
trading desk may trade;
ii. The types and levels of risks that may
be taken by each trading desk; and
iii. The types of hedging instruments used,
hedging strategies employed, and the amount
of risk effectively hedged.
4. Hedging policies and procedures. The
banking entity must establish, maintain, and
enforce written policies and procedures
regarding the use of risk-mitigating hedging
instruments and strategies that, at a
minimum, describe:
i. The positions, techniques and strategies
that each trading desk may use to hedge the
risk of its positions;
ii. The manner in which the banking entity
will identify the risks arising in connection
with and related to the individual or
aggregated positions, contracts or other
holdings of the banking entity that are to be
hedged and determine that those risks have
been properly and effectively hedged;
iii. The level of the organization at which
hedging activity and management will occur;
iv. The manner in which hedging strategies
will be monitored and the personnel
responsible for such monitoring;
v. The risk management processes used to
control unhedged or residual risks; and
vi. The process for developing,
documenting, testing, approving and
reviewing all hedging positions, techniques
and strategies permitted for each trading desk
and for the banking entity in reliance on
§ ll.5.

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5. Analysis and quantitative
measurements. The banking entity must
perform robust analysis and quantitative
measurement of its trading activities that is
reasonably designed to ensure that the
trading activity of each trading desk is
consistent with the banking entity’s
compliance program; monitor and assist in
the identification of potential and actual
prohibited proprietary trading activity; and
prevent the occurrence of prohibited
proprietary trading. Analysis and models
used to determine, measure and limit risk
must be rigorously tested and be reviewed by
management responsible for trading activity
to ensure that trading activities, limits,
strategies, and hedging activities do not
understate the risk and exposure to the
banking entity or allow prohibited
proprietary trading. This review should
include periodic and independent backtesting and revision of activities, limits,
strategies and hedging as appropriate to
contain risk and ensure compliance. In
addition to the quantitative measurements
reported by any banking entity subject to
Appendix A to this part, each banking entity
must develop and implement, to the extent
appropriate to facilitate compliance with this
part, additional quantitative measurements
specifically tailored to the particular risks,
practices, and strategies of its trading desks.
The banking entity’s analysis and
quantitative measurements must incorporate
the quantitative measurements reported by
the banking entity pursuant to Appendix A
(if applicable) and include, at a minimum,
the following:
i. Internal controls and written policies and
procedures reasonably designed to ensure the
accuracy and integrity of quantitative
measurements;
ii. Ongoing, timely monitoring and review
of calculated quantitative measurements;
iii. The establishment of numerical
thresholds and appropriate trading measures
for each trading desk and heightened review
of trading activity not consistent with those
thresholds to ensure compliance with section
13 of the BHC Act and this part, including
analysis of the measurement results or other
information, appropriate escalation
procedures, and documentation related to the
review; and
iv. Immediate review and compliance
investigation of the trading desk’s activities,
escalation to senior management with
oversight responsibilities for the applicable
trading desk, timely notification to [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
quantitative measurements or other
information, considered together with the
facts and circumstances, or findings of
internal audit, independent testing or other
review suggest a reasonable likelihood that
the trading desk has violated any part of
section 13 of the BHC Act or this part.
6. Other Compliance Matters. In addition
to the requirements specified above, the
banking entity’s compliance program must:
i. Identify activities of each trading desk
that will be conducted in reliance on

