2018-13502
Federal Register, Volume 83 Issue 137 (Tuesday, July 17, 2018)
[Federal Register Volume 83, Number 137 (Tuesday, July 17, 2018)]
[Proposed Rules]
[Pages 33432-33605]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-13502]
[[Page 33431]]
Vol. 83
Tuesday,
No. 137
July 17, 2018
Part III
Department of the Treasury
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Office of the Comptroller of the Currency
Federal Reserve System
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Federal Deposit Insurance Corporation
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Securities and Exchange Commission
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Commodity Futures Trading Commission
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12 CFR Parts 44, 248, and 351
17 CFR Parts 75 and 255
Proposed Revisions to Prohibitions and Restrictions on Proprietary
Trading and Certain Interests in, and Relationships With, Hedge Funds
and Private Equity Funds; Proposed Rule
Federal Register / Vol. 83 , No. 137 / Tuesday, July 17, 2018 /
Proposed Rules
[[Page 33432]]
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DEPARTMENT OF TREASURY
Office of the Comptroller of the Currency
12 CFR Part 44
[Docket No. OCC-2018-0010]
RIN 1557-AE27
FEDERAL RESERVE SYSTEM
12 CFR Part 248
[Docket No. R-1608]
RIN 7100-AF 06
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 351
RIN 3064-AE67
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 255
[Release no. BHCA-3; File no. S7-14-18]
RIN 3235-AM10
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 75
RIN 3038-AE72
Proposed Revisions to Prohibitions and Restrictions on
Proprietary Trading and Certain Interests in, and Relationships With,
Hedge Funds and Private Equity Funds
AGENCY: Office of the Comptroller of the Currency, Treasury (``OCC'');
Board of Governors of the Federal Reserve System (``Board''); Federal
Deposit Insurance Corporation (``FDIC''); Securities and Exchange
Commission (``SEC''); and Commodity Futures Trading Commission
(``CFTC'').
ACTION: Notice of proposed rulemaking.
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SUMMARY: The OCC, Board, FDIC, SEC, and CFTC (individually, an
``Agency,'' and collectively, the ``Agencies'') are requesting comment
on a proposal that would amend the regulations implementing section 13
of the Bank Holding Company Act (BHC Act). Section 13 contains certain
restrictions on the ability of a banking entity 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. The proposed amendments are intended to provide
banking entities with clarity about what activities are prohibited and
to improve supervision and implementation of section 13.
DATES: Comments must be received on or before September 17, 2018.
ADDRESSES: Interested parties are encouraged to submit written comments
jointly to all of the Agencies. Commenters are encouraged to use the
title ``Restrictions on Proprietary Trading and Certain Interests in,
and Relationships with, Hedge Funds and Private Equity Funds'' to
facilitate the organization and distribution of comments among the
Agencies. Commenters are also encouraged to identify the number of the
specific question for comment to which they are responding. Comments
should be directed to:
OCC: Because paper mail in the Washington, DC area and at the OCC
is subject to delay, commenters are encouraged to submit comments
through the Federal eRulemaking Portal or email, if possible. Please
use the title ``Proposed Revisions to Prohibitions and Restrictions on
Proprietary Trading and Certain Interests in, and Relationships with,
Hedge Funds and Private Equity Funds'' to facilitate the organization
and distribution of the comments. You may submit comments by any of the
following methods:
Federal eRulemaking Portal--``regulations.gov'': Go to
www.regulations.gov. Enter ``Docket ID OCC-2018-0010'' in the Search
Box and click ``Search.'' Click on ``Comment Now'' to submit public
comments.
Click on the ``Help'' tab on the Regulations.gov home page
to get information on using Regulations.gov, including instructions for
submitting public comments.
Email: [email protected].
Mail: Legislative and Regulatory Activities Division,
Office of the Comptroller of the Currency, 400 7th Street SW, Suite 3E-
218, Washington, DC 20219.
Hand Delivery/Courier: 400 7th Street SW, Suite 3E-218,
Washington, DC 20219.
Fax: (571) 465-4326.
Instructions: You must include ``OCC'' as the agency name and
``Docket ID OCC-2018-0010'' in your comment. In general, the OCC will
enter all comments received into the docket and publish the comments on
the Regulations.gov website without change, including any business or
personal information that you provide such as name and address
information, email addresses, or phone numbers. Comments received,
including attachments and other supporting materials, are part of the
public record and subject to public disclosure. Do not include any
information in your comment or supporting materials that you consider
confidential or inappropriate for public disclosure.
You may review comments and other related materials that pertain to
this rulemaking action by any of the following methods:
Viewing Comments Electronically: Go to
www.regulations.gov. Enter ``Docket ID OCC-2018-0010'' in the Search
box and click ``Search.'' Click on ``Open Docket Folder'' on the right
side of the screen and then ``Comments.'' Comments can be filtered by
clicking on ``View All'' and then using the filtering tools on the left
side of the screen.
Click on the ``Help'' tab on the Regulations.gov home page
to get information on using Regulations.gov. Supporting materials may
be viewed by clicking on ``Open Docket Folder'' and then clicking on
``Supporting Documents.'' The docket may be viewed after the close of
the comment period in the same manner as during the comment period.
Viewing Comments Personally: You may personally inspect
and photocopy comments at the OCC, 400 7th Street SW, Washington, DC
20219. For security reasons, the OCC requires that visitors make an
appointment to inspect comments. You may do so by calling (202) 649-
6700 or, for persons who are deaf or hearing impaired, TTY, (202) 649-
5597. Upon arrival, visitors will be required to present valid
government-issued photo identification and submit to security screening
in order to inspect and photocopy comments.
Board: You may submit comments, identified by Docket No. R-1608;
RIN 7100-AF 06, by any of the following methods:
Agency Website: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Email: [email protected]. Include docket
and RIN numbers in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Ann E. Misback, Secretary, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue NW,
Washington, DC 20551. All public comments are available from the
Board's website at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as submitted, unless modified for technical
[[Page 33433]]
reasons or to remove sensitive personal information at the commenter's
request. Public comments may also be viewed electronically or in paper
form in Room 3515, 1801 K Street NW. (between 18th and 19th Streets NW)
Washington, DC 20006 between 9:00 a.m. and 5:00 p.m. on weekdays.
FDIC: You may submit comments, identified by RIN 3064-AE67 by any
of the following methods:
Agency Website: http://www.FDIC.gov/regulations/laws/federal/propose.html. Follow instructions for submitting comments on
the Agency website.
Mail: Robert E. Feldman, Executive Secretary, Attention:
Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th
Street NW, Washington, DC 20429.
Hand Delivered/Courier: Comments may be hand-delivered to
the guard station at the rear of the 550 17th Street Building (located
on F Street) on business days between 7:00 a.m. and 5:00 p.m.
Email: [email protected]. Include the RIN 3064-AE67 on the
subject line of the message.
Public Inspection: All comments received must include the
agency name and RIN 3064-AE67 for this rulemaking. All comments
received will be posted without change to http://www.fdic.gov/regulations/laws/federal/, including any personal information provided.
Paper copies of public comments may be ordered from the FDIC Public
Information Center, 3501 North Fairfax Drive, Room E-1002, Arlington,
VA 22226 or by telephone at (877) 275-3342 or (703) 562-2200.
SEC: You may submit comments by the following methods:
Electronic Comments
Use the SEC's internet comment form (http://www.sec.gov/rules/proposed.shtml); or
Send an email to [email protected]. Please include File Number
S7-14-18 on the subject line.
Paper Comments
Send paper comments in triplicate to Brent J. Fields,
Secretary, Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549-1090.
All submissions should refer to File Number S7-14-18. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method. The SEC will post all comments on the SEC's website (http://www.sec.gov/rules/proposed.shtml). Comments are also available for
website viewing and printing in the SEC's Public Reference Room, 100 F
Street NE, Washington, DC 20549, on official business days between the
hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted
without change. Persons submitting comments are cautioned that the SEC
does not redact or edit personal identifying information from comment
submissions. You should submit only information that you wish to make
available publicly.
Studies, memoranda, or other substantive items may be added by the
SEC or SEC staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any materials will
be made available on the SEC's website. To ensure direct electronic
receipt of such notifications, sign up through the ``Stay Connected''
option at www.sec.gov to receive notifications by email.
CFTC: You may submit comments, identified by RIN 3038-AE72 and
``Proposed Revisions to Prohibitions and Restrictions on Proprietary
Trading and certain Interests in, and Relationships with, Hedge Funds
and Private Equity Funds,'' by any of the following methods:
Agency Website: https://comments.cftc.gov. Follow the
instructions on the website for submitting comments.
Mail: Send to Christopher Kirkpatrick, Secretary,
Commodity Futures Trading Commission, 1155 21st Street NW, Washington,
DC 20581.
Hand Delivery/Courier: Same as Mail above.
Please submit your comments using only one method. All comments
must be submitted in English, or if not, accompanied by an English
translation. Comments will be posted as received to www.cftc.gov and
the information you submit will be publicly available. If, however, you
submit information that ordinarily is exempt from disclosure under the
Freedom of Information Act, you may submit a petition for confidential
treatment of the exempt information according to the procedures set
forth in CFTC Regulation 145.9.1. The CFTC reserves the right, but
shall have no obligation, to review, pre-screen, filter, redact, refuse
or remove any or all of your submission from www.cftc.gov that it may
deem to be inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the Freedom of Information Act.
FOR FURTHER INFORMATION CONTACT:
OCC: Suzette Greco, Assistant Director; Tabitha Edgens, Senior
Attorney; Mark O'Horo, Attorney, Securities and Corporate Practices
Division (202) 649-5510; for persons who are deaf or hearing impaired,
TTY, (202) 649-5597, Office of the Comptroller of the Currency, 400 7th
Street SW, Washington, DC 20219.
Board: Kevin Tran, Supervisory Financial Analyst, (202) 452-2309,
Amy Lorenc, Financial Analyst, (202) 452-5293, David Lynch, Deputy
Associate Director, (202) 452-2081, David McArthur, Senior Economist,
(202) 452-2985, Division of Supervision and Regulation; Flora Ahn,
Senior Counsel, (202) 452-2317, Gregory Frischmann, Counsel, (202) 452-
2803, or Kirin Walsh, Attorney, (202) 452-3058, Legal Division, Board
of Governors of the Federal Reserve System, 20th and C Streets NW,
Washington, DC 20551. For the hearing impaired only, Telecommunication
Device for the Deaf (TDD), (202) 263-4869.
FDIC: Bobby R. Bean, Associate Director, [email protected], Michael
Spencer, Chief, Capital Markets Strategies Section,
[email protected], or Brian Cox, Capital Markets Policy Analyst,
[email protected], Capital Markets Branch, (202) 898-6888; Michael B.
Phillips, Counsel, [email protected], Benjamin J. Klein, Counsel,
[email protected], or Annmarie H. Boyd, Counsel, [email protected], Legal
Division, Federal Deposit Insurance Corporation, 550 17th Street NW,
Washington, DC 20429.
SEC: Andrew R. Bernstein (Senior Special Counsel), Sophia Colas
(Attorney-Adviser), Sam Litz (Attorney-Adviser), Office of Derivatives
Policy and Trading Practices, or Aaron Washington (Special Counsel),
Elizabeth Sandoe (Senior Special Counsel), Carol McGee (Assistant
Director), or Josephine J. Tao (Assistant Director), at (202) 551-5777,
Division of Trading and Markets, and Nicholas Cordell, Matthew Cook,
Aaron Gilbride (Branch Chief), Brian McLaughlin Johnson (Assistant
Director), and Sara Cortes (Assistant Director), at (202) 551-6787 or
[email protected], Division of Investment Management, U.S. Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549.
CFTC: Erik Remmler, Deputy Director, (202) 418-7630,
[email protected]; Cantrell Dumas, Special Counsel, (202) 418-5043,
[email protected]; Jeffrey Hasterok, Data and Risk Analyst, (646) 746-
9736, [email protected], Division
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of Swap Dealer and Intermediary Oversight; Mark Fajfar, Assistant
General Counsel, (202) 418-6636, [email protected], Office of the
General Counsel; Stephen Kane, Research Economist, (202) 418-5911,
[email protected], Office of the Chief Economist; Commodity Futures
Trading Commission, Three Lafayette Centre,1155 21st Street NW,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the
``Dodd-Frank Act'') was enacted on July 21, 2010.\1\ Section 619 of the
Dodd-Frank Act added a new section 13 to the BHC Act (codified at 12
U.S.C. 1851), also known as the Volcker Rule, 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\
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\1\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
\2\ See 12 U.S.C. 1851. 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
a nonbank financial company supervised by the Board would be subject
to additional capital requirements, quantitative limits, or other
restrictions if the company engages in certain proprietary trading
or covered fund activities. See 12 U.S.C. 1851(a)(2) and (f)(4).
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Section 13 of the BHC Act generally prohibits banking entities from
engaging as principal in 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.\3\ Section 13(d)(1)
expressly exempts from this prohibition, subject to conditions, certain
activities, including:
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\3\ See 12 U.S.C. 1851(a)(1)(A); 1851(h)(4) and (6).
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Trading in U.S. government, agency, and municipal
obligations;
Underwriting and market-making-related activities;
Risk-mitigating hedging activities;
Trading on behalf of customers;
Trading for the general account of insurance companies;
and
Foreign trading by non-U.S. banking entities.\4\
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\4\ See 12 U.S.C. 1851(d)(1).
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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.\5\ Section 13 contains several
exemptions that permit banking entities to make limited investments in
covered 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 significant losses from investments
or other relationships with these funds.\6\
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\5\ See 12 U.S.C. 1851(a)(1)(B).
\6\ See, e.g., 12 U.S.C. 1851(d)(1)(G).
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Under the statute, authority for developing and adopting
regulations to implement the prohibitions and restrictions of section
13 of the BHC Act is divided among the Board of Governors of the
Federal Reserve System, the Federal Deposit Insurance Corporation, the
Office of the Comptroller of the Currency, the Securities and Exchange
Commission, and the Commodity Futures Trading Commission (individually,
an ``Agency,'' and collectively, the ``Agencies'').\7\ The Agencies
issued a final rule implementing these provisions in December 2013 (the
``2013 final rule'').\8\
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\7\ See 12 U.S.C. 1851(b)(2). Under section 13(b)(2)(B) of the
BHC Act, rules implementing section 13's prohibitions and
restrictions must be issued by: (i) The appropriate Federal banking
agencies (i.e., the Board, the OCC, and the FDIC), jointly, with
respect to insured depository institutions; (ii) the Board, with
respect to any company that controls an insured depository
institution, or that is treated as a bank holding company for
purposes of section 8 of the International Banking Act, any nonbank
financial company supervised by the Board, and any subsidiary of any
of the foregoing (other than a subsidiary for which an appropriate
Federal banking agency, the SEC, or the CFTC is the primary
financial regulatory agency); (iii) the CFTC with respect to any
entity for which it is the primary financial regulatory agency, as
defined in section 2 of the Dodd-Frank Act; and (iv) the SEC with
respect to any entity for which it is the primary financial
regulatory agency, as defined in section 2 of the Dodd-Frank Act.
See id.
\8\ See Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships with, Hedge Funds and
Private Equity Funds; Final Rule, 79 FR 5535 (Jan. 31, 2014).
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The Agencies have now had several years of experience implementing
the 2013 final rule and believe that supervision and implementation of
the 2013 final rule can be substantially improved. The Agencies
acknowledge concerns that some parts of the 2013 final rule may be
unclear and potentially difficult to implement in practice. Based on
experience since adoption of the 2013 final rule, the Agencies have
identified opportunities, consistent with the statute, for improving
the rule, including further tailoring its application based on the
activities and risks of banking entities. Accordingly, the Agencies are
issuing this proposal (the ``proposal'' or ``proposed amendments'') to
amend the 2013 final rule, in order to provide banking entities with
greater clarity and certainty about what activities are prohibited and
seek to improve effective allocation of compliance resources where
possible. The Agencies also believe that the modifications proposed
herein would improve the ability of the Agencies to examine for, and
make supervisory assessments regarding, compliance relative to the
statute and the implementing rules.
While section 13 of the BHC Act addresses certain risks related to
proprietary trading and covered fund activities of banking entities,
the Agencies note that the nature and business of banking entities
involves other inherent risks, such as credit risk and general market
risk. To that end, the Agencies have various tools, such as the
regulatory capital rules of the Federal banking agencies and the
comprehensive capital analysis and review framework of the Board, to
require banking entities to manage the risks associated with their
activities. The Agencies believe that the proposed changes to the 2013
final rule would be consistent with safety and soundness and enable
banking entities to implement appropriate risk management policies in
light of the risks associated with the activities in which banking
entities are permitted to engage under section 13.
The Agencies also note that the Economic Growth, Regulatory Relief,
and Consumer Protection Act,\9\ which was enacted on May 24, 2018,
amends section 13 of the BHC Act by narrowing the definition of banking
entity and revising the statutory provisions related to the naming of
covered funds. The Agencies plan to address these statutory amendments
through a separate rulemaking process; no changes have been proposed
herein that would implement these amendments. The amendments took
effect upon enactment, however, and in the interim between enactment
and the adoption of implementing regulations, the Agencies will not
enforce the 2013 final rule in a manner inconsistent with the
amendments to section 13 of the BHC Act with respect to institutions
excluded by the statute and with respect to the naming restrictions for
covered funds. Additionally, the specific regulatory amendments
proposed herein would not be inconsistent with the
[[Page 33435]]
recent statutory amendments to section 13 of the BHC Act.
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\9\ Public Law 115-174, 132 Stat. 1296-1368 (2018).
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A. Rulemaking Framework
Section 13 of the BHC Act requires that implementation of its
provisions occur in several stages. The first stage in implementing
section 13 of the BHC Act was a study by the Financial Stability
Oversight Council (``FSOC'').\10\ The FSOC study was issued on January
18, 2011, and included a detailed discussion of key issues and
recommendations related to implementation of section 13 of the BHC
Act.\11\
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\10\ FSOC, 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, the
FSOC requested public comment on a number of issues to assist the
FSOC in conducting its study. See Public Input for the Study
Regarding the Implementation of the Prohibitions on Proprietary
Trading and Certain Relationships With Hedge Funds and Private
Equity Funds, 75 FR 61758 (Oct. 6, 2010). Approximately 8,000
comments were received from the public, including from members of
Congress, trade associations, individual banking entities, consumer
groups, and individuals. As noted in the issuing release for the
FSOC study, these comments were considered by the FSOC when drafting
the FSOC study.
\11\ See id.
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Following the FSOC study, and 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 a proposal implementing the requirements of
section 13 of the BHC Act.\12\ In February 2012, the CFTC issued a
proposal that was substantially identical to the one proposed in
October 2011 by the other four Agencies.\13\ The Agencies received more
than 600 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. The comments
addressed all major sections of the 2011 proposal. To improve
understanding of the issues raised by commenters, the staffs of the
Agencies met with a number of these commenters to discuss issues
relating to the 2011 proposal, and summaries of these meetings are
available on each of the Agencies' public websites.\14\ The CFTC staff
also hosted a public roundtable on the 2011 proposal.\15\ In
formulating the 2013 final rule, the Agencies carefully reviewed all
comments submitted in connection with the rulemaking and considered the
suggestions and issues they raised in light of the statutory
requirements as well as the FSOC study. In December 2013, the Agencies
issued the 2013 final rule implementing section 13 of the BHC Act.
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\12\ See Prohibitions and Restrictions on Proprietary Trading
and Certain Interests in, and Relationships with, Hedge Funds and
Private Equity Funds, 76 FR 68846 (Nov. 7, 2011) (``2011
proposal'').
\13\ See Prohibitions and Restrictions on Proprietary Trading
and Certain Interests in, and Relationships with, Hedge Funds and
Private Equity Funds, 77 FR 8331 (Feb. 14, 2012).
\14\ See http://www.regulations.gov/#!docketDetail;D=OCC-2011-
0014 (OCC); http://www.federalreserve.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).
\15\ 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.
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The Agencies are committed to revisiting and revising the rule as
appropriate to improve its implementation. Since the adoption of the
2013 final rule, the Agencies have gained several years of experience
implementing the 2013 final rule, and banking entities have had more
than four years of experience implementing the 2013 final rule.\16\
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\16\ The 2013 final rule was published in the Federal Register
on January 31, 2014, and became effective on April 1, 2014. Banking
entities were required to fully conform their proprietary trading
activities and their new covered fund investments and activities to
the requirements of the 2013 final rule by the end of the
conformance period, which the Board extended to July 21, 2015. The
Board extended the conformance period for certain legacy covered
fund activities until July 21, 2017. Upon application, banking
entities also have an additional period to conform certain illiquid
funds to the requirements of section 13 and implementing
regulations.
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In particular, the Agencies have received various communications
from the public and other sources since adoption of the 2013 final rule
and over the course of its implementation. These communications include
written comments from members of Congress; domestic and foreign banking
entities and other financial services firms; trade groups representing
banking, insurance, and other firms within the broader financial
services industry; U.S. state and foreign governments; consumer and
public interest groups; and individuals. The U.S. Department of the
Treasury also issued reports in June 2017 and October 2017, which
contained recommendations regarding section 13 of the BHC Act and the
implementing regulations.\17\ In addition, the OCC issued a Request for
Information (``OCC Notice for Comment'') in August 2017 and received 87
unique comment letters and over 8,400 standardized letters regarding
section 13 of the BHC Act and the implementing regulations.\18\
Moreover, staffs of the Agencies have held numerous meetings with
market participants to discuss the 2013 final rule and its
implementation. Collectively, these sources of public feedback have
provided the Agencies with a better understanding of the concerns and
challenges surrounding implementation of the 2013 final rule.
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\17\ See A Financial System That Creates Economic Opportunities,
Banks and Credit Unions (June 2017), available at https://www.treasury.gov/press-center/press-releases/Documents/A%20Financial%20System.pdf and A Financial System that Creates
Economic Opportunities, Capital Markets (October 2017), available at
https://www.treasury.gov/press-center/press-releases/Documents/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf.
\18\ See Notice Seeking Public Input on the Volcker Rule (August
2017), available at https://www.occ.gov/news-issuances/news-releases/2017/nr-occ-2017-89a.pdf. Corresponding comment letters are
available at https://www.regulations.gov/docketBrowser?rpp=25&so=DESC&sb=commentDueDate&po=0&dct=PS&D=OCC-2017-0014. A summary of the comment letters is available at https://occ.gov/topics/capital-markets/financial-markets/trading-volcker-rule/volcker-notice-comment-summary.pdf.
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Furthermore, the Agencies have collected nearly four years of
quantitative data required under Appendix A of the 2013 final rule. The
data collected in connection with the 2013 final rule, compliance
efforts by banking entities, and the Agencies' experience in reviewing
trading and investment activity under the 2013 final rule, have
provided valuable insights into the effectiveness of the 2013 final
rule. These insights highlighted areas in which the 2013 final rule may
have resulted in ambiguity, overbroad application, or unduly complex
compliance routines. With this proposal, and based on experience gained
over the past few years, the Agencies seek to simplify and tailor the
implementing regulations, where possible, in order to increase
efficiency, reduce excess demands on available compliance capacities at
banking entities, and allow banking entities to more efficiently
provide services to clients, consistent with the requirements of the
statute.\19\
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\19\ A number of Agency principals have suggested modifications
to the 2013 final rule. See Randal K. Quarles, Mar. 5, 2018,
available at https://www.federalreserve.gov/newsevents/speech/quarles20180305a.htm; Daniel K. Tarullo, Apr. 4, 2017, available at
https://www.federalreserve.gov/newsevents/speech/tarullo20170404a.htm; Martin J. Gruenberg, Nov. 14, 2017, available
at https://www.fdic.gov/news/news/speeches/spnov1417.html.
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[[Page 33436]]
B. Agency Coordination
Section 13(b)(2)(B)(ii) of the BHC Act directs the Agencies to
``consult and coordinate'' in developing and issuing the implementing
regulations ``for the purpose of assuring, to the extent possible, that
such regulations are comparable and provide for consistent application
and implementation of the applicable provisions of section 13 of the
BHC Act to avoid providing advantages or imposing disadvantages to the
companies affected . . . .'' \20\ The Agencies recognize that
coordinating with respect to regulatory interpretations, examinations,
supervision, and sharing of information is important to maintain
consistent oversight, promote compliance with section 13 of the BHC Act
and implementing regulations, and foster a level playing field for
affected market participants. The Agencies further recognize that
coordinating these activities helps to avoid unnecessary duplication of
oversight, reduces costs for banking entities, and provides for more
efficient regulation.
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\20\ 12 U.S.C. 1851(b)(2)(B)(ii).
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The Agencies request comment on coordination generally and the
following specific questions:
Question 1. Would it be helpful for the Agencies to hold joint
information gathering sessions with a banking entity that is supervised
or regulated by more than one Agency? If not, why not, and, if so, what
should the Agencies consider in arranging these joint sessions?
Question 2. In what ways could the Agencies improve the
transparency of their implementation of section 13 of the BHC Act? What
specific steps with respect to Agency coordination would banking
entities find helpful to make compliance with section 13 and the
implementing rules more efficient? What steps would commenters
recommend with respect to coordination to better promote and protect
the safety and soundness of banking entities and U.S. financial
stability?
II. Overview of Proposal
A. General Approach
The proposal would adopt a revised risk-based approach that would
rely on a set of clearly articulated standards for both prohibited and
permitted activities and investments, consistent with the requirements
of section 13 of the BHC Act. In formulating the proposal, the Agencies
have attempted to simplify and tailor the 2013 final rule, as described
further below, to allow banking entities to more efficiently provide
services to clients.
The Agencies seek to address a number of targeted areas for
potential revision in this proposal. First, the Agencies are proposing
to tailor the application of the rule based on the size and scope of a
banking entity's trading activities. In particular, the Agencies aim to
further reduce compliance obligations for small and mid-sized firms
that do not have large trading operations and therefore reduce costs
and uncertainty faced by small and mid-size firms in complying with the
final rule, relative to their amount of trading activity.\21\ In the
experience of the Agencies since adoption of the 2013 final rule, the
costs and uncertainty faced by small and mid-sized firms in complying
with the 2013 final rule can be disproportionately high relative to the
amount of trading activity typically undertaken by these firms.
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\21\ The Federal banking agencies issued guidance relating to
compliance with the final rule for community banks in conjunction
with the final rule in December of 2013. See The Volcker Rule:
Community Bank Applicability, https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20131210a4.pdf.
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In addition to tailoring the application of the rule, the Agencies
also seek to streamline and clarify for all banking entities certain
definitions and requirements related to the proprietary trading
prohibition and limitations on covered fund activities and investments.
In particular, this proposal seeks to codify or otherwise addresses
matters currently addressed by staff responses to Frequently Asked
Questions (``FAQs'').\22\ Additionally, the Agencies are seeking in
this proposal to reduce metrics reporting, recordkeeping, and
compliance program requirements for all banking entities and expand
tailoring to make the scale of compliance activity required by the rule
commensurate with a banking entity's size and level of trading
activity.
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\22\ See https://www.occ.treas.gov/topics/capital-markets/financial-markets/trading-volcker-rule/volcker-rule-implementation-faqs.html (OCC); https://www.federalreserve.gov/bankinforeg/volcker-rule/faq.htm (Board); https://www.fdic.gov/regulations/reform/volcker/faq.html (FDIC); https://www.sec.gov/divisions/marketreg/faq-volcker-rule-section13.htm (SEC); https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_28_VolckerRule/index.htm
(CFTC).
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In tailoring these proposed changes to the 2013 final rule, the
Agencies note the following statutory limitations to the permitted
proprietary trading and covered fund activities,\23\ which are
incorporated in the 2013 final rule and have not been changed in the
proposed rule. These statutory limitations provide that such permitted
activities must not: (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.\24\
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\23\ See 12 U.S.C. 1851(d)(2).
\24\ See id.
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As a matter of structure, the proposed amendments would maintain
the 2013 final rule's division into four subparts, and would maintain a
metrics appendix while removing the 2013 final rule's second appendix
regarding enhanced minimum standards for compliance programs, as
follows:
Subpart A of the 2013 final rule, as amended by the
proposal, would describe the authority, scope, purpose, and
relationship to other authorities of the rule and define terms used
commonly throughout the rule;
Subpart B of the 2013 final rule, as amended by the
proposal, would prohibit proprietary trading, define terms relevant to
covered trading activity, establish exemptions from the prohibition on
proprietary trading and limitations on those exemptions, and require
certain banking entities to report certain information with respect to
their trading activities;
Subpart C of the 2013 final rule, as amended by the
proposal, would prohibit or restrict acquisition or retention of an
ownership interest in, and certain relationships with, a covered fund;
define terms relevant to covered fund activities and investments; and
establish exemptions from the restrictions on covered fund activities
and investments and limitations on those exemptions; and
Subpart D of the 2013 final rule, as amended by the
proposal, would generally require banking entities with significant
trading assets and liabilities to establish a compliance program
regarding section 13 of the BHC Act and the rule, including written
policies and procedures, internal controls, a management framework,
independent testing of the compliance program, training, and
recordkeeping; establish metrics reporting requirements for banking
entities with significant trading assets and liabilities, pursuant to
the Appendix; provide tailored compliance program requirements for
banking entities without significant trading assets and liabilities,
including a presumption of compliance for banking entities with limited
trading assets and liabilities; and require certain larger
[[Page 33437]]
banking entities to submit a chief executive officer (``CEO'')
attestation regarding the compliance program.
Given the complexities associated with the 2013 final rule, the
Agencies request comment on the potential impact the proposal may have
on banking entities and the activities in which they engage. The
Agencies are interested in receiving comments regarding revisions
described in the proposal relative to the 2013 final rule.\25\
Additionally, the Agencies recognize that there are economic impacts
that would potentially arise from the proposal and its implementation
of section 13 of the BHC Act. The Agencies have provided an assessment
of the expected impact of the proposed modifications contained in the
proposal, and the Agencies request comment on all aspects of such
impacts, including quantitative data, where possible. Specific requests
for comment are included in the following sections.
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\25\ This proposal contains certain proposed amendments to the
2013 final rule. The 2013 final rule would continue in effect where
no change is made.
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B. Scope of Proposal
To better tailor the application of the rule, the proposal would
establish three categories of banking entities based on their level of
trading activity.\26\ The first category would include banking entities
with ``significant trading assets and liabilities,'' defined as those
banking entities that, together with their affiliates and subsidiaries,
have trading assets and liabilities (excluding obligations of or
guaranteed by the United States or any agency of the United States)
equal to or exceeding $10 billion. These banking entities, which
generally have large trading operations, would be required to comply
with the most extensive set of requirements under the proposal.
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\26\ The proposal would amend Sec. __.2 of the 2013 final rule
to include a new defined term for each of these categories. The
Agencies are proposing to republish Sec. __.2 in its entirety for
clarity due to the renumbering of certain definitions. These
proposed banking entity categories are discussed in further detail
in Section II.G. of the Supplementary Information, below.
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The second category would include banking entities with ``moderate
trading assets and liabilities,'' defined as those banking entities
that do not have significant trading assets and liabilities or limited
trading assets and liabilities. Banking entities with moderate trading
assets and liabilities are those entities that, together with their
affiliates and subsidiaries, have trading assets and liabilities
(excluding obligations of or guaranteed by the United States or any
agency of the United States) less than $10 billion, but above the
threshold described below for banking entities with limited trading
assets and liabilities.\27\ These banking entities would be subject to
reduced compliance requirements and a more tailored approach in light
of their smaller and less complex trading activities.
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\27\ This category would also include banking entities with
trading assets and liabilities of less than $1 billion for which the
presumption of compliance described below has been rebutted.
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The third category includes banking entities with ``limited trading
assets and liabilities,'' defined as those banking entities that have,
together with their 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) less than $1 billion. This $1 billion threshold would be
based on the worldwide trading assets and liabilities of a banking
entity and all of its affiliates. With respect to a foreign banking
organization (``FBO'') and its subsidiaries, the $1 billion threshold
would be based on worldwide consolidated trading assets and
liabilities, and would not be limited to its combined U.S. operations.
The proposal would establish a presumption of compliance for all
banking entities with limited trading assets and liabilities. Banking
entities operating pursuant to this proposed presumption of compliance
would have no obligation to demonstrate compliance with subparts B and
C of the proposal on an ongoing basis. If, however, upon examination or
audit, the relevant Agency determines that the banking entity has
engaged in proprietary trading or covered fund activities that are
prohibited under subpart B or subpart C, such Agency may exercise its
authority to rebut the presumption of compliance and require the
banking entity to comply with the requirements of the rule applicable
to banking entities that have moderate trading assets and liabilities.
The purpose of this presumption of compliance would be to further
reduce compliance costs for small and mid-size banks that either do not
engage in the types of activities subject to section 13 of the BHC Act
or engage in such activities only on a limited scale.
The proposal also includes a reservation of authority that would
allow an Agency to require a banking entity with limited or moderate
trading assets and liabilities to apply any of the more extensive
requirements that would otherwise apply if the banking entity had
significant or moderate trading assets and liabilities, if the Agency
determines that the size or complexity of the banking entity's trading
or investment activities, or the risk of evasion, warrants such
treatment.
C. Proprietary Trading Restrictions
Subpart B of the 2013 final rule implements the statutory
prohibition on proprietary trading and the various exemptions to this
prohibition included in the statute. Section __.3 of the 2013 final
rule contains the core prohibition on proprietary trading and defines a
number of related terms. The proposal would make several changes to
Sec. __.3 of the 2013 final rule. Notably, the proposal would revise,
in a manner consistent with the statute, the definition of ``trading
account'' in order to increase clarity regarding the positions included
in the definition.\28\ The definition of ``trading account'' is a
threshold definition that tells a banking entity whether the purchase
or sale of a financial instrument is subject to the restrictions and
requirements of section 13 of the BHC Act and the 2013 final rule in
the first instance.
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\28\ Definitions used in the proposal would remain the same as
in the 2013 final rule except as otherwise specified.
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In the 2013 final rule, the Agencies defined the statutory term
``trading account'' to include three prongs. The first prong includes
any account that is used by a banking entity to purchase or sell one or
more financial instruments principally for the purpose of short-term
resale, benefitting from short-term price movements, realizing short-
term arbitrage profits, or hedging another trading account position
(the ``short-term intent prong'').\29\ For purposes of this part of the
definition, the 2013 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 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).\30\
The second prong covers trading positions that are both covered
positions and trading positions for purposes of the Federal banking
agencies' market risk capital rules, as well as hedges of covered
positions (the ``market risk capital prong'').\31\ The third prong
covers any account used by a banking entity that is a securities
dealer, swap dealer, or security-based swap dealer that is licensed or
registered, or required to be licensed or registered, as a dealer, swap
dealer, or
[[Page 33438]]
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 (the ``dealer prong'').\32\
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\29\ See 2013 final rule Sec. __.3(b)(1)(i).
\30\ See 2013 final rule Sec. __.3(b)(2).
\31\ See 2013 final rule Sec. __.3(b)(1)(ii).
\32\ See 2013 final rule Sec. __.3(b)(1)(iii)(A). The dealer
prong also includes positions entered into by a banking entity that
is engaged in the business of a dealer, swap dealer, or security-
based swap dealer outside of the United States, to the extent the
instrument is purchased or sold in connection with the activities of
such business. See 2013 final rule Sec. __.3(b)(1)(iii)(B).
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In the experience of the Agencies, determining whether or not
positions fall into the short-term intent prong of the trading account
definition has often proved unclear and subjective, and, consequently,
may result in ambiguity or added costs and delays. For this reason, the
proposal would remove the short-term intent prong from the 2013 final
rule's definition of trading account and eliminate the associated
rebuttable presumption, and would also modify the definition of trading
account as described below to include other accounts described in the
statutory definition of ``trading account.'' \33\
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\33\ 12 U.S.C. 1851(h)(6). As in the 2013 final rule, the
Agencies note that 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 prohibitions on proprietary
trading under the 2013 final rule, including as it would be amended
by the proposal.
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The remaining two prongs of the trading account definition in the
2013 final rule, the market risk capital prong and the dealer prong,
generally would remain unchanged because, in the experience of the
Agencies, interpretation of both prongs has been relatively
straightforward and clear in practice for most banking entities. The
proposal would, however, modify the market risk capital prong to cover
the trading positions of FBOs subject to similar requirements in the
applicable foreign jurisdiction. The Agencies are proposing this
modification for FBOs to take into account the different frameworks and
supervisors FBOs may have in their home countries. Specifically, the
proposal would modify the market risk capital prong to apply to FBOs
that are subject to capital requirements under a market risk framework
established by their respective home country supervisors, provided the
market risk framework is consistent with the market risk framework
published by the Basel Committee on Banking Supervision, as amended.
The Agencies expect that this standard, similar to the current market
risk capital prong referencing the U.S. market risk capital rules,
would include trading account activities of FBOs consistent with the
statutory trading account requirements. The Agencies believe the
proposed approach would be an appropriate interpretation of the
statutory trading account definition. The Agencies likewise believe
that application of the market risk capital prong to FBOs as described
herein would be relatively straightforward and clear in practice.
In addition, the Agencies are proposing two changes related to the
trading account definition that are intended to replace the short-term
intent prong. These changes include: (i) The addition of an accounting
prong and (ii) a presumption of compliance with the prohibition on
proprietary trading for trading desks that are not subject to the
market risk capital prong or the dealer prong, based on a prescribed
profit and loss threshold. Under the proposed accounting prong, a
trading desk that buys or sells a financial instrument (as defined in
the 2013 final rule and unchanged by the proposal) that is recorded at
fair value on a recurring basis under applicable accounting standards
would be doing so for the ``trading account'' of the banking
entity.\34\ Financial instruments that would be covered by the proposed
accounting prong generally include, but are not limited to,
derivatives, trading securities, and available-for-sale securities. For
example, a security that is classified as ``trading'' under U.S.
generally accepted accounting principles (``GAAP'') would be included
in the proposal's definition of ``trading account'' under the proposed
approach because it is recorded at fair value.
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\34\ ``Applicable accounting standards'' is defined in the 2013
final rule, and the proposal would not make any change to this
definition. ``Applicable accounting standards'' means U.S. generally
accepted accounting principles or such other accounting standards
applicable to a covered banking entity that the relevant Agency
determines are appropriate, that the covered banking entity uses in
the ordinary course of its business in preparing its consolidated
financial statements. See 2013 final rule Sec. __.10(d)(1). The
proposal would move this defined term to Sec. __.2, to accommodate
its proposed usage outside of subpart C.
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The proposed presumption of compliance, which would apply at the
trading desk level, would provide that each trading desk that purchases
or sells financial instruments for a trading account pursuant to the
accounting prong may calculate the net gain or loss on the trading
desk's portfolio of financial instruments each business day, reflecting
realized and unrealized gains and losses since the previous business
day, based on the banking entity's fair value for such financial
instruments.
If the sum of the absolute values of the daily net gain and loss
figures for the preceding 90-calendar-day period does not exceed $25
million, the activities of the trading desk would be presumed to be in
compliance with the prohibition on proprietary trading, and the banking
entity would have no obligation to demonstrate that such trading desk's
activity complies with the rule on an ongoing basis. If this
calculation exceeds the $25 million threshold, the banking entity would
have to demonstrate compliance with section 13 of the BHC Act and the
implementing regulations, as described in more detail below. The
Agencies are also proposing to include a reservation of authority to
address any positions that may be incorrectly scoped into or out of the
definition.
Section __.3 of the 2013 final rule also details various exclusions
from the definition of proprietary trading for certain purchases and
sales of financial instruments that generally do not involve the
requisite short-term trading intent under the statute. The proposal
would make several changes to these exclusions. First, the proposal
would clarify and expand the scope of the financial instruments covered
in the liquidity management exclusion. Second, it would add an
exclusion from the definition of proprietary trading for transactions
made to correct errors made in connection with customer-driven or other
permissible transactions.
Section __.4 of the 2013 final rule implements the statutory
exemptions for underwriting and market making-related activities. The
proposal would make several changes to this section intended to improve
the practical application of these exemptions. In particular, the
proposal would establish a presumption that trading within internally
set risk limits satisfies the requirement that permitted underwriting
and market making-related activities must be designed not to exceed the
reasonably expected near-term demands of clients, customers, or
counterparties (``RENTD''). The Agencies believe this presumption would
allow for a clearer application of these exemptions, and would provide
banking entities with more flexibility and certainty in conducting
permissible underwriting and market making-related activities. In
addition, the proposal would make the exemptions' compliance program
requirements applicable only to banking entities with significant
trading assets and liabilities.
The proposal would also modify the 2013 final rule's implementation
of the statutory exemption for permitted risk-mitigating hedging
activities in Sec. __.5, by reducing restrictions on the eligibility
of an activity to qualify as a
[[Page 33439]]
permitted risk-mitigating hedging activity. For banking entities with
moderate or limited trading assets and liabilities, the proposal would
remove all requirements under the 2013 final rule except the
requirement that hedging activity be designed to reduce or otherwise
mitigate one or more specific, identifiable risks arising in connection
with and related to one or more identified positions, contracts, or
other holdings and that the hedging activity be recalibrated to
maintain compliance with the rule. For banking entities with
significant trading assets and liabilities, the proposal would maintain
many of the 2013 final rule's requirements, including the requirement
that the hedging activity be designed to reduce or otherwise mitigate
one or more specific, identifiable risks. The proposal would, however,
eliminate the current requirement that the hedging activity
``demonstrably reduces'' or otherwise ``significantly mitigates'' risk,
reduce documentation requirements associated with risk-mitigating
hedging transactions that are conducted by one desk to hedge positions
at another desk with pre-approved types of instruments within pre-set
hedging limits, and eliminate the 2013 final rule's correlation
analysis requirement. These foregoing changes are intended to reduce
costs and uncertainty and improve the utility of the hedging exemption.
Section __.6(e) of the proposal would remove certain requirements
of the 2013 final rule implementing the statutory exemption for trading
by a foreign banking entity that occurs solely outside of the United
States. In particular, the proposal would modify the requirement that
any personnel of the banking entity or any of its affiliates that
arrange, negotiate, or execute such purchase or sale not be located in
the United States. It also would (1) remove the requirement that no
financing for the banking entity's purchase or sale be 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 (2) eliminate certain limitations on a foreign
banking entity's ability to enter into transactions with a U.S.
counterparty.
The proposal would retain the other requirements of Sec. __.6(e)
of the 2013 final rule, including the requirement that the banking
entity engaging as principal in the purchase or sale (including
relevant personnel) not be located in the United States or organized
under the laws of the United States or of any State, that the banking
entity not book a transaction to a U.S. affiliate or branch, and that
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. Taken as a whole, the proposed amendments to this exemption seek
to reduce the impact of the 2013 final rule on foreign banking
entities' operations outside of the United States by focusing on where
the trading of these banking entities as principal occurs, where the
trading decision is made, and whether the risk of the transaction is
borne outside the United States.
D. Covered Fund Activities and Investments
Subpart C of the 2013 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 __.10 of the 2013 final rule defines the scope of
the prohibition on the acquisition and retention of ownership interests
in, and certain relationships with, a covered fund, and provides the
definition of ``covered fund.'' The Agencies request comment on a
number of potential modifications to this section.
Section __.11(c) of the 2013 final rule outlines the requirements
that apply when a banking entity engages in underwriting or market
making-related activities with respect to a covered fund. The proposal
would modify these requirements with respect to covered fund ownership
interests for third-party covered funds to generally allow for the same
types of activities as are permitted for other financial instruments.
The proposal would also make changes to Sec. __.13(a) of the 2013
final rule to expand a banking entity's ability to engage in hedging
activities involving an ownership interest in a covered fund.
E. Compliance Program Requirements
Subpart D of the 2013 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 proprietary
trading activities and covered fund activities and investments set
forth in section 13 of the BHC Act and the 2013 final rule.
As in the 2013 final rule, the proposal would provide that a
banking entity that does not engage in proprietary 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. To further enhance compliance
efficiencies, the proposal would reduce compliance requirements for
most banking entities and expand tailoring of the requirements based on
the banking entity categories previously described in this
Supplementary Information section.
Under the proposal, a banking entity with significant trading
assets and liabilities would be required to establish a six-pillar
compliance programs commensurate with the size, scope, and complexity
of its activities and business structure that meets six specific
requirements already included in the 2013 final rule. These
requirements include (1) 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; (2) a system of internal controls; (3) a management framework
that, among other things, includes appropriate management review of
trading limits, strategies, hedging activities, investments, incentive
compensation and other matters identified in the rule or by management
as requiring attention; (4) independent testing and audits; (5)
training for certain personnel; and (6) recordkeeping requirements.\35\
Certain additional documentation requirements for covered funds would
also apply to banking entities with significant trading assets and
liabilities. Because the proposal would eliminate Appendix B of the
2013 final rule, which requires large banking entities and banking
entities engaged in significant trading activities to have a separate
compliance program that complies with certain enhanced minimum
standards, the proposed rule would essentially permit a banking entity
with significant trading assets and liabilities to integrate compliance
programs meeting these requirements into its existing compliance
regime.
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\35\ See infra SUPPLEMENTARY INFORMATION, Part III.D.
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Under the proposal, a banking entity with moderate trading assets
and liabilities would be required to include in its existing compliance
policies and procedures appropriate references to the requirements of
section 13 of the BHC Act and the implementing rules as appropriate
given the activities, size,
[[Page 33440]]
scope, and complexity of the banking entity.
The proposal would also include in subpart D the specifications for
the presumption of compliance noted above that would apply for banking
entities with limited trading assets and liabilities.
The proposal would eliminate Appendix B of the 2013 final rule,
which specifies enhanced minimum standards for compliance programs of
large banking entities and banking entities engaged in significant
trading activities. The proposal would, however, maintain the 2013
final rule's CEO attestation requirement, and would apply it to all
banking entities with significant trading assets and liabilities and
moderate trading assets and liabilities.
F. Metrics Reporting Requirement
As part of adopting the 2013 final rule, the Agencies committed to
reviewing and assessing the quantitative measurements data
(``metrics'') for their effectiveness in monitoring covered trading
activities for compliance with section 13 of the BHC Act and the
implementing regulations. Since that time and as part of implementing
the 2013 final rule, the Agencies have reviewed the metrics submitted
by the banking entities and considered whether all of the quantitative
measurements are useful for all asset classes and markets, as well as
for all of the trading activities subject to the metrics requirement,
or whether modifications are appropriate.
In the proposal, the Agencies aim to better align the effectiveness
of the metrics data with its associated value in monitoring compliance.
To that end, the proposal would streamline the metrics reporting and
recordkeeping requirements by tailoring the requirements based on a
banking entity's size and level of trading activity, completely
eliminating particular metrics based on experience working with the
data, and adding a limited set of new metrics. The proposal also would
provide certain firms with additional time to report metrics to the
Agencies, beyond the current deadlines set forth in Appendix A of the
2013 final rule. The Agencies solicit comment regarding whether a
single point of collection among the Agencies for metrics would be more
effective.
G. Banking Entity Categorization and Tailoring
As noted, the proposal would define three different categories of
banking entities based on thresholds of trading assets and liabilities,
in order to improve compliance efficiencies for all banking entities
generally and further reduce compliance costs for firms that have
little or no activity subject to the prohibitions and restrictions of
section 13 of the BHC Act.
The first category would include any banking entity with
significant trading assets and liabilities, defined under the proposal
to mean a banking entity that, together with its affiliates and
subsidiaries, has 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 previous calendar quarters, equals or exceeds $10 billion.\36\
The Agencies believe that this threshold would capture a significant
portion of the trading assets and liabilities in the U.S. banking
system, but would reduce burdens for smaller, less complex banking
entities. The Agencies estimate that approximately 95 percent of the
trading assets and liabilities in the U.S. banking system are currently
held by those banking entities that would have significant trading
assets and liabilities under the proposal. Under the proposal, the most
stringent compliance requirements would apply to these banking
entities, which generally have large trading operations. For example,
as described in the relevant sections of this Supplementary Information
section below, the proposal would require banking entities with
significant trading assets and liabilities to comply with a greater set
of requirements than other banking entities to meet the conditions of
the exemptions for permitted underwriting and market making-related
activities and risk-mitigating hedging activities. In addition, the
proposal would require these banking entities to maintain a six-pillar
compliance program (i.e., written policies and procedures, internal
controls, management framework, independent testing, training, and
records), commensurate with the size, scope, and complexity of their
activities and business structure, which the banking entities could
integrate into their existing compliance regime.
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\36\ See proposal Sec. __.2(ff). With respect to a banking
entity that is an FBO or a subsidiary of an FBO, the threshold would
apply based on the trading assets and liabilities of the FBO's
combined U.S. operations, including all subsidiaries, affiliates,
branches, and agencies. This threshold would align with the
threshold currently used under the 2013 final rule to determine
whether a banking entity is subject to the metrics reporting
requirements of Appendix A of the 2013 final rule.
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The second category would include any banking entity with moderate
trading assets and liabilities, defined as a banking entity that does
not have significant trading assets and liabilities or limited trading
assets and liabilities (described below). These banking entities,
together with their affiliates and subsidiaries, generally have trading
assets and liabilities (excluding obligations of or guaranteed by the
United States or any agency of the United States) of $1 billion or more
but less than $10 billion. As with the threshold described above for
firms with significant trading assets and liabilities, the Agencies
believe that the proposed threshold for firms with moderate trading
assets and liabilities would appropriately cover a significant
percentage of trading activities in the United States. The Agencies
estimate that approximately 98 percent of the trading assets and
liabilities in the U.S. banking system are currently held by those
firms that would have trading assets and liabilities of $1 billion or
more, including firms with both significant and moderate trading assets
and liabilities. Relative to banking entities with significant trading
assets and liabilities, banking entities with moderate trading assets
and liabilities would be subject to reduced requirements and a tailored
approach in light of their smaller portfolio of trading activity. For
example, the proposal would require banking entities with moderate
trading assets and liabilities to comply with a more tailored set of
requirements under the underwriting, market-making, and risk-mitigating
hedging exemptions, as compared to the requirements applicable to
banking entities with significant trading assets and liabilities. In
addition, these firms would be subject to a simplified compliance
program requirement, which would allow the banking entity to comply
with the applicable requirements by updating existing policies and
procedures. The Agencies believe these changes could substantially
reduce the costs of compliance for banking entities that do not have
significant trading assets and liabilities.
The third category would include any banking entity with limited
trading assets and liabilities, defined under the proposal to mean a
banking entity that, together with its affiliates and subsidiaries, has
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
[[Page 33441]]
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 previous calendar quarters, is less than $1
billion.\37\ While entities with less than $1 billion in trading assets
and liabilities engage in some activities covered by section 13 of the
BHC Act and the implementing rules, as noted above, these activities
constitute a relatively small percentage of the trading assets and
liabilities in the U.S. banking system. In light of the relatively
small scale of activities engaged in by such firms, the Agencies are
proposing to provide significant tailoring of requirements for such
firms. Under the proposal, a banking entity with limited trading assets
and liabilities would be presumed to be in compliance with subpart B
and subpart C of the implementing regulations and would have no
affirmative obligation to demonstrate compliance with subpart B and
subpart C on an ongoing basis. If, upon examination or audit, the
relevant Agency determines that the banking entity has engaged in
covered trading activities or covered fund activities that are
otherwise prohibited under subpart B or subpart C, such Agency may
exercise its authority to rebut the presumption of compliance and
require the banking entity to demonstrate compliance with the
requirements of the rule applicable to a banking entity with moderate
trading assets and liabilities. Additionally, as noted below, the
relevant Agency would retain its authority to require a banking entity
to apply any compliance requirements that would otherwise apply if the
banking entity had moderate or significant trading assets and
liabilities if such Agency determines that the size or complexity of
the banking entity's trading or investment activities, or the risk of
evasion, does not warrant a presumption of compliance.
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\37\ The Agencies are proposing to adopt a different measure of
trading assets and liabilities in determining whether a banking
entity has less than $1 billion in trading assets and liabilities
for purposes of tailoring the requirements of the rule described
herein. Specifically, the proposed test would look at worldwide
trading assets and liabilities of all banking entities, including
foreign banking entities. By contrast, the test for whether a
foreign banking entity has significant trading assets and
liabilities provides that the banking entity need only include the
trading assets and liabilities of its consolidated U.S. operations
in this calculation. Banking entities with limited trading assets
and liabilities under the proposal would be eligible for a
presumption of compliance, but such a presumption may not be
appropriate for large foreign banking entities that have substantial
worldwide trading assets and liabilities. Therefore, the Agencies
have proposed to adopt one test that would apply to both domestic
and foreign banking entities for purposes of the limited trading
assets and liabilities threshold.
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The purpose of this proposed presumed compliance provision would be
to significantly reduce compliance program obligations for small and
mid-size banking entities that do not engage on a large scale in
activities subject to the proposal. Based on data from the December 31,
2017, reporting period, all but approximately 40 top-tier banking
entities would be eligible for presumed compliance.
The proposal would apply the 2013 final rule's CEO attestation
requirement for all banking entities with significant or moderate
trading assets and liabilities. Furthermore, all banking entities would
remain subject to the covered fund provisions of the 2013 final rule,
with some modifications described further below, including to the
applicable compliance program requirements based on the trading assets
and liabilities of the banking entity. As under the 2013 final rule,
banking entities that do not engage in covered funds activities or
proprietary trading would not be required to establish a compliance
program unless or until prior to becoming engaged in such activities or
making such investments.\38\
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\38\ See Sec. __.20(f) of the 2013 final rule.
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The proposal also includes a reservation of authority that would
allow an Agency to require a banking entity with limited or moderate
trading assets and liabilities to apply any of the more extensive
requirements that would otherwise apply if the banking entity had
moderate or significant trading assets and liabilities, if the Agency
determines that the size or complexity of the banking entity's trading
or investment activities, or the risk of evasion, warrants such
treatment.
The proposal seeks to tailor requirements based on a relatively
simple, straightforward, and objective measure connected to the
activities subject to section 13 of the BHC Act. Therefore, the
Agencies are proposing thresholds that are based on the trading
activities of a banking entity, and are considered on a consolidated
basis with its affiliates and subsidiaries. In addition, many of the
requirements that the proposal would apply on a tailored basis to
banking entities based on these thresholds relate to the statutory
prohibition on proprietary trading and the associated exemptions, such
as for permitted underwriting, market making, and risk-mitigating
hedging activities. In general, this approach would seek to apply
requirements commensurate with the size and complexity of a banking
entity's trading activities.
Under this approach, banking entities with the largest trading
activity (banking entities with significant trading assets and
liabilities) would be subject to the most extensive requirements. These
firms are currently subject to reporting requirements under Appendix A
of the 2013 final rule due to the fact that they engage in the most
trading activity subject to section 13 of the BHC Act and the
implementing regulations.\39\ Banking entities with moderate trading
activities and liabilities would be subject to more tailored
requirements, commensurate with the smaller scale of their trading
activities. These firms are generally subject to the Federal banking
agencies' market risk capital rules (like banking entities with
significant trading assets and liabilities) and engage in some level of
trading activity that is subject to the requirements of section 13 of
the BHC Act, but not to the same degree as firms with significant
trading assets and liabilities. Banking entities with limited trading
assets and liabilities would be subject to significantly reduced
requirements in recognition of the relatively small scale of covered
activities in which they engage, and in order to reduce compliance
costs associated with activities that are less likely to be relevant
for these firms.
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\39\ As noted above, with respect to foreign banking entities,
the proposal would measure whether a banking entity has significant
trading assets and liabilities by reference to the aggregate assets
of the foreign banking entity's U.S. operations, including its U.S.
branches and agencies, rather than worldwide operations. This
approach is intended to be consistent with the statute's focus on
the risks posed by trading activities within the United States and
also to address concerns regarding the level of burden for foreign
banking entities with respect to their foreign operations.
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The Agencies request comment regarding all aspects of the proposed
approach to tailoring application of the rule. In particular, the
Agencies request comment on the following questions:
Question 3. Would the general approach of the proposal to establish
different requirements for banking entities based on thresholds of
trading assets and liabilities be appropriate? Are the proposed
thresholds appropriate or are there different thresholds that would be
better suited and why? If so, what thresholds should be used and why?
Would the proposed approach materially reduce compliance and other
costs for banking entities that do not have significant trading
activity? Would the proposed approach maintain sufficient measures to
ensure compliance with the requirements of section 13 of the BHC Act?
If not, what approach would work better? Would an approach based on the
risk profile of the
[[Page 33442]]
banking entity be more appropriate? Why or why not?
Question 4. The proposal seeks to establish a streamlined and
comprehensive version of the rule for banking entities with significant
trading assets and liabilities. Is the proposed definition of
``significant trading assets and liabilities'' appropriate? If not,
what definition would be better and why? Would it be more appropriate
to define a banking entity with significant trading assets and
liabilities to include all banking entities subject to the Federal
banking agencies' market risk capital rules? Why or why not?
Question 5. Are the proposed requirements for a banking entity with
moderate trading assets and liabilities appropriate? Why or why not? If
not, what requirements would be better and why? Should any requirements
be added? Should any requirements be removed or modified? If so, please
explain.
Question 6. The proposal contains a presumption of compliance for
banking entities with limited trading assets and liabilities. Should
the Agencies presume compliance for any other levels of activity? Why
or why not? Are the proposed requirements for a banking entity with
limited trading assets and liabilities appropriate? Should any
requirements be added? If so, please explain which requirements should
be added and why. Do commenters believe this approach would work in
practice? Would it reduce costs and increase certainty for small firms?
If not, what approach would work better or be more appropriate and why?
Is the proposed scope of banking entities that would be eligible for
the presumption of compliance appropriately defined? Why or why not?
Please explain. If not, what scope would be more appropriate?
Question 7. The proposal would tailor application of the regulation
by categorizing a banking entity, together with its subsidiaries and
affiliates, based on trading assets and liabilities. Should the
Agencies consider further tailoring the application of the regulation
by categorizing certain banking entities separately from their
subsidiaries and affiliates? For example, should the Agencies consider
further tailoring for a banking entity, including an SEC registered
broker-dealer, that is an affiliate of a banking entity with
significant trading assets and liabilities, but which generally
operates on a basis that the banking entity believes is separate and
independent from its affiliates and parent company for purposes
relevant for compliance with the implementing regulations. Why or why
not?
Question 8. How might a banking entity within a corporate group
demonstrate that it has separate and independent operations from that
of the consolidated holding company group (e.g., information barriers,
separate corporate formalities and management; status as a registered
securities dealer, investment adviser, or futures commission merchant;
written policies and procedures designed to separate the activities of
the affiliate from other banking entities)? Alternatively, could such
entities be identified using certain quantitative measurements, such as
by creating a specific dollar threshold of trading activity or by
calculating a ratio comparing the entity's individual trading assets
and liabilities to the gross trading assets and liabilities of the
consolidated group? Why or why not? In addition, what standards could
be applied to distinguish such arrangements from corporate structures
established to evade compliance requirements that would otherwise apply
under section 13 of the BHC Act and the proposal? Please discuss,
identify, and describe any conditions, functional barriers, or business
practices that may be relevant. Commenters that suggest additional
tailoring of the regulation for certain affiliates of large bank
holding companies should suggest specific and detailed parameters for
such a category. Commenters should also describe why they believe such
parameters are appropriate and are designed to prevent substantial risk
to the holding company, its affiliates, and the financial system.
Question 9. For purposes of determining the appropriate standard
for compliance, the proposal would establish a threshold of $10 billion
in trading assets and liabilities; banking entities with moderate
trading assets and liabilities would be subject to a streamlined set of
requirements under the proposal. If the Agencies were to apply
additional tailoring for certain affiliates of banking entities with
significant trading assets and liabilities, should such banking
entities be subject to the same set of standards for compliance as
those that are being proposed for banking entities with moderate
trading assets and liabilities? Why or why not? Are there requirements
that are not currently contemplated for banking entities with moderate
trading assets and liabilities that nevertheless should apply,
consistent with the statute? Please explain.
Question 10. What are the potential consequences if certain banking
entities were to be subject to a more streamlined set of standards for
compliance than their parent company and affiliates? What are the
potential costs and benefits? Please explain. Are there ways in which a
more tailored compliance regime for these types of banking entities
could be crafted to mitigate any potential negative consequences
associated with this approach, if any, consistent with the statute?
Please explain.
Question 11. Could one or more aspects of the proposed rule
incentivize banking entities to restructure their business operations
to achieve a specific result relative to the rule, such as to
facilitate compliance under the rule in a particular way or to avoid
some or all of its requirements? If so, how? Please be as specific as
possible.
III. Section by Section Summary of Proposal
A. Subpart A--Authority and Definitions
1. Section __.2: Definitions
a. Banking Entity
The 2013 final rule, consistent with section 13 of the BHC Act,
defines the term ``banking entity'' to include: (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; and (iv) any affiliate or subsidiary of any entity
described in clauses (i), (ii), or (iii).\40\
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\40\ See 2013 final rule Sec. __.2(c). Consistent with the
statute, for purposes of this definition, the term ``insured
depository institution'' does not include certain institutions that
function solely in a trust or fiduciary capacity. See 2013 final
rule Sec. __.2(r).
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Under the BHC Act, an entity is generally considered an affiliate
of an insured depository institution, and therefore a banking entity
itself, if it controls, is controlled by, or is under common control
with an insured depository institution. Under the BHC Act, a company
controls another company if: (i) The company directly or indirectly or
acting through one or more other persons owns, controls, or has power
to vote 25 percent or more of any class of voting securities of the
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.\41\
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\41\ See 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
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[[Page 33443]]
The 2013 final rule excludes covered funds and other types of
entities from the definition of banking entity.\42\ In the 2011
proposal, the Agencies reasoned that excluding covered funds from the
definition of banking entity would ``avoid application of section 13 of
the BHC Act in a way that appears unintended by the statute and would
create internal inconsistencies in the statutory scheme.'' \43\
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\42\ A covered fund is not excluded from the banking entity
definition if it is itself an insured depository institution, a
company that controls an insured depository institution, or a
company that is treated as a bank holding company for purposes of
section 8 of the International Banking Act of 1978. The 2013 final
rule also excludes from the banking entity definition a portfolio
company held under the authority contained in section 4(k)(4)(H) or
(I) of the BHC Act, or any portfolio concern, as defined under 13
CFR 107.50, that is controlled by a small business investment
company, as defined in section 103(3) of the Small Business
Investment Act of 1958, so long as the portfolio company or
portfolio concern is not itself an insured depository institution, a
company that controls an insured depository institution, or a
company that is treated as a bank holding company for purposes of
section 8 of the International Banking Act of 1978. The definition
also excludes 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 Act.
\43\ See 2011 proposal, 76 FR at 68885. The Agencies proposed
the clarification ``because the definition of `affiliate' and
`subsidiary' under the BHC Act is broad, and could include a covered
fund that a banking entity has permissibly sponsored or made an
investment in because, for example, the banking entity acts as
general partner or managing member of the covered fund as part of
its permitted sponsorship activities.'' Id. The Agencies observed
that if ``such a covered fund were considered a `banking entity' for
purposes of the proposed rule, the fund itself would become subject
to all of the restrictions and limitations of section 13 of the BHC
Act and the proposed rule, which would be inconsistent with the
purpose and intent of the statute.'' Id.
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Since the adoption of the 2013 final rule, the Agencies have
received a number of requests for guidance regarding instances in which
certain funds that are excluded from the covered fund definition are
considered banking entities. This situation may occur as a result of
the sponsoring banking entity having control over the fund, as defined
under the BHC Act. A banking entity sponsoring a U.S. registered
investment company (``RIC''), a foreign public fund (``FPF''), or
foreign excluded fund could be considered to control the fund by virtue
of a 25 percent or greater investment in any class of voting securities
during a seeding period or, for FPFs and foreign excluded funds, by
virtue of corporate governance structures abroad such as where the
fund's sponsor selects the majority of the fund's directors or
trustees, or otherwise controls the fund for purposes of the BHC Act by
contract or through a controlled corporate director.\44\ Questions
regarding these funds' potential status as banking entities arise, in
part, because of the interaction between the statute's and the 2013
final rule's definitions of the terms ``banking entity'' and ``covered
fund.''
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\44\ Corporate governance structures for RICs have not raised
similar questions because the Board's regulations and orders have
long recognized that a bank holding company may organize, sponsor,
and manage a RIC, including by serving as investment adviser to the
RIC, without controlling the RIC for purposes of the BHC Act. See 79
FR at 5676.
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In particular, following the adoption of the 2013 final rule, the
staffs of the Agencies received numerous inquiries about this issue in
connection with RICs and FPFs, which are excluded from the covered fund
definition. The Agencies similarly received numerous inquiries
regarding certain foreign funds offered and sold outside of the United
States that are excluded from the covered fund definition with respect
to a foreign banking entity (foreign excluded funds).
Sponsors of RICs, FPFs, and foreign excluded funds asserted that
the treatment of these funds as banking entities would disrupt bona
fide asset management activities involving funds that are not covered
funds, which these sponsors argued would be inconsistent with section
13 of the BHC Act. These disruptions would arise because many funds'
investment strategies involve proprietary trading prohibited by the
2013 final rule, and may also involve investments in covered funds.
Sponsors of these funds further asserted that the permitted activities
in the 2013 final rule also do not appear to be designed for funds,
which by design invest in financial instruments for their own account.
The 2013 final rule, for example, provides exemptions from the rule's
proprietary trading restrictions for underwriting and market-making-
related activities--exemptions for activities in which broker-dealers
engage but that are not applicable to funds.
In addition, sponsors of RICs, FPFs, and foreign excluded funds
asserted that restricting banking entities' bona fide investment
management businesses in order to avoid treatment of their funds as
banking entities would put bank-affiliated investment advisers at a
competitive disadvantage relative to non-bank affiliated advisers
engaged in the same activities without advancing the statutory purposes
underlying section 13 of the BHC Act. Sponsors of FPFs and foreign
excluded funds also have asserted that treating a foreign banking
entity's foreign funds offered outside of the United States as banking
entities themselves would be an inappropriate extraterritorial
application of section 13 and the 2013 final rule and also unnecessary
to reduce risks posed to banking entities and U.S. financial stability
by proprietary trading activities and investments in or relationships
with covered funds.
In response to these inquiries, the staffs of the Agencies issued
responses to FAQs addressing the treatment of RICs and FPFs. The staffs
observed in response to an FAQ that the preamble to the 2013 final rule
recognized that a banking entity may own a significant portion of the
shares of a RIC or FPF during a brief period during which the banking
entity is testing the fund's investment strategy, establishing a track
record of the fund's performance for marketing purposes, and attempting
to distribute the fund's shares (the so-called ``seeding period'').\45\
The staffs therefore stated that they would not advise the Agencies to
treat a RIC or FPF as a banking entity under the 2013 final rule solely
on the basis that the RIC or FPF is established with a limited seeding
period, absent other evidence that the RIC or FPF was being used to
evade section 13 and the 2013 final rule. The staffs stated their
understanding that the seeding period for an entity that is a RIC or
FPF may take some time. Recognizing that the length of a seeding period
can vary, the staffs provided an example of three years, the maximum
period of time expressly permitted for seeding a covered fund under the
2013 final rule, without setting any maximum prescribed period for a
RIC or FPF seeding period. Accordingly, the staffs stated that they
would neither advise the Agencies to treat a RIC or FPF as a banking
entity solely on the basis of the level of ownership of the RIC or FPF
by a banking entity during a seeding period, nor expect that a banking
entity would submit an application to the Board to determine the length
of the seeding period.\46\
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\45\ See supra note 22, FAQ 16.
\46\ The staffs also made clear that this guidance was equally
applicable to SEC-regulated business development companies.
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The staffs also provided a response to an FAQ regarding FPFs.\47\
In this response, staffs of the Agencies stated their understanding
that, unlike in the case of RICs, sponsors of FPFs in some foreign
jurisdictions select the majority of the fund's directors or trustees,
or otherwise control the fund for purposes of the BHC Act by contract
or through a controlled corporate director. These and other corporate
governance structures abroad therefore had raised questions regarding
whether FPFs that
[[Page 33444]]
are sponsored and distributed outside the United States and in
accordance with foreign laws are banking entities by virtue of their
relationships with a banking entity. The staffs further observed that,
by referring to characteristics common to publicly distributed foreign
funds rather than requiring that FPFs organize themselves identically
to RICs, the 2013 final rule recognized that foreign jurisdictions have
established their own frameworks governing the details for the
operation and distribution of FPFs. The staffs also observed that Sec.
__.12 of the 2013 final rule further provides that, for purposes of
complying with the covered fund investment limits, a RIC, SEC-regulated
business development company (``BDC''), or FPF will not be considered
to be an affiliate of the banking entity so long as the banking entity
meets the conditions set forth in that section.
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\47\ See supra note 22, FAQ 14.
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Based on these considerations, the staffs stated that they would
not advise that the activities and investments of an FPF that meet the
requirements in Sec. __.10(c)(1) and Sec. __.12(b)(1) of the 2013
final rule be attributed to the banking entity for purposes of section
13 of the BHC Act or the 2013 final rule, where the banking entity,
consistent with Sec. __.12(b)(1) of the 2013 final rule, (i) does not
own, control, or hold with the power to vote 25 percent or more of any
class of voting shares of the FPF (after the seeding period), and (ii)
provides investment advisory, commodity trading, advisory,
administrative, and other services to the fund in compliance with
applicable limitations in the relevant foreign jurisdiction. The staffs
further stated that they would not advise that the FPF be deemed a
banking entity under the 2013 final rule solely by virtue of its
relationship with the sponsoring banking entity, where these same
conditions are met.
With respect to foreign excluded funds, the Federal banking
agencies released a policy statement on July 21, 2017 (the ``policy
statement''), in response to concerns expressed by a number of foreign
banking entities, foreign government officials, and other market
participants about the possible unintended consequences and
extraterritorial impact of section 13 and the 2013 final rule for these
funds, which are excluded from the definition of ``covered fund'' in
the 2013 final rule.\48\ The policy statement provided that the staffs
of the Agencies are considering ways in which the 2013 final rule may
be amended, or other appropriate action that may be taken, to address
any unintended consequences of section 13 and the 2013 final rule for
foreign excluded funds.
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\48\ Statement regarding Treatment of Certain Foreign Funds
under the Rules Implementing Section 13 of the Bank Holding Company
Act (July 21, 2017), available at https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20170721a1.pdf.
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To provide additional time, the policy statement provides that the
Federal banking agencies would not propose to take action during the
one-year period ending July 21, 2018, against a foreign banking entity
\49\ based on attribution of the activities and investments of a
qualifying foreign excluded fund (as defined below) to the foreign
banking entity, or against a qualifying foreign excluded fund as a
banking entity, in each case where the foreign banking entity's
acquisition or retention of any ownership interest in, or sponsorship
of, the qualifying foreign excluded fund would meet the requirements
for permitted covered fund activities and investments solely outside
the United States, as provided in section 13(d)(1)(I) of the BHC Act
and Sec. __.13(b) of the 2013 final rule, as if the qualifying foreign
excluded fund were a covered fund. For purposes of the policy
statement, a ``qualifying foreign excluded fund'' means, with respect
to a foreign banking entity, an entity that:
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\49\ ``Foreign banking entity'' was defined for purposes of the
policy statement to mean a banking entity that is not, and is not
controlled directly or indirectly by, a banking entity that is
located in or organized under the laws of the United States or any
State.
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(1) Is organized or established outside the United States and the
ownership interests of which are offered and sold solely outside the
United States;
(2) Would be a covered fund were the entity organized or
established in the United States, or is, or holds itself out as being,
an entity or arrangement that raises money from investors primarily for
the purpose of investing in financial instruments for resale or other
disposition or otherwise trading in financial instruments;
(3) Would not otherwise be a banking entity except by virtue of the
foreign banking entity's acquisition or retention of an ownership
interest in, or sponsorship of, the entity;
(4) Is established and operated as part of a bona fide asset
management business; and
(5) Is not operated in a manner that enables the foreign banking
entity to evade the requirements of section 13 or implementing
regulations.
The Agencies are continuing to consider the issues raised by the
interaction between the 2013 final rule's definitions of the terms
``banking entity'' and ``covered fund,'' including the issues addressed
by the Agencies' staffs and the Federal banking agencies discussed
above. Accordingly, nothing in the proposal would modify the
application of the staff FAQs discussed above, and the Agencies will
not treat RICs or FPFs that meet the conditions included in the
applicable staff FAQs as banking entities or attribute their activities
and investments to the banking entity that sponsors the fund or
otherwise may control the fund under the circumstances set forth in the
FAQs. In addition, to accommodate the pendency of the proposal, for an
additional period of one year until July 21, 2019, the Agencies will
not treat qualifying foreign excluded funds that meet the conditions
included in the policy statement discussed above as banking entities or
attribute their activities and investments to the banking entity that
sponsors the fund or otherwise may control the fund under the
circumstances set forth in the policy statement. This additional time
will allow the Agencies to benefit from public feedback in response to
the requests for comment that follow. Specifically, the Agencies
request comment on the following:
Question 12. Have commenters experienced disruptions to bona fide
asset management activities involving RICs, FPFs, and foreign excluded
funds as a result of the interaction between the statute's and the 2013
final rule's definitions of the terms ``banking entity'' and ``covered
fund?'' If so, what sorts of disruptions, and how have commenters
addressed them?
Question 13. Has the guidance provided by the staffs of the
Agencies' and the Federal banking agencies discussed above been
effective in allowing banking entities to engage in asset management
activities, consistent with the restrictions and requirements of
section 13?
Question 14. Do commenters believe that there is uncertainty about
the length of permissible seeding periods for RICs, FPFs, and SEC-
regulated business development companies due to the Agencies'
description of a seeding period with reference to the activities a
banking entity undertakes while seeding a fund without specifying a
maximum period of time? Would an approach that specified a particular
period of time beyond which a seeding period cannot extend provide
additional clarity? If so, what would be an appropriate time period?
Should any specified time period be based on the period of time that
typically is required for a RIC or FPF to develop a performance track
record, recognizing that some additional time will also be needed to
market the
[[Page 33445]]
fund after developing the track record? How much time is necessary to
develop a performance track record for a RIC or FPF to effectively
market the fund to third-party investors and how does this vary based
on the fund's strategy or other factors? If the Agencies did specify a
fixed amount of time for seeding generally, should the Agencies also
provide relief that permits a fund's seeding period to exceed this
period of time, without the fund being considered a banking entity,
subject to additional conditions, such as documentation of the business
need for the sponsor's continued investment? Should such additional
relief include the lengthening of the seeding period for such
investments? Conversely, would the current approach of not prescribing
a fixed period of time for a seeding period be more effective in
providing flexibility for funds that may need more time to develop a
track record without having to specify a particular time period that
will be appropriate for all funds?
Question 15. Are there other situations not addressed by the
staffs' guidance for RICs and FPFs that may result in a banking entity
sponsor's investment in the fund exceeding 25 percent, and that limit
banking entities' ability to engage in asset management activities? For
example, could a sponsor's investment exceed 25 percent as investors
redeem in anticipation of a liquidation, causing the sponsor's
investment to increase as a percentage of the fund's assets? Are there
instances in which one or more large investors may redeem from a fund
and, as a result, the sponsor may seek to temporarily invest in the
fund for the benefit of remaining shareholders?
Question 16. Have foreign excluded funds been able to effectively
rely on the policy statement to continue their asset management
activities? Why or why not? Have foreign banking entities experienced
any difficulties in complying with the condition in the policy
statement that a foreign banking entity's acquisition or retention of
any ownership interest in, or sponsorship of, the qualifying foreign
excluded fund would need to meet the requirements for permitted covered
fund activities and investments solely outside the United States, as
provided in section 13(d)(1)(I) of the BHC Act and Sec. __.13(b) of
the 2013 final rule? Would the proposed changes in this proposal to
Sec. __.13(b) or any other provision of the 2013 final rule help
foreign banking entities comply with the policy statement? Is the
policy statement's definition of ``qualifying foreign excluded fund''
appropriate, or is it too narrow or too broad? Is further guidance
needed with respect to any of the requirements in the definition of
``qualifying foreign excluded fund''? For example, is it clear what
constitutes a bona fide asset management business? Has the policy
statement posed any issues for foreign banking entities and their
compliance programs?
Question 17. As stated above, the Agencies will not treat RICs or
FPFs that meet the conditions included in the staff FAQs discussed
above as banking entities or attribute their activities and investments
to the banking entity that sponsors the fund or otherwise may control
the fund under the circumstances set forth in the FAQs. In addition,
the Agencies are extending the application of the policy statement with
respect to qualifying foreign excluded funds for an additional year to
accommodate the pendency of the proposal. The Agencies are requesting
comment on other approaches that the Agencies could take to address
these issues, consistent with the requirements of section 13 of the BHC
Act.
Question 18. Instead of, or in addition to, providing Agency
guidance as discussed above, should the Agencies modify the 2013 final
rule to address the issues raised by the interaction between the 2013
final rule's definitions of the terms ``banking entity'' and ``covered
fund,'' consistent with section 13 of the BHC Act, and if so, how? For
example, should the Agencies modify the 2013 final rule to provide that
a banking entity may elect to treat certain entities, such as a
qualifying foreign excluded fund that meets the conditions of the
policy statement, as covered funds, which would result in exclusion of
these entities from the term ``banking entity?'' Would allowing a
banking entity to invest in, sponsor, or have certain relationships
with, the fund subject to the covered fund limitations in the 2013
final rule be an effective way for banking entities to address the
issues raised? For example, a banking entity could sponsor and retain a
de minimis investment in such a fund, subject to Sec. Sec. __.11 and
__.12 of the 2013 final rule. A foreign bank could invest in or sponsor
such a fund so long as these activities and investments occur solely
outside the United States, subject to the limitations in Sec. __.13(b)
of the 2013 final rule.
Question 19. If a banking entity is willing to subject its
activities and investments with respect to a non-covered fund to the
covered fund limitations in section 13 and the 2013 final rule, which
are designed to prevent banking entities from being exposed to
significant losses from investments in or other relationships with
covered funds, is there any reason that the ability to make this
election should be limited to particular types of non-covered funds?
Conversely, should a banking entity only be permitted to elect to treat
as a covered fund a ``qualifying foreign excluded fund,'' as defined in
the policy statement issued by the Federal banking agencies? \50\
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\50\ See supra note 48.
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Question 20. If a banking entity elected to treat an entity as a
covered fund, what potentially adverse effects could result and how
should the Agencies address them? For example, if a foreign banking
entity elected to treat a foreign excluded fund as a covered fund,
would the application of the restrictions in Sec. __.14 and the
compliance obligations under Sec. __.20 of the 2013 final rule involve
the same or similar disruptions and extraterritorial application of
section 13's restrictions that this approach would be designed to
avoid? If so, what approach, consistent with the statute, should the
Agencies take to address this issue? As discussed below in this
Supplementary Information section, the Agencies are also requesting
comment regarding potential changes in interpretation with respect to
the 2013 final rule's implementation of section 13(f) of the BHC Act.
How would any such modifications change any effects relating to an
election to treat an entity as a covered fund?
Question 21. With respect to foreign excluded funds, to what extent
would the proposed changes, and especially the proposed changes to
Sec. Sec. __.6(e) and __.13(b) of the 2013 final rule, adequately
address the concerns raised regarding the treatment of foreign excluded
funds as banking entities? If not, what additional modifications to
these sections would enable such a fund to engage in proprietary
trading or covered fund activity? Should the Agencies provide or modify
exemptions under the 2013 final rule such that a qualifying foreign
excluded fund could operate more effectively and efficiently,
notwithstanding its status as a banking entity? If so, please explain
how such an exemption would be consistent with the statute.
Question 22. Are there any other investment vehicles or entities
that are treated as banking entities and for which commenters believe
relief, consistent with the statute, would be appropriate? Which ones
and why? What form of relief could be provided in a way consistent with
the statute? For example, staffs of the Agencies have received
inquiries regarding employees' securities companies (``ESCs''), which
[[Page 33446]]
generally rely on an exemption from registration under the Investment
Company Act provided by section 6(b) of that Act. These funds are
controlled by their sponsors and, if those sponsors are banking
entities, may themselves be treated as banking entities. Treating these
ESCs as banking entities, however, may conflict with their stated
investment objectives, which commonly are to invest in covered funds
for the benefit of the employees of the sponsoring banking entity.
Should an ESC be treated differently if its banking entity sponsor
controls the ESC by virtue of corporate governance arrangements, which
is a required condition of the exemptive relief under section 6(b) of
the Investment Company Act that ESCs receive from the SEC, but does not
acquire or retain any ownership interest in the ESC? If so, how should
the Agencies consider residual or reversionary interests resulting from
employees forfeiting their interests in the ESC? In pursuing their
stated investment objectives on behalf of employees, do ESCs make these
investment ``as principal,'' as contemplated by section 13? To what
extent do banking entities invest directly in ESCs? Are there any other
investment vehicles or entities, in pursuing their stated investment
objectives on behalf of employees, that banking entities invest in ``as
principal'' (e.g., nonqualified deferred compensation plans such as
trusts modeled under IRS Revenue Procedure 92-64, commonly referred to
as ``rabbi trusts'')? How should the Agencies consider these investment
vehicles or entities with respect to section 13? Please include an
explanation of how the commenters' preferred treatment of any
investment vehicle would be consistent with section 13 of the BHC Act,
including the statutory definition of ``banking entity.''
b. Limited Trading Assets and Liabilities
The proposed rule would add a definition of limited trading assets
and liabilities. As described in greater detail in Part II.G above,
limited trading assets and liabilities would be defined under the
proposal as 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
previous calendar quarters, does not exceed $1 billion.\51\
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\51\ See supra note 37.
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c. Moderate Trading Assets and Liabilities
The proposed rule would add a definition of moderate trading assets
and liabilities. As described in greater detail in Part II.G above,
moderate trading assets and liabilities would be defined under the
proposal as trading assets and liabilities that are not significant
trading assets and liabilities or limited trading assets and
liabilities.
d. Significant Trading Assets and Liabilities
The proposed rule would add a definition of significant trading
assets and liabilities. As described in greater detail in Part II.G
above, significant trading assets and liabilities would be defined
under the proposal as 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 previous calendar quarters, equals or exceeds $10 billion.\52\
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\52\ See supra note 36.
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B. Subpart B--Proprietary Trading Restrictions
1. Section __.3 Prohibition on Proprietary Trading
Section 13 of the BHC Act generally prohibits banking entities from
engaging in proprietary trading.\53\ The statute defines ``proprietary
trading'' 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, any of a number of financial instruments.\54\
The statute 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.''
\55\
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\53\ 12 U.S.C. 1851(a)(1)(A).
\54\ 12 U.S.C. 1851(h)(4). The statutory proprietary trading
definition applies to the purchase or sale, or the acquisition or
disposition of, any security, derivative, contract of sale of a
commodity for future delivery, option on any such security,
derivative, or contract, or any other security or financial
instrument that the Agencies by rule determine.
\55\ 12 U.S.C. 1851(h)(6) (defining ``trading account'').
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a. Definition of Trading Account
The 2013 final rule, like the statute, defines proprietary trading
as engaging as principal for the trading account of the banking entity
in any purchase or sale of one or more financial instruments.\56\ The
2013 final rule implements the statutory definition of trading account
with a three-pronged definition. The first prong (the ``short-term
intent prong'') includes within the definition of trading account any
account used by a banking entity to purchase or sell one or more
financial instruments principally for the purpose of (a) short-term
resale, (b) benefitting from short-term price movements, (c) realizing
short-term arbitrage profits, or (d) hedging any of the foregoing.\57\
Banking entities and others have informed the Agencies that this prong
of the definition imposes significant compliance costs and uncertainty
because it requires determining the intent of each individual who
purchases and sells a financial instrument.\58\ In gaining experience
implementing the 2013 final rule, the Agencies recognize that banking
entities lack clarity about whether particular purchases and sales of a
financial instrument are included under this prong of the trading
account. The 2013 final rule includes a rebuttable presumption that the
purchase or sale of a financial instrument is for the trading account
under the short-term intent prong if the banking entity holds the
financial instrument for fewer than 60 days or substantially transfers
the risk of the position within 60 days (the ``60-day rebuttable
presumption'').\59\ If a banking entity sells or transfers the risk of
a position within 60 days, it may rebut the presumption by
demonstrating that it did not purchase or sell the financial instrument
principally for short-term trading purposes. In the Agencies'
experience, a broad range of transactions could trigger the 60-day
rebuttable presumption. For example, the purchase of a security with a
maturity (or remaining maturity) of fewer than 60 days to meet the
regulatory requirements of a foreign government or to manage the
banking entity's risks could trigger the 60-day rebuttable presumption
because the banking entity holds the security for fewer than 60 days.
In both cases, however, it is unlikely that the banking entity intended
to purchase or sell the instrument principally for the purpose of
short-term resale.
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\56\ Sec. __.3(a) of the proposed rule.
\57\ Sec. __.3(b)(1)(i) of the proposed rule.
\58\ See supra note 18.
\59\ Sec. __.3(b)(2) of the proposed rule.
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[[Page 33447]]
The other two prongs of the 2013 final rule's definition of trading
account are the ``market risk capital prong'' and the ``dealer prong.''
The ``market risk capital prong'' applies to the purchase or sale of
financial instruments that are both market risk capital rule covered
positions and trading positions.\60\ The ``dealer prong'' applies to
the purchase or sale of financial instruments by a banking entity that
is licensed or registered, or required to be licensed or registered, as
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.\61\
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\60\ Sec. __.3(b)(1)(ii) of the proposed rule.
\61\ Sec. __.3(b)(1)(iii)(A) of the proposed rule. The dealer
prong also includes positions entered into by a banking entity that
is engaged in the business of a dealer, swap dealer, or security-
based swap dealer outside of the United States, to the extent the
instrument is purchased or sold in connection with the activities of
such business. See 2013 final rule Sec. __.3(b)(1)(iii)(B).
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The Agencies are proposing to revise the regulatory trading account
definition to address concerns that the 2013 final rule's short-term
intent prong requires banking entities and the Agencies to make
subjective determinations with respect to each trade a banking entity
conducts, and that the 60-day rebuttable presumption may scope in
activities that do not involve the types of risks or transactions the
statutory definition of proprietary trading appears to have been
intended to cover. Specifically, the Agencies propose to retain the
existing dealer prong and a modified version of the market risk capital
prong, and to replace the 2013 final rule's short-term intent prong
with a new third prong based on the accounting treatment of a position,
in each case to implement the requirements of the statutory definition.
The new prong would provide that ``trading account'' means any account
used by a banking entity to purchase or sell one or more financial
instruments that is recorded at fair value on a recurring basis under
applicable accounting standards (the ``accounting prong''). The
Agencies also propose to eliminate the 60-day rebuttable presumption in
the 2013 final rule.
The Agencies further propose to add a presumption of compliance
with the prohibition on proprietary trading for trading desks that do
not purchase or sell financial instruments subject to the market risk
capital prong or the dealer prong and operate under a prescribed profit
and loss threshold.\62\ While still subject to the prohibition on
proprietary trading under section 13 of the BHC Act and the applicable
regulatory requirements, such eligible trading desks that remain under
the threshold would not have to demonstrate their compliance with
subpart B on an ongoing basis, as discussed below. Notwithstanding this
regulatory presumption of compliance, the Agencies would reserve
authority to determine on a case-by-case basis that a purchase or sale
of one or more financial instruments by a banking entity either is or
is not for the trading account, and, as a result, may require that a
trading desk demonstrate compliance with subpart B on an ongoing basis
with respect to a financial instrument.
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\62\ In addition, the Agencies are proposing to adopt a
presumption of compliance for banking entities with limited trading
activities. See Sec. __.20(g) of the proposed rule.
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Under the proposed approach, ``trading account'' would continue to
include any account used by a banking entity to (1) purchase or sell
one or more financial instruments that are both market risk capital
rule covered positions and trading positions (or hedges of other market
risk capital rule covered positions), if the banking entity, or any
affiliate of the banking entity, is an insured depository institution,
bank holding company, or savings and loan holding company, and
calculates risk-based capital ratios under the market risk capital
rule, or (2) purchase or sell one or more financial instruments for any
purpose, if the banking entity 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, if the instrument is
purchased or sold in connection with the activities that require the
banking entity to be licensed or registered as such \63\ (or if the
banking entity is engaged in the business of a dealer, swap dealer, or
security-based swap dealer outside of the United States, if the
instrument is purchased or sold in connection with the activities of
such business).\64\ The Agencies are proposing to retain these prongs
because both prongs provide clear lines and well-understood standards
for purposes of determining whether or not a purchase or sale of a
financial instrument is in the trading account. The Agencies also
propose to adapt the market risk capital prong to apply to the
activities of FBOs in order to take into account the different
regulatory frameworks and supervisors that FBOs may have in their home
countries. Specifically, the Agencies propose to include within the
market risk capital prong, with respect to a banking entity that is
not, and is not controlled directly or indirectly by a banking entity
that is, located in or organized under the laws of the United States or
any State, any account used by the banking entity to purchase or sell
one or more financial instruments that are subject to capital
requirements under a market risk framework established by the home-
country supervisor that is consistent with the market risk framework
published by the Basel Committee on Banking Supervision, as amended
from time to time.
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\63\ An insured depository institution may be registered as,
among other things, a swap dealer and a security-based swap dealer,
but only the swap and security-based dealing activities that require
it to be so registered are included in the trading account by virtue
of the dealer prong. If an insured depository institution purchases
or sells a financial instrument in connection with activities of the
insured depository institution that do not trigger registration as a
swap dealer, such as lending, deposit-taking, the hedging of
business risks, or other end-user activity, the financial instrument
would be included in the trading account only if the purchase or
sale of the financial instrument falls within the market risk
capital trading account prong under Sec. __.3(b)(1) or the
accounting prong under Sec. __.3(b)(3) of the proposed rule. See 79
FR at 5549, note 135.