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exemptions contained in §§ ll.4 through
ll.6, including an explanation of:
A. How and where in the organization the
activity occurs; and
B. Which exemption is being relied on and
how the activity meets the specific
requirements for reliance on the applicable
exemption;
ii. Include an explanation of the process for
documenting, approving and reviewing
actions taken pursuant to the liquidity
management plan, where in the organization
this activity occurs, the securities permissible
for liquidity management, the process for
ensuring that liquidity management activities
are not conducted for the purpose of
prohibited proprietary trading, and the
process for ensuring that securities
purchased as part of the liquidity
management plan are highly liquid and
conform to the requirements of this part;
iii. Describe how the banking entity
monitors for and prohibits potential or actual
material exposure to high-risk assets or highrisk trading strategies presented by each
trading desk that relies on the exemptions
contained in §§ ll.3(d)(3), and ll.4
through ll.6, which must take into account
potential or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in value cannot
be adequately mitigated by effective hedging;
C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
E. Assets or strategies that have
demonstrated significant historical volatility;
F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that result in large
and significant concentrations to sectors, risk
factors, or counterparties;
iv. Establish responsibility for compliance
with the reporting and recordkeeping
requirements of subpart B and § ll.20; and
v. Establish policies for monitoring and
prohibiting potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties.
7. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any trading activity that may
indicate potential violations of section 13 of
the BHC Act and this part and to prevent
actual violations of section 13 of the BHC Act
and this part. The compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part, and
document all proposed and actual
remediation efforts. The compliance program
must include specific written policies and
procedures that are reasonably designed to

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assess the extent to which any activity
indicates that modification to the banking
entity’s compliance program is warranted
and to ensure that appropriate modifications
are implemented. The written policies and
procedures must provide for prompt
notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
implementation of the compliance program
of the banking entity.
b. Covered Fund Activities or Investments.
A banking entity must establish, maintain
and enforce a compliance program that
includes written policies and procedures that
are appropriate for the types, size,
complexity and risks of the covered fund and
related activities conducted and investments
made, by the banking entity.
1. Identification of covered funds. The
banking entity’s compliance program must
provide a process, which must include
appropriate management review and
independent testing, for identifying and
documenting covered funds that each unit
within the banking entity’s organization
sponsors or organizes and offers, and covered
funds in which each such unit invests. In
addition to the documentation requirements
for covered funds, as specified under § __
.20(e), the documentation must include
information that identifies all pools that the
banking entity sponsors or has an interest in
and the type of exemption from the
Commodity Exchange Act (whether or not
the pool relies on section 4.7 of the
regulations under the Commodity Exchange
Act), and the amount of ownership interest
the banking entity has in those pools.
2. Identification of covered fund activities
and investments. The banking entity’s
compliance program must identify,
document and map each unit within the
organization that is permitted to acquire or
hold an interest in any covered fund or
sponsor any covered fund and map each unit
to the division, business line, or other
organizational structure that will be
responsible for managing and overseeing that
unit’s activities and investments.
3. Explanation of compliance. The banking
entity’s compliance program must explain
how:
i. The banking entity monitors for and
prohibits potential or actual material
conflicts of interest between the banking
entity and its clients, customers, or
counterparties related to its covered fund
activities and investments;
ii. The banking entity monitors for and
prohibits potential or actual transactions or
activities that may threaten the safety and
soundness of the banking entity related to its
covered fund activities and investments; and
iii. The banking entity monitors for and
prohibits potential or actual material
exposure to high-risk assets or high-risk
trading strategies presented by its covered
fund activities and investments, taking into
account potential or actual exposure to:
A. Assets whose values cannot be
externally priced or, where valuation is
reliant on pricing models, whose model
inputs cannot be externally validated;
B. Assets whose changes in values cannot
be adequately mitigated by effective hedging;