\64\ See Sec. __.3(b)(2) of the proposed rule.
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b. Trading Account--Accounting Prong
The proposal's definition of ``trading account'' for purposes of
section 13 of the BHC Act would replace the short-term intent prong in
the 2013 final rule with a new prong based on accounting treatment, by
reference to whether a financial instrument (as defined in the 2013
final rule and unchanged by the proposal) is recorded at fair value on
a recurring basis under applicable accounting standards. Such
instruments generally include, but are not limited to, derivatives,
trading securities, and available-for-sale securities. For example, for
a banking entity that uses GAAP, a security that is classified as
``trading'' under GAAP would be included in the proposal's definition
of ``trading account'' under this approach because it is recorded at
fair value. ``Fair value'' refers to a measurement basis of accounting,
and is defined under GAAP as the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.\65\
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\65\ See Accounting Standards Codification (ASC) 820-10-20 and
International Financial Reporting Standard (IFRS) 13.9.
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The proposal's inclusion of this prong in the definition of
``trading account'' is intended to give greater certainty and clarity
to banking entities about what financial instruments would be included
in the trading account, because banking entities should know which
instruments are recorded at fair value on
[[Page 33448]]
their balance sheets. This modification of the rule's definition of
trading account would include other accounts that may be used by
banking entities for the purpose described in the statutory definition
of ``trading account.'' \66\ The proposal is intended to address
concerns that the statutory definition of trading account may be read
to contemplate an inquiry into the subjective intent underlying a
trade.\67\ The proposal would therefore adopt the accounting prong as
an objective means of ensuring that such positions entered into by
banking entities principally for the purpose of selling in the near
term, or with the intent to resell in order to profit from short-term
price movements, are incorporated in the definition of trading account.
For entities that are not subject to the market-risk capital prong or
the dealer prong, the accounting prong would therefore be the sole
avenue by which such banking entities would become subject to the
requirements in subpart B of the proposed rule.
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\66\ 12 U.S.C. 1851(h)(6).
\67\ See id.
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Question 23. Should the Agencies adopt the proposed new accounting
prong and remove the short-term intent prong? Why or why not? Does
using such a prong provide sufficient clarity regarding which financial
instruments are included in the trading account for purposes of the
proposal? Are there differences in the application of IFRS and GAAP
that the Agencies should consider? What are they and how would they
impact the scope of the proposed accounting prong?
Question 24. Is using the accounting prong appropriate considering
the fact that entities may have discretion over whether certain
financial instruments are recorded at fair value (and therefore subject
to the restrictions in section 13 of the BHC Act)? Could the proposed
accounting prong incentivize banking entities to modify their
accounting treatment with respect to certain financial instruments in
order to evade the prohibition on proprietary trading? Why or why not?
If so, could those effects have an impact on the banking entity's
accounting practices?
Question 25. Should the Agencies include all financial instruments
that are recorded at fair value on a banking entity's balance sheet as
part of the proposed accounting prong? Why or why not? Would such a
definition be overly broad? If so, why and how should the definition be
narrowed, consistent with the statute? Would such a definition be too
narrow and exclude financial instruments that should be included? If
so, should the Agencies apply a different approach? Why or why not?
Question 26. Is the proposal's inclusion of available-for-sale
securities under the proposed accounting prong appropriate? Why or why
not?
Question 27. The proposed accounting prong would include all
derivatives in the proposed accounting prong since derivatives are
required to be recorded at fair value. Is this appropriate? Why or why
not?
Question 28. Should the scope of the proposed accounting prong be
further specified? In particular, should practical expedients to fair
value measurements permitted under applicable accounting standards be
included in the ``trading account'' definition (e.g., equity securities
without readily determinable fair value under ASC 321 or investments
using the net asset value (``NAV'') practical expedient under ASC 820)?
Why or why not? Are there other relevant examples that cause concern?
Question 29. Is there a better approach to defining ``trading
account'' for purposes of section 13 of the BHC Act, consistent with
the statute? If so, please explain.
Question 30. Would the short-term intent prong in the 2013 final
rule be preferable to the proposed accounting prong? Why or why not?
Should the Agencies rely on a potentially objective measure, such as
the accounting treatment of a financial instrument, to implement the
definition of ``trading account'' in section 13(h)(6), which includes
any account used for acquiring or taking positions in certain
securities and instruments ``principally for the purpose of selling in
the near term (or otherwise with the intent to resell in order to
profit from short-term price movements''? \68\
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\68\ 12 U.S.C. 1851(h)(6).
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Question 31. Would references to accounting treatment be better
formulated as safe harbors or presumptions within the short-term intent
prong under the 2013 final rule? Why or why not?
Question 32. What impact, if any, would the proposed accounting
prong have on the liquidity of corporate bonds or other securities?
Please explain.
Question 33. For purposes of determining whether certain trading
activity is within the definition of proprietary trading, is the
proposed accounting prong over- or under-inclusive? If over- or under-
inclusive, is there another alternative that would be a more
appropriate replacement for the short-term prong? Please explain. If
over-inclusive, what types of transactions or positions could
potentially be included in the definition of proprietary trading that
should not be? Please explain, and provide specific examples of the
particular transactions or positions. If under-inclusive, what types of
transactions or positions could potentially be omitted from the
definition of proprietary trading that should be included in light of
the language and purpose of the statute? Please explain and provide
specific examples of the particular transactions or positions.
Question 34. The dealer prong of the trading account definition
includes accounts used for purchases or sales of one or more financial
instruments for any purpose, if the banking entity is, among other
things, 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. In adopting the 2013 final
rule, the Agencies recognized that banking entities that are registered
dealers may not have previously engaged in such an analysis, thereby
resulting in a new regulatory requirement for these entities. The
Agencies did, however, note that if the regulatory analysis otherwise
engaged in by banking entities was substantially similar to the dealer
prong analysis, then any increased compliance burden could be small or
insubstantial. Have any banking entities incurred increased compliance
costs resulting from the requirement to analyze whether particular
activities would require dealer registration? If so, how substantial
are those additional costs and have those costs changed over time,
including as a result of the banking entity becoming more accustomed to
engaging in the required analysis?
Question 35. In the case of banking entities that are registered
dealers, how often does the analysis of whether particular activities
would require dealer registration result in identifying transactions or
positions that would not be included under the dealer prong? How does
the volume of those transactions or positions compare to the volume of
transactions or positions that are included under the dealer prong?
What types of transactions or positions would not be included under the
dealer prong and how often are those transactions included by a
different part of the definition of ``trading account,'' namely the
short-term prong?
Question 36. For transactions or positions not covered by the
dealer
[[Page 33449]]
prong, would those transactions or positions be covered by the proposed
accounting treatment prong? Why or why not?
Question 37. As compared to the 2013 final rule's dealer and short-
term intent prongs taken together, would the proposed accounting prong
result in a greater or lesser amount of trading activity being included
in the definition of ``trading account''? What are the resulting costs
and benefits? In responding to this question, commenters are encouraged
to be as specific as possible in describing the transactions or
positions used to support their analysis.
Question 38. Would banking entities regulated by Agencies that are
market regulators incur additional (or lesser) compliance costs or
burdens in the course of complying with the proposal as compared to the
costs and burdens of other banking entities? How would the costs and
burdens incurred by these banking entities compare as a whole to those
of other banking entities? Please explain.
c. Presumption of Compliance With the Prohibition on Proprietary
Trading
The Agencies propose to include a presumption of compliance with
the proposed rule's proprietary trading prohibition based on an
objective, quantitative measure of a trading desk's activities. This
presumption of compliance would apply to a banking entity's individual
trading desks rather than to the banking entity as a whole. As
described below, a trading desk operating pursuant to the proposed
presumption would not be obligated to demonstrate that the activities
of the trading desk comply with subpart B on an ongoing basis. The
proposed presumption would only be available for a trading desk's
activities that may be within the trading account under the proposed
accounting prong, for a trading desk that is not subject to the market
risk capital prong or the dealer prong of the trading account
definition. The replacement of the short-term intent prong with the
accounting prong would represent a significant change from the 2013
final rule and could potentially apply to certain activities that were
previously not within the regulatory definition of trading account.
However, the presumption of compliance would limit the expansion of the
definition of ``trading account'' to include--unless the presumption is
rebutted--only the activities of a trading desk that engages in a
greater than de minimis amount of activity (unless the presumption is
rebutted).
The proposed presumption would not be available for trading desks
that purchase or sell positions that are within the trading account
under the market risk capital prong or the dealer prong. The Agencies
are not proposing to extend the presumption of compliance with the
prohibition on proprietary trading to activities of banking entities
that are included under the market risk capital prong or the dealer
prong because, based on their experience implementing the 2013 final
rule, the Agencies believe that these two prongs are reasonably
designed to include the appropriate trading activities. Banking
entities subject to the market risk capital prong and the dealer prong
have had several years of experience complying with the requirements of
the 2013 final rule and experience with identifying these activities in
other contexts. The Agencies believe that banking entities with
activities that are covered by these prongs are able to conduct
appropriate trading activities in an efficient manner pursuant to
exclusions from the definition of proprietary trading or pursuant to
the exemptions for permitted activities. The Agencies further note that
the proposed revisions to the exemptions (described herein) are
intended to facilitate the ability of banking entities subject to the
market risk capital prong and the dealer prong to better engage in
otherwise permitted activities such as market-making. Additionally, the
Agencies note that the presumption of compliance with the prohibition
on proprietary trading is optional for a banking entity. Accordingly,
if a banking entity prefers to demonstrate ongoing compliance for
activity captured by the accounting prong rather than calculating the
threshold for presumed compliance described below, it may do so at its
discretion.
Under the proposed compliance presumption, the activities of a
trading desk of a banking entity that are not covered by the market
risk capital prong or the dealer prong would be presumed to comply with
the proposed rule's prohibition on proprietary trading if the
activities do not exceed a specified quantitative threshold. The
trading desk would remain subject to the prohibition, but unless the
desk engages in a material level of trading activity (or the
presumption of compliance is rebutted as described below), the desk
would not be required to comply with the more extensive requirements
that would otherwise apply under the proposal in order to demonstrate
compliance. As described further below, the Agencies propose to use the
absolute value of the trading desk's profit and loss (``absolute P&L'')
on a 90-calendar-day rolling basis as the relevant quantitative measure
for this threshold.
The proposed rule includes a threshold for the presumption of
compliance based on absolute P&L because this measure tends to
correlate with the scale and nature of a trading desk's trading
activities.\69\ In addition, if the positions of a trading desk have
recently significantly contributed to the financial position of the
banking entity, such that the absolute P&L-based threshold is exceeded,
the proposed trading-desk-level presumption would become unavailable
and the banking entity would be required to comply with more extensive
requirements of the rule to ensure compliance. Using absolute P&L as
the relevant measure of trading desk risk would provide an additional
advantage as an objective measure that most banking entities are
already equipped to calculate.\70\ This measure would also indicate the
realized outcomes of the risks of a trading desk's positions, rather
than modeled estimates.
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\69\ For example, trading desks that contemporaneously and
effectively offset or hedge the assets and liabilities that they
acquire through trades with customers as a result of engagement in
customer-driven activities could be expected under most conditions
to generally experience lower amounts of daily profit or loss
attributable to daily fluctuations in the value of the desk's
positions than desks engaged in speculative activities.
\70\ Some banking entities without meaningful trading activities
may not currently calculate P&L as described in this proposal, but
the Agencies believe that many, if not most, of those banking
entities would be banking entities with limited trading assets and
liabilities that would be presumed to comply with the proposed rule
under proposed Sec. __.20(g).
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In general, the proposed presumption of compliance would take the
approach that a trading desk that consistently does not generate more
than a threshold amount of absolute P&L does not engage in trading
activities of a sufficient scale to warrant the costs associated with
more extensive requirements of the rule to otherwise demonstrate
compliance with the prohibition on proprietary trading. Such an
approach is intended to reflect a view that the lesser activity of
these trading desks does not justify the costs of an extensive ongoing
compliance regime for those trading desks in order to ensure compliance
with section 13 of the BHC Act and the implementing regulations.
Under the proposal, each trading desk that operates under the
presumption of compliance with the prohibition on proprietary trading
would be required to determine on a daily basis the absolute value of
its net realized and unrealized
[[Page 33450]]
gains or losses on its portfolio of financial instruments based on the
fair value of the financial instruments. The sum of the absolute values
of gains or losses for each trading date in any 90-calendar-day period
is the trading desk's 90-calendar-day absolute P&L. If this value
exceeds $25 million at any point, then the banking entity would be
required to notify the appropriate Agency that it has exceeded the
threshold in accordance with the Agency's notification policies and
procedures.
The Agencies propose to use the absolute value of a trading desk's
daily P&L because absolute value would ensure that losses would be
counted toward the measurement to the same extent as gains. Thus, a
trading desk could not avoid triggering compliance by offsetting
significant net gains on one day with significant net losses on another
day. Measuring absolute P&L on a rolling basis would mean that the
threshold could be triggered in any 90-calendar-day period.
This proposed trading-desk-level presumption of compliance with the
prohibition on proprietary trading would be intended to allow banking
entities to conduct ordinary banking activities without having to
assess every individual trade for compliance with subpart B of the
implementing regulations and, in particular, the proposed accounting
prong.\71\
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\71\ Provided that a trading desk's absolute P&L does not exceed
the $25 million threshold, a banking entity would not have to assess
the accounting treatment of each transaction of a trading desk that
operates pursuant to the presumption of compliance with the
prohibition on proprietary trading.
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As noted above, one advantage of using absolute P&L as the relevant
measure of trading desk risk is that it would provide a relatively
simple and objective measure that most banking entities are already
equipped to calculate. For example, banking entities subject to the
current metrics reporting requirements should already be equipped to
calculate P&L on a daily basis. Other banking entities with significant
trading activities likely currently calculate P&L on a daily basis for
the purpose of monitoring their positions and risks. Moreover, a
banking entity's methodology for calculating P&L is generally subject
to internal and external audit requirements, managerial monitoring, and
applicable public reporting requirements under the U.S. securities
laws. Under the proposed approach, the Agencies would review banking
entities' methodologies for calculating absolute P&L for purposes of
the presumption of compliance with the prohibition on proprietary
trading.
The specific threshold chosen aims to characterize trading desks
not engaged in prohibited proprietary trading. Based on the metrics
collected by the Agencies since issuance of the 2013 final rule, 90-
calendar-day absolute P&L values below $25 million dollars are
typically indicative of trading desks not engaged in prohibited
proprietary trading. Under the proposal, the activities of a trading
desk that exceeds the $25 million threshold would not presumptively
comply with the prohibition on proprietary trading. If a trading desk
operating pursuant to the proposed presumption of compliance with the
prohibition on proprietary trading exceeded the $25 million threshold,
the banking entity would be required to notify the appropriate Agency,
demonstrate that the trading desk's purchases and sales of financial
instruments comply with subpart B (e.g., the desk's purchases and sales
are not included in the rule's definition of trading account or meet
the terms of an exclusion from the definition of proprietary trading or
a permitted activity exemption), and demonstrate how the trading desk
that exceeded the threshold will maintain compliance with subpart B on
an ongoing basis. The proposed presumption of compliance is intended to
apply to the desks of banking entities that are not engaged in
prohibited proprietary trading and is not intended as a safe harbor.
The Agencies therefore propose to include within the presumption of
compliance a process by which an Agency may rebut this regulatory
presumption of compliance. Under the proposal, the Agency would be able
to rebut the presumption of compliance with the prohibition on
proprietary trading for the activities of a trading desk that does not
exceed the $25 million threshold by providing the banking entity
written notification of the Agency's determination that one or more of
the trading desk's activities violates the prohibition on proprietary
trading under subpart B.
In addition, the proposed rule includes a reservation of authority
(described further below) that would allow an Agency to designate any
activity as a proprietary trading activity if the Agency determines on
a case-by-case basis that the banking entity has engaged as principal
for the trading account of the banking entity in any purchase or sale
of one or more financial instruments under 12 U.S.C. 1851(h)(6).
Question 39. Should the Agencies consider any objective measures
other than accounting treatment to replace the 2013 final rule's short-
term intent prong? For example, should the Agencies consider including
an objective quantitative threshold (such as the absolute P&L threshold
described in the proposed presumption of compliance with the
proprietary trading prohibition) as an element of the trading account
definition? Why or why not, and how would such a measure be consistent
with the requirements of section 13 of the BHC Act?
Question 40. Is the proposed desk-level threshold for presumed
compliance with the prohibition on proprietary trading ($25 million
absolute P&L) an appropriate measure for indicating that the scale of a
trading desk's activities may not warrant the cost of more extensive
compliance requirements? Why or why not? If not, what other measure
would be more appropriate? If absolute P&L is an appropriate measure,
is $25 million an appropriate threshold? Why or why not? Should this
threshold be periodically indexed for inflation?
Question 41. What issues do commenters expect would arise if the
$25 million threshold is applied to each trading desk at a banking
entity? Would variations in levels and types of activity of the
different trading desks raise challenges in the application of the
threshold?
Question 42. What factors, if any, should the Agencies keep in mind
as they consider how the $25 million threshold should be applied over
time, as trading desks' activities change and banking entities may
reorganize their trading desks? Would the $25 million threshold require
any adjustment if a banking entity consolidated more than one trading
desk into one, or split the activities of a trading desk among multiple
trading desks?
Question 43. As described further below, the Agencies are
requesting comment regarding a potential change to the definition of
``trading desk'' that would allow a banking entity greater discretion
to define the business units that constitute trading desks for purposes
of the 2013 final rule. If the Agencies were to adopt both this change
to the definition of ``trading desk'' and the trading desk-level
presumption of compliance described above, would such a combination
create opportunities for evasion? If so, how could such concerns be
mitigated?
Question 44. Recognizing that the Agencies that are market
regulators operate under an examination and enforcement model that
differs from a bank supervisory model, from a practical perspective
would the proposal to replace the current short-
[[Page 33451]]
term intent prong with an accounting prong, including the presumption
of compliance, apply differently to banking entities regulated by
market regulators as compared to other banking entities? Please
explain.
Question 45. Is the process by which the Agencies may rebut the
presumption of compliance sufficiently clear? If not, how should the
process be changed?
Question 46. Under the proposed presumption of compliance, banking
entities would be required to notify the appropriate Agency whenever
the activities of a trading desk with the relevant activities crosses
the $25 million P&L threshold. Should the Agencies consider an
alternative methodology in which a banking entity regulated by the SEC
or CFTC, as appropriate, makes and keeps a detailed record of each
instance and provides such records to SEC or CFTC staff promptly upon
request or during an examination? Why or why not?
Question 47. Would an alternative methodology to the notification
requirement, applicable solely to banking entities regulated by
Agencies that are market regulators, whereby these firms would be
required to escalate notices of instances when the P&L threshold has
been exceeded internally for further inquiry and determination as to
whether notice should be given to the applicable regulator, using
objective factors provided by the rule? Why or why not? If such an
approach would be more appropriate, what objective factors should be
used to determine when notice should be given to the applicable
regulator? Please be as specific as possible.
Question 48. Should the Agencies specify notice and response
procedures in connection with an Agency determination that the
presumption is rebutted pursuant to Sec. __.3(c)(2) of the proposal?
Why or why not? If not, what other approach would be appropriate?
d. Excluded Activities.
As previously discussed, Sec. __.3 of the 2013 final rule
generally prohibits a banking entity from engaging in proprietary
trading.\72\ In addition to defining the scope of trading activity
subject to the prohibition on proprietary trading, the 2013 final rule
also provides several exclusions from the definition of proprietary
trading.\73\ Based on their experience implementing the 2013 final
rule, the Agencies are proposing to modify the exclusion for liquidity
management and to adopt new exclusions for transactions made to correct
errors and for certain offsetting swap transactions. In addition, the
Agencies request comment regarding whether any additional exclusions
should be added, for example, to address certain derivatives entered
into in connection with a customer lending transaction.
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\72\ See 2013 final rule Sec. __.3(a).
\73\ See 2013 final rule Sec. __.3(d).
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1. Liquidity Management Exclusion
The 2013 final rule excludes from the definition of proprietary
trading the purchase or sale of securities for the purpose of liquidity
management in accordance with a documented liquidity management
plan.\74\ This exclusion is subject to several requirements. First, the
liquidity management exclusion is limited by its terms to securities
and requires that transactions be pursuant to a liquidity management
plan that specifically contemplates and authorizes the particular
securities to be used for liquidity management purposes; describes the
amounts, types, and risks of securities that are consistent with the
entity's liquidity management; and the liquidity circumstances in which
the particular securities may or must be used. Second, any purchase or
sale of securities contemplated and authorized by the plan must be
principally for the purpose of managing the liquidity of the banking
entity, and not for the purpose of short-term resale, benefitting from
actual or expected short-term price movements, realizing short-term
arbitrage profits, or hedging a position taken for such short-term
purposes. Third, the plan must require that any securities purchased or
sold for liquidity management purposes be highly liquid and limited to
instruments the market, credit, and other risks of which the banking
entity does not reasonably expect to give rise to appreciable profits
or losses as a result of short-term price movements. Fourth, the plan
must limit any securities purchased or sold for liquidity management
purposes to an amount that is consistent with the banking entity's
near-term funding needs, including deviations from normal operations of
the banking entity or any affiliate thereof, as estimated and
documented pursuant to methods specified in the plan. Fifth, the
banking entity must incorporate into its compliance program internal
controls, analysis, and independent testing designed to ensure that
activities undertaken for liquidity management purposes are conducted
in accordance with the requirements of the 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. These requirements are designed to ensure that the
liquidity management exclusion is not misused for the purpose of
impermissible proprietary trading.\75\
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\74\ See 2013 final rule Sec. __.3(d)(3).
\75\ See 79 FR at 5555.
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The Agencies propose to amend the exclusion for liquidity
management activities to allow banking entities to use foreign exchange
forwards and foreign exchange swaps, each as defined in the Commodity
Exchange Act,\76\ and physically settled cross-currency swaps (i.e.,
cross-currency swaps that involve an actual exchange of the underlying
currencies) as part of their liquidity management activities.
Currently, the liquidity management exclusion is limited to the
``purchase or sale of a security . . . for the purpose of liquidity
management . . .'' if several specified requirements are met.\77\ As a
result, banking entities may not currently rely on the liquidity
management exclusion for foreign exchange derivative transactions used
for liquidity management because the exclusion is limited to
securities. However, the Agencies understand that banking entities
often use foreign exchange forwards, foreign exchange swaps, and cross-
currency swaps for liquidity management purposes. In particular,
foreign exchange forwards, foreign exchange swaps, and cross-currency
swaps are often used by trading desks to manage liquidity both in the
United States and in foreign jurisdictions. For example, foreign
branches and subsidiaries of U.S. banking entities often have liquidity
requirements mandated by foreign jurisdictions, and foreign exchange
products can be used to address currency risk arising from holding this
liquidity in foreign currencies. As a particular example, a U.S.
banking entity may have U.S. dollars to fund its operations but require
Japanese yen for its branch in Japan. The banking entity could use a
foreign exchange swap to convert its U.S. dollars to Japanese yen to
fund the operations of its Japanese branch.
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\76\ See 7 U.S.C. 1a(24) and 1a(25).
\77\ Sec. __.3(d)(3) of the proposed rule (emphasis added).
---------------------------------------------------------------------------
To streamline compliance for banking entities operating in foreign
jurisdictions and using foreign exchange forwards, foreign exchange
swaps, and cross-currency swaps for liquidity management purposes, the
Agencies propose to expand the liquidity management exclusion to permit
the
[[Page 33452]]
purchase or sale of foreign exchange forwards (as that term is defined
in section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)),
foreign exchange swaps (as that term is defined in section 1a(25) of
the Commodity Exchange Act (7 U.S.C. 1a(25)), and physically-settled
cross-currency swaps \78\ entered into by a banking entity for the
purpose of liquidity management in accordance with a documented
liquidity management plan. The proposed rule would permit a banking
entity to purchase or sell foreign exchange forwards, foreign exchange
swaps, and physically-settled cross-currency swaps to the same extent
that a banking entity may purchase or sell securities under the
existing exclusion, and the existing conditions that apply for
securities transactions would also apply to transactions in foreign
exchange forwards, foreign exchange swaps, and physically-settled
cross-currency swaps.\79\
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\78\ The Agencies propose to define a cross-currency swap as a
swap in which one party exchanges with another party principal and
interest rate payments in one currency for principal and interest
rate payments in another currency, and the exchange of principal
occurs on the date the swap is entered into, with a reversal of the
exchange of principal at a later date that is agreed upon when the
swap is entered into. This definition is consistent with regulations
pertaining to margin and capital requirements for covered swap
entities, swap dealers, and major swap participants. See 12 CFR
45.2; 12 CFR 237.2; 12 CFR 349.2; 17 CFR 23.151.
\79\ See Sec. __.3(e)(3)(i)-(vi) of the proposed rule.
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The inclusion of cross-currency swaps would be limited to swaps for
which all payments are made in the currencies being exchanged, as
opposed to cash-settled swaps, to limit the potential for these
instruments to be used for proprietary trading that is not for
liquidity management purposes. While foreign exchange forwards and
foreign exchange swaps, as defined in the Commodity Exchange Act, are
by definition limited to an exchange of the designated currencies, no
similarly limited definition of the term ``cross-currency swap'' is
available for this purpose. Cross-currency swaps generally are more
flexible in their terms, may have longer durations, and may be used to
achieve a greater variety of potential outcomes. Accordingly, out of
concern that cross-currency swaps could be used for prohibited
proprietary trading, the Agencies propose to limit the use of cross-
currency swaps for purposes of the liquidity management exclusion to
only those swaps for which the payments are made in the two currencies
being exchanged.
Question 49. In addition to the example noted above, are there
additional scenarios under which commenters would envision foreign
exchange forwards, foreign exchange swaps, or physically-settled cross-
currency swaps to be used for liquidity management? Are the existing
conditions of the liquidity management exclusion appropriate for these
types of derivatives activities, or should additional conditions be
added to account for the particular characteristics of the financial
instruments that the Agencies are proposing to be added? Should any
existing restrictions be removed to account for the proposed addition
of these transactions?
Question 50. Do the requirements of the existing liquidity
management exclusion, as proposed to be modified by expanding the
exclusion to include foreign exchange forwards, foreign exchange swaps,
or physically-settled cross-currency swaps, sufficiently protect
against the possibility of banking entities using the exclusion to
conduct impermissible speculative trading, while also permitting bona
fide liquidity management? Should the proposal be further modified to
protect against the possibility of firms using the liquidity management
exclusion to evade the requirements of section 13 of the BHC Act and
implementing regulations?
Question 51. Should banking entities be permitted to purchase and
sell physically-settled cross-currency swaps under the liquidity
management exclusion? Should banking entities be permitted to purchase
and sell any other financial instruments under the liquidity management
exclusion?
2. Transactions to Correct Bona Fide Trade Errors
The Agencies understand that, from time to time, a banking entity
may erroneously execute a purchase or sale of a financial instrument in
the course of conducting a permitted or excluded activity. For example,
a trading error may occur when a banking entity is acting solely in its
capacity as an agent, broker, or custodian pursuant to Sec. __.3(d)(7)
of the 2013 final rule, such as by trading the wrong financial
instrument, buying or selling an incorrect amount of a financial
instrument, or purchasing rather than selling a financial instrument
(or vice versa). To correct such errors, a banking entity may need to
engage in a subsequent transaction as principal to fulfill its
obligation to deliver the customer's desired financial instrument
position and to eliminate any principal exposure that the banking
entity acquired in the course of its effort to deliver on the
customer's original request. Under the 2013 final rule, banking
entities have expressed concern that the initial trading error and any
corrective transactions could, depending on the facts and circumstances
involved, fall within the proprietary trading definition if the
transaction is covered by any of the prongs of the trading account
definition and is not otherwise excluded pursuant to a different
provision of the rule.
Accordingly, the Agencies are proposing a new exclusion from the
definition of proprietary trading for trading errors and subsequent
correcting transactions because such transactions do not appear to be
the type of transaction the statutory definition of ``proprietary
trading'' was intended to cover. In particular, these transactions
generally lack the intent described in the statutory definition of
``trading account'' to profit from short-term price movements. The
proposed exclusion would be available for certain purchases or sales of
one or more financial instruments by a banking entity if the purchase
(or sale) is made in error in the course of conducting a permitted or
excluded activity or is a subsequent transaction to correct such an
error. The Agencies note that the availability of the proposed
exclusion will depend on the facts and circumstances of the
transactions. For example, the failure of a banking entity to make
reasonable efforts to prevent errors from occurring--as indicated, for
example, by the magnitude or frequency of errors, taking into account
the size, activities, and risk profile of the banking entity--or to
identify and correct trading errors in a timely and appropriate manner
may indicate trading activity that is not truly an error and therefore
inconsistent with the exclusion.
As an additional condition, once the banking entity identifies
purchases made in error, it would be required to transfer the financial
instrument to a separately-managed trade error account for disposition,
as a further indication that the transaction reflects a bona fide
error. The Agencies believe that this separately-managed trade error
account should be monitored and managed by personnel independent from
the traders who made the error and that banking entities should monitor
and manage trade error corrections and trade error accounts. Doing so
would help prevent personnel from using these accounts to evade the
prohibition on proprietary trading, such as by retaining positions in
error accounts to benefit from short-term price movements or by
intentionally and incorrectly classifying transactions as error trades
or as corrections of error trades in order to realize short term
profits.
[[Page 33453]]
Question 52. Does the proposed exclusion align with existing
policies and procedures that banking entities use to correct trading
errors? Why or why not?
Question 53. Is the proposed exclusion for bona fide errors
sufficiently narrow so as to prevent banking entities from evading
other requirements of the rule? Conversely, would it be too narrow to
be workable? Why or why not?
Question 54. Do commenters believe that the proposed exclusion for
bona fide trade errors is sufficiently clear? If not, why not, and how
should the Agencies clarify it?
Question 55. Does the proposed exclusion conflict with any of the
requirements of a self-regulatory organization's rules for correcting
trading errors? If it does, should the Agencies give banking entities
the option of complying with those rules instead of the requirements of
the proposed exclusion? When answering this question, commenters should
explain why the rules of self-regulatory organizations are sufficient
to prevent personnel from evading the prohibition on proprietary
trading.
Question 56. Should the Agencies provide specific criteria or
factors to help banking entities determine what constitutes a
separately managed trade error account? Why or why not? How would these
factors or criteria help banking entities identify activities that are
covered by the proposed exclusion for trading errors?
3. Definition of Other Terms Related to Proprietary Trading
The Agencies are requesting comment on alternatives to the 2013
final rule's definition of ``trading desk.'' The trading desk
definition is significant because compliance with the underwriting and
market-making provisions is determined at the trading-desk level.\80\
For example, the ``reasonably expected near-term customer demand,'' or
RENTD, requirements for both underwriting and market-making activities
must be calculated for each trading desk.\81\ Additionally, under the
2013 final rule, banking entities must furnish metrics at the trading-
desk level.\82\ Further, the proposed presumption of compliance with
the prohibition on proprietary trading would require trading desks
operating pursuant to the presumption to calculate absolute P&L at the
trading desk level and would apply to all the activities of the trading
desk.
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\80\ See 2013 final rule Sec. __.4(a)(2); Sec. __.4(b)(2).
\81\ See 2013 final rule Sec. __.4(b)(2)(ii).
\82\ See 2013 final rule Appendix A.
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Under the 2013 final rule, ``trading desk'' is defined as ``the
smallest discrete unit of organization of a banking entity that
purchases or sells financial instruments for the trading account of the
banking entity or an affiliate thereof.'' \83\ Some banking entities
have indicated that, in practice, this definition has led to
uncertainty regarding the meaning of ``smallest discrete unit.'' Some
banking entities have also communicated that this definition has caused
confusion and duplicative compliance and reporting efforts for banking
entities that also define trading desks for purposes not related to the
2013 final rule, including for internal risk management and reporting
and calculating regulatory capital requirements.
---------------------------------------------------------------------------
\83\ 2013 final rule Sec. __.3(e)(13).
---------------------------------------------------------------------------
Accordingly, the Agencies are requesting comment on whether to
revise the trading desk definition to align with the trading desk
concept used for other purposes. The Agencies are seeking comment on a
potential multi-factor trading desk definition based on the same
criteria typically used to establish trading desks for other
operational, management, and compliance purposes. For example, the
Agencies could define a trading desk as a unit of organization of a
banking entity that purchases or sells financial instruments for the
trading account of the banking entity or an affiliate thereof that is:
Structured by the banking entity to establish efficient
trading for a market sector;
Organized to ensure appropriate setting, monitoring, and
management review of the desk's trading and hedging limits, current and
potential future loss exposures, strategies, and compensation
incentives; and
Characterized by a clearly-defined unit of personnel that
typically:
[cir] Engages in coordinated trading activity with a unified
approach to its key elements;
[cir] Operates subject to a common and calibrated set of risk
metrics, risk levels, and joint trading limits;
[cir] Submits compliance reports and other information as a unit
for monitoring by management; and
[cir] Books its trades together.
The Agencies believe that this potential approach to the definition
of trading desk could be easier to monitor and for banking entities to
apply. At the same time, however, any revised definition should not be
so broad as to hinder the ability of the Agencies or the banking
entities to detect prohibited proprietary trading.
Under the alternative approach on which the Agencies are requesting
comment, a banking entity's trading desk designations would be subject
to Agency review, as appropriate, through the examination process or
otherwise. Such a definition would be intended to reduce the burdens on
banking entities by aligning the regulation's trading desk concept with
the organizational structure that firms already have in place for
purposes of carrying out their ordinary course business activities.
Specifically, to the extent the trading desk definition in the 2013
final rule has been interpreted to apply at too granular a level, the
Agencies request comment as to whether such a definition would reduce
compliance costs by clarifying that banking entities are not required
to maintain policies and procedures and to collect and report
information at a level of the organization identified solely for
purposes of section 13 of the BHC Act and implementing regulations.
Question 57. Should the Agencies revise the trading desk definition
to align with the level of organization established by banking entities
for other purposes, such as for other operational, management, and
compliance purposes? Which of the proposed factors would be appropriate
to include in the trading desk definition? Do these factors reflect the
same principles banking entities typically use to define trading desks
in the ordinary course of business? Are there any other factors that
the Agencies should consider such as, for example, how a banking entity
would monitor and aggregate P&L for purposes other than compliance with
section 13 of the BHC Act and the implementing regulation?
Question 58. How would the adoption of a different trading desk
definition affect the ability of banking entities and the Agencies to
detect impermissible proprietary trading? Please explain. Would a
different definition of ``trading desk'' make it easier or harder for
banking entities and supervisors to monitor their trading activities
for consistency with section 13 of the BHC Act and implementing
regulations? Would allowing banking entities to define ``trading desk''
for purposes of compliance with section 13 of the BHC Act and the
implementing regulations create opportunities for evasion, and if so,
how could such concerns be mitigated?
Question 59. Please discuss any positive or negative consequences
or costs and benefits that could result if a ``trading desk'' is not
defined as ``the
[[Page 33454]]
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.'' Please include in your
discussion any positive or negative impact with respect to (i) the
ability to record the quantitative measurements required in the
Appendix and (ii) the usefulness of such quantitative measurements.
e. Reservation of Authority
The Agencies propose to include a reservation of authority allowing
an Agency to determine, on a case-by-case basis, that any purchase or
sale of one or more financial instruments by a banking entity for which
it is the primary financial regulatory agency either is or is not for
the trading account as defined in section 13(h)(6) of the BHC Act.\84\
In evaluating whether the Agency should designate a purchase or sale as
for the trading account, the Agency will consider consistency with the
statutory definition, and, to the extent appropriate and consistent
with the statute, may consider the impact of the activity on the safety
and soundness of the financial institution or the financial stability
of the United States, the risk characteristics of the particular
activity, or any other relevant factor.
---------------------------------------------------------------------------
\84\ 12 U.S.C. 1851(h)(6).
---------------------------------------------------------------------------
The Agencies request comment as to whether such a reservation of
authority would be necessary in connection with the proposed definition
of trading account, which would focus on objective factors rather than
on subjective intent.\85\ While the Agencies recognize that the use of
objective factors to define proprietary trading is intended to simplify
compliance, the Agencies also recognize that this approach may, in some
circumstances, produce results that are either under-inclusive or over-
inclusive with respect to the definition of proprietary trading. The
Agencies further recognize that the underlying statute sets forth
elements of proprietary trading that are inherently subjective, for
example, ``intent to resell in order to profit from short-term price
movements.'' \86\ In order to provide appropriate balance and to
recognize the subjective elements of the statute, the Agencies request
comment as to whether a reservation of authority is appropriate.
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\85\ See Sec. __.3(b) of the proposed rule.
\86\ See 12 U.S.C. 1851(h)(6).
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The Agencies propose to administer this reservation of authority
with appropriate notice and response procedures. In those circumstances
where the primary financial regulatory agency of a banking entity
determines that the purchase or sale of one or more financial
instruments is for the trading account, the Agency would be required to
provide written notice to the banking entity explaining why the
purchase or sale is for the trading account. The Agency would also be
required to provide the banking entity with a reasonable opportunity to
provide a written response before the Agency reaches a final decision.
Specifically, a banking entity would have 30 days to respond to the
notice with any objections to the determination and any factors that
the banking entity would have the Agency consider in reaching its final
determination. The Agency could, in its discretion, extend the response
period beyond 30 days for good cause. The Agency could also shorten the
response period if the banking entity consents to a shorter response
period or, if, in the opinion of the Agency, the activities or
condition of the banking entity so requires, provided that the banking
entity is informed promptly of the new response period. Failure to
respond within the time period would amount to a waiver of any
objections to the Agency's determination that a purchase or sale is for
the trading account. After the close of banking entity's response
period, the Agency would decide, based on a review of the banking
entity's response and other information concerning the banking entity,
whether to maintain the Agency's determination that the purchase or
sale is for the trading account. The banking entity would be notified
of the decision in writing. The notice would include an explanation of
the decision.\87\
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\87\ These notice and response procedures would be consistent
with procedures that apply to many banking entities in other
contexts. See 12 CFR 3.404.
---------------------------------------------------------------------------
Question 60. Is the reservation of authority to allow the
appropriate Agency to determine whether a particular activity is
proprietary trading appropriate? Why or why not?
Question 61. Would the proposed reservation of authority further
the goals of transparency and consistency in interpretation of section
13 of the BHC Act and the implementing regulations? Would it be more
appropriate to have these type of determinations made jointly by the
Agencies? Is the standard by which an Agency would make a determination
under the proposed reservation of authority sufficiently clear? If
determinations are not made jointly by the Agencies, what concerns
could be presented if two banking entity affiliates receive different
or conflicting determinations from different Agencies?
Question 62. Should Agencies' determinations pursuant to the
reservation of authority be made public? Would publication of such
determinations further the goals of consistency and transparency?
Please explain. Should the Agencies follow consistent practices with
respect to publishing notices of determinations pursuant to the
reservation of authority?
Question 63. Are the notice and response procedures adequate? Why
or why not? Recognizing that market regulators operate under a
different regulatory structure as compared to the Federal banking
agencies, should the proposed notice and response procedures be
modified to account for such differences (including by creating
separate procedures that would be applicable solely in the case of
reporting to market regulators)? Why or why not?
2. Section __.4: Permitted Underwriting and Market-Making Activities
a. Permitted Underwriting Activities
Section 13(d)(1)(B) of the BHC Act contains an exemption from the
prohibition on proprietary trading for the purchase, sale, acquisition,
or disposition of securities, derivatives, contracts of sale of a
commodity for future delivery, and options on any of the foregoing in
connection with underwriting activities, to the extent that such
activities are designed not to exceed RENTD.\88\ Section __.4(a) of the
2013 final rule implements the statutory exemption for underwriting and
sets forth the requirements that banking entities must meet in order to
rely on the exemption. Among other things, the 2013 final rule requires
that:
---------------------------------------------------------------------------
\88\ 12 U.S.C. 1851(d)(1)(B).
---------------------------------------------------------------------------
The banking entity act as an ``underwriter'' for a
``distribution'' of securities and the trading desk's underwriting
position be related to such distribution;
The amount and types of securities in the trading desk's
underwriting position be designed not to exceed 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;
The banking entity has established and implements,
maintains, and enforces an internal compliance program that is
reasonably designed to
[[Page 33455]]
ensure the banking entity's compliance with the requirements of the
underwriting exemption, including reasonably designed written policies
and procedures, internal controls, analysis, and independent testing
identifying and addressing:
[cir] The products, instruments, or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
[cir] Limits for each trading desk, based on the nature and amount
of the trading 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;
[cir] Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
[cir] Authorization procedures, including escalation procedures
that require review and approval of any trade that would exceed a
trading desk's limit(s), demonstrable analysis of the basis for any
temporary or permanent increase to a trading desk's limit(s), and
independent review of such demonstrable analysis and approval;
The compensation arrangements of persons performing the
banking entity's underwriting activities are designed not to reward or
incentivize prohibited proprietary trading; and
The banking entity is licensed or registered to engage in
the activity described in the underwriting exemption in accordance with
applicable law.
As the Agencies explained in the 2013 final rule, underwriters play
an important role in facilitating issuers' access to funding, and thus
underwriters are important to the capital formation process and
economic growth.\89\ 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.\90\ An underwriter can help reduce these
costs by mitigating the information asymmetry between an issuer and its
potential investors.\91\ 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 of the underwriter as well as its
ability to provide information about the issuer and the
underwriting.\92\
---------------------------------------------------------------------------
\89\ See 79 FR at 5561 (internal footnotes omitted).
\90\ See id.
\91\ See id.
\92\ See id.
---------------------------------------------------------------------------
In recognition of how the underwriting market functions, the
Agencies adopted a comprehensive, multi-faceted approach in the 2013
final rule. In the several years since the adoption of the 2013 final
rule, however, public commenters have observed that the significant
compliance requirements in the regulation may unnecessarily constrain
underwriting without a corresponding reduction in the type of trading
activities that the rule was designed to prohibit.\93\
---------------------------------------------------------------------------
\93\ See supra Part I.A of this Supplementary Information
section.
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As described in further detail below, the Agencies are proposing to
tailor, streamline, and clarify the requirements that a banking entity
must satisfy to avail itself of the underwriting exemption. In that
regard, the Agencies are proposing to modify the underwriting exemption
to clarify how a banking entity may measure and satisfy the statutory
requirement that underwriting activity be designed not to exceed the
reasonably expected near term demand of clients, customers, or
counterparties. Specifically, the proposal would establish a
presumption, available to banking entities both with and without
significant trading assets and liabilities, that trading within
internally set risk limits satisfies the statutory requirement that
permitted underwriting activities must be designed not to exceed RENTD.
The Agencies also are proposing to tailor the underwriting
exemption's compliance program requirements to the size, complexity,
and type of activity conducted by the banking entity by making those
requirements applicable only to banking entities with significant
trading assets and liabilities. Based on feedback the Agencies have
received, banking entities that do not have significant trading assets
and liabilities can incur costs to establish, implement, maintain, and
enforce the compliance program requirements in the 2013 final rule,
notwithstanding the lower level of such banking entities' trading
activities.\94\ Accordingly, the Agencies believe that the proposed
revisions to the underwriting exemption would provide banking entities
that do not have significant trading assets and liabilities with more
flexibility to meet client and customer demands and facilitate the
capital formation process, while, consistent with the statute,
continuing to safeguard against trading activity that could threaten
the safety and soundness of banking entities and the financial
stability of the United States, by more appropriately aligning the
associated compliance obligations with the size of banking entities'
trading activities.
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\94\ Id.
---------------------------------------------------------------------------
b. RENTD Limits and Presumption of Compliance
As described above, the statutory exemption for underwriting in
section 13(d)(1)(B) of the BHC Act requires that such activities be
designed not to exceed the reasonably expected near term demands of
clients, customers, or counterparties.\95\ Consistent with the statute,
Sec. __.4(a)(2)(ii) of the 2013 final rule's underwriting exemption
requires that the amount and type 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 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.\96\
---------------------------------------------------------------------------
\95\ 12 U.S.C. 1851(d)(1)(B).
\96\ See 2013 final rule Sec. __.4(a)(2)(ii).
---------------------------------------------------------------------------
The Agencies' experience implementing the 2013 final rule has
indicated that the approach the Agencies have taken to give effect to
the statutory standard of reasonably expected near term demands of
clients, customers, or counterparties may be overly broad and complex,
and also may inhibit otherwise permissible underwriting activity. The
Agencies have received feedback as part of implementing the rule that
compliance with the factors in the rule can be complex and costly.\97\
---------------------------------------------------------------------------
\97\ See supra Part I.A. of this SUPPLEMENTARY INFORMATION
section.
---------------------------------------------------------------------------
Instead of the approach for the underwriting exemption in the 2013
final rule, the Agencies are proposing to establish the articulation
and use of internal risk limits as a key mechanism for conducting
trading activity in accordance with the rule's underwriting
exemption.\98\ In particular, the proposal would provide that the
purchase or sale of a financial instrument by a banking entity shall be
presumed to be designed not to exceed, on an ongoing basis, the
reasonably expected near term demands
[[Page 33456]]
of clients, customers, or counterparties if the banking entity
establishes internal risk limits for each trading desk, subject to
certain conditions, and implements, maintains, and enforces those
limits, such that the risk of the financial instruments held by the
trading desk does not exceed such limits. The Agencies believe that
this approach would provide firms with more flexibility and certainty
in conducting permissible underwriting.
---------------------------------------------------------------------------
\98\ As a consequence of these proposed changes to focus on risk
limits, many of the requirements of the 2013 final rule relating to
risk limits associated with underwriting would be incorporated into
this requirement and modified or removed as appropriate in this
section of the proposal.
---------------------------------------------------------------------------
Under the proposal, all banking entities, regardless of their
volume of trading assets and liabilities, would be able to voluntarily
avail themselves of the presumption of compliance with the statutory
RENTD requirement in section 13(d)(1)(B) of the BHC Act by establishing
and complying with these internal risk limits. Specifically, the
proposal would provide that a banking entity would establish internal
risk limits for each trading desk that are designed not to exceed the
reasonably expected near term demands of clients, customers, or
counterparties, based on the nature and amount of the trading desk's
underwriting activities, on the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.
Banking entities utilizing this presumption would be required to
maintain internal policies and procedures for setting and reviewing
desk-level risk limits in a manner consistent with the statute.\99\ The
proposed approach would not require that a banking entity's risk limits
be based on any specific or mandated analysis, as required under the
2013 final rule. Rather, a banking entity would establish the risk
limits according to its own internal analyses and processes around
conducting its underwriting activities in accordance with section
13(d)(1)(B).\100\
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\99\ Under the proposal, banking entities with significant
trading assets and liabilities would continue to be required to
establish internal risk limits for each trading desk as part of the
underwriting compliance program requirement in Sec.
__.4(a)(2)(iii)(B), the elements of which would cross-reference
directly to the requirement in proposed Sec. __.4(a)(8)(i). Banking
entities that do not have significant trading assets and liabilities
would no longer be required to establish a compliance program that
is specific for the purposes of complying with the exemption for
underwriting, but would need to do so if they chose to utilize the
proposed presumption of compliance with respect to the statutory
RENTD requirement in section 13(d)(1)(B) of the BHC Act.
\100\ The Agencies expect that the risk and position limits
metric that is already required for certain banking entities under
the 2013 final rule (and would continue to be required under the
Appendix to the proposal) would help banking entities and the
Agencies to manage and monitor the underwriting activities of
banking entities subject to the metrics reporting and recordkeeping
requirements of the Appendix. See infra Part III.E.2.i.i.
---------------------------------------------------------------------------
The proposal would require a banking entity to promptly report to
the appropriate Agency when a trading desk exceeds or increases its
internal risk limits. A banking entity would also be required to report
to the appropriate Agency any temporary or permanent increase in an
internal risk limit. In the case of both reporting requirements (i.e.,
notice of an internal risk limit being exceeded and notice of an
increase to the limit), the notice would be submitted in the form and
manner as directed by the applicable Agency.
As noted, a banking entity would not be required to adhere to any
specific, pre-defined requirements for the limit-setting process beyond
the banking entity's own ongoing and internal assessment of the amount
of activity that is required to conduct underwriting, including to
reflect the banking entity's ongoing and internal assessment of the
reasonably expected near term demands of clients, customers, or
counterparties. The proposal would, however, provide that internal risk
limits established by a banking entity shall be subject to review and
oversight by the appropriate Agency on an ongoing basis. Any review of
such limits would assess whether or not those limits are established
based on the statutory standard--i.e., the trading desk's reasonably
expected near term demands of clients, customers, or counterparties on
an ongoing basis, based on the nature and amount of the trading desk's
underwriting activities. So long as a banking entity has established
and implements, maintains, and enforces such limits, the proposal would
presume that all trading activity conducted within the limits meets the
requirements that the underwriting activity be based on the reasonably
expected near term demands of clients, customers, or counterparties.
The Agencies would expect to closely monitor and review any instances
of a banking entity exceeding a risk limit as well as any temporary or
permanent increase to a trading desk limit.
Under the proposal, the presumption of compliance for permissible
underwriting activities may be rebutted by the Agency if the Agency
determines, based on all relevant facts and circumstances, that a
trading desk is engaging in activity that is not based on the trading
desk's reasonably expected near term demands of clients, customers, or
counterparties on an ongoing basis. The Agency would provide notice of
any such determination to the banking entity in writing.
The Agencies request comment on the proposed addition of a
presumption that conducting underwriting activities within internally
set risk limits satisfies the requirement that permitted underwriting
activities be designed not to exceed the reasonably expected near-term
demands of clients, customers, or counterparties. In particular, the
Agencies request comment on the following questions:
Question 64. Is the proposed presumption of compliance for
underwriting activity within internally set risk limits sufficiently
clear? If not, what changes should the Agencies make to further clarify
the rule?
Question 65. How would the proposed approach, as it relates to the
establishment and reliance on internal trading limits, impact the
capital formation process and the liquidity of particular markets?
Question 66. How would the proposed approach, as it relates to the
establishment and reliance on internal trading limits, impact the
underlying objectives of section 13 of the BHC Act and the 2013 final
rule? For example, how should the Agencies assess internal trading
limits and any changes in them?
Question 67. By proposing an approach that permits banking entities
to rely on internally set limits to comply with the statutory RENTD
requirement, the rule would no longer expressly require firms to, among
other things, conduct a 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. Do commenters agree with the
revised approach? What are the costs and benefits of eliminating these
requirements?
Question 68. Would the proposal's approach to permissible
underwriting activities effectively implement the statutory exemption?
Why or why not? Would this approach improve the ability of banking
entities to engage in underwriting relative to the 2013 final rule? If
not, what approach would be better? Please explain.
Question 69. Does the proposed reliance on using a trading desk's
internal risk limits to comply with the statutory RENTD requirement in
section 13(d)(1)(B) of the BHC Act present opportunities to evade the
overall
[[Page 33457]]
prohibition on proprietary trading? If so, how? Please be as specific
as possible. Additionally, please provide any changes to the proposal
that might address such potential circumvention. Alternatively, please
explain why the proposal to rely on a trading desk's internal risk
limits to comply with the statutory RENTD requirement should not
present opportunities to evade the prohibition on proprietary trading.
Question 70. Do banking entities need greater clarity about how to
set the proposed internal risk limits for permissible underwriting
activity? If so, what additional information would be useful? Please
explain.
Question 71. Are the proposed changes to the exemption for
underwriting appropriately tailored to the operation and structure of
the underwriting market, particularly firm commitment offerings? Could
the proposal be modified in order to better align with the operation
and structure of the underwriting market? Recognizing that the proposal
would not require banking entities to use their internal risk limits to
establish a rebuttable presumption of compliance with the requirements
of section 13(d)(1)(B) of the BHC Act, would the proposal be workable
in the context of underwritten offerings, including firm commitment
underwritings? How would an Agency rebut the presumption of compliance
in the context of underwritten offerings, including firm commitment
underwritings? Could the proposal, if adopted, affect a banking
entity's willingness to participate in a firm commitment underwriting?
Please explain, being as specific as possible.
Question 72. Should any additional guidance or information be
provided to explain the process and standard by which the Agencies
could rebut the presumption of permissible underwriting? If so, please
explain. Please include specific subject areas that could be addressed
in such guidance (e.g., criteria used as the basis for a rebuttal, the
rebuttal process, etc.).
Question 73. Are there other modifications to the 2013 final rule's
requirements for permitted underwriting that would improve the
efficiency of the rule's underwriting requirements while adhering to
the statutory requirement that such activity be designed not to exceed
the reasonably expected near term demands of clients, customers, and
counterparties? If so, please describe these modifications as well as
how they would improve the efficiency of the underwriting exemption and
meet the statutory standard.
Question 74. Under the proposed presumption of compliance for
permissible underwriting activities, banking entities would be required
to notify the appropriate Agency when a trading limit is exceeded or
increased (either on a temporary or permanent basis), in each case in
the form and manner as directed by each Agency. Is this requirement
sufficiently clear? Should the Agencies provide greater clarity about
the form and manner for providing this notice? Should those notices be
required to be provided ``promptly'' or should an alternative time
frame apply? Alternatively, should each Agency establish its own
deadline for when these notices should be provided? Please explain.
Question 75. Should the Agencies instead establish a uniform method
of reporting when a trading desk exceeds or increases an internal risk
limit (e.g., a standardized form)? Why or why not? If so, please
provide as much detail as possible. If not, please describe any
impediments or costs to implementing a uniform notification process and
explain why such a system may not be efficient or might undermine the
effectiveness of the proposed notification requirement.
Question 76: Should the Agencies implement an alternative reporting
methodology for notifying the appropriate Agency when a trading limit
is exceeded or increased that would apply solely in the case of a
banking entity's obligation to report such occurrences to a market
regulator? For example, instead of an affirmative notice requirement,
should such banking entities be required to make and keep a detailed
record of each instance as part of its books and records, and to
provide such records to SEC or CFTC staff promptly upon request or
during an examination? Why or why not? As an additional alternative,
should banking entities be required to escalate notices of limit
exceedances or changes internally for further inquiry and determination
as to whether notice should be given to the applicable market
regulator, using objective factors provided by the rule, be a more
appropriate process for these banking entities? Why or why not? If such
an approach would be more appropriate, what objective factors should be
used to determine when notice should be given to the applicable
regulator? Please be as specific as possible.
Question 77. Should the Agencies specify notice and response
procedures in connection with an Agency determination that the
presumption pursuant to Sec. __.4(a)(8)(iv) is rebutted? Why or why
not? If so, what type of procedures should they specify? For example,
should the notice and response procedures be similar to those in Sec.
__.3(g)(2)? If not, what other approach would be appropriate?
c. Compliance Program and Other Requirements
The underwriting exemption in the 2013 final rule requires that a
banking entity establishes and implements, maintains, and enforces a
compliance program, as required by subpart D, that is reasonably
designed to ensure compliance with the requirements of the exemption.
Such compliance program is required to include reasonably designed
written policies and procedures, internal controls, analysis and
independent testing identifying and addressing: (i) The products,
instruments, or exposures each trading desk may purchase, sell, or
manage as part of its underwriting activities; (ii) 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, based on certain
factors; (iii) internal controls and ongoing monitoring and analysis of
each trading desk's compliance with its limits; and (iv) authorization
procedures, including escalation procedures that require review and
approval of any trade that would exceed one or more of a trading desk's
limits, demonstrable analysis of the basis for any temporary or
permanent increase to one or more of a trading desk's limits, and
independent review (i.e., by risk managers and compliance officers at
the appropriate level independent of the trading desk) of such
demonstrable analysis and approval.
Banking entities and others have stated that the compliance program
requirements of the underwriting exemption are overly complex and
burdensome. The Agencies generally believe the compliance program
requirements play an important role in facilitating and monitoring a
banking entity's compliance with the exemption. However, with the
benefit of experience, the Agencies also believe those requirements can
be appropriately tailored to the scope of the underwriting activities
conducted by each banking entity.
Specifically, the Agencies are proposing a tiered approach to the
underwriting exemption's compliance program requirements so as to make
them commensurate with the size, scope, and complexity of the relevant
banking entity's trading activities and business structure. Consistent
with the
[[Page 33458]]
2013 final rule, a banking entity with significant trading assets and
liabilities would continue to be required to establish, implement,
maintain, and enforce a comprehensive internal compliance program as a
condition for relying on the underwriting exemption. However, the
Agencies propose to eliminate the exemption's compliance program
requirements for banking entities that have moderate or limited trading
assets and liabilities.\101\
---------------------------------------------------------------------------
\101\ Under the 2013 final rule, the compliance program
requirement in Sec. __.4(a)(2)(iii) is part of the compliance
program required by subpart D, but is specifically used for purposes
of complying with the exemption for underwriting activity.
---------------------------------------------------------------------------
The proposed removal of the exemption's compliance program
requirements for banking entities that do not have significant trading
assets and liabilities would not relieve those banking entities of the
obligation to comply with the prohibitions on proprietary trading, and
the other requirements of the exemption for underwriting activities, as
set forth in section 13 of the BHC Act and the 2013 final rule, both as
currently written and as proposed to be amended. However, eliminating
the compliance program requirements as a condition to being able to
rely on the underwriting exemption should provide these banking
entities that do not have significant trading assets and liabilities an
appropriate amount of flexibility to tailor the means by which they
seek to ensure compliance with the underlying requirements of the
exemption for underwriting activities, and to allow them to structure
their internal compliance measures in a way that takes into account the
risk profile and underwriting activity of the particular trading desk.
This proposed change would also be consistent with the proposed
modifications to the general compliance program requirements for these
banking entities under Sec. __.20 of the 2013 final rule, discussed
further below in this Supplementary Information section.
The Agencies understand that banking entities that do not have
significant trading assets and liabilities can incur significant costs
to establish, implement, maintain, and enforce the compliance program
requirements contained in the 2013 final rule. In some instances, those
costs may be disproportionate to the banking entity's trading activity
and risk. Accordingly, eliminating the compliance program requirements
for banking entities that do not have significant trading assets and
liabilities may reduce costs that are passed on to investors and
increase capital formation without materially impacting the rule's
ability to ensure that the objectives set forth in section 13 of the
BHC Act are satisfied.\102\
---------------------------------------------------------------------------
\102\ Under the proposal, the compliance program requirements
that are specific for the purposes of complying with the exemption
for underwriting activities in Sec. __.4(a) would remain unchanged
for banking entities with significant trading assets and
liabilities, although the requirements related to limits for each
trading desk would be moved (but not modified) into new Sec.
__.4(a)(8)(i) as part of the proposed presumption of compliance.
---------------------------------------------------------------------------
The Agencies request comment on the proposed revisions to the
exemption for the underwriting activities compliance program
requirement. In particular, the Agencies request comment on the
following questions:
Question 78. Would the proposed tiered compliance approach based on
a banking entity's trading assets and liabilities appropriately balance
the costs and benefits for banking entities that do not have
significant trading assets and liabilities? Why or why not? If so, how?
If not, what other approach would be more appropriate?
Question 79. Should the Agencies simplify and streamline the
exemption for underwriting activities compliance requirements for
banking entities with significant trading assets and liabilities? If
so, please explain.
Question 80. Do commenters agree with the proposal to have the
underwriting exemption specific compliance program requirements apply
only to banking entities with significant trading assets and
liabilities? Why or why not?
Question 81. In addition to the proposed changes to the
underwriting exemption, are there any technical corrections the
Agencies should make to Sec. __.4(a), such as to eliminate redundant
or duplicative language or to correct or refine certain cross-
references? If so, please explain.
d. Market-Making Activities
Section 13(d)(1)(B) of the BHC Act contains an exemption from the
prohibition on proprietary trading for the purchase, sale, acquisition,
or disposition of securities, derivatives, contracts of sale of a
commodity for future delivery, and options on any of the foregoing in
connection with 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.\103\
Section__.4(b) of the 2013 final rule implements the statutory
exemption for market making-related activities and sets forth the
requirements that all banking entities must meet in order to rely on
the exemption. Among other things, the 2013 final rule requires that:
---------------------------------------------------------------------------
\103\ 12 U.S.C. 1851(d)(1)(B).
---------------------------------------------------------------------------
The trading desk that establishes and manages the
financial exposure routinely stands ready to purchase and sell one or
more types of financial instruments related to its financial exposure
and is willing and available to quote, purchase and sell, or otherwise
enter into long and short positions in those types of financial
instruments for its own account, in commercially reasonable amounts and
throughout market cycles on a basis appropriate for the liquidity,
maturity, and depth of the market for the relevant types of financial
instruments;
The amount, types, and risks of the financial instruments
in the trading desk's market maker inventory are designed not to
exceed, on an ongoing basis, the reasonably expected near term demands
of clients, customers, or counterparties, as required by the statute
and based on certain factors and analysis specified in the rule;
The banking entity has established and implements,
maintains, and enforces an internal compliance program that is
reasonably designed to ensure its compliance with the market making
exemption, including reasonably designed written policies and
procedures, internal controls, analysis, and independent testing
identifying and assessing certain specified factors; \104\
---------------------------------------------------------------------------
\104\ See 79 FR at 5612.
---------------------------------------------------------------------------
To the extent that any required limit \105\ established by
the trading desk is exceeded, the trading desk takes action to bring
the trading desk into compliance with the limits as promptly as
possible after the limit is exceeded;
---------------------------------------------------------------------------
\105\ See id. at 5615.
---------------------------------------------------------------------------
The compensation arrangements of persons performing market
making-related activities are designed not to reward or incentivize
prohibited proprietary trading; and
The banking entity is licensed or registered to engage in
market making-related activities in accordance with applicable law.
When adopting the 2013 final rule, the Agencies endeavored to
balance two goals of section 13 of the BHC Act: To allow market making
to take place, which is important to well-functioning and liquid
markets as well as the economy, and simultaneously to prohibit
proprietary trading unrelated to market making or other permitted
activities, consistent with the statute.\106\
[[Page 33459]]
To accomplish these goals the Agencies adopted a comprehensive, multi-
faceted approach. In the several years since the adoption of the 2013
final rule, however, the Agencies have observed that the significant
compliance requirements and lack of clear bright lines in the
regulation may unnecessarily constrain market making,\107\ and the
Agencies believe some of the requirements are unnecessary to prevent
the type of trading activities that the rule was designed to prohibit.
---------------------------------------------------------------------------
\106\ See id. at 5576. In addition, staffs from some of the
Agencies have analyzed the liquidity of the corporate bond market in
the time since the 2013 final rule was adopted. For example, Federal
Reserve Board staff have prepared quarterly reports to monitor
market-level liquidity in corporate bond markets since 2014. See
https://www.federalreserve.gov/foia/corporate-bond-liquidity-reports.htm. See also Report to Congress: Access to Capital and
Market Liquidity, SEC Division of Economic and Risk Analysis staff,
https://www.sec.gov/files/access-to-capital-and-market-liquidity-study-dera-2017.pdf (``Access to Capital and Market Liquidity'').
\107\ See supra Part I of this SUPPLEMENTARY INFORMATION
section.
---------------------------------------------------------------------------
As described in further detail below, the Agencies are proposing to
tailor, streamline, and clarify the requirements that a banking entity
must satisfy to avail itself of the market making exemption. Similar to
the proposed underwriting exemption,\108\ the Agencies are proposing to
modify the market making exemption by providing a clearer way to
measure and satisfy the statutory requirement that market making-
related activity be designed not to exceed the reasonably expected near
term demand of clients, customers, or counterparties. Specifically, the
proposal would establish a presumption, available to banking entities
both with and without significant trading assets and liabilities, that
trading within internally set risk limits satisfies the statutory
requirement that permitted market making-related activities must be
designed not to exceed RENTD. In addition, the Agencies also are
proposing to tailor the market making exemption's compliance program
requirements to the size, complexity, and type of activity conducted by
the banking entity by making those requirements applicable only to
banking entities with significant trading assets and liabilities.
---------------------------------------------------------------------------
\108\ See supra Part III.B.2.a of this SUPPLEMENTARY INFORMATION
section.
---------------------------------------------------------------------------
Based on feedback the Agencies have received, banking entities that
do not have significant trading assets and liabilities can incur
substantial costs to establish, implement, maintain, and enforce the
compliance program requirements in the 2013 final rule, notwithstanding
the lower level of such banking entities' trading activities.\109\
Accordingly, the Agencies believe that the proposed revisions to the
market making exemption would provide banking entities that do not have
significant trading assets and liabilities with more flexibility to
meet customer demands and facilitate robust trading markets, while
continuing to safeguard against trading activity that could threaten
the safety and soundness of banking entities and the financial
stability of the United States by more appropriately aligning the
associated compliance obligations with the size of banking entities'
trading activities.
---------------------------------------------------------------------------
\109\ Id.
---------------------------------------------------------------------------
e. RENTD Limits and Presumption of Compliance
As described above, the statutory exemption for market making-
related activities in section 13(d)(1)(B) of the BHC Act requires that
such activities be designed not to exceed the reasonably expected near
term demands of clients, customers, or counterparties.\110\ Consistent
with the statute, Sec. __.4(b)(2)(ii) of the 2013 final rule's market
making 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.\111\
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\110\ 12 U.S.C. 1851(d)(1)(B).
\111\ See 2013 final rule Sec. __.4(b)(2)(iii).
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The 2013 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, these factors are: (i) The liquidity,
maturity, and depth of the market for the relevant type of financial
instrument(s), and (ii) demonstrable analysis of historical customer
demand, current inventory of financial instruments, and market and
other factors regarding the amount, types, and risks of or associated
with positions in financial instruments in which the trading desk makes
a market, including through block trades. Under Sec.
__.4(b)(2)(iii)(C) of the 2013 final rule, a banking entity must
account for these considerations when establishing risk and inventory
limits for each trading desk.
The Agencies' experience implementing the 2013 final rule has
indicated that the approach the Agencies have taken to give effect to
the statutory standard of reasonably expected near term demands of
clients, customers, or counterparties may be overly broad and complex,
and also may inhibit otherwise permissible market making-related
activity. In particular, the Agencies have received feedback as part of
implementing the rule that compliance with the factors in the rule can
be complex and costly.\112\ For example, banking entities have
communicated that they must engage in a number of complex and intensive
analyses to meet the ``demonstrable analysis'' requirement under Sec.
__.4(b)(2)(ii)(B) and may still be unable to gain comfort that their
bona fide market making-related activity meets these factors. Finally,
the Agencies' experience implementing the rule also indicates that the
requirements of the 2013 final rule do not provide bright line
conditions under which trading can clearly be classified as permissible
market making.
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\112\ See supra Part I.A.
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Accordingly, the Agencies are seeking comment on a proposal to
implement this key statutory factor in a manner designed to provide
banking entities and the Agencies with greater certainty and clarity
about what activity constitutes permissible market making pursuant to
the exemption. The Agencies are proposing to establish the articulation
and use of internal risk limits as a key mechanism for conducting
trading activity in accordance with the rule's market making
exemption.\113\ In particular, the proposal would provide that the
purchase or sale of a financial instrument by a banking entity shall be
presumed to be designed not to exceed, on an ongoing basis, the
reasonably expected near term demands of clients, customers, or
counterparties, based on the liquidity, maturity, and depth of the
market for the relevant types of financial instrument, if the banking
entity establishes internal risk limits for each trading desk, subject
to certain conditions, and implements, maintains, and enforces those
limits, such that the risk of the financial instruments held by the
trading desk does not exceed such limits. The Agencies believe that
this approach would allow for a clearer application of these
exemptions, and would provide firms with more flexibility and certainty
in conducting market making-related activities.
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\113\ As a consequence of these changes to focus on risk limits,
many of the requirements of the 2013 final rule relating to risk
limits associated with market making-related activity have been
incorporated into this requirement and modified or deleted as
appropriate in this section of the proposal.
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Under the proposal, all banking entities, regardless of their
volume of
[[Page 33460]]
trading assets and liabilities, would be able to voluntarily avail
themselves of the presumption of compliance with the statutory RENTD
requirement in section 13(d)(1)(B) of the BHC Act by establishing and
complying with internal risk limits. Specifically, the proposal would
provide that a banking entity would establish internal risk limits for
each trading desk that are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
based on the nature and amount of the trading desk's market making-
related activities, on the:
(1) Amount, types, and risks of its market maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.
Banking entities utilizing this presumption would be required to
maintain internal policies and procedures for setting and reviewing
desk-level risk limits in a manner consistent with the statute.\114\
The proposed approach would not require that a banking entity's risk
limits be based on any specific or mandated analysis, as required under
the 2013 final rule. Rather, a banking entity would establish the risk
limits according to its own internal analyses and processes around
conducting its market making activities in accordance with section
13(d)(1)(B).\115\
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\114\ Under the proposal, banking entities with significant
trading assets and liabilities would continue to be required to
establish internal risk limits for each trading desk as part of the
market making compliance program requirement in Sec.
__.4(b)(2)(iii)(C), the elements of which would cross-reference
directly to the requirement in proposed Sec. __.4(b)(6)(i). Banking
entities without significant trading assets and liabilities would no
longer be required to establish a compliance program that is
specific for the purposes of complying with the exemption for market
making-related activity, but would need to establish and implement,
maintain, and enforce these limits if they chose to utilize the
proposed presumption of compliance with respect to the statutory
RENTD requirement in section 13(d)(1)(B) of the BHC Act.
\115\ The Agencies expect that the risk and position limits
metric that is already required for certain banking entities under
the 2013 final rule (and would continue to be required under the
Appendix to the proposal) would help banking entities and the
Agencies to manage and monitor the market making activities of
banking entities subject to the metrics reporting and recordkeeping
requirements of the Appendix. See infra Part III.E.2.i.i.
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The proposal would require a banking entity to promptly report to
the appropriate Agency when a trading desk exceeds or increases its
internal risk limits. A banking entity would also be required to report
to the appropriate Agency any temporary or permanent increase in an
internal risk limit. In the case of both reporting requirements (i.e.,
notice of an internal risk limit being exceeded and notice of an
increase to the limit), the notice would be submitted in the form and
manner as directed by the applicable Agency.
As noted, a banking entity would not be required to adhere to any
specific, pre-defined requirements for the limit-setting process beyond
the banking entity's own ongoing and internal assessment of the amount
of activity that is required to conduct market making activity,
including to reflect the banking entity's ongoing and internal
assessment of the reasonably expected near term demands of clients,
customers, or counterparties. The proposal would, however, provide that
internal risk limits established by a banking entity shall be subject
to review and oversight by the appropriate Agency on an ongoing basis.
Any review of such limits would assess whether or not those limits are
established based on the statutory standard--i.e., the trading desk's
reasonably expected near term demands of clients, customers, or
counterparties on an ongoing basis, based on the nature and amount of
the trading desk's market making-related activities. So long as a
banking entity has established and implements, maintains, and enforces
such limits, the proposal would presume that all trading activity
conducted within the limits meets the requirements that the market
making activity be based on the reasonably expected near term demands
of clients, customers, or counterparties. The Agencies would expect to
closely monitor and review any instances of a banking entity exceeding
a risk limit as well as any temporary or permanent increase to a
trading desk limit.
Under the proposal, the presumption of compliance for permissible
market making-related activities may be rebutted by the Agency if the
Agency determines, based on all relevant facts and circumstances, that
a trading desk is engaging in activity that is not based on the trading
desk's reasonably expected near term demands of clients, customers, or
counterparties on an ongoing basis. The Agency would provide notice of
any such determination to the banking entity in writing.
The following is an example of the presumption of compliance for
permissible market making-related activities. A transport company
customer may seek to hedge its long-term exposure to price fluctuations
in fuel by asking a banking entity to create a structured ten-year fuel
swap with a notional amount of $1 billion because there is no liquid
market for this type of swap. A trading desk at the banking entity that
makes a market in energy swaps may respond to this customer's hedging
needs by executing a custom fuel swap with the customer. If the risk
resulting from activities related to the transaction does not exceed
the internal risk limits for the trading desk that makes a market in
energy swaps, the banking entity shall be presumed to be engaged in
permissible market making-related activity that is designed not to
exceed, on an ongoing basis, the reasonably expected near term demands
of clients, customers, or counterparties. Moreover, if assuming the
position would result in an exposure exceeding the trading desk's
limits, the banking entity could increase the risk limit in accordance
with its internal policies and procedures for reviewing and increasing
risk limits so long as the increase was consistent with meeting the
reasonably expected near term demands of clients, customers, and
counterparties.
The Agencies request comment on the proposed addition of a
presumption that trading within internally set risk limits satisfies
the statutory requirement that permitted market making-related
activities be designed not to exceed the reasonably expected near-term
demands of clients, customers, or counterparties. In particular, the
Agencies request comment on the following questions:
Question 82. Is the proposed presumption of compliance for
transactions that are within internally set risk limits sufficiently
clear? If not, what changes would further clarify the rule? Is there
another approach that would be more appropriate?
Question 83. Would the proposed approach--namely the reliance on
internally set limits based on RENTD--adequately eliminate the need for
a definition for ``market maker inventory?'' Why or why not?
Question 84. How would the proposed approach, as it relates to the
establishment and reliance on internal trading limits, impact the
liquidity of particular markets?
Question 85. How would the proposed approach, as it relates to the
establishment and reliance on internal trading limits, impact the
underlying objectives of section 13 of the BHC Act and the 2013 final
rule? For example, how should the Agencies assess internal trading
limits and any changes in them?
Question 86. By proposing an approach that permits banking entities
to rely on internally set limits to comply
[[Page 33461]]
with the statutory RENTD requirement, the rule would no longer
expressly require firms to, among other things, conduct a 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.
Do commenters agree with the revised approach? What are the costs and
benefits of eliminating these requirements?
Question 87. Would the market making exemption, as proposed,
present any problems for a trading desk that makes a market in
derivatives? Are there any changes the Agencies could make to the
proposal to clarify how the market making exemption applies to trading
desks that make a market in derivatives?
Question 88. Would the proposal's approach to permissible market
making-related activities effectively implement the statutory
exemption? Why or why not? Would this approach improve the ability of
banking entities to engage in market making relative to the 2013 final
rule? If not, what approach would be better? Please explain.
Question 89. Does the proposed reliance on using a trading desk's
internal risk limits to comply with the statutory RENTD requirement in
section 13(d)(1)(B) of the BHC Act present opportunities to evade the
overall prohibition on proprietary trading? If so, how? Please be as
specific as possible. Additionally, please provide any changes to the
proposal that might address such potential circumvention.
Alternatively, please explain whether the proposal to rely on a trading
desk's internal risk limits to comply with the statutory RENTD
requirement would present opportunities to evade the prohibition on
proprietary trading.
Question 90. Do banking entities require greater clarity about how
to set their internal risk limits for permissible market making-related
activity? If so, what additional information would be useful? Please
explain.
Question 91. Should any additional guidance or information be
provided to explain the process and standard by which the Agencies
could rebut the presumption of permissible market making, including
specific subject areas that could be addressed in such guidance (e.g.,
criteria used as the basis for a rebuttal, the rebuttal process, etc.)?
If so, please explain.
Question 92. Are there other modifications to the 2013 final rule's
requirements for permitted market making that would improve the
efficiency of the rule's requirements while adhering to the statutory
requirement that such activity be designed not to exceed the reasonably
expected near term demands of clients, customers, and counterparties?
If so, please describe these modifications as well as how they would
improve the efficiency of the rule and meet the statutory standard.
Question 93. Under the proposed presumption of compliance for
permissible market making-related activities, banking entities would be
required to notify the appropriate Agency when a trading limit is
exceeded or increased (either on a temporary or permanent basis), in
each case in the form and manner as directed by each Agency. Is this
requirement sufficiently clear? Should the Agencies provide greater
clarity about the form and manner for providing this notice? Should
those notices be required to be provided ``promptly'' or should an
alternative timeframe apply? Alternatively, should each Agency
establish its own deadline for when these notices should be provided?
Please explain.
Question 94. Should the Agencies instead establish a uniform method
of reporting when a trading desk exceeds or increases an internal risk
limit (e.g., a standardized form)? Why or why not? If yes, please
provide as much detail as possible. If not, please describe any
impediments or costs to implementing a uniform notification process and
explain why such a system may not be efficient or might undermine the
effectiveness of the proposed notification requirement.
Question 95: Should the Agencies implement an alternative reporting
methodology for notifying the appropriate Agency when a trading limit
is exceeded or increased that would apply solely in the case of a
banking entity's obligation to report such occurrences to a market
regulator? For example, instead of an affirmative notice requirement,
should such banking entity instead be required to make and keep a
detailed record of each instance as part of its books and records, and
to provide such records to SEC or CFTC staff promptly upon request or
during an examination? Why or why not? As an additional alternative,
should banking entities be required to escalate notices of limit
exceedances or changes internally for further inquiry and determination
as to whether notice should be given to the applicable market
regulator, using objective factors provided by the rule? Why or why
not? If such an approach would be more appropriate, what objective
factors should be used to determine when notice should be given to the
applicable regulator? Please be as specific as possible.
Question 96. Should the Agencies specify notice and response
procedures in connection with an Agency determination that the
presumption pursuant to Sec. __.4(b)(6)(iv) is rebutted? Why or why
not? If so, what type of procedures should they specify? For example,
should the notice and response procedures be similar to those in Sec.
__.3(g)(2)? If not, what other approach would be appropriate?
f. Compliance Program and Other Requirements
The market making exemption in the 2013 final rule requires that a
banking entity establish and implement, maintain, and enforce a
compliance program, as required by subpart D, that is reasonably
designed to ensure compliance with the requirements of the exemption.
Such a compliance program is required to include reasonably designed
written policies and procedures, internal controls, analysis, and
independent testing identifying and addressing: (i) The financial
instruments each trading desk stands ready to purchase and sell in
accordance with the exemption for market making-related activities;
(ii) the actions the trading desk will take to demonstrably reduce or
otherwise significantly mitigate the risks of its financial exposure
consistent with the limits required under paragraph (b)(2)(iii)(C), the
products, instruments, and exposures each trading desk may use for risk
management purposes; the techniques and strategies each trading desk
may use to manage the risks of its market making-related activities and
inventory; and the process, strategies, and personnel responsible for
ensuring that the actions taken by the trading desk to mitigate these
risks are and continue to be effective; (iii) limits for each trading
desk, based on the nature and amount of the trading desk's market
making activities, including the reasonably expected near term demands
of clients, customers, or counterparties; (iv) internal controls and
ongoing monitoring and analysis of each trading desk's compliance with
its limits; and (v) authorization procedures, including escalation
procedures that require review and approval of any trade that would
exceed one or more of a trading desk's limits, demonstrable analysis of
the basis for any temporary or permanent increase to one or more of a
trading desk's limits, and independent review (i.e., by risk managers
and compliance officers at the appropriate
[[Page 33462]]
level independent of the trading desk) of such demonstrable analysis
and approval.
Banking entities and others have stated that the compliance program
requirements of the market making exemption can be overly complex and
burdensome. The Agencies generally believe the compliance program
requirements play an important role in facilitating and monitoring a
banking entity's compliance with the exemption. However, with the
benefit of time and experience, the Agencies believe it is appropriate
to tailor those requirements to the scope of the market making-related
activities conducted by each banking entity.
Specifically, the Agencies are proposing a tiered approach to the
market making exemption's compliance program requirements so as to make
them commensurate with the size, scope, and complexity of the relevant
banking entity's activities and business structure. Consistent with the
2013 final rule, a banking entity with significant trading assets and
liabilities would continue to be required to establish, implement,
maintain, and enforce a comprehensive internal compliance program as a
condition for relying on the market making exemption. However, the
Agencies propose to eliminate the exemption's compliance program
requirements for banking entities that have moderate or limited trading
assets and liabilities.\116\
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\116\ Under the 2013 final rule, the compliance program
requirement in Sec. __.4(b)(2)(iii) is part of the compliance
program required by subpart D, but is specifically used for purposes
of complying with the exemption for market making-related activity.
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The proposed removal of the exemption's compliance program
requirements for banking entities that do not have significant trading
assets and liabilities would not relieve those banking entities of the
obligation to comply with the prohibitions on proprietary trading, and
the other requirements of the exemption for market making-related
activities, as set forth in section 13 of the BHC Act and the 2013
final rule, both as currently written and as proposed to be amended.
However, eliminating the compliance program requirements as a condition
to being able to rely on the market making exemption should provide
these banking entities that do not have significant trading assets and
liabilities an appropriate amount of flexibility to tailor the means by
which they seek to ensure compliance with the underlying requirements
of the exemption for market making-related activities, and to allow
them to structure their internal compliance measures in a way that
takes into account the risk profile and market making activity of the
particular trading desk.
As noted in the discussion pertaining to the underwriting
exemption,\117\ banking entities that do not have significant trading
assets and liabilities can incur significant costs to establish,
implement, maintain, and enforce the compliance program requirements
contained in the 2013 final rule. In some instances, those costs may be
disproportionate to the banking entity's trading activity and risk.
Accordingly, eliminating the compliance program requirements for
banking entities that do not have significant trading assets and
liabilities may reduce costs that are passed on to investors and
increase liquidity without materially impacting the rule's ability to
ensure that the objectives set forth in section 13 of the BHC Act are
satisfied.\118\
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\117\ See supra Part III.B.2 of this SUPPLEMENTARY INFORMATION
section.
\118\ Under the proposal, the compliance program requirements
that are specific for the purposes of complying with the exemption
for market making-related activities in Sec. __.4(b) would remain
unchanged for banking entities with significant trading assets and
liabilities, although the requirements related to limits for each
trading desk would be moved (but not modified) into new Sec.
__.4(b)(6)(i) as part of the proposed presumption of compliance.
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The Agencies request comment on the proposed revisions to the
exemption for market making-related activities compliance program
requirement. In particular, the Agencies request comment on the
following questions:
Question 97. Would the proposed tiered compliance approach based on
a banking entity's trading assets and liabilities appropriately balance
the costs and benefits for banking entities that do not have
significant trading assets and liabilities? Why or why not?
Question 98. Should the Agencies make specific changes to simplify
and streamline the compliance requirements of the exemption for market
making-related activities for banking entities with significant trading
assets and liabilities? If so, how?
Question 99. Do commenters agree with the proposal to have the
market making exemption specific compliance program requirements apply
only to banking entities with significant trading assets and
liabilities? Why or why not?
Question 100. In addition to the proposed changes to the market
making exemption, are there any technical corrections the Agencies
should make to Sec. __.4(b), such as to eliminate redundant or
duplicative language or to correct or refine certain cross-references?
If so, please explain.
g. Loan-Related Swaps
The Agencies have received inquiries--typically from smaller
banking entities that are not subject to the market risk capital rule
and are not required to register as dealers--as to the treatment of
certain swaps entered into with a customer in connection with a loan
(``loan-related swap'').\119\ These loan-related swaps are financial
instruments under the 2013 final rule and would also be financial
instruments under the proposal. In addition, if the proposed accounting
prong of the trading account definition is adopted, any derivative
transaction would constitute proprietary trading pursuant to the
definition of ``trading account'' if it were recorded at fair value on
a recurring basis under applicable accounting standards. The Agencies
believe it is likely that loan-related swaps would be considered
proprietary trading on this basis. Accordingly, for the transaction to
be permissible, a banking entity would need to rely on an applicable
exclusion from the definition of proprietary trading or exemption in
the implementing regulations.
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\119\ In the case of national banks, a loan-related swap is
considered to be a customer-driven derivatives transaction. See 12
U.S.C 24 (Seventh). See also OCC, Activities Permissible for
National Banks and Federal Savings Associations, Cumulative (Oct.
2017), available at https://www.occ.gov/publications/publications-by-type/other-publications-reports/pub-other-activities-permissible-october-2017.pdf.
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In a loan-related swap transaction, a banking entity enters into a
swap with a customer in connection with a customer's loan and
contemporaneously offsets the swap with a third party. The swap with
the loan customer is directly related to the terms of the customer's
loan, such as a term loan, revolving credit facility, or other
extension of credit. A common example of a loan-related swap begins
with a banking entity offering a loan to a customer. The banking entity
seeks to make a floating-rate loan to reduce interest rate risk, but
the customer would prefer a fixed-rate loan. To achieve the desired
result, the banking entity makes a floating-rate loan to the customer
and contemporaneously or nearly contemporaneously enters into an
interest rate swap with the same customer and an offsetting swap with
another counterparty. As a result, the customer receives economics
similar to a fixed-rate loan. The banking entity has offset its market
risk associated with the customer-facing swap but retains counterparty
risk from both swaps.
The inquiries received by the Agencies have asked whether the loan-
related swap and the offsetting hedging swap would be permissible under
the
[[Page 33463]]
exemption for market making related activities.\120\ In particular,
some banking entities enter into these swaps relatively infrequently
and, as a result, have asked whether such activity could satisfy the
requirement of the exemption in the 2013 final rule that the trading
desk using the exemption routinely stands ready to purchase and sell
the relevant type of financial instrument, in commercially reasonable
amounts and throughout market cycles on a basis appropriate for the
liquidity, maturity, and depth of the market for the type of financial
instrument.\121\
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\120\ The Agencies note that ``market making'' for purposes of
the 2013 final rule, including for this proposal, is limited to the
context of the 2013 final rule and is not applicable to any other
rule, the federal securities laws, or in any other context outside
of the 2013 final rule.
\121\ See 2013 final rule Sec. __.4(b)(2)(i); 79 FR at 5595-
5597.
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The Agencies understand that a banking entity's decision to enter
into loan-related swaps tends to be situational and dependent on
changes in market conditions, as well as the interaction of a number of
factors specific to the banking entity, such as the nature of the
customer relationship. Under certain market conditions and with certain
types of customers, the frequency and use of loan-related swaps may be
infrequent, or the frequency may change over time as conditions change.
It also may be the case that a banking entity, particularly smaller
banking entities, may enter into a limited number of loan-related swaps
in one quarter and then not execute another such swap for a year or
more. Accordingly, for these swaps it may be appropriate to apply the
market making exemption by focusing on the characteristics of the
relevant market. For purposes of the exemption, the relevant market may
be a market with minimal demand, such as a market with a customer base
that demands, for example, only a few loan-related swaps in a
year.\122\ The Agencies therefore request comment as to whether it is
appropriate to permit loan-related swaps to be conducted pursuant to
the exemption for market making-related activities where the frequency
with which a banking entity executes such swaps is minimal, but the
banking entity remains prepared to execute such swaps when a customer
makes an appropriate request.\123\ For example, a banking entity could
meet the requirement to routinely stand ready to make a market in loan-
related swaps in the context of its customer base and the relevant
market if it is willing and available to engage in loan-related swap
transactions with its loan customers to meet the customers' needs in
respect of one or more loans entered into with such banking entity
throughout market cycles and as such customers' needs change.
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\122\ See, e.g., 79 FR at 5596 (``. . . 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.'') (emphasis
added).
\123\ The Agencies understand that, for the reasons described in
this section, loan-related swaps present a particular challenge for
smaller banking entities that are neither subject to the market risk
rule nor registered as dealers. On the other hand, such swaps
typically do not present the same challenges for banking entities
that are subject to the market risk rule or are registered as
dealers because the availability of the market-making exemption is
apparent.
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In addition, the Agencies note that a banking entity may also
infrequently enter into loan-related swaps in both directions because
of how those swaps are commonly used by market participants. For
example, providing a floating to fixed swap is common in connection
with a floating rate loan (as described in the example above), but the
reverse (i.e., seeking to convert from a fixed rate to a floating rate)
is much less common. Accordingly, the Agencies request comment on
whether loan-related swaps should be permitted under the market-making
exemption if the banking entity stands ready to make a market in both
directions whenever a customer makes an appropriate request, but in
practice primarily makes a market in the swaps in one direction because
of how the swaps are used.\124\
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\124\ This section's focus on market making is provided solely
for purpose of the proposal's implementation of section 13 of the
BHC Act and does not affect a banking entity's obligation to comply
with additional or different requirements under applicable
securities, derivatives, banking, or other laws.
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The Agencies are also considering whether it would be appropriate
to exclude loan-related swaps from the definition of proprietary
trading for some banking entities or to permit the activity pursuant to
an exemption from the prohibition on proprietary trading other than
market making. For example, possible additions or alternatives could
include a new exclusion in Sec. __.3(d) or a new exemption in Sec.
__.6 pursuant to the Agencies' exemptive authority under section
13(d)(1)(J) of the BHC Act. In particular, the Agencies request comment
regarding a specific option that would add an exclusion in Sec.
__.3(d), which would specify that ``proprietary trading'' under Sec.
__3 does not include the purchase or sale of related swaps by a banking
entity in a transaction in which the banking entity purchases (or
sells) a swap with a customer and contemporaneously sells (or
purchases) an offsetting derivative in connection with a loan or open
credit facility between the banking entity and the customer, if the
rate, asset, liability or other notional item underlying the swap with
the customer is, or is directly related to, a financial term of the
loan or open credit facility with the customer (including, without
limitation, the loan or open credit facility's duration, rate of
interest, currency or currencies, or principal amount) and the
offsetting swap is designed to reduce or otherwise significantly
mitigate one or more specific, identifiable risks of the swap(s) with
the customer.
In considering any of these alternatives, the Agencies request
comment on what parameters would be appropriate for the exclusion or
exemption and what conditions should be considered to address any
concerns about whether such an exclusion or exemption could be too
broad.
Question 101. Is it appropriate to treat loan-related swaps as
permissible under the market making exemption if a banking entity
stands ready to enter into such swaps upon request by a customer, but
enters into such swaps on an infrequent basis due to the nature of the
demand for such swaps? Why or why not?
Question 102. Should a banking entity standing ready to transact in
either direction on behalf of customers in such swaps be eligible for
the market making exemption if, as a practical matter, it more
frequently encounters demand on one side of the market and less
frequently encounters demand on the other side for such products? Why
or why not?
Question 103. Is the scenario described above for the treatment of
loan-related swaps workable? If not, why not? Are there alternative
approaches that would be more effective and consistent with the
statute?
Question 104. Should the Agencies exclude loan-related swaps from
the definition of proprietary trading under Sec. __.3? Would including
loan-related swaps within the definition of the ``trading account'' or
``proprietary trading'' be consistent with the statutory definition of
trading account? Why or why not?
Question 105. In the alternative, should the Agencies provide an
exclusion for such loan-related swaps under Sec. __.6? What would be
the benefits or drawbacks of each approach? How would permitting such
loan-related swaps pursuant to the Agencies' authority under section
13(d)(1)(J) of the BHC Act promote and protect the safety and soundness
of banking entities and
[[Page 33464]]
the financial stability of the United States? If an exclusion or
permitted activity is adopted, should the Agencies limit which banking
entities may use the exclusion or permitted activity, and what
conditions, if any, should be placed on the types, volume, or other
characteristics of the loan-related swaps and the related activity?
Question 106. How should loan-related swaps be defined? What
parameters should be used to assess which swaps meet the definition?
Question 107. Should other types of swaps also be addressed in the
same manner? For example, should the Agencies provide further guidance,
or include in any exclusion or exemption other end-user customer driven
swaps used by the customer to hedge commercial risk?
h. Market Making Hedging
During implementation of the 2013 final rule, the Agencies received
a number of inquiries regarding the circumstances under which banking
entities could elect to comply with market making risk management
provisions permitted in Sec. __.4(b) or alternatively the risk-
mitigating hedging requirements under Sec. __.5. These inquiries
generally related to whether a trading desk could treat an affiliated
trading desk as a client, customer, or counterparty for purposes of the
market making exemption's RENTD requirement; and whether, and under
what circumstances, one trading desk could undertake market making risk
management activities for one or more other trading desks.
Each trading desk engaging in a transaction with an affiliated
trading desk that meets the definition of proprietary trading must rely
on one of the exemptions of section 13 of the BHC Act and the 2013
final rule in order for the transaction to be permissible. In one
example presented to the Agencies, one trading desk of a banking entity
may make a market in a certain financial instrument (e.g., interest
rate swaps), and then transfer some of the risk of that instrument
(e.g., foreign exchange (``FX'') risk) to a second trading desk (e.g.,
an FX swaps desk) that may or may not separately engage in market
making-related activity. The Agencies request comment as to whether, in
such a scenario, the desk taking the risk (in the preceding example,
the FX swaps desk) and the market making desk (in the preceding
example, the interest rate desk) should be permitted to treat each
other as a client, customer, or counterparty for purposes of
establishing risk limits or reasonably expected near-term demand levels
under the market making exemption.
The Agencies also request comment as to whether each desk should be
permitted to treat swaps executed between the desks as permitted market
making-related activities of one or both desks if the swap does not
cause the relevant desk to exceed its applicable limits and if the swap
is entered into and maintained in accordance with the compliance
requirements applicable to the desk, without treating the affiliated
desk as a client, customer, or counterparty for purposes of
establishing or increasing its limits. This approach would be intended
to maintain appropriate limits on proprietary trading by not permitting
an expansion of a trading desk's market making limits based on internal
transactions. At the same time, this approach would be intended to
permit efficient internal risk management strategies within the limits
established for each desk. The Agencies are also requesting comment on
the circumstances in which an organizational unit of an affiliate
(``affiliated unit'') of a trading desk engaged in market making-
related activities in compliance with Sec. __.4(b) (``market making
desk'') would be permitted to enter into a transaction with the market
making desk in reliance on the market making risk management exemption
available to the market making desk. In this scenario, to effect such
reliance the market making desk would direct the affiliated unit to
execute a risk-mitigating transaction on the market making desk's
behalf. If the affiliated unit does not independently satisfy the
requirements of the market making exemption with respect to the
transaction, it would be permitted to rely on the market making
exemption available to the market making desk for the transaction if:
(i) The affiliated unit acts in accordance with the market making
desk's risk management policies and procedures established in
accordance with Sec. __.4(b)(2)(iii); and (ii) the resulting risk
mitigating position is attributed to the market making desk's financial
exposure (and not the affiliated unit's financial exposure) and is
included in the market making desk's daily profit and loss calculation.
If the affiliated unit establishes a risk-mitigating position for the
market making desk on its own accord (i.e., not at the direction of the
market making desk) or if the risk-mitigating position is included in
the affiliated unit's financial exposure or daily profit and loss
calculation, then the affiliated unit may still be able to comply with
the requirements of the risk-mitigating hedging exemption pursuant to
Sec. __.5 for such activity.
The Agencies request comment on the issues identified above. In
particular, the Agencies request comment on the following questions:
Question 108. Should the Agencies clarify the ability of banking
entities to engage in hedging transactions directly related to market
making positions, including multi-desk market making hedging,
regardless of which desk undertakes the hedging trades?
Question 109. Have banking entities found that certain restrictions
on market making hedging activities under the final rule impede the
ability of banking entities to effectively and efficiently engage in
such hedging transactions? If so, what specific requirements have
proved to be the most problematic?
Question 110. How effective are the existing restrictions on market
making hedging activities at reducing risks within a banking entity's
investment portfolio? Please explain.
Question 111. Should the Agencies permit banking entities to
include affiliate hedging transactions in determining the reasonably
expected near-term demand of customers, clients, and counterparties,
and in establishing internal risk limits? Why or why not?
Question 112. Would the changes separately proposed to Sec. __.5
of the 2013 final rule, or other changes to Sec. __.5, eliminate the
need for the additional interpretations described above, for example,
because a banking entity could more easily conduct these activities in
accordance with the requirements of Sec. __.5?
3. Section __.5: Permitted Risk-Mitigating Hedging Activities
a. Section __.5 of the 2013 Final Rule
Section 13(d)(1)(C) provides an exemption for risk-mitigating
hedging activities that are designed to reduce the specific risks to a
banking entity in connection with and related to individual or
aggregated positions, contracts, or other holdings. Section _.5 of the
2013 final rule implements section 13(d)(1)(C) of the BHC Act.
Section __.5 of the 2013 final rule provides a multi-faceted
approach to implementing the hedging exemption to ensure that hedging
activity is designed to be risk-reducing and does not mask prohibited
proprietary trading. Risk-mitigating hedging activities must comply
with certain conditions for those activities to qualify for the
exemption. Generally, a banking entity relying on the hedging exemption
must have in place an appropriate internal
[[Page 33465]]
compliance program that meets specific requirements to support its
compliance with the terms of the exemption, and the compensation
arrangements of persons performing risk-mitigating hedging activities
must be designed not to reward or incentivize prohibited proprietary
trading.\125\ In addition, the hedging activity itself must meet
specified conditions; for example, at inception, it must be designed to
reduce or otherwise significantly mitigate and must demonstrably reduce
or otherwise significantly mitigate one or more specific, identifiable
risks arising in connection with and related to identified positions,
contracts, or other holdings of the banking entity, and the activity
must not give rise to any significant new or additional risk that is
not itself contemporaneously hedged.\126\ Finally, Sec. __.5
establishes certain documentation requirements with respect to the
purchase or sale of financial instruments made in reliance of the risk-
mitigating exemption under certain circumstances.\127\
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\125\ See 2013 final rule Sec. __.5(b)(1) and (3).
\126\ See 2013 final rule Sec. __.5(b)(2).
\127\ See 2013 final rule Sec. __.5(c).
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b. Proposed Amendments to Section __.5
i. Correlation Analysis for Section __.5(b)(1)(iii)
Section __.5(b)(1)(iii) of the 2013 final rule requires a
correlation analysis as part of the broader analysis of whether a
hedging position, technique, or strategy (1) may reasonably be expected
to reduce or otherwise significantly mitigate the specific risks being
hedged, and (2) demonstrably reduces or otherwise significantly
mitigates the specific risks being hedged.
In adopting the 2013 final rule, the Agencies indicated that they
expected the banking entity to undertake a correlation analysis that
will 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. 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
sufficient correlation cannot be demonstrated, then the Agencies
expected that such analysis would explain why not and also how the
proposed hedging position, technique, or strategy was designed to
reduce or significantly mitigate risk and how that reduction or
mitigation can be demonstrated.
In the course of implementing Sec. __.5 of the 2013 final rule,
the Agencies have become aware of practical difficulties with the
correlation analysis requirement. In particular, banking entities have
communicated that the correlation analysis requirement can add delays,
costs, and uncertainty, and have questioned the extent to which the
required correlation analysis helps to ensure the accuracy of hedging
activity or compliance with the requirements of section 13 of the BHC
Act.
During implementation, the Agencies have observed that a banking
entity may sometimes develop or modify its hedging activities as the
risks it seeks to hedge are occurring, and the banking entity may not
have enough time to undertake a complete correlation analysis before it
needs to put the hedging transaction in place to fully hedge against
the risks as they arise. In other cases, the hedging activity, while
designed to reduce risk as required by the statute, may not be
practical if delays or compliance costs resulting from undertaking a
correlation analysis outweigh the benefits of performing the analysis.
In addition, the extent to which two activities are correlated and will
remain correlated into the future can vary significantly from one
position, strategy, or technique to another. Assessing whether a
particular hedge is sufficiently correlated to satisfy the correlation
requirement of Sec. __.5(b)(1)(iii) may be difficult, especially if
that assessment must be justified after the hedge is entered into (when
information that may not have been available earlier may become
relevant). Given this uncertainty, banking entities may be hesitant to
undertake a risk-mitigating hedge out of concern of inadvertently
violating the regulation because the hedge did not satisfy one of the
requirements.
Based on the implementation experience of the Agencies and public
feedback, the Agencies are proposing to remove the correlation analysis
requirement for risk-mitigating hedging activities. The Agencies
anticipate that removing this correlation analysis requirement would
avoid the uncertainties described above without significantly impacting
the conditions that risk-mitigating hedging activities must meet in
order to qualify for the exemption. The Agencies also note that section
13 of the BHC Act does not specifically require this correlation
analysis. Instead, the statute only provides that a hedging position,
technique, or strategy is permitted so long as it is ``. . . designed
to reduce the specific risks to the banking entity . . .'' \128\ The
2013 final rule added the correlation analysis requirement as a measure
intended to ensure compliance with this exemption.
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\128\ 12 U.S.C. 1851(d)(1)(C).
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ii. Hedge Demonstrably Reduces or Otherwise Significantly Mitigates
Specific Risks for Section __.5(b)(2)(iv)(B)
Similarly, the requirement in Sec. __.5(b)(2)(iv)(B) that a risk-
mitigating hedging activity demonstrably reduces or otherwise
significantly mitigates specific risks is not directly required by
section 13(d)(1)(C) of the BHC Act. As noted above, the statute instead
requires that the hedge be designed to reduce or otherwise
significantly mitigate specific risks. The Agencies believe that this
is effective for addressing the relevant risks.
In practice, it appears that the requirement to show that hedging
activity demonstrably reduces or otherwise significantly mitigates a
specific, identifiable risk that develops over time can be complex and
could potentially reduce bona fide risk-mitigating hedging activity.
The Agencies recognize that in some circumstances, it may be difficult
for banking entities to know with sufficient certainty that a potential
hedging activity being considered will continuously demonstrably reduce
or significantly mitigate an identifiable risk after it is implemented.
For example, unforeseeable changes in market conditions, event risk,
sovereign risk, and other factors that cannot be known in advance could
reduce or eliminate the otherwise intended hedging benefits. In these
events, it would be very difficult, if not impossible, for a banking
entity to comply with the continuous requirement to demonstrably reduce
or significantly mitigate the identifiable risks. In such cases, a
banking entity may determine not to enter into what would otherwise be
an effective hedge of foreseeable risks out of concern that the banking
entity may not be able to effectively comply with the continuing
hedging or mitigation requirement if unforeseen risks occur. Therefore,
the proposal would remove the ``demonstrably reduces or otherwise
significantly mitigates'' specific risk requirement from Sec.
__.5(b)(1)(iv)(B).\129\
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\129\ For the same reasons, the Agencies are proposing to revise
Sec. __.13(a) of the 2013 final rule (relating to permitted risk-
mitigating hedging activities involving acquisition or retention of
an ownership interest in a covered fund) to remove the references to
covered fund ownership interests acquired or retained by the banking
entity ``demonstrably'' reducing or otherwise significantly
mitigating the specific, identifiable risks to the banking entity
described in that section.
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[[Page 33466]]
iii. Reduced Compliance Requirements for Banking Entities that do not
have Significant Trading Assets and Liabilities for Section __.5(b) and
(c)
Consistent with the proposed changes relating to the scope of the
requirements for banking entities that do not have significant trading
assets and liabilities, the Agencies have reassessed the requirements
in Sec. __.5(b) and Sec. __.5(c) for banking entities that do not
have significant trading assets and liabilities. For these firms, the
Agencies are proposing to eliminate the requirements for a separate
internal compliance program for risk-mitigating hedging under Sec.
__.5(b)(1); certain of the specific requirements of Sec. __.5(b)(2);
the limits on compensation arrangements for persons performing risk-
mitigating activities in Sec. __.5(b)(3); and the documentation
requirements for those activities in Sec. __.5(c). These requirements
are overly burdensome and complex for banking entities with moderate
trading assets and liabilities. In general, the Agencies expect that
banking entities without significant trading assets and liabilities are
less likely to engage in the types of trading activities and hedging
strategies that would necessitate these additional compliance
requirements.
Given these considerations, it appears that removing the
requirements for banking entities that do not have significant trading
assets and liabilities to comply with the requirements of Sec. __.5(b)
and Sec. __.5(c) is unlikely to materially increase risks to the
safety and soundness of the banking entity or U.S. financial stability.
Therefore, the Agencies are proposing to eliminate and modify these
requirements for banking entities that do not have significant trading
assets and liabilities. In place of those requirements, new Sec.
__.5(b)(2) of the proposal would require that risk-mitigating hedging
activities for those banking entities be: (i) At the inception of the
hedging activity (including any adjustments), designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks, including the risks specifically enumerated in the proposal; and
(ii) subject to ongoing recalibration, as appropriate, to ensure that
the hedge remains designed to reduce or otherwise significantly
mitigate one or more specific, identifiable risks. The Agencies
anticipate that these tailored requirements for banking entities
without significant trading assets and liabilities would effectively
implement the statutory requirement that the hedging transactions be
designed to reduce specific risks the banking entity incurs. In
connection with these proposed changes, the proposal also includes
conforming changes to Sec. __.5(b)(1) and Sec. __.5(c) of the final
2013 rule to make the requirements of those sections applicable only to
banking entities that have significant trading assets and liabilities.
iv. Reduced Documentation Requirements for Banking Entities That Have
Significant Trading Assets and Liabilities for Section __.5(c)
Section __.5(c) of the 2013 final rule requires enhanced
documentation for hedging activity conducted under the risk-mitigating
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.\130\ The 2013 final rule also requires enhanced
documentation for hedges established to hedge aggregated positions
across two or more desks. The 2013 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 2013 final rule
provides that the documentation requirements in Sec. __.5(c) apply if
a trading desk is hedging aggregated positions that include positions
from more than one trading desk.\131\
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\130\ See 2013 final rule Sec. __.5(c)(1)(i).
\131\ See 2013 final rule Sec. __.5(c)(1)(iii)
---------------------------------------------------------------------------
The 2013 final rule also requires 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 hedge is 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.\132\ The Agencies note that
this documentation requirement does not apply to hedging activity
conducted by a trading desk in connection with the market making-
related 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.
---------------------------------------------------------------------------
\132\ See 2013 final rule Sec. __.5(c)(1)(ii)
---------------------------------------------------------------------------
For banking entities that have significant trading assets and
liabilities, the proposal would retain the enhanced documentation
requirements for the hedging transactions identified in Sec.
__.5(c)(1) to permit evaluation of the activity. While this
documentation requirement results in certain more extensive compliance
efforts (as acknowledged by the Agencies when the 2013 final rule was
adopted),\133\ the Agencies continue to believe this requirement serves
an important role to prevent evasion of the requirements of section 13
of the BHC Act and the 2013 final rule.
---------------------------------------------------------------------------
\133\ 79 FR at 5638-39.
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However, based on the Agencies' experience during the first several
years of implementation of the 2013 final rule, it appears that many
hedges established by one trading desk for other affiliated desks are
often part of common hedging strategies that are used repetitively. In
those instances, the regulatory purpose for the documentation
requirements of Sec. __.5(c) of the 2013 final rule, to permit
subsequent evaluation of the hedging activity and prevent evasion, is
much less relevant. In weighing the significantly reduced regulatory
and supervisory relevance of additional documentation of common hedging
trades against the complexity of complying with the enhanced
documentation requirements, it appears that the documentation
requirements are not necessary in those instances. Reducing the
documentation requirement for common hedging activity undertaken in the
normal course of business for the benefit of one or more other trading
desks would also make beneficial risk-mitigating activity more
efficient and potentially improve the timeliness of important risk-
mitigating hedging activity, the effectiveness of which can be time
sensitive.
Accordingly, the Agencies are proposing a new paragraph (c)(4) in
Sec. __.5 that would eliminate the enhanced documentation requirement
for hedging activities that meets certain conditions. In excluding a
trading desk's common hedging instruments from the enhanced
documentation requirements in Sec. __.5(c), the Agencies seek to
distinguish those financial instruments that are commonly used for
hedging activities and require the banking entity to have in place
appropriate limits so that less common or unusual levels of hedging
activity would still be subject to
[[Page 33467]]
the enhanced documentation requirements. Accordingly, the proposal
would provide that compliance with the enhanced documentation
requirement would not apply to purchases and sales of financial
instruments for hedging activities that are identified on a written
list of financial instruments pre-approved by the banking entity that
are commonly used by the trading desk for the specific types of hedging
activity for which the financial instrument is being purchased or sold.
In addition, under the proposal, at the time of the purchase or sale of
the financial instruments, the related hedging activity would need to
comply with written, pre-approved hedging limits for the trading desk
purchasing or selling the financial instrument, which would be required
to be appropriate for the size, types, and risks of the hedging
activities commonly undertaken by the trading desk; the financial
instruments purchased and sold by the trading desk for hedging
activities; and the levels and duration of the risk exposures being
hedged. These conditions on the pre-approved limits are intended to
provide clarity as to the types and characteristics of the limits
needed to comply with the proposal. The Agencies would expect that a
banking entity's pre-approved limits should be reasonable and set to
correspond to the type of hedging activity commonly undertaken and at
levels consistent with the hedging activity undertaken by the trading
desk in the normal course.
The Agencies request comment on the proposed revisions to Sec.
__.5 regarding permitted risk-mitigating hedging activities. In
particular, the Agencies request comment on the following questions:
Question 113. What factors, if any, should the Agencies consider in
determining whether to remove the requirement that a correlation
analysis must be used to determine whether a hedging position,
technique, or strategy reduces or otherwise significantly mitigates the
specific risk being hedged?
Question 114. Is the Agencies' assessment of the complexities of
the correlation analysis requirement across the spectrum of hedging
activities accurate? Why or why not?
Question 115. How does the requirement to undertake a correlation
analysis impact a banking entity's decision on whether to enter into
different types of hedges?
Question 116. How does the correlation analysis requirement affect
the timing of hedging activities?
Question 117. Does the current requirement that a hedge must
demonstrably reduce or otherwise significantly mitigate specific risks
lead banking entities to decline to enter into hedging transactions
that would otherwise be designed to reduce or otherwise significantly
mitigate specific risks arising in connection with identified
positions, contracts, or other holdings of the banking entity? If so,
under what circumstances?
Question 118. Would reducing the compliance requirements of Sec.
__.5(b) and Sec. __.5(c) for banking entities that do not have
significant trading assets and liabilities reduce compliance costs and
increase certainty for these banking entities?
Question 119. Would the proposed reductions in the compliance
requirements for risk-mitigating hedging activities by banking entities
that do not have significant trading assets and liabilities increase
materially the risks to the safety and soundness of the banking entity
or U.S. financial stability? Why or why not?
Question 120. Would the proposed exclusion from the enhanced
documentation requirements for trading desks that hedge risk of other
desks under the circumstances described make risk-mitigating hedging
activities more efficient and timely? Why or why not? Should any of the
existing documentation requirements be retained for firms without
significant trading assets and liabilities? Are there any hedging
documentation requirements applicable in other contexts (e.g.,
accounting) that could be leveraged for the purposes of this
requirement? How would the proposed exclusion from the enhanced
documentation requirements impact both internal and external compliance
and oversight of a banking entity?
Question 121. With respect to the proposed exclusion from enhanced
documentation for trading desks that hedge risk of other desks under
certain circumstances, are the requirements for a pre-approved list of
financial instruments and pre-approved hedging limits reasonable?
Should those requirements be modified, expanded, or reduced? If so,
how? Should the Agencies provide greater clarity for determining which
financial instruments are ``commonly used by the trading desk for the
specific type of hedging activity for which the financial instrument is
being purchased or sold'' for inclusion on the pre-approved list?
Similarly, should the Agencies provide greater clarity for determining
pre-approved hedging limits?
Question 122: The Agencies have proposed using accounting
principles as part of the definition of trading account. Should the
Agencies similarly use accounting principles to refer to risk-mitigated
hedging activity? For example, should the Agencies provide an exemption
for hedging activity that is accounted for under the provisions of ASC
815 (Derivatives and Hedging)? Why or why not? Should the Agencies
require entities that engage in risk-mitigating hedging activity
measure hedge effectiveness? Why or why not?
4. Section __.6(e): Permitted Trading Activities of a Foreign Banking
Entity
Section 13(d)(1)(H) of the BHC Act \134\ permits certain foreign
banking entities to engage in proprietary trading that occurs solely
outside of the United States (the foreign trading exemption).\135\ The
statute does not define when a foreign banking entity's trading occurs
``solely outside of the United States.''
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\134\ Section 13(d)(1)(H) of the BHC Act permits trading
conducted by a foreign banking entity pursuant to paragraph (9) or
(13) of section 4(c) of the BHC Act (12 U.S.C. 1843(c)), if the
trading occurs solely outside of the United States, and the banking
entity is not directly or indirectly controlled by a banking entity
that is organized under the laws of the United States or of one or
more States. See 12 U.S.C. 1851(d)(1)(H).
\135\ This section's discussion of the concept of ``solely
outside of the United States'' is provided solely for purposes of
the proposal's implementation of section 13(d)(1)(H) of the BHC Act,
and does not affect a banking entity's obligation to comply with
additional or different requirements under applicable securities,
banking, or other laws. Among other differences, section 13 of the
BHC Act does not necessarily include the customer protection,
transparency, anti-fraud, anti-manipulation, and market orderliness
goals of other statutes administered by the Agencies. These other
goals or other aspects of those statutory provisions may require
different approaches to the concept of ``solely outside of the
United States'' in other contexts.
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a. Permitted Trading Activities of a Foreign Banking Entity
The 2013 final rule includes several conditions on the availability
of the foreign trading exemption. Specifically, in addition to limiting
the exemption to foreign banking entities where the purchase or sale is
made pursuant to paragraph (9) or (13) of section 4(c) of the BHC
Act,\136\ the 2013 final rule provides that the foreign trading
exemption is available only if:
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\136\ 12 U.S.C. 1843(c)(9), (13). See 2013 final rule Sec.
__.6(e)(1)(i) and (ii).
---------------------------------------------------------------------------
(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
[[Page 33468]]
is not located in the United States or organized under the laws of the
United States or of any State;
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State;
(iv) No financing for the banking entity's purchase or sale is
provided, directly or indirectly, by any branch or affiliate that is
located in the United States or organized under the laws of the United
States or of any State;
(v) The purchase or sale is not conducted with or through any U.S.
entity,\137\ other than:
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\137\ ``U.S. entity'' is defined for purposes of this provision
as any entity that is, or is controlled by, or is acting on behalf
of, or at the direction of, any other entity that is, located in the
United States or organized under the laws of the United States or of
any State. See 2013 final rule Sec. __.6(e)(4).
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(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 also exercised their authority under section
13(d)(1)(J) \138\ to allow the following types of purchases or sales to
be conducted with a U.S. entity:
---------------------------------------------------------------------------
\138\ 12 U.S.C. 1851(d)(1)(J).
---------------------------------------------------------------------------
(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,
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 proposal would modify the requirements of the 2013 final rule
relating to the foreign trading exemption in a number of ways.
Specifically, the proposal would retain the first three requirements of
the 2013 final rule, with a modification to the first requirement, and
would remove the last two requirements of Sec. __.6(e)(3). As a
result, Sec. __.6(e)(3), as modified by the proposal, would require
that for a foreign banking entity to be eligible for this exemption:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
The proposal would maintain these three requirements in order to
ensure that the banking entity (including any relevant personnel) that
engages in the purchase or sale as principal or makes the decision to
purchase or sell as principal is not located in the United States or
organized under the laws of the United States or any State.
Furthermore, the proposal would retain the 2013 final rule's
requirement that the purchase or sale, including any transaction
arising from a related risk-mitigating hedging transaction, is not
accounted for as principal at the U.S. operations of the foreign
banking entity. The proposal would, however, modify the first
requirement relative to the 2013 final rule, to replace the requirement
that any personnel of the banking entity that arrange, negotiate, or
execute such purchase or sale are not located in the United States with
one that would restrict only the relevant personnel engaged in the
banking entity's decision in the purchase or sale not located in the
United States. Under the proposed approach, for purposes of section 13
of the BHC Act and the implementing regulations, the focus of the
requirement would be on whether the banking entity that engages in the
purchase or sale as principal (including any relevant personnel) is
located in the United States. The purpose of this modification is to
make clear that some limited involvement by U.S. personnel (e.g.,
arranging or negotiating) would be consistent with this exemption so
long as the principal bearing the risk of a purchase or sale is outside
the United States. The proposed modifications would permit a foreign
banking entity to engage in a purchase or sale under this exemption so
long as the principal risk and actions of the purchase or sale do not
take place in the United States for purposes of section 13 and the
implementing regulations. The proposal would also eliminate the
following two requirements from Sec. __.6(e), which are referred to as
the ``financing prong'' and the ``counterparty prong,'' respectively,
in the discussion that follows:
No financing for the banking entity's purchase or sale is provided,
directly or indirectly, by any branch or affiliate that is located in
the United States or organized under the laws of the United States or
of any State;
The purchase or sale is not conducted with or through any U.S.
entity, other than:
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.
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
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.
Since the adoption of the 2013 final rule, foreign banking entities
have communicated to the Agencies that these requirements have unduly
limited their ability to make use of the statutory exemption for
proprietary trading and have resulted in an impact on foreign banking
entities' operations outside of the United States that these banking
entities believe is broader than necessary to achieve compliance with
the requirements of section 13 of the BHC Act. In response to these
concerns, the Agencies are proposing to remove the financing prong and
the counterparty prong, which would focus the key requirements of this
exemption on the principal actions and risk of the transaction. In
addition, the proposal would remove the financing prong to address
concerns that the fungibility of financing has made this requirement
difficult to apply in practice in certain circumstances to determine
whether particular financing is tied to a
[[Page 33469]]
particular trade. Market participants have raised a number of questions
about the financing prong and have indicated that identifying whether
financing has been provided by a U.S. affiliate or branch can be
exceedingly complex, in particular with respect to demonstrating that
financing has not been provided by a U.S. affiliate or branch with
respect to a particular transaction. To address the concerns raised by
foreign banking entities and other market participants, the proposal
would amend the foreign trading exemption to focus on the principal
risk of a transaction and the location of the actions as principal and
trading decisions, so that a foreign banking entity would be able to
make use of the exemption so long as the risk of the transaction is
booked outside of the United States. While the Agencies recognize that
a U.S. branch or affiliate that extends financing could bear some
risks, the Agencies note that the proposed modifications to the foreign
trading exemption are designed to require that the principal risks of
the transaction occur and remain solely outside of the United States.
For example, the exemption would continue to provide that the purchase
or sale, including any transaction arising from risk-mitigating hedging
related to the instruments purchased or sold, may not be accounted for
as principal directly or indirectly on a consolidated basis by any U.S.
branch or affiliate.
Similarly, foreign banking entities have communicated to the
Agencies that the counterparty prong has been overly difficult and
costly for banking entities to monitor, track, and comply with in
practice. As a result, the Agencies are proposing to remove the
requirement that any transaction with a U.S. counterparty be executed
solely with the foreign operations of the U.S. counterparty (including
the requirement that no personnel of the counterparty involved in the
arrangement, negotiation, or execution may be located in the United
States) or through an unaffiliated intermediary and an anonymous
exchange in order to materially reduce the reported inefficiencies
associated with rule compliance. In addition, market participants have
indicated that this requirement has in practice led foreign banking
entities to overly restrict the range of counterparties with which
transactions can be conducted, as well as disproportionately burdened
compliance resources associated with those transactions, including with
respect to counterparties seeking to do business with the foreign
banking entity in foreign jurisdictions.
As a result, the Agencies propose to remove the counterparty prong.
The proposal would focus the requirements of the foreign trading
exemption on the location of a foreign banking entity's decision to
trade, action as principal, and principal risk of the purchase or sale.
This proposed focus on the location of actions and risk as principal is
intended to align with the statute's definition of ``proprietary
trading'' as ``engaging as principal for the trading account of the
banking entity.'' \139\ Consistent with that approach, the focus of the
proposed approach would be on the activities of a foreign banking
entity as principal in the United States. The statute exempts the
trading of foreign banking entities that is conducted ``solely''
outside the United States. Under the proposal, the relevant inquiry
would focus on whether the principal risk of the transaction is located
or held outside of the United States and the location of the trading
decision and banking entity acting as principal. The proposal would
remove the requirements of Sec. __.6(e)(3) that are less directly
relevant to these considerations.
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\139\ See 12 U.S.C. 1851(h)(4) (emphasis added).
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Information provided by foreign banking entities has demonstrated
that few trading desks of foreign banking entities have utilized the
foreign trading exemption in practice. This information has raised
concerns that the current requirements for the exemption may be overly
restrictive of permitted activities. Accordingly, the proposal would
modify the exemption under the 2013 final rule to make the requirements
more workable, so that it may be available to foreign banking entities
trading solely outside the United States.
The Agencies request comment as to whether the proposed
modifications to the foreign trading exemption would result in
disadvantages for U.S. banking entities competing with foreign banking
entities. The statute contains an exemption to allow foreign banking
entities to engage in trading activity that is solely outside the
United States. The statute also contains a prohibition on proprietary
trading for U.S. banking entities regardless of where their activity is
conducted. The statute generally prohibits U.S. banking entities from
engaging in proprietary trading because of the perceived risks of those
activities to U.S. banking entities and the U.S. economy. The Agencies
believe that this means that the prohibition on proprietary trading is
intended make U.S. banking entities safer and stronger, and reduce
risks to U.S. financial stability, and that the foreign operations of
foreign banking entities should not be subject to the prohibition on
proprietary trading for their activities overseas. The proposal would
implement this distinction with respect to transactions that occur
outside of the United States where the principal risk is booked outside
of the United States and the actions and decisions as principal occur
outside of the United States by foreign operations of foreign banking
entities. Under the statute and the rulemaking framework, U.S. banking
entities would be able to continue trading activities that are
consistent with the statute and regulation, including permissible
market-making, underwriting, and risk-mitigating hedging activities as
well as other types of trading activities such as trading on behalf of
customers. U.S. banking entities are permitted to engage in these
trading activities as exemptions from the general prohibition on
proprietary trading under the statute. Moreover, and consistent with
the statute, the proposal seeks to streamline and reduce the
requirements of several of these key exemptions to make them more
workable and available in practice to all banking entities subject to
section 13 of the BHC Act and the implementing regulations.\140\
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\140\ At the same time, however, the Agencies recognize the
possibility that there may also be risks to U.S. banking entities
and the U.S. economy as a result of allowing foreign banking
entities to conduct a broader range of activities within the United
States. For example, and as discussed above, the Agencies are
requesting comment on whether the proposal would give foreign
banking entities a competitive advantage over U.S. banking entities
with respect to identical trading activity in the United States.
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Consistent with the 2013 final rule, the exemption under the
proposal would not exempt the U.S. or foreign operations of U.S.
banking entities from having to comply with the restrictions and
limitations of section 13 of the BHC Act. Thus, the U.S. and foreign
operations of a U.S. banking entity that is engaged in permissible
market making-related activities or other permitted activities may
engage in those transactions with a foreign banking entity that is
engaged in proprietary trading in accordance with the exemption under
Sec. __.6(e) of the 2013 final rule, so long as the U.S. banking
entity complies with the requirements of Sec. __.4(b), in the case of
market making-related activities, or other relevant exemption
applicable to the U.S. banking entity. The proposal, like the 2013
final rule, would 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 and the implementing
regulations. Rather, that
[[Page 33470]]
obligation would be on each party subject to section 13 to ensure that
it is conducting its activities in accordance with section 13 and the
implementing regulations.
The proposal's exemption for trading of foreign banking entities
outside the United States could potentially give foreign banking
entities a competitive advantage over U.S. banking entities with
respect to permitted activities of U.S. banking entities because
foreign banking entities could trade directly with U.S. counterparties
without being subject to the limitations associated with the market-
making or other exemptions under the rule. This competitive disparity
in turn could create a significant potential for regulatory arbitrage.
In this respect, the Agencies seek to mitigate this concern through
other changes in the proposal; for example, U.S. banking entities would
continue to be able to engage in all of the activities permitted under
the 2013 final rule and the proposal, including the simplified and
streamlined requirements for market-making and risk-mitigating hedging
and other types of trading activities. The proposal's modifications
therefore in general seek to balance concerns regarding competitive
impact while mitigating the concern that an overly narrow approach to
the foreign trading exemption may cause market bifurcations, reduce the
efficiency and liquidity of markets, make the exemption overly
restrictive to foreign banking entities, and harm U.S. market
participants.
The Agencies request comment on the proposal's revised approach to
implementing the foreign trading exemption. In particular, the Agencies
request comment on the following questions:
Question 123. Is the proposal's implementation of the foreign
trading exemption appropriate and effectively delineated? If not, what
alternative would be more appropriate and effective?
Question 124. Are the proposal's provisions regarding when an
activity will be considered to have occurred solely outside the United
States for purposes of the foreign trading exemption effective and
sufficiently clear? If not, what alternative would be clearer and more
effective? Should any requirements be modified or removed? If so, which
requirements and why? Should additional requirements be added? If so,
what requirements and why? For example, should the financing prong or
the counterparty prong be retained or modified rather than eliminated?
Why or why not? Do the proposed modifications effectively focus the
foreign trading exemption on the principal actions and risk of the
transaction and ensure that the principal risk remains solely outside
the United States? Are there any other conditions the Agencies should
include in the foreign trading and foreign fund exemptions to address
the possibility that risks associated with foreign trading or covered
fund activities could flow into the U.S. financial system through
financing for those activities coming from U.S. branches of affiliates,
without raising the same compliance difficulties banking entities have
experienced with the current financing prong?
Question 125. What effects do commenters believe the proposed
modifications to the foreign trading exemption, particularly with
respect to trading with U.S. entities, would have with respect to the
safety and soundness of banking entities and U.S. financial stability?
Would the proposed modifications allow for risks to aggregate in the
United States based on activity of foreign banking entities? For
example, what effects would removal of the counterparty prong have for
U.S. financial market liquidity, and what consequences could such
effects have for the safety and soundness of banking entities and U.S.
financial stability? Could the proposal be further modified, consistent
with statutory requirements, to better promote and protect the safety
and soundness of banking entities and U.S. financial stability? Please
explain.
Question 126. What impact could the proposal have on a foreign
banking entity's ability to trade in the United States? Should any
additional requirements of the 2013 final rule be removed? Why or why
not? If so, which requirements and why? Should any of the requirements
of the 2013 final rule that the Agencies are proposing to eliminate be
retained? Why or why not? If so, which requirements and why?
Question 127. Does the proposal's approach raise competitive equity
concerns for U.S. banking entities? If so, in what ways? Would the
proposed modifications allow for foreign entities to access the U.S.
markets without commensurate regulation? How would this impact
competition? Would this disadvantage U.S. entities? Would the proposed
revisions to the 2013 final rule's exemptions for market making,
underwriting, and risk-mitigating hedging and new exclusions contained
in this proposal help to mitigate these concerns? How could such
concerns be addressed while effectively implementing this statutory
exemption?
Question 128. The proposed approach would eliminate the requirement
in the 2013 final rule that trading performed pursuant to the foreign
trading exemption not be conducted with or through any U.S. entity,
subject to certain exceptions.\141\ Would eliminating this requirement
give foreign banking entities a competitive advantage over U.S. banking
entities with respect to identical trading activity in the United
States? For example, would eliminating this requirement give foreign
banking entities a competitive advantage over U.S. banking entities
with respect to permitted market-making or underwriting activities? Why
or why not? Are there ways that any such competitive disparities could
potentially be mitigated or eliminated in a manner consistent with the
statute? If so, please explain. Would the proposed approach create
opportunities for certain banking entities to avoid the operation of
the rule in ways that would frustrate the purposes of the statute? If
so, how?
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\141\ See Sec. __.6(e)(3).
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Question 129. The proposed approach would eliminate the requirement
in the 2013 final rule that personnel of the banking entity who
arrange, negotiate, or execute a purchase or sale under the foreign
trading exemption be located outside the United States.\142\ Should
this requirement be removed? Why or why not? Would eliminating this
restriction, thereby allowing foreign banking entities to perform
certain core market-facing activities in the United States and with
U.S. customers, create competitive disparities between foreign banking
entities and U.S. banking entities? Please explain. Are there ways that
any such competitive disparities could potentially be mitigated or
eliminated in a manner consistent with the statute? If so, please
explain. Would the proposed approach create opportunities for banking
entities to avoid the operation of the rule in ways that would
frustrate the purposes of the statute? If so, how?
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\142\ See Sec. Sec. __.6(e)(3)(i) and __.6(e)(3)(v)(A).
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Question 130. Instead of removing the requirement that any
personnel of the banking entity that arrange, negotiate, or execute a
purchase or sale be located outside of the United States, should the
Agencies provide definitions or guidance on these terms, for example,
similar to definitions and guidance adopted or issued by the SEC and
CFTC under Title VII of the Dodd-Frank Act and implementing
regulations? Are there any other modifications that would be more
appropriate?
[[Page 33471]]
C. Subpart C--Covered Fund Activities and Investments
1. Section __.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
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 interest in, or sponsoring, a
covered fund.\143\ Section 13(d) of the BHC Act contains certain
exemptions to this prohibition. Subpart C of the 2013 final rule
implements these and other provisions of section 13 related to covered
funds. Specifically, Sec. __.10(a) of the 2013 final rule establishes
the scope of the covered fund prohibitions and Sec. __.10(b) of the
2013 final rule defines a number of key terms, including ``covered
fund.'' Section __.10(c) of the 2013 final rule tailors the definition
of ``covered fund'' by providing particular exclusions. The covered
fund definition, taking into account the particular exclusions, is
central to the operation of subpart C of the 2013 final rule because it
specifies the types of entities to which the prohibition contained in
Sec. __.10(a) of the 2013 final rule applies, unless the relevant
activity is specifically permitted under an available exemption
contained elsewhere in subpart C of the final rule.
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\143\ See 12 U.S.C. 1851(a)(1)(B).
---------------------------------------------------------------------------
In the 2013 final rule, the Agencies adopted a tailored definition
of ``covered fund'' that covers issuers of the type that would be
investment companies but for section 3(c)(1) or 3(c)(7) of the
Investment Company Act \144\ with exclusions for certain specific types
of issuers. The Agencies designed the exclusions to focus the covered
fund definition on vehicles used for the investment purposes that the
Agencies believed were the target of section 13 of the BHC Act.\145\
The definition of ``covered fund'' under the 2013 final rule also
includes certain funds organized and offered outside of the United
States to address the potential for circumvention of the restrictions
in section 13 through foreign fund structures and certain types of
commodity pools for which a registered commodity pool operator has
elected to claim the exemption provided by section 4.7 of the CFTC's
regulations or investor limitations apply.\146\ In the preamble to the
2013 final rule, the Agencies stated their belief that the definition
was consistent with the words, structure, purpose, and legislative
history of section 13 of the BHC Act.\147\ In particular, the Agencies
stated that the purpose of section 13 appears to be to limit the
involvement of banking entities in high-risk 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.\148\ Further, the Agencies indicated that section 13
permitted 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).\149\ Tailoring the scope of the definition was
intended to allow the Agencies to avoid any unintended results that
might follow from a definition that was inappropriately imprecise.\150\
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\144\ 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. 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 short-term paper); or (2) any issuer, the
outstanding securities of which are owned exclusively by persons
who, at the time of acquisition of such securities, are ``qualified
purchasers'' as defined by section 2(a)(51) of the Investment
Company Act, and which is not making and does not at that time
propose to make a public offering of such securities. See 15 U.S.C.
80a-3(c)(1) and (c)(7).
\145\ See 79 FR at 5671.
\146\ Id. In the preamble to the 2013 final rule, the Agencies
also expressed their intent 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. The
2013 final rule permits the Agencies to jointly determine to include
within the definition of ``covered fund'' any fund excluded from
that definition, and this authority may be exercised to address
instances of evasion. See 2013 final rule Sec. __.10(c).
\147\ See 79 FR at 5670. Section 13(h)(2) provides that: ``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.'' See 12 U.S.C.
1851(h)(2) (emphasis added).
\148\ See 79 FR at 5670.
\149\ See id. at 5666.
\150\ In adopting the 2013 final rule, the Agencies referred to
legislative history that suggested 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. See id. at
5670-71.
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The Agencies request comment on whether the 2013 final rule's
covered fund definition effectively implements the statute and is
appropriately tailored to identify funds that engage in the investment
activities contemplated by section 13. The Agencies also request
comment on whether the definition has been inappropriately imprecise
and, if so, whether that has led to any unintended results.
i. Covered Fund ``Base Definition''--Section __.10(b)
In considering whether to further tailor the covered fund
definition, the Agencies seek comment in this section on the 2013 final
rule's general approach to defining the term ``covered fund'' and the
2013 final rule's ``base definition'' of covered fund, that is, the
definition as provided in Sec. __.10(b) before applying the exclusions
found in Sec. __.10(c), as well as alternatives to this base
definition.\151\ In the sections that follow the Agencies request
comment on exclusions from the covered fund definition that relate to
specific areas of concern expressed to the Agencies.
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\151\ See 2013 final rule Sec. __.10(b)(1)(i), (ii), and (iii).
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Question 131. The Agencies adopted in the 2013 final rule a unified
definition of ``covered fund'' rather than having separate definitions
for ``hedge fund'' and ``private equity fund'' because the statute
defines ``hedge fund'' and ``private equity fund'' without
differentiation. Instead of retaining a unified definition of ``covered
fund,'' should the Agencies separately define ``hedge fund'' and
``private equity fund'' or define ``covered fund'' as a ``hedge fund''
or ``private equity fund''? Would such an approach more effectively
implement the statute? If so, how should the Agencies define these
terms and why? Alternatively, the Agencies request comment below as to
whether the Agencies should provide exclusions from the covered fund
base definition for an issuer that does not share certain
characteristics commonly associated with a hedge fund or private equity
fund. If the Agencies were to define the terms ``hedge fund'' and
``private equity fund,'' would it be more effective to do so with an
exclusion from the covered fund definition for issuers that do not
resemble ``hedge funds'' and ``private equity funds''?
Question 132. In the 2013 final rule, the Agencies tailored the
scope of the definition to funds that engage in the investment
activities contemplated by section 13. Does the 2013 final rule's
definition of ``covered fund'' effectively include funds that engage in
those
[[Page 33472]]
investment activities? Are there funds that are included in the
definition of ``covered fund'' that do not engage in those investment
activities? If so, what types of funds, and should the Agencies modify
the definition to exclude them? Are there funds that engage in those
investment activities but are not included in the definition of
``covered fund''? If so, what types of funds and should the Agencies
modify the definition to include them? If the Agencies should modify
the definition, how should it be modified?
Question 133. In the preamble to the 2013 final rule, the Agencies
stated that tailoring the scope of the definition of ``covered fund''
would allow the Agencies to avoid unintended results that might follow
from a definition that is ``inappropriately imprecise.'' \152\ Has the
final definition been ``inappropriately imprecise'' in practice? If so,
how? Should the Agencies modify the base definition to be more precise?
If so, how? Alternatively or in addition to modifying the base
definition, could the Agencies modify or add any exclusions to make the
definition more precise, as discussed below?
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\152\ See 79 FR at 5670-71.
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Question 134. The 2013 final rule's definition of ``covered fund''
includes certain funds organized and offered outside of the United
States with respect to a U.S. banking entity that sponsors or invests
in the fund in order to address structures that might otherwise allow
circumvention of the restrictions of section 13. Does this ``foreign
covered fund'' provision effectively address those circumvention
concerns? If not, should the Agencies modify this provision to address
those circumvention concerns more directly or in some other way? If so,
how?
Question 135. The 2013 final rule's definition of ``covered fund''
includes certain commodity pools in order to address structures that
might otherwise allow circumvention of the restrictions in section 13.
In adopting this ``covered commodity pool'' provision, the Agencies
sought to take a tailored approach that is designed to accurately
identify those commodity pools that are similar to issuers that would
be investment companies as defined in the Investment Company Act but
for section 3(c)(1) or 3(c)(7) of that Act, consistent with section
13(h)(2) of the BHC Act. Does this ``covered commodity pool'' provision
effectively address those circumvention concerns? If not, should the
Agencies modify this provision to address those circumvention concerns
more directly or in some other way? If so, how? Has the covered
commodity pool provision been effective in including in the covered
fund base definition those commodity pools that are similar to issuers
that would be investment companies but for section 3(c)(1) or 3(c)(7)?
Has it been under- or over-inclusive? What kinds of commodity pools
have been included in or excluded from the covered fund base definition
and are these inclusions or exclusions appropriate? If the covered
commodity pool provision is under- or over-inclusive, what changes
should the Agencies make and how would those changes be more effective?
Question 136. What kinds of compliance and other costs have banking
entities incurred in analyzing whether particular issuers are covered
funds and implementing compliance programs for covered fund activities?
Has the breadth of the base definition raised particular compliance
challenges? Have the 2013 final rule's exclusions from the covered fund
definition helped to reduce compliance costs or provided greater
certainty as to the scope of the covered fund definition?
Question 137. If the Agencies modify the covered fund base
definition in whole or in part, would banking entities expect to incur
significant costs or burdens in order to become compliant? That is,
after having established compliance, trading, risk management, and
other systems predicated on the 2013 final rule's covered fund
definition, what are the kinds of costs and any other burdens and their
magnitude that banking entities would experience if the Agencies were
to modify the covered fund base definition?
Question 138. The Agencies understand that banking entities have
already expended resources in reviewing a wide range of issuers to
determine if they are covered funds, as defined in the 2013 final rule.
What kinds of costs and burdens would banking entities and others
expect to incur if the Agencies were to modify the covered fund base
definition to the extent any modifications were to require banking
entities to reevaluate issuers to determine if they meet any revised
covered fund definition? To what extent would modifying the covered
fund base definition require banking entities to reevaluate issuers
that a banking entity previously had determined are not covered funds?
Would any costs and burdens be justified to the extent the Agencies
more effectively tailor the covered fund definition to focus on the
concerns underlying section 13? Could any costs and burdens be
mitigated if the Agencies further tailored or added exclusions from the
covered fund definition or developed new exclusions, as opposed to
changing the covered fund base definition?
Question 139. To what extent do the proposed modifications to other
provisions of the 2013 final rule affect the impact of the scope of the
covered fund definition? For example, as described below, the Agencies
are proposing to eliminate some of the additional, covered-fund
specific limitations that apply under the 2013 final rule to a banking
entity's underwriting, market making, and risk-mitigating hedging
activities. As another example, the Agencies are requesting comment
below about whether to incorporate into Sec. __.14's limitations on
covered transactions the exemptions provided in section 23A of the
Federal Reserve Act (``FR Act'') and the Board's Regulation W. To the
extent commenters have concerns regarding the breadth of the covered
fund definition, would these concerns be addressed or mitigated by the
changes the Agencies are proposing to the other covered fund provisions
or on which the Agencies are seeking comment?
ii. Particular Exclusions From the Covered Fund Definition
As discussed above, the 2013 final rule contains exclusions from
the base definition of ``covered fund'' that tailor the covered fund
definition. The Agencies designed these exclusions to avoid any
unintended results that might follow from a definition of ``covered
fund'' that was inappropriately imprecise. In this section, the
Agencies request comment on whether to modify certain existing
exclusions from the covered fund definition. The Agencies also request
comment on whether to provide new exclusions in order to more
effectively tailor the definition. Finally, with respect to all of the
potential modifications the Agencies discuss in this section, the
Agencies seek comment as to the potential effect of the other changes
the Agencies are proposing today to the covered fund provisions and on
additional changes on which the Agencies seek comment. That is, would
these proposed changes address in whole or in part any concerns about
the breadth of the covered fund definition?
iii. Foreign Public Funds
The 2013 final rule generally excludes from the definition of
``covered fund'' any issuer that is organized or established outside of
the United States and the ownership interests of which are (i)
authorized to be offered and sold to retail investors in the issuer's
home jurisdiction and (ii) sold predominantly
[[Page 33473]]
through one or more public offerings outside of the United States.\153\
The Agencies stated in the preamble to the 2013 final rule that they
generally expect that an offering is made predominantly outside of the
United States if 85 percent or more of the fund's interests are sold to
investors that are not residents of the United States.\154\
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\153\ See 2013 final rule Sec. __.10(c)(1); See also 79 FR at
5678 (``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 [RIC] rather than to a U.S.
covered fund.''); 2013 final rule Sec. __.10(c)(1)(iii) (defining
the term ``public offering'' for purposes of this exclusion to mean
a ``distribution,'' as defined in Sec. __.4(a)(3) of subpart B, of
securities in any jurisdiction outside the United States to
investors, including retail investors, provided that, the
distribution complies with all applicable requirements in the
jurisdiction in which such distribution is being made; the
distribution does not restrict availability to investors having a
minimum level of net worth or net investment assets; and the issuer
has filed or submitted, with the appropriate regulatory authority in
such jurisdiction, offering disclosure documents that are publicly
available).
\154\ 79 FR at 5678.
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The 2013 final rule places an additional condition on a U.S.
banking entity's ability to rely on the FPF exclusion with respect to
any FPF it sponsors.\155\ The FPF 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.\156\ The Agencies stated in the preamble to the 2013 final
rule that, consistent with the Agencies' view concerning whether an FPF
has been sold predominantly outside of the United States, the Agencies
generally expect that an FPF 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 the specified persons
connected to that banking entity.\157\
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\155\ Although 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 2013
final rule Sec. __.10(c)(1)(ii) (applying this limitation ``[w]ith
respect to a banking entity that is, or is controlled directly or
indirectly by a banking entity that is, located in or organized
under the laws of the United States or of any State and any issuer
for which such banking entity acts as sponsor'').
\156\ See 2013 final rule Sec. __.10(c)(1)(ii).
\157\ 79 FR at 5678.
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In adopting the FPF exclusion, the Agencies' view was that it is
appropriate to exclude these funds from the ``covered fund'' definition
because they are sufficiently similar to U.S. RICs.\158\ The Agencies
also expressed the view that the additional condition applicable to
U.S. banking entities is designed to treat FPFs 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, while also seeking
to limit the possibility for evasion through foreign public funds.\159\
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\158\ Id. (``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 [RICs] such that it is
appropriate to exclude these foreign funds from the covered fund
definition.'')
\159\ Id. (``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.'').
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The Agencies request comment on all aspects of the FPF exclusion,
including whether the exclusion is effective in identifying foreign
funds that may be sufficiently similar to RICs and permitting U.S.
banking entities and their foreign affiliates to carry on traditional
asset management businesses outside of the United States, as the
Agencies contemplated in adopting this exclusion. As reflected in the
detailed questions that follow, the Agencies seek comment on a range of
possible ways to modify this exclusion, including: (i) Whether the
Agencies could simplify or omit certain of the exclusion's conditions--
including those not applicable to excluded RICs--while still
identifying funds that should be excluded and addressing the
possibility for evasion through the Agencies' broad anti-evasion
authority; (ii) whether the exclusion's conditions requiring a fund to
be authorized for sale to retail investors in the issuer's home
jurisdiction and sold predominantly in public offerings outside of the
United States should be retained and, if so, whether the Agencies
should modify or clarify these conditions; and (iii) whether the
additional conditions for U.S. banking entities with respect to the
FPFs they sponsor are appropriate. Specifically, in considering whether
to further tailor the FPF exclusion, the Agencies seek comment below on
the following:
Question 140. Are foreign funds that satisfy the current conditions
in the FPF exclusion sufficiently similar to RICs such that it is
appropriate to exclude these foreign funds from the covered fund
definition? Why or why not? Are there foreign funds that cannot satisfy
the exclusion's conditions but that are nonetheless sufficiently
similar to RICs such that it is appropriate to exclude these foreign
funds from the covered fund definition? If so, how should the Agencies
modify the exclusion's conditions to permit these funds to rely on it?
Conversely, are there foreign funds that satisfy the exclusion's
conditions but are not sufficiently similar to RICs such that it is not
appropriate to exclude these funds from the covered fund definition? If
so, how should the Agencies modify the exclusion's conditions to
prohibit these funds from relying on it? Conversely, are changes to the
FPF exclusion necessary given the other changes the Agencies are
proposing today and on which the Agencies seek comment?
Question 141. RICs are excluded from the covered fund definition
regardless of whether their ownership interests are sold in public
offerings or whether their 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. Is such an exclusion appropriate? Why or why not?
Question 142: As discussed above, the Agencies designed the FPF
exclusion to identify foreign funds that are sufficiently similar to
RICs such that it is appropriate to exclude these foreign funds from
the covered fund definition, but included additional conditions not
applicable to RICs in part to limit the possibility for evasion of the
2013 final rule. Do FPFs present a heightened risk of evasion that
justifies these additional conditions, as they currently exist or with
any of the modifications on which the Agencies request comment below?
Why or why not?
Question 143: As an alternative, should the Agencies address
concerns about evasion through other means, such as the anti-evasion
provisions in Sec. __.21 of the 2013 final rule? \160\ The
[[Page 33474]]
2013 final rule includes recordkeeping requirements designed to
facilitate the Agencies' ability to monitor banking entities'
investments in FPFs to ensure that banking entities do not use the
exclusion for FPFs in a manner that functions as an evasion of section
13. Specifically, under the 2013 final rule, a U.S. banking entity with
more than $10 billion in total consolidated assets is required to
document its investments in foreign public funds, broken out by each
FPF and each foreign jurisdiction in which any FPF is organized, if the
U.S. banking entity and its affiliates' ownership interests in FPFs
exceed $50 million at the end of two or more consecutive calendar
quarters.\161\ The Agencies are proposing to retain these and other
covered fund recordkeeping requirements with respect to banking
entities with significant trading assets and liabilities.
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\160\ Section __.21 of the 2013 final rule provides in part that
whenever an 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 the 2013 final rule, 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 the 2013 final
rule, the Agency may take any action permitted by law to enforce
compliance with section 13 of the BHC Act and the 2013 final rule,
including directing the banking entity to restrict, limit, or
terminate any or all activities under the 2013 final rule and
dispose of any investment.
\161\ See 2013 final rule Sec. __.20(e).
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Alternatively, would retaining specific provisions designed to
address anti-evasion concerns, whether as they currently exist or
modified, provide greater clarity as to the scope of foreign funds
excluded from the definition and avoid uncertainty that could result
from a less prescriptive exclusion?
Question 144. One condition of the FPF exclusion is that the fund
must be ``authorized to offer and sell ownership interests to retail
investors in the issuer's home jurisdiction.'' The Agencies understand
that banking entities generally interpret the 2013 final rule's
reference to the issuer's ``home jurisdiction'' to mean the
jurisdiction in which the issuer is organized. Is this condition
helpful in identifying FPFs that should be excluded from the covered
fund definition? Why or why not? The Agencies provided guidance
regarding the 2013 final rule's current reference to ``retail
investors.'' \162\ Has this provided sufficient clarity? Additionally,
as discussed below, the 2013 final rule contains an additional
condition requiring that to meet the exclusion, a fund must sell
ownership interests predominantly through one or more public offerings
outside the United States. As an alternative to requiring that the fund
be authorized to sell interests to retail investors, should the
Agencies instead require that the fund be authorized to sell interests
in a ``public offering''?
---------------------------------------------------------------------------
\162\ See supra note 153.
---------------------------------------------------------------------------
Question 145. The Agencies understand that some funds may be formed
under the laws of one non-U.S. jurisdiction, but offered to retail
investors in another. For example, Undertakings for Collective
Investment in Transferable Securities (``UCITS'') funds and investment
companies with variable capital, or SICAVs, may be domiciled in one
jurisdiction in the European Union, such as Ireland or Luxembourg, but
may be offered and sold in one or more other E.U. member states. In
this case a foreign fund could be authorized for sale to retail
investors, as contemplated by the FPF exclusion, but fail to satisfy
this condition. Should the Agencies modify this condition to address
this situation? If so, how?
Question 146. Should the Agencies, for example, modify the
condition to omit any reference to the fund's ``home jurisdiction'' and
instead provide, for example, that the fund must be authorized to offer
and sell ownership interests to retail investors in ``the primary
jurisdiction'' in which the issuer's ownership interests are offered
and sold? Would that or a similar approach effectively identify funds
that are sufficiently similar to RICs, including funds that are formed
under the laws of one jurisdiction and offered and sold in another? For
purposes of determining the primary jurisdiction, would the Agencies
need to define the term ``primary'' or a similar term to provide
sufficient clarity? If so, how should the Agencies define this or a
similar term? Are there funds for which it could be difficult to
identify a ``primary'' jurisdiction? Does the condition need to refer
to a ``primary jurisdiction,'' or would it be sufficient to require
that the fund be authorized to offer and sell ownership interests to
retail investors in ``any jurisdiction'' in which the issuer's
ownership interests are offered and sold? Should the exclusion focus on
whether the fund is authorized to make a public offering in the
primary, or any, jurisdiction in which it is offered and sold as a
proxy for whether it is authorized for sale to retail investors?
If the Agencies were to make a modification like the one described
immediately above, should the exclusion retain the reference to the
issuer's ``home'' jurisdiction? For example, should the Agencies modify
this condition to require that the fund be ``authorized to offer and
sell ownership interests to retail investors in the primary
jurisdiction in which the issuer's ownership interests are offered and
sold,'' without any reference to the home jurisdiction? Would this
modification be effective, or does the exclusion need to retain a
reference to an issuer the ownership interests of which are authorized
for sale to retail investors in the home jurisdiction, as well as the
primary jurisdiction in which the issuer's ownership interests are
offered and sold? Why? If the rule retained a reference to
authorization in the fund's home jurisdiction, would this raise
concerns if a fund were authorized to be sold to retail investors in
the fund's home jurisdiction, but was not sold in that jurisdiction and
instead was sold to institutions or other non-retail investors in a
different jurisdiction in which the fund was not authorized to sell
interests to retail investors or to make a public offering? Are there
other formulations the Agencies should make to identify foreign funds
that are authorized to offer and sell their ownership interests to
retail investors? Which formulations and why?
Question 147. Under the 2013 final rule, a foreign public fund's
ownership interests must be sold predominantly through one or more
``public offerings'' outside of the United States, in addition to the
condition discussed above that the fund must be authorized for sale to
retail investors. One result of this ``public offerings'' condition is
that a fund that is authorized for sale to retail investors--including
a fund authorized to make a public offering--cannot rely on the
exclusion if the fund does not in fact offer and sell ownership
interests in public offerings. Some foreign funds, like some RICs, may
be authorized for sale to retail investors but may choose to offer
ownership interests to high-net worth individuals or institutions in
non-public offerings. Do commenters believe it is appropriate that
these foreign funds cannot rely on the FPF exclusion? Should the
Agencies further tailor the FPF exclusion to focus on whether the
fund's ownership interests are authorized for sale to retail investors
or the fund is authorized to conduct a public offering, as discussed
above, rather than whether the fund interests were actually sold in a
public offering? Would the investor protection and other regulatory
requirements that would tend to make foreign funds similar to a U.S.
registered fund generally be a consequence of a fund's authorization
for sale to retail investors or authorization to make a public
offering?
If a fund is authorized to conduct a public offering in a non-U.S.
jurisdiction, would the fund be subject to all of the regulatory
requirements that apply in that jurisdiction for funds
[[Page 33475]]
intended for broad distribution, including to retail investors, even if
the fund is not in fact sold in a public offering to retail investors?
Question 148. The 2013 final rule defines the term ``public
offering'' for purposes of this exclusion to mean a ``distribution''
(as defined in Sec. __.4(a)(3) of the 2013 final rule) 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.\163\ If the Agencies were to
modify the FPF exclusion to focus on whether the fund's ownership
interests are authorized for sale to retail investors or the fund is
authorized to conduct a public offering--rather than whether the fund's
interests were actually sold in a public offering--should the Agencies
retain some or all of the conditions included in the 2013 final rule's
definition of the term ``public offering''? For example, should the
Agencies retain the requirement that a public offering is one that does
not restrict availability to investors having a minimum level of net
worth or net investment assets; and/or the requirement that an FPF file
or submit, with the appropriate regulatory authority in such
jurisdiction, offering disclosure documents that are publicly
available? Would either of these two conditions, either alone or
together, help to identify foreign funds that are sufficiently similar
to RICs? Why or why not? Is the reference to a ``distribution'' (as
defined in Sec. __.4(a)(3) of the 2013 final rule) effective? Should
the Agencies modify the reference to a ``distribution'' to address
instances in which a fund's ownership interests generally are sold to
retail investors in secondary market transactions, as with exchange-
traded funds, for example? Should the definition of ``public offering''
also take into account whether a fund's interests are listed on an
exchange?
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\163\ See 2013 final rule Sec. __.10(c)(1)(iii).
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Question 149. The public offering definition provides in part that
the distribution does not restrict availability to investors having a
minimum level of net worth or net investment assets. Are there
jurisdictions that permit offerings that would otherwise meet the
definition of a public offering but that restrict availability to
investors having a minimum level of net worth or net investment assets
or that otherwise restrict the types of investors who can participate?
Conversely, should the Agencies retain the requirement that an FPF
actually conduct a public offering outside of the United States? Would
a foreign fund that actually sells ownership interests in public
offerings outside of the United States tend to provide greater
information to the public or be subject to additional regulatory
requirements than a fund that is authorized to conduct a public
offering but offers and sells its ownership interests in non-public
offerings?
Question 150. If the Agencies retain the requirement that an FPF
actually conduct a public offering outside of the United States, should
the Agencies retain the requirement that the fund's ownership interests
must be sold ``predominantly'' through one or more such offerings? Why
or why not? As mentioned above, the Agencies stated in the preamble to
the 2013 final rule that they generally expect a fund's offering would
satisfy this requirement if 85 percent or more of the fund's interests
are sold to investors that are not residents of the United States. Has
this guidance been helpful in identifying FPFs that should be excluded,
if the Agencies retain the requirement that an FPF actually conduct a
public offering outside of the United States?
Question 151. The Agencies understand that some banking entities
have faced compliance challenges in determining whether 85 percent or
more of the fund's interests are sold to investors that are not
residents of the United States. Where foreign funds are listed on a
foreign exchange, for example, it may not be feasible to obtain
sufficient information about a fund's owners to make these
determinations. The Agencies understand that banking entities also have
experienced difficulties in obtaining sufficient information about a
fund's owners in some cases where the foreign fund is sold through
intermediaries. What sorts of compliance and other costs have banking
entities incurred in developing and maintaining compliance systems to
track foreign public funds' compliance with this condition? To the
extent that commenters have experienced these or other compliance
challenges, how have commenters addressed them? Have funds failed to
qualify for the FPF exclusion because of this condition? Which kinds of
funds and why? Do commenters believe that these funds should
nonetheless be treated as FPFs? Why? If the Agencies retain this
condition, should they reduce the required percentage of a fund's
ownership interests that must be sold to investors that are not
residents of the United States? Which percentage would be appropriate?
Should the percentage be more than 50 percent, for example? Would a
lower percentage mitigate the compliance challenges discussed above? If
the Agencies do not retain the condition that an FPF must be sold
predominantly through one or more public offerings outside of the
United States, should the Agencies impose any limitations on the extent
to which the fund can be offered in private offerings in the United
States?
Question 152. The 2013 final rule places an additional condition on
a U.S. banking entity's ability to rely on the FPF exclusion with
respect to any FPF it sponsors: The fund's ownership interests must be
sold predominantly to persons other than the sponsoring banking entity
and certain persons connected to that banking entity. Has this
additional condition been effective in identifying FPFs that should be
excluded from the covered fund definition? Has it been effective in
permitting 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? Conversely, has this additional
condition resulted in the compliance challenges discussed above in
connection with the Agencies' view that a fund generally is sold
``predominantly'' in public offerings 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 Agencies understand that
determining whether the employees and directors of a banking entity and
its affiliates have invested in a foreign fund has been particularly
challenging for banking entities because the 2013 final rule defines
the term ``employee'' to include a member of the immediate family of
the employee.\164\ Is there a more direct way to define the term
``employee'' to mitigate the compliance challenges but still be
effective in limiting the opportunity for evasion of section 13? If so,
how? Should a revised definition specify who is included in an
employee's immediate family for this purpose? Should a revised
definition exclude immediate family members? If so, why?
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\164\ See 2013 final rule Sec. __.2(j).
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Question 153. What other aspects of the conditions for FPFs have
resulted in
[[Page 33476]]
compliance challenges? Has the condition that FPFs be sold
predominantly through public offerings outside of the United States
resulted in U.S. banking entities, including their foreign affiliates
and subsidiaries, determining not to sponsor new FPFs because of
concerns about compliance challenges and costs? If the Agencies retain
this additional condition, should they reduce the required percentage
of a fund's ownership interests sold to persons other than the
sponsoring U.S. banking entity and certain persons connected to that
banking entity? Which percentage would be appropriate? Would a lower
percentage mitigate the compliance challenges discussed above? Are
there other conditions that might better serve the same purpose but
reduce the challenges presented by this condition? One effect of this
condition is that a U.S. banking entity can own up to 15 percent of an
FPF that it sponsors, but can own up to 25 percent of a RIC after the
seeding period.\165\ Is this disparate treatment appropriate? Another
effect of this condition is that a U.S. banking entity can own up to 15
percent of an FPF that it sponsors, but a foreign banking entity can
own up to 25 percent of an FPF that it sponsors. Is this disparate
treatment appropriate?
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\165\ The limitation on a banking entity's investment in a U.S.
registered fund under the 2013 final rule results from the
definition of ``banking entity.'' If a banking entity owns,
controls, or has power to vote 25 percent or more of any class of
voting securities of another company, including a U.S. registered
fund after a seeding period, that other company will itself be a
banking entity under the 2013 final rule.
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Question 154. Following the adoption of the 2013 final rule, staffs
of the Agencies provided responses to certain FAQs, including whether
an entity that is formed and operated pursuant to a written plan to
become an FPF would receive the same treatment as an entity formed and
operated pursuant to a written plan to become a RIC or BDC.\166\
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\166\ All the Agencies have published all FAQs on each of their
public websites. See Frequently Asked Question number 5, available
at https://www.federalreserve.gov/bankinforeg/volcker-rule/faq.htm#5; Covered Fund Definition, available at https://www.sec.gov/divisions/marketreg/faq-volcker-rule-section13.htm;
Foreign Public Fund Seeding Vehicles, available at https://www.fdic.gov/regulations/reform/volcker/faq/foreign.html; Foreign
Public Fund Seeding Vehicles, available at https://occ.gov/topics/capital-markets/financial-markets/trading-volcker-rule/volcker-rule-implementation-faqs.html#foreign; Foreign Public Fund Seeding
Vehicles, available at https://www.cftc.gov/sites/default/files/idc/groups/public/@externalaffairs/documents/file/volckerrule_faq060914.pdf.
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The staffs observed that the 2013 final rule explicitly excludes
from the covered fund definition an issuer that is formed and operated
pursuant to a written plan to become a RIC or BDC in accordance with
the banking entity's compliance program as described in Sec.
__.20(e)(3) of the 2013 final rule and that complies with the
requirements of section 18 of the Investment Company Act. The staffs
observed that the 2013 final rule does not include a parallel provision
for an issuer that will become a foreign public fund. The staffs stated
that they do not intend to advise the Agencies to treat as a covered
fund under the 2013 final rule an issuer that is formed and operated
pursuant to a written plan to become a qualifying foreign public fund.
The staffs observed that any written plan would be expected to document
the banking entity's determination that the seeding vehicle will become
a foreign public fund, the period of time during which the seeding
vehicle will operate as a seeding vehicle, the banking entity's plan to
market the seeding vehicle to third-party investors and convert it into
an FPF within the time period specified in Sec. __.12(a)(2)(i)(B) of
the 2013 final rule, and the banking entity's plan to operate the
seeding vehicle in a manner consistent with the investment strategy,
including leverage, of the seeding vehicle upon becoming a foreign
public fund. Has the staffs' position facilitated consistent treatment
for seeding vehicles that operate pursuant to a plan to become an FPF
as that provided for seeding vehicles that operate pursuant to plans to
become RICs or BDCs? Why or why not? Should the Agencies amend the 2013
final rule to implement this or a different approach for seeding
vehicles that will become foreign public funds? What other approaches
should the Agencies take and why? Should the Agencies amend the 2013
final rule to require seeding vehicles that operate pursuant to a
written plan to become an FPF to include in such written plan the same
or different types of documentation as the documentation required of
seeding vehicles that operate pursuant to plans to become RICs or BDCs?
If different types of documentation should be required of seeding
vehicles that will become foreign public funds, why would those
different types of documentation be appropriate? Would requiring those
different types of documentation impose costs or burdens on the issuers
that are greater or less than the costs and burdens imposed on issuers
that will become RICs or BDCs?
iv. Family Wealth Management Vehicles
Some families manage their wealth by establishing and acquiring
ownership interests in ``family wealth management vehicles.'' Family
wealth management vehicles take a variety of legal forms, including
limited liability companies, limited partnerships, other pooled
investment vehicles, and trusts. The structures in which these vehicles
operate vary in complexity, ranging from simple standalone arrangements
covering a single beneficiary to complex multi-tier structures intended
to benefit multiple generations of family members. In some cases, these
vehicles have been in existence for more than 100 years while in other
cases, they are nascent entities with little to no operating history.
The Agencies are aware of no set of consistent standards that govern
the characteristics of family wealth management vehicles or the manner
in which they operate.
Because family wealth management vehicles might hold assets that
meet the definition of ``investment securities'' \167\ in the
Investment Company Act, they may be investment companies that either
need to register as such or otherwise rely on an exclusion from the
definition of investment company. Many family wealth management
vehicles rely on the exclusions provided by sections 3(c)(1) or 3(c)(7)
of the Investment Company Act. Family wealth management vehicles that
would be investment companies but for sections 3(c)(1) or 3(c)(7) will
therefore be covered funds unless they satisfy the conditions for one
of the 2013 final rule's exclusions from the covered fund definition.
Concerns regarding family wealth management vehicles were raised to the
Agencies following the adoption of the 2013 final rule, which does not
provide an exclusion from the covered fund definition specifically
designed to address these vehicles.
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\167\ Section 3(a)(2) of the Investment Company Act defines
``investment securities'' to include all securities except
Government securities, securities issued by employees' securities
companies, and majority-owned subsidiaries of the owner which are
not investment companies, and are not relying on the exception from
the definition of investment company in section 3(c)(1) or 3(c)(7).
Section 3(a)(1)(C) defines an investment company, in part, as any
issuer that is engaged or proposes to engage in the business of
investing, reinvesting, owning, holding, or trading in securities,
and owns or proposes to acquire investment securities having a value
exceeding 40 per centum of the value of each such issuer's total
assets (exclusive of Government securities and cash items) on an
unconsolidated basis.
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Family wealth management vehicles also often maintain accounts and
advisory arrangements with banking entities. These banking entities may
provide a range of services to family wealth management vehicles,
including investment advice, brokerage execution, financing, and
clearance and settlement services. Family wealth management vehicles
structured as trusts for the benefit of family members also often
[[Page 33477]]
appoint banking entities, acting in a fiduciary capacity, as trustees
for the trusts.
Section __.14 of the 2013 final rule provides, in part, that no
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 the fund under Sec. __.11
of the 2013 final rule, may enter into a transaction with the covered
fund that would be a ``covered transaction,'' as defined in section 23A
of the FR Act.\168\ To the extent that a family wealth management
vehicle is a covered fund, then Sec. __.14 would apply. Specifically,
if a banking entity provides services, such as advisory services, that
trigger application of Sec. __.14, the banking entity would be
prohibited from providing the family wealth management vehicle a range
of customer-facing banking services that involve ``covered
transactions.'' Examples of these prohibited covered transactions
include intraday or short-term extensions of credit in connection with
the clearance and settlement of securities transactions executed by the
banking entity for the family wealth management vehicle.
---------------------------------------------------------------------------
\168\ See 2013 final rule Sec. __.14(a).
---------------------------------------------------------------------------
The Agencies are not proposing changes in the status of family
wealth management vehicles in the proposal, but are seeking comment on
their reliance on exclusions in the Investment Company Act, whether or
not they should be excluded from the definition of covered fund, the
role of banking entities with respect to family wealth management
vehicles, and the potential implications of changes in their status
under the 2013 final rule. In considering whether to address the status
of family wealth management vehicles, the Agencies seek comment on the
following:
Question 155. Do family wealth management vehicles typically rely
on the exclusions in sections 3(c)(1) or 3(c)(7) under the Investment
Company Act? Are there other exclusions from the definition of
``investment company'' in the Investment Company Act upon which family
wealth management vehicles can rely? What have been the additional
challenges for family wealth management vehicles and the banking
entities that service them when considering whether these vehicles rely
on the exclusions in sections 3(c)(1) or 3(c)(7)?
Question 156. Should the Agencies exclude family wealth management
vehicles from the definition of ``covered fund''? If so, how should the
Agencies define ``family wealth management vehicle,'' and is this the
appropriate terminology? What factors should the Agencies consider to
distinguish a family wealth management vehicle from a hedge fund or
private equity fund, as contemplated by the statute, given that these
vehicles may utilize identical structures and pursue comparable
investment strategies? Would any of the definitions in rule
202(a)(11)(G)-1 under the Investment Advisers Act of 1940 effectively
define family wealth management vehicle? Should the Agencies, for
example, define a family wealth management vehicle to mean an issuer
that would be a ``family client,'' as defined in rule 202(a)(11)(G)-
1(d)(4)? What modifications to that definition would be appropriate for
purposes of any exclusion from the covered fund definition? For
example, that definition defines a ``family client,'' in part, to
include any company wholly owned (directly or indirectly) exclusively
by, and operated for the sole benefit of, one or more other family
clients, which include any family member or former family member. That
rule defines a ``family member'' to mean ``all lineal descendants
(including by adoption, stepchildren, foster children, and individuals
that were a minor when another family member became a legal guardian of
that individual) of a common ancestor (who may be living or deceased),
and such lineal descendants' spouses or spousal equivalents; provided
that the common ancestor is no more than 10 generations removed from
the youngest generation of family members.'' Would this approach to
defining a ``family member'' be appropriate in the context of an
exclusion from the covered fund definition? Why or why not and, if not,
what other approaches should the Agencies take? Are there any family
wealth management vehicles organized or managed outside of the United
States that raise similar concerns? If so, should the Agencies define
these family wealth management vehicles differently?
Question 157. Would an exclusion for family wealth management
vehicles create any opportunities for evasion, for example, by allowing
a banking entity to structure investment vehicles in a manner to evade
the restrictions of section 13 on covered fund activities? Why or why
not? If so, how could such concerns be addressed? Please explain.
Question 158. What services do banking entities provide to family
wealth management vehicles? Below, the Agencies seek comment on whether
section 14 of the implementing regulation should incorporate the
exemptions within section 23A of the FR Act and the Board's Regulation
W. Would this approach permit banking entities to provide these
services to family wealth management vehicles? Are there other ways in
which the Agencies should address the issue of banking entities being
prohibited from providing services to family wealth vehicles that would
be covered transactions?
Question 159. Are there any similar vehicles outside of the family
wealth management context that pose similar issues?
v. Fund Characteristics
As the Agencies stated in the preamble to the 2013 final rule, an
alternative to the 2013 final rule's approach of defining a covered
fund would be to reference fund characteristics. In the preamble to the
2013 final rule, the Agencies stated that a characteristics-based
definition could be less effective than the approach taken in the 2013
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.\169\ The Agencies also stated that a
characteristics-based approach could require more analysis by banking
entities to apply those characteristics to every potential covered fund
on a case-by-case basis and could create greater opportunity for
evasion. Finally, the Agencies stated that although a characteristics-
based approach could mitigate the costs associated with an investment
company analysis, depending on the characteristics, such an approach
could result in additional compliance costs in some cases to the extent
banking entities would be required to implement policies and procedures
to prevent issuers from having characteristics that would bring them
within the covered fund definition.
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\169\ See 79 FR at 5671.
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As the Agencies consider whether to further tailor the covered fund
definition, the Agencies invite commenters' views and request comment
on whether it may be appropriate to exclude from the definition of
``covered fund'' entities that lack certain characteristics commonly
associated with being a hedge fund or a private equity fund:
Question 160. Should the Agencies exclude from the definition of
``covered fund'' entities that lack certain enumerated traits or
factors of a hedge fund or private equity fund? If so, what traits or
factors should be incorporated and why? For instance, the SEC's Form
[[Page 33478]]
PF defines the terms ``hedge fund'' and ``private equity fund,'' as
described below.\170\ Would it be appropriate to exclude from the
definition of ``covered fund'' an entity that does not meet either of
the Form PF definitions of ``hedge fund'' and ``private equity fund''?
If the Agencies were to take this approach, should we, for example,
modify the 2013 final rule to provide that an issuer is excluded from
the covered fund definition if that issuer is neither a ``hedge fund''
nor a ``private equity fund,'' as defined in Form PF, or should the
Agencies incorporate some or all of the substance of the definitions in
Form PF into the 2013 final rule?
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\170\ See Form PF, Glossary of Terms. Form PF uses a
characteristics-based approach to define different types of private
funds. A ``private fund'' for purposes of Form PF is any issuer that
would be an investment company, as defined in section 3 of the
Investment Company Act, but for section 3(c)(1) or 3(c)(7) of that
Act. Form PF defines the following types of private funds: Hedge
funds, private equity funds, liquidity funds, real estate funds,
securitized asset funds, venture capital funds, and other private
funds. See infra at note 167.
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Question 161. If the Agencies were to incorporate the substance of
the definitions of hedge fund and private equity fund in Form PF,
should the Agencies make any modifications to these definitions for
purposes of the 2013 final rule? Also, Form PF is designed for
reporting by funds advised by SEC-registered advisers. Would any
modifications be needed to have the characteristics-based exclusion
apply to funds not advised by SEC-registered advisers, in particular
foreign funds with non-U.S. advisers not registered with the SEC?
Question 162. Form PF defines ``hedge fund'' to mean any private
fund (other than a securitized asset fund): (a) With respect to which
one or more investment advisers (or related persons of investment
advisers) may be paid a performance fee or allocation calculated by
taking into account unrealized gains (other than a fee or allocation
the calculation of which may take into account unrealized gains solely
for the purpose of reducing such fee or allocation to reflect net
unrealized losses); (b) that may borrow an amount in excess of one-half
of its net asset value (including any committed capital) or may have
gross notional exposure in excess of twice its net asset value
(including any committed capital); or (c) that may sell securities or
other assets short or enter into similar transactions (other than for
the purpose of hedging currency exposure or managing duration). If the
Agencies were to incorporate these provisions as part of a
characteristics-based exclusion, should any of these provisions be
modified? If so, how? Additionally, Form PF's definition of the term
``hedge fund'' provides that, solely for purposes of Form PF, any
commodity pool is categorized as a hedge fund.\171\ If the Agencies
were to define the term ``hedge fund'' based on the definition in Form
PF, should the term include only those commodity pools that come within
the ``hedge fund'' definition without regard to this clause in the Form
PF definition that treats every commodity pool as a hedge fund for
purposes of Form PF? Why or why not?
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\171\ Form PF defines ``commodity pool'' by reference to the
definition in section 1a(10) of the Commodity Exchange Act. See 7
U.S.C. 1a(10).
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Question 163. By contrast, Form PF primarily defines ``private
equity fund'' not by affirmative characteristics, but as any private
fund that is not a hedge fund, liquidity fund, real estate fund,
securitized asset fund or venture capital fund, as those terms are
defined in Form PF,\172\ and that does not provide investors with
redemption rights in the ordinary course. If the Agencies were to
provide a characteristics-based exclusion, should the Agencies do so by
incorporating the definitions of these other private funds? If so,
should the Agencies modify such definitions, and if so, how?
Alternatively, rather than referencing the definition of private equity
fund in Form PF in a characteristics-based exclusion, the Agencies
could design their own definition of a private equity fund based on
traits and factors commonly associated with a private equity fund. For
example, the Agencies understand that private equity funds commonly (i)
have restricted or limited investor redemption rights; (ii) invest in
public and non-public companies through privately negotiated
transactions resulting in private ownership of the business; (iii)
acquire the unregistered equity or equity-like securities of such
companies that are illiquid as there is no public market and third
party valuations are not readily available; (iv) require holding
investments long-term; (v) have a limited duration of ten years or
less; and (vi) realize returns on investments and distribute the
proceeds to investors before the anticipated expiration of the fund's
duration. Are there other traits or factors the Agencies should
incorporate if the Agencies were to provide a characteristics-based
exclusion? Should any of these traits or factors be omitted?
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\172\ Form PF defines ``liquidity fund'' to mean any private
fund that seeks to generate income by investing in a portfolio of
short term obligations in order to maintain a stable net asset value
per unit or minimize principal volatility for investors; ``real
estate fund'' to mean any private fund that is not a hedge fund,
that does not provide investors with redemption rights in the
ordinary course and that invests primarily in real estate and real
estate related assets; ``securitized asset fund'' to mean any
private fund whose primary purpose is to issue asset backed
securities and whose investors are primarily debt-holders; and
``venture capital fund'' to mean any private fund meeting the
definition of venture capital fund in rule 203(l)-1 under the
Investment Advisers Act of 1940.
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Question 164. A venture capital fund, as defined in rule 203(l)-1
under the Advisers Act, is not a ``private equity fund'' or ``hedge
fund,'' as those terms are defined in Form PF. In the preamble to the
2013 final rule, the Agencies explained why they believed that the
statutory language of section 13 did not support providing an exclusion
for venture capital funds from the definition of ``covered fund.''
\173\ If the Agencies were to adopt a characteristics-based exclusion
based on the definition of private equity fund in Form PF, should the
Agencies specify that venture capital funds are private equity funds
for purposes of this rule so that venture capital funds would not be
excluded from the covered fund definition? Do commenters believe that
this approach would be consistent with the statutory language of
section 13?
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\173\ See 79 FR at 5704 (``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. This indicates that Congress knew how
to distinguish venture capital funds from other types of private
equity funds when it desired to do so. 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.'') (footnotes omitted). Section 13 also provides an
extended transition period for ``illiquid funds,'' which section 13
defines, in part, as a hedge fund or private equity fund that, as of
May 1, 2010, was principally invested in, or was invested and
contractually committed to principally invest in, illiquid assets,
such as portfolio companies, real estate investments, and venture
capital investments. Congress appears to have contemplated that
covered funds would include funds principally invested in venture
capital investments.
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Question 165. The Agencies request that commenters advocating for a
characteristics-based exclusion explain why particular characteristics
are appropriate, what kinds of funds and what kinds of investment
strategies or portfolio holdings might be excluded by the commenters'
suggested approach, and why that would be appropriate.
Question 166. If the Agencies were to provide a characteristics-
based exclusion, should it exclude only funds that have none of the
enumerated
[[Page 33479]]
characteristics? Alternatively, are there any circumstances where a
fund should be able to rely on a characteristics-based exclusion if it
had some, but not most, of the characteristics?
Question 167. Would a characteristics-based exclusion present
opportunities for evasion? Should the Agencies address any concerns
about evasion through other means, such as the anti-evasion provisions
in Sec. __.21 of the 2013 final rule, rather than by including a
broader range of funds in the covered fund definition?
Question 168. If the Agencies were to provide a characteristics-
based exclusion, would any existing exclusions from the definition of
``covered fund'' be unnecessary? If so, which ones and why?
Question 169. If the Agencies were to provide a characteristics-
based exclusion, to what extent and how should the Agencies consider
section 13's limitations both on proprietary trading and on covered
fund activities? For example, section 13 limits a banking entity's
ability to engage in proprietary trading, which section 13 defines as
engaging as a principal for the trading account, and defines the term
``trading account'' generally as any account used for acquiring or
taking positions in the securities and the instruments specified in the
proprietary trading definition 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).\174\ This suggests that a fund
engaged in selling financial instruments in the near term, or otherwise
with the intent to resell in order to profit from short-term price
movements, should be included in the covered fund definition in order
to prevent a banking entity from evading the limitations in section 13
through investments in funds. The statute also, however, contemplates
that the covered fund definition would include funds that make longer-
term investments and specifically references private equity funds. For
example, the statute provides for an extended conformance period for
``illiquid funds,'' which section 13 defines, in part, as hedge funds
or private equity funds that, as of May 1, 2010, were principally
invested in, or were invested and contractually committed to
principally invest in, illiquid assets, such as portfolio companies,
real estate investments, and venture capital investments.\175\ Trading
strategies involving these and other types of illiquid assets generally
do not involve selling financial instruments in the near term, or
otherwise with the intent to resell in order to profit from short-term
price movements.
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\174\ See 12 U.S.C. 1851(h)(4) (defining ``proprietary
trading''); 12 U.S.C. 1851(h)(6) (defining ``trading account'').
\175\ 12 U.S.C. 1851(c)(3).
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Question 170. Should the Agencies therefore provide an exclusion
from the covered fund definition for a fund that (i) is not engaged in
selling financial instruments in the near term, or otherwise with the
intent to resell in order to profit from short-term price movements;
and (ii) does not invest, or principally invest, in illiquid assets,
such as portfolio companies, real estate investments, and venture
capital investments? Would this or a similar approach help to exclude
from the covered fund definition issuers that do not engage in the
investment activities contemplated by section 13? Would such an
approach be sufficiently clear? Would it be clear when a fund is and is
not engaged in selling financial instruments in the near term, or
otherwise with the intent to resell in order to profit from short-term
price movements? Would this approach result in funds being excluded
from the definition that commenters believe should be covered funds
under the rule? The Agencies similarly request comment as to whether a
reference to illiquid assets, with the examples drawn from section 13,
would be sufficiently clear and, if not, how the Agencies could provide
greater clarity.
Question 171. Rather than providing a characteristics-based
exclusion, should the Agencies instead revise the base definition of
``covered fund'' using a characteristics-based approach? \176\ That is,
should the Agencies provide that none of the types of funds currently
included in the base definition--investment companies but for section
3(c)(1) or 3(c)(7) and certain commodity pools and foreign funds--will
be covered funds in the first instance unless they have characteristics
of a hedge fund or private equity fund?
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\176\ See supra Part III.C.1.a.i.
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vi. Joint Ventures
The Agencies, in tailoring the covered fund definition, noted that
many joint ventures rely on section 3(c)(1) or 3(c)(7). Under the 2013
final rule, a joint venture is excluded from the covered fund
definition if the joint venture (i) is between the banking entity or
any of its affiliates and no more than 10 unaffiliated co-venturers;
(ii) 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 (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.\177\ The Agencies
observed in the preamble to the 2013 final rule that, with this
exclusion, banking entities ``will continue to be able to share the
risk and cost of financing their banking activities through these types
of entities which . . . may allow banking entities to more efficiently
manage the risk of their operations.'' \178\
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\177\ See 2013 final rule Sec. __.10(c)(3).
\178\ 79 FR at 5681.
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In 2015, the staffs of the Agencies provided a response to FAQs
regarding the extent to which an excluded joint venture could invest in
securities, consistent with the condition in the 2013 final rule that
an excluded joint venture may 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.\179\ The Agencies observed in the preamble to the 2013
final rule that this condition ``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.'' \180\ The staffs
expressed the view in their response to a FAQ that this condition
generally could not be met by, and the exclusion would therefore not be
available to, an issuer that:
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\179\ See supra note. 21.
\180\ 79 FR at 5681. The Agencies also observed that,
``[c]onsistent 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.'' Id.