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C. New products with rapid growth,
including those that do not have a market
history;
D. Assets or strategies that include
significant embedded leverage;
E. Assets or strategies that have
demonstrated significant historical volatility;
F. Assets or strategies for which the
application of capital and liquidity standards
would not adequately account for the risk;
and
G. Assets or strategies that expose the
banking entity to large and significant
concentrations with respect to sectors, risk
factors, or counterparties;
4. Description and documentation of
covered fund activities and investments. For
each organizational unit engaged in covered
fund activities and investments, the banking
entity’s compliance program must document:
i. The covered fund activities and
investments that the unit is authorized to
conduct;
ii. The banking entity’s plan for actively
seeking unaffiliated investors to ensure that
any investment by the banking entity
conforms to the limits contained in § __.12 or
registered in compliance with the securities
laws and thereby exempt from those limits
within the time periods allotted in§ __.12;
and
iii. How it complies with the requirements
of subpart C.
5. Internal Controls. A banking entity must
establish, maintain, and enforce internal
controls that are reasonably designed to
ensure that its covered fund activities or
investments comply with the requirements of
section 13 of the BHC Act and this part and
are appropriate given the limits on risk
established by the banking entity. These
written internal controls must be reasonably
designed and established to effectively
monitor and identify for further analysis any
covered fund activity or investment that may
indicate potential violations of section 13 of
the BHC Act or this part. The internal
controls must, at a minimum require:
i. Monitoring and limiting the banking
entity’s individual and aggregate investments
in covered funds;
ii. Monitoring the amount and timing of
seed capital investments for compliance with
the limitations under subpart C (including
but not limited to the redemption, sale or
disposition requirements) of § __.12, and the
effectiveness of efforts to seek unaffiliated
investors to ensure compliance with those
limits;
iii. Calculating the individual and
aggregate levels of ownership interests in one
or more covered fund required by § __.12;
iv. Attributing the appropriate instruments
to the individual and aggregate ownership
interest calculations above;
v. Making disclosures to prospective and
actual investors in any covered fund
organized and offered or sponsored by the
banking entity, as provided under
§ __.11(a)(8);
vi Monitoring for and preventing any
relationship or transaction between the
banking entity and a covered fund that is
prohibited under § __.14, including where
the banking entity has been designated as the
sponsor, investment manager, investment

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adviser, or commodity trading advisor to a
covered fund by another banking entity; and
vii. Appropriate management review and
supervision across legal entities of the
banking entity to ensure that services and
products provided by all affiliated entities
comply with the limitation on services and
products contained in § __.14.
6. Remediation of violations. The banking
entity’s compliance program must be
reasonably designed and established to
effectively monitor and identify for further
analysis any covered fund activity or
investment that may indicate potential
violations of section 13 of the BHC Act or
this part and to prevent actual violations of
section 13 of the BHC Act and this part. The
banking entity’s compliance program must
describe procedures for identifying and
remedying violations of section 13 of the
BHC Act and this part, and must include, at
a minimum, a requirement to promptly
document, address and remedy any violation
of section 13 of the BHC Act or this part,
including § __.21, and document all proposed
and actual remediation efforts. The
compliance program must include specific
written policies and procedures that are
reasonably designed to assess the extent to
which any activity or investment indicates
that modification to the banking entity’s
compliance program is warranted and to
ensure that appropriate modifications are
implemented. The written policies and
procedures must provide for prompt
notification to appropriate management,
including senior management and the board
of directors, of any material weakness or
significant deficiencies in the design or
implementation of the compliance program
of the banking entity.
III. Responsibility and Accountability for the
Compliance Program
a. A banking entity must establish,
maintain, and enforce a governance and
management framework to manage its
business and employees with a view to
preventing violations of section 13 of the
BHC Act and this part. A banking entity must
have an appropriate management framework
reasonably designed to ensure that:
appropriate personnel are responsible and
accountable for the effective implementation
and enforcement of the compliance program;
a clear reporting line with a chain of
responsibility is delineated; and the
compliance program is reviewed periodically
by senior management. The board of
directors (or equivalent governance body)
and senior management should have the
appropriate authority and access to personnel
and information within the organizations as
well as appropriate resources to conduct
their oversight activities effectively.
1. Corporate governance. The banking
entity must adopt a written compliance
program approved by the board of directors,
an appropriate committee of the board, or
equivalent governance body, and senior
management.
2. Management procedures. The banking
entity must establish, maintain, and enforce
a governance framework that is reasonably
designed to achieve compliance with section
13 of the BHC Act and this part, which, at
a minimum, provides for:

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i. The designation of appropriate senior
management or committee of senior
management with authority to carry out the
management responsibilities of the banking
entity for each trading desk and for each
organizational unit engaged in covered fund
activities;
ii. Written procedures addressing the
management of the activities of the banking
entity that are reasonably designed to achieve
compliance with section 13 of the BHC Act
and this part, including:
A. A description of the management
system, including the titles, qualifications,
and locations of managers and the specific
responsibilities of each person with respect
to the banking entity’s activities governed by
section 13 of the BHC Act and this part; and
B. Procedures for determining
compensation arrangements for traders
engaged in underwriting or market makingrelated activities under § __.4 or riskmitigating hedging activities under § __.5 so
that such compensation arrangements are
designed not to reward or incentivize
prohibited proprietary trading and
appropriately balance risk and financial
results in a manner that does not encourage
employees to expose the banking entity to
excessive or imprudent risk.
3. Business line managers. Managers with
responsibility for one or more trading desks
of the banking entity are accountable for the
effective implementation and enforcement of
the compliance program with respect to the
applicable trading desk(s).
4. Board of directors, or similar corporate
body, and senior management. The board of
directors, or similar corporate body, and
senior management are responsible for
setting and communicating an appropriate
culture of compliance with section 13 of the
BHC Act and this part and ensuring that
appropriate policies regarding the
management of trading activities and covered
fund activities or investments are adopted to
comply with section 13 of the BHC Act and
this part. The board of directors or similar
corporate body (such as a designated
committee of the board or an equivalent
governance body) must ensure that senior
management is fully capable, qualified, and
properly motivated to manage compliance
with this part in light of the organization’s
business activities and the expectations of
the board of directors. The board of directors
or similar corporate body must also ensure
that senior management has established
appropriate incentives and adequate
resources to support compliance with this
part, including the implementation of a
compliance program meeting the
requirements of this appendix into
management goals and compensation
structures across the banking entity.
5. Senior management. Senior management
is responsible for implementing and
enforcing the approved compliance program.
Senior management must also ensure that
effective corrective action is taken when
failures in compliance with section 13 of the
BHC Act and this part are identified. Senior
management and control personnel charged
with overseeing compliance with section 13
of the BHC Act and this part should review
the compliance program for the banking

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entity periodically and report to the board, or
an appropriate committee thereof, on the
effectiveness of the compliance program and
compliance matters with a frequency
appropriate to the size, scope, and risk
profile of the banking entity’s trading
activities and covered fund activities or
investments, which shall be at least annually.
6. CEO attestation. Based on a review by
the CEO of the banking entity, the CEO of the
banking entity must, annually, attest in
writing to [Agency] that the banking entity
has in place processes to establish, maintain,
enforce, review, test and modify the
compliance program established under this
Appendix and § __.20 of this part in a
manner reasonably designed to achieve
compliance with section 13 of the BHC Act
and this part. In the case of a U.S. branch or
agency of a foreign banking entity, the
attestation may be provided for the entire
U.S. operations of the foreign banking entity
by the senior management officer of the
United States operations of the foreign
banking entity who is located in the United
States.
IV. Independent Testing
a. Independent testing must occur with a
frequency appropriate to the size, scope, and
risk profile of the banking entity’s trading
and covered fund activities or investments,
which shall be at least annually. This
independent testing must include an
evaluation of:
1. The overall adequacy and effectiveness
of the banking entity’s compliance program,
including an analysis of the extent to which
the program contains all the required
elements of this appendix;
2. The effectiveness of the banking entity’s
internal controls, including an analysis and
documentation of instances in which such
internal controls have been breached, and
how such breaches were addressed and
resolved; and
3. The effectiveness of the banking entity’s
management procedures.
b. A banking entity must ensure that
independent testing regarding the
effectiveness of the banking entity’s
compliance program is conducted by a
qualified independent party, such as the
banking entity’s internal audit department,
compliance personnel or risk managers
independent of the organizational unit being
tested, outside auditors, consultants, or other
qualified independent parties. A banking
entity must promptly take appropriate action
to remedy any significant deficiencies or
material weaknesses in its compliance
program and to terminate any violations of
section 13 of the BHC Act or this part.
V. Training
Banking entities must provide adequate
training to personnel and managers of the
banking entity engaged in activities or
investments governed by section 13 of the
BHC Act or this part, as well as other
appropriate supervisory, risk, independent
testing, and audit personnel, in order to
effectively implement and enforce the
compliance program. This training should
occur with a frequency appropriate to the
size and the risk profile of the banking