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[cir] ``[R]aise[s] money from investors primarily for the purpose
of investing in securities for the benefit of one or more investors and
sharing the income, gain or losses on securities acquired by that
entity,'' observing that ``[t]he limitations in the joint venture
exclusion are meant to ensure that the joint venture is not an
investment vehicle and that the joint venture exclusion is not used as
a means to evade the limitations in the BHC Act on investing in covered
funds'';
[cir] ``[R]aises money from a small number of investors primarily
for the purpose of investing in securities, whether the securities are
intended to be traded frequently, held for a longer duration, held to
maturity, or held until the dissolution of the entity''; or
[cir] ``[R]aises funds from investors primarily for the purpose of
sharing in
[[Page 33480]]
the benefits, income, gains or losses from ownership of securities--as
opposed to conducting a business or engaging in operations or other
non-investment activities,'' reasoning that such an issuer ``would be
raising money from investors primarily for the purpose of `investing in
securities,' even if the vehicle may have other purposes,'' and that
the exclusion ``also is not met by an entity that raises money from
investors primarily for the purpose of investing in securities for
resale or other disposition or otherwise trading in securities merely
because one of the purposes for establishing the vehicle may be to
provide financing to an entity to obtain and hold securities.''
The staffs also observed that, in addition to the conditions in the
joint venture exclusion, as an initial matter, an entity seeking to
rely on the exclusion must be a joint venture. The staffs observed that
the basic elements of a joint venture are well recognized, including
under state law, although the term is not defined in the 2013 final
rule. The staffs also observed that although any determination of
whether an arrangement is a joint venture will depend on the facts and
circumstances, the staffs generally would not expect that a person that
does not have some degree of control over the business of an entity
would be considered to be participating in ``a joint venture between a
banking entity or any of its affiliates and one or more unaffiliated
persons,'' as specified in the 2013 final rule's joint venture
exclusion.
The Agencies request comment on all aspects of the 2013 final
rule's exclusion for joint ventures, including the extent to which the
Agencies should modify the joint venture exclusion:
Question 172. Has the 2013 final rule's exclusion for joint
ventures allowed banking entities to continue to be able to share the
risk and cost of financing their banking activities through joint
ventures, and therefore allowed banking entities to more efficiently
manage the risk of their operations, as contemplated by the Agencies in
adopting this exclusion? If not, what modifications should the Agencies
make to the joint venture exclusion?
Question 173. Should the Agencies make any changes to the joint
venture exclusion to clarify the condition that a joint venture may 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? Should the Agencies
incorporate some or all of the views expressed by the staffs in their
FAQ response? If so, which views and why? Should the Agencies, for
example, modify the conditions to clarify that an excluded joint
venture may not be, or hold itself out as being, an entity or
arrangement that raises money from investors primarily for the purpose
of investing in securities, whether the securities are intended to be
traded frequently, held for a longer duration, held to maturity, or
held until the dissolution of the entity? Conversely, do the views
expressed by the staffs in their FAQ response, or similar conditions
the Agencies might add to the joint venture exclusion, affect the
utility of the joint venture exclusion? If so, how could the Agencies
increase or preserve the utility of the joint venture exclusion as a
means of structuring business arrangements without allowing an excluded
joint venture to be used by a banking entity to invest in or sponsor
what is in effect a covered fund that merely has no more than ten
unaffiliated investors?
Question 174. Are there other conditions the Agencies should
include, or modifications to the exclusion's current conditions that
the Agencies should make, to clarify that the joint venture exclusion
is designed to allow banking entities to structure business ventures,
as opposed to an entity that may be labelled a joint venture but that
is in reality a hedge fund or private equity fund established for
investment purposes?
Question 175. The 2013 final rule does not define the term ``joint
venture.'' Should the Agencies define that term? If so, how should the
Agencies define the term? Should the Agencies, for example, modify the
2013 final rule to reflect the view expressed by the staffs that a
person that does not have some degree of control over the business of
an entity would generally not be considered to be participating in ``a
joint venture between a banking entity or any of its affiliates and one
or more unaffiliated persons''? Would this modification serve to
differentiate a participant in a joint venture from an investor in what
would otherwise be a covered fund? Has state law been useful in
determining whether a structure is a joint venture for purposes of the
2013 final rule? Are there other changes to the joint venture exclusion
the Agencies should make on this point?
vii. Securitizations
The 2013 final rule contains several provisions designed to address
securitizations and to implement the rule of construction in section
13(g)(2) of the BHC Act, which provides that nothing in section 13
shall be construed to limit or restrict the ability of a banking entity
to sell or securitize loans in a manner that is otherwise permitted by
law. These provisions include the 2013 final rule's exclusions from the
covered fund definition for loan securitizations, qualifying asset-
backed commercial paper conduits, and qualifying covered bonds. The
Agencies request comment on all aspects of the 2013 final rule's
application to securitizations, including:
Question 176. Are there any concerns about how the 2013 final
rule's exclusions from the covered fund definition for loan
securitizations, qualifying asset-backed commercial paper conduits, and
qualifying covered bonds work in practice? If commenters believe the
Agencies can make these provisions more effective, what modifications
should the Agencies make and why?
Question 177. The 2013 final rule's loan securitization exclusion
excludes an issuing entity for asset-backed securities that, among
other things, has assets or holdings consisting solely of certain types
of permissible assets enumerated in the 2013 final rule. These
permissible assets generally are loans, certain servicing assets, and
special units of beneficial interest and collateral certificates. Are
there particular issues with complying with the terms of this exclusion
for vehicles that are holding loans? Are there any modifications the
Agencies should make and if so, why and what are they? How would such
modifications be consistent with the statutory provisions? For example,
debt securities generally are not permissible assets for an excluded
loan securitization.\181\ What effect does this limitation have on loan
securitization vehicles? Should the Agencies consider permitting a loan
securitization vehicle to hold 5 percent or 10 percent of assets that
are considered debt securities rather than ``loans,'' as defined in the
2013 final rule? Are there other types of similar assets that are not
``loans,'' as defined in the 2013 final rule, but that have similar
financial characteristics that an excluded loan securitization vehicle
should be permitted to own as 5 percent or 10 percent of the vehicle's
assets? Conversely, would this additional flexibility be necessary or
appropriate now that banking entities have restructured loan
securitizations as necessary to comply with the 2013 final
[[Page 33481]]
rule and structured loan securitizations formed after the 2013 final
rule was adopted in order to comply with the 2013 final rule? After
banking entities have undertaken these efforts, would allowing an
excluded loan securitization to hold additional types of assets allow a
banking entity indirectly to engage in investment activities that may
implicate section 13 rather than as an alternative way for a banking
entity either to securitize or own loans through a securitization, as
contemplated by the rule of construction in section 13(g)(2) of the BHC
Act?
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\181\ The 2013 final rule does, however, permit an excluded loan
securitization to hold cash equivalents for purposes of the rights
and assets in paragraph (c)(8)(i)(B) of the final rule, and
securities received in lieu of debts previously contracted with
respect to the loans supporting the asset-backed securities. See
2013 final rule Sec. __.10(c)(8)(iii).
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Question 178. Should the Agencies modify the loan securitization
exclusion to reflect the views expressed by the Agencies' staffs in
response to a FAQ \182\ that the servicing assets described in
paragraph 10(c)(8)(i)(B) of the 2013 final rule may be any type of
asset, provided that any servicing asset that is a security must be a
permitted security under paragraph 10(c)(8)(iii) of the 2013 final
rule? Should the Agencies, for example, modify paragraph 10(c)(8)(i)(B)
of the 2013 final rule to add the underlined text: ``Rights or other
assets designed to assure the servicing or timely distribution of
proceeds to holders of such securities and rights or other assets that
are related or incidental to purchasing or otherwise acquiring and
holding the loans, provided that each asset that is a security meets
the requirements of paragraph (c)(8)(iii) of this section.'' Should the
2013 final rule be amended to include this language? Are there other
clarifying modifications that would better address the expressed
concern?
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\182\ See supra note 22.
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Question 179. Are there modifications the Agencies should make to
the 2013 final rule's definition of the term ``ownership interest'' in
the context of securitizations? If so, what modifications should the
Agencies make and how would they be consistent with the ownership
interest restrictions? Banking entities have raised questions regarding
the scope of the provision of the 2013 final rule that provides that an
ownership interest includes an interest that has, among other
characteristics, ``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)'' in the context of creditor rights. Should the
Agencies modify this parenthetical to provide greater clarity to
banking entities regarding this parenthetical? For example, should the
Agencies modify the parenthetical to provide that the ``rights of a
creditor to exercise remedies upon the occurrence of an event of
default or an acceleration event'' include the right to participate in
the removal of an investment manager for cause, or to nominate or vote
on a nominated replacement manager upon an investment manager's
resignation or removal? Would the ability to participate in the removal
or replacement of an investment manager under these limited
circumstances more closely resemble a creditor's rights upon default to
protect its interest, as opposed to the right to vote on matters
affecting the management of an issuer that may be more typically
associated with equity or partnership interests? Why or why not? What
actions do holders of interests in loan securitizations today take with
respect to investment managers and under what circumstances? Are such
rights limited to certain classes of holders?
Question 180. The Agencies understand that in many securitization
transactions, there are multiple tranches of interests that are sold.
The Agencies also understand that some of these interests may have
characteristics that are the same as debt securities with fixed
maturities and fixed rates of interest, and with no other residual
interest or payment. In the context of the definition of ownership
interest for securitization vehicles, should the Agencies consider
whether securitization interests that have only these types of
characteristics be considered ``other similar interests'' for purposes
of the ownership interest definition? If so, why or why not? If so, why
should a distribution of profits from a passive investment such as a
securitization be treated differently than a distribution of profits
from any other type of passive investment? Please explain why
securitization vehicles should be treated differently than other
covered funds, some of which also could have tranched investment
interests.
viii. Selected Other Issuers
In this section the Agencies request comment on the 2013 final
rule's application to certain types of issuers for which banking
entities and others have expressed concern to one or more of the
Agencies:
Question 181. The 2013 final rule excludes from the covered fund
definition an issuer that is a small business investment company, as
defined in section 103(3) of the Small Business Investment Act of 1958,
or that has received from the Small Business Administration notice to
proceed to qualify for a license as a small business investment
company, which notice or license has not been revoked. A small business
investment company that relinquishes its license as the company
liquidates its holdings, however, will no longer be a ``small business
investment company,'' as defined in section 103(3) of the Small
Business Investment Act of 1958, and will therefore no longer be
excluded from the covered fund definition. Should the Agencies modify
the exclusion to provide that the exclusion will remain available under
these circumstances when a small business investment company
relinquishes or voluntarily surrenders its license? If so, how should
the Agencies specify the circumstances under which the company may
operate after relinquishing or voluntarily surrendering its license
while still relying on the exclusion? Does the absence of a license
from the Small Business Administration under these circumstances affect
whether the company is engaged in the investment activities
contemplated by section 13? Why or why not? Are there other examples of
an entity that is excluded from the covered fund definition and that
could no longer satisfy the relevant exclusion as the entity is
liquidated? Which kinds of entities, what causes them to no longer
satisfy the exclusion, and what modifications to the 2013 final rule do
commenters believe would be appropriate to address them? For example,
have banking entities encountered any difficulties with respect to RICs
that use liquidating trusts?
Question 182. The 2013 final rule does not provide a specific
exclusion from the definition of ``covered fund'' for an issuer that is
a municipal securities tender option bond vehicle.\183\
[[Page 33482]]
The 2013 final rule ``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.'' \184\ To the extent that a tender option bond vehicle
is a covered fund, then, Sec. __.14 would apply. If a banking entity
organizes and offers or sponsors a tender option bond vehicle, for
example, Sec. __.14 of the 2013 final rule prohibits the banking
entity from engaging in any ``covered transaction'' with the vehicle.
Such a ``covered transaction'' could include the sponsoring banking
entity providing a liquidity facility to support the put right that is
a key feature of the ``floater'' security issued by a tender option
bond vehicle. The Agencies understand that after adoption of the 2013
final rule, banking entities restructured tender option bond vehicles,
or structured new tender option bond vehicles formed after adoption, in
order to comply with the 2013 final rule. What role do banking entities
play in creating the tender option bond trust and how have the
restrictions on ``covered transactions'' affected the continuing use of
this financing structure? Why should tender option bond vehicles
sponsored by banking entities be viewed differently than other types of
covered funds sponsored by banking entities? As discussed above, the
Agencies are requesting comment about whether to incorporate into Sec.
__.14's limitations on covered transactions the exemptions provided in
section 23A of the FR Act and the Board's Regulation W. Would
incorporating some or all of these exemptions address any challenges
banking entities that sponsor tender option bond trusts have faced with
respect to subsequent and ongoing covered transactions with such tender
option bond vehicles?
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\183\ In the preamble to the 2013 final rule, the Agencies noted
commenters' description of a ``typical tender option bond
transaction'' as consisting of ``the deposit of a single issue of
highly-rated, long-term 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.''
See 79 FR at 5702.
\184\ See 79 FR at 5703.
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2. Section __.11: Activities Permitted in Connection With Organizing
and Offering a Covered Fund
a. Underwriting and Market Making for a Covered Fund
Section 13(d)(1)(B) of the BHC Act permits a banking entity to
purchase and sell securities and other instruments described in
13(h)(4) in connection with certain underwriting or market making-
related activities.\185\ The 2013 final rule addressed how this
exemption applied in the context of underwriting or market making of
ownership interests in covered funds. In particular, Sec. __.11(c) of
the 2013 final rule provides that the prohibition in Sec. __.10(a) on
ownership or sponsorship of a covered fund does not apply to a banking
entity's underwriting and market making-related activities involving a
covered fund so long as:
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\185\ 12 U.S.C. 1851(d)(1)(B).
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The banking entity conducts the activities in accordance with the
requirements of the underwriting exemption in Sec. __.4(a) of the 2013
final rule or market-making exemption in Sec. __.4(b) of the 2013
final rule, respectively;
The banking entity includes the aggregate value of all ownership
interests of the covered fund acquired or retained by the banking
entity and its affiliates for purposes of the limitation on aggregate
investments in covered funds (the ``aggregate-fund limit'') \186\ and
capital deduction requirement; \187\ and
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\186\ See 2013 final rule Sec. __.12(a)(iii).
\187\ See 2013 final rule Sec. __.12(d).
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The banking entity includes any ownership interests that it
acquires or retains for purposes of the limitation on investments in a
single covered fund (the ``per-fund limit'') if the banking entity (or
an affiliate): (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 in reliance on the
exemption for organizing and offering a covered fund in Sec. __.11(a)
of the 2013 final rule; (iii) acquires and retains an ownership
interest in such covered fund and is either a securitizer, as that term
is used in section 15G(a)(3) of the Exchange Act, or is acquiring and
retaining an ownership interest in such covered fund in compliance with
section 15G of that Act and the implementing regulations issued
thereunder, each as permitted by Sec. __.11(b) of the 2013 final rule;
or (iv) directly or indirectly, guarantees, assumes, or otherwise
insures the obligations or performance of the covered fund or of any
covered fund in which such fund invests.\188\
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\188\ See 2013 final rule Sec. __.11(c).
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The Agencies continue to 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. 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 proposed amendments to Sec. __.11(c) are intended to better
achieve these objectives, consistent with the requirements of the
statute and based on the experience of the Agencies following
implementation of the 2013 final rule. Specifically, for a covered fund
that the banking entity does not organize or offer pursuant to Sec.
__.11(a) or (b) of the 2013 final rule, the proposal would remove the
requirement that the banking entity include for purposes of the
aggregate fund limit and capital deduction the value of any ownership
interests of the covered fund acquired or retained in accordance with
the underwriting or market-making exemption. Under the proposed
amendments, these limits, as well as the per fund limit, would only
apply to a covered fund that the banking entity organizes or offers and
in which the banking entity retains an ownership interest pursuant to
Sec. __.11(a) or (b) of the 2013 final rule. The Agencies seek with
this change to more closely align the requirements for engaging in
underwriting or market-making-related activities with respect to
ownership interests in a covered fund with the requirements for
engaging in these activities with respect to other financial
instruments. The Agencies expect this change would reduce compliance
costs for banking entities that engage in these activities without
exposing banking entities to additional risks beyond those inherent in
underwriting and market making-related activities involving otherwise
similar financial instruments as permitted by the statute. This is
because banking entities that engage in underwriting or market making-
related activities with respect to covered funds would remain subject
to the
[[Page 33483]]
requirements of those exemptions in subpart B, as modified by the
proposal, including requirements relating to risk management and
limitations based on the reasonably expected near term demand of
clients, customers, or counterparties.
The proposal would retain the requirements of the 2013 final rule
associated with the per-fund limit, aggregate fund limit, and capital
deduction where the banking entity engages in activity in reliance on
Sec. __.11(a) or (b) with respect to a covered fund, consistent with
the limitations of section 13(d)(1)(G)(iii) of the BHC Act that
restrict a banking entity that relies on this exemption from acquiring
or retaining an ownership interest in a covered fund beyond a de
minimis investment amount.
In addition, the proposal would maintain the requirement that the
underwriting or market-making-related activities be conducted in
accordance with the requirements of Sec. __.4(a) or Sec. __4(b) of
the 2013 final rule (as modified by the proposal), respectively. These
requirements are designed specifically to address a banking entity's
underwriting and market making-related activities and to permit holding
exposures consistent with the reasonably expected near term demand of
clients, customers and counterparties.
Question 183. What effects do commenters believe the proposed
changes to the requirements for engaging in underwriting or market-
making-related activities with respect to ownership interests in
covered funds would have on the capital raising activities of covered
funds and other issuers? What other changes should the Agencies
consider, if any, to more closely align the requirements for engaging
in underwriting or market-making-related activities with respect to
ownership interests in a covered fund with the requirements for
engaging in these activities with respect to other financial
instruments? For example, because the exemption for underwriting and
market making-related activities under section 13(d)(1)(B), by its
terms, is a statutorily permitted activity and an exemption from the
prohibitions in section 13(a), is it necessary to continue to retain
the per-fund limit, aggregate fund limit, and capital deduction where
the banking entity engages in activity in reliance on Sec. __.11(a) or
(b)? Should these limitations apply only with respect to covered fund
interests acquired or retained by the banking entity in reliance on
section 13(d)(1)(G)(iii) of the BHC Act, and not to interests held in
reliance on the separate exemption provided for underwriting and market
making activities, where the banking entity seeks to rely on separate
exemptions for permitted activities related to the same covered fund?
That is, should we remove the requirement that the banking entity
include for purposes of the per fund limit, aggregate fund limit, and
capital deduction the value of any ownership interests of the covered
fund acquired or retained in accordance with the underwriting or
market-making exemption, regardless of whether the banking entity
engages in activity in reliance on Sec. __.11(a) or (b) with respect
to the fund? Why or why not? Conversely, should the Agencies retain the
requirement that all covered fund ownership interests acquired or
retained in connection with underwriting or market-making-related
activities be included for purposes of the aggregate fund limit and
capital deduction as a means to effectuate the limitations on permitted
activities in section (d)(2)(A) of the BHC Act?
Question 184. Please describe whether the restrictions on
underwriting or market making of ownership interests in covered funds
are appropriate. Why or why not?
Question 185. Please describe any potential restrictions that
commenters believe should be included or indicate any restrictions that
should be removed, along with the commenter's rationale for such
changes, and how such changes would be consistent with the statute.
3. Section __.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 risk-mitigating hedging activities.\189\ In the context of
covered fund activities, the 2013 final rule implemented this authority
narrowly, permitting only limited risk-mitigating hedging activities
involving ownership interests in covered funds for hedging employee
compensation arrangements. In particular, Sec. __.13(a) of the 2013
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.
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\189\ See 12 U.S.C. 1851(d)(1)(C).
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In the 2011 proposal, the Agencies considered permitting a banking
entity to acquire or retain an ownership interest in a covered fund as
a hedge in a second context, in addition to hedging employee
compensation arrangements. Specifically, the 2011 proposal included a
provision that would have allowed a banking entity to acquire or retain
an ownership interest in a covered fund as a risk-mitigating hedge when
acting as an intermediary on behalf of a customer that is not itself a
banking entity to facilitate the exposure by the customer to the
profits and losses of the covered fund.\190\ After receiving comments
on the 2011 proposal, the Agencies determined not to include this
second provision in the 2013 final rule. At the time, the Agencies
determined based on information available and comments received, 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, constituted a high-risk strategy that could threaten the safety
and soundness of the banking entity. The Agencies were concerned that
these transactions could 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, and that 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. The
Agencies therefore concluded that these transactions could 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.\191\
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\190\ See 2011 proposal.
\191\ See 79 FR at 5737.
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Since the Agencies' adoption of the 2013 final rule, some market
participants have argued that the 2013 final rule should be modified to
permit a banking entity to acquire or retain an ownership interest in a
covered fund as a risk-mitigating hedge when acting as an intermediary
on behalf of a customer that is not itself a banking entity to
facilitate the exposure by the customer to the profits and losses of
the covered fund. These market participants have urged that allowing
banking entities to facilitate customer activity would be consistent
with the intent of the statute. In the view of these market
participants, permitting such activity would not be inconsistent with
safety and soundness because it would be conducted consistent with the
requirements of the 2013 final rule, as modified by the proposal,
including the requirements
[[Page 33484]]
with respect to risk-mitigating hedging transactions. For example, such
exposures would be subject to required risk limits and policies and
procedures and must be appropriately monitored and risk managed.
Although a banking entity could be exposed to the risk of the covered
fund if the customer fails to perform, this counterparty default risk
would be present whenever a banking entity facilitates the exposure by
the customer to the profits and losses of a financial instrument and
seeks to hedge its own exposure by investing in the financial
instrument.
Accordingly, the Agencies are including this provision in the
proposal and requesting comment below as to whether the 2013 final rule
should be modified to permit this additional category of risk-
mitigating hedging transactions.
As in the 2011 proposal, this proposal would allow a banking entity
to acquire a covered fund interest as a hedge when acting as an
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund. The hedging of employee compensation
arrangements involving covered fund interests would remain unchanged
from the 2013 final rule. Moreover, a banking entity that seeks to use
a covered fund interest to hedge on behalf of a customer would need to
comply with all of the requirements of Sec. __.13(a), which generally
track the requirements of Sec. __.5, as modified by this
proposal.\192\ The Agencies believe that to effectively implement the
statute, banking entities should have a broader ability to acquire or
retain a covered fund interest as a permissible hedging activity.
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\192\ The proposal would also amend Sec. __.13(a) to align with
the proposed modifications to Sec. __5. In particular, the proposal
would require that a risk-mitigating hedging transaction pursuant to
Sec. __.13(a) be designed to reduce or otherwise significantly
mitigate one or more specific, identifiable risks to the banking
entity. It would also remove the requirement that the hedging
transaction ``demonstrably reduces or otherwise significantly
mitigates'' the relevant risks, consistent with the proposed
modifications to Sec. __.5. See supra Part III.B.3 of this
Supplementary Information section.
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In addition to those questions raised in connection with the
proposed implementation of the risk-mitigating hedging exemption under
Sec. __.5 of the proposal, the Agencies request comment on the
proposed implementation of that same exemption with respect to covered
fund activities. In particular, the Agencies request comment on the
following questions:
Question 186. Should a banking entity be permitted to acquire or
retain an ownership interest in a covered fund as a hedge when acting
as an intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund? If so, what kinds of transactions would
banking entities enter into to facilitate the exposure by the customer
to the profits and losses of the covered fund, what types of covered
funds would be used to hedge, how would they be used to hedge, and what
kinds of customers would be involved? Should the Agencies place
additional limitations on these arrangements, such as a requirement for
a banking entity to take prompt action to hedge or eliminate its
covered fund exposure if the customer fails to perform?
Question 187. At the time the Agencies adopted the 2013 final rule,
they 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, constituted a high-risk strategy that
could threaten the safety and soundness of the banking entity. Do these
arrangements constitute a high-risk strategy, threaten the safety and
soundness of a banking entity, and pose significant potential to expose
banking entities to the same or similar economic risks that section 13
of the BHC Act sought to eliminate? Why or why not? Commenters are
encouraged to provide specific information that would help the
Agencies' analysis of this question.
Question 188. Are there other circumstances on which a banking
entity should be permitted to acquire or retain an ownership interest
in a covered fund? If so, please explain. For example, should the
Agencies amend the 2013 final rule to provide that, in addition to the
proposed amendment, banking entities be permitted to acquire or retain
ownership interests in covered funds where the acquisition or retention
meets the requirements of Sec. __.5 of the 2013 final rule, as
modified by the proposal?
b. Permitted Covered Fund Activities and Investments Outside of the
United States
Section 13(d)(1)(I) of the BHC Act \193\ permits foreign banking
entities to acquire or retain an ownership interest in, or act as
sponsor to, a covered fund, so long as those activities and investments
occur solely outside the United States and certain other conditions are
met (the foreign fund exemption).\194\ 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 equity among U.S.
and foreign banking entities within the United States.\195\ The statute
does not explicitly define what is meant by ``solely outside of the
United States.''
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\193\ Section 13(d)(1)(I) of the BHC Act permits a banking
entity to acquire or retain an ownership interest in or have certain
relationships with, a covered fund notwithstanding the restrictions
on investments in, and relationships with, a covered fund, if: (i)
Such activity or investment is conducted by a banking entity
pursuant to paragraph (9) or (13) of section 4(c) of the BHC Act;
(ii) the activity occurs solely outside of the United States; (iii)
no ownership interest in such fund is offered for sale or sold to a
resident of the United States; and (iv) the banking entity is not
directly or indirectly controlled by a banking entity that is
organized under the laws of the United States or of one or more
States. See 12 U.S.C. 1851(d)(1)(I).
\194\ This section's discussion of the concept ``solely outside
of the United States'' is provided solely for purposes of the
proposal'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.
\195\ 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.'').
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i. Activities or Investments Solely Outside of the United States
The 2013 final rule establishes several conditions on the
availability of the foreign fund exemption. Specifically, the 2013
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 is not controlled directly or
indirectly by, a banking entity that is located in the United States or
established under the laws of the United States or of any State;
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
[[Page 33485]]
United States or organized under the laws of the United States or of
any State;
The investment or sponsorship, including any transaction
arising from risk-mitigating hedging related to an ownership interest,
is not accounted for as principal directly or indirectly on a
consolidated basis by any branch or affiliate that is located in the
United States or organized under the laws of the United States or of
any State; and
No financing for the banking entity's ownership or
sponsorship is provided, directly or indirectly, by any branch or
affiliate that is located in the United States or organized under the
laws of the United States or of any State (the ``financing
prong'').\196\
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\196\ See final rule Sec. __.13(b)(4).
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Much like the similar requirement under the exemption for permitted
trading activities of a foreign banking entity, experience since
adoption of the 2013 final rule has indicated that the financing prong
has been difficult to comply with in practice. As a result, the
proposal would remove the financing prong of the foreign fund exemption
for the same reasons as described above for the trading outside of the
United States exemption. This modification would streamline the
requirements of this exemption with the intention of improving
implementation of the statutory exemption. Although a U.S. branch or
affiliate that extends financing for a covered fund investment solely
outside of the United States could bear some risks--for example, if the
U.S. branch of an affiliate provides a loan secured by a covered fund
interest that then declines in value--the conditions to the foreign
fund exemption, as modified by the proposal, are designed to require
that the principal risks of covered fund investments and sponsorship by
foreign banking entities permitted under the foreign fund exemption
occur and remain solely outside of the United States. For example, the
foreign fund exemption would continue to provide that the investment or
sponsorship, including any transaction arising from risk-mitigating
hedging related to an ownership interest, may not be accounted for as
principal directly or indirectly on a consolidated basis by any U.S.
branch or affiliate. One of the principal purposes of section 13 of the
BHC Act appears to be to limit the risks that covered fund investments
and activities may pose to the safety and soundness of U.S. banking
entities and the U.S. financial system. A purpose of the foreign fund
exemption appears to be to limit the extraterritorial application of
section 13 as it applies to foreign banking entities subject to section
13. The modifications to these requirements under the proposal are
intended 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.
ii. Offered for Sale or Sold to a Resident of the United States
One of the restrictions of the exemption for covered fund
activities conducted by foreign banking entities outside the United
States is the restriction that no ownership interest in the covered
fund may be offered for sale or sold to a resident of the United
States.\197\ To implement this restriction, Sec. __.13(b) of the 2013
final rule requires, as one condition of the foreign fund exemption,
that ``no ownership interest in such hedge fund or private equity fund
is offered for sale or sold to a resident of the United States'' (the
``marketing restriction''). Section __.13(b)(3) of the 2013 final rule
further specifies that an ownership interest in a covered fund is not
offered for sale or sold to a resident of the United States for
purposes of the marketing restriction if it is sold or has been sold
pursuant to an offering that does not target residents of the United
States.\198\
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\197\ See 12 U.S.C. 1851(d)(1)(I).
\198\ 2013 final rule Sec. __.13(b)(3).
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After issuance of the 2013 final rule, foreign banking entities
requested clarification from the Agencies regarding whether the
marketing restriction applied only to the activities of a foreign
banking entity that is seeking to rely on the foreign fund exemption or
whether it applied more generally to the activities of any person
offering for sale or selling ownership interests in the covered fund.
Specifically, sponsors of covered funds and foreign banking entities
asked how this condition would apply to a foreign banking entity that
has made, or intends to make, an investment in a covered fund where the
foreign banking entity (including its affiliates) does not sponsor, or
serve, directly or indirectly, as the investment manager, investment
adviser, commodity pool operator, or commodity trading advisor to the
covered fund (a third-party covered fund).
After issuance of the 2013 final rule, the staffs of the Agencies
issued guidance to address these issues, and the proposal would amend
the 2013 final rule to clearly incorporate this guidance.\199\ The
proposal therefore provides that an ownership interest in a covered
fund is not offered for sale or sold to a resident of the United States
for purposes of the marketing restriction only if it is not sold and
has not been sold pursuant to an offering that targets residents of the
United States in which the banking entity or any affiliate of the
banking entity participates. If the banking entity or an affiliate
sponsors or serves, directly or indirectly, as the investment manager,
investment adviser, commodity pool operator, or commodity trading
advisor to a covered fund, then the banking entity or affiliate will be
deemed for purposes of the marketing restriction to participate in any
offer or sale by the covered fund of ownership interests in the covered
fund.\200\
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\199\ https://www.federalreserve.gov/bankinforeg/volcker-rule/faq.htm#13.
\200\ See proposal Sec. __.13(b)(3).
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The purpose of this provision is to make clear that the marketing
restriction applies to the activity of the foreign banking entity that
is seeking to rely on the exemption (including its affiliates). The
marketing restriction constrains the foreign banking entity in
connection with its own activities with respect to covered funds rather
than the activities of unaffiliated third parties, thereby requiring
that the foreign banking entity seeking to rely on this exemption does
not engage in an offering of ownership interests that targets residents
of the United States. This view is consistent with limiting the
extraterritorial application of section 13 to foreign banking entities
while seeking to ensure that the risks of covered fund investments by
foreign banking entities occur and remain solely outside of the United
States. If the marketing restriction were applied to the activities of
third parties, such as the sponsor of a third-party covered fund
(rather than the foreign banking entity investing in a third-party
covered fund), this exemption may not be available in certain
circumstances where the risks and activities of a foreign banking
entity with respect to its investment in the covered fund are solely
outside the United States.\201\ In describing the
[[Page 33486]]
marketing restriction in the preamble to the 2013 final rule, the
Agencies stated that the marketing restriction serves to limit the
foreign fund exemption so that it ``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.'' \202\
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\201\ The Agencies note that foreign funds that sell securities
to residents of the United States in an offering that targets
residents of the United States will be covered funds under Sec.
__.10(b)(i) of the 2013 final rule if such funds are unable to rely
on an exclusion or exemption under the Investment Company Act other
than section 3(c)(1) or 3(c)(7) of that Act. If the marketing
restriction were to apply more generally to the activities of any
person (including the covered fund itself), the applicability of the
foreign fund exemption would be significantly limited because a
third-party foreign fund's offering that targets residents of the
United States would make the foreign fund exemption unavailable for
all foreign banking entity investors in the fund.
\202\ See, 79 FR at 5742 (emphasis added).
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A foreign banking entity (including its affiliates) that seeks to
rely on the foreign fund exemption must comply with all of the
conditions to that exemption, including the marketing restriction. A
foreign banking entity that participates in an offer or sale of covered
fund interests to a resident of the United States thus cannot rely on
the foreign fund exemption with respect to that covered fund. Further,
where a banking entity sponsors or serves, directly or indirectly, as
the investment manager, investment adviser, commodity pool operator, or
commodity trading advisor to a covered fund, that banking entity will
be viewed as participating in an offer or sale by the covered fund of
ownership interests in the covered fund, and therefore such foreign
banking entity would not qualify for the foreign fund exemption for
that covered fund if that covered fund offers or sells covered fund
ownership interests to a resident of the United States. The Agencies
request comment on the proposal's approach to implementing the foreign
fund exemption. In particular, the Agencies request comment on the
following questions:
Question 189. Is the proposal's implementation of the foreign fund
exemption effective? If not, what alternative would be more effective
and/or clearer?
Question 190. Are the proposal's provisions effective and
sufficiently clear regarding when a transaction or activity will be
considered to have occurred solely outside the United States? If not,
what alternative would be more effective and/or clearer?
Question 191. Should the financing prong of the foreign fund
exemption be retained? Why or why not? Should additional requirements
be added to the foreign fund exemption? If so, what requirements and
why? Should additional requirements be modified or removed? If so, what
requirements and why and how? How would such changes be consistent with
the statute?
Question 192. Is the proposed exemption consistent with limiting
the extraterritorial reach of the rule with respect to FBOs? Does the
proposed exemption create competitive advantages for foreign banking
entities with respect to U.S. banking entities? Why or why not?
Question 193. Is the Agencies' proposal regarding the 2013 final
rule's marketing restriction, which reflects the staff interpretations
incorporated within previous FAQs, sufficiently clear? Should the
marketing restriction apply more broadly to third-party funds that the
foreign banking entity does not advise or sponsor? Why or why not?
4. Section __.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 such covered fund that would be a
covered transaction as defined in section 23A of the FR Act.\203\ In
the 2013 final rule, the Agencies noted that ``[s]ection 13(f) of the
BHC Act does not incorporate or reference the exemptions contained in
section 23A of the FR Act or the Board's Regulation W.'' \204\ However,
the Agencies also noted that notwithstanding the prohibition in section
13(f)(1) of the BHC Act, ``other specific portions of the statute
permit a banking entity to engage in certain transactions or
relationships'' with a related covered fund.\205\ The Agencies
addressed the apparent conflict between section 13(f)(1) and particular
provisions in section 13(d)(1) of the BHC Act in the 2013 final rule by
interpreting the statutory language to permit a banking entity ``to
acquire or retain an ownership interest in a covered fund in accordance
with the requirements of section 13.'' \206\ In doing so, the Agencies
noted that a contrary interpretation would make the ``specific
transactions that permit covered transactions between a banking entity
and a covered fund mere surplusage.'' \207\ In light of the apparent
conflict and ambiguity between particular provisions in sections
13(d)(1) and 13(f)(1) of the BHC Act, the Agencies solicit comment
below on the approach adopted in the 2013 final rule and potential
alternative approaches to interpreting these provisions and reconciling
any apparent conflicts or redundancies between these provisions.
---------------------------------------------------------------------------
\203\ 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.
\204\ 79 FR at 5746.
\205\ Id.
\206\ Id.
\207\ Id.
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Section 13(f) also provides an exemption for prime brokerage
transactions between a banking entity and a covered fund in which a
covered fund managed, sponsored, or advised by that banking entity has
taken an ownership interest. In addition, section 13(f) subjects any
transaction permitted under section 13(f) of the BHC Act (including a
permitted prime brokerage transaction) between a banking entity and
covered fund to section 23B of the FR Act.\208\
---------------------------------------------------------------------------
\208\ 12 U.S.C. 371c-1.
---------------------------------------------------------------------------
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 __.14 of the 2013 final rule
implemented these provisions.\209\
---------------------------------------------------------------------------
\209\ See 2013 final rule Sec. __.14.
---------------------------------------------------------------------------
a. Prime Brokerage Transactions
Section 13(f) of the BHC Act provides an exemption 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''). The statute by its terms
permits a banking entity with a relationship to a covered fund
described in section 13(f) of the BHC Act to engage in prime brokerage
transactions (that are covered transactions) only with second-tier
funds and does not extend to covered funds more generally. Neither the
statute nor the proposal limits covered transactions between a banking
entity and a covered fund for which the banking entity does not serve
as investment manager, investment adviser, or sponsor (as defined in
section 13 of the BHC Act) or have an interest in reliance on section
13(d)(1)(G) of the BHC Act. Under the statute, the exemption for prime
brokerage transactions is available only so long as certain enumerated
conditions are satisfied.\210\ The conditions are that (i) the banking
entity is in compliance with each of the limitations set forth in Sec.
__.11 of the 2013 final rule with respect to a covered
[[Page 33487]]
fund organized and offered by the banking entity or any of its
affiliates; (ii) the CEO (or equivalent officer) of the banking entity
certifies in writing annually that the banking entity does not,
directly or indirectly, guarantee, assume, or otherwise insure the
obligations or performance of the covered fund or of any covered fund
in which such covered fund invests; and (iii) the Board has not
determined that such transaction is inconsistent with the safe and
sound operation and condition of the banking entity. The proposal would
retain each of these provisions, including that the required
certification be made to the appropriate Agency for the banking entity.
---------------------------------------------------------------------------
\210\ See 12 U.S.C. 1851(f)(3).
---------------------------------------------------------------------------
The staffs of the Agencies previously issued guidance explaining
when a banking entity was required to provide this certification during
the conformance period.\211\ To reflect this guidance, the Agencies are
proposing a change to the rule that provides the timing for when a
banking entity must submit such certification. In particular, the
proposal provides a banking entity must provide the CEO certification
annually no later than March 31 of the relevant year. As under the 2013
final rule, under the proposal, the CEO would have a duty to update the
certification if the information in the certification materially
changes at any time during the year when he or she becomes aware of the
material change. This change is intended to provide banking entities
with certainty about when the required certification must be provided
to the appropriate Agency in order to comply with the prime brokerage
exemption.
---------------------------------------------------------------------------
\211\ https://www.federalreserve.gov/bankinforeg/volcker-rule/faq.htm#18.
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b. FCM Clearing Services
On March 29, 2017, the CFTC's Division of Swap Dealer and
Intermediary Oversight (``DSIO'') issued a letter to a futures
commission merchant (``FCM'') stating that the DSIO would not recommend
that an enforcement action against the FCM be initiated in connection
with Sec. __.14(a) of the 2013 final rule. The letter provides relief
for futures, options, and swaps clearing services provided by a
registered FCM to covered funds for which affiliates of the FCM are
engaged in the services identified in Sec. __.14(a) including, for
example, investment management services.\212\
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\212\ CFTC Staff Letter 17-18 (Mar. 29, 2017).
---------------------------------------------------------------------------
The CFTC believes the relief provided to the FCM is warranted and
would extend the relief from the requirements of Sec. __.14(a) of the
2013 final rule to all FCMs performing futures, options, and swaps
clearing services. Providing such clearing services to customers of
affiliates does not appear to be the type of relationship that was
intended to be limited under section 13(f) of the BHCA. The provision
of futures, options, and swaps clearing services by an FCM is a
facilitation service that the CFTC believes would not give rise to a
relationship that might evade the prohibition against acquiring or
retaining an interest in or sponsoring a covered fund. An FCM earns
clearing fees and is not in a position to profit from any gain or loss
that the customer may have on its cleared futures, options, or swaps
positions. The other Agencies do not object to the relief provided to
the FCMs as described above.
Question 194. Are clearing services provided by an FCM to its
customers a relationship that would give rise to the policy concerns
addressed by Sec. __.14 of the 2013 final rule?
Question 195. Does the no-action relief provided by the CFTC staff
together with the statement herein provide sufficient certainty for
market participants regarding the application of Sec. __.14(a) of the
2013 final rule to FCM clearing services?
Question 196. If the exemptions in section 23A of the FR Act and
the Board's Regulation W are made available under a modification to
Sec. __.14 of the 2013 final rule, what would be the effect, if any,
for FCM clearing services? Would incorporating those exemptions further
support the relief provided by the CFTC? If so, how?
The Agencies request comment on all aspects of the proposal's
approach to implementing the limitations on certain relationships with
covered funds. In particular, the Agencies request comment on the
following questions:
Question 197. Is the proposal's approach to implementing the
limitations on certain transactions with a covered fund effective? If
not, what alternative approach would be more effective and why?
Question 198. Should the Agencies adopt a different interpretation
of section 13(f)(1) of the BHC Act than the interpretation adopted in
the preamble to the 2013 final rule? For example, should the Agencies
amend Sec. __.14 of the 2013 final rule to incorporate some or all of
the exemptions in section 23A of the FR Act and the Board's Regulation
W? Why or why not? Why should these transactions be permitted? For
example, what would be the effect on banking entities' ability to meet
the needs and demands of their clients and how would incorporating some
or all of the exemptions that exist in section 23A of the FR Act and
the Board's Regulation W facilitate a banking entity's ability to meet
client needs and demands? If permitted, should these additional
transactions be subject to any limitations?
Question 199. Should the Agencies amend Sec. __.14 of the 2013
final rule to incorporate the quantitative limits in section 23A of the
Federal Reserve and the Board's Regulation W? Why or why not? Are there
any other elements of section 23A and the Board's Regulation W that the
Agencies should consider incorporating? Please explain.
Question 200. Are there other transactions between a banking entity
and covered funds that should be prohibited or limited as part of this
rulemaking?
Question 201. Is the definition of ``prime brokerage transaction''
under the proposal appropriate? If not, what definition would be
appropriate? Are there any transactions that should be included in the
definition of ``prime brokerage transaction'' that are not currently
included?
Question 202. With respect to the CEO (or equivalent officer)
certification required under section 13(f)(3)(A)(ii) and Sec.
__.14(a)(2)(ii)(B) of this proposal, what would be the most useful,
efficient method of certification (e.g., a new stand-alone
certification, a certification incorporated into an existing form or
filing, website certification or certification filed directly with the
relevant Agency?) Is it sufficiently clear by when a certification must
be provided by a banking entity? If not, how could the Agencies provide
additional clarity?
D. Subpart D--Compliance Program Requirements; Violations
1. Section __.20: Program for Compliance; Reporting
Section __.20 of the 2013 final rule contains compliance program
and metrics collection and reporting requirements. These requirements
are tailored based on banking entity size and complexity of activity.
The 2013 final rule was intended to focus the most significant
compliance obligations on the largest and most complex organizations,
while minimizing the economic impact on small banking entities.\213\
However, public feedback
[[Page 33488]]
has indicated that even determining whether a banking entity is
eligible for the simplified compliance program can require significant
analysis for small banking entities. In addition, certain traditional
banking activities of small banks have fallen within the scope of the
proprietary trading and covered fund prohibitions and exemptions,
making them ineligible for the simplified program available to banking
entities with no covered activities. Public feedback has indicated that
the compliance program requirements are also significant for larger
banking entities that must implement the rule's enhanced compliance
program, metrics, and CEO attestation requirements. The Agencies
propose to revise the compliance program requirements to allow greater
flexibility and focus the requirements on the banking entities with the
most significant and complex activities.
---------------------------------------------------------------------------
\213\ The OCC, Board and FDIC statement on the 2013 final rule's
applicability to community banks recognized that ``[t]he vast
majority of these community banks have little or no involvement in
prohibited proprietary trading or investment activities in covered
funds. Accordingly, community banks do not have any compliance
obligations under the final rule if they do not engage in any
covered activities other than trading in certain government, agency,
State or municipal obligations.'' Board of Governors of the Federal
Reserve System, Federal Deposit Insurance Corporation, and Office of
the Comptroller of the Currency, The Volcker Rule: Community Bank
Applicability (Dec. 10, 2013).
---------------------------------------------------------------------------
Specifically, the Agencies propose to apply the compliance program
requirement to banking entities as follows:
Banking entities with significant trading assets and
liabilities. Banking entities with significant trading assets and
liabilities would be subject to the six-pillar compliance program
requirement (currently set forth in Sec. __.20(b) of the 2013 final
rule), the metrics reporting requirements (Sec. __.20(d) of the 2013
final rule), the covered fund documentation requirements (Sec.
__.20(e) of the 2013 final rule), and the CEO attestation requirement
(currently in Appendix B of the 2013 final rule).
Banking entities with moderate trading assets and
liabilities. Banking entities with moderate trading assets and
liabilities would be required to establish the simplified compliance
program (currently described in Sec. __.20(f)(2) of the 2013 final
rule), and comply with the CEO attestation requirement (currently in
Appendix B of the 2013 final rule).
Banking entities with limited trading assets and
liabilities. Banking entities with limited trading assets and
liabilities would be presumed to be in compliance with the proposal and
would have no obligation to demonstrate compliance with subpart B and
subpart C of the implementing regulations on an ongoing basis. These
banking entities would not be required to demonstrate compliance with
the rule unless and until the appropriate Agency, based upon a review
of the banking entity's activities, determines that the banking entity
must establish the simplified compliance program (currently described
in Sec. Sec. __.20(b) or __.20(f)(2) of the 2013 final rule).
a. Compliance Program Requirements for Banking Entities With
Significant Trading Assets and Liabilities
i. Section 20(b)--Six-Pillar Compliance Program
Section __.20(b) of the 2013 final rule specifies six elements that
each compliance program required under that section must at a minimum
contain.
The six elements specified in Sec. __.20(b) are:
Written policies and procedures reasonably designed to
document, describe, monitor and limit trading activities and covered
fund activities and investments conducted by the banking entity to
ensure that all activities and investments that are subject to section
13 of the BHC Act and the rule comply with section 13 of the BHC Act
and the 2013 final rule;
A system of internal controls reasonably designed to
monitor compliance with section 13 of the BHC Act and the rule and to
prevent the occurrence of activities or investments that are prohibited
by section 13 of the BHC Act and the 2013 final rule;
A management framework that clearly delineates
responsibility and accountability for compliance with section 13 of the
BHC Act and the 2013 final rule and includes appropriate management
review of trading limits, strategies, hedging activities, investments,
incentive compensation and other matters identified in the rule or by
management as requiring attention;
Independent testing and audit of the effectiveness of the
compliance program conducted periodically by qualified personnel of the
banking entity or by a qualified outside party;
Training for trading personnel and managers, as well as
other appropriate personnel, to effectively implement and enforce the
compliance program; and
Records sufficient to demonstrate compliance with section
13 of the BHC Act and the 2013 final rule, which a banking entity must
promptly provide to the relevant Agency upon request and retain for a
period of no less than 5 years.
Under the 2013 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 covered trading
activities and investments subject to section 13 of the BHC Act and the
implementing regulations.
The Agencies are proposing to apply the six-pillar compliance
program requirements only to banking entities with significant trading
assets and liabilities. The Agencies preliminarily believe these
banking entities are engaged in activities at a scale that warrants the
costs of establishing the compliance program elements described in
Sec. Sec. __.20(b) and __.20(e) of the 2013 final rule. Accordingly,
the Agencies believe it is appropriate to require banking entities with
significant trading assets and liabilities to maintain a six-pillar
compliance program to ensure that banking entities' activities are
conducted in compliance with section 13 of the BHC Act and the
implementing regulations.
As described further in the ``Enhanced Minimum Standards for
Compliance Programs'' below, the Agencies are proposing to eliminate
the current enhanced compliance program requirements found in Appendix
B of the 2013 final rule. The Agencies believe that the six-pillar
compliance program requirements (currently in Sec. __.20(b) of the
2013 final rule) can be appropriately tailored to the size and
activities of each banking entity that is subject to these
requirements. The proposed approach would afford banking entities
flexibility to integrate the Sec. __.20 compliance program
requirements into other compliance programs of the banking entity,
which may reduce complexity for banking entities currently subject to
the enhanced compliance program requirements.
Question 203. Should the six-pillar compliance program requirements
apply only to banking entities with significant trading assets and
liabilities? Is the scope of the six-pillar compliance program
appropriate? Why or why not? Are there particular aspects of this
requirement that should be modified or eliminated? If so, which ones
and why?
ii. CEO Attestation Requirement
The 2013 final rule includes a requirement, currently included in
Appendix B, that a banking entity CEO must review and annually attest
in writing to the appropriate Agency that the banking entity has in
place processes to establish, maintain, enforce, review, test and
modify the compliance program established pursuant to Appendix B and
Sec. __.20 of the 2013 final rule in a manner reasonably designed to
achieve compliance with section 13 of the BHC Act and the implementing
regulations.
[[Page 33489]]
The Agencies are proposing to eliminate the current Appendix B (as
described further below) but to apply a modified CEO attestation
requirement for banking entities other than those with limited trading
assets and liabilities. While the Agencies believe the revisions to the
compliance program requirements under the proposal generally simplify
the compliance program requirements, this simplification should be
balanced against the requirement for all banking entities to maintain
compliance with section 13 of the BHC Act and the implementing
regulations. Accordingly, the Agencies believe that applying the CEO
attestation requirement for banking entities with meaningful trading
activities would ensure that the compliance programs established by
these banking entities pursuant to Sec. __.20(b) or Sec. __.20(f)(2)
of the proposal are reasonably designed to achieve compliance with
section 13 of the BHC Act and the implementing regulations as proposed.
The Agencies propose limiting the CEO attestation requirement to
banking entities with significant trading assets and liabilities or
moderate trading assets and liabilities because, if the Agencies'
proposal is adopted, banking entities with limited trading assets and
liabilities would be subject to a rebuttable presumption of compliance,
as described below. The Agencies do not believe it is necessary to
require a CEO attestation for banking entities with limited trading
assets and liabilities as those banking entities would not be subject
to the express requirement to maintain a compliance program pursuant to
Sec. __.20 under the proposal.
Question 204. What are the costs associated with preparing the
required CEO attestation? How significant are those costs relative to
the potential benefits of requiring a CEO attestation? What are some of
the specific operational or other burdens or expenses associated with
the CEO attestation requirement? Please explain the circumstances under
which those potential burdens or expenses may arise.
Question 205. Are there existing business practices and procedures
that render the CEO attestation requirement redundant and/or
unnecessary? If so, please identify and describe those existing
business practices. Alternatively, are there other regulatory
requirements that fulfill the same purpose as the CEO attestation with
respect to a compliance program? Please explain.
Question 206. Is the scope of the CEO attestation requirements
appropriate? Should banking entities with limited trading assets and
liabilities, but with a large amount of consolidated assets, for
example consolidated assets in excess of $50 billion be required to
provide a CEO attestation with respect to the banking entity's
compliance program notwithstanding that such institution may be
entitled to the rebuttable presumption of compliance under the
proposal?
Question 207. How costly are the existing CEO attestation
requirements for banking entities, broken down based on whether they
are categorized as having significant, moderate, and limited trading
assets and liabilities under the proposal? How would those annual costs
change if the modifications described in the proposal were adopted? Can
the costs described above, both as the requirement is currently drafted
and as proposed to be amended, be broken down based on the type of
banking entity involved, such as for broker-dealers and registered
investment advisers? Please be as specific as possible.
Question 208. Under the proposal, banking entities with limited
trading assets and liabilities (for which the presumption of compliance
has not been rebutted) would not be subject to the CEO attestation
requirement? Do commenters agree with that approach? As an alternative,
should a banking entity with limited trading assets and liabilities be
subject to a similar requirement? For example, should these types of
banking entities be required to conduct an annual review, to be
performed by objective, qualified personnel, of its compliance with the
rule and submit such annual review to its Board of Directors and the
Agencies? Why or why not? What are the costs and benefits of such
requirement?
iii. Covered Fund Documentation Requirements
Currently, Sec. __.20(e) of the 2013 final rule requires banking
entities with greater than $10 billion in total consolidated assets to
maintain additional documentation related to covered funds as part of
their compliance program. The Agencies are proposing to apply the
covered fund documentation requirements only to banking entities with
significant trading assets and liabilities. The Agencies do not believe
that these additional documentation requirements are necessary for
banking entities without significant trading assets and liabilities
because the Agencies expect that their covered funds activities may
generally be smaller in scale and less complex than banking entities
with significant trading assets and liabilities. Accordingly, the
Agencies believe these banking entities' activities are unlikely to
justify the costs associated with complying with these documentation
requirements. Furthermore, the Agencies expect they would be able to
examine and supervise these banking entities' compliance with the
covered fund prohibition without requiring such additional
documentation as part of the banking entities' compliance program.
b. Compliance Program Requirements for Banking Entities With Moderate
Trading Assets and Liabilities
The 2013 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 engages in covered activities or
investments pursuant to subpart B or subpart C of the 2013 final rule
(other than trading activities permitted under Sec. __.6(a) of the
2013 final rule) may satisfy the compliance program requirements by
including in its existing compliance policies and procedures references
to the requirements of section 13 of the BHC Act and subpart D of the
implementing regulations and adjustments as appropriate given the
activities, size, scope, and complexity of the banking entity.\214\
---------------------------------------------------------------------------
\214\ 12 CFR 44.20(f)(2).
---------------------------------------------------------------------------
The Agencies propose to extend availability of this simplified
compliance program to all banking entities with moderate trading assets
and liabilities. The Agencies believe that streamlining the compliance
program requirements for banking entities with moderate trading assets
and liabilities is appropriate. The scale and nature of the activities
and investments in which these banking entities are engaged may not
justify the additional costs associated with establishing the
compliance program elements under Sec. Sec. __.20(b) and (e) of the
2013 final rule and may be appropriately examined and supervised
through an appropriately tailored simplified compliance program.
Consistent with the compliance program requirements for banking
entities with significant trading assets and liabilities, the Agencies
note that banking entities with moderate trading assets and liabilities
would be able to incorporate their simplified compliance program as
part of any existing compliance policies and procedures and tailor
their compliance program to the size and nature of their activities.
[[Page 33490]]
c. Compliance Program Requirements for Banking Entities With Limited
Trading Assets and Liabilities
The proposal would include a presumption of compliance for certain
banking entities with limited trading assets and liabilities. Under the
proposal, a banking entity that, together with its affiliates and
subsidiaries on a worldwide basis, has trading assets and liabilities
(excluding obligations of or guaranteed by the United States or any
agency of the United States) the average gross sum of which over the
previous four quarters, as measured as of the last day of each of the
four previous calendar quarters, is less than $1 billion, would be
presumed to be in compliance with the proposal. Banking entities
meeting these conditions would have no obligation to demonstrate
compliance with subpart B and subpart C of the implementing regulations
on an ongoing basis. The Agencies believe, based on experience
implementing and supervising compliance with the 2013 final rule, that
these banking entities are generally engaged in traditional banking
activities. The Agencies do not believe it is necessary to require
banking entities with limited trading assets and liabilities to
demonstrate compliance with the prohibitions of section 13 of the BHC
Act by establishing a compliance program, given the limited scale of
their trading operations. Further, the Agencies believe that the
limited trading assets and liabilities of the banking entities
qualifying for the presumption of compliance are unlikely to warrant
the costs of establishing a compliance program under Sec. __.20.
A banking entity that meets the proposed criteria for the
presumption of compliance would be subject to the statutory
prohibitions of section 13 of the BHC Act and the implementing
regulations on an ongoing basis. The Agencies would not expect a
banking entity that meets the proposed criteria for the presumption of
compliance to demonstrate compliance with the proposal in conjunction
with the Agencies' normal supervisory and examination processes.
However, the appropriate Agency may exercise its authority to treat the
banking entity as if it does not have limited trading assets and
liabilities if, upon review of the banking entity's activities, the
relevant Agency determines that the banking entity has engaged in
proprietary trading or covered fund activities that are otherwise
prohibited under subpart B or subpart C. A banking entity would be
expected to remediate any impermissible activity upon being notified of
such determination by the Agency. A banking entity would be required to
remediate the impermissible activity within a period of time deemed
appropriate by the relevant Agency.
The Agencies believe this presumption of compliance for certain
banking entities with limited trading assets and liabilities would
allow flexibility for these banking entities to operate under their
existing internal policies and procedures. The Agencies generally
expect these banking entities, in the ordinary course of business, to
develop and adhere to internal policies and procedures that promote
prudent risk management practices.
Irrespective of whether a banking entity has engaged in activities
in violation of subpart B or C of this proposal, the relevant Agency
retains its authority to require a banking entity to apply the
compliance program requirements that would otherwise apply if the
banking entity had significant or moderate trading assets and
liabilities if the relevant Agency determines that the size or
complexity of the banking entities trading or investment activities, or
the risk of evasion, does not warrant a presumption of compliance.
Question 209. Should the Agencies specify the notice and response
procedures in connection with an Agency determination that the
presumption pursuant to __.20(g)(2) is rebutted? Why or why not?
d. Enhanced Minimum Standards
i. Enhanced Minimum Standards for Compliance Programs
Section __. 20(c) of the 2013 final rule requires certain banking
entities to establish, maintain and enforce an enhanced compliance
program that includes the requirements and standards. Appendix B of the
2013 final rule specifies the enhanced minimum standards applicable to
the compliance programs of large banking entities and banking entities
engaged in significant trading activities. Section I.a of Appendix B
provides that the enhanced compliance program must:
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 2013 final
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 2013 final 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 Agencies continue to believe that banking entities with
significant trading assets and liabilities should have detailed and
comprehensive programs for ensuring compliance with the requirements of
section 13 of the BHC Act. The Agencies recognize, however, that many
banking entities have found implementing certain aspects of the
enhanced compliance program requirements of Appendix B to be
inefficient, duplicative of, and in some instances inconsistent with,
their existing compliance regimes and risk management programs.
While recognizing the need to establish and maintain an appropriate
compliance program, the Agencies also believe that banking entities
should be provided discretion to tailor their compliance programs to
the structure and activities of their organizations. The flexibility to
build 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, may reduce
the costs and complexity of compliance while also enabling a robust
compliance mechanism for section 13 of the BHC Act. After carefully
considering the overall effects of the enhanced compliance program
standards in the context of existing banking entity compliance
frameworks, the Agencies are proposing certain modifications to limit
the implementation, operational or other complexities associated with
the compliance program requirements set forth in Sec. __.20.
The Agencies believe that many of the compliance requirements of
the current
[[Page 33491]]
enhanced compliance program could be implemented effectively if
incorporated into a risk management framework already developed and
designed to fit a banking entity's organizational and reporting
structure. The prescribed six-pillar compliance requirements in Sec.
__.20 are consistent with general standards of safety and soundness as
well as diligent supervision, the implementation of which conforms with
the traditional risk management processes of ensuring governance,
controls, and records appropriately tailored to the risks and
activities of each banking entity. Accordingly, the Agencies propose to
eliminate the requirements of Appendix B (other than the CEO
attestation) and permit banking entities with significant trading
assets and liabilities to satisfy compliance program requirements by
meeting the six elements currently specified in Sec. __.20(b) of the
2013 final rule, commensurate with the size, scope, and complexity of
their activities and business structure, and subject to a CEO
attestation requirement.
A banking entity that does not have significant trading assets and
liabilities under the proposal, but which is currently subject to
Appendix B under the 2013 final rule, would be permitted to satisfy its
compliance requirements in the proposal by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act as appropriate given the
activities, size, scope, and complexity of the banking entity.
ii. Proprietary Trading Activities
Section II.a of Appendix B of the 2013 final rule generally
requires a banking entity subject to the Appendix, in addition to the
requirements of Sec. __.20, to: (1) Have written policies and
procedures governing each trading desk; (2) include a comprehensive
description of the risk management program for the trading activity of
the banking entity; (3) 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; (4) establish, maintain and enforce policies and procedures
regarding the use of risk-mitigating hedging instruments and
strategies; (5) 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; (6) identify
the activities of each trading desk that will be conducted in reliance
on the exemptions contained in Sec. Sec. __.4 through __.6; and (7) 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.
These requirements of Appendix B in the 2013 final rule reflect the
Agencies' expectation that banking organizations with significant
trading activities adopt compliance regimes that, among other things,
take into account the size and complexity of the banking entity's
activities and structure of its business. However, the Agencies
recognize that operationalizing the prescriptive requirements of
Appendix B may limit the ability of banking entities to adapt their
existing risk management frameworks for purposes of compliance with the
2013 final rule. Therefore, based on experience since the adoption of
the 2013 final rule, the Agencies believe that a banking entity
currently subject to Appendix B requirements under the 2013 final rule
should be permitted to implement an appropriately robust compliance
program by tailoring the requirements of Sec. __.20 to the type, size,
scope, and complexity of its activities and business structure. The
Agencies are therefore proposing to eliminate the requirements of
section II.a of Appendix B in order to reduce the operational
complexities associated with the compliance requirements of the 2013
final rule. As described above, the Agencies believe that the
compliance program requirements in Sec. Sec. __.20 can be
appropriately scaled (pursuant to Sec. __.20(a)) to the size, scope,
and complexity of each banking entity and should afford banking
entities flexibility to integrate their Sec. __.20 compliance program
into their other compliance programs.
The Agencies believe that, under the proposal, compliance programs
that satisfy Sec. __.20 and that are appropriately tailored to the
size, scope, and complexity of the banking entity's activities, would
be effective in meeting the objectives underlying the enhanced
requirements set forth in Appendix B of the 2013 final rule with
respect to proprietary trading activities. Furthermore, affording
banking entities the flexibility to adapt their existing risk
management frameworks to satisfy the requirements of Sec. __.20 would
reduce the complexity of compliance with section 13 of the BHC Act and
the implementing regulations.
Question 210. The Agencies are requesting comment on whether the
requirements of Sec. __.20 of the proposal would be effective in
ensuring that banking entities with significant trading assets and
liabilities and banking entities with moderate trading assets and
liabilities comply with the proprietary trading requirements and
restrictions of section 13 of the BHC Act and the proposal. In addition
to the CEO attestation requirement in proposed Sec. __.20(c), are
there certain requirements included in Appendix B that should be
incorporated into the requirements of Sec. __.20, particularly with
respect to banking entities with significant trading assets and
liabilities, in order to ensure compliance with the proprietary trading
requirements and restrictions of section 13 of the BHC Act and the
proposal? To what extent would the elimination of Appendix B reduce the
complexity of compliance with section 13 of the BHC Act? What other
options should the Agencies consider in order to reduce complexity
while still ensuring robust compliance with the proprietary trading
requirements and restrictions of section 13 of the BHC Act and the
implementing regulations?
iii. Covered Fund Activities and Investments
The enhanced minimum standards in section II.b of Appendix B of the
2013 final rule prescribe the establishment, maintenance and
enforcement of a compliance program that includes written policies and
procedures that are appropriate for the type, size, complexity, and
risks of the covered fund and related activities conducted and
investments made, by a banking entity. In addition to the requirements
of Sec. __.20, Sec. II.b of Appendix B requires that compliance
programs be designed to: (1) Include appropriate management review and
independent testing for identifying and documenting covered funds in
which the banking entity invests, or that each unit within the banking
entity's organization sponsors or organizes and offers, and covered
funds in which each such unit invests; (2) 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; (3)
explain the banking entity's strategy for monitoring, mitigating, or
prohibiting conflicts of interest, transactions or covered fund
activities and investments that may
[[Page 33492]]
threaten safety and soundness, and exposure to high-risk assets and
trading strategies presented by its covered fund activities and
investments; (4) document the covered fund activities and investments
that each organizational unit is authorized to conduct, 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 section 12 or registered in compliance with the securities
laws and is thereby exempt from those limits within the time periods
allotted in section 12, and how it complies with the requirements of
subpart C; (5) establish, maintain, and enforce internal controls that
are reasonably designed to ensure that the banking entity's covered
fund activities or investments are compliant and to detect potential
compliance violations; and (6) identify, document, address, and remedy
any compliance violations.
The 2013 final rule subjects certain banking entities to the
enhanced minimum compliance standards of Appendix B to reflect the
Agencies' expectation that banking entities with significant covered
fund activities or investments adopt sophisticated compliance regimes.
However, the Agencies recognize that operationalizing these
requirements may restrict the flexibility of banking entities to adapt
their existing risk management frameworks for purposes of compliance
with the 2013 final rule. The Agencies believe that a banking entity
with significant trading assets and liabilities or moderate trading
assets and liabilities currently subject to Appendix B requirements
could effectively implement an appropriately robust compliance program
by tailoring the requirements of Sec. __.20 to the type, size, scope,
and complexity of its covered fund activities and business structure.
Accordingly, the Agencies propose to eliminate the requirements of
Sec. II.b of Appendix B to the 2013 final rule.
Under the proposal, a banking entity with significant trading
assets and liabilities or with moderate trading assets and liabilities
would satisfy the compliance program requirements by appropriately
scaling the compliance program requirements in Sec. __.20. A banking
entity with significant trading assets and liabilities would also be
required to adopt the covered fund documentation requirements in Sec.
__.20(e) of the proposal.
The Agencies believe that, under the proposal, compliance programs
that satisfy the foregoing requirements and that are appropriately
tailored to the size, scope, and complexity of the banking entity's
activities, would be effective in meeting the objectives underlying the
enhanced requirements set forth in Appendix B of the 2013 final rule
with respect to covered fund investments and activities. Furthermore,
affording banking entities the flexibility to adapt their existing risk
management frameworks to satisfy the Sec. __.20 compliance program
requirements would reduce the complexity of compliance with section 13
of the BHC Act.
Question 211. The Agencies are requesting comment on whether the
requirements of Sec. __.20 of the proposal would, if appropriately
tailored to the size, scope, and complexity of the banking entity's
activities, be effective in ensuring that banking entities with
significant trading assets and liabilities and banking entities with
moderate trading assets and liabilities comply with the covered fund
requirements and restrictions of section 13 of the BHC Act and the
implementing regulations. In addition to CEO attestation requirement in
proposed Sec. __.20(c), are there certain requirements included in
Appendix B that should be incorporated into the requirements of Sec.
__.20, particularly with respect to banking entities with significant
trading assets and liabilities, in order to ensure compliance with the
covered fund requirements and restrictions of section 13 of the BHC Act
and the implementing regulations? To what extent would the elimination
of Appendix B reduce the complexity of compliance with section 13 of
the BHC Act? What other options should the Agencies consider in order
to reduce complexity while still ensuring robust compliance with the
covered fund requirements and restrictions of section 13 of the BHC Act
and the implementing regulations?
Question 212. How do banking entities that are registered
investment advisers currently meet their compliance program
obligations? That is, to what extent are banking entities' compliance
programs related to the covered fund prohibitions of the 2013 final
rule implemented by the registered investment adviser as opposed to the
other affiliates or subsidiaries that are part of the banking entity?
How costly are the existing compliance program requirements for banking
entities that are registered investment advisers, broken down based on
whether they are categorized as having significant, moderate, and
limited trading assets and liabilities under the proposal? How would
those annual costs change if the modifications described in the
proposal were adopted?
iv. Responsibility and Accountability
Appendix B of the 2013 final rule contains a CEO attestation
requirement as part of the enhanced minimum standards for compliance
programs as a means to ensure that a strong governance framework is
implemented with respect to compliance with section 13 of the BHC Act.
This provision requires a banking entity's CEO to review and annually
attest in writing to the appropriate Agency that the banking entity has
in place processes to establish, maintain, enforce, review, test and
modify the compliance program established pursuant to Appendix B and
Sec. __.20 of the 2013 final rule in a manner reasonably designed to
achieve compliance with section 13 of the BHC Act and the 2013 final
rule. Appendix B of the 2013 final rule also specifies that in the case
of the U.S. operations of a foreign banking entity, including a U.S.
branch or agency of a foreign banking entity, the attestation may be
provided for the entire U.S. operations of the foreign banking entity
by the senior management officer of the U.S. operations of the foreign
banking entity who is located in the United States.
Consistent with the Agencies' proposal to remove the specific,
enhanced minimum standards included in Appendix B of the 2013 final
rule, the Agencies propose to incorporate the CEO attestation
requirement within Sec. __.20(c) so that it will to apply to banking
entities with significant trading assets and liabilities and banking
entities with moderate trading assets and liabilities. Further, the
Agencies propose that the CEO attestation requirement in Sec. __.20(c)
specify that in the case of the U.S. operations of a foreign banking
entity, including a U.S. branch or agency of a foreign banking entity,
the attestation may be provided for the entire U.S. operations of the
foreign banking entity by the senior management officer of the U.S.
operations of the foreign banking entity who is located in the United
States.
Preserving the CEO attestation requirement and incorporating it
within the proposal underscores the importance of CEO engagement within
the overall compliance framework for banking entities with significant
trading assets and liabilities and for banking entities with moderate
trading assets and liabilities. The Agencies believe that the CEO
attestation requirement may reinforce the importance of creating and
communicating an appropriate ``tone at the top,'' setting an
appropriate culture of compliance, and establishing
[[Page 33493]]
clear policies regarding the management of the firm's covered trading
activities and its covered fund activities and investments.
The Agencies believe that incorporating the CEO attestation
requirement into proposed Sec. __.20(c) could help to ensure that the
compliance program established pursuant to that section is reasonably
designed to achieve compliance with section 13 of the BHC Act and the
implementing regulations, while the removal of the specific, enhanced
minimum standards in Appendix B will afford a banking entity
considerable flexibility to satisfy the elements of Sec. __.20 in a
manner that it determines to be most appropriate given its existing
compliance regimes, organizational structure, and activities.
Question 213. The Agencies are requesting comment on whether
incorporating the CEO attestation requirement in proposed Sec.
__.20(c) would ensure that a strong governance framework is implemented
with respect to compliance with section 13 of the BHC Act and the
proposal. What other options should the Agencies consider in order to
encourage CEO engagement in ensuring robust compliance with section 13
of the BHC Act and the proposal?
v. Independent Testing
After careful consideration, the Agencies propose to eliminate the
specific enhanced minimum standards for independent testing prescribed
in Appendix B, section IV of the 2013 final rule and permit banking
entities with significant trading assets and liabilities to satisfy the
compliance program requirements by meeting the independent testing
requirements outlined in Sec. __.20(b)(4) of the proposal. Section
__.20(b)(4) of the proposal specifies that the contents of the
compliance program shall include 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. As with all elements of the required compliance program under
proposed Sec. __.20(b), independent testing should be designed and
implemented in a manner that is appropriate for the type, size, scope,
and complexity of activities and business structure of the banking
entity. Section __.20(b)(4) allows for a tailored approach to ensure
that the effectiveness of the compliance program is subject to an
objective review with appropriate frequency and depth. Under the
proposal, a banking entity with moderate trading assets and liabilities
would be permitted to incorporate independent testing into its existing
compliance programs as appropriate given the activities, size, scope,
and complexity of the banking entity.
vi. Training
After careful consideration, the Agencies propose to eliminate the
training element of the enhanced compliance program of Appendix B,
section V of the 2013 final rule and permit banking entities to satisfy
compliance program requirements by meeting the training requirements
outlined in Sec. __.20(b)(5) of the proposal. Section __.20(b)(5)
specifies that the contents of the compliance program shall include
training for trading personnel and managers, as well as other
appropriate personnel, to effectively implement and enforce the
compliance program. As with all elements of the required compliance
program under Sec. __.20(b), the Agencies expect the training regimen
to be designed and implemented in a manner that is appropriate for the
type, size, scope, and complexity of activities and business structure
of the banking entity. Under the proposal, a banking entity with
moderate trading assets and liabilities would be permitted to
incorporate training into its existing compliance programs as
appropriate given the activities, size, scope and complexity of the
banking entity.
vii. Recordkeeping
Appendix B, section VI of the 2013 final rule requires banking
entities to create and retain records sufficient to demonstrate
compliance and support the operations and effectiveness of the
compliance program. After careful consideration, the Agencies believe
that the enhanced minimum standards under Appendix B, section VI can be
replaced by the requirements prescribed in Sec. __.20(b)(6) of the
proposal. Section __.20(b)(6) of the proposal specifies that the
banking entity must establish records sufficient to demonstrate
compliance with section 13 of the BHC Act and subpart D and promptly
provide to the relevant Agency upon request and retain such records for
no less than 5 years or for such longer period as required by the
relevant Agency. As with all elements of the required compliance
program under Sec. __.20(b), the Agencies expect the record keeping
requirement to be designed and implemented in a manner that is
appropriate for the type, size, scope, and complexity of activity and
business structure of the banking entity. A banking entity with
moderate trading assets and liabilities would be permitted to
incorporate recordkeeping into its existing compliance programs as
appropriate given the activities, size, scope, and complexity of the
banking entity.
Question 214. The Agencies are requesting comment on whether the
existing independent testing, training, and recordkeeping requirements
of Sec. __.20(b) would, if appropriately tailored to the size, scope,
and complexity of the banking entity's activities, be effective in
ensuring that banking entities with significant trading assets and
liabilities and moderate trading assets and liabilities comply with the
requirements and restrictions of section 13 of the BHC Act and the
implementing regulations. Are there certain requirements included in
independent testing, training, and recordkeeping requirements of
Appendix B that should be incorporated into the requirements of Sec.
__.20, particularly with respect to banking entities with significant
trading, in order to ensure compliance with the requirements and
restrictions of section 13 of the BHC Act and the implementing
regulations? To what extent would the elimination of the independent
testing, training, and recordkeeping requirements of Appendix B reduce
the complexity of complying with section 13 of the BHC Act? What other
options should the Agencies consider with respect to independent
testing, training, and recordkeeping in order to reduce complexity
while still ensuring robust compliance with the requirements and
restrictions of section 13 of the BHC Act and the implementing
regulations?
e. Summary of Proposed Revisions to Compliance Program Requirements
The following table provides a summary of the proposed changes to
the compliance program requirements:
[[Page 33494]]
Summary of Proposed Changes to Compliance Program Requirements
------------------------------------------------------------------------
Banking entities Banking entities
Requirement (citation to subject to subject to
2013 final rule) requirement in 2013 requirement in
final rule proposal
------------------------------------------------------------------------
6 Pillar Compliance Program Banking entities Banking entities
(Section __.20(b)). with more than $10 with significant
billion in total trading assets and
consolidated assets. liabilities.
Enhanced compliance program Banking entities Not applicable.
(Section __.20(c), Appendix with: Enhanced compliance
B). program eliminated
(but see CEO
Attestation
Requirement below).
$50
billion or more
in total
consolidated
assets, or.
Trading
assets and
liabilities of
$10 billion or
greater over the
previous
consecutive four
quarters, as
measured as of
the last day of
each of the four
prior calendar
quarters, if the
banking entity
engages in
proprietary
trading activity
permitted under
subpart B.
Additionally,
any other
banking entity
notified in
writing by the
Agency.
CEO Attestation Requirement Banking entities Banking
(Section __.20(c), Appendix with: entities with
B). significant trading
assets and
liabilities.
$50
billion or more
in total
consolidated
assets, or.
Trading Banking
assets and entities with
liabilities of moderate trading
$10 billion or assets and
greater over the liabilities.
previous
consecutive four
quarters, as
measured as of
the last day of
each of the four
prior calendar
quarters.
Any other
Additionally, banking entity
any other notified in writing
banking entity by the Agencythe
notified in Agency.
writing by the
Agency.
Metrics Reporting Banking Banking
Requirements (Section entities with entities with
__.20(d), Appendix A). trading assets and significant trading
liabilities the assets and
average gross sum liabilities.
of which over the
previous
consecutive four
quarters, as
measured as of the
last day of each of
the four prior
calendar quarters,
is $10 billion or
greater, if the
banking entity
engages in
proprietary trading
activity permitted
under subpart B.
Any
other banking
entity notified
in writing by
the Agency.
Additional covered fund Banking entities Banking entities
documentation requirements with more than $10 with significant
(Section __.20(e)). billion in total trading assets and
consolidated assets liabilities.
as reported on
December 31 of the
previous two
calendar years.
Simplified program for Banking entities Banking entities
banking entities with no that do not engage that do not engage
covered activities (Section in activities or in activities or
__.20(f)(1)). investments investments
pursuant to subpart pursuant to subpart
B or subpart C B or subpart C
(other than trading (other than trading
activities activities
permitted pursuant permitted pursuant
to Sec. __.6(a) to Sec. __.6(a)
of subpart B). of subpart B).
Simplified program for Banking entities Banking entities
banking entities with with $10 billion or with moderate
modest activities (Section less in total trading assets and
__.20(f)(2)). consolidated assets liabilities.
as reported on
December 31 of the
previous two
calendar years that
engage in
activities or
investments
pursuant to subpart
B or subpart C
(other than trading
activities
permitted pursuant
to Sec. __.6(a)
of subpart B).
No compliance program Not applicable...... Banking entities
requirement unless Agency with limited
directs otherwise (N/A). trading assets and
liabilities subject
to the presumption
of compliance.
------------------------------------------------------------------------
E. Appendix to Part []--Reporting and Recordkeeping
Requirements
1. Overview of the Proposal and Significant Changes From the 2013 Final
Rule
As provided in the preamble to the 2013 final rule, the Agencies
have assessed the metrics data for its effectiveness in monitoring
covered trading activities for compliance with section 13 of the BHC
Act and for its costs.\215\ The Agencies have also considered 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 whether modifications are appropriate.\216\ As
a result of this evaluation, and as described in detail below, the
Agencies are proposing the following amendments to Appendix A of the
2013 final rule:\217\
---------------------------------------------------------------------------
\215\ See 79 FR at 5772.
\216\ Id.
\217\ In connection with the Appendix, the following documents
have also been published and made available on each Agency's
respective website: Instructions for Preparing and Submitting
Quantitative Measurement Information (``Instructions''), Technical
Specifications Guidance, and an eXtensible Markup Language Schema
(``XML Schema'').
---------------------------------------------------------------------------
Limit the applicability of certain metrics only to market
making and underwriting desks.
Replace the Customer-Facing Trade Ratio with a new
Transaction Volumes metric to more precisely cover types of trading
desk transactions with counterparties.
Replace Inventory Turnover with a new Positions metric,
which measures the value of all securities and derivatives positions.
[[Page 33495]]
Remove the requirement to separately report values that
can be easily calculated from other quantitative measurements already
reported.
Streamline and make consistent value calculations for
different product types, using both notional value and market value to
facilitate better comparison of metrics across trading desks and
banking entities.
Eliminate inventory aging data for derivatives because
aging, as applied to derivatives, does not appear to provide a
meaningful indicator of potential impermissible trading activity or
excessive risk-taking.
Require banking entities to provide qualitative
information specifying for each trading desk the types of financial
instruments traded, the types of covered trading activity the desk
conducts, and the legal entities into which the trading desk books
trades.
Require a Narrative Statement describing changes in
calculation methods, trading desk structure, or trading desk
strategies.
Remove the paragraphs labeled ``General Calculation
Guidance'' from the regulation. The Instructions generally would
provide calculation guidance.\218\
---------------------------------------------------------------------------
\218\ The Instructions are available on each Agency's respective
website at the addresses specified in the Paperwork Reduction Act
section of this Supplementary Information. For the SEC and CFTC,
this document represents the views of SEC staff and CFTC staff, and
neither Commission has approved nor disapproved the Staff
Instructions for Preparing and Submitting Quantitative Measurement
Information.
---------------------------------------------------------------------------
Remove the requirement that banking entities establish and
report limits on Stressed Value-at-Risk at the trading desk-level
because trading desks do not typically use such limits to manage and
control risk-taking.
Require banking entities to provide descriptive
information about their reported metrics, including information
uniquely identifying and describing certain risk measurements and
information identifying the relationships of these measurements within
a trading desk and across trading desks.
Require electronic submission of the Trading Desk
Information, Quantitative Measurements Identifying Information, and
each applicable quantitative measurement in accordance with the XML
Schema specified and published on each Agency's website.\219\
---------------------------------------------------------------------------
\219\ The staff-level Technical Specifications Guidance
describes the XML Schema. The Technical Specifications Guidance and
the XML Schema are available on each Agency's respective website at
the addresses specified in the Paperwork Reduction Act section of
this Supplementary Information.
---------------------------------------------------------------------------
Taken together, these changes--particularly limiting the
applicability of certain metrics requirements only to trading desks
engaged in certain types of covered trading activity--are designed to
reduce compliance-related inefficiencies relative to the 2013 final
rule. The proposed amendments to Appendix A of the 2013 final rule
should allow collection of data that permits the Agencies to better
monitor compliance with section 13 of the BHC Act.\220\
---------------------------------------------------------------------------
\220\ As previously noted in the section entitled ``Enhanced
Minimum Standards for Compliance Programs,'' the Agencies are
proposing to eliminate Appendix B of the 2013 final rule. If that
aspect of the proposal is adopted, current Appendix A, as modified
by the proposal, would be re-designated as the ``Appendix.''
---------------------------------------------------------------------------
2. Summary of the Proposal
a. Purpose
Paragraph I.c of Appendix A of the 2013 final rule provides that
the quantitative measurements that are required to be reported under
the rule are not intended to serve as a dispositive tool for
identifying permissible or impermissible activities. The Agencies
propose to expand paragraph I.c of Appendix A of the 2013 final rule to
cover all information that must be furnished pursuant to the appendix,
rather than only to the quantitative measurements themselves. \221\
---------------------------------------------------------------------------
\221\ The proposed amendment to paragraph I.c. of Appendix A
would make clear that none of the information that a banking entity
would be required to report under the proposal is intended to serve
as a dispositive tool for identifying permissible or impermissible
activities. Currently, that qualifying language only applies to the
quantitative measurements. As proposed, that information would
continue to be used to monitor patterns and identify activity that
may warrant further review.
---------------------------------------------------------------------------
The Agencies propose to remove paragraph I.d. in Appendix A of the
2013 final rule, which provides for an initial review by the Agencies
of the metrics data and revision of the collection requirement as
appropriate. The Agencies have conducted this preliminary evaluation of
the effectiveness of the quantitative measurements collected to date
and are proposing modifications to Appendix A of the 2013 final rule
where appropriate. The Agencies are, however, requesting comment on
whether the rule should provide for a subsequent Agency review within a
fixed period of time after adoption to consider whether further changes
are warranted. The Agencies further note that they continue to monitor
and review the effectiveness of the data as part of their ongoing
oversight of the banking entities and will continue to do so should the
proposed changes to Appendix A be adopted.
b. Definitions
The Agencies are proposing a clarifying change to the definition of
``covered trading activity.'' The Agencies are proposing to add the
phrase ``in its covered trading activity'' to clarify that the term
``covered trading activity,'' as used in the proposed appendix, may
include trading conducted under Sec. Sec. __.3(e), __.6(c), __.6(d),
or __.6(e) of the proposal. The proposed change would simply clarify
that banking entities would have the discretion (but not the
obligation) to report metrics with respect to a broader range of
activities.
In addition, the proposal defines two additional terms for purposes
of the appendix, ``applicability'' and ``trading day,'' that were not
defined in the 2013 final rule. In particular, the proposal provides:
Applicability identifies the trading desks for which a
banking entity is required to calculate and report a particular
quantitative measurement based on the type of covered trading activity
conducted by the trading desk.
Trading day means a calendar day on which a trading desk
is open for trading.
``Applicability'' is defined in this proposal to clarify when
certain metrics are required to be reported for specific trading desks.
As described further below, this proposal would make several metrics
applicable only to desks engaged in market making or underwriting.
The Agencies are proposing to create a definition of ``trading
day'' to clarify the meaning of a term that is used throughout Appendix
A of the 2013 final rule. Appendix A provides that the calculation
period for each quantitative measurement is one trading day. The
proposal would make clear that a banking entity would be required to
calculate each metric for each calendar day on which a trading desk is
open for trading.\222\ If a trading desk books positions to a banking
entity on a calendar day that is not a business day (e.g., a day that
falls on a weekend), then the desk is considered open for trading on
that day. Even if a trading desk does not conduct any trades on a
business day, the banking entity would be required to report metrics on
the trading desk's existing positions for that calendar day because the
trading desk is open to conduct trading. Similarly, if a trading desk
spans a U.S. entity and a
[[Page 33496]]
foreign entity and a national holiday occurs on a business day in the
United States but not in the foreign jurisdiction (or vice versa), the
banking entity would be required to report metrics for the trading desk
on that calendar day because the trading desk is open to conduct
trading in at least one jurisdiction. The Agencies believe that the
proposed definition of trading day is both objective and transparent,
while also providing flexibility to banking entities by tying the
definition directly to the schedule in which they operate their trading
desks.
---------------------------------------------------------------------------
\222\ As a general matter, a trading desk is not considered to
be open for trading on a weekend.
---------------------------------------------------------------------------
The Agencies request comments on the definitions in this proposal,
including comments on the following questions:
Question 215. Is the proposed definition of ``Applicability''
effective and clear? If not, what alternative definition would be more
effective and/or clearer?
Question 216. Is the proposed definition of ``Trading day''
effective and clear? If not, what alternative definition would be more
effective and/or clearer?
Question 217. Is the proposed modification of ``Covered trading
activity'' effective and clear? If not, what alternative definition
would be more effective and/or clearer?
Question 218. Should any other terms be defined? If so, are there
existing definitions in other rules or regulations that could be used
in this context? Why would the use of such other definitions be
appropriate?
c. Reporting and Recordkeeping
i. Scope of Required Reporting
The Agencies are proposing several modifications to paragraph III.a
of Appendix A of the 2013 final rule. The Agencies are proposing to
remove the Inventory Turnover and Customer-Facing Trade Ratio metrics
and replace them with the Positions and Transaction Volumes
quantitative measurements, respectively. In addition, as discussed
below, the proposal provides that the Inventory Aging metric would only
apply to securities, and would not apply to derivatives or securities
that also meet the 2013 final rule's definition of a derivative.\223\
As a result, the Agencies are proposing to change the name of the
Inventory Aging quantitative measurement to the Securities Inventory
Aging metric. Moreover, as described in more detail below, the Agencies
are proposing amendments to Appendix A that would limit the application
of certain quantitative measurements to trading desks that engage in
specific covered trading activities.\224\ As a result, the Agencies are
proposing to add the phrase ``as applicable'' to paragraph III.a.\225\
Finally, the Agencies are proposing to add references in paragraph
III.a to the proposed Trading Desk Information, Quantitative
Measurements Identifying Information, and Narrative Statement
requirements.\226\
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\223\ See infra Part III.E.2.i.v (discussing the Securities
Inventory Aging quantitative measurement). The definition of
``security'' and ``derivative'' are set forth in Sec. __.2 of the
2013 final rule. See 2013 final rule Sec. Sec. __.2 (h), (y).
\224\ As discussed below, the proposed Positions, Transaction
Volumes, and Securities Inventory Aging quantitative measurements
generally apply only to trading desks that rely on Sec. __.4(a) or
Sec. __.4(b) to conduct underwriting activity or market making-
related activity, respectively. See infra Part III.E.2.i.iii
(discussing the Positions, Transaction Volumes, and Securities
Inventory Aging quantitative measurements).
\225\ See 79 FR at 5616.
\226\ In addition, the Agencies propose to add to paragraph
III.a. a requirement that banking entities include file identifying
information in each submission to the relevant Agency pursuant to
Appendix A of the 2013 final rule. File identifying information
reflects administrative information needed to identify the reporting
requirement that is being met and distinguish between files
submitted pursuant to Appendix A. File identifying information must
include the name of the banking entity, the RSSD ID assigned to the
top-tier banking entity by the Board, the reporting period, and the
creation date and time.
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d. Trading Desk Information
The Agencies are proposing to add new paragraph III.b to Appendix A
to require banking entities to report certain descriptive information
regarding each trading desk engaged in covered trading activity:
i. Trading Desk Name and Trading Desk Identifier
Under paragraph III.b. of the proposed Appendix, the banking entity
would be required to provide the trading desk name and trading desk
identifier for each desk engaged in covered trading activities. While
this proposed requirement may affect the banking entity's overall
reporting obligations, this identifying information should enable the
Agencies to track a banking entity's trading desk structure over time,
which the Agencies believe will help identify situations when a
significant data change is the result of a structural change and assist
the Agencies' ability to monitor patterns in the quantitative
measurements. The Agencies also believe that the proposed qualitative
information, including the items identified in the sections below,
potentially could provide the Agencies with enough contextual basis to
facilitate the examination and supervisory processes. Such context also
could potentially lessen the need for Agency follow-up in when a red
flag is identified.
The trading desk name must be the name of the trading desk used
internally by the banking entity. The trading desk identifier is a
unique identification label that should be permanently assigned to a
desk by the banking entity. A trading desk at a banking entity may not
have the same trading desk identifier as another desk at that banking
entity. The trading desk identifier that is assigned to each desk
should remain the same for each submission of quantitative
measurements. In the event a banking entity restructures its operations
and merges two or more trading desks, the banking entity should assign
a new trading desk identifier to the merged desk (i.e., the merged
desk's identifier should not replicate a trading desk identifier
assigned to a previously unmerged trading desk) and permanently retire
the unmerged desks' identifiers. Similarly, if a banking entity
eliminates a trading desk, the trading desk identifier assigned to the
eliminated desk should be permanently retired (i.e., the eliminated
desk's identifier should not be reassigned to a current or future
trading desk).
Question 219. Should the Agencies require banking entities to
report changes in desk structure in the XML reporting format in
addition to a description of the changes in the Narrative Statement?
For example, a ``change event'' element could be added to the proposal
that would link the trading desk identifiers of predecessor and
successor desks before and after trading desk mergers and splits. Would
the modifications improve the banking entities' and the Agencies'
ability to track changes in trading desk structure and strategy across
reporting periods? How significant are any potential costs relative to
the potential benefits in facilitating the tracking of trading desk
changes? Please quantify your answers, to the extent feasible.
ii. Type of Covered Trading Activity
Proposed paragraph III.b. would require a banking entity to
identify each type of covered trading activity that the trading desk
conducts. As previously discussed, the proposal defines ``covered
trading activity,'' in part, as trading conducted by a trading desk
under Sec. Sec. __.4, __.5, __.6(a), or __.6(b).\227\ To the extent a
trading desk relies on one or more of these permitted activity
exemptions, the banking entity would be required to identify the
type(s)
[[Page 33497]]
of covered trading activity (e.g., underwriting, market making, risk-
mitigating hedging, etc.) in which the trading desk is engaged.