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entity’s trading activities and covered fund
activities or investments.
VI. Recordkeeping
Banking entities must create and retain
records sufficient to demonstrate compliance
and support the operations and effectiveness
of the compliance program. A banking entity
must retain these records for a period that is
no less than 5 years or such longer period as
required by [Agency] in a form that allows it
to promptly produce such records to
[Agency] on request.

End of Common Rule
List of Subjects
12 CFR Part 44
Banks, Banking, Capital
Compensation, Credit, Derivatives,
Government securities, Insurance,
Investments, National banks, Federal
savings associations, Federal branches
and agencies, Penalties, Reporting and
recordkeeping requirements, Risk, Risk
retention, Securities, Trusts and trustees
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.
12 CFR Part 351
Banks, Banking, Capital,
Compensation, Conflicts of interest,
Credit, Derivatives, Government
securities, Insurance, Insurance
companies, Investments, Penalties,
Reporting and recordkeeping
requirements, Risk, Risk retention,
Securities, State nonmember banks,
State savings associations, Trusts and
trustees.
17 CFR Part 255
Banks, Brokers, Dealers, Investment
advisers, Recordkeeping, Reporting,
Securities.
DEPARTMENT OF THE TREASURY

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Office of the Comptroller of the
Currency
Authority and Issuance
For the reasons stated in the Common
Preamble, the Office of the Comptroller
of the Currency hereby amends chapter
I of Title 12, Code of Federal
Regulations as follows:

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PART 44—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
1. The authority 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,
1467a, 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 revised to read as
follows:
■

§ 44.1 Authority, purpose, scope, and
relationship to other authorities.

(a) Authority. This part is issued by
the OCC under section 13 of the Bank
Holding Company Act of 1956, as
amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading and on investments
in or relationships with covered funds
by certain banking entities, including
national banks, Federal branches and
agencies of foreign banks, Federal
savings associations, and certain
subsidiaries thereof. This part
implements section 13 of the Bank
Holding Company Act by defining terms
used in the statute and related terms,
establishing prohibitions and
restrictions on proprietary trading and
on investments in or relationships with
covered funds, and explaining the
statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to banking
entities for which the OCC is authorized
to issue regulations under section
13(b)(2) of the Bank Holding Company
Act (12 U.S.C. 1851(b)(2)) and take
actions under section 13(e) of that Act
(12 U.S.C. 1851(e)). These include
national banks, Federal branches and
Federal agencies of foreign banks,
Federal savings associations, Federal
savings banks, and any of their
respective subsidiaries (except a
subsidiary for which there is a different
primary financial regulatory agency, as
that term is defined in this part).
(d) Relationship to other authorities.
Except as otherwise provided under
section 13 of the Bank Holding
Company Act or this part, and
notwithstanding any other provision of

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law, the prohibitions and restrictions
under section 13 of the Bank Holding
Company Act and this part shall apply
to the activities and investments of a
banking entity identified in paragraph
(c) of this section, even if such activities
and investments are authorized for the
banking entity under other applicable
provisions of law.
(e) Preservation of authority. Nothing
in this part limits in any way the
authority of the OCC to impose on a
banking entity identified in paragraph
(c) of this section additional
requirements or restrictions with respect
to any activity, investment, or
relationship covered under section 13 of
the Bank Holding Company Act or this
part, or additional penalties for
violation of this part provided under
any other applicable provision of law.
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE
Authority and Issuance
For the reasons set forth in the
Supplementary Information, the Board
of Governors of the Federal Reserve
System is adding 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 CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS (Regulation VV)
5. The authority 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.

6. Part 248 is added as set forth at the
end of the Common Preamble.
■ 7. Part 248 is amended by removing
‘‘[Agency]’’ wherever it appears and
adding in its place ‘‘the Board.’’
■ 8. Part 248 is amended by removing
‘‘the [Agency]’’ wherever it appears and
adding in its place ‘‘the Board.’’
■ 9. Section 248.1 is revised to read as
follows:
■

§ 248.1 Authority, purpose, scope, and
relationship to other authorities.

(a) Authority. This part (Regulation
VV) is issued by the Board under
section 13 of the Bank Holding
Company Act of 1956, as amended (12
U.S.C. 1851), as well as under the
Federal Reserve Act, as amended (12
U.S.C. 221 et seq.); section 8 of the
Federal Deposit Insurance Act, as
amended (12 U.S.C. 1818); the Bank
Holding Company Act of 1956, as
amended (12 U.S.C. 1841 et seq.); and

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations
the International Banking Act of 1978,
as amended (12 U.S.C. 3101 et seq.).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading and on investments
in or relationships with covered funds
by certain banking entities, including
state member banks, bank holding
companies, savings and loan holding
companies, other companies that
control an insured depository
institution, foreign banking
organizations, and certain subsidiaries
thereof. This part implements section 13
of the Bank Holding Company Act by
defining terms used in the statute and
related terms, establishing prohibitions
and restrictions on proprietary trading
and on investments in or relationships
with covered funds, and explaining the
statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to banking
entities for which the Board is
authorized to issue regulations under
section 13(b)(2) of the Bank Holding
Company Act (12 U.S.C. 1851(b)(2)) and
take actions under section 13(e) of that
Act (12 U.S.C. 1851(e)). These include
any state bank that is a member of the
Federal Reserve System, any company
that controls an insured depository
institution (including a bank holding
company and savings and loan holding
company), any company that is treated
as a bank holding company for purposes
of section 8 of the International Banking
Act (12 U.S.C. 3106), and any subsidiary
of the foregoing other than a subsidiary
for which the OCC, FDIC, CFTC, or SEC
is the primary financial regulatory
agency (as defined in section 2(12) of
the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (12
U.S.C. 5301(12)).
(d) Relationship to other authorities.
Except as otherwise provided under
section 13 of the BHC Act or this part,
and notwithstanding any other
provision of law, the prohibitions and
restrictions under section 13 of BHC Act
and this part shall apply to the activities
of a banking entity, even if such
activities are authorized for the banking
entity under other applicable provisions
of law.
(e) Preservation of authority. Nothing
in this part limits in any way the
authority of the Board to impose on a
banking entity identified in paragraph
(c) of this section additional
requirements or restrictions with respect
to any activity, investment, or
relationship covered under section 13 of
the Bank Holding Company Act or this
part, or additional penalties for

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violation of this part provided under
any other applicable provision of law.
FEDERAL DEPOSIT INSURANCE
CORPORATION
Authority and Issuance
For the reasons set forth in the
Supplementary Information, the Federal
Deposit Insurance Corporation is adding
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:
PART 351—PROPRIETARY TRADING
AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
10. The authority for part 351 is added
to read as follows:

■

Authority: 12 U.S.C. 1851; 1811 et seq.;
3101 et seq.; and 5412.

11. Part 351 is added as set forth at the
end of the Common Preamble.
■ 12. 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.’’
■ 13. Section 351.1 is revised to read as
follows:
■

§ 351.1 Authority, purpose, scope, and
relationship to other authorities.

(a) Authority. This part is issued by
the FDIC under section 13 of the Bank
Holding Company Act of 1956, as
amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes
prohibitions and restrictions on
proprietary trading and investments in
or relationships with covered funds by
certain banking entities, including any
insured depository institution as
defined in section 3(c)(2) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(c)(2)) and certain subsidiaries
thereof for which the FDIC is the
appropriate Federal banking agency as
defined in section 3(q) of the Federal
Deposit Insurance Act (12 U.S.C.
1813(q)). This part implements section
13 of the Bank Holding Company Act by
defining terms used in the statute and
related terms, establishing prohibitions
and restrictions on proprietary trading
and investments in or relationships with
covered funds, and explaining the
statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to insured
depository institutions for which the