---------------------------------------------------------------------------
\227\ See supra Part III.E.2.b (discussing the covered trading
activity definition).
---------------------------------------------------------------------------
The proposed definition of ``covered trading activity'' also
provides that a banking entity may include in its covered trading
activity trading conducted under Sec. Sec. __.3(e), __.6(c), __.6(d),
or __.6(e). If a trading desk relies on any of the exclusions discussed
in Sec. __.3(e) or the permitted activity exemptions discussed in
Sec. Sec. __.6(c) through __.6(e) and the banking entity includes such
activity as ``covered trading activity'' for the desk under the
proposed Appendix, the banking entity would need to identify these
activity types (e.g., securities lending, liquidity management,
fiduciary transactions, etc.) for the trading desk.
While this proposed requirement may impact a firm's overall
reporting obligations, the Agencies believe the identification of each
desk's covered trading activity will help the relevant Agency establish
the appropriate scope of examination of such activity and assist with
identifying the relevant exemptions or exclusions for a particular
trading desk, which in turn enables an evaluation of a desk's reported
data in the context of those exemptions or exclusions.
iii. Trading Desk Description
Proposed paragraph III.b. would require a banking entity to provide
a description of each trading desk engaged in covered trading
activities. Specifically, the banking entity would be required to
provide a brief description of the trading desk's general strategy
(i.e., the method for conducting authorized trading activities). The
Agencies believe this descriptive information would improve the
Agencies ability to assess the risks associated with a given covered
trading activity and would further assist the relevant Agency in
determining the appropriate frequency and scope of examination of such
activity.
iv. Types of Financial Instruments and Other Products
Proposed paragraph III.b. would require a banking entity to provide
descriptive information regarding the financial instruments and other
products traded by each desk engaged in covered trading activities.
Under the proposal, a banking entity would be required to prepare a
list identifying all the types of financial instruments purchased and
sold by the trading desk.\228\ The banking entity may include other
products that are not defined as financial instruments under Sec.
__.3(c)(1) of the 2013 final rule in this list. In addition, the
proposal requires a banking entity to indicate which of these financial
instruments and other products (if applicable) are the main instruments
and products purchased and sold by the trading desk. If the trading
desk relies on the permitted activity exemption for market making-
related activities, the banking entity would be required to specify
whether each type of financial instrument included in the listing of
all financial instruments is or is not included in the trading desk's
market-making positions.\229\
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\228\ For example, a banking entity may specify that its high
grade credit trading desk purchases and sells the following types of
financial instruments: U.S. corporate debt, convertible bonds,
credit default swaps, and credit default swap indices.
\229\ The term ``market-maker positions'' means all of the
positions in the financial instruments for which the trading desk
stands ready to make a market in accordance with paragraph Sec.
__.4(b)(2)(i) of the proposal, that are managed by the trading desk,
including the trading desk's open positions or exposures arising
from open transactions. See proposal Sec. __.4(b)(5).
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The proposal also addresses ``excluded products'' traded by desks
engaged in covered trading activities. The definition of the term
``financial instrument'' in the 2013 final rule does not include loans,
spot commodities, and spot foreign exchange or currency (collectively,
``excluded products'').\230\ While positions in excluded products are
not subject to the 2013 final rule's restrictions on proprietary
trading, a banking entity may decide to include exposures in excluded
products that are related to a trading desk's covered trading
activities in its quantitative measurements.\231\ A banking entity
generally should use a consistent approach for including or excluding
positions in products that are not financial instruments when
calculating metrics for a trading desk.\232\
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\230\ See 2013 final rule Sec. __.3(c)(2).
\231\ The Agencies note that banking entities are not required
to calculate quantitative measurements based on positions in
products that are not ``financial instruments,'' as defined under
Sec. __.3(c)(2) of the 2013 final rule, or positions that do not
represent ``covered trading activity.'' However, a banking entity
may decide to include exposures in products that are not financial
instruments in a trading desk's calculations where doing so provides
a more accurate picture of the risks associated with the trading
desk. For example, a market maker in foreign exchange forwards or
swaps that mitigates the risks of its market-maker inventory with
spot foreign exchange may include spot foreign exchange positions in
its metrics calculations.
\232\ A banking entity generally should not incorporate excluded
products in the quantitative measurements of a trading desk one
month, and omit these products from the trading desk's measurements
the following month. Excluded products generally should be reported
consistently from period to period. Any change in reporting practice
for excluded products must be identified in the banking entity's
Narrative Statement for the relevant trading desk(s). See infra Part
III.E.2.f (discussing the Narrative Statement).
---------------------------------------------------------------------------
In recognition that a banking entity may include excluded products
in its quantitative measurements, proposed paragraph III.b. would
require a banking entity to indicate whether each trading desk engaged
in covered trading activities is including excluded products in its
quantitative measurements. If excluded products are included in a
trading desk's metrics, the banking entity would have to identify the
specific products that are included.
This information should enable the Agencies to better understand
the scope of covered trading activities, and thus help in identifying
the profile of particular covered trading activities of a banking
entity and its individual trading desks. Such identification is
necessary to establish the appropriate frequency and scope of
examination by the relevant Agency of such activity, evaluate whether a
banking entity's covered trading activity is consistent with the 2013
final rule, and assess the risks associated with the activity.
v. Legal Entities the Trading Desk Uses
As discussed in the preamble to the 2013 final rule, the Agencies
recognize that a trading desk may book positions into a single legal
entity or into multiple affiliated legal entities.\233\ To assist in
establishing the appropriate scope of examination by the relevant
Agency of a banking entity's covered trading activities, the Agencies
are proposing to require each banking entity to identify each legal
entity that serves as a booking entity for each trading desk engaged in
covered trading activities, and to indicate which of these legal
entities are the main booking entities for covered trading activities
of each desk. The banking entity would have to provide the complete
name for each legal entity (i.e., the banking entity could not use
abbreviations or acronyms), and the banking entity would have to
provide any applicable entity identifiers.\234\
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\233\ 79 FR at 5591.
\234\ The Agencies are not proposing to require each legal
entity that serves as a booking entity to obtain an entity
identifier to comply with the proposed appendix. If a legal entity
does not have an applicable entity identifier, it should report
``None'' in the appropriate field.
---------------------------------------------------------------------------
vi. Legal Entity Type Identification
The Agencies are proposing to require each banking entity to
specify any applicable entity type for each legal entity that serves as
a booking entity for
[[Page 33498]]
trading desks engaged in covered trading activities. The proposal
provides a list of key entity types for this purpose. For example, if a
trading desk books trades into a legal entity that is a U.S.-registered
broker-dealer, the banking entity would indicate ``U.S.-registered
broker-dealer'' in the entity type identification field for that
particular trading desk. If more than one entity type applies to a
particular legal entity that serves as a booking entity, the banking
entity must specify any applicable entity type for that legal entity.
For example, if a trading desk books trades into a legal entity that is
a U.S.-registered broker-dealer and a registered futures commission
merchant, the banking entity would indicate ``U.S.-registered broker-
dealer'' and ``futures commission merchant'' in the entity type
identification field for that particular trading desk.
The proposal also requires that a banking entity identify entity
types that are not otherwise enumerated in the proposed Appendix,
including a subsidiary of a legal entity that is listed where the
subsidiary itself is not included in the list. For example, the
Agencies understand that a trading desk may book some or all of its
positions into a legal entity that is incorporated under foreign law.
In this situation, the banking entity should provide a brief
description of the entity (e.g., foreign-registered securities dealer)
in the entity type identification field for that trading desk. The
Agencies believe that the information collected under this section
would assist banking entities and the Agencies in monitoring and
understanding the scope of covered trading activities. In particular,
the proposed entity type information, in conjunction with the
identification of legal entities used by the trading desk (discussed
above), would facilitate the Agencies' ability to coordinate with each
other, as appropriate.\235\
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\235\ See 79 FR at 5758. The Agencies expect to continue to
coordinate their 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 2013 final rule. See id.
---------------------------------------------------------------------------
vii. Trading Day Indicator
In order to facilitate metrics reporting, paragraph III.b. of the
proposed Appendix requires a banking entity to indicate whether each
calendar date is a trading day or not a trading day for each trading
desk engaged in covered trading activities. The Agencies believe that
this information would assist banking entities and the Agencies in
monitoring covered trading activities. Specifically, the identification
of trading days and non-trading days will allow the Agencies to
understand why metrics may not be reported on a particular day for a
particular trading desk. In addition, the Agencies expect that this
information would improve consistency in metrics reports by requiring
banking entities to determine whether metrics are, or are not, required
to be reported for each calendar day.
viii. Currency Reported and Currency Conversion Rate
In recognition that a banking entity may report quantitative
measurements for a trading desk engaged in covered trading activities
in a currency other than U.S. dollars, paragraph III.b. of the proposed
Appendix requires a banking entity to specify the currency used by that
trading desk as well as the conversion rate to U.S. dollars. Under the
proposal, the banking entity would be required to provide the currency
reported on a monthly basis and the currency conversion rate for each
trading day. The Agencies believe this information would assist banking
entities and the Agencies in monitoring covered trading activities by
facilitating the identification of quantitative measurements reported
in a currency other than U.S. dollars and the conversion of such
measurements to U.S. dollars. The ability to convert a banking entity's
reported quantitative measurements into one consistent currency
enhances the ability of the Agencies to evaluate the metrics and
facilitates cross-desk comparisons.
Question 220. Is the description of the proposal's Trading Desk
Information requirement effective and sufficiently clear? If not, what
alternative would be more effective or clearer? Is more or less
specific guidance necessary? If so, what level of specificity is needed
to prepare the proposed Trading Desk Information? If the proposed
Trading Desk Information is not sufficiently specific, how should it be
modified to reach the appropriate level of specificity? If the proposed
Trading Desk Information is overly specific, why is it too specific and
how should it be modified to reach the appropriate level of
specificity?
Question 221. Is the proposed Trading Desk Information helpful to
understanding the scope, type, and profile of a trading desk's covered
trading activities and associated risks? Why or why not? Does the
proposed Trading Desk Information appropriately highlight relevant
changes in a banking entity's trading desk structure and covered
trading activities over time? Why or why not? Do banking entities
expect that the proposed Trading Desk Information would reduce,
increase, or have no effect on the number of information requests from
the Agencies regarding the quantitative measurements? Please explain.
Question 222. Is any of the information required by the proposed
Trading Desk Information already available to banking entities? Please
explain.
Question 223. Does the proposed Trading Desk Information strike the
appropriate balance between the potential benefits of the reporting
requirements for monitoring and assuring compliance and the potential
costs of those reporting requirements? If not, how could that balance
be improved?
Question 224. Are there burdens or costs associated with preparing
the proposed Trading Desk Information, and if so, how burdensome or
costly would it be to prepare such information? What are the additional
burdens or costs associated with preparing this information for
particular trading desks? How significant are those potential costs
relative to the potential benefits of the information in understanding
the scope, type, and profile of a trading desk's covered trading
activities and associated risks? Are there potential modifications that
could be made to the proposed Trading Desk Information that would
reduce the burden or cost while achieving the purpose of the proposal?
If so, what are those modifications? Please quantify your answers, to
the extent feasible.
Question 225. In light of the size, scope, complexity, and risk of
covered trading activities, do commenters anticipate the need to hire
new staff with particular expertise in order to prepare the proposed
Trading Desk Information (e.g., collect data and map legal entities)?
Do commenters anticipate the need to develop additional infrastructure
to obtain and retain data necessary to prepare this schedule? Please
explain and quantify your answers, to the extent feasible.
Question 226. What operational or logistical challenges might be
associated with preparing the proposed Trading Desk Information and
obtaining any necessary informational inputs?
Question 227. How might the proposed Trading Desk Information
affect the behavior of banking entities? To what extent and in what
ways might uncertainty as to how the Agencies will review and evaluate
the proposed Trading Desk Information affect the behavior of banking
entities?
Question 228. Is the meaning of the term ``main,'' as that term is
used in the proposed Trading Desk Information (e.g., main financial
instruments or
[[Page 33499]]
products, main booking entities), effective and sufficiently clear? If
not, how should the Agencies define this term such that it is more
effective and/or clearer? Should the meaning of the term ``main'' be
the same with respect to: (i) Main financial instruments or other
products; and (ii) main booking entities? Why or why not?
Question 229. In addition to reporting ``main'' financial
instruments or products and ``main'' booking entities, should banking
entities be required to report the amount of profit and loss
attributable to each ``main'' financial instrument or product and/or
``main'' booking entity utilized by the trading desk in the Trading
Desk Information? Why or why not?
Question 230. Is the proposal's requirement that a banking entity
identify all financial instruments or other products traded on a desk
effective and clear? Why or why not? Should the Agencies provide a
specific list of financial instruments or other product types from
which to choose when identifying financial instruments or other
products traded on a desk? If so, please provide examples.
Question 231. Should banking entities be required to report at
least one valid unique entity identifier (e.g., LEI, CRD, RSSD, or CIK)
for each legal entity identified as a booking entity for covered
trading activities of a desk? How burdensome and costly would it be for
a banking entity to obtain an entity identifier for each legal entity
serving as a booking entity that does not already have an identifier?
What are the additional burdens or costs associated with obtaining an
entity identifier for particular legal entities? How significant are
those potential costs relative to the potential benefits in
facilitating the identification of legal entities? Please quantify your
answers, to the extent feasible.
Question 232. Is more guidance needed on what a banking entity
should report in response to the proposed requirement to specify the
applicable entity type(s) for each legal entity that serves as a
booking entity for covered trading activities of a trading desk? If so,
please explain.
Question 233. How burdensome and costly would it be for banking
entities to report which Agencies receive reported quantitative
measurements for each specific trading desk?
e. Quantitative Measurements Identifying Information
The Agencies are proposing to add new paragraph III.c. to the
proposed Appendix to require banking entities to prepare and report
descriptive information regarding their quantitative measurements. This
information would have to be reported collectively for all relevant
trading desks. For example, a banking entity would report one Risk and
Position Limits Information Schedule, rather than separate Risk and
Position Limits Information Schedules for each of those trading desks.
i. Risk and Position Limits Information Schedule
The proposed Risk and Position Limits Information Schedule requires
banking entities to provide detailed information regarding each limit
reported in the Risk and Position Limits and Usage quantitative
measurement, including the unique identification label for the limit,
the limit name, limit description, whether the limit is intraday or
end-of-day, the unit of measurement for the limit, whether the limit
measures risk on a net or gross basis, and the type of limit. The
unique identification label for the limit should be a character string
identifier that remains consistent across all trading desks and
reporting periods. When reporting the type of limit, the banking entity
would identify which of the following categories best describes the
limit: Value-at-Risk, position limit, sensitivity limit, stress
scenario, or other. If ``other'' is reported, the banking entity would
provide a brief description of the type of limit. The Agencies believe
this more detailed limit information would enable the Agencies to
better understand how banking entities assess and address risks
associated with their covered trading activities.
ii. Risk Factor Sensitivities Information Schedule
The proposed Risk Factor Sensitivities Information Schedule
requires banking entities to provide detailed information regarding
each risk factor sensitivity reported in the Risk Factor Sensitivities
quantitative measurement, including the unique identification label for
the risk factor sensitivity, the name of the risk factor sensitivity, a
description of the risk factor sensitivity, and the risk factor
sensitivity's risk factor change unit. The unique identification label
for the risk factor sensitivity should be a character string identifier
that remains consistent across all trading desks and reporting periods.
The risk factor change unit is the measurement unit of the risk factor
change that impacts the trading desk's portfolio value.\236\ This
proposed schedule should enable the Agencies to better understand the
exposure of a banking entity's trading desks to individual risk
factors.
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\236\ For example, the risk factor change unit for the dollar
value of a one-basis point change (DV01) could be reported as
``basis point.'' Similarly, the risk factor change unit for equity
delta could be reported as ``dollar change in equity prices'' or
``percentage change in equity prices.''
---------------------------------------------------------------------------
iii. Risk Factor Attribution Information Schedule
The proposed Risk Factor Attribution Information Schedule requires
banking entities to provide detailed information regarding each
attribution of existing position profit and loss to risk factor
reported in the Comprehensive Profit and Loss Attribution quantitative
measurement, including the unique identification label for each risk
factor or other factor attribution, the name of the risk factor or
other factor, a description of the risk factor or other factor, and the
risk factor or other factor's change unit. The unique identification
label for the risk factor or other factor attribution should be a
character string identifier that remains consistent across all trading
desks and reporting periods. The factor change unit is the measurement
unit of the risk factor or other factor change that impacts the trading
desk's portfolio value.\237\ This proposed schedule should improve the
Agencies' understanding of the individual risk factors and other
factors that contribute to the daily profit and loss of trading desks
engaged in covered trading activities.
---------------------------------------------------------------------------
\237\ See supra note 236.
---------------------------------------------------------------------------
iv. Limit/Sensitivity Cross-Reference Schedule
The Agencies recognize that risk factor sensitivities that are
reported in the Risk Factor Sensitivities quantitative measurement
frequently relate to, or are associated with, risk and position limits
that are reported in the Risk and Position Limits and Usage metric. In
recognition of the relationship between risk and position limits and
associated risk factor sensitivities, the Agencies propose an amendment
to Appendix A of the 2013 final rule that would require banking
entities to prepare a Limit/Sensitivity Cross-Reference Schedule.
Specifically, banking entities would be required to cross-reference, by
unique identification label, a limit reported in the Risk and Position
Limits Information Schedule to any associated risk factor sensitivity
reported in the Risk Factor Sensitivities Information Schedule.
Highlighting the relationship between limits and risk factor
sensitivities should provide a broader picture of a
[[Page 33500]]
trading desk's covered trading activities and improve the Agencies'
understanding of the quantitative measurements. For example, the
proposed Limit/Sensitivity Cross-Reference Schedule should help the
Agencies better evaluate a reported limit on a risk factor sensitivity
by allowing the Agencies to efficiently identify additional contextual
information about the risk factor sensitivity in the banking entity's
metrics submission.
v. Risk Factor Sensitivity/Attribution Cross-Reference Schedule
The Agencies note that the specific risk factors and other factors
that are reported in the Comprehensive Profit and Loss Attribution
quantitative measurement may relate to the risk factor sensitivities
reported in the Risk Factor Sensitivities metric. As a result, the
Agencies are proposing an amendment to Appendix A of the 2013 final
rule that would require banking entities to prepare a Risk Factor
Sensitivity/Attribution Cross-Reference Schedule. Specifically, banking
entities would be required to cross-reference, by unique identification
label, a risk factor sensitivity reported in the Risk Factor
Sensitivities Information Schedule to any associated risk factor
attribution reported in the Risk Factor Attribution Information
Schedule. This proposed cross-reference schedule is intended to clarify
the relationship between risk factors that serve as sensitivities and
the profit and loss that is attributed to those risk factors. In
conjunction with the Limit/Sensitivity Cross-Reference Schedule, the
Risk Factor Sensitivity/Attribution Cross-Reference Schedule should
assist the Agencies in understanding the broader scope, type, and
profile of a banking entity's covered trading activities and assessing
associated risks, and facilitate the relevant Agency's efforts in
monitoring those covered trading activities. For example, the proposed
Risk Factor Sensitivity/Attribution Cross-Reference Schedule should
help the Agencies compare the variables that a banking entity has
identified as significant sources of its trading desks' profitability
and risk for purposes of the Risk Factor Sensitivities metric to the
factor(s) that account for actual changes in the banking entity's
trading desk-level profit and loss, as reported in the Comprehensive
Profit and Loss Attribution metric. This comparison will allow the
Agencies to evaluate whether a banking entity has identified risk
factors in the Risk Factor Sensitivities metric of a trading desk that
help explain the trading desk's profit and loss.
Question 234. Is the information required by the proposed
Quantitative Measurements Identifying Information effective and
sufficiently clear? If not, what alternative would be more effective or
clearer? Is more or less specific guidance necessary? If so, what level
of specificity is needed to prepare the relevant schedule? If the
proposed Quantitative Measurements Identifying Information is not
sufficiently specific, how should it be modified to reach the
appropriate level of specificity? If the proposed Quantitative
Measurements Identifying Information is overly specific, why is it too
specific and how should it be modified to reach the appropriate level
of specificity?
Question 235. Is the information required by the proposed
Quantitative Measurements Identifying Information helpful or not
helpful to understanding a banking entity's covered trading activities
and associated risks? Identify which specific pieces of information are
helpful or not helpful and explain why. Does the information provide
necessary clarity about a banking entity's risk measures and how such
risk measures relate to one another over time and within and across
trading desks? Do banking entities expect that the schedules will
reduce, increase, or have no effect on the number of information
requests from the Agencies regarding the quantitative measurements?
Please explain.
Question 236. Is the information required by the proposed
Quantitative Measurements Identifying Information already available to
banking entities? Please explain.
Question 237. Does the proposed Quantitative Measurements
Identifying Information strike the appropriate balance between the
potential benefits of the reporting requirements for monitoring and
assuring compliance and the potential costs of those reporting
requirements? If not, how could that balance be improved?
Question 238. How burdensome and costly would it be to prepare each
schedule within the proposed Quantitative Measurements Identifying
Information? What are the additional burdens costs associated with
preparing these schedules for particular trading desks? How significant
are those potential costs relative to the potential benefits of the
schedules in monitoring covered trading activities and assessing risks
associated with those activities? Are there potential modifications
that could be made to these schedules that would reduce the burden or
cost? If so, what are those modifications? Please quantify your
answers, to the extent feasible.
Question 239. In light of the size, scope, complexity, and risk of
covered trading activities, do commenters anticipate the need to hire
new staff with particular expertise in order to prepare the information
required by the proposed Quantitative Measurements Identifying
Information (e.g., to program information systems and collect data)? Do
commenters anticipate the need to develop additional infrastructure to
obtain and retain data necessary to prepare these schedules? Please
explain and quantify your answers, to the extent feasible.
Question 240. What operational or logistical challenges might be
associated with preparing the information required by the proposed
Quantitative Measurements Identifying Information and obtaining any
necessary informational inputs?
Question 241. How might the proposed Quantitative Measurements
Identifying Information affect the behavior of banking entities? To
what extent and in what ways might uncertainty as to how the Agencies
will review and evaluate the proposed Quantitative Measurements
Identifying Information affect the behavior of banking entities?
f. Narrative Statement
The proposed paragraph III.d. requires a banking entity to submit a
Narrative Statement in a separate electronic document to the relevant
Agency that describes any changes in calculation methods used for its
quantitative measurements and to indicate when this change occurred. In
addition, a banking entity would have to prepare and submit a Narrative
Statement when there are any changes in the banking entity's trading
desk structure (e.g., adding, terminating, or merging pre-existing
desks) or trading desk strategies. Under these circumstances, the
Narrative Statement would have to describe the change, document the
reasons for the change, and specify when the change occurred.
Under the proposal, the banking entity would have to report in a
Narrative Statement any other information the banking entity views as
relevant for assessing the information schedules or quantitative
measurements, such as a further description of calculation methods that
the banking entity is using. In addition, a banking entity would have
to explain its inability to report a particular quantitative
measurement in the Narrative Statement. A banking entity also would
have to provide notice in its Narrative Statement if a trading desk
changes its approach to including or
[[Page 33501]]
excluding products that are not financial instruments in its metrics.
If a banking entity does not have any information to report in a
Narrative Statement, the banking entity would have to submit an
electronic document stating that it does not have any information to
report in a Narrative Statement.
Question 242. Should the Narrative Statement be required? If so,
why? Should the proposed requirement apply to all changes in the
calculation methods a banking entity uses for its quantitative
measurements or should the proposed rule text be revised to apply only
to changes that rise to a certain level of significance? Please
explain.
Question 243. Is the proposed Narrative Statement requirement
effective and sufficiently clear? If not, what alternative would be
more effective or clearer? Are there other circumstances in which a
Narrative Statement should be required? If so, what are those
circumstances?
Question 244. How burdensome or costly is the proposed Narrative
Statement to prepare? Are there potential benefits of the Narrative
Statement to banking entities, particularly as it relates to the
ability of banking entities and the Agencies to monitor a firm's
covered trading activities?
g. Frequency and Method of Required Calculation and Reporting
The 2013 final rule established a reporting schedule in Sec. __.20
that required banking entities with $50 billion or more in trading
assets and liabilities to report the information required by Appendix A
of the 2013 final rule within 10 days of the end of each calendar
month. The Agencies are proposing to adjust this reporting schedule to
extend the time to be within 20 days of the end of each calendar
month.\238\ Experience with implementing the 2013 final rule has shown
that the information submitted within ten days is often incomplete or
contains errors. Banking entities must regularly provide resubmissions
to correct or complete their initial information submission. This
extension of the time for reporting is expected to reduce compliance
costs as the additional time would allow the required workflow to be
conducted under less time pressure and with greater efficiency and
fewer resubmissions should be necessary. The schedule for banking
entities with less than $50 billion in trading assets and liabilities
would remain unchanged.
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\238\ See Sec. __.20(d) of the proposal.
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Question 245. Is the proposed frequency of reporting the Trading
Desk Information, Quantitative Measurements Identifying Information,
and Narrative Statement appropriate and effective? If not, what
frequency would be more effective? Should the information be required
to be reported quarterly, annually, or upon the request of the
applicable Agency and, if so, why?
Question 246. Would providing banking entities with additional time
to report quantitative measurements meaningfully reduce resubmissions?
If so, would the additional time reduce burdens on banking entities?
Please provide quantitative data to the extent feasible.
Question 247. Is there a calculation period other than daily that
would provide more meaningful data for certain metrics? For example,
would weekly inventory aging instead of daily inventory aging be more
effective? Why or why not?
Appendix A of the 2013 final rule did not specify a format in which
metrics should be reported. As a technical matter, banking entities may
currently report quantitative measurements to the relevant Agency using
various formats and conventions. After consultation with staffs of the
Agencies, the reporting banking entities submitted their quantitative
measurement data electronically in a pipe-delimited flat file format.
However, this flat file format has proved to be unwieldy and its
syntactical requirements have been unclear. There has been no easy way
for banking entities to validate that their data files are in the
correct format before submitting them, and so banking entities have
often needed to resubmit their quantitative measurements to address
formatting issues.
To make the formatting requirements for the data submissions
clearer, and to help ensure the quality and consistency of data
submissions across banking entities, the Agencies are proposing to
require that the Trading Desk Information, the Quantitative
Measurements Identifying Information, and each applicable quantitative
measurement be reported in accordance with an XML Schema to be
specified and published on the relevant Agency's website.\239\ By
requiring the XML Schema, the Agencies look to establish a structured
model through which reported data can be recognized and processed by
standard computer code or software (i.e., made machine-readable). The
proposed reporting format should promote complete and intelligible
records of covered trading activities and facilitate the reporting of
key identifying and descriptive information. Submissions structured
according to the XML Schema should enhance the Agencies' ability to
normalize, aggregate, and analyze reported metrics. In turn, the
proposed reporting format should facilitate monitoring of covered
trading activities and enable the relevant Agency to more efficiently
interpret and evaluate reported metrics. For example, the proposed
reporting format should enhance the Agencies' ability to compare data
across trading desks and analyze data over different time horizons.
---------------------------------------------------------------------------
\239\ To the extent the XML Schema is updated, the version of
the XML Schema that must be used by banking entities would be
specified on the relevant Agency's website. A banking entity must
not use an outdated version of the XML Schema to report the Trading
Desk Information, Quantitative Measurements Identifying Information,
and applicable quantitative measurements to the relevant Agency.
---------------------------------------------------------------------------
Question 248. How burdensome and costly would it be to develop new
systems, or modify existing systems, to implement the proposed
Appendix's electronic reporting requirement and XML Schema? How
significant are those potential costs relative to the potential
benefits of electronic reporting and the XML Schema in facilitating
review and analysis of a banking entity's covered trading activities?
Are there potential modifications that could be made to the proposal's
electronic reporting requirement or XML Schema that would reduce the
burden or cost? If so, what are those modifications? Please quantify
your answers, to the extent feasible.
Question 249. Is the proposed XML reporting format for submission
of the Trading Desk Information, applicable quantitative measurements,
and the Quantitative Measurements Identifying Information appropriate
and effective? Why or why not?
Question 250. Is there a reporting format other than the XML Schema
that the Agencies should consider as acceptable? Should the Agencies
allow banking entities to develop their own reporting formats? If so,
are there any general reporting standards that should be included in
the rule to facilitate the Agencies' ability to normalize, aggregate,
and analyze data that is reported pursuant to different electronic
formats or schemas? Please explain in detail.
Question 251. What would be the costs to a banking entity to
provide quantitative measurements data according to the proposed XML
reporting format? Please quantify your answers, to the extent feasible.
Question 252. For a banking entity currently reporting quantitative
[[Page 33502]]
measurements in some other electronic format, what would be the costs
(such as equipment, systems, training, or ongoing staffing or
maintenance) to convert current systems to use the proposed XML
reporting format? Please quantify your answers, to the extent feasible.
Question 253. Is there a more effective way to distribute the XML
Schema than the current proposal of having each Agency host a copy of
the XML Schema on its respective website? For example, would it be more
effective for all Agencies to point to only one location where the XML
Schema will be hosted? If so, please identify how the alternative would
improve data quality and accessibility. How long should the
implementation period be?
Question 254. Currently banking entities are reporting quantitative
measurements separately to each Agency using tailored data files
containing only the measurements for the trading desks that book into
legal entities for which an Agency is the primary supervisor. Would it
be more effective for all Agencies to use a single point of collection
for the quantitative measurements? If so, would there be any impact on
Agencies ability to review and analyze a banking entity's covered
trading activities? How significant are the costs of reporting
separately to each Agency? Please quantify your answers, to the extent
feasible. Are there any other ways to make the metrics requirements
more efficient? For example, are any banking entities subject to any
separate or related data reporting requirements that could be leveraged
to make the proposal more efficient?
h. Recordkeeping
Under paragraph III.c. of Appendix A of the 2013 final rule, a
banking entity's reported quantitative measurements are subject to the
record retention requirements provided in the appendix. Under the
proposal, this provision would be in paragraph III.f. of the appendix.
The Agencies propose to expand this provision to include the Narrative
Statement, the Trading Desk Information, and the Quantitative
Measurements Identifying Information in the appendix's record retention
requirements.
Question 255. Is the proposed application of Appendix A's record
retention requirement to the Trading Desk Information, Quantitative
Measurements Identifying Information, and Narrative Statement
appropriate? If not, what alternatives would be more appropriate? What
costs would be associated with retaining the Narrative Statements and
information schedules on that basis, and how could those costs be
reduced or eliminated? Please quantify your answers, to the extent
feasible.
Question 256. Should the proposed Trading Desk Information,
Quantitative Measurements Identifying Information, and Narrative
Statement be subject to the same five-year retention requirement that
applies to the quantitative measurements? Why or why not? If not, how
long should the information schedules and Narrative Statements be
retained, and why?
i. Quantitative Measurements
Section IV of Appendix A of the 2013 final rule sets forth the
individual quantitative measurements required by the appendix. The
Agencies are proposing to add an ``Applicability'' paragraph to each
quantitative measurement that identifies the trading desks for which a
banking entity would be required to calculate and report a particular
metric based on the type of covered trading activity conducted by the
desk. In addition, the Agencies are proposing to remove the ``General
Calculation Guidance'' paragraphs that appear in section IV of Appendix
A of the 2013 final rule for each quantitative measurement. Content of
these General Calculation Guidance paragraphs would instead generally
be addressed in the Instructions.
i. Risk-Management Measurements
A. Risk and Position Limits and Usage
The Agencies are proposing to remove references to Stressed Value-
at-Risk (Stressed VaR) in the Risk and Position Limits and Usage
metric. Eliminating the requirement to report desk-level limits for
Stressed VaR should reduce reporting obligations for banking entities
without reducing the Agencies' ability to monitor proprietary trading.
The proposal clarifies in new ``Applicability'' paragraph
IV.a.1.iv. that, as in the 2013 final rule, the Risk and Position
Limits and Usage metric applies to all trading desks engaged in covered
trading activities. For each trading desk, the proposal requires that a
banking entity report the unique identification label for each limit as
listed in the Risk and Position Limits Information Schedule, the limit
size (distinguishing between the upper bound and lower bound of the
limit, where applicable), and the value of usage of the limit.\240\ The
unique identification label should allow the Agencies to efficiently
obtain the descriptive information regarding the limit that is
separately reported in the Risk and Position Limits Information
Schedule.\241\ The proposal requires a banking entity to report this
descriptive information in the Risk and Position Limits Information
Schedule for the entire banking entity's covered trading activity,
rather than multiple times in the Risk and Position Limits and Usage
metric for different trading desks, to help alleviate inefficiencies
associated with reporting redundant information and reduce electronic
file submission sizes.
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\240\ If a limit is introduced or discontinued during a calendar
month, the banking entity must report this information for each
trading day that the trading desk used the limit during the calendar
month.
\241\ Such information includes the name of the limit, a
description of the limit, whether the limit is intraday or end-of-
day, the unit of measurement for the limit, whether the limit
measures risk on a net or gross basis, and the type of limit.
---------------------------------------------------------------------------
Unlike the 2013 final rule, the proposal requires a banking entity
to report the limit size of both the upper bound and the lower bound of
a limit if a trading desk has both an upper and lower limit. The
Agencies understand that, based on a review of the collected data and
discussions with banking entities, trading desks may have upper and
lower limits. An upper limit means the value of risk cannot go above
the limit, while a lower limit means the value of risk cannot go below
the limit. This proposed amendment is intended to help identify when a
trading desk has both an upper limit and a lower limit and avoid
incomplete or unclear reporting under these circumstances. In addition,
receipt of information about upper and lower limits, where applicable,
should allow the Agencies to better evaluate the constraints that a
banking entity places on the risks of a trading desk. For example, if a
trading desk has both upper and lower limits but only one such limit is
reported, the Agencies would not have complete information about the
desk's limits or the usage of such limits, including potential limit
breaches that may warrant further review.
The proposal also clarifies the 2013 final rule's requirement to
separately report a trading desk's usage of its limit. As noted above,
usage is the value of the trading desk's risk or positions that are
accounted for by the current activity of the desk. The value of the
usage generally should be reported as of the end of the day for limits
that are accounted for at the end of the day; conversely, banking
entities generally should report the maximum value of the usage for
limits accounted for intraday.
[[Page 33503]]
Question 257. Should Stressed VaR limits be removed as a reporting
requirement for desks engaged in permitted market making-related
activity or risk-mitigating hedging activity? Are VaR limits without
accompanying Stressed VaR limits adequate for these desks? Should
another type of limit be required to replace Stressed VaR, such as
expected shortfall? Should Stressed VaR limits instead be required for
other types of covered trading activities besides market making-related
activity or risk-mitigating hedging activity?
Question 258. Should VaR limits be removed as a reporting
requirement for trading desks engaged in permitted market making-
related activity or risk-mitigating hedging activity? Why or why not?
Question 259. The proposal requires a banking entity to report the
limit size of both the upper bound and the lower bound of a limit if a
trading desk has both an upper and lower limit. Should banking entities
be required to report both the upper bound and the lower bound of a
limit (if applicable) or should the requirement only apply to the upper
limit? Please discuss the anticipated costs and other burdens of this
new requirement and how they compare to the benefits.
B. Risk Factor Sensitivities
The proposed ``Applicability'' paragraph IV.a.2.iv. provides that,
as in the 2013 final rule, the Risk Factor Sensitivities metric applies
to all trading desks engaged in covered trading activities. Under the
proposal, a banking entity would have to report for each trading desk
the unique identification label associated with each risk factor
sensitivity of the desk, the magnitude of the change in the risk
factor, and the aggregate change in value across all positions of the
desk given the change in risk factor.\242\
---------------------------------------------------------------------------
\242\ If a risk factor sensitivity is introduced or discontinued
during a calendar month, the banking entity must report this
information for each trading day that the trading desk used the
sensitivity during the calendar month.
---------------------------------------------------------------------------
The proposed unique identification label should allow the Agencies
to efficiently obtain the descriptive information for the Risk Factor
Sensitivity that is separately reported in the Risk Factor
Sensitivities Information Schedule.\243\ The proposal requires a
banking entity to report this descriptive information in the Risk
Factor Sensitivities Information Schedule for the entire banking
entity's covered trading activity, rather than multiple times in the
Risk Factor Sensitivities metric for different trading desks, to help
alleviate inefficiencies associated with reporting redundant
information and reduce electronic file submission sizes.
---------------------------------------------------------------------------
\243\ Such information includes the name of the sensitivity, a
description of the sensitivity, and the sensitivity's risk factor
change unit.
---------------------------------------------------------------------------
C. Value-at-Risk and Stressed Value-at-Risk
The proposal modifies the description of Stressed VaR to align its
calculation with that of Value-at-Risk and removes the General
Calculation Guidance. A new ``Applicability'' paragraph IV.a.3.iv.
provides that Stressed VaR is not required to be reported for trading
desks whose covered trading activity is conducted exclusively to hedge
products excluded from the definition of financial instrument in Sec.
__.3(d)(2) of the proposal. The Agencies believe that limiting the
applicability of the Stressed VaR metric in this manner may reduce
burden without impacting the ability of the Agencies to monitor for
prohibited proprietary trading. In particular, the Agencies believe
that applying Stressed VaR to trading desks whose covered trading
activity is conducted exclusively to hedge excluded products does not
provide meaningful information about whether the trading desk is
engaged in proprietary trading. For example, when Stressed VaR is
applied to hedges of loans held-to-maturity on a trading desk, Stressed
VaR is unlikely to provide an accurate indication of the risk taken on
that desk. Thus, the Agencies are providing that Stressed VaR need not
be reported under these circumstances.
Question 260. Is Stressed VaR a useful metric for monitoring
covered trading activity for trading desks engaged in permitted market
making-related activity or underwriting activity? Why or why not? Are
there other covered trading activities for which Stressed VaR is useful
or not useful?
ii. Source-of-Revenue Measurements
A. Comprehensive Profit and Loss Attribution
It is unnecessary for banking entities to calculate and report
volatility of comprehensive profit and loss because the measurement can
be calculated from the profit and loss amounts reported under the
Comprehensive Profit and Loss Attribution metric. Thus, the proposed
Appendix would remove this requirement.
With respect to the profit and loss attribution to individual risk
factors and other factors, the Agencies are proposing to add to the
proposed Appendix a new paragraph IV.b.1.B. Under the proposal, a
banking entity would be required to provide, for one or more factors
that explain the preponderance of the profit or loss changes due to
risk factor changes, a unique identification label for the factor and
the profit or loss due to the factor change. The proposal requires a
banking entity to report a unique identification label for the factor
so the Agencies can efficiently obtain the descriptive information
regarding the factor that is separately reported in the Risk Factor
Attribution Information Schedule.\244\ The proposal requires a banking
entity to report this descriptive information in the Risk Factor
Attribution Information Schedule for the entire banking entity's
covered trading activity, rather than multiple times in the
Comprehensive Profit and Loss Attribution metric for different trading
desks, to help alleviate inefficiencies associated with reporting
redundant information and reduce electronic file submission sizes.
---------------------------------------------------------------------------
\244\ Such information includes the name of the risk factor or
other factor, a description of the risk factor or other factor, and
the change unit of the risk factor or other factor.
---------------------------------------------------------------------------
A new ``Applicability'' paragraph IV.b.1.iv provides that, as in
the 2013 final rule, the Comprehensive Profit and Loss Attribution
metric applies to all trading desks engaged in covered trading
activities.
Question 261. Appendix A of the 2013 final rule specified under
Source-of-Revenue Measurements that Comprehensive Profit and Loss be
divided into three categories: (i) Profit and loss attributable to
existing positions; (ii) profit and loss attributable to 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. Appendix A of the 2013 final rule further
required that 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. The proposed Appendix does not change
these specifications. However, the Agencies' experience implementing
the 2013 final rule has shown that the two statements about residual
profit and loss can give rise to conflicting interpretations. The
Agencies see value in monitoring any profit and loss that cannot be
attributed to existing or new positions. The Agencies also see value in
monitoring the profit and loss
[[Page 33504]]
attribution to risk factors, and the Agencies' experience is that many
reporters of quantitative measurements include the remainder from
profit and loss attribution in the item for Residual Profit and Loss.
In practice, however, profit and loss attribution is performed on
existing position profit and loss, so this interpretation breaks the
additivity of (i), (ii), and (iii) above. A potential resolution of
this conflict would be to clarify in the Instructions for Preparing and
Submitting Quantitative Measurements Information that Residual Profit
and Loss is only profit and loss that cannot be attributed to existing
or new positions, and to add a separate reporting item for Unexplained
Profit and Loss from Existing Positions. The Agencies are seeking
comment on how beneficial for institutions and regulators this
additional item would be to show and assess banking entities' profit
and loss attribution analysis. How much would adding this item consume
additional compliance resources of reporters?
Question 262. Appendix A of the 2013 final rule specified that
profit and loss from existing positions be further attributed to (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. The metrics reporting instructions further
specified that the preponderance of profit and loss due to risk factor
changes should be reported as profit and loss attributions to
individual factors. The proposed Appendix and metrics instructions do
not change these requirements. However, experience implementing the
2013 final rule has shown that the definition of Profit and Loss Due to
Changes in Risk Factors is vague and open to multiple interpretations.
The Agencies see value in monitoring the total profit and loss
attribution to risk factors that banking entities use to monitor their
sources of revenue, which may go beyond the preponderance of profit and
loss that is reported as attributions to individual factors. Moreover,
in practice profit and loss attribution is often sensitivity-based and
an approximation. Banking entities also routinely calculate
``hypothetical'' or ``clean'' profit and loss, which is the full
revaluation of existing positions under all risk factor changes, and is
used in banking entities' risk management to compare to VaR. The
Agencies are seeking comment on how best to specify the calculation for
Profit and Loss Due to Risk Factor Changes. Do commenters expect that
``hypothetical'' profit and loss can be derived from other items
already reported? If not, what are the costs and benefits of clarifying
the definition of Profit and Loss Due to Risk Factor Changes to make it
align with ``hypothetical'' or ``Clean P&L'' as prescribed by market
risk capital rules? Alternatively, what are the costs and benefits of
clarifying the definition to be the sum of all profit and loss
attributions regardless of whether they are reported individually? What
would be the additional compliance costs of requiring that both
``hypothetical'' profit and loss and the sum of all profit and loss
attributions be reported as separate items in the quantitative
measurements?
iii. Positions, Transaction Volumes, and Securities Inventory Aging
Measurements
A. Positions and Inventory Turnover
Paragraph IV.c.1. of Appendix A of the 2013 final rule requires
banking entities to calculate and report Inventory Turnover. This
metric is required to be calculated on a daily basis for 30-day, 60-
day, and 90-day calculation periods. The Agencies are proposing to
replace the Inventory Turnover metric with the daily data underlying
that metric, rather than proposing specific calculation periods,
because the Agencies may choose to use different inventory turnover
calculation periods depending on the particular trading desk or covered
trading activity under review. The proposal replaces Inventory Turnover
with the daily Positions quantitative measurement. In conjunction with
the proposed Transaction Volumes metric (discussed below), the proposed
Positions metric would provide the Agencies with flexibility to
calculate inventory turnover ratios over any period of time, including
a single trading day.
Based on an evaluation of the information collected pursuant to the
Inventory Turnover quantitative measurement, the Agencies are proposing
to limit the scope of applicability of the Positions metric to trading
desks that rely on Sec. __.4(a) or Sec. __.4(b) to conduct
underwriting activity or market making-related activity, respectively.
As a result, a trading desk that does not rely on Sec. __.4(a) or
Sec. __.4(b) would not be subject to the proposed Positions
metric.\245\ The proposed Positions metric would require a banking
entity to report the value of securities and derivatives positions
managed by an applicable trading desk. Thus, if a trading desk relies
on Sec. __.4(a) or Sec. __.4(b) and engages in other covered trading
activity, the reported Positions metric would have to reflect all of
the covered trading activities conducted by the desk.\246\
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\245\ For example, a trading desk that relies solely on Sec.
__.5 to conduct risk-mitigating hedging activity is not subject to
the proposed Positions metric.
\246\ For example, if a trading desk relies on Sec. __.4(b) and
Sec. __.5 to conduct market making-related activity and risk-
mitigating hedging activity, respectively, the reported Positions
metric for the desk would be required to reflect its risk-mitigating
hedging activity in addition to its market making-related activity.
The Agencies note, however, that a trading desk would not be
required to include trading activity conducted under Sec. Sec.
__.3(e), __6(c), __.6(d), or __.6(e) in the proposed Positions
metric, unless the banking entity includes such activity as
``covered trading activity'' for the desk under the appendix. This
is consistent with the proposed definition of ``covered trading
activity,'' which provides that a banking entity may include in its
covered trading activity trading conducted under Sec. Sec. __.3(e),
__.6(c), __.6(d), or __.6(e).
---------------------------------------------------------------------------
The proposal provides that banking entities subject to the appendix
would have to separately report the market value of all long securities
positions, the market value of all short securities positions, the
market value of all derivatives receivables, the market value of all
derivatives payables, the notional value of all derivatives
receivables, and the notional value of all derivatives payables.\247\
---------------------------------------------------------------------------
\247\ The Agencies note that banking entities must report the
effective notional value of derivatives receivables and derivatives
payables for those derivatives whose stated notional amount is
leveraged. For example, if an exchange of payments associated with a
$2 million notional equity swap is based on three times the return
associated with the underlying equity, the effective notional amount
of the equity swap would be $6 million.
---------------------------------------------------------------------------
Finally, the proposal addresses the classification of securities
and derivatives for purposes of the proposed Positions quantitative
measurement. The Agencies recognize that the 2013 final rule's
definition of ``security'' and ``derivative'' overlap.\248\ For
example, under the 2013 final rule a security-based swap is both a
``security'' and a ``derivative.'' \249\ The proposed Positions
quantitative measurement would require banking entities to separately
report the value of all securities and derivatives positions managed by
a
[[Page 33505]]
trading desk. To avoid double-counting financial instruments, the
proposed Positions metric would require banking entities subject to the
appendix to not include in the Positions calculation for ``securities''
those securities that are also ``derivatives,'' as those terms are
defined under the final rule. Instead, securities that are also
derivatives under the final rule are required to be reported as
``derivatives'' for purposes of the proposed Positions metric.
---------------------------------------------------------------------------
\248\ See 2013 final rule Sec. Sec. __.2(h), (y).
\249\ The term ``security'' is defined in the 2013 final rule by
reference to section 3(a)(10) of the Securities Exchange Act of 1934
(the ``Exchange Act''). See 2013 final rule Sec. __.2(y). Under the
Exchange Act, the term ``security'' means, in part, any security-
based swap. See 15 U.S.C. 78c(a)(10). The term ``security-based
swap'' is defined in section 3(a)(68) of the Exchange Act. See 15
U.S.C. 78c(a)(68). Under the 2013 final rule, the term
``derivative'' means, in part, any security-based swap as that term
is defined in section 3(a)(68) of the Exchange Act. See 2013 final
rule Sec. __.2(h).
---------------------------------------------------------------------------
Question 263. Should the Agencies eliminate the Inventory Turnover
quantitative measurement? Why or why not? Should the Agencies replace
Inventory Turnover with the proposed Positions metric in the proposed
Appendix? Why or why not? Should the Agencies modify the Inventory
Turnover metric rather than remove it from the proposed Appendix? If
so, what modifications should the Agencies make to the Inventory
Turnover metric, and why?
Question 264. What are the current benefits and costs associated
with calculating the Inventory Turnover metric? To what extent would
the removal of this metric reduce the costs of compliance with the
proposed Appendix? Please quantify your answers, to the extent
feasible.
Question 265. Is the use of the proposed Positions metric to help
distinguish between permitted and prohibited trading activities
effective? If not, what alternative would be more effective? What
factors should be considered in order to further refine the proposed
Positions metric to better distinguish prohibited proprietary trading
from permitted trading activity? Does the proposed Positions metric
provide any additional information of value relative to other
quantitative measurements?
Question 266. Is the use of the proposed Positions metric to help
determine whether an otherwise-permitted trading strategy is consistent
with the requirement that such activity not result, directly or
indirectly, in a material exposure by the banking entity to high-risk
assets and high-risk trading strategies effective? If not, what
alternative would be more effective?
Question 267. Is the proposed Positions metric substantially likely
to frequently produce false negatives or false positives that suggest
that prohibited proprietary trading is occurring when it is not, or
vice versa? If so, why? If so, how should the Agencies modify this
quantitative measurement, and why? If so, what alternative quantitative
measurement would better help identify prohibited proprietary trading?
Question 268. How beneficial is the information that the proposed
Positions metric provides for evaluating underwriting activity or
market making-related activity? Does the proposed Positions metric,
alone or coupled with other required metrics, provide information that
is useful in evaluating the customer-facing activity of a trading desk?
Do any of the other quantitative measurements provide the same level of
beneficial information for underwriting activity or market making-
related activity? Would the proposed Positions metric be useful to
evaluate other types of covered trading activity?
Question 269. How burdensome and costly would it be to calculate
the proposed Positions metric at the specified calculation frequency
and calculation period? What are the additional burdens or costs
associated with calculating the measurement for particular trading
desks? How significant are those potential costs relative to the
potential benefits of the measurement in monitoring for impermissible
proprietary trading? Are there potential modifications that could be
made to the measurement that would reduce the burden or cost? If so,
what are those modifications? Please quantify your answers, to the
extent feasible.
Question 270. How will the proposed Positions and Inventory
Turnover requirements impact burdens as compared to benefits? Would the
proposed changes affect a firm's confidential business information?
iv. Transaction Volumes and the Customer-Facing Trade Ratio
Paragraph IV.c.3. of Appendix A of the 2013 final rule requires
banking entities to calculate and report a Customer-Facing Trade Ratio
comparing transactions involving a counterparty that is a customer of
the trading desk to transactions with a counterparty that is not a
customer of the desk. Appendix A of the 2013 final rule requires the
Customer-Facing Trade Ratio to be computed by measuring trades on both
a trade count basis and value basis. In addition, Appendix A of the
2013 final rule provides that the term ``customer'' for purposes of the
Customer-Facing Trade Ratio is defined in the same manner as the terms
``client, customer, and counterparty'' used in Sec. __.4(b) of the
2013 final rule describing the permitted activity exemption for market
making-related activities. This metric is required to be calculated on
a daily basis for 30-day, 60-day, and 90-day calculation periods.
While the Customer-Facing Trade Ratio may provide directionally
useful information in some circumstances regarding the extent to which
trades are conducted with customers, the Agencies are proposing to
replace this metric with the daily Transaction Volumes quantitative
measurement, set out in paragraph IV.c.2. of the proposed Appendix, for
two reasons. First, the information provided by the Customer-Facing
Trade Ratio metric has not been sufficiently granular to permit the
Agencies to effectively assess the extent to which a trading desk's
covered trading activities are focused on servicing customer demand.
Reviewing and analyzing data representing trading activity that occurs
over a single trading day should be more effective. The proposed
Transaction Volumes metric will provide the Agencies with flexibility
to calculate customer-facing trade ratios over any period of time,
including a single trading day. This will assist banking entities and
the Agencies in monitoring covered trading activities. The Agencies are
proposing to replace the Customer-Facing Trade Ratio with the daily
data underlying that metric rather than proposing a daily calculation
period for the Customer-Facing Trade Ratio because the Agencies may
choose to use different customer-facing trade ratio calculation periods
depending on the particular trading desk or covered trading activity
under review.
Second, based on a review of the collected data, the Agencies
recognize that the current Customer-Facing Trade Ratio metric does not
provide meaningful information when a trading desk only conducts
customer-facing trading activity. The numerator of the ratio represents
transactions with counterparties that are customers, while the
denominator represents transactions with counterparties that are not
customers. If a trading desk only trades with customers, it will not be
able to calculate this ratio because the denominator will be zero. The
proposed Transaction Volumes metric enables the analysis of customer-
facing activity using more meaningful and appropriate calculations.
The proposed Transaction Volumes metric measures the number and
value \250\ of all securities and derivatives transactions conducted by
a trading desk engaged in permitted underwriting activity or market
making-related activity under the 2013 final rule with
[[Page 33506]]
four categories of counterparties: (i) Customers (excluding internal
transactions); (ii) non-customers (excluding internal transactions);
(iii) trading desks and other organizational units where the
transaction is booked into the same banking entity; and (iv) trading
desks and other organizational units where the transaction is booked
into an affiliated banking entity. To avoid double-counting
transactions, these four categories are exclusive of each other (i.e.,
a transaction must only be reported in one category). The proposal
requires this quantitative measurement to be calculated each trading
day.
---------------------------------------------------------------------------
\250\ For purposes of the proposed Transaction Volumes metric,
value means gross market value with respect to securities. For
commodity derivatives, value means the gross notional value (i.e.,
the current dollar market value of the quantity of the commodity
underlying the derivative). For all other derivatives, value means
the gross notional value.
---------------------------------------------------------------------------
As described above, the Agencies have evaluated the data collected
under Appendix A of the 2013 final rule to determine whether certain
quantitative measurements should be tailored to specific covered
trading activities. The Customer-Facing Trade Ratio metric has
primarily been used to assist in the evaluation of a trading desk's
customer-facing activity, which is a relevant consideration for desks
engaged in underwriting or market making-related activity under Sec.
__.4 of the 2013 final rule. Such analysis is less relevant to, for
example, desks that use only the risk-mitigating hedging exemption
under Sec. __.5 of the 2013 final rule. Based on an evaluation of the
information collected under the Customer-Facing Trade Ratio, the
Agencies are proposing to limit the applicability of the proposed
Transaction Volumes metric.
Specifically, the proposal provides that a banking entity would be
required to calculate and report the proposed Transaction Volumes
metric for all trading desks that rely on Sec. __.4(a) or Sec.
__.4(b) to conduct underwriting activity or market making-related
activity, respectively. This means that a trading desk that does not
rely on Sec. __.4(a) or Sec. __.4(b) would not be subject to the
proposed Transaction Volumes metric.\251\ The proposed Transaction
Volumes metric measures covered trading activity conducted by an
applicable trading desk with specific categories of counterparties.
Thus, if a trading desk relies on Sec. __.4(a) or Sec. __.4(b) and
engages in other covered trading activity, the reported Transaction
Volumes metric would have to reflect all of the covered trading
activities conducted by the desk.\252\ Limiting the scope of the
Transaction Volumes metric to only those trading desks engaged in
market-making activity or underwriting activity may reduce reporting
inefficiencies for banking entities.
---------------------------------------------------------------------------
\251\ For example, a trading desk that relies solely on Sec.
__.5 to conduct risk-mitigating hedging activity would not be
subject to the proposed Transaction Volumes metric.
\252\ For example, if a trading desk relies on Sec. __.4(b) and
Sec. __.5 to conduct market making-related activity and risk-
mitigating hedging activity, respectively, the reported Transaction
Volumes metric for the desk would have to reflect its risk-
mitigating hedging activity in addition to its market making-related
activity. The Agencies note, however, that a trading desk would not
be required to include trading activity conducted under Sec. Sec.
__.3(e), __.6(c), __.6(d), or __.6(e) in the proposed Transaction
Volumes metric, unless the banking entity includes such activity as
``covered trading activity'' for the desk under the proposed
Appendix. The Agencies note that this is consistent with the
definition of ``covered trading activity,'' which provides that a
banking entity may include in its covered trading activity trading
conducted under Sec. Sec. __.3(e), __.6(c), __.6(d), or __.6(e).
---------------------------------------------------------------------------
This metric should provide meaningful information regarding the
extent to which a trading desk facilitates demand for each category of
counterparty. While the Agencies recognize that the requirement to
provide additional granularity may require banking entities to expend
additional compliance resources, the Agencies believe the information
would enhance compliance efficiencies. In particular, by requiring
transactions to be separated into these four categories, the
information collected under this metric will facilitate better
classification of internal trades, and thus, will assist banking
entities and the Agencies in evaluating whether the covered trading
activities of desks engaged in underwriting or market making-related
activities are consistent with the final rule's requirements governing
those activities. For example, the Agencies believe that this metric
could be helpful in evaluating the extent to which a market making desk
routinely stands ready to purchase and sell financial instruments
related to its financial exposure, as well as the extent to which a
trading desk engaged in underwriting or market making-related activity
facilitates customer demand in accordance with the reasonably expected
near term demand requirements under the relevant exemption.\253\
---------------------------------------------------------------------------
\253\ See 2013 final rule Sec. Sec. __.4(a)(2)(ii) and
__.4(b)(2)(ii).
---------------------------------------------------------------------------
The definition of the term ``customer'' that is used for purposes
of this quantitative measurement depends on the type of covered trading
activity a desk conducts. For a trading desk engaged in market making-
related activity pursuant to Sec. __.4(b) of the 2013 final rule, the
desk must construe the term ``customer'' in the same manner as the
terms ``client, customer, and counterparty'' used for purposes of the
market-making exemption under the 2013 final rule. For a trading desk
engaged in underwriting activity pursuant to Sec. __.4(a) of the 2013
final rule, the desk must construe the term ``customer'' in the same
manner as the terms ``client, customer, and counterparty'' used for
purposes of the underwriting exemption under the final rule.\254\
---------------------------------------------------------------------------
\254\ Under the proposal, the calculation guidance regarding
reporting of transactions with another banking entity with trading
assets and liabilities of $50 billion or more would be moved from
Appendix A of the 2013 final rule into the reporting instructions.
The proposed instructions for the Transaction Volumes quantitative
measurement would clarify that any transaction with another banking
entity with trading assets and liabilities of $50 billion or more
would be included in one of the four categories noted above,
including: (i) Customers (excluding internal transactions); (ii)
non-customers (excluding internal transactions); (iii) trading desks
and other organizational units where the transaction is booked into
the same banking entity; and (iv) trading desks and other
organizational units where the transaction is booked into an
affiliated banking entity.
---------------------------------------------------------------------------
Similar to the proposed Positions metric, the proposed Transaction
Volumes metric addresses the classification of securities and
derivatives for purposes of the proposed Transaction Volumes
quantitative measurement. The proposed Transaction Volumes metric
requires banking entities to separately report the value and number of
securities and derivatives transactions conducted by a trading desk
with the four categories of counterparties described above. To avoid
double-counting financial instruments, the proposed Transaction Volumes
metric would require banking entities subject to the appendix to not
include in the Transaction Volumes calculation for ``securities'' those
securities that are also ``derivatives,'' as those terms are defined
under the 2013 final rule.\255\ Instead, securities that are also
derivatives under the final rule would be required to be reported as
``derivatives'' for purposes of the proposed Transaction Volumes
metric.
---------------------------------------------------------------------------
\255\ See 2013 final rule Sec. Sec. __.2(h), (y). See also
supra Part III.E.2.i (discussing the classification of securities
and derivatives for purposes of the proposed Positions quantitative
measurement).
---------------------------------------------------------------------------
Question 271. Should the Agencies eliminate the Customer-Facing
Trade Ratio? Why or why not? Should the Agencies replace the Customer-
Facing Trade Ratio with the proposed Transaction Volumes metric in the
proposed Appendix? Why or why not? Should the Agencies modify the
Customer-Facing Trade Ratio rather than remove it from the proposed
Appendix? If so, what modifications should the Agencies make to the
Customer-Facing Trade Ratio, and why?
Question 272. What are the current benefits and costs associated
with
[[Page 33507]]
calculating the Customer-Facing Trade Ratio? To what extent would the
removal of this metric reduce the costs of compliance with the proposed
Appendix? Please quantify your answers, to the extent feasible.
Question 273. Would the use of the proposed Transaction Volumes
metric to help distinguish between permitted and prohibited trading
activities be effective? If not, what alternative would be more
effective? What factors should be considered in order to further refine
the proposed Transaction Volumes metric to better distinguish
prohibited proprietary trading from permitted trading activity? Does
the proposed Transaction Volumes metric provide any additional
information of value relative to other quantitative measurements?
Question 274. Is the scope of the four categories of counterparties
set forth in the proposed Transaction Volumes metric appropriate and
effective? Why or why not?
Question 275. Is the proposed Transaction Volumes metric
substantially likely to frequently produce false negatives or false
positives that suggest that prohibited proprietary trading is occurring
when it is not, or vice versa? If so, why? If so, how should the
Agencies modify this quantitative measurement, and why? If so, what
alternative quantitative measurement would better help identify
prohibited proprietary trading?
Question 276. How beneficial is the information that the proposed
Transaction Volumes metric provides for evaluating underwriting
activity or market making-related activity? Could these changes affect
legitimate underwriting activity or market making-related activity? If
so, how? Do any of the other quantitative measurements provide the same
level of beneficial information for underwriting activity or market
making-related activity? Would this metric be useful to evaluate other
types of covered trading activity?
Question 277. What operational or logistical challenges might be
associated with performing the calculation of the proposed Transaction
Volumes metric and obtaining any necessary informational inputs? Please
explain.
Question 278. How burdensome and costly would it be to calculate
the proposed Transaction Volumes metric at the specified calculation
frequency and calculation period? What are the additional burdens or
costs associated with calculating the measurement for particular
trading desks? How significant are those potential costs relative to
the potential benefits of the measurement in monitoring for
impermissible proprietary trading? Are there potential modifications
that could be made to the measurement that would reduce the burden or
cost? If so, what are those modifications? Please quantify your
answers, to the extent feasible.
Question 279. Should the Agencies develop and publish more detailed
instructions for how different transaction life cycle events such as
amendments, novations, compressions, maturations, allocations, unwinds,
terminations, option exercises, option expirations, and partial
amendments affect the calculation of Transaction Volumes and the
Comprehensive Profit and Loss Attribution? Please explain.
v. Securities Inventory Aging
The Agencies have evaluated whether the Inventory Aging metric is
useful for all financial instruments, as well as for all covered
trading activities. Based on this evaluation and a review of the data
collected under this quantitative measurement, the Agencies understand
that, with respect to derivatives, Inventory Aging is not easily
calculated and does not provide useful risk or customer-facing activity
information. Thus, the Agencies are proposing several modifications to
the Inventory Aging metric.
First, the scope of the proposed Securities Inventory Aging metric,
set forth in proposed paragraph IV.c.3., would be limited to a trading
desk's securities positions. Under the proposal, banking entities
subject to the Appendix would be required to measure and report the age
profile of a trading desk's securities positions through a security-
asset aging schedule and a security liability-aging schedule. The
proposed Securities Inventory Aging metric would not require banking
entities to prepare an aging schedule for derivatives or include in its
securities aging schedules those ``securities'' that are also
``derivatives,'' as those terms are defined under the 2013 final
rule.\256\
---------------------------------------------------------------------------
\256\ See 2013 final rule Sec. Sec. __.2(h), (y). See also
supra Part III.E.2.i (discussing the classification of securities
and derivatives for purposes of the proposed Positions quantitative
measurement).
---------------------------------------------------------------------------
Second, the Agencies are proposing to limit the applicability of
the Securities Inventory Aging metric to trading desks that engage in
specific covered trading activities. Consistent with the proposed
Positions and Transaction Volumes metrics, the proposal provides that a
banking entity would be required to calculate and report the Securities
Inventory Aging metric for all trading desks that rely on Sec. __.4(a)
or Sec. __.4(b) to conduct underwriting activity or market making-
related activity, respectively. This means that a trading desk that
does not rely on Sec. __.4(a) or Sec. __.4(b) would not be subject to
the proposed Securities Inventory Aging metric.\257\ The proposal would
require that the Securities Inventory Aging metric measure the age
profile of an applicable trading desk's securities positions. Thus, if
a trading desk relies on Sec. __.4(a) or Sec. __.4(b) and engages in
other covered trading activity, the reported Securities Inventory Aging
metric would have to reflect all of the covered trading activities in
securities \258\ conducted by the desk.\259\ Narrowing the scope of the
Inventory Aging metric to securities inventory and to desks that engage
in market-making and underwriting activities should reduce reporting
inefficiencies for banking entities without reducing the usefulness of
the metric, as it has proved to be of limited utility for derivative
positions or trading desks that engage in other types of covered
trading activity.
---------------------------------------------------------------------------
\257\ For example, a trading desk that relies solely on Sec.
__.5 to conduct risk-mitigating hedging activity would not be
subject to the proposed Securities Inventory Aging metric.
\258\ The Agencies note that a banking entity would not be
required to prepare an Inventory Aging schedule for any derivatives
traded by a trading desk, including ``securities'' that are also
``derivatives'' as those terms are defined under the 2013 final
rule, in the event the trading desk relies on Sec. __.4(a) or Sec.
__.4(b) and another permitted activity exemption.
\259\ For example, if a trading desk relies on Sec. __.4(b) and
Sec. __.5 to conduct market making-related activity and risk-
mitigating hedging activity, respectively, the reported Securities
Inventory Aging metric for the desk would have to reflect the risk-
mitigating hedging activity and market making-related activity
associated with the desk's securities positions. The Agencies note,
however, that a trading desk would not be required to include
trading activity conducted under Sec. Sec. __.3(e), __.6(c),
__.6(d), or __.6(e) in the proposed Securities Inventory Aging
metric, unless the banking entity includes such activity as
``covered trading activity'' for the desk under the proposed
Appendix. The Agencies note that this is consistent with the
definition of ``covered trading activity,'' which provides that a
banking entity may include in its covered trading activity trading
conducted under Sec. Sec. __.3(e), __.6(c), __.6(d), or __.6(e).
---------------------------------------------------------------------------
Finally, the proposal would require a banking entity to calculate
and report the Securities Inventory Aging metric according to a
specific set of age ranges. Specifically, banking entities would have
to calculate and report the market value of security assets and
security liabilities over the following holding periods: 0-30 calendar
days; 31-60 calendar days; 61-90 calendar days; 91-180 calendar days;
181-360 calendar days; and greater than 360 calendar days.
Question 280. How beneficial is the information that the proposed
Securities Inventory Aging metric provides for evaluating underwriting
activity or
[[Page 33508]]
market making-related activity? Do any of the other quantitative
measurements provide the same level of beneficial information for
underwriting activity or market making-related activity?
Question 281. Is inventory aging of derivatives a useful metric for
monitoring covered trading activity at trading desks? Why or why not?
Question 282. Is inventory aging of futures a useful metric for
monitoring covered trading activity at trading desks? Why or why not?
Question 283. Would it reduce the calculation burden on banking
entities to limit the scope of the Inventory Aging metric to securities
inventory and to trading desks engaged in market-making and
underwriting activities? Why or why not?
Question 284. Should the Agencies require banking entities to
report the Securities Inventory Aging metric according to a specific
set of age ranges? Why or why not? If so, taken together, are the
proposed age ranges appropriate and effective, or should the proposed
Securities Inventory Aging metric require different age ranges? Do
banking entities already routinely measure their securities positions
using the same, or similar, age ranges?
j. Request for Comment
The Agencies request comment on the costs and benefits of the
proposal's revised approach under revisions to Appendix A of the 2013
final rule. In particular, the Agencies request comment on the
following questions:
Question 285. Are the quantitative measurements, both as currently
existing and as proposed to be modified, appropriate in general? If
not, is there an alternative(s) approach that the banking entities and
the Agencies could use to more effectively and efficiently identify
potentially prohibited proprietary trading? If so, being as specific as
possible, please describe that alternative. Should certain proposed
quantitative measurements be eliminated? If so, which requirements, and
why? Should additional quantitative measurements be added? If so, which
measurements, and why? How would those additional measurements be
described and calculated?
Question 286. What are the current annual compliance costs for
banking entities to comply with the requirements in Appendix A of the
2013 final rule to calculate and report certain quantitative
measurements to the Agencies? Please discuss the benefits of the
proposal, including but not limited to the benefits derived from
qualitative information, such as narratives and trading desk
information, as compared to the costs and burdens of preparing such
information. How would those annual compliance costs change if the
modifications described in the proposal were adopted? Please be as
specific as possible and, where feasible, provide quantitative data
broken out by requirement. Would this proposal affect certain types of
banking entities, such as broker-dealers and registered investment
advisers, differently as compared to other banking entities in terms of
annual compliance costs?
Question 287. In addition to the proposed changes to the
requirement to calculate and report quantitative measurements to the
Agencies, the proposed Appendix contains new qualitative requirements
that are not currently required in Appendix A of the 2013 final rule,
including, but not limited to, trading desk information, quantitative
measurements identifying information, and a narrative statement. Please
discuss the benefits and costs associated with such proposed
requirements. How would the overall burden change, in terms of both
costs and benefits, as a result of the proposal, taken as a whole, as
compared to the existing requirements under Appendix A? Please provide
quantitative data to the extent feasible.
Question 288. Which of the proposed quantitative measurements do
banking entities currently use? What are the current benefits, and
would the proposed revisions result in increased compliance costs
associated with calculating such quantitative measurements? Would the
reporting and recordkeeping requirements in the proposed Appendix for
such quantitative measurements generate any significant, additional
benefits or costs? Please quantify your answers, to the extent
feasible.
Question 289. How are the ongoing costs of compliance associated
with the requirements of Appendix A of the 2013 final rule allocated
among the different steps in the process (e.g., calculating
quantitative measurements, preparing reports, delivering reports to the
relevant Agencies, etc.)?
Question 290. Which requirements of Appendix A of the 2013 final
rule are costliest to comply with, and what are those burdens? Please
be as specific as possible. Does the proposal meaningfully reduce these
aspects? Why or why not? Please quantify your answers, to the extent
feasible.
Question 291. Which of the proposed quantitative measurements do
banking entities currently not use? What are the potential benefits and
costs of calculating these quantitative measurements and complying with
the proposed reporting and recordkeeping requirements? Please quantify
your answers, to the extent feasible.
Question 292. For each individual quantitative measurement that is
proposed, is the description sufficiently clear? Is there an
alternative that would be more appropriate or clearer? Is the
description of the quantitative measurement appropriate, or is it
overly broad or narrow? If it is overly broad, what additional
clarification is needed? If the description is overly narrow, how
should it be modified to appropriately describe the quantitative
measurement, and why? Should the Agencies provide any additional
clarification to the Appendix's description of the quantitative
measurement, and why?
Question 293. For each individual quantitative measurement that is
proposed, is the calculation guidance provided in the proposal
effective and sufficiently clear? If not, what alternative would be
more effective or clearer? Is more or less specific calculation
guidance necessary? If so, what level of specificity is needed to
calculate the quantitative measurement? If the proposed calculation
guidance is not sufficiently specific, how should the calculation
guidance be modified to reach the appropriate level of specificity? If
the proposed calculation guidance is overly specific, why is it too
specific and how should it be modified to reach the appropriate level
of specificity?
Question 294. Does the use of the proposed Appendix as part of the
multi-faceted approach to implementing the prohibition on proprietary
trading continue to be appropriate? Why or why not?
Question 295. Should a trading desk be permitted not to furnish a
quantitative measurement otherwise required under the proposed Appendix
if it can demonstrate that the measurement is not, as applied to that
desk, calculable or useful in achieving the purposes of the Appendix
with respect to the trading desk's covered trading activities? How
might a banking entity make such a demonstration?
Question 296. Where a trading desk engages in more than one type of
covered trading activity, such as activity conducted under the
underwriting and risk-mitigating hedging exemptions, should the
quantitative measurements be calculated, reported, and recorded
separately for trading activity conducted under each exemption relied
on by the trading desk? What are the costs and benefits of such an
approach? Please explain.
[[Page 33509]]
Question 297. How much time do banking entities need to develop new
systems and processes, or modify existing systems and processes, to
implement for banking entities that are subject to the proposed
Appendix's reporting and recordkeeping requirements, and why? Does the
amount of time needed to develop or modify information systems to
comply with proposed Appendix, including the electronic reporting and
XML Schema requirements, vary based on the size of a banking entity's
trading assets and liabilities? Why or why not? What are the costs
associated with such requirements?
Question 298. Under both the 2013 final rule and the proposal,
banking entities that, together with their affiliates and subsidiaries,
have significant trading assets and liabilities are required to
calculate, maintain, and report a number of quantitative measurements.
Should the Agencies eliminate this metrics reporting requirement and
instead require banking entities to: (1) Calculate the required
quantitative measurements data, in the same form, manner, and
timeframes as they would otherwise be required to under the rule; (2)
maintain the required quantitative measurements data; and (3) provide
the relevant Agency or Agencies with the data upon request for
examination and review?
Question 299. Should the requirement to calculate and report
quantitative metrics be eliminated and replaced by a different method
for assisting banking entities and the Agencies in monitoring covered
trading activities for compliance with section 13 of the BHC Act and
the 2013 final rule? If so, what alternative approaches should the
Agencies consider?
Question 300. Should some or all reported quantitative measurements
be made publicly available? Why or why not? If so, which quantitative
measurements should be made publicly available, and what are the
benefits and costs of making such measurements publicly available? If
so, how should quantitative measurements be made publicly available?
Should quantitative measurements be made publicly available in the same
form they are furnished to the Agencies, or should information be
aggregated before it is made publicly available? If information should
be aggregated, how should it be aggregated, and what are the benefits
and costs associated with aggregate data being available to the public?
Should quantitative measurements be made publicly available at-or-near
the same time such measurements are reported to the Agencies, or should
information be made publicly available on a delayed basis? If
information should be made public on a delayed basis, how much time
should pass before information is publicly available, and what are the
benefits and costs associated with non-current metrics information
being available to the public? Are there other approaches the Agencies
should consider to make the quantitative measurements publicly
available, and if so, what are the benefits and costs associated with
each approach? What are the costs and benefits of such an approach?
Please discuss and provide detailed examples of any costs or benefits
identified.
Question 301. Do commenters have concerns about the potential for
the inadvertent exposure of confidential business information, either
as part of the reporting process or to the extent that any of the
quantitative measurements (or related information) are made publicly
available? If so, what are the risks involved and how might they be
mitigated? Are certain quantitative measurements more likely to contain
confidential information? If so, which ones and why?
IV. The Economic Impact of the Proposal Under Section 13 of the BHC
Act--Request for Comment
The Agencies are proposing a number of changes to the 2013 final
rule that are intended to reduce the costs of compliance while
continuing the rule's effectiveness in limiting prohibited activities.
In what follows, the key proposed changes to the regulation that are
expected to have a material impact on the costs of implementing the
regulation are discussed as is the rationale for expecting a material
reduction in the costs associated with compliance. The Agencies seek
broad comment from the public on any and all aspects of the proposed
changes to the regulation and the extent to which these changes will
reduce compliance costs and improve the effectiveness of the
implementing regulations. The Agencies also seek comment on whether
there are any additional ways to reduce compliance costs while
effectively implementing the statute. Finally, commenters are
encouraged to provide the Agencies with any specific data or
information that could be useful for quantifying the reductions or
increases in costs associated with the proposed changes.
A key proposed change to the rule relates to the treatment of
banking entities with limited trading activities, which under the 2013
final rule can face compliance costs that are disproportionately high
relative to the amount of trading activity typically undertaken and the
amount of risk the activities of these firms that are subject to
section 13 pose to financial stability. More specifically, the Agencies
are proposing to identify those banking entities with total
consolidated 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
previous calendar quarters, is less than $1 billion. These banking
entities with limited trading assets and liabilities would be subject
to a presumption of compliance under the proposal, while remaining
subject to the rule's prohibitions in subparts B and C. The relevant
Agency may rebut the presumption of compliance by providing written
notice to the banking entity that it has determined that one or more of
the banking entity's activities violates the prohibitions under
subparts B or C.
The Agencies expect that this presumption would materially reduce
the costs associated with complying with the rule for two reasons.
First, as a result of presumed compliance, these banking entities would
not be required to demonstrate compliance with many of the rule's
specific requirements on an ongoing basis. As a specific example,
entities with limited trading assets and liabilities would not be
required to comply with the documentation requirements associated with
the hedging exemption. Additionally, these entities would not be
required to specify and maintain trading risk limits to comply with the
rule's market making exemption. As a result, this proposed change is
expected to meaningfully reduce the costs associated with rule
compliance for smaller banking entities that do not engage in the types
of trading the rule seeks to address.
Second, these banking entities would not be subject to the express
requirement to maintain a compliance program pursuant to Sec. __.20
under the proposal to demonstrate compliance with the rule. The
presumption would be rebuttable, so firms may need to maintain a
certain level of resources to respond to supervisory requests for
information in the event that the Agencies exercise their authority to
rebut the presumption of compliance for any activity that they
determine to violate prohibitions under subparts B and C. The amount of
resources required for such purposes is expected to be significantly
smaller than the
[[Page 33510]]
amount of resources that would be required to maintain and execute an
ongoing compliance program.
Question 302. Do commenters agree that the proposed establishment
of a presumption of compliance for certain banking entities would
meaningfully reduce the compliance costs associated with the rule
relative to the requirements of the 2013 final rule?
Question 303. Have commenters quantified the extent to which such
costs are reduced? If so, could this information be provided to the
Agencies during the notice and comment period?
Question 304. Do commenters believe that any aspect of the proposed
establishment of a presumption of compliance would increase the costs
associated with rule compliance? If so, which aspects of the
presumption would raise costs, why, and to what extent? How could these
compliance costs be addressed or reduced?
Question 305. What costs do commenters anticipate a banking entity
subject to presumed compliance would bear to respond to possible
questions from the Agencies about the banking entity's compliance with
the statute and the sections of the regulation that remain applicable
to it? In general, how and to what extent does a shifting of the burden
from banking entity to Agencies affect compliance costs? What steps
could the Agencies take to appropriately reduce compliance burdens in
this regard--especially for banking entities that engage in less
trading activity?
The Agencies are also proposing two changes related to the 2013
final rule's definition of ``trading account'' that are expected to
simplify the analysis associated with determining whether or not a
banking entity's purchase or sale of a financial instrument is for the
trading account, and thereby are expected to reduce the costs
associated with complying with the rule. Specifically, the Agencies are
proposing to add an accounting prong to the definition of ``trading
account'' and to remove the short-term intent prong and the 60-day
rebuttable presumption. The Agencies expect that the removal of the
short-term intent prong will substantially reduce the costs of
complying with the rule.
In the case of the short-term intent prong and the 60-day
rebuttable presumption, the Agencies' experience with implementing the
2013 final rule strongly suggests that application of the short-term
intent prong resulted in a variety of analyses to determine if a
financial position was taken with the ``intent'' of generating short-
term profits, or benefitting from short-term price movements. Assessing
intent is qualitative and can be subject to significant interpretation.
Accordingly, experience suggests that banking entities engage in a
number of lengthy analyses to determine whether or not a financial
position needs to be included in the trading account, and that these
analyses may not always result in a clear indication.
In the case of the 60-day rebuttable presumption, the Agencies'
experience suggests that the 60-day rebuttable presumption may be an
overly inclusive instrument to determine whether a financial instrument
is in the trading account. Many financial positions are scoped into the
trading account automatically due to the 60-day presumption, and
banking entities routinely conduct detailed and lengthy assessments of
transactions to document that these positions should not be included in
the trading account. However, experience indicates that there is no
clear set of analyses that may be conducted to rebut the presumption
and a clear standard for successfully rebutting the presumption has
been difficult to establish in practice. Accordingly, the Agencies
expect that removing the 60-day rebuttable presumption would materially
reduce the costs associated with complying with the rule and
determining whether a financial instrument is in the trading account.
The Agencies expect that this proposal would reduce the costs of
rule compliance since banking entities are already familiar with
accounting standards and use these standards to classify financial
instruments on a regular basis to satisfy reporting and related
requirements. The Agencies would expect that no new compliance costs
would result from using accounting concepts that are already familiar
to banking entities for purposes of identifying activity in the trading
account.
The Agencies are also proposing to include a presumption of
compliance for trading desks, the positions of which are included in
the trading account due to the accounting prong, so long as the profit
and loss of the desk does not exceed a certain threshold. Specifically,
the trading activity conducted by a trading desk is presumed to be in
compliance with the prohibition on proprietary trading if (i) none of
the financial instruments of the desk are included in the trading
account pursuant to the market risk capital prong, (ii) none of the
financial instruments of the desk are booked in a dealer, swap dealer,
or security-based swap dealer, and (iii) the sum over the preceding 90-
calendar-day period of the absolute values of the daily net realized
and unrealized gains and losses of the desk's portfolio of financial
instruments does not exceed $25 million. Banking entities and
supervisors will only need to consider cases in which the size of
trading activity exceeds the $25 million threshold for these desks.
Moreover, this analysis draws on profit and loss metrics that banking
entities already regularly maintain and consequently would not be
expected to contribute to any increased regulatory costs.
The Agencies recognize that implementing the new definition of
``trading account'' and the presumption of compliance would result in
some amount of compliance costs. However, the Agencies expect that the
compliance costs associated with this new definition and presumption of
compliance would be significantly less than the compliance costs of
either the short-term intent prong or the 60-day rebuttable
presumption. As noted above, the new trading account definition ties to
accounting concepts that are already familiar to banking entities.
Similarly, the new presumption of compliance ties to profit and loss
metrics that banking entities already maintain. As such, the Agencies
expect that the new trading account definition and the presumption of
compliance would materially reduce the costs of rule compliance
relative to the 2013 final rule's existing requirements.
Question 306. Do commenters believe that the proposed changes to
the trading account definition would materially reduce costs associated
with rule compliance relative to the final rule? Why or why not?
Question 307. Do commenters have any specific data or information
that could be used to quantify the extent to which such costs would be
reduced under the proposal?
Question 308. Do commenters believe that any aspect of the proposed
changes to the trading account definition increase the costs associated
with rule compliance? If so, which aspects of the proposed changes
raise costs, why, and to what extent?
As described in section 1(d)(3) of this Supplementary Information,
the Agencies are proposing a specific alternative to allow banking
entities to define trading desks in a manner consistent with their own
internal business unit organization. The Agencies request comment
regarding the relative costs and benefits of this possible alternative.
Question 309. Do commenters believe that the relative benefits of
the definition of ``trading desk'' in the current 2013 final rule
outweigh any
[[Page 33511]]
potential cost reductions for banking entities under the alternative?
Question 310. Do commenters have any specific data or information
that could be used to quantify the extent to which such costs would be
reduced?
Question 311. Do commenters think that any aspect of the proposed
changes to the trading desk definition increases the regulatory burden
associated with rule compliance? If so which aspects of the proposed
changes raise the regulatory burden, why, and to what extent?
A key statutory exemption from the prohibition on proprietary
trading is the exemption for underwriting. The 2013 final rule contains
a number of complex requirements that are intended to ensure that
banking entities comply with the underwriting exemption and that
proprietary trading activity is not conducted under the guise of
underwriting. Since adoption of the 2013 final rule, banking entities
have communicated to the Agencies that complying with all of the 2013
final rule's underwriting requirements can be difficult and costly
relative to the underlying activities. In particular, banking entities
have communicated that they believe they must engage in a number of
complex and intensive analyses to gain comfort that their underwriting
activities meets all of the 2013 final rule's requirements. Moreover,
banking entities have communicated that they find the requirements of
the 2013 final rule ambiguous to apply in practice and do not provide
sufficiently bright-line conditions under which trading activity can
clearly be classified as permissible underwriting.
The Agencies are proposing to establish the articulation and use of
internal risk limits as a key mechanism for conducting trading activity
in accordance with the underwriting exemption. These risk limits would
be established by the banking entity at the trading desk level and
designed not to exceed the reasonably expected near term demands of
clients, customers, or counterparties. The proposed risk limits would
not be required to be based on any specific or mandated analysis.
Rather, a banking entity would be permitted to establish the risk
limits according to its own internal analyses and processes around
conducting its underwriting activities. Banking entities would be
expected to maintain internal policies and procedures for setting and
reviewing desk-level risk limits in a manner consistent with the
applicable statutory factor. A banking entity's risk limits would be
subject to general supervisory review and oversight, but the limit-
setting process would not be required to adhere to specific, pre-
defined requirements beyond adherence to the banking entity's own
ongoing and internal assessment of the reasonably expected near-term
demands of clients, customers, or counterparties. So long as a banking
entity maintains an ongoing and consistent process for setting such
limits in accordance with the proposal, then the Agencies anticipate
that trading activity conducted within the limits would generally be
presumed to be underwriting.
The Agencies expect that the proposed reliance on risk limits to
satisfy the underwriting exemption will materially reduce the costs of
complying with the final rule's underwriting exemption. In particular,
the limit-setting process is intended to leverage a banking entity's
existing internal risk management and capital allocation processes, and
would not be required to conform to any specific or pre-defined
requirements other than being set in accordance with RENTD. The
Agencies expect that reliance on risk limits would therefore align with
the firm's internal policies and procedures for conducting underwriting
in a manner consistent with the requirements of section 13 of the BHC
Act. Accordingly, the Agencies expect that this proposed approach would
generally be more efficient and less costly than the practices required
by the 2013 final rule as they rely to a greater extent on the banking
entity's own internal policies, procedures, and processes.
Question 312. The Agencies are also proposing to further tailor the
requirements for banking entities with moderate trading activities and
liabilities. In particular, the compliance program requirements that
are part of the underwriting exemption would not apply to these firms.
Do commenters believe that the proposed changes related to the use of
risk limits in satisfying the underwriting exemption would materially
reduce the costs associated with rule compliance relative to the 2013
final rule?
Question 313. Do commenters believe there are any benefits of the
approach in the 2013 final rule that would be forgone with the proposed
changes related to the use of risk limits in satisfying the
underwriting exemption?
Question 314. Do commenters have any specific data or information
that could be used to quantify the extent to which such costs are
reduced?
Question 315. Do commenters believe that any aspect of the proposed
changes related to the use of risk limits in satisfying the
underwriting exemption increases the costs associated with rule
compliance? If so which aspects of the proposed changes raise
compliance costs, why, and to what extent?
Question 316. Do commenters believe that the proposed changes
related to the reduced compliance program requirements for banking
entities with moderate trading assets and liabilities to satisfy the
underwriting exemption would materially reduce the costs associated
with rule compliance relative to the 2013 final rule?
Question 317. Do commenters believe there are any benefits to the
approach in the 2013 final rule that would be forgone with the proposed
changes related to the compliance requirements in satisfying the
underwriting exemption?
Question 318. Do commenters have any specific data or information
that could be used to quantify the extent to which such costs are
reduced?
Question 319. Do commenters think that any aspect of the proposed
changes related to the use of compliance program requirements in
satisfying the underwriting exemption would increase the costs
associated with rule compliance? If so, which aspects of the proposed
changes would increase compliance costs, why, and to what extent?
Another key statutory exemption from the prohibition on proprietary
trading is the exemption for market making. The 2013 final rule
contains a number of complex requirements that are intended to ensure
that proprietary trading activity is not conducted under the guise of
market making. Since adoption of the 2013 final rule, banking entities
have communicated that complying with all of the 2013 final rule's
market making requirements can be difficult and costly. In particular,
banking entities have communicated that they believe they must engage
in a number of complex and intensive analyses to gain comfort that
their bona fide market making activity meets all of the 2013 final
rule's requirements. Moreover, banking entities have communicated that
they view the requirements of the 2013 final rule as ambiguous and not
providing sufficiently bright-line conditions under which trading
activity can clearly be classified as permissible market making.
The Agencies are proposing to establish the articulation and use of
internal risk limits as the key mechanism for conducting trading
activity in accordance with the rule's exemption for market making-
related activities. These risk limits would be established by the
banking entity at the trading desk level and be designed not to exceed
the reasonably expected near
[[Page 33512]]
term demands of clients, customers, or counterparties. Banking entities
would be expected to maintain internal policies and procedures for
setting and reviewing desk-level risk limits in a manner consistent
with the applicable statutory factor. Moreover, the proposed risk
limits would not be required to be based on any specific or mandated
analysis. Rather, a banking entity would be permitted to establish the
risk limits according to its own internal analyses and processes around
conducting its market making activities as market making is defined by
the applicable statutory factor. A banking entity's risk limits would
be subject to supervisory review and oversight, but the limit-setting
process would not be required to adhere to any specific, pre-defined
requirements beyond adherence to the banking entity's own ongoing and
internal assessment of the reasonably expected near-term demand of
clients, customers, or counterparties. So long as a banking entity
maintains an ongoing and consistent process for setting such limits in
accordance with the proposal, then the Agencies anticipate that trading
activity conducted within the limits would generally be presumed to be
market making.
The Agencies expect that the proposed reliance on internal risk
limits to satisfy the statutory requirement that market making-related
activities be designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties would materially
reduce the costs of complying with the 2013 final rule's market making
exemption. In particular, the limit-setting process would be intended
to leverage a banking entity's existing internal risk management and
capital allocation processes and would not be required to conform to
specific or pre-defined requirements. The Agencies expect that reliance
on risk limits would therefore align with the firm's internal policies
and procedures for conducting market making in a manner consistent with
the requirements of section 13 of the BHC Act. Accordingly, the
agencies expect that this proposed approach would generally be more
efficient and less costly than the practices required by the 2013 final
rule as they rely to a greater extent on the banking entity's own
internal policies, procedures, and processes.
The Agencies are also proposing to further tailor the requirements
for banking entities with moderate trading activities and liabilities.
In particular, the compliance program requirements that are part of the
market making exemption would not apply to these firms.
Question 320. Do commenters believe that the proposed changes
related to the use of risk limits in satisfying the market making
exemption would materially reduce the costs associated with rule
compliance relative to the 2013 final rule?
Question 321. Do commenters believe there are any benefits of the
approach in the 2013 final rule that would be forgone with the proposed
changes related to the use of risk limits in satisfying the market
making exemption?
Question 322. Do commenters have any specific data or information
that could be used to quantify the extent to which such costs are
reduced?
Question 323. Do commenters believe that any aspect of the proposed
changes related to the use of risk limits in satisfying the market
making exemption increases the costs associated with rule compliance?
If so, which aspects of the proposed changes raise compliance costs,
why, and to what extent?
Question 324. Do commenters agree that the proposed changes related
to the reduced compliance program requirements for banking entities
with moderate trading assets and liabilities to satisfy the market
making exemption materially reduce the costs associated with rule
compliance relative to the 2013 final rule?
Question 325. Do commenters believe there are any benefits of the
approach in the 2013 final rule that would be forgone with the proposed
changes related to the compliance requirements in satisfying the market
making exemption?
Question 326. Do commenters have any specific data or information
that could be used to quantify the extent to which such costs are
reduced?
Question 327. Do commenters believe that any aspect of the proposed
changes related to the use of risk limits in satisfying the market
making exemption increases the costs associated with rule compliance?
If so, which aspects of the proposed changes raise compliance costs,
why, and to what extent?
The agencies are proposing a number of changes to the requirements
of the 2013 final rule's exemption for risk-mitigating hedging
activities that are expected to reduce the costs associated with
complying with the final rule's requirements.
First, for banking entities with significant trading assets and
liabilities, the 2013 final rule's requirement in the risk mitigating
hedging exemption to conduct a correlation analysis would be removed.
Since adoption of the 2013 final rule, banking entities have
communicated that this requirement has in practice been unclear and
often not useful in determining whether or not a given transaction
provides meaningful hedging benefits. The Agencies expect that the
proposed removal of this requirement from the final rule would
materially reduce the costs of rule compliance since larger banking
entities would not be required to conduct a specific analysis that is
currently required under the 2013 final rule.
Second, for these banking entities with significant trading assets
and liabilities, the Agencies are proposing that the requirement that
the hedging transaction ``demonstrably reduce (or otherwise
significantly mitigate)'' risk be removed. Banking entities have
communicated that these requirements can be unclear and these banking
entities must often engage in a number of complex and time-intensive
analyses to assess whether these standards have been met. Moreover, the
above hedging standards have not aligned well with banking entities'
internal processes for assessing the economic value of a hedging
transaction. Accordingly, the Agencies expect that eliminating these
requirements would materially reduce the costs associated with
complying with the requirements of the rule's hedging exemption.
Third, for banking entities with moderate trading assets and
liabilities, the Agencies are proposing to remove all of the hedging
requirements under the 2013 final rule except for the requirement that
the transaction be designed to reduce or otherwise significantly
mitigate one or more specific, identifiable risks in connection with
and related to one or more identified positions and that the hedging
activity be recalibrated to maintain compliance with the rule. The
Agencies expect this proposed change to materially reduce the costs of
rule compliance since no additional documentation or prescribed
analyses would be required beyond a banking entity's already existing
practices and whatever analyses are required to ascertain that the
remaining factors are satisfied, consistent with the statute. In light
of Agency experience with the hedging requirements of the 2013 final
rule, the Agencies expect that this proposed change would result in a
material reduction in the costs associated with complying with the
rule's hedging requirements.
Question 328. Do commenters believe that the proposed changes that
streamline the hedging requirements of the rule materially reduce the
costs associated with rule compliance relative to the 2013 final rule?
[[Page 33513]]
Question 329. Do commenters have any specific data or information
that could be used to quantify the extent to which such costs are
reduced?
Question 330. Do commenters believe that any aspect of the proposed
changes to streamline the hedging requirements of the rule increases
the costs associated with rule compliance? If so, which aspects of the
proposed changes raise costs, why, and to what extent?
The Agencies are proposing to eliminate a number of requirements
related to the foreign trading exemption. These proposed changes are
intended to respond to concerns raised by FBOs subject to the 2013
final rule that they find its foreign trading exemption to be difficult
to comply with in practice.
The Agencies are proposing to modify the requirement of this
exemption that personnel of the banking entity who arrange, negotiate,
or execute a purchase or sale must be outside the United States and to
eliminate the requirements that: (1) No financing be provided by a U.S.
affiliate or branch, and (2) a transaction with a U.S. counterparty
must be executed through an unaffiliated intermediary and an anonymous
exchange.
The Agencies expect that the modification and removal of these
requirements would materially reduce the compliance costs associated
with the foreign trading exemption.
In addition, banking entities have communicated that the
requirement that any transaction with a U.S. counterparty be executed
without involvement of U.S. personnel of the counterparty or through an
unaffiliated intermediary and an anonymous exchange may in some cases
significantly reduce the range of counterparties with which
transactions can be conducted as well as increase the cost of those
transactions, including with respect to counterparties seeking to do
business with a foreign banking entity in foreign jurisdictions.
Therefore, the Agencies also expect that removing this requirement
would materially reduce the costs associated with rule compliance.
Question 331. Do commenters believe that the proposed changes to
modify and eliminate certain requirements from the foreign trading
exemption would materially reduce the regulatory burden associated with
rule compliance relative to the 2013 final rule?
Question 332. Do commenters have any specific data or information
that could be used to quantify the extent to which such costs are
reduced?
Question 333. Do commenters believe that any aspect of the proposed
changes to eliminate certain requirements from the foreign trading
exemption increases the costs associated with rule compliance? If so
which aspects of the proposed changes raise costs, why, and to what
extent?
The Agencies are proposing to make a number of changes to the
metrics reporting requirements that are intended to improve the
effectiveness of the metrics. On the whole, these changes are also
expected to reduce the compliance costs associated with the metrics
reporting requirements. In particular, the Agencies are proposing to
add qualitative information schedules that would improve the Agencies'
ability to understand and analyze the quantitative measurements. The
Agencies are also proposing to remove certain metrics, such as
inventory aging for derivatives and stressed value-at-risk for risk
mitigating hedging desks, that based on experience with implementing
the 2013 final rule, are not effective for identifying whether a
banking entity's trading activity is consistent with the requirements
of the 2013 final rule. In addition, the Agencies are proposing to
switch to a standard XML format for the metrics data file. The Agencies
expect this to improve consistency and data quality by both clarifying
the format specification and making it possible to check the validity
of data files against a published template using generally available
software. Finally, the Agencies are proposing to make a number of
changes to the technical calculation guidance for a number of metrics
that should make the required calculations clearer and less
complicated.
The Agencies are also proposing to provide certain banking entities
that must report metrics with additional time to report metrics.
Specifically, the firms with $50 billion in trading assets and
liabilities would have 20 days instead of 10 days to report metrics to
the Agencies. This change is expected to reduce compliance costs as the
additional time would allow the required workflow to be conducted under
less time pressure and with greater efficiency and accuracy.
Question 334. Do commenters believe that the proposed changes to
the metrics reporting requirements would materially reduce the costs
associated with rule compliance relative to the 2013 final rule?
Question 335. Do commenters have any specific data or information
that could be used to quantify the extent to which such costs are
reduced?
Question 336. Do commenters believe that any aspect of the proposed
changes to the metrics reporting requirements would increase the costs
associated with rule compliance? If so, which aspects of the proposed
changes increase costs, why, and to what extent?
The Agencies are proposing to modify certain requirements regarding
the ability of banking entities to engage in underwriting and market-
making of third-party covered funds that would remove some of the
restrictions on activities with respect to covered fund interests. The
Agencies expect that this proposed change would reduce the costs of
compliance with the 2013 final rule's requirements. In particular, the
2013 final rule places a number of restrictions on underwriting and
market-making of covered fund interests that banking entities have
indicated are costly to comply with and view as unduly limiting
activity that is otherwise consistent with bona fide underwriting and
market-making activity that would be allowed with respect to any other
type of financial instrument, consistent with the statutory factors
defining these activities.
Question 337. Do commenters believe that the proposed changes to
certain restrictions on covered fund related activities would
materially reduce the costs associated with rule compliance relative to
the 2013 final rule?
Question 338. Do commenters have any specific data or information
that could be used to quantify the extent to which such costs are
reduced?
Question 339. Do commenters believe that any aspect of the proposed
changes to certain restrictions on covered fund related activities
would increase the costs associated with rule compliance? If so, which
aspects of the proposed changes would raise costs, why, and to what
extent?
The Agencies are proposing several changes to the required
compliance program requirements that are expected to materially reduce
the costs associated with complying with the rule's requirements.
Specifically, banking entities with significant trading assets and
liabilities would only need to maintain a standard six-pillar
compliance program (i.e., written policies and procedures, internal
controls, management framework, independent testing, training, and
records) and would not be required to maintain most aspects of the
enhanced compliance program that is required by the 2013 final rule for
such large banking entities. Agency experience with implementing the
2013 final rule indicates that the operation of the 2013 final rule's
enhanced compliance program can be costly and unrelated to other
compliance efforts that these banking entities routinely conduct.
Accordingly, eliminating this requirement would be expected to
[[Page 33514]]
materially reduce the costs of complying with the rule.
In the case of banking entities with moderate trading assets and
liabilities, these banking entities would only be required to maintain
the simplified compliance program that is described in the 2013 final
rule. Namely, these entities would only be required to update their
existing compliance policies and procedures and would not be required
to maintain a standard six-pillar compliance program as is required
under the 2013 final rule. Since the simplified compliance program is
much less intensive and costly to implement than the standard six-
pillar compliance program, the Agencies expect that this proposed
change would materially reduce the costs associated with complying with
the 2013 final rule's compliance program requirements for these smaller
banking entities.
Question 340. Do commenters agree that the proposed changes to the
compliance program requirements would materially reduce the costs
associated with rule compliance relative to the 2013 final rule?
Question 341. Do commenters have any specific data or information
that could be used to quantify the extent to which such costs are
reduced?
Question 342. Do commenters believe that any aspect of the proposed
changes to the compliance program requirements increases the costs
associated with rule compliance? If so which aspects of the proposed
changes would raise costs, why, and to what extent?
The above discussion outlines the Agencies' views on the most
significant sources of cost reduction that arise from this proposal. At
the same time, the Agencies are aware that there may be other aspects
of the proposal that commenters view as either decreasing or increasing
costs associated with the 2013 final rule. Accordingly, the Agencies
seek broad comment on any other aspects of the proposal that would
either increase or decrease the costs associated with the rule.
Commenters are encouraged to be specific and to provide any data or
information that would help demonstrate their views as well as
potential ways to mitigate costs.
V. Administrative Law Matters
A. Solicitation of Comments on 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 Federal banking agencies have
sought to present the proposal in a simple and straightforward manner,
and invite your comments on how to make this proposal easier to
understand.
For example:
Have the agencies organized the material to suit your
needs? If not, how could this material be better organized?
Are the requirements in the proposal clearly stated? If
not, how could the proposal be more clearly stated?
Does the proposal contain language or jargon that is not
clear? If so, which language requires clarification?
Would a different format (e.g., grouping and order of
sections, use of headings, paragraphing) make the proposal easier to
understand? If so, what changes to the format would make the proposal
easier to understand?
Would more, but shorter, sections be better? If so, which
sections should be changed?
What else could the agencies do to make the regulation
easier to understand?
B. Paperwork Reduction Act Analysis Request for Comment on Proposed
Information Collection
Certain provisions of the proposed rule contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act (PRA) of 1995 (44 U.S.C. 3501-3521). In accordance with
the requirements of the PRA, the agencies may not conduct or sponsor,
and a respondent is not required to respond to, an information
collection unless it displays a currently valid Office of Management
and Budget (OMB) control number. The agencies reviewed the proposed
rule and determined that the proposed rule revises certain reporting
and recordkeeping requirements that have been previously cleared under
various OMB control numbers. The agencies are proposing to extend for
three years, with revision, these information collections. The
information collection requirements contained in this joint notice of
proposed rulemaking have been submitted by the OCC and FDIC to OMB for
review and approval under section 3507(d) of the PRA (44 U.S.C.
3507(d)) and section 1320.11 of the OMB's implementing regulations (5
CFR 1320). The Board reviewed the proposed rule under the authority
delegated to the Board by OMB. The Board will submit information
collection burden estimates to OMB and the submission will include
burden for Federal Reserve-supervised institutions, as well as burden
for OCC-, FDIC-, SEC-, and CFTC-supervised institutions under a holding
company. The OCC and the FDIC will take burden for banking entities
that are not under a holding company.
Comments are invited on:
a. Whether the collections of information are necessary for the
proper performance of the agencies' functions, including whether the
information has practical utility;
b. The accuracy of the estimates of the burden of the information
collections, including the validity of the methodology and assumptions
used;
c. Ways to enhance the quality, utility, and clarity of the
information to be collected;
d. Ways to minimize the burden of the information collections on
respondents, including through the use of automated collection
techniques or other forms of information technology; and
e. Estimates of capital or startup costs and costs of operation,
maintenance, and purchase of services to provide information.
All comments will become a matter of public record. Comments on
aspects of this notice that may affect reporting, recordkeeping, or
disclosure requirements and burden estimates should be sent to the
addresses listed in the ADDRESSES section. A copy of the comments may
also be submitted to the OMB desk officer for the Agencies by mail to
U.S. Office of Management and Budget, 725 17th Street NW, #10235,
Washington, DC 20503, by facsimile to 202-395-5806, or by email to
[email protected], Attention, Commission and Federal Banking
Agency Desk Officer.
Abstract
Section 619 of the Dodd-Frank Act added section 13 to the BHC Act,
which generally prohibits any banking entity from engaging in
proprietary trading or from acquiring or retaining an ownership
interest in, sponsoring, or having certain relationships with a covered
fund, subject to certain exemptions. The exemptions allow certain types
of permissible trading activities such as underwriting, market making,
and risk-mitigating hedging, among others. Each agency issued a common
final rule implementing section 619 that became effective on April 1,
2014. Section __.20(d) and Appendix A of the final rule require certain
of the largest banking entities to report to the appropriate agency
certain quantitative measurements.
Current Actions
The proposed rule contains requirements subject to the PRA and the
changes relative to the current final rule are discussed herein. The
new and modified reporting requirements are
[[Page 33515]]
found in sections __.3(c), __.3(g), __.4(a)(8)(iii), __.4(a)(8)(iv),
__.4(b)(6)(iii), __.4(b)(6)(iv), __.20(d), and __.20(g)(3). The
modified recordkeeping requirements are found in sections __.5(c),
__.20(b), __.20(c), __.20 (d), __.20(e), and __.20(f)(2). The modified
information collection requirements \260\ would implement section 619
of the Dodd-Frank Act. The respondents are for-profit financial
institutions, including small businesses. A covered entity must retain
these records for a period that is no less than 5 years in a form that
allows it to promptly produce such records to the relevant Agency on
request.
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\260\ In an effort to provide transparency, the total cumulative
burden for each agency is shown. In addition to the changes
resulting from the proposed rule, the agencies are also applying a
conforming methodology for calculating the burden estimates in order
to be consistent across the agencies.
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Reporting Requirements
Section __.3(c) would require that under the revised short-term
prong, certain banking entities to report to the appropriate agency
when a trading desk exceeds $25 million in absolute values of the daily
net realized and unrealized gain and loss over the preceding 90 day
period if the banking entity chooses to perform this calculation for a
trading desk in order to meet the presumption of compliance. The
agencies estimate that the new reporting requirement would be collected
twice a year with an average hour per response of 1 hour.
Section __.3(g) would require that notice and response procedures
be followed under the reservation of authority provision. The agencies
estimate that the new reporting requirement would be collected once a
year with an average hours per response of 2 hours.
Sections __.4(a)(8)(iii) and __.4(b)(6)(iii) would require that
banking entities report to the appropriate agency when their internal
risk limits under the RENTD framework for market-making and
underwriting have been exceeded. These reporting requirements would be
included in the section __.20(d) reporting requirements.
Section __.20(d) would be modified by extending the reporting
period for banking entities with $50 billion or more in trading assets
and liabilities from within 10 days of the end of each calendar month
to 20 days of the end of each calendar month. The agencies estimate
that the current average hours per response would decrease by 14 hours
(decrease 40 hours for initial set-up).
Sections __.3(c)(2), __.3(g)(2), __.4(a)(8)(iv), __.4(b)(6)(iv),
and __.20(g)(3) would set forth proposed notice and response procedures
that an agency would follow when exercising its reservation of
authority to modify what is in or out of the trading account. These
reporting requirements would be included in the section __.3(c)
reporting requirements for section __.3(c)(2); the section __.3(g)
reporting requirements for section __.3(g)(2); and the section __.20(d)
reporting requirements for section __.4(a)(8)(iv), __.4(b)(6)(iv), and
__.20(g)(3).
Recordkeeping Requirements
Section __.5(c) would be modified by reducing the requirements for
banking entities that do not have significant trading assets and
liabilities and eliminating documentation requirements for certain
hedging activities. The agencies estimate that the current average
hours per response would decrease by 20 hours (decrease 10 hours for
initial set-up).
Section __.20(b) would be modified by limiting the requirement only
to banking entities with significant trading assets and liabilities.
The agencies estimate that the current average hour per response would
not change.
Section __.20(c) would be modified by limiting the CEO attestation
requirement to a banking entity that has significant trading assets and
liabilities or moderate trading assets and liabilities. The agencies
estimate that the current average hours per response would decrease by
1,100 hours (decrease 3,300 hours for initial set-up).
Section __.20(d) would be modified by extending the time period for
reporting for banking entities with $50 billion or more in trading
assets and liabilities from within 10 days of the end of each calendar
month to 20 days of the end of each calendar month. The agencies
estimate that the current average hours per response would decrease by
3 hours.
Section __.20(e) would be modified by limiting the requirement to
banking entities with significant trading assets and liabilities. The
agencies estimate that the current average hours per response would not
change.
Section __.20(f)(2) would be modified by limiting the requirement
to banking entities with moderate trading assets and liabilities. The
agencies estimate that the current average hours per response would not
change.
The Instructions for Preparing and Submitting Quantitative
Measurement Information, Technical Specifications Guidance, and XML
Schema are available for review on each agency's public website:
OCC: http://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/volcker-rule-implementation/index-volcker-rule-implementation.html;
Board: https://www.federalreserve.gov/apps/reportforms/review.aspx;
FDIC: https://www.fdic.gov/regulations/reform/volcker/index.html;
CFTC: https://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/DF_28_VolckerRule/index.htm;
SEC: https://www.sec.gov/structureddata/dera_taxonomies.
Proposed Revision, With Extension, of the Following Information
Collections
Estimated average hours per response:
Reporting
Section __.3(c)--1 hour for an average of 2 times per year.
Section __.3(g)--2 hours.
Section __.12(e)--20 hours (Initial set-up 50 hours) for an average
of 10 times per year.
Section __.20(d)--41 hours (Initial set-up 125 hours) for quarterly
and monthly filers.
Recordkeeping
Section __.3(e)(3)--1 hour (Initial set-up 3 hours).
Section __.4(b)(3)(i)(A)--2 hours for quarterly filers.
Section __.5(c)--80 hours (Initial setup 40 hours).
Section __.11(a)(2)--10 hours.
Section __.20(b)--265 hours (Initial set-up 795 hours).
Section __.20(c)--100 hours (Initial set-up 300 hours).
Section __.20(d) (entities with $50 billion or more in trading
assets and liabilities)--13 hours.
Section __.20(d) (entities with at least $10 billion and less than
$50 billion in trading assets and liabilities)--10 hours.
Section __.20(e)--200 hours.
Section __.20(f)(1)--8 hours.
Section __.20(f)(2)--40 hours (Initial set-up 100 hours).
Disclosure
Section __.11(a)(8)(i)--0.1 hours for an average of 26 times per
year.
OCC
Title of Information Collection: Reporting, Recordkeeping, and
Disclosure Requirements Associated with Restrictions on Proprietary
Trading and Certain Relationships with Hedge Funds and Private Equity
Funds.
Frequency: Annual, monthly, quarterly, and on occasion.
[[Page 33516]]
Affected Public: Businesses or other for-profit.
Respondents: National banks, state member banks, state nonmember
banks, and state and federal savings associations.
OMB control number: 1557-0309.
Estimated number of respondents: 38.
Proposed revisions estimated annual burden: -469 hours.
Estimated annual burden hours: 20,712 hours (1,784 hour for initial
set-up and 18,928 hours for ongoing).
Board
Title of Information Collection: Reporting, Recordkeeping, and
Disclosure Requirements Associated with Regulation VV.
Frequency: Annual, monthly, quarterly, and on occasion.
Affected Public: Businesses or other for-profit.
Respondents: State member banks, bank holding companies, savings
and loan holding companies, foreign banking organizations, U.S. State
branches or agencies of foreign banks, and other holding companies that
control an insured depository institution and any subsidiary of the
foregoing other than a subsidiary for which the OCC, FDIC, CFTC, or SEC
is the primary financial regulatory agency. The Board will take burden
for all institutions under a holding company including:
OCC-supervised institutions,
FDIC-supervised institutions,
Banking entities for which the CFTC is the primary
financial regulatory agency, as defined in section 2(12)(C) of the
Dodd-Frank Act, and
Banking entities for which the SEC is the primary
financial regulatory agency, as defined in section 2(12)(B) of the
Dodd-Frank Act.
Legal authorization and confidentiality: This information
collection is authorized by section 13 of the Bank Holding Company Act
(BHC Act) (12 U.S.C. 1851(b)(2) and 12 U.S.C. 1851(e)(1)). The
information collection is required in order for covered entities to
obtain the benefit of engaging in certain types of proprietary trading
or investing in, sponsoring, or having certain relationships with a
hedge fund or private equity fund, under the restrictions set forth in
section 13 and the final rule. If a respondent considers the
information to be trade secrets and/or privileged such information
could be withheld from the public under the authority of the Freedom of
Information Act (5 U.S.C. 552(b)(4)). Additionally, to the extent that
such information may be contained in an examination report such
information could also be withheld from the public (5 U.S.C. 552
(b)(8)).
Agency form number: FR VV.
OMB control number: 7100-0360.
Estimated number of respondents: 41.
Proposed revisions estimated annual burden: -51,219 hours.
Estimated annual burden hours: 45,558 hours (1,784 hour for initial
set-up and 43,774 hours for ongoing).
FDIC
Title of Information Collection: Volcker Rule Restrictions on
Proprietary Trading and Relationships with Hedge Funds and Private
Equity Funds.
Frequency: Annual, monthly, quarterly, and on occasion.
Affected Public: Businesses or other for-profit.
Respondents: State nonmember banks, state savings associations, and
certain subsidiaries of those entities.
OMB control number: 3064-0184.
Estimated number of respondents: 53.
Proposed revisions estimated annual burden: -10,305 hours.
Estimated annual burden hours: 10,632 hours (1,784 hours for
initial set-up and 8,848 hours for ongoing).
C. Initial Regulatory Flexibility Act Analysis
The Regulatory Flexibility Act (``RFA'') \261\ requires an agency
to either provide an initial regulatory flexibility analysis with a
proposal or certify that the proposal will not have a significant
economic impact on a substantial number of small entities. The U.S.
Small Business Administration (``SBA'') establishes size standards that
define which entities are small businesses for purposes of the
RFA.\262\ Except as otherwise specified below, the size standard to be
considered a small business for banking entities subject to the
proposal is $550 million or less in consolidated assets.\263\ The
Agencies are separately publishing initial regulatory flexibility
analyses for the proposals as set forth in this NPR.
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\261\ 5 U.S.C. 601 et seq.
\262\ U.S. SBA, Table of Small Business Size Standards Matched
to North American Industry Classification System Codes, available at
https://www.sba.gov/sites/default/files/files/Size_Standards_Table.pdf.
\263\ See id. Pursuant to SBA regulations, the asset size of a
concern includes the assets of the concern whose size is at issue
and all of its domestic and foreign affiliates. 13 CFR 121.103(6).
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Board
The Board has considered the potential impact of the proposed rule
on small entities in accordance with the RFA. Based on the Board's
analysis, and for the reasons stated below, the Board believes that
this proposed rule will not have a significant economic impact on a
substantial of number of small entities. Nevertheless, the Board is
publishing and inviting comment on this initial regulatory flexibility
analysis. A final regulatory flexibility analysis will be conducted
after comments received during the public comment period have been
considered.
The Board welcomes comment on all aspects of its analysis. In
particular, the Board requests that commenters describe the nature of
any impact on small entities and provide empirical data to illustrate
and support the extent of the impact.
1. Reasons for the Proposal
As discussed in the SUPPLEMENTARY INFORMATION, the Agencies are
proposing to revise the 2013 final rule in order to provide clarity to
banking entities about what activities are prohibited, reduce
compliance costs, and improve the ability of the Agencies to make
supervisory assessments regarding compliance relative to the 2013 final
rule. To minimize the costs associated with the 2013 final rule in a
manner consistent with section 13 of the BHC Act, the Agencies are
proposing to simplify and tailor the rule in a manner that would
substantially reduce compliance costs for all banking entities and, in
particular, small banking entities and banking entities without
significant trading operations.
2. Statement of Objectives and Legal Basis
As discussed above, the Agencies' objective in proposing this rule
is to reduce the compliance costs for all banking entities and, in
particular, to tailor the rule based on the size of the banking entity
and the complexity of its trading operations. The Agencies are
explicitly authorized under section 13(b)(2) of the BHC Act to adopt
rules implementing section 13.\264\
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\264\ 12 U.S.C. 1851(b)(2).
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3. Description of Small Entities to Which the Regulation Applies
The Board's proposal would apply to state-chartered banks that are
members of the Federal Reserve System (state member banks), bank
holding companies, foreign banking organizations, and nonbank financial
companies supervised by the Board (collectively, ``Board-regulated
banking entities''). However, the Board notes that the Economic Growth,
Regulatory Relief, and Consumer Protection Act,\265\ which was enacted
on May 24, 2018,
[[Page 33517]]
amends section 13 of the BHC Act by narrowing the definition of banking
entity. Accordingly, no small top-tier bank holding company would meet
the threshold criteria for application of the provisions provided in
this proposal and, therefore, the proposed amendments to the 2013 final
rule would not have a significant economic impact on a substantial
number of small entities.
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\265\ Public Law 115-174, 132 Stat. 1296-1368 (2018).
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4. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
The proposal would reduce reporting, recordkeeping, and other
compliance requirements for small entities. First, banking entities
with consolidated gross trading assets and liabilities below $10
billion would be subject to reduced requirements and a tailored
approach in light of their significantly smaller and less complex
trading activities. Second, in order to further reduce compliance
requirements for small and mid-sized banking entities, the Agencies
have proposed a rebuttable presumption of compliance for firms that do
not have consolidated gross trading assets and liabilities in excess of
$1 billion. All Board-regulated banking entities that meet the SBA
definition of small entities (i.e., those with consolidated assets of
$550 million or less) have consolidated gross trading assets and
liabilities below $1 billion and thus would be subject to the
presumption of compliance.
As discussed in the SUPPLEMENTARY INFORMATION, the Agencies expect
that this rebuttable presumption of compliance would materially reduce
the costs associated with complying with the rule. As a result of this
presumed compliance, these banking entities would not be required to
comply with many of the rule's specific requirements to demonstrate
compliance, such as the documentation requirements associated with the
hedging exemption. Additionally, these entities would not be required
to specify and maintain trading risk limits to comply with the rule's
market making exemption. Accordingly, these smaller entities would
generally not be required to devote resources to demonstrate compliance
with any of the rule's requirements.
Without this presumption of compliance, these banking entities
would generally be required to comply with the rule's applicable
substantive requirements to demonstrate compliance with the rule. As a
result, this proposed change is expected to meaningfully reduce the
costs associated with rule compliance for small banking entities. The
presumption would be rebuttable, so a banking entity would need to
maintain a certain level of resources to respond to supervisory
requests for information in the event that the presumption of
compliance is rebutted; however, the Agencies would not expect these
banking entities to maintain anything other than what they would
normally maintain in the ordinary course. The amount of resources
required for such purposes is expected to be significantly smaller than
the amount of resources that would be required to maintain and execute
ongoing compliance with the 2013 final rule's requirements.
5. Identification of Duplicative, Overlapping, or Conflicting Federal
Regulations
The Board has not identified any federal statutes or regulations
that would duplicate, overlap, or conflict with the proposed revisions.
6. Discussion of Significant Alternatives
The Board believes the proposed amendments to the 2013 final rule
will not have a significant economic impact on small banking entities
supervised by the Board and therefore believes that there are no
significant alternatives to the proposal that would reduce the economic
impact on small banking entities supervised by the Board.
OCC
The RFA, requires an agency, in connection with a proposed rule, to
prepare an Initial Regulatory Flexibility Analysis describing the
impact of the proposed rule on small entities, or to certify that the
proposed rule would not have a significant economic impact on a
substantial number of small entities. For purposes of the RFA, the SBA
defines small entities as those with $550 million or less in assets for
commercial banks and savings institutions, and $38.5 million or less in
assets for trust companies.
The OCC currently supervises approximately 886 small entities.\266\
Pursuant to section 203 of the Economic Growth, Regulatory Relief, and
Consumer Protection Act (May 24, 2018), OCC-supervised institutions
with total consolidated assets of $10 billion or less are not ``banking
entities'' within the scope of Section 13 of the BHCA, if their trading
assets and trading liabilities do not exceed 5 percent of their total
consolidated assets, and they are not controlled by a company that has
total consolidated assets over $10 billion or total trading assets and
trading liabilities that exceed 5 percent of total consolidated assets.
The proposal may impact two OCC-supervised small entities, which is not
a substantial number. Therefore, the OCC certifies that the proposal
would not have a significant economic impact on a substantial number of
small entities.
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\266\ The number of small entities supervised by the OCC is
determined using the SBA's size thresholds for commercial banks and
savings institutions, and trust companies, which are $550 million
and $38.5 million, respectively. Consistent with the General
Principles of Affiliation 13 CFR 121.103(a), the OCC counts the
assets of affiliated financial institutions when determining if we
should classify an OCC-supervised institution as a small entity. The
OCC used December 31, 2017, to determine size because a ``financial
institution's assets are determined by averaging the assets reported
on its four quarterly financial statements for the preceding year.''
See footnote 8 of the U.S. Small Business Administration's Table of
Size Standards.
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FDIC
a. Regulatory Flexibility Act
The RFA, generally requires an agency, in connection with a
proposed rule, to prepare and make available for public comment an
initial regulatory flexibility analysis that describes the impact of a
proposed rule on small entities.\267\ However, a regulatory flexibility
analysis is not required if the agency certifies that the rule will not
have a significant economic impact on a substantial number of small
entities. The SBA has defined ``small entities'' to include banking
organizations with total assets of less than or equal to $550
million.\268\ As discussed further below, the FDIC certifies that this
proposed rule would not have a significant economic impact on a
substantial number of FDIC-supervised small entities.
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\267\ 5 U.S.C. 601 et seq.
\268\ 13 CFR 121.201 (as amended, effective December 2, 2014).
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b. Reasons for and Policy Objectives of the Proposed Rule
The Agencies are issuing this proposal to amend the 2013 final rule
in order to provide banking entities with additional certainty and
reduce compliance obligations and costs where possible. The Agencies
acknowledge that many small banking entities have found certain aspects
of the 2013 final rule to be complex or difficult to apply in
practice.\269\ The proposed rule amends existing requirements in order
the make them more efficient. However, the proposed amendments do not
alter the Volcker Rule's existing restrictions on the ability of
banking entities to engage in proprietary trading and have
[[Page 33518]]
certain interests in, and relationships with, covered funds.
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\269\ The FDIC has issued twenty-one FAQs since inception of the
2013 rule.
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c. Description of the Rule
The Agencies are proposing to tailor the application of the 2013
final rule based on a banking entity's risk profile and the size and
scope of its trading activities. Second, the Agencies aim to further
streamline compliance obligations, particularly for entities without
large trading operations. Third, the agencies seek to streamline and
refine certain definitions and requirements related to the proprietary
trading prohibition and limitations on covered fund activities and
investments. Please refer to Section II: Overview of Proposal, for
further information.
d. Other Statutes and Federal Rules
The FDIC has not identified any likely duplication, overlap, and/or
potential conflict between the proposed rule and any other federal
rule.
On May 24, 2018, the Economic Growth, Regulatory Relief, and
Consumer Protection Act was enacted, which, among other things, amends
section 13 of the BHC Act. As a result, section 13 excludes from the
definition of banking entity any institution that, together with their
affiliates and subsidiaries, has: (1) Total assets of $10 billion or
less, and (2) trading assets and liabilities that comprise 5 percent or
less of total assets. This excludes every FDIC-supervised small entity
from the statutory definition of banking entity, except those that are
controlled by a company that is not excluded. The SBA has defined
``small entities'' to include banking organizations with total assets
less than or equal to $550 million.\270\
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\270\ 13 CFR 121.201.
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e. Small Entities Affected
The FDIC supervises 3,597 depository institutions,\271\ of which,
2,885 are defined as small entity.\272\ There are no FDIC-supervised
small entities that engage in significant or moderate trading of assets
and liabilities at the depository institution level.\273\ There are
only five FDIC-supervised small entities, which are controlled by
companies not excluded by section 13, as amended, that would be
required to implement compliance elements prescribed by the proposed
rule and would have compliance obligations under the proposed rule, of
which one is categorized as having ``significant'' trading, one is
categorized as having ``moderate'' trading and three are categorized as
having ``limited'' trading activity.\274\
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\271\ FDIC-supervised institutions are set forth in 12 U.S.C.
1813(q)(2).
\272\ FDIC Call Report, March 31, 2018.
\273\ Based on data from the December 31, 2017 Call Reports and
Y9C reports. Top tier institutions that have a four-quarter average
trading assets and liabilities, excluding U.S. treasuries and
obligations or guarantees of government agencies, exceeding $10
billion have ``significant'' trading activity while those between $1
billion and $10 billion have ``moderate'' trading activity and those
below $1 billion have ``limited'' trading activity.
\274\ Id.
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f. Expected Effects of the Proposed Rule
The potential benefits of this proposed rule consist of any
reduction in the regulatory costs borne by covered entities. The
potential costs of this rule consist of any reduction in the efficacy
of the objectives in the existing regulatory framework. As explained in
the following sections, certain of these potential costs and benefits
are difficult to quantify.
1. Expected Costs
By reducing the reporting requirements of the 2013 final rule,
there is a chance that the Agencies would fail to recognize prohibited
proprietary trading, resulting in additional risk of loss to an
institution, the Deposit Insurance Fund (DIF), the financial sector,
and the economy. The FDIC believes the potential costs associated with
these risks are minimal. First, the reporting metrics that would be
removed or replaced by the proposed rule have contributed little as
indicators of risk, and there would be no cost associated with
replacing them. Second, the banking entities that would be relieved
from compliance requirements under section __.20 of the proposed rule
are primarily small entities that conduct limited to no trading
activity, and which are therefore excluded from Section 13 by the
Economic Growth, Regulatory Relief, and Consumer Protection Act. The
FDIC would maintain its ability to recognize and respond to potential
risks of prohibited activity by these small entities through off-site
monitoring of Call Reports as well as periodic on-site examinations.
The proposed rule has no additional or transition costs because the new
reporting metrics in the proposed rule consist of data that covered
entities already collect in the course of business and for regulatory
compliance.
2. Expected Benefits
The potential benefits of the proposed rule can be expressed in
terms of the potential reduction in the costs of compliance incurred by
small, FDIC-supervised affected banking entities under the proposed
rule. These benefits cannot be quantified because covered institutions
do not collect data and report to the FDIC the precise burden relating
to parts of the 2013 final rule. Nevertheless, supervisory experience
and feedback received from FDIC-supervised banking entities have
demonstrated that these burdens exist. The proposed rule clarifies many
requirements and definitions that are expected to enable banking
entities to more efficiently and effectively comply with the rule, thus
providing benefits to those entities.
g. Alternatives Considered
The primary alternative to the proposed rule is to maintain the
status quo under the 2013 final rule. As discussed above, however, the
proposed rule implements the statutory requirements, but is expected to
provide more certainty and result in lower costs.
The proposed rule also seeks public comment on alternative
regulatory approaches that would reduce the compliance burden of the
2013 final rule without reducing its effectiveness in eliminating the
moral hazard of proprietary trading.
h. Certification Statement
Section 13, as amended, exempts almost all of the FDIC-supervised
small institutions from compliance with the Volcker Rule. The proposed
rule provides benefits to the remaining five FDIC-supervised small
institutions with parent companies subject to the rule. Therefore, the
FDIC certifies that this proposed rule will not have a significant
economic impact on a substantial number of FDIC-supervised small
entities.\275\
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\275\ Notwithstanding S.2155, the rule does provide benefits to
a substantial number of moderate sized banks above $550 million in
total assets and below $1 billion in trading assets and liabilities
as well as to large banks with very little trading activity.
---------------------------------------------------------------------------
i. Request for Comments
The FDIC invites comments on all aspects of the supporting
information provided in this RFA section. In particular, would this
rule have any significant effect on small entities that the FDIC has
not identified? If the proposed rule is implemented, how many hours of
burden would small institutions save?
SEC
Pursuant to 5 U.S.C. 605(b), the SEC hereby certifies that the
proposed amendments to the 2013 final rule would not, if adopted, have
a significant economic impact on a substantial number of small
entities.
As discussed in the Supplementary Information, the Agencies are
proposing
[[Page 33519]]
to revise the 2013 final rule in order to provide clarity to banking
entities about what activities are prohibited, reduce compliance costs,
and improve the ability of the Agencies to make assessments regarding
compliance relative to the 2013 final rule. To minimize the costs
associated with the 2013 final rule in a manner consistent with section
13 of the BHC Act, the Agencies are proposing to simplify and tailor
the rule in a manner that would substantially reduce compliance costs
for all banking entities and, in particular, small banking entities and
banking entities without significant trading operations.
The proposed revisions would generally apply to banking entities,
including certain SEC-registered entities. These entities include bank-
affiliated SEC-registered broker-dealers, investment advisers, and
security-based swap dealers. Based on information in filings submitted
by these entities, the SEC preliminarily believes that there are no
banking entity registered investment advisers \276\ or broker-dealers
\277\ that are small entities for purposes of the RFA.\278\ For this
reason, the SEC believes that the proposed amendments to the 2013 final
rule would not, if adopted, have a significant economic impact on a
substantial number of small entities.
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\276\ For the purposes of an SEC rulemaking in connection with
the RFA, an investment adviser generally is a small entity if it:
(1) Has assets under management having a total value of less than
$25 million; (2) did not have total assets of $5 million or more on
the last day of the most recent fiscal year; and (3) does not
control, is not controlled by, and is not under common control with
another investment adviser that has assets under management of $25
million or more, or any person (other than a natural person) that
had total assets of $5 million or more on the last day of its most
recent fiscal year. See 17 CFR 275.0-7.
\277\ For the purposes of an SEC rulemaking in connection with
the RFA, a broker-dealer will be deemed a small entity if it: (1)
Had total capital (net worth plus subordinated liabilities) of less
than $500,000 on the date in the prior fiscal year as of which its
audited financial statements were prepared pursuant to 17 CFR
240.17a-5(d), or, if not required to file such statements, had total
capital (net worth plus subordinated liabilities) of less than
$500,000 on the last day of the preceding fiscal year (or in the
time that it has been in business, if shorter); and (2) is not
affiliated with any person (other than a natural person) that is not
a small business or small organization. See 17 CFR 240.0-10(c).
Under the standards adopted by the SBA, small entities also include
entities engaged in financial investments and related activities
with $38.5 million or less in annual receipts. See 13 CFR 121.201
(Subsector 523).
\278\ Based on SEC analysis of Form ADV data, the SEC
preliminarily believes that there are not a substantial number of
registered investment advisers affected by the proposed amendments
that would qualify as small entities under RFA. Based on SEC
analysis of broker-dealer FOCUS filings and NIC relationship data,
the SEC preliminarily believes that there are no SEC-registered
broker-dealers affected by the proposed amendments that would
qualify as small entities under RFA. With respect to security-based
swap dealers, based on feedback from market participants and our
information about the security-based swap markets, the Commission
believes that the types of entities that would engage in more than a
de minims amount of dealing activity involving security-based
swaps--which generally would be large financial institutions--would
not be ``small entities'' for purposes of the RFA.
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The SEC encourages written comments regarding this certification.
Specifically, the SEC solicits comment as to whether the proposed
amendments could have an impact on small entities that has not been
considered. Commenters should describe the nature of any impact on
small entities and provide empirical data to support the extent of such
impact.
CFTC
Pursuant to 5 U.S.C. 605(b), the CFTC hereby certifies that the
proposed amendments to the 2013 final rule would not, if adopted, have
a significant economic impact on a substantial number of small entities
for which the CFTC is the primary financial regulatory agency.
As discussed in this SUPPLEMENTARY INFORMATION, the Agencies are
proposing to revise the 2013 final rule in order to provide clarity to
banking entities about what activities are prohibited, reduce
compliance costs, and improve the ability of the Agencies to make
assessments regarding compliance relative to the 2013 final rule. To
minimize the costs associated with the 2013 final rule in a manner
consistent with section 13 of the BHC Act, the Agencies are proposing
to simplify and tailor the rule in a manner that would substantially
reduce compliance costs for all banking entities and, in particular,
small banking entities and banking entities without significant trading
operations.
The proposed revisions would generally apply to banking entities,
including certain CFTC-registered entities. These entities include
bank-affiliated CFTC-registered swap dealers, FCMs, commodity trading
advisors and commodity pool operators.\279\ The CFTC has previously
determined that swap dealers, futures commission merchants and
commodity pool operators are not small entities for purposes of the RFA
and, therefore, the requirements of the RFA do not apply to those
entities.\280\ As for commodity trading advisors, the CFTC has found it
appropriate to consider whether such registrants should be deemed small
entities for purposes of the RFA on a case-by-case basis, in the
context of the particular regulation at issue.\281\
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\279\ The proposed revisions may also apply to other types of
CFTC registrants that are banking entities, such as introducing
brokers, but the CFTC believes it is unlikely that such other
registrants will have significant activities that would implicate
the proposed revisions. See 79 FR 5808, 5813 (Jan. 31, 2014) (CFTC
version of 2013 final rule).
\280\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (Apr. 30, 1982) (futures commission merchants and
commodity pool operators); Registration of Swap Dealers and Major
Swap Participants, 77 FR 2613, 2620 (Jan. 19, 2012) (swap dealers
and major swap participants).
\281\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18620 (Apr. 30, 1982).
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In the context of the proposed revisions to the 2013 final rule,
the CFTC believes it is unlikely that a substantial number of the
commodity trading advisors that are potentially affected are small
entities for purposes of the RFA. In this regard, the CFTC notes that
only commodity trading advisors that are registered with the CFTC are
covered by the 2013 final rule, and generally those that are registered
have larger businesses. Similarly, the 2013 final rule applies to only
those commodity trading advisors that are affiliated with banks, which
the CFTC expects are larger businesses. The CFTC requests that
commenters address in particular whether any of these commodity trading
advisors, or other CFTC registrants covered by the proposed revisions
to the 2013 final rule, are small entities for purposes of the RFA.
Because the CFTC believes that there are not a substantial number
of registered, banking entity-affiliated commodity trading advisors
that are small entities for purposes of the RFA, and the other CFTC
registrants that may be affected by the proposed revisions have been
determined not to be small entities, the CFTC believes that the
proposed revisions to the 2013 final rule would not, if adopted, have a
significant economic impact on a substantial number of small entities
for which the CFTC is the primary financial regulatory agency.
The CFTC encourages written comments regarding this certification.
Specifically, the CFTC solicits comment as to whether the proposed
amendments could have a direct impact on small entities that were not
considered. Commenters should describe the nature of any impact on
small entities and provide empirical data to support the extent of such
impact.
A. OCC Unfunded Mandates Reform Act of 1995 Determination
The OCC analyzed the proposed rule under the factors set forth in
the
[[Page 33520]]
Unfunded Mandates Reform Act of 1995 (2 U.S.C. 1532). Under this
analysis, the OCC considered whether the proposed rule includes a
federal mandate that may result in the expenditure by state, local, and
Tribal governments, in the aggregate, or by the private sector, of $100
million or more in any one year (adjusted annually for inflation).
The OCC has determined this proposed rule is likely to result in
the expenditure by the private sector of approximately $11.6 million in
the first year. Therefore, the OCC concludes that implementation of the
proposed rule would not result in an expenditure of $100 million or
more annually by state, local, and tribal governments, or by the
private sector.
B. SEC: Small Business Regulatory Enforcement Fairness Act
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996, or ``SBREFA,'' \282\ the SEC requests comment on the
potential effect of the proposed amendments on the U.S. economy on an
annual basis; any potential increase in costs or prices for consumers
or individual industries; and any potential effect on competition,
investment or innovation. Commenters are requested to provide empirical
data and other factual support for their views to the extent possible.
---------------------------------------------------------------------------
\282\ Public Law 104-121, Title II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
---------------------------------------------------------------------------
D. SEC Economic Analysis
1. Broad Economic Considerations
Section 13 of the BHC Act generally prohibits banking entities from
engaging in proprietary trading and from acquiring or retaining an
ownership interest in, sponsoring, or having certain relationships with
covered funds, subject to certain exemptions. Under the BHC Act,
``banking entities'' include insured depository institutions, 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 of 1978, and their affiliates and
subsidiaries.\283\ Accordingly, certain SEC-regulated entities, such as
broker-dealers, security-based swap dealers (``SBSDs''), and registered
investment advisers (``RIAs'') affiliated with a banking entity, fall
under the definition of ``banking entity'' and are subject to the
prohibitions of section 13 of the BHC Act.\284\ In addition, the
Economic Growth, Regulatory Relief, and Consumer Protection Act,
enacted on May 24, 2018, amends section 13 of the BHC Act to exclude
from the scope of ``insured depository institution'' in the banking
entity definition any entity that does not have and is not controlled
by a company that has (1) more than $10 billion in total consolidated
assets; and (2) total trading assets and trading liabilities, as
reported on the most recent applicable regulatory filing filed by the
institution, that are more than 5% of total consolidated assets.\285\
---------------------------------------------------------------------------
\283\ See 12 U.S.C. 1851(h)(1).
\284\ Throughout this economic analysis, the term ``banking
entity'' generally refers only to banking entities for which the SEC
is the primary financial regulatory agency unless otherwise noted.
While section 13 of the BHC Act and its associated rules apply to a
broader set of banking entities, this economic analysis is limited
to those banking entities for which the SEC is the primary financial
regulatory agency as defined in section 2(12)(B) of the Dodd-Frank
Act. See 12 U.S.C. 1851(b)(2); 12 U.S.C. 5301(12)(B).
We recognize that compliance with SBSD registration requirements
is not yet required and that there are currently no registered
SBSDs. However, the SEC has previously estimated that as many as 50
entities may potentially register as security-based swap dealers and
that as many as 16 of these entities may already be SEC-registered
broker-dealers. See Registration Process for Security-Based Swap
Dealers and Major Security-Based Swap Participants, Exchange Act
Release No. 75611 (Aug. 5, 2015), 80 FR 48963 (Aug. 14, 2015)
(``SBSD and MSP Registration Release'').
For the purposes of this economic analysis, the term ``dealer''
generally refers to SEC-registered broker-dealers and SBSDs.
Throughout this economic analysis, ``we'' refers only to the SEC
and not the other Agencies, except where otherwise indicated.
\285\ The legislation also alters the name sharing provisions in
section 13(d)(1)(G)(vi). This economic analysis assumes that the
legislation's changes to section 13 of the BHC Act are in effect.
---------------------------------------------------------------------------
The Agencies issued final regulations implementing section 13 of
the BHC Act in December 2013, with an initial effective date of April
1, 2014.\286\ The 2013 final rule prohibits banking entities (e.g.,
bank-affiliated broker-dealers, SBSDs, and investment advisers) from
engaging, as principal, in short-term trading of securities,
derivatives, futures contracts, and options on these instruments,
subject to certain exemptions. In addition, the 2013 final rule
generally prohibits the same entities from acquiring or retaining an
ownership interest in, sponsoring, or having certain relationships with
a ``covered fund,'' subject to certain exemptions. The 2013 final rule
defines the term ``covered fund'' to include any issuer that would be
an investment company under the Investment Company Act of 1940 if it
were not otherwise excluded by sections 3(c)(1) or 3(c)(7) of that act,
as well as certain foreign funds and commodity pools.\287\ However, the
definition contains a number of exclusions for entities that would
otherwise meet the covered fund definition but that the Agencies did
not believe are engaged in investment activities contemplated by
section 13 of the BHC Act.\288\
---------------------------------------------------------------------------
\286\ See 79 FR at 5536. The 2013 final rule was published in
the Federal Register on January 31, 2014, and became effective on
April 1, 2014. Banking entities were required to fully conform their
proprietary trading activities and their new covered fund
investments and activities to the requirements of the final rule by
the end of the conformance period, which the Board extended to July
21, 2015. The Board extended the conformance period for legacy-
covered fund activities until July 21, 2017. Upon application,
banking entities also have an additional period to conform certain
illiquid funds to the requirements of section 13 and implementing
regulations.
\287\ See 2013 final rule Sec. __.10(b).
\288\ See 2013 final rule Sec. __.10(c).
---------------------------------------------------------------------------
In implementing section 13 of the BHC Act, the Agencies sought to
increase the safety and soundness of banking entities, promote
financial stability, and reduce conflicts of interest between banking
entities and their customers.\289\ The regulatory regime created by the
2013 final rule may enhance regulatory oversight and compliance with
the substantive prohibitions but could also impact capital formation
and liquidity. The Agencies also recognized that client-oriented
financial services, such as underwriting and market making, are
critical to capital formation and can facilitate the provision of
market liquidity, and that the ability to hedge is fundamental to
prudent risk management as well as capital formation.\290\
---------------------------------------------------------------------------
\289\ See, e.g., 79 FR at 5666, 5574, 5541, 5659. An extensive
body of research has examined moral hazard arising out of federal
deposit insurance, implicit bailout guarantees, and systemic risk
issues. See, e.g., Atkeson, d'Avernas, Eisfeldt, and Weill, 2018,
``Government Guarantees and the Valuation of American Banks,''
working paper. See also Bianchi, 2016, ``Efficient Bailouts?''
American Economic Review 106 (12), 3607-3659; Kelly, Lustig, and Van
Nieuwerburgh, 2016, ``Too-Systematic-to-Fail: What Option Markets
Imply about Sector-Wide Government Guarantees,'' American Economic
Review 106(6), 1278-1319; Anginer, Demirguc-Kunt, and Zhu, 2014,
``How Does Deposit Insurance Affect Bank Risk? Evidence from the
Recent Crisis,'' Journal of Banking and Finance 48, 312-321;
Beltratti and Stulz, 2012, ``The Credit Crisis Around the Globe: Why
Did Some Banks Perform Better?'' Journal of Financial Economics 105,
1-17; Veronesi and Zingales, 2010, ``Paulson's Gift,'' Journal of
Financial Economics 97(3), 339-368. For a literature review, see,
e.g., Benoit, Colliard, Hurlin, and Perignon, 2017, ``Where the
Risks Lie: A Survey on Systemic Risk,'' Review of Finance 21(1),
109-152.
See also, e.g., Avci, Schipani, and Seyhun, 2017, ``Eliminating
Conflicts of Interests in Banks: The Significance of the Volcker
Rule,'' Yale Journal on Regulation 35 (2).
\290\ See, e.g., 79 FR at 5541, 5546, 5561. In addition, a
significant amount of research has focused on changes in liquidity
provision following the financial crisis and regulatory reforms.
See, e.g., Bessembinder, Jacobsen, Maxwell, and Venkataraman 2017,
``Capital Commitment and Illiquidity in Corporate Bonds,'' Journal
of Finance, forthcoming. See also Bao, O'Hara and Zhou, 2017, ``The
Volcker Rule and Corporate Bond Market Making in Times of Stress,''
Journal of Financial Economics, forthcoming. Bao et al. (2017) shows
that dealers not subject to the Volcker rule increased their market-
making activities, partially offsetting the reduction market making
by dealers affected by the Volcker Rule. See also, Anderson and
Stulz, 2017, ``Is Post-Crisis Bond Liquidity Lower?'' working paper;
Goldstein and Hotchkiss, 2017, ``Providing Liquidity in an Illiquid
Market: Dealer Behavior in U.S. Corporate Bonds,'' working paper.
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[[Page 33521]]
Section 13 of the BHC Act also provides a number of statutory
exemptions to the general prohibitions on proprietary trading and
covered funds activities. For example, the statute exempts from the
proprietary trading restrictions certain underwriting, market making,
and risk-mitigating hedging activities, as well as certain trading
activities outside of the United States.\291\ Similarly, section 13
provides exemptions for certain covered funds activities, such as
exemptions for organizing and offering covered funds.\292\ The 2013
final rule implemented these exemptions.\293\ In addition, some banking
entities engaged in proprietary trading are required to furnish
periodic reports that include a variety of quantitative measurements of
their covered trading activities, and banking entities engaged in
activities covered by section 13 of the BHC Act and the 2013 final rule
are required to establish a compliance program reasonably designed to
ensure and monitor compliance with the 2013 final rule.\294\
---------------------------------------------------------------------------
\291\ See 12 U.S.C. 1851(d).
\292\ See section 13(d)(1)(G) of the BHC Act.
\293\ See 2013 final rule Sec. Sec. __.4, __.5, __.6, __.11,
__.13.
\294\ See 2013 final rule Sec. __.20.
---------------------------------------------------------------------------
Certain aspects of the rule may have resulted in a complex and
costly compliance regime that is unduly restrictive and burdensome on
some affected banking entities, particularly smaller firms that do not
qualify for the simplified compliance and reporting regime. The
Agencies also recognize that distinguishing between permissible and
prohibited activities may be complex and costly for some firms.
Moreover, the 2013 final rule may have included in its scope some
groups of market participants that do not necessarily engage in the
activities or pose the risks that section 13 of the BHC Act intended to
address. For example, the 2013 final rule's definition of the term
``covered fund'' is broad and, as a result, may include funds that do
not engage in the investment activities contemplated by section 13 of
the BHC Act. As another example, foreign banking entities' ability to
trade financial instruments in the United States may have been
significantly limited despite the foreign trading exemption in the 2013
final rule.
The amendments to the 2013 final rule proposed in this release
include those that influence the scope of permitted activities for all
or a subset of banking entities and covered funds, and those that
simplify, tailor, or eliminate the application of certain aspects of
the rule to reduce compliance and reporting burdens.
Some of the proposed amendments affect the scope of permitted
activities (e.g., foreign trading, underwriting, market making, and
risk-mitigating hedging). These changes would expand the scope of
permitted activities, which may benefit the parties to those
transactions and broader capital markets, for example, if reduced
compliance costs translate into increased willingness of banking
entities to underwrite securities or make markets. These changes also,
however, could facilitate risk-taking or create conflicts of interest
among certain groups of market participants. Moreover, amendments that
redefine the scope of entities subject to certain provisions of the
rule may impact competition, allocative efficiency, and capital
formation. Broadly, to the extent that the proposed amendments and
changes on which the Agencies are requesting comment increase or
decrease the scope of permissible activities, they may magnify or
attenuate the economic tradeoffs above. As we discuss below, to the
extent that the proposed amendments or changes on which the Agencies
are requesting comments reduce burdens on some groups of market
participants (e.g., on entities without significant trading assets and
liabilities, foreign banking entities, certain types of covered funds),
the proposed amendments may increase competition and trading activity
in various market segments.
Other proposed amendments reduce compliance program, reporting, and
documentation requirements for some entities. While these amendments
are designed to reduce the compliance burdens of regulated entities,
they may also reduce the efficacy of regulatory oversight, internal
compliance, and supervision. Amendments and changes on which the
Agencies are requesting comment that decrease (or increase) compliance
program and reporting requirements tip the balance of economic
tradeoffs toward (or away from) competition, trading activity, and
capital formation on the one hand, and against (or in favor of)
regulatory and internal oversight on the other. However, as discussed
below, some of the changes need not reduce the efficacy of the
Agencies' regulatory oversight. Further, under the proposal, banking
entities (other than banking entities with limited trading assets and
liabilities for which the proposed presumption of compliance has not
been rebutted) would still be required to develop and provide for the
continued administration of a compliance program reasonably designed to
ensure and monitor compliance with the prohibitions and restrictions
set forth in section 13 of the BHC Act and the 2013 final rule, as it
is proposed to be amended.
Where possible, we have attempted to quantify the costs and
benefits expected to result from the proposed amendments. In many
cases, however, the SEC is unable to quantify these potential economic
effects. Some of the primary economic effects, such as the effect on
incentives that may give rise to conflicts of interest in various
regulated entities and the efficacy of regulatory oversight under
various compliance regimes, are inherently difficult to quantify.
Moreover, some of the benefits of the 2013 final rule's definitions and
prohibitions that are being amended here, for example potential
benefits for resilience during a crisis, are less readily observable
under strong economic conditions. Lastly, because of overlapping
implementation periods of various post-crisis regulations affecting the
same group of SEC registrants, the long implementation timeline of the
2013 final rule, and the fact that many market participants changed
their behavior in anticipation of future changes in regulation, it is
difficult to quantify the net economic effects of the individual
amendments to rule provisions proposed here.
In some instances, we lack the information or data necessary to
provide reasonable estimates for the economic effects of the proposed
amendments. For example, we lack information and data on the volume of
trading activity that does not occur because of uncertainty about how
to demonstrate that underwriting or market-making activities satisfy
the RENTD requirement; the extent to which internally-set risk limits
capture expected customer demand; how accurately correlation analysis
reflects underlying exposures of banking entities with, and without,
significant trading assets and liabilities in normal times and in times
of market stress; the feasibility and costs of reorganization that may
enable some U.S. banking entities to become foreign banking entities
for the purposes of relying on the foreign trading exemption; how
market participants may choose to
[[Page 33522]]
restructure their interests in various types of private funds in
response to the proposed amendments or other changes on which the
Agencies seek comment; the amount of capital formation in covered funds
that does not occur because of current covered fund provisions,
including those concerning underwriting, market making, or hedging with
covered funds; or the volume of loans, guarantees, securities lending,
and derivatives activity dealers may wish to engage in with the covered
funds they advise; the extent of risk reduction associated with the
2013 final rule. Where we cannot quantify the relevant economic
effects, we discuss them in qualitative terms.
In addition, the broader economic effects of the proposed
amendments, such as those related to efficiency, competition, and
capital formation, are difficult to quantify with any degree of
certainty. The proposed amendments tailor, remove, or alter the scope
of requirements in the 2013 final rule. Thus, some of the
methodological challenges in analyzing market effects of these
amendments are somewhat similar to those that arise when analyzing the
effects of the 2013 final rule. As we have noted elsewhere, analysis of
the effects of the implementation of the 2013 final rule is confounded
by, among others, macroeconomic factors, other policy interventions,
post-crisis changes to market participants' risk aversion and return
expectations, and technological advancements unrelated to regulations.
Because of the extended timeline of implementation of section 13 of the
BHC Act and the overlap of the 2013 final rule period with other post-
crisis changes affecting the same group of SEC registrants, typical
quantitative methods that might otherwise enable causal attribution and
quantification of the effects of section 13 of the BHC Act and the 2013
final rule on measures of capital formation, liquidity, and
informational or allocative efficiency are not available. Where
existing research has sought to test causal effects and to measure them
quantitatively, the presence, direction, and magnitude of the effects
are sensitive to econometric methodology, measurement, choice of
market, and the time period studied.\295\ Moreover, empirical measures
of capital formation or liquidity do not reflect issuance and
transaction activity that does not occur as a result of the
implementing rules. Accordingly, it is difficult to quantify the
primary issuance and market liquidity that would have been observed
following the financial crisis absent the ensuing reforms. Finally,
since section 13 of the BHC Act and the 2013 final rule combined a
number of different requirements, it is difficult to attribute the
observed effects to a specific provision or set of requirements.
---------------------------------------------------------------------------
\295\ See, e.g., Access to Capital and Market Liquidity supra
note 106.
---------------------------------------------------------------------------
In addition, the existing securities markets--including market
participants, their business models, market structure, etc.--differ in
significant ways from the securities markets that existed prior to the
2013 final rule's implementation. For example, the role of dealers in
intermediating trading activity has changed in important ways,
including: Bank-dealer capital commitment declined while non-bank
dealer capital commitment increased; electronic trading in some
securities markets became more prominent; the profitability of trading
after the financial crisis may have decreased significantly; and the
introduction of alternative credit markets may have contributed to
liquidity fragmentation across markets.\296\
---------------------------------------------------------------------------
\296\ See, e.g., Bessembinder et al. (2017), Bao et al. (2017),
Anderson and Stulz (2017). See also, Trebbi and Xiao, 2018,
``Regulation and Market Liquidity,'' Management Science,
forthcoming; Oehmke and Zawadowski, 2017, ``The Anatomy of the CDS
Market,'' Review of Financial Studies 30(1), 80-119.
---------------------------------------------------------------------------
The SEC continues to recognize that post-crisis financial reforms
in general, and the 2013 final rule in particular, impose costs on
certain groups of market participants. Since the rule became effective,
new estimates regarding compliance burdens and new information about
the various effects of the final rule have become available. The
passage of time has also enabled an assessment of the value of
individual requirements that enable SEC oversight, such as the
requirement to report certain quantitative metrics, relative to
compliance burdens. This and other information and considerations
inform the SEC's economic analysis.
From the outset, we note that this analysis is limited to areas
within the scope of the SEC's function as the primary securities
markets regulator in the United States. In particular, the SEC's
economic analysis is focused on the potential effects of the proposed
amendments on SEC registrants, the functioning and efficiency of the
securities markets, and capital formation. Specifically, this economic
analysis generally concerns entities subject to the 2013 final rule for
which the SEC is the primary financial regulatory agency, including
SEC-registered broker-dealers, SBSDs, and RIAs.\297\ In addition, the
analysis of the covered funds provisions discusses their economic
effects on covered funds as well as the economic effects of the
Agencies modifying the definition of covered funds. Thus, the below
analysis does not consider broker-dealers, SBSDs, and investment
advisers that are not banking entities, and banking entities that are
not SEC registrants, beyond the potential spillover effects on these
entities and effects on efficiency, competition, and capital formation
in securities markets.
---------------------------------------------------------------------------
\297\ See Responses to Frequently Asked Questions Regarding the
Commission's Rule under Section 13 of the Bank Holding Company Act
(the ``Volcker Rule''), June 10, 2014; Updated March 4, 2016,
available at https://www.sec.gov/divisions/marketreg/faq-volcker-rule-section13.htm (providing background on the application of the
Commission's rule).
---------------------------------------------------------------------------
2. Overview of the Baseline
In the context of this economic analysis, the economic costs and
benefits, and the impact of the proposed amendments on efficiency,
competition, and capital formation, are considered relative to a
baseline that includes the 2013 final rule and recent legislative
amendments as applicable and current practices aimed at compliance with
these regulations.
a. Regulation
To assess the economic impact of the proposed rule, we are using as
our baseline the legal and regulatory framework as it exists at the
time of this release. Thus, the regulatory baseline for our economic
analysis includes section 13 of the BHC Act as amended by the Economic
Growth, Regulatory Relief, and Consumer Protection Act and the 2013
final rule. Further, our baseline accounts for the fact that since the
adoption of the 2013 final rule, the staffs of the Agencies have
provided FAQ responses related to the regulatory obligations of banking
entities, including SEC-regulated entities that are also banking
entities under the 2013 final rule, which likely influenced these
entities' means of compliance with the 2013 final rule.\298\ In
addition, the Federal banking agencies released a 2017 policy statement
with respect to foreign excluded funds.\299\
---------------------------------------------------------------------------
\298\ See id.
\299\ See Statement regarding Treatment of Certain Foreign Funds
under the Rules Implementing Section 13 of the Bank Holding Company
Act supra note 48.
---------------------------------------------------------------------------
Three major areas of the 2013 final rule--proprietary trading
restrictions, covered fund restrictions, and compliance requirements--
are relevant to establishing an economic baseline. First, with respect
to proprietary trading restrictions, the features of the existing
regulatory framework relevant to the baseline of this economic analysis
[[Page 33523]]
include definitions of ``trading account'' and ``trading desk;''
requirements for permissible underwriting, market making, and risk-
mitigating hedging activities; the liquidity management exclusion;
treatment of error-related trades; restrictions on transactions between
foreign banking entities and their U.S.-dealer affiliates; and the
compliance and metrics-reporting requirements for dealers affiliated
with banking entities. The potential that a RIC or a BDC would be
treated as a banking entity where the fund's sponsor is a banking
entity and holds 25% of more of the RIC or BDC's voting securities
after a seeding period also forms part of our baseline.
Second, with respect to the restrictions on covered funds, the
features of the existing regulatory framework under the 2013 final rule
relevant to the baseline include the definition of the term ``covered
fund;'' restrictions on a banking entity's relationships with covered
funds; and restrictions on underwriting, market making, and hedging
with covered funds.
Third, with respect to compliance, relevant requirements include
the 2013 final rule's compliance program requirements, including those
under Sec. __.20 and Appendix B, as well as recordkeeping and
reporting of metrics under Appendix A.
The 2013 final rule differentiates banking entities on the basis of
certain monetary thresholds, including the size of consolidated trading
assets and liabilities of their parent company. More specifically, U.S.
banking entities that have, together with affiliates and subsidiaries,
trading assets and liabilities (excluding trading assets and
liabilities involving obligations of or guaranteed by the United States
or any agency of the United States) the average gross sum of which (on
a worldwide consolidated basis) over the previous consecutive four
quarters, as measured as of the last day of each of the four prior
calendar quarters, equals $10 billion or more are currently subject to
reporting requirements of Appendix A of the 2013 final rule. Entities
below this threshold do not need to comply with Appendix A.
Additionally, banking entities with total consolidated assets of $10
billion or less as reported on December 31 of the previous 2 calendar
years that engage in covered activities qualify for the simplified
compliance regime, and banking entities that have $50 billion or more
in total consolidated assets and banking entities with over $10 billion
in consolidated trading assets and liabilities are currently subject to
the requirement to adopt an enhanced compliance program pursuant to
Appendix B.
In the sections that follow we discuss rule provisions currently in
effect, how each proposed amendment changes regulatory requirements,
and the anticipated costs and benefits of the proposed amendments.
b. Affected Participants
The SEC-regulated entities directly affected by the proposed
amendments include broker-dealers, security-based swap dealers, and
investment advisers.
i. Broker-Dealers \300\
---------------------------------------------------------------------------
\300\ Data sources included Reporting Form FR Y-9C data for
domestic holding companies on a consolidated basis and Report of
Condition and Income data for banks regulated by the Board, FDIC,
and OCC as of Q3 2017. Broker-dealer bank affiliations were obtained
from the Federal Financial Institutions Examination Council's
(FFIEC) National Information Center (NIC). Broker-dealer assets and
holdings were obtained from FOCUS Report data for Q3 2017.
---------------------------------------------------------------------------
Under the 2013 final rule, some of the largest SEC-regulated
broker-dealers are banking entities. Table 1 reports the number, total
assets, and holdings of broker-dealers by the broker-dealer's bank
affiliation.
While the 3,658 domestic broker-dealers that are not affiliated
with holding companies greatly outnumber the 138 banking entity broker-
dealers subject to the 2013 final rule, these banking entity broker-
dealers dominate non-banking entity broker-dealers in terms of total
assets (74% of total broker-dealer assets) and aggregate holdings (72%
of total broker-dealer holdings).
Table 1--Broker-Dealer Count, Assets, and Holdings by Affiliation
----------------------------------------------------------------------------------------------------------------
Holdings
Broker-dealer affiliation Number Total assets, Holdings, $mln (alternative),
$mln 301 302 $mln 303
----------------------------------------------------------------------------------------------------------------
Affected bank broker-dealers \304\............ 138 3,039,337 724,706 536,555
Other bank broker-dealers \305\............... 124 125,595 12,312 5,582
Non-bank broker-dealers....................... 3,658 929,240 270,876 151,516
-----------------------------------------------------------------
Total..................................... 3,920 4,094,172 1,007,894 693,653
----------------------------------------------------------------------------------------------------------------
Some of the changes being proposed to the 2013 final rule
differentiate banking entities on the basis of their consolidated
trading assets and liabilities.\306\ Table 2 reports the distribution
of broker-dealer banking entities' counts, assets, and holdings by
consolidated trading assets and liabilities of the (top-level) parent
firm. We estimate that 89 broker-dealer affiliates of firms with less
than $10 billion in consolidated trading assets and liabilities account
for 7% of bank-affiliated broker-dealer assets and 5% of holdings (or
3% using the alternative measure of holdings). These figures may
overestimate or underestimate the number of affected broker-dealers as
they may include broker-dealers that do not engage in various types of
covered trading activity.
---------------------------------------------------------------------------
\301\ Broker-dealer total assets are based on FOCUS report data
for ``Total Assets.''
\302\ Broker-dealer holdings are based on FOCUS report data for
securities and spot commodities owned at market value, including
bankers' acceptances, certificates of deposit and commercial paper,
state and municipal government obligations, corporate obligations,
stocks and warrants, options, arbitrage, other securities, U.S. and
Canadian government obligations, and spot commodities.
\303\ This alternative measure excludes U.S. and Canadian
government obligations and spot commodities.
\304\ This category includes all banking entity broker-dealers
except those affiliated with banks that have consolidated total
assets less than or equal to $10 billion and trading assets and
liabilities less than or equal to 5% of total assets, and those for
which bank trading asset and liability data was not available.
\305\ This category includes all banking entity broker-dealers
affiliated with firms that have consolidated total assets less than
or equal to $10 billion and trading assets and liabilities less than
or equal to 5% of total assets, as well as banking entity broker-
dealers for which bank trading asset and liability data was not
available.
\306\ See, e.g., 2013 final rule Sec. __.20(d)(1).
[[Page 33524]]
Table 2--Broker-Dealer Counts, Assets, and Holdings by Consolidated Trading Assets and Liabilities of the Banking Entity 307
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total Holdings
Consolidated trading assets and liabilities 308 Number Percentage assets, Percentage Holdings, Percentage (altern.), Percentage
$mln $mln $mln
--------------------------------------------------------------------------------------------------------------------------------------------------------
>=50bln......................................... 29 21 2,215,295 73 554,125 76 492,017 92
25bln-50bln..................................... 8 6 417,099 14 76,865 11 21,083 4
10bln-25bln..................................... 12 9 184,591 6 58,232 8 7,494 1
5bln-10bln...................................... 24 17 145,151 5 23,321 3 10,527 2
1bln-5bln....................................... 23 17 9,756 0 3,628 1 1,795 0
<=1bln.......................................... 42 30 67,446 2 8,534 1 3,638 1
-------------------------------------------------------------------------------------------------------
Total....................................... 138 100 3,039,338 100 724,705 100 536,554 100
--------------------------------------------------------------------------------------------------------------------------------------------------------
ii. Security-Based Swap Dealers
The proposed amendments may also affect bank-affiliated SBSDs. As
compliance with SBSD registration requirements is not yet required,
there are currently no registered SBSDs. However, the SEC has
previously estimated that as many as 50 entities may potentially
register as security-based swap dealers and that as many as 16 of these
entities may already be SEC-registered broker-dealers.\309\ Given our
analysis of DTCC Derivatives Repository Limited Trade Information
Warehouse (``TIW'') transaction and positions data on single-name
credit-default swaps, we preliminarily believe that all entities that
may register with the SEC as SBSDs are bank-affiliated firms, including
those that are SEC-registered broker-dealers. Therefore, we
preliminarily estimate that, in addition to the bank-affiliated SBSDs
that are already registered as broker-dealers and included in the
discussion above, as many as 34 other bank-affiliated SBSDs may be
affected by the proposed amendments.
---------------------------------------------------------------------------
\307\ This analysis excludes SEC-registered broker-dealers
affiliated with firms that have consolidated total assets less than
or equal to $10 billion and trading assets and liabilities less than
or equal to 5% of total assets, as well as firms for which bank
trading asset and liability data was not available.
\308\ Consolidated trading assets and liabilities are estimated
using information reported in form Y-9C data. These estimates
exclude from the definition of consolidated trading assets and
liabilities Treasury securities--we subtract from the sum of total
trading assets and liabilities reported in items BHCK3545 and
BHCK3547 trading assets that are U.S. Treasury securities as
reported in item BHCK3531 and calculate average trading assets and
liabilities using 2016Q4 through 2017Q3 data. However, our estimates
do not exclude agency securities as such information is not
otherwise available. Thus, these figures may overestimate or
underestimate the number of affected bank affiliated broker-dealers.
We also note that we do not have data on worldwide consolidated
trading assets and liabilities of foreign banking entities with
which some SEC registrants are affiliated, and consolidated trading
assets and liabilities for such foreign banking entities are
calculated based on their U.S. operations. Thus, the figures may
overestimate or underestimate the number of affected bank affiliated
broker-dealers.
\309\ See SBSD and MSP Registration Release, supra note 284.
---------------------------------------------------------------------------
Importantly, capital and other substantive requirements for SBSDs
under Title VII of the Dodd-Frank Act have not yet been adopted. We
recognize that firms may choose to move security-based swap trading
activity into (or out of) an affiliated bank or an affiliated broker-
dealer instead of registering as a standalone SBSD, if bank or broker-
dealer capital and other regulatory requirements are less (or more)
costly than those that may be imposed on SBSDs under Title VII. As a
result, the above figures may overestimate or underestimate the number
of SBSDs that are not broker-dealers and that may become SEC-registered
entities that would be affected by the proposed amendments.
Quantitative cost estimates are provided separately for affected
broker-dealers and potential SBSDs.
iii. Private Funds and Private Fund Advisers \310\
---------------------------------------------------------------------------
\310\ These estimates are calculated from Form ADV data as of
March 31, 2018. We define an investment adviser as a ``private fund
adviser'' if it indicates that it is an adviser to any private fund
on Form ADV Item 7.B. We define an investment adviser as a ``banking
entity RIA'' if it indicates on Form ADV Item 6.A.(7) that it is
actively engaged in business as a bank, or it indicates on Form ADV
Item 7.A.(8) that it has a ``related person'' that is a banking or
thrift institution. For purposes of Form ADV, a ``related person''
is any advisory affiliate and any person that is under common
control with the adviser. We recognize that the definition of
``control'' for purposes of Form ADV, which is used in identifying
related persons on the form, differs from the definition of
``control'' under the BHC Act. In addition, this analysis does not
exclude SEC-registered investment advisers affiliated with banks
that have consolidated total assets less than or equal to $10
billion and trading assets and liabilities less than or equal to 5%
of total assets. Thus, these figures may overestimate or
underestimate the number of banking entity RIAs.
---------------------------------------------------------------------------
In this section, we focus on RIAs advising private funds. Using
Form ADV data, Table 3 reports the number of RIAs advising private
funds by fund type, as those types are defined in Form ADV. Table 4
reports the number and gross assets of private funds advised by RIAs
and separately reports these statistics for banking entity RIAs. As can
be seen from Table 3, the two largest categories of private funds
advised by RIAs are hedge funds and private equity funds.
Banking entity RIAs advise a total of 4,250 private funds with
approximately $2 trillion in gross assets. Using Form ADV data, we
observe that banking entity RIAs' gross private fund assets under
management is concentrated in hedge funds and private equity funds. We
estimate on the basis of this data that banking entity RIAs advise 947
hedge funds with approximately $616 billion in gross assets and 1,282
private equity funds with approximately $350 billion in assets. While
banking entity RIAs are subject to all of section 13's restrictions,
because RIAs do not typically engage in proprietary trading, we
preliminarily believe that they will not be impacted by the proposed
amendments related to proprietary trading.
Table 3--SEC-Registered Investment Advisers Advising Private Funds by
Fund Type 311
------------------------------------------------------------------------
Banking entity
Fund type All RIA RIA
------------------------------------------------------------------------
Hedge Funds............................. 2,691 173
Private Equity Funds.................... 1,538 90
[[Page 33525]]
Real Estate Funds....................... 486 56
Securitized Asset Funds................. 222 43
Venture Capital Funds................... 173 16
Liquidity Funds......................... 46 7
Other Private Funds..................... 1,043 148
-------------------------------
Total Private Fund Advisers......... 4,660 308
------------------------------------------------------------------------
Table 4--The Number and Gross Assets of Private Funds Advised by SEC-Registered Investment Advisers 312
----------------------------------------------------------------------------------------------------------------
Number of private funds Gross assets, $bln
---------------------------------------------------------------
Fund type Banking entity Banking entity
All RIA RIA All RIA RIA
----------------------------------------------------------------------------------------------------------------
Hedge Funds..................................... 10,329 947 7,081 616
Private Equity Funds............................ 13,588 1,282 2,919 350
Real Estate Funds............................... 3,252 323 564 84
Securitized Asset Funds......................... 1,707 360 562 120
Liquidity Funds................................. 1,073 29 109 190
Venture Capital Funds........................... 76 42 291 2
Other Private Funds............................. 4,337 1,268 1,568 689
---------------------------------------------------------------
Total Private Funds......................... 34,359 4,250 13,093 2,052
----------------------------------------------------------------------------------------------------------------
Banking entity RIAs advise a total of 4,250 private funds with
approximately $2 trillion in gross assets. Using Form ADV data, we
observe that banking entity RIAs' gross private fund assets under
management is concentrated in hedge funds and private equity funds. We
estimate on the basis of this data that banking entity RIAs advise 947
hedge funds with approximately $616 billion in gross assets and 1,282
private equity funds with approximately $350 billion in assets. While
banking entity RIAs are subject to all of section 13's restrictions,
because RIAs do not typically engage in proprietary trading, we
preliminarily believe that they will not be impacted by the proposed
amendments related to proprietary trading.
---------------------------------------------------------------------------
\311\ This table includes only the advisers that list private
funds on Section 7.B.(1) of Form ADV. The number of advisers in the
``Any Private Fund'' row is not the sum of the rows that follow
since an adviser may advise multiple types of private funds. Each
listed private fund type (e.g., real estate fund, liquidity fund) is
defined in Form ADV, and those definitions are the same for purposes
of the SEC's Form PF.
\312\ Gross assets include uncalled capital commitments on Form
ADV.
---------------------------------------------------------------------------
iv. Registered Investment Companies
Based on SEC filings and public data, we estimate that, as of
January 2018, there were approximately 15,500 RICs \313\ and 100 BDCs.
Although RICs and BDCs are generally not banking entities themselves
subject to the 2013 final rule, they may be indirectly affected by the
2013 final rule and the proposed amendments to the extent that their
advisers are banking entities. For instance, banking entity RIAs or
their affiliates may reduce their level of investment in the funds they
advise, or potentially close these funds, to avoid these funds becoming
banking entities themselves. As discussed in more detail in section
III.A, however, the Agencies have made clear that nothing in the
proposal would modify the application of the staff FAQs discussed
above, and the Agencies will not treat RICs (or FPFs) that meet the
conditions included in the applicable staff FAQs as banking entities or
attribute their activities and investments to the banking entity that
sponsors the fund or otherwise may control the fund under the
circumstances set forth in the FAQs. In addition, and also as discussed
in more detail in section III.A, to accommodate the pendency of the
proposal, for an additional period of one year until July 21, 2019, the
Agencies will not treat qualifying foreign excluded funds that meet the
conditions included in the policy statement discussed above as banking
entities or attribute their activities and investments to the banking
entity that sponsors the fund or otherwise may control the fund under
the circumstances set forth in the policy statement.
---------------------------------------------------------------------------
\313\ For the purposes of this analysis, the term RIC refers to
the fund or series, not the legal entity.
---------------------------------------------------------------------------
3. Economic Effects
a. Treatment of Entities Based on the Size of Trading Assets and
Liabilities
i. Costs and Benefits
The proposal categorizes banking entities into three groups on the
basis of the size of their trading activity: (1) Banking entities with
significant trading assets and liabilities, (2) banking entities with
moderate trading assets and liabilities, and (3) banking entities with
limited trading assets and liabilities. Banking entities with
significant trading assets and liabilities are defined as those that
have, together with affiliates and subsidiaries, trading assets and
liabilities (excluding trading assets and liabilities involving
obligations of or guaranteed by the United States or any agency of the
United States) the average gross sum of which over the previous
consecutive four quarters, as measured as of the last day of each of
the four previous calendar quarters, equaling or exceeding $10
billion.\314\ Banking entities with limited trading assets and
liabilities are defined as those that have, together with affiliates
and subsidiaries on a worldwide consolidated basis, trading assets and
liabilities (excluding
[[Page 33526]]
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 over the previous consecutive four quarters, as
measured as of the last day of each of the four previous calendar
quarters, is less than $1 billion. Finally, banking entities with
moderate trading assets and liabilities are defined as those that are
neither banking entities with significant trading assets and
liabilities nor banking entities with limited trading assets and
liabilities.
---------------------------------------------------------------------------
\314\ With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, this
threshold for having significant trading assets and liabilities
would apply based on the trading assets and liabilities of the
combined U.S. operations, including all subsidiaries, affiliates,
branches and agencies.
---------------------------------------------------------------------------
We further refer to SEC-registered broker-dealer, investment
adviser, and SBSD affiliates of banking entities with significant
trading assets and liabilities as ``Group A'' entities, to affiliates
of banking entities with moderate trading assets and liabilities as
``Group B'' entities, and to affiliates of banking entities with
limited trading assets and liabilities as ``Group C'' entities.
Under the proposed amendments, Group A entities would be required
to comply with a streamlined but comprehensive version of the 2013
final rule's compliance program requirements, as discussed below. Group
B entities would be subject to reduced requirements and an even more
tailored approach in light of their smaller and less complex trading
activities. The burdens are further reduced for Group C entities, for
which the proposed rule establishes presumed compliance, which can be
rebutted by the Agencies. We discuss the economic effects of each of
the substantive amendments on these groups of entities in the sections
that follow.
This economic analysis is focused on the expected economic effects
of the proposed amendments on SEC registrants. Table 2 in the economic
baseline quantifies broker-dealer activity by gross trading assets and
liabilities of banking entities they are affiliated with. We estimate
that there are approximately 89 broker-dealers affiliated with firms
that have less than $10 billion in consolidated trading assets and
liabilities (Group B and Group C broker-dealers). Group B and Group C
broker-dealers account for approximately 7% of assets and 5% (or 3% on
the basis on the alternative measure of holdings) of total bank broker-
dealer holdings.
The primary effects of the proposed amendments for SEC registrants
are reduced compliance burdens for Group B and Group C entities, as
discussed in more detail in later sections. To the extent that the
compliance costs of Group B and Group C entities are currently passed
along to customers and counterparties, some of the cost reductions for
these entities associated with the proposed amendments may flow through
to counterparties and clients in the form of reduced transaction costs
or a greater willingness to engage in activity, including
intermediation that facilitates risk-sharing.
The proposed $10 billion threshold would leave firms with moderate
trading assets and liabilities with reduced compliance program
requirements and more tailored supervision. The proposed $1 billion
threshold would leave firms with limited trading assets and liabilities
presumed compliant with all proprietary trading and covered fund
activity prohibitions. We note that, from above, Group B and Group C
broker-dealers currently account for only 3% to 5% of total bank
broker-dealer holdings. To the extent that holdings reflect risk
exposure resulting from trading activity, current trading activity by
Group B and Group C entities may represent lower risks than the risks
posed by covered trading of Group A entities.
We recognize that some Group B and Group C entities that currently
exhibit low levels of trading activity because of the costs of
compliance may respond to the proposed amendments by increasing their
trading assets and liabilities while still remaining under the $10
billion and $1 billion thresholds at the holding company level.
Increases in aggregate risk-taking by Group B and Group C entities may
be magnified if trading activity becomes more highly correlated among
such entities, or dampened if trading activity becomes less correlated
among such entities. Since it is difficult to estimate the number of
Group B and Group C entities that may increase their risk-taking and
the degree to which their trading activity would be correlated, the
implications of this effect for aggregate risk-taking and capital
market activity are unclear.
Such shifts in risk-taking may have two competing effects. On the
one hand, if Group B and Group C entities are able to bear risk at a
lower cost than their customers, increased risk-taking could promote
secondary market trading activity and capital formation in primary
markets, and increase access to capital for issuers. On the other hand,
depending on the risk-taking incentives of Group B and Group C firms,
increased risk-taking may result in increased moral hazard and market
fragility, could exacerbate conflicts of interest between banking
entities and their customers, and could ultimately negatively impact
issuers and investors. However, we note that the proposed amendments
are focused on tailoring the compliance regime based on the amount of
covered activity engaged in by each banking entity, and all banking
entities would still be subject to the prohibitions related to such
covered activities. Thus, the magnitude of increased moral hazard,
market fragility, and the severity of conflicts of interest effects may
be attenuated.
In response to the proposed amendments, trading activity that was
once consolidated within a small number of unaffiliated banking
entities may become fragmented among a larger number of unaffiliated
banking entities that each ``manage down'' their trading books under
the $10 billion and $1 billion trading asset and liability thresholds
to enjoy reduced hedging compliance and documentation requirements and
a less costly compliance and reporting regime described in sections
V.D.3.c, V.D.3.d, and V.D.3.i. The extent to which banking entities may
seek to manage down their trading books will likely depend on the size
and complexity of each banking entity's trading activities and
organizational structure, along with those of its affiliated entities,
as well as forms of potential restructuring and the magnitude of
expected compliance savings from such restructuring relative to the
cost of restructuring. We anticipate that the incentives to manage the
trading book under the $10 billion and $1 billion thresholds may be
strongest for those holding companies that are just above the
thresholds. Such management of the trading book may reduce the size of
trading activity of some banking entities and reduce the number of
banking entities subject to more stringent hedging, compliance, and
reporting requirements. At the same time, to the degree that the
proposed amendments incentivize banking entities to have smaller
trading books, they may mitigate moral hazard and reduce market impacts
from the failure of a given banking entity.
ii. Efficiency, Competition, and Capital Formation
The 2013 final rule currently imposes compliance burdens that may
be particularly significant for smaller market participants. Moreover,
such compliance burdens may be passed along to counterparties and
customers in the form of higher costs, reduced capital formation, or a
reduced willingness to transact. For example, one commenter estimated
that the funding cost for an average non-financial firm may have
increased by as much as $30 million after the 2013 final
[[Page 33527]]
rule's implementation.\315\ At the same time, and as discussed above in
section V.D.1, the SEC continues to recognize that the 2013 final rule
may have yielded important qualitative benefits, such as reducing moral
hazard and potential incentive conflicts that could be posed by certain
types of proprietary trading by dealers, and enhancing oversight and
supervision.
---------------------------------------------------------------------------
\315\ See supra note 18.
---------------------------------------------------------------------------
On one hand, as a result of the proposed amendments, Group B and
Group C entities might enjoy a competitive advantage relative to
similarly situated Group A and Group B entities respectively. As noted,
firms that are close to the $10 billion threshold may actively manage
their trading book to avoid triggering stricter requirements, and some
firms above the threshold may seek to manage down the trading activity
to qualify for streamlined treatment under the proposed amendments. As
a result, the proposed amendments may result in greater competition
between Group B and Group A entities around the $10 billion threshold,
and similarly, between Group B and Group C entities around the $1
billion threshold. On the other hand, to the extent that Group B and
Group C entities increase risk-taking as they compete with Group A and
Group B entities, respectively, investors may demand additional
compensation for bearing financial risk. A higher required rate of
return and higher cost of capital could therefore offset potential
competitive advantages for Group B and Group C entities.
We recognize that cost savings to Group B and Group C entities
related to the reduced hedging documentation requirements and
compliance requirements described in sections V.D.3.d and V.D.3.i may
be partially or fully passed along to clients and counterparties. To
the extent that hedging documentation and compliance requirements for
Group B and Group C entities are currently resulting in a reduced
willingness to make markets or underwrite placements, the proposed
amendments may facilitate trading activity and risk-sharing, as well as
capital formation and reduced costs of access to capital. Crucially,
the proposed amendments do not eliminate substantive prohibitions under
the 2013 final rule but create a simplified compliance regime for
entities affiliated with firms without significant trading assets and
liabilities. Thus, the 2013 final rule's restrictions on proprietary
trading and covered funds activities will continue to apply to all
affected entities, including Group B and Group C entities.
iii. Alternatives
The Agencies could have taken alternative approaches. For example,
the proposed rule could have used other values for thresholds for total
consolidated trading assets and liabilities in the definition of
entities with significant trading assets and liabilities. As noted in
the discussion of the economic baseline, using different thresholds
would affect the scope of application of the hedging documentation,
compliance program and metrics-reporting requirements by changing the
number and size of affected dealers. For instance, using a $1 billion
or a $5 billion threshold in a definition of significant trading assets
and liabilities would scope a larger number of entities into Group A,
as compared to the proposed $10 billion threshold, thereby subjecting a
larger share of the dealer and investment adviser industries to six-
pillar compliance obligations. However, we continue to recognize that
trading activity is heavily concentrated in the right tail of the
distribution, and using a lower threshold would not significantly
increase the volume of trading assets and liabilities scoped into the
Group A regime. For example, Table 2 shows that 65 broker-dealers
affiliated with banking entities that have less than $5 billion in
consolidated trading assets and liabilities and are subject to section
13 of the BHC Act as amended by the Economic Growth, Regulatory Relief,
and Consumer Protection Act account for only 2.5% of bank-affiliated
broker-dealer assets and between 1.7% and 1% of holdings.
Alternatively, 42 broker-dealer affiliates of firms that have less than
$1 billion in consolidated trading assets and liabilities and are
subject to section 13 of the BHC Act account for only 2% of bank-
affiliated broker-dealer assets and 1% of holdings. At the same time,
with a lower threshold, more banking entities would face higher
compliance burdens and related costs.