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5805

FDIC is the appropriate Federal banking
agency, as defined in section 3(q) of the
Federal Deposit Insurance Act, and
certain subsidiaries of the foregoing.
(d) Relationship to other authorities.
Except as otherwise provided in under
section 13 of the Bank Holding
Company Act, and notwithstanding any
other provision of law, the prohibitions
and restrictions under section 13 of
Bank Holding Company Act shall apply
to the activities and investments of a
banking entity, even if such activities
and investments are authorized for a
banking entity under other applicable
provisions of law.
(e) Preservation of authority. Nothing
in this part limits in any way the
authority of the FDIC to impose on a
banking entity identified in paragraph
(c) of this section additional
requirements or restrictions with respect
to any activity, investment, or
relationship covered under section 13 of
the Bank Holding Company Act or this
part, or additional penalties for
violation of this part provided under
any other applicable provision of law.
SECURITIES AND EXCHANGE
COMMISSION
Authority and Issuance
For the reasons stated in the Common
Preamble, the Securities and Exchange
Commission is adding 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 CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED
FUNDS
14. The authority for part 255 is added
to read as follows:

■

Authority: 12 U.S.C. 1851.

15. Part 255 is added as set forth at the
end of the Common Preamble.
■ 16. Part 255 is amended by:
■ a. Removing ‘‘[Agency]’’ wherever it
appears and adding in its place ‘‘the
SEC;’’ and
■ b. Removing ‘‘the [Agency]’’ wherever
it appears and adding in its place ‘‘the
SEC.’’
■ 17. Section 255.1 is revised to read as
follows:
■

§ 255.1 Authority, purpose, scope, and
relationship to other authorities.

(a) Authority. This part is issued by
the SEC under section 13 of the Bank
Holding Company Act of 1956, as
amended (12 U.S.C. 1851).
(b) Purpose. Section 13 of the Bank
Holding Company Act establishes

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Federal Register / Vol. 79, No. 21 / Friday, January 31, 2014 / Rules and Regulations

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prohibitions and restrictions on
proprietary trading and investments in
or relationships with covered funds by
certain banking entities, including
registered broker-dealers, registered
investment advisers, and registered
security-based swap dealers, among
others identified in section 2(12)(B) of
the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (12
U.S.C. 5301(12)(B)). This part
implements section 13 of the Bank
Holding Company Act by defining terms
used in the statute and related terms,
establishing prohibitions and
restrictions on proprietary trading and
investments in or relationships with
covered funds, and explaining the
statute’s requirements.
(c) Scope. This part implements
section 13 of the Bank Holding
Company Act with respect to banking
entities for which the SEC is the

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primary financial regulatory agency, as
that term is defined in this part.
(d) Relationship to other authorities.
Except as otherwise provided under
section 13 of the Bank Holding
Company Act, and notwithstanding any
other provision of law, the prohibitions
and restrictions under section 13 of
Bank Holding Company Act shall apply
to the activities and investments of a
banking entity identified in paragraph
(c) of this section, even if such activities
and investments are authorized for the
banking entity under other applicable
provisions of law.
(e) Preservation of authority. Nothing
in this part limits in any way the
authority of the SEC to impose on a
banking entity identified in paragraph
(c) of this section additional
requirements or restrictions with respect
to any activity, investment, or
relationship covered under section 13 of
the Bank Holding Company Act or this
part, or additional penalties for

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violation of this part provided under
any other applicable provision of law.
Dated: December 10, 2013.
Thomas J. Curry,
Comptroller of the Currency.
By order of the Board of Governors of the
Federal Reserve System, December 23, 2013.
Robert deV. Frierson,
Secretary of the Board.
By order of the Board of Directors.
Dated at Washington, DC this 10th day of
December, 2013.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary
By the Securities and Exchange
Commission.
Dated: December 10, 2013.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2013–31511 Filed 1–30–14; 8:45 am]
BILLING CODE 4810–33–P

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