The Agencies also could have proposed a percentage-based threshold
for determining whether a banking entity has significant trading assets
and liabilities. For example, the proposed amendment could have relied
exclusively on threshold where banking entities are considered to be
entities with significant trading assets and liabilities if the firm's
total consolidated trading assets and liabilities are above a certain
percentage (for example, 10% or 25%) of the firm's total consolidated
assets. Under this alternative, a greater number of entities may
benefit from lower compliance costs and a streamlined regime for Group
B entities. However, under this approach, even firms in the extreme
right tail of the trading asset distribution could be considered
without significant trading assets and liabilities if they are also in
the extreme right tail of the total assets distribution. Thus, without
placing an additional limit on total assets within such regime,
entities with the largest trading books may be scoped into the Group B
regime if they also have a sufficiently large amount of total
consolidated assets, while entities with significantly smaller trading
books could be categorized as Group A entities if they have fewer
assets overall.
Alternatively, the Agencies could have relied on a threshold based
on total assets. However, a threshold based on total assets may not be
as meaningful as a threshold based on trading assets and liabilities
being proposed here when considered in the context of section 13 of the
BHC Act. A threshold based on total assets would scope in entities
based merely on their balance sheet size, even though they may have
little or no trading activity, notwithstanding the fact that the moral
hazard and conflicts of interest that section 13 of the BHC Act are
intended to address are more likely to arise out of such trading
activity (and not necessarily from the banking entity size, as measured
by total consolidated assets). However, it is possible that losses on
small trading portfolios can be amplified through their effect on non-
trading assets held by a firm. To that extent, a threshold based on
total assets may be useful in potentially capturing both direct and
indirect losses that originate from trading activity of a holding
company.
The Agencies also could have based the thresholds on the level of
total revenues from permitted trading activities. To the extent that
revenues could be a proxy for the structure of a banking entity's
business and the focus of its operations, this alternative may apply
more stringent compliance requirements to those entities profiting the
most from covered activities. However, revenues from trading activity
fluctuate over time, rising during economic booms and deteriorating
during crises and liquidity freezes. As a result, under the
alternative, a banking entity that is scoped in the regulatory regime
during normal times may be scoped out during the time of market stress
due to a decrease in the revenues from permitted activities. That is,
under such alternative, the weakest compliance regime may be applied to
banking entities with the largest trading books in times of acute
market stress, when the performance of trading desks is deteriorating
and the underlying
[[Page 33528]]
requirements of the 2013 final rule may be the most valuable.
Finally, the Agencies could have excluded from the definition of
entities with significant trading assets and liabilities those entities
that may be affiliated with a firm with over $10 billion in
consolidated trading assets and liabilities but that are operated
separately and independently from its affiliates and that have total
trading assets and liabilities (excluding trading assets and
liabilities involving obligations of or guaranteed by the United States
or any agency of the United States) under $10 billion. We do not have
data on the number of dealers that are operated ``separately and
independently'' from affiliated entities with significant trading
assets and liabilities. However, as shown in Table 5, this alternative
could decrease the scope of application of the Group A regime.
Table 5--Broker-Dealer Assets and Holdings by Gross Trading Asset and Liability Threshold of Affiliated Banking
Entities
----------------------------------------------------------------------------------------------------------------
Holdings
Type of broker-dealer Number Total assets Holdings (altern.)
($mln) ($mln) ($mln)
----------------------------------------------------------------------------------------------------------------
Holdings >=$10bln and affiliated with firms with 14 2,538,656 668,283 515,443
gross trading assets and liabilities >=$10bln..
Holdings <$10bln and affiliated with firms with 35 278,329 20,940 5,152
gross trading assets and liabilities >=$10bln..
Affiliated with firms with gross trading assets 89 222,352 35,483 15,960
and liabilities <$10bln \316\..................
---------------------------------------------------------------
Total....................................... 138 3,039,337 724,706 536,555
----------------------------------------------------------------------------------------------------------------
This alternative would increase the number of entities able to
avail themselves of the reduced compliance, documentation and metrics-
reporting requirements, potentially resulting in cost reductions
flowing through to customers and counterparties. At the same time, this
alternative would permit greater risk-taking by entities affiliated
with firms that have gross trading assets and liabilities in excess of
$10 billion. In addition, it could encourage such firms to fragment
their trading activity, for instance, across multiple dealers, and
operate them ``separately and independently,'' thereby relieving such
firms of the requirement to comply with the hedging, compliance, and
reporting regime of the 2013 final rule. This alternative may,
therefore, reduce the regulatory oversight and compliance benefits of
the full hedging, documentation, reporting, and compliance requirements
for Group A banking entities. The feasibility and costs of such
fragmentation would depend, in part, on organizational complexity of a
firm's trading activity, the architecture of trading systems, the
location and skillsets of personnel across various dealers affiliated
with such entities, and current inter-affiliate hedging and risk
mitigation practices.
---------------------------------------------------------------------------
\316\ This category excludes SEC-registered broker-dealers
affiliated with banks that have consolidated total assets less than
or equal to $10 billion and trading assets and liabilities less than
or equal to 5% of total assets, as well as firms for which bank
trading asset and liability data was not available.
---------------------------------------------------------------------------
b. Proprietary Trading
i. Trading Account
A. Costs and Benefits
Under the 2013 final rule, proprietary trading is defined as
engaging as principal for the ``trading account'' of a banking
entity.\317\ Thus, the definition of the trading account effectively
determines the trading activity that falls within the scope of the 2013
final rule prohibitions and the compliance regime associated with such
activity. The current definition of trading account has three prongs,
including the registered dealer prong. As discussed elsewhere in this
Supplementary Information, the proposed amendments introduce certain
changes to the trading account test. However, the proposal does not
remove or modify the registered dealer prong. As a result, the proposed
definition of ``trading account'' would continue to automatically
include transactions in financial instruments by a registered dealer,
swap dealer, or security-based swap dealer, if the purchase or sale is
made in connection with the activity that requires the entity to be
registered as such.\318\ Thus, most (if not substantially all) trading
activity by SEC-registered dealers should continue to be captured by
the ``trading account'' of a banking entity, notwithstanding any of the
changes made to the definition.
---------------------------------------------------------------------------
\317\ See 2013 final rule Sec. __.3(b).
\318\ See 2013 final rule Sec. __.3(b)(1)(iii).
---------------------------------------------------------------------------
We recognize the possibility that some market participants may
engage in transaction activity that does not trigger a dealer
registration requirement. Under the baseline, such activity would be
scoped into the ``trading account'' definition by the short-term prong
and the rebuttable presumption by virtue of the fact that most
transactions by a dealer are likely to be indicative of short-term
intent as noted in the 2013 final rule.\319\ We preliminarily believe
that, under the proposal, such trading would likely be included in the
trading account definition under the new prong on the basis of
accounting treatment in reference to whether a financial instrument (as
defined in the 2013 final rule and unchanged by the proposal) is
recorded at fair value on a recurring basis under applicable accounting
standards. In addition, persons engaging in the type and volume of
activity that would be scoped in under the proposed accounting prong
are likely engaged in the business of buying and selling securities for
their own account as part of regular business, which would trigger
broker-dealer (depending on the volume of activity) or SBSD
registration requirements.
---------------------------------------------------------------------------
\319\ See 79 FR at 5549 (``The Agencies believe the scope of the
dealer prong is appropriate because, as noted in the proposal,
positions held by a registered dealer in connection with its dealing
activity are generally held for sale to customers upon request or
otherwise support the firm's trading activities (e.g., by hedging
its dealing positions), which is indicative of short term
intent.'').
---------------------------------------------------------------------------
To the extent that the proposed amendments increase (or decrease)
the scope of trading activity that falls under the proprietary trading
prohibitions of the 2013 final rule, the amendments would increase (or
decrease) the economic costs, benefits, and tradeoffs outlined in
section V.D.1. However, we preliminarily believe that the largest share
of dealing activity subject to SEC oversight is already captured by the
registered dealer prong and that the
[[Page 33529]]
economic effects of the proposed amendments to the definition of the
trading account on SEC-registered entities may be de minimis.
Therefore, we do not estimate any additional reporting costs for SEC
registrants.
The Agencies also propose to include a reservation of authority
allowing for determination, on a case-by-case basis, with appropriate
notice and response procedures, that any purchase or sale of one or
more financial instruments by a banking entity for which it is the
primary financial regulatory agency either ``is'' or ``is not'' for the
trading account. While the Agencies recognize that the use of objective
factors to define proprietary trading is intended to provide bright
lines that simplify compliance, the Agencies also recognize that this
approach may, in some circumstances, produce results that are either
underinclusive or overinclusive with respect to the definition of
proprietary trading. The proposed reservation of authority may add
uncertainty for banking entities about whether a particular transaction
could be deemed as a proprietary trade by the regulating agency, which
may affect the banking entity's decision to engage in transactions that
are currently not included in the definition of the trading account. As
discussed in section V.B,\320\ notice and response procedures related
to the reservation of authority provision may cost as much as $20,319
for SEC-registered broker-dealers, and $5,006 for entities that may
choose to register with the SEC as SBSDs.\321\
---------------------------------------------------------------------------
\320\ For the purposes of the burden estimates in this release,
we are assuming the cost of $409 per hour for an attorney, from
SIFMA's ``Management & Professional Earnings in the Securities
Industry 2013,'' modified to account for an 1800-hour work year and
multiplied by 5.35 to account for bonuses, firm size, employee
benefits, and overhead, and adjusted for inflation.
\321\ We preliminarily believe that the burden reduction for
SEC-regulated entities will be a fraction of the burden reduction
for the holding company as a whole. We estimate the ratio on the
basis of the fraction of total assets of broker-dealer affiliates of
banking entities relative to the total consolidated assets of parent
holding companies at approximately 0.18. To the extent that
compliance burdens represent a fixed cost that does not scale with
assets, or if the role and compliance burdens of entities that may
register with the SEC as SBSDs may differ from those of broker-
dealers, these figures may overestimate or underestimate compliance
cost reductions for SEC-registered entities. Reporting burden for
broker-dealers: 2 Hours per firm per year x 0.18 weight x (Attorney
at $409 per hour) x 138 firms = $20,319. Reporting burden for
entities that may register as SBSDs: 2 hours per firm per year x
0.18 weight x (Attorney at $409 per hour) x 34 firms = $5,006.
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B. Alternatives
Specific Activities
The Agencies could have taken the approach of excluding specific
trading activities from the scope of the proprietary trading
prohibitions. For example, the Agencies could exclude transactions in
derivatives on government securities, transactions in foreign sovereign
debt and derivatives on foreign sovereign debt, and transactions
executed by SEC-registered dealers on behalf of their asset management
customers.
The 2013 final rule exempts all trading in domestic government
obligations and trading in foreign government obligations under certain
conditions; however, derivatives referencing such obligations-including
derivatives portfolios that can replicate the payoffs and risks of such
government obligations-are not exempted. Therefore, existing
requirements reduce the flexibility of banking entities to engage in
asset-liability management and treat two groups of financial
instruments that have similar risks and payoffs differently. Excluding
derivatives transactions on government obligations from the trading
account definition could reduce costs to market participants and
provide greater flexibility in their asset-liability management. This
alternative could also result in increased volume of trading in markets
for derivatives on government obligations, such as Treasury futures. We
recognize, nonetheless, that derivatives portfolios that reference an
obligation, including Treasuries, can be structured to magnify the
economic exposure to fluctuations in the price of the reference
obligation. Moreover, derivatives transactions involve counterparty
credit risk not present in transactions in reference obligations
themselves. Since the alternative would exclude all derivatives
transactions on government obligations, and not just those that are
intended to mitigate risk, this alternative could permit banking
entities to increase their exposure to counterparty, interest rate, and
liquidity risk.
Length of the Holding Period
In addition, the current registered dealer prong does not condition
the trading account definition for registered dealers on the length of
the holding period. This is because, as noted in the 2013 final rule,
positions held by a registered dealer in connection with its dealing
activity are generally held for sale to customers upon request or
otherwise support the firm's trading activities (e.g., by hedging its
dealing positions), which is indicative of short term intent.\322\ As
an alternative, the Agencies could have modified the registered dealer
prong of the trading account definition to include only ``near-term
trading,'' e.g., positions held for less than 60, 90, or 120 days. This
alternative would likely narrow the scope of application of the
substantive proprietary trading prohibitions to a smaller portion of a
banking entity's activities.
---------------------------------------------------------------------------
\322\ 79 FR at 5549.
---------------------------------------------------------------------------
Under this alternative, dealers affiliated with banking entities
would be able to amass large trading positions at the ``near-term
definition'' boundary (e.g., for 61, 91, or 121 days) to take advantage
of a directional market view, to profit from mispricing in an
instrument, or to collect a liquidity premium in a particular
instrument. This may significantly increase risk-taking and moral
hazard in the activities of dealers affiliated with banking entities.
However, as this alternative could stimulate an increase in potentially
impermissible proprietary trading by these dealers, the volume of
trading activity in certain instruments and liquidity in certain
markets may increase.
We also note that the temporal thresholds necessary to implement
such a ``short-term'' trading alternative would be difficult to
quantify and may have to vary by product, asset class, and aggregate
market conditions, among other factors. For instance, the markets for
large cap equities and investment grade corporate bonds have different
structures, types of participants, latency of trading, and liquidity
levels. Therefore, an appropriate horizon for ``short-term'' positions
will likely vary across these markets. Similarly, the ability to
transact quickly differs under strong macroeconomic conditions and in
times of stress. A meaningful implementation of this alternative would
likely require calibrating and recalibrating complex thresholds to
exempt non-near-term proprietary trading and so could introduce
additional uncertainty and increase the compliance burdens on SEC-
regulated banking entities.
``Trading Desk'' Definition
The definition of ``trading desk'' is an important component of the
implementation of the 2013 final rule in that certain requirements,
such as those applicable to the underwriting and market-making
exemptions, and the metrics-reporting requirements apply at the level
of the trading desk. Under the current requirements, a trading desk is
defined as the smallest discrete unit of organization of a banking
entity that purchases or sells financial instruments for the trading
account of the banking
[[Page 33530]]
entity or an affiliate thereof. The 2013 final rule recognizes that
underwriting and market-making activities are essential financial
services that facilitate capital formation and promote liquidity, and
that metrics reporting may facilitate the SEC oversight of banking
entities. The application of these rules at the trading desk level may
facilitate monitoring and review of compliance with the underwriting
and market-making exemptions and allow for better identification of the
aggregate trading volume that must be reviewed for consistency with the
underwriting, market making, and metrics-reporting requirements.
At the same time, some market participants have noted that the
trading desk designation under the 2013 final rule may be unduly
burdensome and costly and may have engendered inefficient fragmentation
of trading activity. For example, some market participants report an
average of 95 trading desks engaged in permitted activities.\323\ Since
under the 2013 final rule metrics reporting is required at the trading
desk level, such fragmentation may result in operational inefficiencies
and decentralized compliance programs, with some participants currently
reporting as many as 5,000,000 data points per entity per filing.\324\
---------------------------------------------------------------------------
\323\ See supra note 18.
\324\ See id.
---------------------------------------------------------------------------
The Agencies are requesting comment on whether the trading desk
definition should be amended to refer to a less granular ``business
unit'' or a ``unit designed to establish efficient trading for a market
sector.'' This approach would allow a trading desk to be defined on the
basis of the same criteria that are used to establish trading desks for
other operational, management, and compliance purposes, which typically
depend on the type of trading activity, asset class, product line
offered, and individual banking entity structure and internal
compliance policies and procedures. For example, the Agencies could
define the trading desk as a unit of organization of a banking entity
that engages in purchasing or selling of financial instruments for the
trading account of the banking entity or an affiliate thereof that is
structured by a banking entity to establish efficient trading for a
market sector, organized to ensure appropriate setting, monitoring, and
review of trading and hedging limits, and characterized by a clearly
defined unit of personnel. This would provide banking entities greater
flexibility in determining their own optimal organizational structure
and allow banking entities organized with various degrees of complexity
to reflect their organizational structure in the trading desk
definition. This alternative could reduce operational costs from
fragmentation of trading activity and compliance program requirements,
as well as enable more streamlined metrics reporting.
On the other hand, under this alternative, a banking entity may be
able to aggregate impermissible proprietary trading with permissible
activity (e.g., underwriting, market making, or hedging) into the same
trading desk and consequently take speculative positions under the
guise of permitted activities. To the extent that this alternative
would allow banking entities to use a highly aggregated definition of a
trading desk, it may increase moral hazard and the risks that the
prohibitions of section 13 of the BHC Act aim to address. The SEC does
not have data on operating and compliance costs because of the
fragmentation incurred by SEC-regulated banking entities, or data on
the organizational complexity of such dealers, and the extent of
variation therein.
ii. Liquidity Management Exclusion
Liquidity management serves an important purpose in ensuring
banking entities have sufficient resources to meet their short-term
operational needs. Under the 2013 final rule, certain activities
related to liquidity management are excluded from the scope of the
proprietary trading prohibition under some conditions.\325\ The current
exclusion covers 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 that meets a number of requirements.
Moreover, current rules require 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.
---------------------------------------------------------------------------
\325\ See 2013 final rule Sec. __.3(d)(3).
---------------------------------------------------------------------------
The Agencies recognize that the liquidity management exclusion may
be narrow and that the trading account definition may scope in routine
asset-liability management and commercial-banking related activities
that trigger the rebuttable presumption or the market-risk capital
prong. Accordingly, the Agencies are proposing to expand the liquidity
management exclusion. Specifically, the proposed amendments would
broaden the liquidity management exclusion such that it would apply not
only to securities, but also to foreign exchange forwards and foreign
exchange swaps (as defined in the Commodity Exchange Act), and to
physically settled cross-currency swaps.
Under the proposed amendment, SEC-regulated banking entities would
face lower burdens and enjoy greater flexibility in currency-risk
management as part of their overall liquidity management plans. To the
degree that the 2013 final rule may be restricting liquidity-risk
management by banking entities, and to the extent that these effects
impact their trading activity, the proposed amendment could facilitate
more efficient risk management, greater secondary market activity, and
more capital formation in primary markets. However, in the absence of
other conditions governing reliance on the liquidity management
exclusion, this flexibility may also lead to currency derivatives
exposures, including potentially very large exposures, being scoped out
of the trading account definition and the ensuing substantive
prohibitions of the 2013 final rule. In addition, some entities may
seek to rely on this exclusion while engaging in speculative currency
trading, which may increase their risk-taking and moral hazard and
reduce the effectiveness of regulatory oversight. While the proposed
amendment broadens the set of instruments that banking entities may use
to manage liquidity, the proposed reservation of authority would
provide the Agencies with the ability to determine whether a particular
purchase or sale of a financial instrument by a banking entity either
is or is not for the trading account.
iii. Error Trades
The 2013 final rule excludes from the proprietary trading
prohibition certain ``clearing activities'' by banking entities that
are members of clearing agencies, derivatives clearing organizations,
or designated financial market utilities. Specifically, such clearing
activities are defined to include, among others, any purchase or sale
necessary to correct error trades made by, or on behalf of, customers
with respect to customer transactions that are cleared, provided the
purchase or sale is conducted in accordance with certain regulations,
rules, or procedures. However, the current exclusion for error trades
is applicable only to clearing members with respect to cleared customer
transactions.\326\
---------------------------------------------------------------------------
\326\ See 2013 final rule Sec. __.3(e)(7).
---------------------------------------------------------------------------
The proposed amendments would exclude trading errors and subsequent
correcting transactions from the definition of proprietary trading. The
[[Page 33531]]
proposed amendments primarily impact SEC-registered dealers that are
not clearing members with respect to all customer trades and dealers
that are clearing members with respect to customer trades that are not
cleared. Table 6 reports information about broker-dealer count, assets,
and holdings, by affiliation and clearing type.
Table 6--Broker-Dealer Assets and Holdings by Clearing Status \327\
----------------------------------------------------------------------------------------------------------------
Holdings
Broker-dealers subject to section 13 of the BHC Number Total assets Holdings (altern.)
Act ($mln) ($mln) ($mln)
----------------------------------------------------------------------------------------------------------------
Clear/carry..................................... 56 3,002,341 720,863 533,100
Other........................................... 82 36,996 3,843 3,455
---------------------------------------------------------------
Total....................................... 138 3,039,337 724,706 536,555
----------------------------------------------------------------------------------------------------------------
Since correcting error trades by or on behalf of customers is not
conducted for the purpose of profiting from short-term price movements,
this amendment is likely to facilitate valuable customer-facing
activities. As discussed elsewhere in this Supplementary Information,
the Agencies believe that banking entities should monitor and manage
their error trade account because doing so would help prevent personnel
from using these accounts for the purpose of evading the 2013 final
rule. We preliminarily believe that existing requirements and SEC
oversight would be sufficient to deter participants from using the
error trade exclusion to obfuscate impermissible proprietary trades.
---------------------------------------------------------------------------
\327\ Broker-dealers clearing and/or carrying customer accounts
are identified using FOCUS filings. Broadly, broker-dealers that are
clearing or carrying firms directly carry customer accounts,
maintain custody of the assets, and clear trades. Other broker-
dealers may accept customer orders but do not maintain custody of
assets. See, e.g., Clearing Firms FAQ, FINRA, https://www.finra.org/arbitration-mediation/overview/additional-resources/faq/clearing-firms. This analysis
excludes SEC-registered broker-dealers affiliated with banks that
have consolidated total assets less than or equal to $10 billion and
trading assets and liabilities less than or equal to 5% of total
assets, as well as firms for which bank trading asset and liability
data was not available.
---------------------------------------------------------------------------
c. Permitted Underwriting and Market Making
i. Regulatory Baseline
Underwriting and market making are customer-oriented financial
services that are essential to capital formation and market liquidity,
and the risks and profit sources related to these activities are
distinct from those related to impermissible proprietary trading.
Therefore, the 2013 final rule contains exemptions for underwriting and
market making-related activities.
Under the 2013 final rule, all banking entities with covered
activities must satisfy five requirements with respect to their
underwriting activities to qualify for the underwriting exemption.\328\
First, the banking entity must act as an underwriter for a distribution
of securities, and the trading desk's underwriting position must be
related to such distribution.\329\ Second, the amount and type of the
securities in the trading desk's underwriting position must be designed
not to exceed RENTD, and reasonable efforts must 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.\330\ Third, the banking entity must
establish and implement, maintain, and enforce an internal compliance
system that is reasonably designed to ensure the banking entity's
compliance with the requirements. The compliance program must include
the list of the products, instruments, or exposures each trading desk
may purchase, sell, or manage as part of its underwriting activities,
as well as the limits for each trading desk, based on the nature and
amount of the trading desk's underwriting activities, including RENTD
limits.\331\ Fourth, the compensation arrangements of persons engaged
in underwriting must be designed to not reward or incentivize
prohibited proprietary trading.\332\ Fifth, the banking entity must be
appropriately licensed or registered to perform underwriting
activities.\333\
---------------------------------------------------------------------------
\328\ See 2013 final rule Sec. __.4 (a).
\329\ See 2013 final rule Sec. __.4 (a)(2)(i).
\330\ See 2013 final rule Sec. __.4 (a)(2)(ii).
\331\ See 2013 final rule Sec. __.4 (a)(2)(iii).
\332\ See 2013 final rule Sec. __.4 (a)(2)(iv).
\333\ See 2013 final rule Sec. __.4 (a)(2)(v).
---------------------------------------------------------------------------
Under the current baseline, all banking entities with covered
activities must satisfy six requirements with respect to their market-
making activities to qualify for the market-making exemption.\334\
First, the trading desk responsible for the market-making activities
must routinely stand ready to purchase and sell the financial
instruments in which it is making markets and must be willing and
available to quote, purchase, and sell, or otherwise enter into long
and short positions in these types of financial instruments for its own
account in commercially reasonable amounts and throughout market
cycles.\335\ Second, the trading desks' market-maker inventory must be
designed not to exceed, on an ongoing basis, RENTD.\336\ Third, the
banking entity must establish, implement, and enforce an internal
compliance program, reasonably designed to ensure compliance with the
requirements. This compliance program must include, among other things,
limits for each trading desk that address RENTD.\337\ Fourth, the
banking entity must ensure that any violations of risk limits are
promptly corrected. Fifth, the compensation arrangements of persons
engaged in market making must be designed so as to not reward or
incentivize prohibited proprietary trading. Finally, the banking entity
must be appropriately licensed or registered.
---------------------------------------------------------------------------
\334\ See 2013 final rule Sec. __.4 (b).
\335\ See 2013 final rule Sec. __.4 (b)(2)(i).
\336\ See 2013 final rule Sec. __.4 (b)(2)(ii).
\337\ See 2013 final rule Sec. __.4 (b)(2)(iii).
---------------------------------------------------------------------------
We also note that, under the baseline, an organizational unit or a
trading desk of another banking entity that has consolidated trading
assets and liabilities of $50 billion or more is generally not
considered a client, customer, or counterparty for the purposes of the
RENTD requirement.\338\ Thus, such demand does not contribute to RENTD
unless such demand is affected through an anonymous trading facility or
unless the trading desk documents how and why the organizational unit
of said large banking entity should be treated as a client, customer,
or counterparty. To the extent that such documentation requirements
increase the cost of intermediating interdealer transactions, this
current requirement may impact the volume and cost of interdealer
trading.
---------------------------------------------------------------------------
\338\ See 2013 final rule Sec. __.4 (b)(3)(i).
---------------------------------------------------------------------------
The Agencies understand that current compliance with the RENTD
[[Page 33532]]
requirements under both the underwriting and market-making exemptions
creates ambiguity for some market participants, is over-reliant on
historical demand, and necessitates an accurate calibration of RENTD
for different asset classes, time periods, and market conditions.\339\
Since forecasting future customer demand involves uncertainty,
particularly in less liquid and more volatile instruments and products,
banking entity affiliated dealers may face uncertainty about the
ability to rely on the underwriting and market-making exemptions. This
uncertainty can reduce a banking entity's willingness to engage in
principal transactions with customers,\340\ which, along with reducing
profits, can adversely impact the volume of transactions intermediated
by banking entities. To the extent that non-banking entities do not
step in to intermediate trades that do not occur as a result of the
RENTD requirement,\341\ and to the extent that technological advances
do not allow customers to trade against other customers,\342\ thereby
shortening dealer intermediation chains, counterparties of affected
banking entities may have difficulty transacting in some market
segments.\343\
---------------------------------------------------------------------------
\339\ See supra note 18.
\340\ For instance, Bessembinder et al. (2017) shows that
dealers have shrunk their intraday capital commitment, measured as
the absolute difference between their daily accumulated buy volume
and sell volume. Similarly, the FRB's ``Staff Q2 2017 Report on
Corporate Bond Market Liquidity'' (available at https://www.federalreserve.gov/foia/files/bond-market-liquidity-report-2017Q2.pdf) shows a steep decline in broker-dealer holdings of
corporate and foreign bonds between 2007 and 2009 and a gradual
decline in 2012 onwards.
While some research suggests the decline in dealer inventories
is attributable to the 2013 final rule (e.g., Bessembinder et al.
(2017)), other studies show that inventory declines in fixed income
markets occurred in the immediate aftermath of the financial crisis
and coincided with a drastic decline in profitability of trading
desks during the crisis (e.g., Access to Capital and Market
Liquidity, supra note 106, Figure 34). It is difficult to clearly
distinguish the causal effects of the various provisions of section
13 of the BHC Act from the influence of other confounding factors,
such as crisis-related changes in dealer risk aversion and declines
in profitability of trading, macroeconomic conditions, the evolution
of market structure and new technology, and other factors.
\341\ See supra note 290.
\342\ See, e.g., Access to Capital and Market Liquidity supra
note 106, Part IV.C.4 (describing corporate bond activity on
electronic venues).
\343\ We are not aware of any data that allows us to quantify
the impacts of individual provisions of section 13 of the BHC Act on
dealer inventories or market liquidity. The evidence on the impacts
of section 13 on various measures of corporate bond, credit default
swap (CDS), and bond fund liquidity is sensitive to the choice of
market, measure, time period, and empirical methodology. For a
literature review, see, e.g., Access to Capital and Market Liquidity
supra note 106.
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ii. Costs and Benefits
Under the proposal, Group A and Group B entities with covered
activities would be presumed compliant with the RENTD requirements of
the underwriting and market-making exemptions if the banking entity
establishes and implements, maintains, and enforces internally set risk
limits. These risk limits would be subject to regulatory review and
oversight on an ongoing basis, which would include an assessment of
whether the limits are designed not to exceed RENTD. For Group A
entities, these limits are required to be established within the
entity's compliance program. Under the proposed amendment, Group B
entities would not be required to establish a separate compliance
program for underwriting and market-making requirements, including the
risk limits for RENTD. However, in order to be presumed compliant with
the underwriting and market-making exemptions, Group B entities must
establish and comply with the RENTD limits. We note that Group B
entities seeking to rely on the presumption of compliance would still
be required to comply with the RENTD requirements, even though they
would not be required to design a specific underwriting or market-
making compliance program. Under the proposed amendments, Group C
banking entities would be presumed compliant with requirements of
subpart B and subpart C of the rule, including with respect to the
reliance on the underwriting and market-making exemptions, without
reference to their internal RENTD limits. In addition, under the
proposal, Group A entities relying on internal risk limits for market-
making RENTD requirements must promptly reduce the risk exposure when
the risk limit is exceeded.
The proposed amendments may provide SEC-registered banking entities
with more flexibility and certainty in conducting permissible
underwriting and market making-related activities. The proposed
presumption allows the reliance on internally-set risk limits in
accordance with a banking entity's risk management function that may
already be used to meet other regulatory requirements, such as
obligations under the SEC and FINRA capital and liquidity rules,\344\
so long as these limits meet the requirements under the proposed
amendment. Therefore, the proposed amendment may prevent unnecessary
duplication of risk-management compliance procedures for the purposes
of complying with multiple regulations and may reduce compliance costs
for SEC-regulated banking entities. To the extent that the uncertainty
and compliance burdens related to the RENTD requirements are currently
impeding otherwise profitable permissible underwriting and market
making by dealers, the proposed amendments may increase banking
entities' profits and the volume of dealer intermediation.
---------------------------------------------------------------------------
\344\ See, e.g., 17 CFR 240.15c3-1.
---------------------------------------------------------------------------
The proposed regulatory oversight of the internally-set risk limits
may result in new compliance burdens for SEC registrants, potentially
offsetting the cost-reducing effects of other proposed amendments to
the compliance with the underwriting and market-making exemptions.
However, if banking entities are permitted to rely on internal risk
limits to meet the RENTD requirement, Agency oversight of internal risk
limits for the purposes of compliance with the proposed rule may help
support the benefits and costs of the substantive prohibitions of
section 13 of the BHC Act. Additionally, the costs of the prompt notice
requirement for exceeding the risk limits will depend on a given
entity's trading activity and on its design of internal risk limits,
which are likely to reflect, among other factors, the entity's
respective business model, organizational structure, profitability and
volume of trading activity. As a result, we cannot estimate these costs
with any degree of certainty.
The overall economic effect of these amendments will depend on the
amount and profitability of economic activity that currently does not
occur because of the uncertainty surrounding the RENTD requirement
compared to the potential costs of establishing and maintaining
internal risk limits, and uncertainty related to validation that these
limits would meet the requirements under the proposed amendments. We do
not have data on the volume of trading activity that does not occur
because of uncertainty and costs surrounding the RENTD requirement, or
data on the profitability of such trading activity for banking
entities. To the best of our knowledge, no such data is publicly
available.
To the extent that internal risk limits may be designed to exceed
the actual RENTD, introducing the proposed presumption may also
increase risk-taking by banking entity dealers. As a result, under the
proposed amendments, some entities may be able to maintain positions
that are larger than RENTD and, thus, increase their risk-taking. This
type of activity could increase moral hazard and reduce the economic
effects of section 13 of the BHC Act and the implementing rules.
However, to
[[Page 33533]]
mitigate this effect, the Agencies are proposing that the internally
set risk limits that would be used to establish the presumption of
compliance would be subject to ongoing regulatory assessments as to
whether they are designed not to exceed RENTD.
We note that the proposed amendments tailor regulatory relief for
smaller banking entities for both the underwriting and market-making
exemptions. More specifically, the threshold for the reduced
requirements is based on trading assets and liabilities for both
exemptions. We also recognize that the nature, profit sources, and
risks of underwriting and market-making activities differ. For example,
underwriting may involve pricing, book building, and placement of
securities with investors, whereas market making centers on
intermediation of trading activity.
In that regard, the Agencies could have proposed an approach, under
which underwriting and market-making requirements are tailored to
banking entities on the basis of different thresholds. For example, the
Agencies could have instead relied on the trading assets and
liabilities threshold for market-making compliance (as proposed), but
applied a different threshold for underwriting compliance, on the basis
of the volume or profitability of past underwriting activity. This
alternative would have tailored the compliance requirements for SEC-
regulated banking entities with respect to underwriting activities.
However, the volume and profitability of underwriting activity is
highly cyclical and is likely to decline in weak macroeconomic
conditions. As a result, under the alternative, SEC-regulated banking
entities would face lower compliance obligations with respect to
underwriting activity during times of economic stress when covered
trading activity related to underwriting may pose the highest risk of
loss.
iii. Efficiency, Competition, and Capital Formation
As discussed above, these proposed amendments may reduce the costs
of relying on the underwriting and market-making exemptions, which may
facilitate the activities related to these exemptions. The evolution in
market structure in some asset classes (e.g., equities) has transformed
the role of traditional dealers vis-[agrave]-vis other participants,
particularly as it relates to high-frequency trading and electronic
platforms. However, dealers continue to play a central role in less
liquid markets, such as corporate bond and over-the-counter derivatives
markets. While it is difficult to establish causality, corporate bond
dealers, particularly bank-affiliated dealers, have, on aggregate,
significantly reduced their capital commitment post-crisis--a finding
that is consistent with a reduction in liquidity provision in corporate
bonds due to the 2013 final rule.\345\ In addition, corporate bond
dealers may have shifted from trading in a principal capacity to agency
trading.\346\ To the extent that this change cannot be explained by
enhanced ability of dealers to manage corporate bond inventory,
electronic trading, post-crisis changes in dealer risk tolerance and
macro factors (effects which themselves need not be fully independent
of the effect of section 13 of the BHC Act and the 2013 final rule),
such effects may point to a reduced supply of liquidity by dealers.
Moreover, corporate bond dealers decrease liquidity provision in times
of stress in general (e.g., during a financial crisis) \347\ and after
the 2013 final rule in particular (under a few isolated stressed
selling conditions, some evidence shows greater price impact from
trading activity).\348\ In dealer-centric single-name CDS markets,
interdealer trade activity, trade sizes, quoting activity, and quoted
spreads for illiquid underliers have deteriorated since 2010, but
dealer-customer activity and various trading activity metrics have
remained stable.\349\
---------------------------------------------------------------------------
\345\ See, e.g., Staff Q2 2017 Report on Corporate Bond Market
Liquidity supra note 340; see also Bessembinder et al. (2017).
\346\ Dealers can trade as agents, matching customer buys to
customer sells, or as principals, absorbing customer buys and
customer sells into inventory and committing the necessary capital.
\347\ Dealers provide less liquidity to clients and peripheral
dealers during stress times; during the peak of the crisis core
dealers charged higher spreads to peripheral dealers and clients but
lower spreads to dealers with whom they had strong ties. See Di
Maggio, Kermani, and Song, 2017, ``The Value of Trading
Relationships in Turbulent Times.'' Journal of Financial Economics
124(2), 266-284; see also Choi and Shachar, 2013, ``Did Liquidity
Providers Become Liquidity Seekers?'' New York Fed Staff Report No.
650, available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr650.pdf.
\348\ See Bao et al. (2017); Anderson and Stulz (2017).
\349\ For a literature review and data, see Access to Capital
and Market Liquidity supra note 106.
---------------------------------------------------------------------------
Because of the methodological challenges described earlier in this
analysis, we cannot quantify potential effects of the 2013 final rule
in general, and the RENTD, underwriting, and market-making provisions
of the 2013 final rule in particular, on capital formation and market
liquidity. We also recognize that these provisions may not be currently
affecting all securities markets, asset classes, and products
uniformly. If, because of uncertainty and the costs of relying on
market-making and hedging exemptions, dealers are limiting their
market-making and hedging activity in certain products, the proposed
amendments may facilitate market making. Because secondary market
liquidity can influence the willingness to invest in primary markets,
and access to these markets can enable market participants to mitigate
undesirable risk exposures, the amendments may increase trading
activity and capital formation in some segments of the market.
While the statute and the 2013 final rule, including as proposed to
be amended, prohibit banking entities from engaging in proprietary
trading, some trading desks may attempt to use certain elements of the
proposed RENTD amendments to circumvent those restrictions. This may
reduce the economic benefits and costs of the 2013 final rule outlined
in section V.D.1. We continue to recognize that proprietary trading by
banking entities may give rise to moral hazard, economic inefficiency
because of implicitly subsidized risk-taking, and market fragility, and
may increase conflicts of interest between banking entities and their
customers. An analysis of the effects of the 2013 final rule in
general, and the specific amendments being proposed here in particular,
on moral hazard, risk-taking, systemic risk, and conflicts of interest
described above, faces the same methodological challenges discussed in
section V.D.1. and in this section. In addition, existing qualitative
analysis and quantitative estimates of moral hazard, risk-taking
incentives resulting from deposit insurance and implicit bailout
guarantees, and systemic risk implications of proprietary trading,
centers on banking entities that are not SEC registrants.\350\ However,
we
[[Page 33534]]
continue to recognize that the effects of the proposed amendments on
bank entity risk-taking and conflicts of interest may flow through to
SEC-registered dealers and investment advisers affiliated with banks
and bank holding companies and may impact securities markets. As
suggested by academic evidence, the presence and magnitude of
spillovers across different types of financial institutions vary over
time and may be more significant in times of stress.\351\
---------------------------------------------------------------------------
\350\ For a literature review, see, e.g., Benoit et al. (2017).
Some examples include:
A large proportion of the variation in bank market-to-
book ratios over time may be due to changes in the value of
government guarantees. See Atkeson et al. (2018).
Moral hazard resulting from idiosyncratic and targeted
bailouts may make the economy significantly more exposed to
financial crises, while moral hazard effects may be limited if
bailouts are systemic and broad based. See Bianchi (2016); see also
Kelly et al. (2016).
Deposit insurance and financial safety nets increased
bank risk-taking and measures of systemic fragility in the run-up to
the global financial crisis. However, during the crisis itself,
deposit insurance reduced bank risk and systemic stability. See
Anginer et al. (2014).
Short-term capital market funding may increase bank
fragility. See Beltratti and Stulz (2012).
Implicit bailout guarantees for the financial sector as
a whole are priced in spreads on index put options far more than
those on put options of individual banks. See, e.g., Kelly et al.
(2016).
Other research used CDS data to measure the value of
government bailouts to bondholders and stockholders of large
financial firms during the global financial crisis. See Veronesi and
Zingales (2010).
\351\ See, e.g., Billio, Getmansky, Lo, and Pelizzon, 2012,
Econometric Measures of Connectedness and Systemic Risk in the
Finance and Insurance Sectors, Journal of Financial Economics
104(3), 535-559; see also Alam, Fuss, and Gropp, 2014, Spillover
Effects Among Financial Institutions: A State-Dependent Sensitivity
Value at Risk Approach (SDSVar). Journal of Financial and
Quantitative Analysis 49(3), 575-598; Adrian and Brunnermeier, 2016,
CoVar, American Economic Review 106(7), 1705-1741.
---------------------------------------------------------------------------
Where the proposed amendments increase the scope of permissible
activities or decrease the risk of detection of proprietary trading,
their impact on informational efficiency stems from a balance of two
effects. On the one hand, where banking entities' proprietary trading
strategies are based on superior analysis and prediction models, their
reduced ability to trade on such information may make securities
markets less informationally efficient. While such proprietary trading
strategies can be executed by broker-dealers unaffiliated with banking
entities and unaffected by the prohibitions on proprietary trading,
their ability to do so may be constrained by their limited access to
capital and a lack of scale needed to profit from such strategies. On
the other hand, if superior information is obtained by an entity from
its customer-facing activities and as a result of conflicts of
interest, proprietary trading may make customers less willing to
transact with banks or participate in securities markets.
iv. Loan-Related Swaps
The Agencies are requesting comment on the treatment of swaps
entered into with a customer in connection with a loan provided to the
customer. Specifically, loan-related swaps are transactions between a
banking entity and a loan customer that are directly related to the
terms of the customer's loan. The Agencies understand that such swaps
may be considered financial instruments triggering proprietary trading
prohibitions of the 2013 final rule. As a result, a banking entity
would need to rely on an applicable exclusion from the definition of
proprietary trading or an exemption in the implementing regulations in
order for this activity to be permissible.
Accordingly, the Agencies are requesting comment on whether loan-
related swaps should be permitted under the market-making exemption if
the banking entity stands ready to make a market in both directions
whenever a customer makes an appropriate request, but in practice
primarily makes a market in the swaps only in one direction. The
Agencies are also requesting comment on whether it would be appropriate
to exclude loan-related swaps from the definition of proprietary
trading for some banking entities or to permit the activity pursuant to
an exemption from the prohibition on proprietary trading other than
market making.
Addressing the treatment of loan-related swaps may benefit banking
entities that are currently unsure as to their ability to engage in
loan-related swaps pursuant to the existing market-making exemption.
Legal certainty in this space may increase the willingness of banking
entities to accommodate customer demand for such loans and increase
certainty that such activity would not trigger the proprietary trading
prohibition. To the degree that the back-to-back offsetting purchases
and sales of derivatives are not immediate, and to the extent that such
transactions are not cleared and involve counterparty risk, this may
also increase risk-taking by banking entities. To the extent that the
proposed guidance was to increase the scope of permissible proprietary
trading activity, such activity would implicate the economic tradeoffs
of the proprietary trading prohibitions of the 2013 final rule
discussed in section V.D.1.
d. Permitted Risk-Mitigating Hedging
i. Regulatory Baseline
Under the baseline, certain risk-mitigating hedging activities may
be exempt from the restriction on proprietary trading under the risk-
mitigating hedging exemption. To make use of this exemption, the 2013
final rule requires all banking entities to comply with a comprehensive
and multi-faceted set of requirements, including: (1) The establishment
and implementation, and maintenance of an internal compliance program;
(2) satisfaction of various criteria for hedging activities; and (3)
the existence of compensation arrangements for persons performing risk-
mitigating hedging activities that are designed not to reward or
incentivize prohibited proprietary trading. In addition, certain
activities under the hedging exemption are subject to documentation
requirements.\352\
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\352\ See 2013 final rule Sec. __.5.
---------------------------------------------------------------------------
Specifically, 2013 final rule requires that a banking entity
seeking to rely on the risk-mitigating hedging exemption must
establish, implement, maintain, and enforce an internal compliance
program that is reasonably designed to ensure compliance with the
requirements of the rule. Such a compliance program 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 particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts, or other holdings. The compliance program
also must provide for internal controls and ongoing monitoring,
management, and authorization procedures, including relevant escalation
procedures. In addition, the 2013 final rule requires that all banking
entities, as part of their compliance program, must conduct analysis,
including correlation analysis, and independent testing designed to
ensure that the positions, techniques, and strategies that may be used
for hedging are designed to reduce or otherwise significantly mitigate
and demonstrably reduce or otherwise significantly mitigate the
specific, identifiable risk(s) being hedged.
The 2013 final rule does not require a banking entity to prove
correlation mathematically--rather, the nature and extent of the
correlation analysis should be dependent on the facts and circumstances
of the hedge and the underlying risks targeted. Moreover, if
correlation cannot be demonstrated, the analysis needs to state the
reason and explain how the proposed hedging position, technique, or
strategy is designed to reduce or significantly mitigate risk and how
that reduction or mitigation can be demonstrated without
correlation.\353\ Some market participants have argued that the
inability to perform correlation analysis, for instance, for non-
trading assets such as mortgage servicing assets, can add as much as 2%
of the asset value to the cost of hedging.\354\
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\353\ See 79 FR at 5631.
\354\ See supra note 18.
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[[Page 33535]]
To qualify for the risk-mitigating hedging exemption, the hedging
activity, both at inception and at the time of any adjustment to the
hedging activity, must be designed to reduce or otherwise significantly
mitigate and demonstrably reduce or significantly mitigate one or more
specific identifiable risks.\355\ Hedging activities also must not give
rise, at the inception of the hedge, to any significant new or
additional risk that is not itself hedged contemporaneously.
Additionally, the hedging activity must be subject to continuing
review, monitoring, and management by the banking entity, including
ongoing recalibration of the hedging activity to ensure that the
hedging activity satisfies the requirements for the exemption and does
not constitute prohibited proprietary trading. Lastly, the compensation
arrangements of persons performing risk-mitigating hedging activities
must be designed so as to not reward or incentivize prohibited
proprietary trading.
---------------------------------------------------------------------------
\355\ See 2013 final rule Sec. __.5(b)(2)(ii).
---------------------------------------------------------------------------
Finally, the 2013 final rule requires banking entities to document
and retain information related to the purchase or sale of hedging
instruments that are either (1) established by a trading desk that is
different from the trading desk establishing or responsible for the
risks being hedged; (2) established by the specific trading desk
establishing or responsible for the risks being hedged but that are
effected through means not specifically identified in the trading desks
written policies and procedures; or (3) established to hedge aggregate
positions across two or more trading desks. \356\ The documentation
must include the specific identifiable risks being hedged, the specific
risk-mitigating strategy that is being implemented, and the trading
desk that is establishing and responsible for the hedge. These records
must be retained for a period of not less than 5 years in a form that
allows them to be promptly produced if requested.\357\
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\356\ See 2013 final rule Sec. __.5(c)(1).
\357\ See 2013 final rule Sec. __.5(c)(3); see also 2013 final
rule Sec. __.20(b)(6).
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As discussed elsewhere in this Supplementary Information, the
Agencies recognize that, in some circumstances, it may be difficult to
know with sufficient certainty whether a potential hedging activity
will continue to demonstrably reduce or significantly mitigate an
identifiable risk after it is implemented. Unforeseeable changes in
market conditions and other factors could reduce or eliminate the
intended risk-mitigating impact of the hedging activity, making it
difficult for a banking entity to comply with the continuous
requirement that the hedging activity demonstrably reduce or
significantly mitigate specific, identifiable risks. In such cases, a
banking entity may choose not to enter into a hedge out of concern that
it may not be able to effectively comply with the continuing
requirement to demonstrate risk mitigation.
We also recognize that SEC-regulated entities may engage in both
static and dynamic hedging at the portfolio (and not at the
transaction) level and monitor and reevaluate aggregate portfolio risk
exposures on an ongoing basis, rather than the risk exposure of
individual transactions. Dynamic hedging may be particularly common
among dealers with large derivative portfolios, especially when the
values of these portfolios are nonlinear functions of the prices of the
underlying assets (e.g., gamma hedging of options). The rules currently
in effect permit dynamic hedging, but require the banking entity to
document and support its decisions regarding individual hedging
transactions, strategies, and techniques for ongoing activity in the
same manner as for its initial activities, rather than the hedging
decisions regarding a portfolio as a whole.
ii. Costs and Benefits
As discussed elsewhere in this Supplementary Information, the
Agencies recognize that hedging is an essential tool for risk
mitigation and can enhance a banking entity's provision of client-
facing services, such as market making and underwriting, as well as
facilitate financial stability. In recognition of the role that this
activity plays as part of a banking entity's overall operations, the
Agencies have proposed a number of changes that are intended to
streamline and clarify the current exemption for risk-mitigating
hedging activities.
The first proposed amendment concerns the ``demonstrability''
requirement of the risk-mitigating hedging exemption. Specifically, the
Agencies propose to eliminate the requirement that the risk-mitigating
hedging activity must demonstrably reduce or otherwise significantly
mitigate one or more specific identifiable risks at the inception of
the hedge. Additionally, the demonstrability requirement would also be
removed from the requirement to continually review, monitor, and manage
the banking entity's existing hedging activity. We also note that
banking entities would continue to be subject to the requirement that
the risk-mitigating hedging activity be designed to reduce or otherwise
significantly mitigate one or more specific, identifiable risks, as
well as to the requirement that the hedging activity be subject to
continuing review, monitoring and management by the banking entity to
confirm that such activity is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks that develop
over time from the risk-mitigating hedging.
The removal of the demonstrability requirement is expected to
benefit banking entity dealers, as it would decrease uncertainty about
the ability to rely on the risk-mitigating hedging exemption and may
reduce the compliance costs of engaging in permitted hedging
activities. While this aspect of the proposal may alleviate compliance
burdens related to risk management and potentially facilitate greater
trading activity and liquidity provision by bank-affiliated dealers, it
could also enable dealers to accumulate large proprietary positions
through adjustments (or lack thereof) to otherwise permissible hedging
portfolios. Therefore, we recognize that the proposed amendment could
increase moral hazard risks related to proprietary trading by allowing
dealers to take positions that are economically equivalent to positions
they could have taken in the absence of the 2013 final rule.
The second proposed amendment to the risk-mitigating hedging
exemption is the removal of the requirement to perform the correlation
analysis. The Agencies recognize that a correlation analysis based on
returns may be prohibitively complex for some asset classes, and that a
correlation coefficient may not always serve as a meaningful or
predictive risk metric. While we recognize that, in some instances,
correlation analysis of past returns may be helpful in evaluating
whether a hedging transaction was effective in offsetting the risks
intended to be mitigated, correlation analysis may not be an effective
tool for such evaluation in other instances. For example, correlation
across assets and asset classes evolves over time and may exhibit jumps
at times of idiosyncratic or systematic stress. Additionally, the
hedging activity, even if properly designed to reduce risk, may not be
practicable if costly delays or compliance complexities result from a
requirement to undertake a correlation analysis. Thus, the removal of
the correlation analysis requirement may provide dealers with greater
flexibility in selecting and executing risk-
[[Page 33536]]
mitigating hedging activities. However, we also recognize that the
removal of the correlation analysis requirement may result in tradeoffs
discussed above. To the extent that some banking entities may be able
to engage in speculative proprietary trading activities while relying
on the risk-mitigating hedging exemption, the proposed amendment may
potentially increase moral hazard and conflicts of interest between
banking entities and their customers, notwithstanding the fact that a
potential increase in permitted risk-mitigating hedging may increase
capital formation and trading activity by banking entities.
The third proposed amendment simplifies the requirements of the
risk-mitigating hedging exemption for Group B banking entities (i.e.,
those with moderate trading assets and liabilities). The proposed
amendment would remove the requirement to have a specific risk-
mitigating hedging compliance program, as well as the documentation
requirements and certain hedging activity requirements for Group B
entities.\358\ As a result, these dealers would be subject to two key
hedging activity requirements: (1) That a hedging transaction must be
designed to reduce or otherwise significantly mitigate one or more
specific, identifiable risks; and (2) that a hedging transaction is
subject, as appropriate, to ongoing review, monitoring, and management
by the banking entity that requires recalibration of the hedging
activity to ensure that the hedging activity satisfies the requirements
on an ongoing basis and is not prohibited proprietary trading. Under
the proposed amendments, Group C banking entities are presumed
compliant with subpart B and subpart C of the proposed rule, including
with respect to the reliance on the hedging exemption.
---------------------------------------------------------------------------
\358\ Group C banking entities (i.e., those with limited trading
assets and liabilities) also would not be subject to these express
requirements.
---------------------------------------------------------------------------
As discussed elsewhere in this Supplementary Information, the
Agencies recognize that banking entities without significant trading
assets and liabilities are less likely to engage in large and/or
complicated trading activities and hedging strategies. We continue to
recognize that compliance with the 2013 final rule may impose
disproportionate costs on banking entities without significant trading
assets and liabilities. Therefore, the proposed amendment would benefit
Group B and Group C entities, as it would reduce the costs of relying
on the hedging exemption and, thus, engaging in hedging activities. To
the extent that the removal of these requirements may reduce the costs
of risk-mitigating hedging activity, Group B and Group C entities may
increase their intermediation activity while also growing their trading
assets and liabilities.
The fourth proposed amendment reduces documentation requirements
for Group A entities. In particular, the proposal removes the
documentation requirements for some financial instruments used for
hedging. More specifically, the instrument would not be subject to the
documentation requirement if: (1) It is identified on a written list of
pre-approved financial instruments commonly used by the trading desk
for the specific type of hedging activity; and (2) at the time the
financial instrument is purchased or sold the hedging activity
(including the purchase or sale of the financial instrument) complies
with written, pre-approved hedging limits for the trading desk
purchasing or selling the financial instrument for hedging activities
undertaken for one or more other trading desks. The SEC lacks
information or data that would allow us to quantify the magnitude of
the expected cost reductions, as the prevalence of hedging activities
depends on each registrant's organizational structure, business model,
and complexity of risk exposures. However, the SEC preliminarily
believes that the flexibility to choose between providing documentation
regarding risk-mitigating hedging transactions and establishing hedging
limits for pre-approved instruments may be beneficial for Group A
entities, as it will allow these entities to tailor their compliance
regime to their specific organizational structure and existing policies
and procedures. Finally, in section V.B, the Agencies estimate burden
reductions per firm from the proposed amendments. The proposed
amendments to Sec. __.5(c) will result in ongoing cost savings
estimated at $203,191 for SEC-registered broker-dealers.\359\
Additionally, the proposed amendments will result in lower ongoing
costs for potential SBSD registrants relative to the costs that they
would incur under the current regime if they were to choose to register
with the SEC--this cost reduction is estimated to reach up to
$50,062.\360\ However, we recognize that compliance with SBSD
registration requirements is not yet required and that there are
currently no registered SBSDs. Similarly, the proposed amendments may
also reduce initial set-up costs related to Sec. __.5(c) by $101,596
for SEC-registered broker-dealers and up to $25,031 for entities that
may choose to register with the SEC as SBSDs.\361\
---------------------------------------------------------------------------
\359\ Recordkeeping burden reduction for broker-dealers: 20
hours per firm x 0.18 weight x (Attorney at $409 per hour) x 138
firms = $203,191. Recordkeeping burden reduction for entities that
may register as SBSDs: 20 hours per firm x 0.18 weight x (Attorney
at $409 per hour) x 34 firms = $50,062.
\360\ Recordkeeping burden reduction for entities that may
register as SBSDs: 20 hours per firm x 0.18 weight x (Attorney at
$409 per hour) x 34 firms = $50,062.
\361\ Initial set-up burden reduction for broker-dealers: 10
hours per firm x 0.18 weight x (Attorney at $409 per hour) x 138
firms = $101,596. Initial set-up burden reduction for entities that
may register as SBSDs: 10 hours per firm x 0.18 weight x (Attorney
at $409 per hour) x 34 firms = $25,031.
---------------------------------------------------------------------------
The proposed hedging amendment eliminates all hedging-specific
compliance program requirements including correlation analysis,
documentation requirements, and some hedging activity requirements for
Group B entities. The proposed amendments eliminate only some of the
compliance program requirements for Group A entities and provide a
documentation requirement exemption for some hedging activity of these
entities. Since the fixed costs of relying on such exemptions may be
more significant for entities with smaller trading books, the proposed
hedging amendment may permit Group B entities just below the $10
billion threshold to more effectively compete with Group A entities
just above the threshold.
The proposed hedging amendments may also impact the volume of
hedging activity and capital formation. To the extent that some
registrants currently experience significant compliance costs related
to the hedging exemption, these costs may constrain the amount of risk-
mitigating hedging they currently engage in. The ability to hedge
underlying risks at a low cost can facilitate the willingness of SEC-
regulated entities to commit capital and take on underlying risk
exposures. Because the proposed amendments would reduce costs of
relying on the hedging exemption, these entities may become more
incentivized to engage in risk-mitigating hedging activity, which may
in turn contribute to greater capital formation.
e. Trading Outside the United States
i. Baseline
Under the 2013 final rule, a foreign banking entity that has a
branch, agency, or subsidiary located in the United States (and is not
itself located in the United States) is subject to the
[[Page 33537]]
proprietary trading prohibitions and related compliance requirements
unless it meets five criteria.\362\ First, a branch, agency, or
subsidiary of a foreign banking organization that is located in the
United States or organized under the laws of the United States or of
any state may not engage as principal in the purchase or sale of
financial instruments (including any personnel that arrange, negotiate,
or execute a purchase or sale). Second, the banking entity (including
relevant personnel) that makes the decision to engage in the
transaction must not be located in the United States or organized under
the laws of the United States or of any state. Third, the transaction,
including any transaction arising from risk-mitigating hedging related
to the transaction, must not be accounted for as principal directly or
on a consolidated basis by any branch or affiliate that is located in
the United States or organized under the laws of the United States or
of any state. Fourth, no financing for the transaction can be provided
by any branch or affiliate of a foreign banking entity that is located
in the United States or organized under the laws of the United States
or of any state (the ``financing prong''). Fifth, the transaction must
generally not be conducted with or through any U.S. entity (the
``counterparty prong''), unless: (1) No personnel of a U.S. entity that
are located in the United States are involved in the arrangement,
negotiation, or execution of such transaction; (2) the transaction is
with an unaffiliated U.S. market intermediary acting as principal and
is promptly cleared and settled through a central counterparty; or (3)
the transaction is executed through an unaffiliated U.S. market
intermediary acting as agent, conducted anonymously through an exchange
or similar trading facility, and is promptly cleared and settled
through a central counterparty.\363\
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\362\ See 2013 final rule Sec. __.6(e).
\363\ See 2013 final rule Sec. __.6(e)(3).
---------------------------------------------------------------------------
As discussed elsewhere in this Supplementary Information, the
Agencies recognize that foreign banking entities seeking to rely on the
exemption for trading outside the United States face a complex set of
compliance requirements that may result in implementation
inefficiencies. In particular, the application of the financing prong
may be challenging because of the fungibility of some forms of
financing. In addition, the Agencies recognize that satisfying the
counterparty prong is burdensome for foreign banking entities and may
have led some foreign banking entities to reduce the range of
counterparties with which they engage in trading activity.
ii. Costs and Benefits
The proposed amendments remove the financing and counterparty
prongs.
Under the proposed rule, financing for the transaction relying on
the foreign trading exemption can be provided by U.S. branches or
affiliates of foreign banking entities, including SEC-registered
dealers. Foreign banking entities may benefit from the proposed
amendments and enjoy greater flexibility in financing their transaction
activity. However, some of the economic exposure and risks of
proprietary trading by foreign banking entities would flow not just to
the foreign banking entities, but to U.S.-located entities financing
the transactions, e.g., through margin loans. While SEC-registered
banking entity dealers financing the transactions of foreign entities
are themselves subject to the substantive requirements of the 2013
final rule, SEC-registered dealers that are not banking entities under
the BHC Act are not. The proposal retains the requirement that the
transactions of a foreign banking entity, including any hedging trades,
are not to be accounted for as principal directly or on a consolidated
basis by any U.S. branch or affiliate.
In addition, the proposed amendment removes the counterparty prong
and its corresponding clearing and anonymous exchange requirements.
Currently, a foreign banking entity may transact with or through U.S.
counterparties if the trades are conducted anonymously on an exchange
(for trades executed by a counterparty acting as an agent) and cleared
and settled through a clearing agency or derivatives clearing
organization acting as a central counterparty (for trades executed by a
counterparty acting as either an agent or principal). As a result, the
proposed amendments would make it easier for foreign banking entities
to transact with or through U.S. counterparties. To the extent that
foreign banking entities are currently passing along compliance burdens
to their U.S. counterparties, or are unwilling to intermediate or
engage in certain transactions with or through U.S. counterparties, the
proposed amendments may reduce transaction costs for U.S.
counterparties and may increase the volume of trading activity between
U.S. counterparties and foreign banking entities.
We note that, even when a foreign banking entity engages in
proprietary trading through a U.S. dealer, the principal risk of the
foreign banking entities' position is consolidated to the foreign
banking entity. While such trades expose the counterparty to risks
related to the transaction, such risks born by U.S. counterparties
likely depend on both the identity of the counterparty and the nature
of the instrument and terms of trading position. Moreover, concerns
about moral hazard and the volume of risk-taking by U.S. banking
entities may be less relevant for foreign banking entities. The current
requirement that foreign banking entities transact with U.S.
counterparties through unaffiliated dealers steers trading business to
unaffiliated U.S. dealers but does not necessarily reduce moral hazard
in the U.S. financial system.
iii. Efficiency, Competition, and Capital Formation
The proposed amendments would likely narrow the scope of
transaction activity and banking entities to which the substantive
prohibitions of the 2013 final rule apply. As a result, the amendments
may reduce the effects on efficiency, competition, and capital
formation of the implementing rules currently in place. The proposed
amendments reflect consideration of the potentially inefficient
restructuring undergone by foreign banking entities after the 2013
final rule came into effect and enhanced access to securities markets
by U.S. market participants on the one hand,\364\ and, advancing the
objectives of the 2013 final rule as discussed above on the other.
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\364\ For instance, a commenter has stated that at least seven
international banks have terminated or transferred existing
transactions with U.S. counterparties in order to comply with the
foreign trading exemption and to avoid compliance costs of relying
on alternative exemptions or exclusions. See supra note 18.
---------------------------------------------------------------------------
Allowing foreign banking entities to be financed by U.S.-dealer
affiliates and to transact with U.S. counterparties off exchange and
without clearing the trades, may reduce costs of non-U.S. banking
entities' activity in the United States and with U.S. counterparties.
These costs may currently represent barriers to entry for foreign
banking entities that contemplate engaging in trading and other
transaction activity using a U.S. affiliate's financing and trading
with U.S. counterparties off exchange. To that extent, the proposed
amendments may provide incentives for foreign banking entities that
currently receive financing from non-U.S. affiliates to move financing
to U.S. dealer affiliates, and incentives for foreign banking entities
that currently transact through or with U.S. counterparties via
anonymous exchanges and clearing agencies to
[[Page 33538]]
transact through or with U.S. counterparties outside of anonymous
exchanges and clearing. As a result, the number of banking entities
engaging in securities trading in U.S. markets may increase, which may
enhance the incorporation of new information into prices. However, the
amendments may result in a shift in securities trading activity away
from U.S. banking entities to foreign banking entities that are not
comparably regulated. Thus, the amendments may reduce the benefits and
costs of the 2013 final rule discussed in section V.D.1.
The proposed amendments may increase market entry as they will
decrease the need for foreign banking entities to rely only on a narrow
set of unaffiliated market intermediaries for the purposes of avoiding
the compliance costs associated with the 2013 final rule. Additionally,
the proposed amendments may increase operational efficiency of trading
activity by foreign banking entities in the United States, which may
decrease costs to market participants and may increase the level of
market participation by U.S-dealer affiliates of foreign banking
entities.
The proposed amendments would also affect competition among banking
entities. These amendments may introduce competitive disparities
between U.S. and foreign banking entities. Under the proposed
amendments, foreign banking entities would enjoy a greater degree of
flexibility in financing proprietary trading and transacting through or
with U.S. counterparties. At the same time, U.S. banking entities would
not be able to engage in proprietary trading and would be subject to
the substantive prohibitions of section 13 of the BHC Act. To the
extent that banking entities at the holding company level may be able
to reorganize and move their business to a foreign jurisdiction, some
U.S. banking entity holding companies may exit from the U.S. regulatory
regime. However, under sections 4(c)(9) and 4(c)(13) of the Banking
Act, domestic entities would have to conduct the majority of their
business outside the United States to become eligible for the
exemption. In addition, certain changes in control of banks and bank
holding companies require supervisory approval. Hence, the feasibility
and magnitude of such regulatory arbitrage remain unclear.
To the extent that foreign banking entities currently engage in
cleared and anonymous transactions through or with U.S. counterparties
because of the existing counterparty prong but would have chosen not to
do so otherwise, the proposed approach may reduce the amount of cleared
transactions and the trading volume in anonymous markets. This may
reduce opportunities for risk-sharing among market participants and
increase idiosyncratic counterparty risk born by U.S. and foreign
counterparties.
At the same time, the proposed amendments may increase the
availability of liquidity and reduce transaction costs for market
participants seeking to trade in U.S. securities markets. To the extent
that non-U.S. banking entities will face lower costs of transacting
with U.S. counterparties, it may become easier for U.S. banking
entities or customers to find a transaction counterparty that would be
willing to engage in, for instance, hedging transactions. To that
extent, U.S. market participants accessing securities markets to hedge
financial and commercial risks may increase their hedging activity and
assume a more efficient amount of risk. The potential consequences of
relocation of non-U.S. banking entity activity to the United States on
liquidity and risk sharing would be most concentrated in those asset
classes and market segments where activity is most constrained by
current requirements.
f. Metrics Reporting
i. Regulatory Baseline
The regulatory baseline against which we are assessing proposed
amendments includes requirements for banking entities with consolidated
trading assets and liabilities above $10 billion to record and report
certain quantitative measurements for each trading desk engaged in
covered trading.\365\ The metrics-reporting requirements currently in
place were intended to facilitate monitoring of patterns in covered
trading activities and to identify activities that may warrant further
review for compliance with the restrictions on proprietary trading of
section 13 of the BHC Act and the implementing rules.
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\365\ See 2013 final rule Sec. __.20(d) and Appendix A.
---------------------------------------------------------------------------
Specifically, the quantitative measurements reported under the
baseline were intended to assist banking entities and the SEC in
achieving the following: A better understanding of the scope, type, and
profile of covered trading activities; identification of covered
trading activities that warrant further review or examination by the
banking entity to verify compliance with the rule's proprietary trading
restrictions; evaluation of whether the covered trading activities of
trading desks engaged in permitted activities are consistent with the
provisions of the permitted activity exemptions; evaluation of whether
the covered trading activities of trading desks that are engaged in
permitted trading activities (i.e., underwriting and market making-
related activity, risk-mitigating hedging, or trading in certain
government obligations) are consistent with the requirement that such
activity not result, directly or indirectly, in a material exposure to
high-risk assets or high-risk trading strategies; identification of the
profile of particular covered trading activities of the banking entity,
and its individual trading desks, to help establish the appropriate
frequency and scope of the SEC's examinations of such activity; and the
assessment and addressing of the risks associated with the banking
entity's covered trading activities.\366\
---------------------------------------------------------------------------
\366\ See 2013 final rule Sec. __.20 and Appendix A.
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Under the regulatory baseline, dealers affiliated with banking
entities that have less than $10 billion in consolidated trading assets
and liabilities are not subject to the 2013 final rule's metrics
reporting and recordkeeping requirements. Group A entities (i.e., SEC
registrants affiliated with banking entities that have more than $10
billion in consolidated trading assets and liabilities) are required to
record and report the following quantitative measurements for each
trading day and for each trading desk engaged in covered trading
activities: (i) Risk and Position Limits and Usage; (ii) Risk Factor
Sensitivities; (iii) Value-at-Risk and Stress Value-at-Risk; (iv)
Comprehensive Profit and Loss Attribution; (v) Inventory Turnover; (vi)
Inventory Aging; and (vii) Customer-Facing Trade Ratio.
Currently, Group A entities affiliated with banking entities that
have less than $50 billion in consolidated trading assets and
liabilities are required to report metrics for each quarter within 30
days of the end of that quarter. In contrast, Group A entities
affiliated with banking entities with total trading assets and
liabilities equal to or above $50 billion are required to report
metrics more frequently--each month within 10 days of the end of that
month.\367\ Table 2 quantifies the number and trading book of SEC-
registered broker-dealers affiliated with firms above and below the $10
billion and $50 billion thresholds.
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\367\ See 2013 final rule Sec. __.20(d)(3).
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ii. Costs and Benefits
We understand that the current metrics reporting and recordkeeping
requirements may involve large compliance costs. For instance, the
[[Page 33539]]
average cost of collecting and filing metrics subject to the reporting
requirements may be as high as $2 million per year per participant, and
market participants may submit an average of over 5 million data points
in each filing.\368\ One firm reported incurring approximately $3
million in costs associated with the build out of new IT infrastructure
and system enhancements, and estimated that this IT infrastructure will
require at least $250,000 in maintenance and operating costs year-to-
year. \369\ In addition, the same firm estimated costs related to
compliance consultants assisting with the construction of a 2013 final
rule compliance regime at $3 million.\370\
---------------------------------------------------------------------------
\368\ See supra note 18.
\369\ Id.
\370\ To the extent that costs related to compliance consulting
include both costs of metrics reporting and related systems, as well
as costs related to other compliance requirements under the 2013
final rule, we cannot estimate the firm's all-in metrics reporting
costs.
---------------------------------------------------------------------------
The proposed amendments streamline the metrics reporting and
recordkeeping requirements, eliminating or adding particular metrics on
the basis of regulatory experience with the data and providing some
entities with additional reporting time. Broadly, metrics reporting
provides information for regulatory oversight and supervision but
presents compliance burdens for registrants. The balance of these
effects turns on the value of different metrics in evaluating covered
trading activity for compliance with the rule, as well as their
usefulness for risk assessment and general supervision. We discuss
these effects with respect to each proposed amendment in the sections
that follow.
A. Reporting and Recordkeeping Burden for SEC-Regulated Banking
Entities
In section V.B, the Agencies estimate that extending the reporting
period for banking entities with $50 billion or more in trading assets
and liabilities from10 days to 20 days after the end of each calendar
month may decrease the initial setup cost by $85,399 and ongoing annual
reporting cost by $358,677 for broker-dealers, as well as initial setup
cost decrease of up to $100,123 and ongoing reporting costs decrease of
up to $420,517 for SBSDs that choose to register with the SEC.\371\ In
addition, the change to the reporting period for banking entities with
$50 billion or more in trading assets and liabilities may result in
ongoing annual recordkeeping cost savings of $76,859 for broker-dealers
and up to $90,111 for SBSDs.\372\ These figures reflect the estimated
burden reductions net of any new systems costs imposed by the proposed
amendments and discussed in greater detail in the section that follows.
---------------------------------------------------------------------------
\371\ Initial setup cost reduction for broker-dealers: 40 hours
per firm x 0.18 weight x (Attorney at $409 per hour) x 29 firms =
$85,399. Initial setup cost reduction for entities that may register
as SBSDs: 40 hours per firm x 0.18 weight x (Attorney at $409 per
hour) x 34 firms= $100,123. Ongoing reporting cost reduction for
broker-dealers: 14 hours per response x 12 responses per year x 0.18
weight x (Attorney at $409 per hour) x 29 firms= $358,677. Ongoing
reporting cost reduction for SBSDs: 14 hours per response x 12
responses per year x 0.18 weight x (Attorney at $409 per hour) x 34
firms = $420,517. The estimate for SBSDs assumes that all 34 SBSDs
have more than $50 billion in trading assets and liabilities.
\372\ Ongoing recordkeeping cost reduction for broker-dealers: 3
hours per response x 12 responses per year x 0.18 weight x (Attorney
at $409 per hour) x 29 firms = $76,859. Ongoing recordkeeping cost
reduction for SBSDs: 3 hours per response x 12 responses per year x
0.18 weight x (Attorney at $409 per hour) x 34 firms = $90,111. The
estimate for SBSDs assumes that all 34 have more than $50 billion in
trading assets and liabilities.
---------------------------------------------------------------------------
The proposed amendments generate both costs (from new reporting
requirements) and savings (from limitations to the scope of certain
metrics and reduced analytical burden). To the extent that the costs of
compliance with the existing metrics requirements have a significant
fixed cost component and may be sunk, the potential cost savings of the
proposed amendments may be reduced. The SEC recognizes that while these
amendments will reduce the aggregate metrics reporting and
recordkeeping burden across all types of banking entities, the
allocation of these costs and benefits may differ across banking entity
types. For example, one of the proposed amendments replaces the
Inventory Turnover and Customer-Facing Trade Ratio metrics with
Positions and Transaction Volumes metrics, and limits the scope of
these metrics to trading desks engaged in market-making and
underwriting activities. Because SEC-registered dealers are routinely
engaged in market-making and underwriting activities, we preliminarily
expect that a greater share of the costs associated with the Positions
and Transaction Volumes metrics, such as the costs associated with
tagging intra-company and inter-affiliate transactions for purposes of
the Transaction Volumes metric, may fall on SEC-regulated entities,
while a greater share of the savings, such as the savings associated
with the elimination of this reporting requirement for desks engaged
solely in risk-mitigating hedging activities, may be allocated to non-
SEC-regulated banking entities.
The SEC preliminarily believes reporters will need to modify
existing systems to comply with the proposed amendments.\373\ On the
basis of its experience in similar rulemakings, the SEC believes that
the costs necessary to modify existing systems used to comply with the
proposed metrics reporting and recordkeeping amendments \374\ would
depend on the particular structure and activities of each SEC-regulated
banking entity's trading desks.\375\ In order to allocate the estimated
aggregate costs across the various proposed amendments, we make several
assumptions about the relative costs of the proposed amendments, as
described below. These assumptions are based on the SEC's experience
with reporters, as well as the SEC's preliminary belief that the most
significant component of the estimated costs will be the initial
implementation cost for the new reporting requirements.
---------------------------------------------------------------------------
\373\ In addition, SEC-regulated banking entities may incur
costs associated with reporting metrics in accordance with the XML
Schema published on each Agency's website. We discuss these costs
below.
\374\ We believe that affiliated SEC-regulated banking entities
will collaborate with one another to take advantage of efficiencies
that may exist and have factored that assumption into our analysis.
\375\ This estimate also includes personnel costs associated
with preparing the proposed narrative statement. These cost
estimates are based, in part, on staff experience, as well as
consideration of recent estimates of the one-time and ongoing
systems costs associated with other SEC rulemakings. See, e.g.,
Regulation SBSR--Reporting and Dissemination of Security-Based Swap
Information, Exchange Act Release No. 78321 (July 14, 2016), 81 FR
53546, 53629 (Aug. 12, 2016) (estimating the one-time costs for
trade execution platforms and registered clearing agencies to
develop transaction processing systems and report transaction-level
information to swap data repositories); see also Trade
Acknowledgment and Verification of Security-Based Swap Transactions,
Exchange Act Release No. 78011 (June 8, 2016), 81 FR 39807, 39839
(June 17, 2016) (estimating the one-time costs for registered
security-based swap dealers and major participants to develop
internal order and trade management systems to electronically
process transactions and send trade acknowledgments).
Although the substance and content of systems associated with
reporting transaction-level information to swap data repositories
and derivatives counterparties would be different from the substance
and content of systems associated with reporting quantitative
measurements of covered trading activity, the costs associated with
the proposed amendments, like the costs associated with the
referenced security-based swap rules, would entail gathering and
maintaining transaction-level information, and planning, coding,
testing, and installing relevant system modifications.
---------------------------------------------------------------------------
The primary systems-related costs of approximately $120,000 to
$130,000, estimated at the level of the reporter, will come from: (i)
Personnel costs associated with preparing the written Narrative
Statement for a single reporter that is not already providing this
information ($11,000); (ii) costs related to providing data in relation
to the Positions and Transaction Volumes metrics that is more granular
than is
[[Page 33540]]
currently required for the Inventory Turnover and Customer Facing Trade
Ratio metrics ($8,000); (iii) systems costs related to reporting intra-
company and inter-affiliate transactions under the Positions and
Transaction Volumes metrics ($7,000); (iv) initial implementation costs
for the Quantitative Measurements Identifying Information metric
($26,000); (v) ongoing costs related to the Quantitative Measurements
Identifying Information metric ($3,000); (vi) one-time costs of
establishing and implementing systems in accordance with the XML Schema
($75,000). As discussed above, we preliminarily believe that the net
burden savings estimated in section V.B and monetized in the previous
section reflect these new systems costs, as well as gross cost savings
from the proposed amendments. We discuss these costs, as well as
potential benefits of the proposed amendments, in greater detail below.
The SEC further considered how to assess the costs of the proposed
rule for SEC-regulated banking entities. The metrics costs are
generally estimated at the holding company level for 17 reporters.\376\
We then allocate these costs to the affiliated SEC-regulated banking
entity.\377\ We preliminarily believe that estimating the cost savings
of the proposal at the individual registrant level would be
inconsistent with our understanding of how these entities are complying
with the current metrics reporting requirement. Specifically, we
anticipate that SEC-regulated banking entities within the same
corporate group will collaborate with one another to comply with the
proposed amendments, to take advantage of efficiencies of scale.
Further, we note that individual SEC-regulated banking entities may
vary in the scope and type of activity they conduct and that not all
entities within an organization subject to Appendix A engage in the
types of covered trading activity for which metrics must be reported.
Thus, to the extent that metrics compliance occurs at the holding
company level, estimating costs at the registrant level may overstate
the magnitude of the costs and cost savings for SEC-regulated entities
from the proposed amendments.
---------------------------------------------------------------------------
\376\ The SEC currently receives metrics from 19 entities,
including two reporters that are below $10 billion in trading assets
and liabilities, and two reporters that belong to the same holding
company. Since voluntary reporters are not constrained by the
requirements of the proposed amendment, they are not reflected in
our cost estimates. In addition, we believe that the additional
systems costs estimated here will be incurred at the holding company
level and scope in the trading activity of all SEC-registered
banking entity affiliates.
\377\ See supra note 321.
---------------------------------------------------------------------------
We considered an alternative approach to estimating costs of the
proposed metrics amendments--specifically, doing so at the trading desk
level. We anticipate that individual trading desks and their personnel
may not be directly involved in complying with the full scope of the
proposed amendments. For example, the Quantitative Measurements
Identifying Information and the Narrative Statement must be prepared
and reported collectively for all relevant trading desks. We also
expect that trading desks within the same holding company could share
systems to implement many of the proposed amendments to the
quantitative measurements. Thus, a cost estimate at the trading desk
level may not be an accurate proxy of the costs of the proposed
amendments to SEC-regulated banking entities. Hence, such an analytical
approach is likely to overestimate the total cost savings of the
proposed amendments to SEC-regulated entities.
B. Elimination, Replacement, and Streamlining of Certain Metrics
The proposed amendments replace the Inventory Aging metric with a
Securities Inventory Aging metric and eliminate the Inventory Aging
metric for derivatives. In addition, the proposed amendments remove the
requirement to establish and report limits on Stressed Value-at-Risk
(VaR) at the trading desk level, replace the Customer-Facing Trade
Ratio metric with a new Transaction Volumes metric, replace Inventory
Turnover with a new Positions metric (reflecting both securities and
derivatives positions), streamline valuation of metrics calculations
for comparability, limit certain metrics to market-making and
underwriting desks, modify instructions for metrics reporting,
including with respect to profit and loss attribution, and remove
metrics that can be calculated from other reported measurements.
In general, the key economic tradeoff from metrics reporting is
between compliance burdens, which may be particularly significant for
smaller Group A entities, and the amount and usefulness of information
provided for regulatory oversight of the 2013 final rule, as well as
for general supervision and oversight. The proposed limitation of
certain metrics to market-making and underwriting desks, elimination of
the inventory aging metric, and removal of the Stressed VaR risk limit
requirements may reduce burdens related to reporting and recordkeeping
for Group A entities. As proprietary trading activity is inherently
difficult to distinguish from permitted market making, risk-mitigating
hedging, or underwriting activity, certain metrics may provide
additional information that is useful for regulatory oversight.
However, eliminating inventory turnover and Stressed VaR metrics should
not reduce the benefits of metrics reporting, as, these metrics do not
enable a clear identification of prohibited proprietary trading or
exempt market-making, risk-mitigating hedging, or underwriting
activities.
The proposed amendments replace the Inventory Turnover metric with
the Positions quantitative measurement and replace the Customer-Facing
Trade Ratio metric with the Transaction Volumes quantitative
measurement. The Inventory Turnover and Customer-Facing Trade Ratio
metrics are ratios that measure the turnover of a trading desk's
inventory and compare the transactions involving customers and non-
customers of the trading desk, respectively. The proposed Positions and
Transaction Volumes metrics would provide information about risk
exposure and trading activity at a more granular level. Specifically,
the proposed rule requires that banking entities provide the relevant
Agency with the underlying data used to calculate the ratios for each
trading day, rather than providing more aggregated data over 30-, 60-,
and 90-day calculation periods. By providing more granular data, the
proposed Positions metric, in conjunction with the proposed Transaction
Volumes metric, is expected to provide the SEC with the flexibility to
calculate inventory turnover ratios and customer-facing trade ratios
over any period of time, including a single trading day, allowing the
use of the calculation method we find most effective for monitoring and
understanding trading activity.
In addition, the new Positions and Transaction Volumes metrics will
distinguish between securities and derivatives positions, unlike the
Inventory Turnover and Customer-Facing Trade Ratio metrics. The
proposed Positions and Transaction Volumes metrics would require a
banking entity to separately report the value of securities positions
and the value of derivatives positions. While the current Inventory
Turnover and Customer-Facing Trade Ratio metrics require banking
entities to use different methodologies for valuing securities
positions and derivatives positions because of differences between
these asset classes, these metrics currently require banking entities
to aggregate
[[Page 33541]]
such values for reporting purposes. By combining separate and distinct
valuation types (e.g., market value and notional value), the Inventory
Turnover and Customer-Facing Trade Ratio metrics are currently
providing less meaningful information than was intended. Therefore,
requiring banking entities to disaggregate the value of securities
positions and the value of derivatives positions for reporting purposes
may enhance the usability of this information.
In addition to requiring separate reporting of the value of
securities positions and the value of derivatives positions, the
proposed rule would also streamline valuation method requirements for
different product types. We understand that certain valuation
methodologies currently required by the Inventory Turnover and the
Customer-Facing Trade Ratio metrics may not be otherwise used by
banking entities (e.g., for internal monitoring or external reporting
purposes). Furthermore, current requirements result in information
being aggregated and furnished to the SEC in non-comparable units.
Therefore, the proposed requirement to report notional and market value
for all derivatives positions may further enhance the usability of the
information provided in the Positions and Transaction Volumes metrics.
Moreover, the valuation methods required under the proposed rule
are intended to be more consistent with our understanding of how
banking entities value securities and derivatives positions in other
contexts, such as internal monitoring or external reporting purposes,
which may allow them to leverage existing systems and reduce ongoing
costs relatively to the costs of current reporting requirements. While
a banking entity may incur one-time costs in modifying how it values
certain positions for purposes of metrics reporting, we do not expect
such systems costs to be significant, particularly if the banking
entity is able to use the systems it currently has in place for
purposes of metrics reporting to value positions consistent with the
proposed rule.
Notably, the SEC does not anticipate that requiring banking
entities to provide more granular data in the Positions and Transaction
Volumes metrics will significantly alter the costs associated with the
current Inventory Turnover and Customer-Facing Trade Ratio metrics. The
Positions and Transaction Volumes metrics are based on the same
underlying data regarding the trading activity of a trading desk as the
Inventory Turnover and Customer-Facing Trade Ratio metrics, so we
expect that banking entities already keep records of these data and
have systems in place that collect these data. However, the SEC
anticipates that reporting more granular information in the Positions
and Transaction Volumes metrics may result in costs of $24,480.\378\
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\378\ The SEC anticipates that costs associated with the more
granular reporting in the Positions and Transaction Volumes metrics
will be $8,000 per affiliated group of SEC-regulated banking
entities. ($8,000 x 17 reporters x 0.18 SEC-registered banking
entity weight) = $24,480.
---------------------------------------------------------------------------
Similar to the Customer-Facing Trade Ratio, the proposed
Transaction Volumes metric would require banking entities to identify
the value and the number of transactions a trading desk conducts with
customers and non-customers. However, the proposed Transaction Volumes
metric would add two additional categories of counterparties to capture
the value and number of internal transactions a trading desk conducts.
These include transactions booked within the same banking entity
(intra-company) and those booked with an affiliated banking entity
(inter-affiliate). These additional categories of information should
facilitate better classification of internal transactions, which may
assist the SEC in evaluating whether the trading desk's activities are
consistent with the requirements of the exemptions for underwriting or
market making-related activity. The SEC estimates that modifying the
current requirements of the Customer-Facing Trade Ratio to require SEC-
regulated banking entities to further categorize trading desk
transactions may impose additional systems costs related to tagging
internal transactions and maintaining associated records valued at
$21,420.\379\
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\379\ The SEC estimates that the additional costs associated
with categorizing transactions under the Transaction Volumes metric
will be $7,000 per reporter. ($7,000 x 17 reporters x 0.18 SEC-
registered banking entity weight) = $21,420.
---------------------------------------------------------------------------
In addition, we anticipate that the proposed Positions and
Transaction Volumes metrics may reduce costs compared to the current
reporting requirements by limiting the scope of trading desks that must
provide the position- and trade-based data that is currently required
by the Inventory Turnover and Customer-Facing Trade Ratio metrics.
Under the 2013 final rule, banking entities are required to calculate
and report the Inventory Turnover and the Customer-Facing Trade Ratio
metrics for all trading desks engaged in covered trading activity. The
proposal would limit the scope of trading desks for which a banking
entity would be required to calculate and report the Positions and
Transaction Volumes metrics to only those trading desks engaged in
market making-related activity or underwriting activity. As noted
above, we do not expect SEC-regulated banking entities to realize the
same amount of cost savings as other banking entities would with
respect to this aspect of the proposed rule, since SEC-regulated
banking entities are the entities that typically engage in market
making-related and underwriting activities.
C. New Qualitative Information: Trading Desk, Narrative Statement, and
Descriptive Information
The proposed amendments require banking entities to provide
additional information. Specifically, the proposal requires entities to
provide: (1) Desk level qualitative information about the types of
financial instruments the desk uses and covered trading activity the
desk conducts, and about the legal entities into which the trading desk
books trades; (2) a narrative describing changes in calculation
methods, trading desk structure, or trading desk strategies; (3)
descriptive information about reported metrics, including information
uniquely identifying and describing risk measurements and identifying
the relationships of these measurements within a trading desk and
across trading desks.
D. Trading Desk Information and Narrative Statement
As recognized in Appendix A of the 2013 final rule, the
effectiveness of particular quantitative measurements may differ
depending on the profile of a particular trading desk, including the
types of instruments traded and trading activities and strategies.\380\
Thus, the additional qualitative information the Agencies propose to
collect in the Trading Desk Information provision may facilitate SEC
review and analysis of covered trading activities and reported metrics.
For instance, the proposed trading desk description may help the SEC
assess the risks associated with a given activity and establish the
appropriate frequency and scope of examination of such activity.
---------------------------------------------------------------------------
\380\ See 79 FR at 5798.
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The Agencies are also proposing to require banking entities to
provide a Narrative Statement that describes any changes in calculation
methods used, a description of and reasons for changes in the trading
desk structure or trading desk strategies, and when any such change
occurred. The Narrative Statement must also include any information the
banking entity views as
[[Page 33542]]
relevant for assessing the information reported, such as further
description of calculation methods used. If a banking entity does not
have any information to report in the Narrative Statement, it must
submit an electronic document stating that it does not have any
information to report. The Narrative Statement will provide banking
entities with an opportunity to describe and explain unusual aspects of
the data or modifications that may have occurred since the last
submission, which may facilitate better evaluation of the reported
data.
The SEC anticipates that the proposed Trading Desk Information and
Narrative Statement may enhance the efficiency of data review by
regulators. Having access to both quantitative data and qualitative
information for trading desks in each submission may allow the SEC to
consider the specifics of each trading desk's activities during the
reporting period, which may facilitate our ability to monitor patterns
in the quantitative measurements.
We note that all the SEC-regulated entities that currently report
Appendix A metrics are also currently providing certain elements of the
proposed Trading Desk Information to the SEC. Therefore, we
preliminarily believe that the costs of gathering the relevant Trading
Desk Information as well as the benefits of this requirement may be de
minimis.
The costs associated with preparing the Narrative Statement will
depend on the extent to which a banking entity modifies its calculation
methods, makes changes to a trading desk's structure or trading
strategies, or otherwise has additional information that it views as
relevant for assessing the information reported. Preparation of a
Narrative Statement is expected to be a more manual process involving a
written description of pertinent issues. However, all but one SEC
reporter already provides a narrative with every submission. Thus, the
proposed Narrative Statement requirement is expected to result in
ongoing personnel and monitoring costs of only $1,980.\381\ Since only
one SEC reporter is likely to be affected by this amendment, we believe
the benefits of the requirement will be de minimis.
---------------------------------------------------------------------------
\381\ The SEC estimates that costs associated with the proposed
Narrative Statement will be $11,000 per affiliated group of SEC-
regulated banking entities. ($11,000 x 1 reporter x 0.18 entity) =
$1,980.
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E. Quantitative Measurements Identifying Information
The Agencies are proposing to require banking entities to report a
Risk and Position Limits Information Schedule, a Risk Factor
Sensitivities Information Schedule, a Risk Factor Attribution Schedule,
a Limit/Sensitivity Cross-Reference Schedule, and a Risk Factor
Sensitivity/Attribution Cross-Reference Schedule. This additional
information may improve our understanding of how reported limits and
risk factors relate to each other for one or more trading desks, both
within the same reporting period and across reporting periods. The SEC
preliminarily believes that, while these new reporting elements may
increase compliance costs for banking entities, the information
contained in the reports may allow for more meaningful interpretation
of quantitative metrics data.
Banking entities will incur certain initial implementation costs to
develop these schedules of information, including costs associated with
developing unique identifiers for all limits, risk factor
sensitivities, and risk factor or other factor attributions used by the
banking entity and brief descriptions of all such limits,
sensitivities, and factors. This will include personnel costs to
prepare the descriptions and systems costs to collect and maintain the
relevant information for each schedule. The SEC estimates initial
implementation costs associated with the proposed Quantitative
Measurements Identifying Information at $79,560.\382\ There will also
likely be ongoing maintenance costs associated with updating and
storing the information schedules and ongoing monitoring costs to
ensure that the information schedules continue to accurately describe
the banking entity's reported limits, sensitivities, and factors over
time. However, since this information is not expected to change
significantly from reporting period to reporting period, banking
entities should be able to routinize the preparation of these
information schedules to minimize or mitigate ongoing costs. We
estimate the proposed Quantitative Measurements Identifying Information
will result in $9,180 of ongoing costs.\383\ To limit burdens
associated with reporting the identifying and descriptive information
covered by the Quantitative Measurements Identifying Information, the
proposed rule requires a banking entity to report this information in
the relevant information schedule for the entire banking entity rather
than for each trading desk.
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\382\ The SEC estimates that the costs associated with the
initial implementation of the Quantitative Measurements Identifying
Information will be $26,000 per affiliated group of SEC-regulated
banking entities. ($26,000 x 17 reporters x 0.18 entity weight) =
$79,560.
\383\ The SEC estimates that the ongoing costs associated with
the Quantitative Measurements Identifying Information will be $3,000
per affiliated group of SEC-regulated banking entities per year.
($3,000 x 17 reporters x 0.18 entity weight) = $9,180.
---------------------------------------------------------------------------
F. XML Format
The Agencies are proposing to require banking entities to submit
the Trading Desk Information, the Quantitative Measurements Identifying
Information, and each applicable quantitative measurement in accordance
with the XML Schema specified and published on the relevant Agency's
website.\384\ The metrics are not currently required to be reported in
a structured format, and banking entities are currently reporting
quantitative measurement data electronically. On the basis of
discussions with metrics reporters, most of these entities indicated a
familiarity with XML, and further, several indicated that they use XML
internally for other reporting purposes. In addition, we note that
banks currently submit quarterly Reports of Condition and Income
(``Call Reports'') to the Federal Financial Institutions Examination
Council (``FFIEC'') Central Data Repository in eXtensible Business
Reporting Language (``XBRL'') format, an XML-based reporting language,
so they are generally familiar with the processes and technology for
submitting regulatory reports in a structured data format. We believe
that familiarity with these practices at the bank level will facilitate
the implementation of these practices for affiliated SEC registrants.
Furthermore, FINRA requires its member broker-dealers to file their
FOCUS Reports in a structured format through its eFOCUS system.\385\
The eFOCUS system permits broker-dealers to import the FOCUS Report
data into a filing using an Excel, XML, or text file. Therefore, the
SEC preliminarily believes that all SEC-registered dealers covered by
the metrics reporting and recordkeeping requirements have experience
applying the XML format to their data.
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\384\ XML is an open standard, meaning that it is a
technological standard that is widely available to the public at no
cost. XML is also widely used across the industry.
\385\ For example, FINRA members commonly use FINRA's Web EFT
system, which requires that all data be submitted in XML. See Web
EFT Schema Documentation and Schema Files, FINRA, http://www.finra.org/industry/web-crd/web-eft-schema-documentation-and-schema-files; see also Disclosure of Order Handling Information,
Exchange Act Release No. 78309 (July 13, 2016), 81 FR 49431, 49499
(July 27, 2016). Information about FINRA's eFOCUS system is
available at http://www.finra.org/industry/focus.
---------------------------------------------------------------------------
Reporting metrics and other information in XML allows data to be
[[Page 33543]]
tagged, which in turn identifies the content of the underlying
information. The data then becomes instantly machine-readable through
the use of standard software. Requiring banking entities to submit the
metrics in accordance with the XML Schema would enhance the ability to
process and analyze the data. Once the data is in a structured format,
it can easily be organized for viewing, manipulation, and analysis
through the use of commonly used software tools and applications.
Structured data allows users to discern patterns from large quantities
of information much more easily than unstructured data. Structured data
also facilitates users' abilities to dynamically search, aggregate, and
compare information across submissions, whether within a banking
entity, across multiple banking entities, or across multiple date
ranges. The data supplied in a structured format could help the SEC
identify outliers or trends that could warrant further investigation.
The XML Schema would also incorporate certain validations to help
ensure consistent formatting among all reports--in other words, it
would help ensure data quality. The validations are restrictions placed
on the formatting for each data element so that data is presented
comparably. Requiring banking entities to report using the XML Schema
may help ensure timely access to the data in a format that is already
consistent and comparable for automated machine-processing and
analysis. However, these validations are not designed to ensure the
underlying accuracy of the data. Any reports provided by banking
entities under the proposed requirement would have to comply with these
validations that are incorporated within the XML Schema; otherwise the
reports would not be considered to have been provided using the XML
Schema specified and published on the SEC's website.
Specifying the format in which banking entities must report
information may help the Agencies ensure that we receive consistently
comparable information in an efficient manner across banking entities.
The costs associated with providing XML data lie in the specialized
software or services required to make the submission and the time
required to map the required data elements to the requisite taxonomy.
In addition to enhanced viewing, manipulation, and analysis, the
benefits associated with providing XML data lie in the enhanced
validation tools that minimize the likelihood that data are reported
with errors. Therefore, subsequent reporting periods may require fewer
resources, relative to both initial reporting periods and the current
reporting process.
We expect that the requirement to submit the Narrative Statement
electronically will result in minimal information systems costs, as
banking entities already have systems in place to submit information to
the SEC electronically. However, the SEC recognizes that, as a result
of the proposed amendments, banking entities will be required to
establish and implement systems in accordance with the XML Schema that
will result in one-time costs \386\ of approximately $75,000 per
holding company banking entity, on average, for an expected aggregate
one-time cost of approximately $229,500.\387\ Because we expect that
XML reporting will result in a more efficient submission process,
including validation of submissions, we anticipate that some of the
implementation costs may be partially offset, over time, by these
greater efficiencies.
---------------------------------------------------------------------------
\386\ These cost estimates are based in part on the SEC's recent
estimates of the one-time systems costs associated with the proposed
requirement that security-based swap data repositories (``SDRs'')
make transaction-level security-based swap data available to the SEC
in Financial products Markup Language (``FpML'') and Financial
Information eXchange Markup Language (``FIXML''). See Establishing
the Form and Manner with which Security-Based Swap Data Repositories
Must Make Security-Based Swap Data Available to the Commission,
Exchange Act Release No. 76624 (Dec. 11, 2015), 80 FR 79757 (Dec.
23, 2015) (``SBS Taxonomy rule proposing release''). The SBS
Taxonomy rule proposing release estimates a one-time cost per SDR of
$127,000. Although the substance of reporting associated with the
metrics is different from the information collected and made
available by SDRs, the SEC expects similar costs to apply to the
implementation of XML for the reporting metrics. In particular, on
the basis of its experience with similar structured data reporting
requirements in other contexts (e.g., the SBS Taxonomy rule), the
SEC expects that systems engineering fixed costs will represent the
bulk of the costs related to the XML requirement. Among other
things, the proposed SBS Taxonomy rule would require SDRs to make
available to the SEC in a specific format (in this case, FpML or
FIXML) transaction-level data that they are already required to
provide. Similarly, the proposed metrics amendments would require
banking entities to produce in XML metrics reports that they are
already required (or will be required) to provide. However, our
estimate is reduced to account for the fact that registered broker-
dealers already provide eFOCUS reports to FINRA in XML and,
therefore, must have the requisite systems in place. Our cost
estimates include responsibilities for modifications of information
technology systems to an attorney, a compliance Manager, a
programmer analyst, and a senior business analyst and
responsibilities for policies and procedures to an attorney, a
compliance Manager, a senior systems analyst, and an operations
specialist.
\387\ The SEC computes total costs as follows: $75,000 x 17
reporters x 0.18 entity weight = $229,500.
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G. Extended Time To Report
The proposed changes also extend the time to report metrics for
different groups of filers. Because processes enabling reporting under
tight deadlines may generally be costlier, we anticipate that the
amended reporting requirements may marginally reduce compliance costs,
particularly for filers with less sophisticated data and trading
infrastructure. In addition, the amendments may result in fewer
resubmissions by filers. To a limited extent, the proposed amendment
may reduce the timeliness of data received from dealers, making
supervision less agile. However, the SEC will continue to have access
to quantitative metrics and related information through the standard
examination and review process and existing recordkeeping requirements.
iii. Competition, Efficiency, and Capital Formation
Under the proposed amendments, Group A entities would incur lower
costs of compliance with metrics-reporting requirements. To the extent
that these compliance burdens may be significant for some Group A
entities, and since Group B entities are not subject to any metrics
requirements, smaller Group A entities around the threshold may become
more competitive with Group B entities. Since metrics are reported only
to the Agencies and are not publicly disseminated, this amendment does
not change the scope of information available to investors. As such, we
do not anticipate effects on informational efficiency to be
significant. To the extent that some Group A entities are currently
experiencing significant metrics-reporting costs and partially or fully
passing them along to customers in the form of reduced access to
capital or higher cost of capital, the proposed amendments may reduce
costs of and increase access to capital. However, as estimated cost
savings from the proposed amendments are small, we do not anticipate a
substantial increase in access to capital as a result of the proposed
amendments to metrics reporting requirements.
iv. Alternatives
The Agencies could have taken alternative approaches. First, the
Agencies could keep the metrics being reported unchanged but increase
or decrease the trading activity thresholds used to determine metrics
recordkeeping and reporting by filers and the frequency of such
reporting. For instance, the $10 billion trading activity threshold for
quarterly reporting could be replaced by the $25 billion threshold. As
shown in Table 2, we estimate that this alternative would affect 12
bank-
[[Page 33544]]
affiliated SEC-registered broker-dealers. Under the alternative, these
dealers would no longer be required to keep or report metrics, enjoying
lower compliance burdens. However, the alternative reduces the amount
and frequency of quantitative data available for regulatory oversight
of banking entities. Similarly, lowering the recordkeeping and
reporting thresholds would increase the scope of application of the
metrics reporting requirement, increasing accompanying recordkeeping
and reporting obligations as well as potential oversight and
supervision benefits. However, we continue to recognize that while
metrics being reported under the 2013 final rule do not allow a clear
delineation of proprietary trading and market-making or hedging
activities, they may be used to flag risks and enhance general
supervision, as well as demonstrate prudent risk management.
In addition, the Agencies could have proposed eliminating the VaR
requirement. Both VaR and Stressed VaR are based on firm-wide activity,
and VaR limits may not be routinely used by banking entities to manage
and control risk-taking activities at the desk level. The alternative
would remove from Appendix A the requirement for VaR limits because
such limits may not be meaningful at the trading desk level. This
alternative may reduce the burden of reporting and compliance costs
without necessarily reducing the effectiveness of regulatory oversight
by the SEC.
The Agencies have also considered eliminating all quantitative
metrics recordkeeping and reporting requirements under Appendix A of
the 2013 final rule. This alternative would reduce the amount of data
produced and transmitted to the Agencies. Appendix A metrics enable
regulators to have a more complete picture of risk-taking and profit
and loss attribution for supervised entities. However, the metric
reporting regime is costly, and banking entities currently subject to
the 2013 final rule and SEC oversight are also subject to other
compliance and reporting requirements unrelated to the 2013 final rule,
as well as the standard examination and review process. It is not clear
that the Appendix A metrics are superior to internal quantitative risk
measurements or other data (such as metrics in the FOCUS reports)
reported by SEC registered broker-dealers in describing risk exposures
and profitability of various activities by SEC registrants. Crucially,
Appendix A metrics, such as VaR, dealer inventory, transaction volume,
and profit and loss attribution, do not delineate a prohibited
proprietary trade and a permitted market making, underwriting or
hedging trade, particularly when executed in highly illiquid products
and times of stress. Moreover, reporters' flexibility in defining the
metrics may reduce their comparability. We recognize that while
Appendix A metrics do not allow a clear identification of proprietary
trading by SEC registrants, they may be used to flag risks and enhance
general supervision, as well as demonstrate prudent risk management.
g. Covered Funds
Section 13 of the BHC Act generally prohibits banking entities from
acquiring or retaining an ownership interest in, sponsoring, or having
certain relationships with covered funds, subject to certain
exemptions.\388\ The SEC's economic analysis concerns the potential
costs, benefits, and effects on efficiency, competition, and capital
formation of the proposed covered fund amendments for four groups of
market participants. First, the proposed amendments may impact SEC-
registered investment advisers that are banking entities, including
those that sponsor or advise covered funds and those that do not, as
well as SEC-registered investment advisers that are not banking
entities that sponsor or advise covered funds and compete with banking
entity RIAs. Second, the proposed amendments affect the ability of
bank-affiliated dealers to underwrite, make markets, or engage in risk-
mitigating hedging transactions involving covered funds. Third, the
proposed amendments impact private funds, including those funds scoped
in or out of the covered fund provisions of the 2013 final rule, as
well as private funds competing with such funds. Fourth, to the extent
that the proposed amendments impact efficiency, competition, and
capital formation in covered funds or underlying securities, investors
in and sponsors of covered funds and underlying securities may be
affected as well.
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\388\ See 12 U.S.C. 1851.
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As discussed in greater detail below, the primary economic tradeoff
posed by the proposed amendments to the covered fund provisions and
other potential changes to these provisions on which the Agencies seek
comment is the tradeoff between enhanced competition and capital
formation in covered funds and the potential moral hazard and related
financial risks posed by fund investments. To the extent that the
current covered fund provisions limit fund formation, the proposed
amendments and other amendments on which the Agencies seek comment
could reduce long-term compliance costs and increase revenues for
banking entities, and, as a result, increase capital formation. We are
currently not aware of any information or data about the extent to
which the covered fund provisions of the 2013 final rule are inhibiting
capital formation in funds. Therefore, the bulk of the analysis below
is necessarily qualitative.
i. Definition of ``Covered Fund''
Regulatory Baseline
The definition of ``covered fund'' impacts the scope of the
substantive prohibitions on banking entities' acquiring or retaining an
ownership interest in, sponsoring, and having certain relationships
with covered funds. The covered fund provisions of the 2013 final rule
may reduce the ability and incentives of banking entities to bail out
affiliated funds to mitigate reputational risk; limit conflicts of
interest with clients, customers, and counterparties; and reduce the
ability of banking entities to engage in proprietary trading indirectly
through funds. The 2013 final rule defines covered funds as issuers
that would be investment companies but for section 3(c)(1) or 3(c)(7)
of the Investment Company Act and then excludes specific types of
entities from the definition. The definition also includes certain
commodity pools as well as certain foreign funds, but only with respect
to a U.S. banking entity that sponsors or invests in the foreign fund.
Funds that rely on the exclusions in sections 3(c)(1) or 3(c)(7) of the
Investment Company Act are covered funds unless an exemption from the
covered fund definition is available; generally, funds that rely on
other exclusions in the Investment Company Act, such as real estate and
mortgage funds that rely on the exclusion in section 3(c)(5)(C), are
not covered funds under the 2013 final rule.
The broad definition of covered funds above encompasses many
different types of vehicles, and the 2013 final rule excludes some of
them from the definition of a covered fund.\389\ The excluded fund
types relevant to the baseline are funds regulated under the Investment
Company Act, that is, RICs and BDCs. Seeding vehicles for these funds
are also excluded from the covered fund definition during their seeding
period.\390\
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\389\ The exclusions from the covered fund definition are set
forth in Sec. __.10(c) of the 2013 final rule.
\390\ See 2013 final rule Sec. __.10(c)(12).
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[[Page 33545]]
Scope of the Covered Fund Definition: Costs and Benefits
The Agencies are requesting comment on potential modifications to
the covered fund definition. For instance, with respect to the foreign
public funds exclusion, the Agencies are requesting comment as to
whether to remove the condition that, for a foreign public fund
sponsored by a U.S. banking entity, 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. As another example, the
Agencies are requesting comment as to whether to revise the exclusion
to focus on the qualification of the fund in foreign jurisdictions and
markets as eligible for retail sales, without including requirements
related to the manner in which the fund's interests are sold, or to
tailor the exclusion's use of the defined term ``distribution'' to
address instances in which a fund's ownership interests generally are
sold to retail investors in secondary market transactions, as with
foreign exchange-traded funds. The Agencies are also requesting comment
on excluding other funds, such as family wealth vehicles, from the
scope of the covered fund definition. The Agencies are requesting
comment on modifying the loan securitization exclusion to permit
limited holdings of debt securities and synthetic instruments in
addition to loans. As a final example, the Agencies are requesting
comment on revising the covered fund definition to provide an exclusion
focused on the characteristics of an entity rather than only whether it
would be an investment company but for section 3(c)(1) or 3(c)(7) of
the Investment Company Act or would otherwise come within the covered
fund base definition.
Broadly, such modifications to the existing covered fund definition
and additional exclusions would reduce the number and types of funds
that are impacted by the 2013 final rule. Hence, these alternatives may
decrease both the economic benefits and the economic costs of the 2013
final rule's covered fund provisions, as discussed further below.
Form ADV data is not always sufficiently granular to allow us to
estimate the number of funds and fund advisers affected by the
different modifications to the covered fund definition on which the
Agencies are seeking comment. However, Table 3 and Table 4 in the
economic baseline quantify the number and asset size of private funds
advised by banking entity RIAs by the type of private fund they advise,
as those fund types are defined in Form ADV. These fund types include
hedge funds, private equity funds, real estate funds, securitized asset
funds, venture capital funds, liquidity, and other private funds.
The Agencies are requesting comment on whether to tailor the
covered funds definition by using a characteristics-based exclusion.
For instance, the Agencies are requesting comment on whether the
covered fund definition should exclude funds that are not hedge funds
or private equity funds, as defined in Form PF. This would exclude
other types of funds from the covered fund definition (such as venture
capital, real estate, securitized asset, liquidity, and all other
private funds, as those terms are defined in Form PF).
Using Form ADV data, we preliminarily estimate that approximately
173 banking entity RIAs advise hedge funds and 90 banking entity RIAs
advise private equity funds.\391\ As can be seen from Table 3 in the
economic baseline, 43 banking entity RIAs advise securitized asset
funds. Table 4 shows that banking entity RIAs advise 360 securitized
asset funds with $120 billion in gross assets. Another 56 banking
entity RIAs advise real estate funds, and banking entity RIAs advise
323 real estate funds with $84 billion in gross assets. Venture capital
funds are advised by only 16 banking entity RIAs, and all 42 venture
capital funds advised by RIAs have on aggregate approximately $2
billion in gross assets.
---------------------------------------------------------------------------
\391\ As noted in the economic baseline, a single RIA may advise
multiple types of funds.
---------------------------------------------------------------------------
As noted elsewhere in this Supplementary Information, the covered
fund provisions of the 2013 final rule may limit the ability of banking
entities to engage in trading through covered funds in circumvention of
the proprietary trading prohibition, reduce bank incentives to bailout
their covered funds, and mitigate conflicts of interest between banking
entities and its clients, customers, or counterparties. However, the
covered fund definition in the implementing rules is broad, and some
have argued that the rules currently in place may limit the ability of
banking entities to conduct traditional asset management activities and
to promote capital formation. The Agencies recognize that the covered
fund provisions of the implementing rules, as currently in effect, may
impose significant costs on some entities. The Agencies also understand
that the breadth of the covered fund definition requires market
participants to review hundreds of thousands of issuers, and
potentially more, to determine if the issuers are covered funds as
defined in the 2013 final rule. We understand that this has included a
review of hundreds of thousands of CUSIPs issued by common types of
securitizations for covered fund status.\392\ The need to perform an
in-depth analysis and make covered funds determinations across such a
large scope of entities involves costs and may adversely affect the
willingness of banking entities to own, sponsor, and have relationships
with covered funds and financial instruments that may be covered funds.
Moreover, the 2013 final rule's limitations on banking entities'
investment in covered funds may be more significant for covered funds
that are typically small in size, with potentially more negative
spillover effects on capital formation in underlying securities.\393\
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\392\ See supra note 18.
\393\ We understand that, for instance, the median venture
capital fund size in some locations is approximately $15 million.
One fund may have lost as much as $50 million dollars in investment
because of the prohibitions of section 13 of the BHC Act and
implementing regulations. See supra note 18.
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The potential modifications to the covered fund definition on which
the Agencies are seeking comment would reduce further the scope of
funds that need to be analyzed for covered fund status or would
simplify this analysis and would enable banking entities to own,
sponsor, and have relationships with certain groups of funds that are
currently defined as a covered fund. Accordingly, these potential
modifications may reduce costs of banking entity ownership,
sponsorship, and transactions with certain private funds, may promote
greater capital formation in, and competition among such funds, and may
improve access to capital for issuers of underlying debt or equity.
They may also benefit banking entity dealers through higher profits or
more underwriting business. Reducing the covered fund restrictions by
further tailoring the covered fund definition may encourage more
launches of funds that are excluded from the definition, increasing
capital formation and, possibly, competition in those types of funds.
If competition increases the quality of funds available to investors or
reduces the fees they are charged, investors in funds may benefit.
We do not observe the amount of capital formation in different
types of covered funds or underlying equity and debt securities that
does not occur because of the 2013 final rule. Because of the prolonged
and overlapping implementation timeline of various
[[Page 33546]]
post-crisis reforms and because market participants restructured their
trading and covered funds activities in anticipation of the
implementing rules being effective, we cannot measure the
counterfactual levels of capital formation and liquidity that would
have been observed after the financial crisis, absent the covered fund
provisions currently in place. Similarly, we cannot establish whether
competition in covered funds is adversely affected by the covered fund
definition currently in effect. We solicit any information,
particularly quantitative data, that would allow us to estimate the
magnitudes of the potential costs and benefits of the covered fund
provisions on banking entity-affiliated broker-dealers and investment
advisers advising the different types of funds discussed above and any
effects on efficiency, competition, and capital formation in different
types of funds and their underlying securities.
ii. Covered Funds: Underwriting, Market Making, and Risk-Mitigating
Hedging Regulatory Baseline
Under the baseline, as described above, the 2013 final rule
provides for market-making and hedging exemptions to the prohibition on
proprietary trading. However, the 2013 final rule places tighter
restrictions on the amount of underwriting, market making, and hedging
a banking entity can engage in when those transactions involve covered
funds. For underwriting and market-making transactions in covered
funds, if the banking entity sponsors or advises a covered fund, or
acts in any of the other capacities specified in Sec. __.11(c)(2) of
the 2013 final rule, then any ownership interests acquired or retained
by the banking entity and its affiliates in connection with
underwriting and market making-related activities for that particular
covered fund must be included in the per-fund and aggregate covered
fund investment limits in Sec. __.12 of the 2013 final rule and
subject to the capital deduction provided in Sec. __.12(d) of the 2013
final rule.\394\ Additionally, a banking entity's aggregate investment
in all covered funds is limited to 3 percent of a banking entity's tier
1 capital, and all banking entities must include ownership interests
acquired or retained in connection with underwriting and market making-
related activities for purposes of this calculation.\395\ Moreover,
hedging transactions in a covered fund are only permitted if the
transaction mitigates risks associated with the compensation of a
banking entity employee or an affiliate that provides advisory or other
services to the covered fund.\396\
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\394\ See 2013 final rule Sec. __.12(a)(2)(ii); see also Sec.
__.11(c)(2).
\395\ 2013 final rule Sec. __.12(a)(2)(iii); see also Sec.
__.11(c)(3).
\396\ 2013 final rule Sec. __.13(a).
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Costs and Benefits
The increased requirements imposed on SEC-registered dealers'
transactions in covered funds relative to other securities mean that a
dealer may not be able to make markets in a covered fund or may be
limited in its ability to do so, even if the dealer may be able to make
markets in the underlying securities owned by the covered fund or
securities that are otherwise similar to the covered fund. The
Agencies' proposed changes would provide banking entities greater
flexibility in underwriting and market making in covered fund
interests. Specifically, as discussed elsewhere in this Supplementary
Information, for a covered fund that the banking entity does not
organize or offer pursuant to Sec. __.11(a) or (b) of the 2013 final
rule, the proposal would remove the requirement that the banking entity
include, for purposes of the aggregate fund limits and capital
deduction, the value of any ownership interests of the covered fund
acquired or retained in connection with underwriting or market making-
related activities. Under the proposed amendments, these limits, as
well as the per fund limit, would only apply to a covered fund that the
banking entity organizes or offers and in which the banking entity
retains an ownership interest pursuant to Sec. __.11(a) or (b) of the
2013 final rule.
The proposed amendment aligns the requirements for underwriting and
market making with respect to ownership interests in covered funds that
the banking entity does not organize or offer, with requirements for
engaging in these activities with respect to other financial
instruments. We understand that the 2013 final rule's restrictions on
underwriting and making-related activities involving covered funds
impose costs on banking entities and may constrain their underwriting
and market making in covered funds. Under the proposed amendments,
banking entities would be able to engage in potentially profitable
market making and underwriting in covered funds they do not organize or
offer without the per-fund and aggregate limits and capital deductions.
SEC-registered banking entities are expected to benefit from this
amendment to the extent they profit from underwriting and market-making
activities in such covered funds. In addition, these benefits may, at
least partially, flow through to funds and fund investors.
Specifically, banking entities may become more willing and able to
underwrite and make markets in covered funds, and provide investors
with more readily available economic exposure to the returns and risks
of certain covered funds.
We recognize that ownership interests in covered funds expose
owners to the risks related to covered funds. It is possible that
covered fund ownership interests acquired or retained by a banking
entity acting as an underwriter or engaged in market making-related
activities may lead to losses for banking entities. However, we
recognize that the risks of market making or underwriting of covered
funds are substantively similar to the risks of market making or
underwriting of otherwise comparable securities. Therefore, the same
general tradeoffs discussed in section V.D.3.c of this Supplementary
Information between potential benefits for capital formation and
liquidity and potential costs related to moral hazard and market
fragility apply to banking entities' underwriting and market-making
activities involving covered funds and other types of securities.
Banking entities are also currently unable to retain ownership
interests in covered funds as part of routine risk-mitigating hedging.
These restrictions may currently be limiting banking entities' ability
to hedge the risks of fund-linked derivatives through shares of covered
funds referenced by fund-linked products. The Agencies recognized that,
as a result of this approach, banking entities may no longer be able to
participate in offering certain customer facilitating products relating
to covered funds. The Agencies recognized that increased use of
ownership interests in covered funds could result in exposure to
greater risk.\397\ Moreover, banking entities' transactions in fund-
linked products that reference covered funds with customers can expose
a banking entity to risk in cases where a customer fails to perform,
transforming the banking entity's covered fund hedge of the customer
trade into an unhedged, and potentially illiquid, position in the
covered fund (unless and until the banking entity takes action to hedge
this exposure and bears the corresponding costs).
---------------------------------------------------------------------------
\397\ 79 FR at 5737.
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The proposal expands the scope of permissible risk-mitigating
hedging with covered funds. Specifically, under the proposal, in
addition to being able to
[[Page 33547]]
acquire or retain an ownership interest in a covered fund as a risk-
mitigating hedge with respect to certain compensation agreements as
permitted under the 2013 final rule, the banking entity would also be
able to acquire or retain an ownership interest in a covered fund when
acting as an intermediary on behalf of a non-banking entity customer to
facilitate exposure by the customer to the profits and losses of the
covered fund.
The proposal is likely to benefit banking entities and their
customers, as well as advisers of covered funds. The proposed
amendments increase the ability of banking entities to facilitate
customer-facing transactions while hedging their own risk exposure. As
a result, this amendment may increase banking entity intermediation and
provide customers with easier access to the risks and returns of
covered funds. To the degree that banking entities' investments in
covered funds to hedge customer-facing transactions may facilitate
their engagement in customer-facing trades, customers of banking
entities may benefit from greater availability of financial instruments
providing exposure to covered funds and related intermediation. Access
to covered funds may be particularly valuable when private capital
plays an increasingly important role in U.S. capital markets and firm
financing.
We also recognize that the proposed amendments may increase risks
to banking entities. For instance, when a banking entity enters into a
transaction with a customer that provides exposure to the profits and
losses of a covered fund to a customer, even when such exposure is
hedged, the banking entity may suffer losses if a customer fails to
perform and fund investments are illiquid and decline in value.
However, such counterparty default risk is present in any principal
transaction in illiquid financial instruments, including when
facilitating customer trades in the securities in which covered funds
invest, as well as in market-making and underwriting activities. We
note that, under the proposal, risk-mitigating hedging transactions
involving covered funds would be conducted consistent with the
requirements of the 2013 final rule, as modified by the proposal,
including the requirements with respect to risk-mitigating hedging
transactions. For example, such exposures would be subject to required
risk limits and policies and procedures and would have to be
appropriately monitored and risk managed. Therefore, it is not clear
that hedging or customer facilitation in covered funds would pose a
greater risk to banking entities than hedging or customer facilitation
in similar securities that is permissible under the 2013 final rule.
Alternatives
An alternative would be to provide greater flexibility for
underwriting, market making, and risk-mitigating hedging transactions
involving covered fund interests. Specifically, the Agencies could
consider eliminating the per-fund limit, aggregate fund limit, and
capital deduction for a banking entity acting as an underwriter or
engaged in market making-related activities with respect to a covered
fund that the banking entity organizes and offers. The Agencies also
could have proposed amending the 2013 final rule to provide that, in
addition to the proposed amendment, banking entities should be
permitted to acquire or retain ownership interests in covered funds as
risk-mitigating hedging transactions where the acquisition or retention
meets the requirements of Sec. __.5 of the 2013 final rule, as
modified by the proposal. If the Agencies made all of these changes,
this would provide dealers the same level of flexibility in
underwriting, making markets in, or hedging with, covered funds as
applied to these activities with respect to all other types of
financial instruments, including the underlying financial instruments
owned by the same covered funds.
Compliance with current rules for covered funds imposes costs on
banking entities. To the extent that, under the baseline, such costs
prevent dealer subsidiaries of banking entities from making markets in
or underwriting certain financial instruments, the alternative would
enable them to engage in potentially profitable market making in,
underwriting, and hedging with, covered funds. Banking entity dealers
could benefit from this alternative, to the extent they profit from
underwriting and market-making activities in covered funds and to the
extent that investing in covered funds to hedge a banking entity's
exposure in transactions such as total return swaps reduce their risk
profile.
The benefits of this alternative may also flow through to funds,
investors, and customers. Under the alternative, banking entities would
enjoy greater flexibility in transacting in covered funds with
customers and in hedging banking entities' exposure with covered funds.
As a result, banking entities may become more willing and able to
underwrite and market products linked to covered funds and to provide
customers with an economic interest in the profits and losses of
covered funds. This may increase investor access to the returns and
risks of private funds, which may be particularly valuable when issuers
are increasingly relying on private capital and delaying public
offerings. Finally, the increased ability of banking entities to
transact in covered funds under the alternative may increase market
quality for covered funds that are traded.
We continue to recognize that transactions in covered funds--
including transactions with customers, and holdings of ownership
interests in covered funds related to underwriting, market making, or
hedging activities--necessarily involve the risk of losses. However,
the risks of market making, underwriting, or hedging by banking
entities of financial instruments underlying the covered fund, or
financial instruments or securities that are otherwise similar to
covered funds, are substantively similar. Therefore, the same tradeoffs
discussed in section V.D.3.c in this Supplementary Information between
potential benefits to capital formation and liquidity and potential
costs related to moral hazard and market fragility apply to both
banking entity interests from underwriting and market making in
financial instruments and underwriting and market making in covered
funds. It is not clear that the existence of a legal and management
structure of a covered fund per se changes the economic risk exposure
of banking entities, and, thus, the capital formation and other
tradeoffs discussed above. We note that the alternative would simply
involve a consistent treatment of financial instruments and funds as it
pertains to underwriting, market making, and hedging activities.
However, as discussed above in section V.D.1 of this Supplementary
Information, some of the effects of the 2013 final rule's provisions
are difficult to evaluate outside of economic downturns, and we are
unable to measure the amount of capital formation or liquidity in
covered funds or underlying products that does not occur because of the
existing treatment of underwriting, market making, and hedging using
covered funds.
iii. Restrictions on Relationships Between Banking Entities and Covered
Funds Regulatory Baseline
Under the baseline, banking entities are limited in the types of
transactions they are able to engage in with covered funds with which
they have certain relationships. Banking entities that serve in certain
capacities with respect to a covered fund, such as the fund's
investment manager, adviser, or sponsor, are prohibited from engaging
in
[[Page 33548]]
a ``covered transaction,'' as defined in section 23A of the FR Act,
with the covered fund.\398\ This prohibits transactions such as loans,
guarantees, securities lending, and derivatives transactions that cause
the banking entity to have credit exposure to the affiliate. However,
the 2013 final rule exempts from the prohibition 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''). Therefore, banking entities with a
relationship to a covered fund can engage in prime brokerage
transactions (that are covered transactions) only with second-tier
funds and not with all covered funds.\399\
---------------------------------------------------------------------------
\398\ See 2013 final rule Sec. __.14(a).
\399\ See 2013 final rule Sec. __.14(c).
---------------------------------------------------------------------------
Costs and Benefits
The Agencies request comments on whether the Agencies should amend
Sec. __.14 of the 2013 final rule to incorporate the exemptions under
section 23A of the FR Act and the Board's Regulation W, such as
intraday extensions of credit that facilitate settlement.\400\ As a
result of the restrictions on covered transactions in the 2013 final
rule, some banking entities may be outsourcing the provision of routine
services to sponsored funds, such as custody and clearing services, to
outside providers. We recognize that outsourcing such activities may
adversely affect customer relationships, increase costs, and decrease
operational efficiency for banking entities and covered funds. The
changes on which the Agencies seek comment would provide banking
entities greater flexibility to provide these and other services
directly to covered funds. If being able to provide custody, clearing,
and other services to sponsored funds reduces the costs of these
services, fund advisers and, indirectly, fund investors, may benefit
from incorporating the exemptions. We note that most direct benefits
are likely to accrue to banking entity advisers to covered funds that
are currently relying on third-party service providers as a result of
the requirements of the 2013 final rule.
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\400\ The Agencies also are requesting comment as to whether the
definition of ``prime brokerage transaction'' under the proposal is
appropriate and, if not, what definition would be appropriate and
which transactions should be included in the definition. The costs,
benefits, and other implications of expansions to the definition of
``prime brokerage transaction'' would generally be similar to those
associated with the potential changes to Sec. __.14 discussed in
this section, except that they likely would be less significant
because the statute permits prime brokerage transactions only with
second-tier funds and does not extend to covered funds more
generally.
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These changes would increase banking entities' ability to engage in
custody, clearing, and other transactions with their covered funds and
benefit banking entities that are currently unable to engage in
otherwise profitable or efficient activities with covered funds they
own or advise. Moreover, this could enhance operational efficiency and
reduce costs incurred by covered funds, which are currently unable to
rely on their affiliated banking entity for custody, clearing, and
other transactions. Conversely, to the extent that this approach
increases transactions between a banking entity and related covered
funds, banking entities could incur any risks associated with these
transactions, recognizing that the transactions would be subject to the
limitations in section 23A of the FR Act and the Board's Regulation W,
as well as Sec. __.14(b) of the 2013 final rule and other applicable
laws.
iv. Covered Fund Activities and Investments Outside of the United
States Regulatory Baseline
Under the 2013 final rule, foreign banking entities can acquire or
retain an ownership interest in, or act as sponsor to, a covered fund,
so long as those activities and investments occur solely outside the
United States, no ownership interest in such fund is offered for sale
or sold to a resident of the United States (the ``marketing
restriction''), and certain other conditions are met. An activity or
investment occurs solely outside of the United States if (1) the
banking entity is not itself, and is not controlled directly or
indirectly by, a banking entity that is located in the United States or
established under the laws of the United States or of any state; (2)
the banking entity (and relevant personnel) that makes the decision to
acquire or retain the ownership interest or act as sponsor to the
covered fund is not located in the United States or organized under the
laws of the United States or of any state; (3) the investment or
sponsorship, including any risk-mitigating hedging transaction related
to an ownership interest, is not accounted for as principal by any U.S.
branch or affiliate; and (4) no financing is provided, directly or
indirectly, by any U.S. branch or affiliate. In addition, the staffs of
the Agencies issued FAQs concerning the requirement that no ownership
interest in such fund is offered for sale or sold to a resident of the
United States.
Costs and Benefits
The proposed amendments remove the financing prong of the foreign
funds exemption and codify the FAQs regarding marketing of foreign
funds to U.S. residents.\401\ Thus, under the proposed amendments,
foreign banking entities would be able to acquire or retain ownership
interests in and sponsor covered funds with financing provided directly
or indirectly by U.S. branches and affiliates, including SEC-registered
dealers. The costs, benefits, and effects on efficiency, competition,
and capital formation of this amendment generally parallel those of the
removal of the financing prong with respect to trading activity outside
the United States in section V.D.3.e of this Supplementary Information.
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\401\ We understand that market participants have adjusted their
activity in reliance on the FAQs regarding the marketing
restriction. Hence, we preliminarily believe that the economic
effects of the proposed amendment to reflect the position expressed
in the staffs' FAQs are likely to be de minimis and we focus this
discussion on the proposed removal of the financing prong.
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Foreign banking entities may benefit from the proposed amendments
and enjoy greater flexibility in financing their covered fund activity.
Allowing foreign banking entities to obtain financing of covered fund
transactions from U.S.-dealer affiliates may reduce costs of foreign
banking entity activity in covered funds. The amendment may decrease
the need for foreign banking entities to rely on foreign dealer
affiliates solely for the purposes of avoiding the compliance costs and
prohibitions of the 2013 final rule. This may increase operational
efficiency of covered fund activity by foreign banking entities. To the
extent that costs of compliance with the foreign fund exemption may
currently represent barriers to entry for foreign banking entities'
covered fund activities, the proposed amendment may increase foreign
banking entities' sponsorship and financing of covered funds.
The economic exposure and risks of foreign banking entities'
covered funds activities may be incurred not just by the foreign
banking entities, but by U.S. entities financing the covered fund
ownership interests, e.g., through margin loans covering particular
transactions. However, the proposal retains the requirement that the
investment or sponsorship, including any related hedging, is not
accounted for as principal by any U.S. branch or affiliate. We continue
to note that moral hazard risks and concerns about the volume of U.S.
banking entity risk-taking are less relevant when the covered fund
activity is conducted by,
[[Page 33549]]
and the risk consolidates to, foreign banking entities.
Competitive effects of this amendment may differ from the proposed
amendment regarding trading activity outside of the United States.
Under the proposed amendment to the foreign fund exemption, foreign
banking entities will enjoy a greater degree of flexibility and
potentially lower costs of financing covered fund transactions outside
of the United States. Because the 2013 final rule's exemption for
covered funds activities solely outside of the United States is
available only to foreign banking entities, the proposed amendments may
reduce costs for some foreign banking entities but need not affect the
competitive standing of U.S. banking entities relative to foreign
banking entities with respect to covered funds activities in the United
States.
h. Definition of Banking Entity
As discussed elsewhere in this Supplementary Information, staffs of
the Agencies have responded to questions raised regarding the potential
treatment of RICs as banking entities as a result of a sponsor's seed
investment, as well as issues related to FPFs and foreign excluded
funds. The Agencies are continuing to consider the issues raised by the
interaction between the 2013 final rule's definitions of the terms
``banking entity'' and ``covered fund,'' including the issues addressed
by the Agencies' staffs and the Federal banking agencies discussed
above. Accordingly, the Agencies have made clear that nothing in the
proposal would modify the application of the staffs' FAQs discussed
above, and the Agencies will not treat RICs or FPFs that meet the
conditions included in the applicable staff FAQs as banking entities or
attribute their activities and investments to the banking entity that
sponsors the fund or otherwise may control the fund under the
circumstances set forth in the FAQs. In addition, to accommodate the
pendency of the proposal, for an additional period of one year until
July 21, 2019, the Agencies will not treat qualifying foreign excluded
funds that meet the conditions included in the policy statement
discussed above as banking entities or attribute their activities and
investments to the banking entity that sponsors the fund or otherwise
may control the fund under the circumstances set forth in the policy
statement. This section focuses on the seeding of RICs, because they
are registered with the SEC (and applies to BDCs as well, which are
regulated by the SEC). To the extent that the same considerations
generally apply to the seeding of FPFs, the analysis below may be
relevant for the seeding of these funds as well.\402\
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\402\ This section does not focus on foreign excluded funds. The
information the SEC collects on Form ADV does not allow the SEC to
estimate the number of SEC-registered investment advisers that
advise foreign excluded funds. For example, Form ADV does not
require advisers with a principal office and place of business
outside the United States to provide information on Schedule D of
Part 1A with respect to any private fund that, during the last
fiscal year, was not a U.S. person, was not offered in the United
States, and was not beneficially owned by any U.S. person. Because
foreign excluded funds are organized and offered outside of the
United States by foreign banking entities, however, many foreign
excluded funds may be advised by foreign banks or other foreign
affiliates or subsidiaries that are not SEC-registered investment
advisers. Therefore, we preliminarily believe that the proposal and
any further modifications to the 2013 final rule on which the
Agencies seek comment would likely primarily impact foreign
activities of foreign banking entities and funds outside of the
SEC's regulatory oversight.
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The FAQ issued by the staffs related to seeding RICs and FPFs
observed that the preamble to the 2013 final rule recognized that a
banking entity may own a significant portion of the shares of a RIC or
FPF during a brief period during which the banking entity is testing
the fund's investment strategy, establishing a track record of the
fund's performance for marketing purposes, and attempting to distribute
the fund's shares. The FAQ recognizes that the length of a seeding
period can vary and therefore provides an example of 3 years, the
maximum period of time that could be permitted under certain conditions
for seeding a covered fund under the 2013 final rule, without setting
any maximum prescribed period for a RIC or FPF seeding period. The
Agencies are seeking comment on whether this guidance has been
effective, including questions as to whether the Agencies should
specify a maximum period of time for a seeding period or, conversely,
whether the current approach of not prescribing a fixed period of time
for a seeding period is more effective in providing flexibility for
funds that may need more time to develop a track record without having
to specify a particular time period that will be appropriate for all
funds.
The SEC understands that RICs (and FPFs) commonly require some time
to establish a performance track necessary to market the fund
effectively to third-party investors. Some funds will need a 3-year
performance track record, and sometimes longer, to be distributed
through certain intermediaries or to attract sufficient investor
interest. For example, the SEC understands that some funds might need a
5-year track record to be distributed effectively.
On the one hand, providing a fixed period of time beyond which a
seeding period for a RIC cannot extend would provide banking entities
with greater certainty, which may incentivize banking entities to form
new funds. On the other hand, the current approach of not prescribing a
fixed period of time for a seeding period for a RIC may provide
flexibility for funds that need more time to develop a track record.
This approach would recognize that banking entities may be able to
quickly reduce a seed investment in some RICs but not in others.
However, the lack of certainty about the length of permissible seeding
period could disincentivize a banking entity from sponsoring a RIC.
Another potential approach, on which the Agencies seek comment,
would be to specify a fixed period of time for a seeding period while
also permitting a banking entity to hold an investment beyond this
fixed period if the banking entity complies with additional conditions,
such as documentation of the business need for the sponsor's continued
investment. This may provide benefits by providing more certainty to
banking entities, while providing for the ability to exceed a fixed
seeding period in appropriate circumstances.
In addition, longer seeding periods for RICs and FPFs extend the
period of time during which a banking entity may be subject to the
risks associated with the seed investment. We note, however, that RICs
are subject to all of the requirements under the Investment Company
Act, and the exclusion for FPFs is designed to identify foreign funds
that are sufficiently similar to RICs such that it is appropriate to
exclude these foreign funds from the covered fund definition.
Therefore, although section 13 and the 2013 final rule under certain
conditions permit a seeding period of up to 3 years for covered funds
(which are not subject to substantive SEC regulation and are the target
of section 13's restrictions), longer seeding periods for RICs and FPFs
may not raise the same concerns.
i. Compliance Program
i. Regulatory Baseline
The 2013 final rule emphasized the importance of a strong
compliance program and sought to tailor the compliance program to the
size of banking entities and the size of their trading activity. The
Agencies believed it was necessary to balance compliance burdens posed
on smaller banking entities with specificity and rigor necessary for
large and complex banking organizations facing high compliance risks.
As a result, the current compliance regime is progressively
[[Page 33550]]
more stringent with the size of covered activities and/or balance sheet
of banking entities.
Under the 2013 final rule, all banking entities with covered
activities must develop and maintain a compliance program that is
reasonably designed to ensure and monitor compliance with section 13 of
the BHC Act and the implementing regulations. The terms, scope, and
detail of the compliance program depend on the types, size, scope, and
complexity of activities and business structure of the banking
entity.\403\ Under the 2013 final rule, banking entities with total
consolidated assets of less than $10 billion as reported on December 31
of the 2 previous calendar years face a simplified compliance program:
Such entities are able to incorporate compliance with the 2013 final
rule into their regular compliance policies and procedures by
reference, adjusting as appropriate given the entities' activities,
size, scope, and complexity.\404\
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\403\ See 2013 final rule Sec. __.20(a).
\404\ See 2013 final rule Sec. __.20(f). Note that if an entity
does not have any covered activities, it is not required to
establish a compliance program until it begins to engage in covered
activity.
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All other banking entities with covered activities are, at a
minimum, required to implement a six-pillar compliance program. The six
pillars include: (1) Written policies and procedures reasonably
designed to document, describe, monitor and limit proprietary trading
and covered fund activities and investments for compliance; (2) a
system of internal controls reasonably designed to monitor compliance;
(3) a management framework that clearly delineates responsibility and
accountability for compliance, including management review of trading
limits, strategies, hedging activities, investments, and incentive
compensation; (4) independent testing and audit of the effectiveness of
the compliance program; (5) training for personnel to effectively
implement and enforce the compliance program; and (6) recordkeeping
sufficient to demonstrate compliance.\405\
---------------------------------------------------------------------------
\405\ See 2013 final rule Sec. __.20(b).
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In addition, under the 2013 final rule, banking entities with
covered activities that do not qualify as those with modest activity
(total consolidated assets in excess of $10 billion) and that either
are subject to the reporting requirements of Appendix A or have more
than $50 billion in gross consolidated total assets are required to
comply with the enhanced minimum standards for compliance programs that
are specified in Appendix B of the 2013 final rule.\406\ That is,
Appendix B scopes in (1) all banking entities with significant trading
assets and liabilities; and (2) banking entities with covered activity
that have more than $50 billion in gross consolidated total assets,
regardless of whether or not these banking entities have significant
trading assets and liabilities.
---------------------------------------------------------------------------
\406\ See 2013 final rule Sec. __.20(c) and Appendix B.
---------------------------------------------------------------------------
As described in greater detail elsewhere in the Supplementary
Information, Appendix B requires the compliance program to (1) be
reasonably designed to supervise the permitted trading and covered fund
activities and investments, identify and monitor the risks of those
activities and potential areas of noncompliance, and prevent prohibited
activities and investments; (2) establish and enforce appropriate
limits on the covered activities and investments, including limits on
the size, scope, complexity, and risks of the individual activities or
investments consistent with the requirements of section 13 of the BHC
Act and the 2013 final rule; (3) subject the compliance program to
periodic independent review and testing and ensure the entity's
internal audit, compliance, and internal control functions are
effective and independent; (4) make senior management and others
accountable for the effective implementation of the compliance program,
and ensure that the chief executive officer and board of directors
review the program; and (5) facilitate supervision and examination by
the Agencies.
Additionally, under the 2013 final rule, any banking entity that
has more than $10 billion in total consolidated assets as reported in
the previous 2 calendar years shall maintain additional records in
relation to covered funds. In particular, a banking entity must
document the exclusions or exemptions relied on by each fund sponsored
by the banking entity (including all subsidiaries and affiliates) in
determining that such fund is not a covered fund, including
documentation that supports such determination; for each seeding
vehicle that will become a registered investment company or SEC-
regulated business development company, a written plan documenting the
banking entity's determination that the seeding vehicle will become a
registered investment company or SEC-regulated business development
company, the period of time during which the vehicle will operate as a
seeding vehicle, and the banking entity's plan to market the vehicle to
third-party investors and convert it into a registered investment
company or SEC-regulated business development company within the time
period specified.\407\
---------------------------------------------------------------------------
\407\ See 2013 final rule Sec. __.20(e).
---------------------------------------------------------------------------
The Agencies recognize that the scope and breadth of the compliance
obligations impose significant costs on banking entities, which may be
particularly impactful for smaller entities. For example, some
commenters estimate that banking entities may have added as many as
2,500 pages of policies, procedures, mandates, and controls per
institution for the purposes of compliance with the 2013 final rule,
which need to be monitored and updated on an ongoing basis.\408\
Moreover, some banking entities may spend, on average, more than 10,000
hours on training each year.\409\ In terms of ongoing costs, some
banking entities may have 15 regularly meeting committees and forums,
with as many as 50 participants per institution dedicated to compliance
with the 2013 final rule.
---------------------------------------------------------------------------
\408\ See supra note 18.
\409\ Id.
---------------------------------------------------------------------------
The current compliance regime and related burdens may reduce the
profitability of covered activities by dealers and investment advisers
affiliated with banking entities and may be passed along to customers
or clients in the form of reduced provision of services or higher
service costs. Moreover, the Agencies recognize that the extensive
compliance program under the 2013 final rule may detract resources of
banking entities and their compliance departments and supervisors from
other routine compliance matters, risk management, and supervision.
Finally, prescriptive compliance requirements may not optimally reflect
the organizational structures, governance mechanisms, or risk
management practices of complex, innovative, and global banking
entities.
ii. Costs and Benefits
The proposed amendments are expected to lower compliance burdens in
two ways. First, the proposed amendments increase flexibility in
complying with the 2013 final rule for banking entities without
significant trading assets and liabilities, which may reduce compliance
costs for these entities. Second, the proposed amendments streamline
the compliance program for large banking entities. To the extent that
current requirements are duplicative and maintaining both an enhanced
compliance program and regular compliance systems is
[[Page 33551]]
inefficient, large entities may benefit from the proposed amendments.
Specifically, the proposed amendments introduce four main changes to
the compliance program requirements of the 2013 final rule.
First, Group C entities would be subject to presumed compliance
with proprietary trading and covered fund prohibitions. Specifically,
the rebuttable presumption of compliance would apply to all holding
companies with less than $1 billion in combined total of consolidated
trading assets and trading liabilities (excluding trading assets and
liabilities involving obligations of or guaranteed by the United States
or any agency of the United States). We preliminarily estimate that
approximately 42 broker-dealers would be able to avail themselves of
the rebuttable presumption and would not have to apply the 2013 final
rule's compliance program requirements. The presumed compliance
standard proposed for Group C entities may benefit entities with very
low levels of trading activity by providing additional compliance
flexibility. While this may increase the risks of non-compliance, the
proposed amendments do not waive the proprietary trading and covered
fund prohibitions of the 2013 final rule for such entities.
Second, the threshold for a simplified compliance program would be
based on a banking entity's consolidated trading assets and liabilities
instead of its total assets. The Agencies recognize that existing
compliance program requirements may burden entities that engage in
little covered trading activity but have larger total assets. The
proposed amendment may reduce costs for banking entities that have more
than $10 billion in total assets but do not have significant trading
activity. Since the volume of consolidated trading assets and
liabilities is likely less than the size of the firm's balance sheet,
this amendment would scope in more holding companies--and consequently
SEC-registered dealers and investment advisers affiliated with them--
into the simplified compliance program regime.
Third, under the proposed amendments covered fund recordkeeping
requirements apply to banking entities with significant trading assets
and liabilities, rather than to banking entities with over $10 billion
in total assets. As discussed above, the Agencies expect that the
covered funds activities of banking entities without significant
trading assets and liabilities may generally be smaller in scale and
less complex than those of banking entities with significant trading
assets and liabilities. Thus, the value of additional documentation
requirements for banking entities without significant trading assets
and liabilities may be lower. The proposal reflects these
considerations and may reduce the costs associated with these covered
funds recordkeeping requirements by reducing the number of banking
entities subject to these requirements.\410\ We note that entities with
moderate trading assets and liabilities would still be required to
comply with all the covered fund provisions, and the proposal simply
eliminates recordkeeping for the purposes of demonstrating compliance.
While, in general, the removal of such recordkeeping requirements may
reduce the effectiveness of regulatory oversight, we preliminarily
believe that SEC oversight of registered dealers and investment
advisers of covered funds may not be adversely affected.
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\410\ We do not have the information necessary to quantify the
current costs of compliance programs specific to banking entity
RIAs. Thus, we do not allocate cost savings from monetized PRA
burdens to banking entity RIAs from the proposed Appendix B
amendments. To the degree that some banking entity RIAs may be
complying using compliance resources and systems independent of the
affiliated holding company or affiliates and subsidiaries, we may be
underestimating the cost savings from the proposed amendments.
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Fourth, with an exception for the CEO attestation, the requirements
in Appendix B of the 2013 final rule would be removed. The Agencies
understand that compliance with Appendix B required entities to develop
and administer an enhanced compliance program that may not be tailored
to the business model or risks of specific institutions. Further, some
banking entities have established as many as 500 controls related to
Appendix B obligations, some of which may be duplicating existing
policies and procedures designed as part of prudential safety and
soundness.\411\ The removal of Appendix B requirements will affect all
Group A banking entities and Group B and Group C banking entities that
have total consolidated assets of $50 billion or more. We estimate that
there are 100 broker-dealers that may experience reduced compliance
costs as a result of this amendment. The removal of the Appendix B
requirements may significantly reduce the number and complexity of the
compliance requirements such entities are subject to. Given the size of
affected holding companies, a stringent compliance regime may reduce
compliance risks related to the substantive prohibition of the 2013
final rule. However, Group A and Group B entities will continue to be
required to establish and maintain a compliance program under Sec.
__.20.
---------------------------------------------------------------------------
\411\ See supra note 18.
---------------------------------------------------------------------------
Finally, the proposed amendment would require all Group A and Group
B entities to comply with the CEO attestation requirement. Under the
2013 final rule, banking entities with $50 billion or more in total
consolidated assets, banking entities with over $10 billion in
consolidated trading assets and liabilities, and those banking entities
that an Agency has notified in writing are subject to the CEO
attestation requirement.\412\ We estimate that currently as many as 100
banking entity broker-dealers are required to comply with the CEO
attestation requirement. Based on the counts in Table 2, we estimate
that the proposed amendment will reduce this number to approximately 96
entities. However, we recognize that entities have flexibility to
comply with the attestation requirement, including providing it at the
SEC-registrant or at the holding-company level. For example, in 2017
the SEC received a total of 57 attestations, including those from
registrants and holding companies. While the proposed amendment may
slightly decrease the number of affected broker-dealers because of this
flexibility in compliance, the effects on compliance burdens for SEC
registrants, if any, are unclear.
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\412\ As a baseline matter, the CEO is currently required to
annually attest that the banking entity has in place processes to
establish, maintain, enforce, review, test, and modify the
compliance program established pursuant to Appendix B in a manner
reasonably designed to achieve compliance with section 13 of the BHC
Act and the 2013 final rule.
---------------------------------------------------------------------------
As an alternative, the Agencies could have proposed amending the
2013 final rule by requiring CEO attestations for all Group A entities
only if they have over $50 billion in total assets; removing the CEO
attestation requirement; or allowing other senior officers, such as the
chief compliance officer (CCO), to provide the requisite attestation
for some or all affected banking entities. The Agencies recognize that
the CEO attestation process is costly and that some banking entities
may spend more than 1,700 hours on the CEO attestation process and that
the elimination of this requirement may reduce time dedicated towards
the compliance program by as much as 10%.\413\ The Agencies also
recognize that allowing other senior officers to provide the
attestation would provide beneficial flexibility to banking entities
with different business models, organizational structures, delegation
of duties, and internal reporting and oversight lines. In addition, as
the
[[Page 33552]]
Agencies have discussed in other contexts,\414\ certification and
attestation requirements may increase CEO liability when the CEO
executes the required attestation. If CEOs of banking entities are risk
averse, they may require additional liability insurance, higher
compensation or lower incentive pay as a fraction of overall
compensation. However, liability related to the attestation may also
serve as a disciplining mechanism by incentivizing compliance and may
reduce risk-taking by banking entities. We also note that the covered
activities of larger and more complex banking entities with higher
volumes of trading activity may involve more significant moral hazard
and conflicts of interest.
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\413\ See supra note 18.
\414\ See, e.g., Business Conduct Standards for Security-Based
Swap Dealers and Major Security-Based Swap Participants, Exchange
Act Release No. 77617 (Apr. 13, 2016), 81 FR 29960, 30128 (May 24,
2016).
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The Agencies also recognize that CEO attestation may be costly for
foreign banking entities. For example, one foreign firm reported that
it organizes and manages a global controls sub-certification process
that takes 6 months to complete and involves over 400 staff (including
over 260 outside the United States) in order for the CEO to sign and
deliver the annual attestation.\415\ As an alternative, the Agencies
could have proposed exempting foreign banking entities from the CEO
attestation requirement. Currently, the requirement covers only the
U.S. operations of a foreign banking entity and not its foreign
operations. Similar to the analysis of the proposed amendment to
trading outside the United States, this alternative may decrease
compliance costs and increase trading activity by foreign banking
entities in the United States, but result in losses in market share and
profitability for U.S. banking entities that would remain subject to
the attestation requirement and would be placed at a competitive
disadvantage as a result.
---------------------------------------------------------------------------
\415\ See supra note 18.
---------------------------------------------------------------------------
As can be seen from section V.B, the Agencies do not estimate any
recordkeeping or reporting burden reductions related to compliance
requirements in Sec. __.20(b) of the final rule. The proposed removal
of Appendix B requirements will result in ongoing annual cost savings
estimated as $8,098,200 for registered broker-dealers and as up to
$2,753,388 for entities that may choose to register as SBSDs.\416\ In
addition, the removal of Appendix B requirements may result in initial
cost savings estimated as $24,294,600 for registered broker-dealers,
and up to $8,260,164 for entities that may choose to register as
SBSDs.\417\ As can be seen from section V.B, the Agencies do not
estimate any recordkeeping or reporting burden reductions related to
proposed presumed compliance amendment in Sec. __.20(f)(2) of the
final rule.
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\416\ Cost reduction for broker-dealers: 1,100 hours per firm x
0.18 dealer weight x 100 broker-dealers x (Attorney at $409 per
hour) = $8,098,200. Cost reductions for entities that may register
as SBSDs may be as high as: 1,100 hours per firm x 0.18 dealer
weight x 34 firms x (Attorney at $409 per hour) = $2,753,388. The
estimate for SBSDs assumes that all 34 SBSDs would be subject to
Appendix B requirements, and may over-estimate the cost savings.
\417\ Initial set-up cost reduction for broker-dealers: 3,300
hours per firm x 0.18 dealer weight x 100 broker-dealers x (Attorney
at $409 per hour) = $24,294,600. Cost reductions for entities that
may register as SBSDs may be as high as: 3,300 hours per firm x 0.18
dealer weight x 34 firms x (Attorney at $409 per hour) = $8,260,164.
The estimate for SBSDs assumes that all 34 SBSDs would be subject to
Appendix B requirements, and may over-estimate the cost savings.
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iii. Competition, Efficiency, and Capital Formation
Under the proposed amendments, both Group A and Group B entities
will enjoy reduced compliance program requirements and Group C will be
presumed compliant with prohibitions of sections B and C of the
proposed rule. To the extent that compliance program requirements for
Group B entities are less costly, Group A entities close to the
threshold may choose to manage down their trading book such that they
would qualify for the simplified compliance program, resulting in more
competition among entities that are close to the threshold. Similarly,
the proposed amendment may incentivize Group B entities close to the
threshold to rebalance their trading book and qualify for the presumed
compliance treatment of Group C entities. Such management of the
trading book may reduce the risk of each individual banking entity and
may decrease moral hazard addressed by the 2013 final rule. We note
that entities are likely to weigh potential cost savings related to
lighter compliance requirements for Group B and Group C entities
against the costs of reducing trading activity below the $10 billion
and $1 billion thresholds. Therefore, this competition effect may be
particularly significant for Group A entities that are close to the $10
billion threshold and for Group B entities that are close to the $1
billion threshold.
Since the compliance requirements do not impact the scope of
information available to investors, we do not anticipate effects on
informational efficiency to be significant. To the extent that some
dealers are experiencing large compliance costs and partially or fully
passing them along to customers in the form of reduced access to
capital or higher cost of capital, the amendment may reduce costs of
and increase access to capital.
4. Request for Comment
The SEC is requesting comment regarding the economic analysis set
forth here. To the extent possible, the SEC requests that market
participants and other commenters provide supporting data and analysis
with respect to the benefits, costs, and effects on competition,
efficiency, and capital formation of adopting the proposed amendments
or any reasonable alternatives. In addition, the SEC asks commenters to
consider the following questions:
Question SEC-1. What additional qualitative or quantitative
information should the SEC consider as part of the baseline for its
economic analysis of the proposed amendments?
Question SEC-2. What additional considerations can the SEC use to
estimate the costs and benefits of implementing the proposed amendments
for SEC-regulated banking entities?
Question SEC-3. Is it likely that certain cost savings associated
with the proposed rule will not be recognized by SEC-regulated banking
entities because of the nature of their activities or because of new
costs the proposal would impose on these activities? Why or why not?
Are there other benefits or costs associated with the proposed rule
that will impact SEC-regulated banking entities differently than other
types of banking entities?
Question SEC-4. Has the SEC considered all relevant aspects of the
proposed amendments? Are the estimated costs of the proposed rule for
SEC-regulated banking entities reasonable? If not, please explain in
detail why the cost estimates should be higher or lower than those
provided. Have we accurately described the benefits of the proposed
rule? Why or why not? Please identify any other benefits associated
with the proposed rule in detail. Please identify any costs associated
with the proposed rule that we have not identified.
List of Subjects
12 CFR Part 44
Banks, Banking, Compensation, Credit, Derivatives, Government
securities, Insurance, Investments, National banks, Penalties,
Reporting and recordkeeping requirements, Risk, Risk retention,
Securities, Trusts and trustees.
[[Page 33553]]
12 CFR Part 248
Administrative practice and procedure, Banks, Banking, Conflict of
interests, Credit, Foreign banking, Government securities, Holding
companies, Insurance, Insurance companies, Investments, Penalties,
Reporting and recordkeeping requirements, Securities, State nonmember
banks, State savings associations, Trusts and trustees
12 CFR Part 351
Banks, Banking, Capital, Compensation, Conflicts of interest,
Credit, Derivatives, Government securities, Insurance, Insurance
companies, Investments, Penalties, Reporting and recordkeeping
requirements, Risk, Risk retention, Securities, Trusts and trustees
17 CFR Part 75
Banks, Banking, Compensation, Credit, Derivatives, Federal branches
and agencies, Federal savings associations, Government securities,
Hedge funds, Insurance, Investments, National banks, Penalties,
Proprietary trading, Reporting and recordkeeping requirements, Risk,
Risk retention, Securities, Swap dealers, Trusts and trustees, Volcker
rule.
17 CFR Part 255
Banks, Brokers, Dealers, Investment advisers, Recordkeeping,
Reporting, Securities.
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Chapter I
Authority and Issuance
For the reasons stated in the Common Preamble, the Office of the
Comptroller of the Currency proposes to amend chapter I of Title 12,
Code of Federal Regulations as follows:
PART 44--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
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1. The authority citation for part 44 continues to read as follows:
Authority: 7 U.S.C. 27 et seq., 12 U.S.C. 1, 24, 92a, 93a, 161,
1461, 1462a, 1463, 1464, 1467a, 1813(q), 1818, 1851, 3101, 3102,
3108, 5412.
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2. Section 44.2 is revised to read as follows:
Sec. 44.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Applicable accounting standards means U.S. generally accepted
accounting principles, or such other accounting standards applicable to
a banking entity that the OCC determines are appropriate and that the
banking entity uses in the ordinary course of its business in preparing
its consolidated financial statements.
(c) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(d) Banking entity. (1) Except as provided in paragraph (d)(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 (d)(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 (d)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraphs (d)(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.
(e) Board means the Board of Governors of the Federal Reserve
System.
(f) CFTC means the Commodity Futures Trading Commission.
(g) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(h) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(i) Derivative. (1) Except as provided in paragraph (i)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, guidance, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(j) Employee includes a member of the immediate family of the
employee.
(k) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(l) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(m) FDIC means the Federal Deposit Insurance Corporation.
(n) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(o) 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
[[Page 33554]]
Virgin Islands, or the Commonwealth of the Northern Mariana Islands.
(p) 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.
(q) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(r) 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).
(s) 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)).
(t) Limited trading assets and liabilities means, with respect to a
banking entity, that:
(1) The banking entity has, together with its affiliates and
subsidiaries on a worldwide consolidated basis, 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 over the previous
consecutive four quarters, as measured as of the last day of each of
the four previous calendar quarters, is less than $1,000,000,000; and
(2) The OCC has not determined pursuant to Sec. 44.20(g) or (h) of
this part that the banking entity should not be treated as having
limited trading assets and liabilities.
(u) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(v) Moderate trading assets and liabilities means, with respect to
a banking entity, that the banking entity does not have significant
trading assets and liabilities or limited trading assets and
liabilities.
(w) 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)).
(x) 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.
(y) 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)).
(z) SEC means the Securities and Exchange Commission.
(aa) 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.
(bb) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(cc) 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)).
(dd) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(ee) 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.
(ff) Significant trading assets and liabilities.--(1) Significant
trading assets and liabilities means, with respect to a banking entity,
that:
(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, equals or
exceeds $10,000,000,000; or
(ii) The OCC has determined pursuant to Sec. 44.20(h) of this part
that the banking entity should be treated as having significant trading
assets and liabilities.
(2) With respect to a banking entity other than a banking entity
described in paragraph (3), trading assets and liabilities for purposes
of this paragraph (ff) means 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) on a worldwide
consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (ff) means the
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) of the combined U.S. operations of
the top-tier foreign banking organization (including all subsidiaries,
affiliates, branches, and agencies of the foreign banking organization
operating, located, or organized in the United States).
(ii) For purposes of paragraph (ff)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(gg) 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.
(hh) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(ii) 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.
(jj) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
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3. Section 44.3 is amended by:
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a. Revising paragraph (b);
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b. Redesignating paragraphs (c) through (e) as paragraphs (d) through
(f);
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c. Adding a new paragraph (c);
[[Page 33555]]
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d. Revising paragraph (e)(3) and adding paragraph (e)(10);
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e. Redesignating paragraphs (f)(5) through (f)(13) as paragraphs (f)(6)
through (f)(14) and adding new paragraph (f)(5); and
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f. Adding paragraph (g).
The revisions and additions read as follows:
Sec. 44.3 Prohibition on proprietary trading.
* * * * *
(b) Definition of trading account. Trading account means any
account that is used by a banking entity to:
(1)(i) Purchase or sell one or more financial instruments that are
both market risk capital rule covered positions and trading positions
(or hedges of other market risk capital rule covered positions), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule; or
(ii) With respect to a banking entity that is not, and is not
controlled directly or indirectly by a banking entity that is, located
in or organized under the laws of the United States or any State,
purchase or sell one or more financial instruments that are subject to
capital requirements under a market risk framework established by the
home-country supervisor that is consistent with the market risk
framework published by the Basel Committee on Banking Supervision, as
amended from time to time.
(2) Purchase or sell one or more financial instruments for any
purpose, if the banking entity:
(i) 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
(ii) 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; or
(3) Purchase or sell one or more financial instruments, with
respect to a financial instrument that is recorded at fair value on a
recurring basis under applicable accounting standards.
(c) Presumption of compliance. (1)(i) Each trading desk that does
not purchase or sell financial instruments for a trading account
defined in paragraphs (b)(1) or (b)(2) of this section may calculate
the net gain or net loss on the trading desk's portfolio of financial
instruments each business day, reflecting realized and unrealized gains
and losses since the previous business day, based on the banking
entity's fair value for such financial instruments.
(ii) If the sum of the absolute values of the daily net gain and
loss figures determined in accordance with paragraph (c)(1)(i) of this
section for the preceding 90-calendar-day period does not exceed $25
million, the activities of the trading desk shall be presumed to be in
compliance with the prohibition in paragraph (a) of this section.
(2) The OCC may rebut the presumption of compliance in paragraph
(c)(1)(ii) of this section by providing written notice to the banking
entity that the OCC has determined that one or more of the banking
entity's activities violates the prohibitions under subpart B.
(3) If a trading desk operating pursuant to paragraph (c)(1)(ii) of
this section exceeds the $25 million threshold in that paragraph at any
point, the banking entity shall, in accordance with any policies and
procedures adopted by the OCC:
(i) Promptly notify the OCC;
(ii) Demonstrate that the trading desk's purchases and sales of
financial instruments comply with subpart B; and
(iii) Demonstrate, with respect to the trading desk, how the
banking entity will maintain compliance with subpart B on an ongoing
basis.
* * * * *
(e) * * *
(3) Any purchase or sale of a security, foreign exchange forward
(as that term is defined in section 1a(24) of the Commodity Exchange
Act (7 U.S.C. 1a(24)), foreign exchange swap (as that term is defined
in section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)), or
physically-settled cross-currency swap, by a banking entity for the
purpose of liquidity management in accordance with a documented
liquidity management plan of the banking entity that, with respect to
such financial instruments:
(i) Specifically contemplates and authorizes the particular
financial instruments to be used for liquidity management purposes, the
amount, types, and risks of these financial instruments that are
consistent with liquidity management, and the liquidity circumstances
in which the particular financial instruments may or must be used;
(ii) Requires that any purchase or sale of financial instruments
contemplated and authorized by the plan be principally for the purpose
of managing the liquidity of the banking entity, and not for the
purpose of short-term resale, benefitting from actual or expected
short-term price movements, realizing short-term arbitrage profits, or
hedging a position taken for such short-term purposes;
(iii) Requires that any financial instruments purchased or sold for
liquidity management purposes be highly liquid and limited to financial
instruments the market, credit, and other risks of which the banking
entity does not reasonably expect to give rise to appreciable profits
or losses as a result of short-term price movements;
(iv) Limits any financial instruments purchased or sold for
liquidity management purposes, together with any other instruments
purchased or sold for such purposes, to an amount that is consistent
with the banking entity's near-term funding needs, including deviations
from normal operations of the banking entity or any affiliate thereof,
as estimated and documented pursuant to methods specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of financial instruments that are not permitted under Sec. Sec.
44.6(a) or (b) of this subpart are for the purpose of liquidity
management and in accordance with the liquidity management plan
described in paragraph (e)(3) of this section; and
(vi) Is consistent with the OCC's supervisory requirements,
guidance, and expectations regarding liquidity management;
* * * * *
(10) Any purchase (or sale) of one or more financial instruments
that was made in error by a banking entity in the course of conducting
a permitted or excluded activity or is a subsequent transaction to
correct such an error, and the erroneously purchased (or sold)
financial instrument is promptly transferred to a separately-managed
trade error account for disposition.
(f) * * *
(5) Cross-currency swap means a swap in which one party exchanges
with another party principal and interest rate payments in one currency
for principal and interest rate payments in another currency, and the
exchange of principal occurs on the date the swap is entered into, with
a reversal of the exchange of principal at a later date that is agreed
upon when the swap is entered into.
* * * * *
(g) Reservation of Authority: (1) The OCC may determine, on a case-
by-case basis, that a purchase or sale of one or
[[Page 33556]]
more financial instruments by a banking entity either is or is not for
the trading account as defined at 12 U.S.C. 1851(h)(6).
(2) Notice and Response Procedures.--(i) Notice. When the OCC
determines that the purchase or sale of one or more financial
instruments is for the trading account under paragraph (g)(1) of this
section, the OCC will notify the banking entity in writing of the
determination and provide an explanation of the determination.
(ii) Response. (A) The banking entity may respond to any or all
items in the notice. The response should include any matters that the
banking entity would have the OCC consider in deciding whether the
purchase or sale is for the trading account. The response must be in
writing and delivered to the designated OCC official within 30 days
after the date on which the banking entity received the notice. The OCC
may shorten the time period when, in the opinion of the OCC, the
activities or condition of the banking entity so requires, provided
that the banking entity is informed promptly of the new time period, or
with the consent of the banking entity. In its discretion, the OCC may
extend the time period for good cause.
(B) Failure to respond within 30 days or such other time period as
may be specified by the OCC shall constitute a waiver of any objections
to the OCC's determination.
(iii) After the close of banking entity's response period, the OCC
will decide, based on a review of the banking entity's response and
other information concerning the banking entity, whether to maintain
the OCC's determination that the purchase or sale of one or more
financial instruments is for the trading account. The banking entity
will be notified of the decision in writing. The notice will include an
explanation of the decision.
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4. Section 44.4 is amended by:
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a. Revising paragraph (a)(2);
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b. Adding paragraph (a)(8);
0
c. Revising paragraph (b)(2);
0
d. Revising the introductory text of paragraph (b)(3)(i);
0
e. In paragraph (b)(5) removing ``inventory'' wherever it appears and
adding ``positions'' in its place; and
0
f. Adding a new paragraph (b)(6).
The revisions and additions read as follows:
Sec. 44.4 Permitted underwriting and market making-related
activities.
(a) * * *
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii) (A) The amount and type of the securities in the trading
desk's underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
taking into account the liquidity, maturity, and depth of the market
for the relevant type of security, and
(B) Reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant type
of security;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (a) of this section, including reasonably designed written
policies and procedures, internal controls, analysis, and independent
testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, in accordance with paragraph
(a)(8)(i) of this section;
(C) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(D) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis of the basis for any temporary
or permanent increase to a trading desk's limit(s), and independent
review of such demonstrable analysis and approval;
(iv) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(v) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
* * * * *
(8) Rebuttable presumption of compliance.--(i) Risk limits. (A) A
banking entity shall be presumed to meet the requirements of paragraph
(a)(2)(ii)(A) of this section with respect to the purchase or sale of a
financial instrument if the banking entity has established and
implements, maintains, and enforces the limits described in paragraph
(a)(8)(i)(B) and does not exceed such limits.
(B) The presumption described in paragraph (8)(i)(A) of this
section shall be available with respect to limits for each trading desk
that are designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties, based on the nature
and amount of the trading desk's underwriting activities, on the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.
(ii) Supervisory review and oversight. The limits described in
paragraph (a)(8)(i) of this section shall be subject to supervisory
review and oversight by the OCC on an ongoing basis. Any review of such
limits will include assessment of whether the limits are designed not
to exceed the reasonably expected near term demands of clients,
customers, or counterparties.
(iii) Reporting. With respect to any limit identified pursuant to
paragraph (a)(8)(i) of this section, a banking entity shall promptly
report to the OCC (A) to the extent that any limit is exceeded and (B)
any temporary or permanent increase to any limit(s), in each case in
the form and manner as directed by the OCC.
(iv) Rebutting the presumption. The presumption in paragraph
(a)(8)(i) of this section may be rebutted by the OCC if the OCC
determines, based on all relevant facts and circumstances, that a
trading desk is engaging in activity that is not based on the
reasonably expected near term demands of clients, customers, or
counterparties. The OCC will provide notice of any such determination
to the banking entity in writing.
(b) * * *
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
[[Page 33557]]
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The trading desk's market-making related activities are
designed not to exceed, on an ongoing basis, the reasonably expected
near term demands of clients, customers, or counterparties, based on
the liquidity, maturity, and depth of the market for the relevant types
of financial instrument(s).
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (b) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and positions; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, in accordance with paragraph
(b)(6)(i) of this section;
(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) In the case of a banking entity with significant trading
assets and liabilities, 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) * * *
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with the methodology described in
definition of ``significant trading assets and liabilities'' contained
in Sec. 44.2 of this part, unless:
* * * * *
(6) Rebuttable presumption of compliance.
(i) Risk limits.
(A) A banking entity shall be presumed to meet the requirements of
paragraph (b)(2)(ii) of this section with respect to the purchase or
sale of a financial instrument if the banking entity has established
and implements, maintains, and enforces the limits described in
paragraph (b)(6)(i)(B) and does not exceed such limits.
(B) The presumption described in paragraph (6)(i)(A) of this
section shall be available with respect to limits for each trading desk
that are designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties, based on the nature
and amount of the trading desk's market making-related activities, on
the:
(1) Amount, types, and risks of its market-maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.
(ii) Supervisory review and oversight. The limits described in
paragraph (b)(6)(i) of this section shall be subject to supervisory
review and oversight by the OCC on an ongoing basis. Any review of such
limits will include assessment of whether the limits are designed not
to exceed the reasonably expected near term demands of clients,
customers, or counterparties.
(iii) Reporting. With respect to any limit identified pursuant to
paragraph (b)(6)(i) of this section, a banking entity shall promptly
report to the OCC (A) to the extent that any limit is exceeded and (B)
any temporary or permanent increase to any limit(s), in each case in
the form and manner as directed by the OCC.
(iv) Rebutting the presumption. The presumption in paragraph
(b)(6)(i) of this section may be rebutted by the OCC if the OCC
determines, based on all relevant facts and circumstances, that a
trading desk is engaging in activity that is not based on the
reasonably expected near term demands of clients, customers, or
counterparties. The OCC will provide notice of any such determination
to the banking entity in writing.
0
5. Section 44.5 is amended by revising paragraphs (b) and (c)(1)
introductory text and adding paragraph (c)(4) to read as follows:
Sec. 44.5 Permitted risk-mitigating hedging activities.
* * * * *
(b) Requirements.
(1) The risk-mitigating hedging activities of a banking entity that
has significant trading assets and liabilities are permitted under
paragraph (a) of this section only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(C) The conduct of analysis and independent testing designed to
ensure that the positions, techniques and strategies that may be used
for hedging may reasonably be expected to reduce or otherwise
significantly mitigate the specific, identifiable risk(s) being hedged;
(ii) The risk-mitigating hedging activity:
(A) Is conducted in accordance with the written policies,
procedures, and
[[Page 33558]]
internal controls required under this section;
(B) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(D) Is subject to continuing review, monitoring and management by
the banking entity that:
(1) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1)(i) of this section;
(2) Is designed to reduce or otherwise significantly mitigate the
specific, identifiable risks that develop over time from the risk-
mitigating hedging activities undertaken under this section and the
underlying positions, contracts, and other holdings of the banking
entity, based upon the facts and circumstances of the underlying and
hedging positions, contracts and other holdings of the banking entity
and the risks and liquidity thereof; and
(3) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(1)(ii) of this section and is not
prohibited proprietary trading; and
(iii) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(2) The risk-mitigating hedging activities of a banking entity that
does not have significant trading assets and liabilities are permitted
under paragraph (a) of this section only if the risk-mitigating hedging
activity:
(i) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading.
(c) * * * (1) A banking entity that has significant trading assets
and liabilities must comply with the requirements of paragraphs (c)(2)
and (3) of this section, unless the requirements of paragraph (c)(4) of
this section are met, with respect to any purchase or sale of financial
instruments made in reliance on this section for risk-mitigating
hedging purposes that is:
* * * * *
(4) The requirements of paragraphs (c)(2) and (3) of this section
do not apply to the purchase or sale of a financial instrument
described in paragraph (c)(1) of this section if:
(i) The financial instrument purchased or sold is identified on a
written list of pre-approved financial instruments that are commonly
used by the trading desk for the specific type of hedging activity for
which the financial instrument is being purchased or sold; and
(ii) At the time the financial instrument is purchased or sold, the
hedging activity (including the purchase or sale of the financial
instrument) complies with written, pre-approved hedging limits for the
trading desk purchasing or selling the financial instrument for hedging
activities undertaken for one or more other trading desks. The hedging
limits shall be appropriate for the:
(A) Size, types, and risks of the hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased and sold for hedging activities
by the trading desk; and
(C) Levels and duration of the risk exposures being hedged.
0
6. Section 44.6 is amended by revising paragraph (e)(3) and removing
paragraph (e)(6) to read as follows:
Sec. 44.6 Other permitted proprietary trading activities.
* * * * *
(e) * * *
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
* * * * *
Sec. 44.10 [Amended]
0
7. Section 44.10 is amended by:
0
a. In paragraph (c)(8)(i)(A) removing ``Sec. 44.2(s)'' and adding
``Sec. 44.2(u)'' in its place;
0
b. Removing paragraph (d)(1);
0
c. Redesignating paragraphs (d)(2) through (d)(10) as paragraphs (d)(1)
through (d)(9);
0
d. In paragraph (d)(5)(i)(G) revising the reference to ``(d)(6)(i)(A)''
to read ``(d)(5)(i)(A)''; and
0
e. In paragraph (d)(9) revising the reference to ``(d)(9)'' to read
``(d)(8)'' and the reference to ``(d)(10)(i)(A)'' to read
``(d)(9)(i)(A)'' and the reference to ``(d)(10)(i)'' to read
``(d)(9)(i)''.
0
8. Section 44.11 is amended by revising paragraph (c) as follows:
Sec. 44.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
* * * * *
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 44.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 44.4(a) or Sec. 44.4(b) of subpart B,
respectively; and
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; or acquires and retains an ownership interest in such
covered fund and is
[[Page 33559]]
either a securitizer, as that term is used in section 15G(a)(3) of the
Exchange Act (15 U.S.C. 78o-11(a)(3)), or is acquiring and retaining an
ownership interest in such covered fund in compliance with section 15G
of that Act (15 U.S.C.78o-11) and the implementing regulations issued
thereunder each as permitted by paragraph (b) of this section, then in
each such case any ownership interests acquired or retained by the
banking entity and its affiliates in connection with underwriting and
market making related activities for that particular covered fund are
included in the calculation of ownership interests permitted to be held
by the banking entity and its affiliates under the limitations of Sec.
44.12(a)(2)(ii); Sec. 44.12(a)(2)(iii), and Sec. 44.12(d) of this
subpart.
Sec. 44.12 [Amended]
0
9. Section 44.12 is amended by:
0
a. In paragraphs (c)(1) and (d) removing ``Sec. 44.10(d)(6)(ii)'' and
adding ``Sec. 44.10(d)(5)(ii)'' in its place;
0
b. Removing paragraph (e)(2)(vii); and
0
c. Redesignating the second instance of paragraph (e)(2)(vi) as
paragraph (e)(2)(vii).
0
10. Section 44.13 is amended by revising paragraphs (a) and (b)(3) and
removing paragraph (b)(4)(iv) to read as follows:
Sec. 44.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 44.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks to the banking
entity in connection with:
(i) A compensation arrangement with an employee of the banking
entity or an affiliate thereof that directly provides investment
advisory, commodity trading advisory or other services to the covered
fund; or
(ii) A position taken by the banking entity when acting as
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund.
(2) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program in accordance with subpart
D of this part that is reasonably designed to ensure the banking
entity's compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures,
and internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks arising:
(1) Out of a transaction conducted solely to accommodate a specific
customer request with respect to the covered fund; or
(2) In connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) With respect to risk-mitigating hedging activity conducted
pursuant to paragraph (a)(1)(i), the compensation arrangement relates
solely to the covered fund in which the banking entity or any affiliate
has acquired an ownership interest pursuant to paragraph (a)(1)(i) and
such compensation arrangement provides that any losses incurred by the
banking entity on such ownership interest will be offset by
corresponding decreases in amounts payable under such compensation
arrangement.
(b) * * *
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is not sold and has not been
sold pursuant to an offering that targets residents of the United
States in which the banking entity or any affiliate of the banking
entity participates. If the banking entity or an affiliate sponsors or
serves, directly or indirectly, as the investment manager, investment
adviser, commodity pool operator or commodity trading advisor to a
covered fund, then the banking entity or affiliate will be deemed for
purposes of this paragraph (b)(3) to participate in any offer or sale
by the covered fund of ownership interests in the covered fund.
* * * * *
0
11. Section 44.14 is amended by revising paragraph (a)(2)(ii)(B) as
follows:
Sec. 44.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually no later than March 31 to
the OCC (with a duty to update the certification if the information in
the certification materially changes) that the banking entity does not,
directly or indirectly, guarantee, assume, or otherwise insure the
obligations or performance of the covered fund or of any covered fund
in which such covered fund invests; and
* * * * *
0
12. Section 44.20 is amended by:
0
a. Revising paragraph (a);
0
b. Revising the introductory text of paragraph (b);
0
c. Revising paragraph (c);
0
d. Revising paragraph (d);
0
e. Revising the introductory text of paragraph (e);
0
f. Revising paragraph (f)(2); and
0
g. Adding new paragraphs (g) and (h).
The revisions read as follows:
Sec. 44.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities) shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
(b) Banking entities with significant trading assets and
liabilities. With respect to a banking entity with significant trading
assets and liabilities, the compliance program required by paragraph
(a) of this section, at a minimum, shall include:
* * * * *
(c) CEO attestation.
(1) The CEO of a banking entity described in paragraph (2) must,
based on a review by the CEO of the banking entity, attest in writing
to the OCC, each year no later than March 31, that the banking entity
has in place processes
[[Page 33560]]
reasonably designed to achieve compliance with section 13 of the BHC
Act and this part. In the case of a U.S. branch or agency of a foreign
banking entity, the attestation may be provided for the entire U.S.
operations of the foreign banking entity by the senior management
officer of the U.S. operations of the foreign banking entity who is
located in the United States.
(2) The requirements of paragraph (c)(1) apply to a banking entity
if:
(i) The banking entity does not have limited trading assets and
liabilities; or
(ii) The OCC notifies the banking entity in writing that it must
satisfy the requirements contained in paragraph (c)(1).
(d) Reporting requirements under the Appendix to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B shall comply with the reporting requirements described in the
Appendix, if:
(i) The banking entity has significant trading assets and
liabilities; or
(ii) The OCC notifies the banking entity in writing that it must
satisfy the reporting requirements contained in the Appendix.
(2) Frequency of reporting: Unless the OCC notifies the banking
entity in writing that it must report on a different basis, a banking
entity with $50 billion or more in trading assets and liabilities (as
calculated in accordance with the methodology described in the
definition of ``significant trading assets and liabilities'' contained
in Sec. 44.2 of this part of this part) shall report the information
required by the Appendix for each calendar month within 20 days of the
end of each calendar month. Any other banking entity subject to the
Appendix shall report the information required by the Appendix for each
calendar quarter within 30 days of the end of that calendar quarter
unless the OCC notifies the banking entity in writing that it must
report on a different basis.
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities shall maintain records
that include:
* * * * *
(f) * * *
(2) Banking entities with moderate trading assets and liabilities.
A banking entity with moderate trading assets and liabilities may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope, and complexity of the
banking entity.
(g) Rebuttable presumption of compliance for banking entities with
limited trading assets and liabilities.
(1) Rebuttable presumption. Except as otherwise provided in this
paragraph, a banking entity with limited trading assets and liabilities
shall be presumed to be compliant with subpart B and subpart C and
shall have no obligation to demonstrate compliance with this part on an
ongoing basis.
(2) Rebuttal of presumption. (i) If upon examination or audit, the
OCC determines that the banking entity has engaged in proprietary
trading or covered fund activities that are otherwise prohibited under
subpart B or subpart C, the OCC may require the banking entity to be
treated under this part as if it did not have limited trading assets
and liabilities.
(ii) Notice and Response Procedures. (A) Notice. The OCC will
notify the banking entity in writing of any determination pursuant to
paragraph (g)(2)(i) of this section to rebut the presumption described
in this paragraph (g) and will provide an explanation of the
determination.
(B) Response. (1) The banking entity may respond to any or all
items in the notice described in paragraph (g)(2)(ii)(A) of this
section. The response should include any matters that the banking
entity would have the OCC consider in deciding whether the banking
entity has engaged in proprietary trading or covered fund activities
prohibited under subpart B or subpart C. The response must be in
writing and delivered to the designated OCC official within 30 days
after the date on which the banking entity received the notice. The OCC
may shorten the time period when, in the opinion of the OCC, the
activities or condition of the banking entity so requires, provided
that the banking entity is informed promptly of the new time period, or
with the consent of the banking entity. In its discretion, the OCC may
extend the time period for good cause.
(2) Failure to respond within 30 days or such other time period as
may be specified by the OCC shall constitute a waiver of any objections
to the OCC's determination.
(C) After the close of banking entity's response period, the OCC
will decide, based on a review of the banking entity's response and
other information concerning the banking entity, whether to maintain
the OCC's determination that banking entity has engaged in proprietary
trading or covered fund activities prohibited under subpart B or
subpart C. The banking entity will be notified of the decision in
writing. The notice will include an explanation of the decision.
(h) Reservation of authority. Notwithstanding any other provision
of this part, the OCC retains its authority to require a banking entity
without significant trading assets and liabilities to apply any
requirements of this part that would otherwise apply if the banking
entity had significant or moderate trading assets and liabilities if
the OCC determines that the size or complexity of the banking entity's
trading or investment activities, or the risk of evasion of subpart B
or subpart C, does not warrant a presumption of compliance under
paragraph (g) of this section or treatment as a banking entity with
moderate trading assets and liabilities, as applicable.
0
13. Remove Appendix A and Appendix B to Part 44 and add Appendix to
Part 44--Reporting and Recordkeeping Requirements for Covered Trading
Activities
Appendix to Part 44--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
44.20(d), this appendix applies to a banking entity that, together
with its affiliates and subsidiaries, has significant trading assets
and liabilities. These entities are required to (i) furnish periodic
reports to the OCC regarding a variety of quantitative measurements
of their covered trading activities, which vary depending on the
scope and size of covered trading activities, and (ii) create and
maintain records documenting the preparation and content of these
reports. The requirements of this appendix must be incorporated into
the banking entity's internal compliance program under Sec. 44.20.
b. The purpose of this appendix is to assist banking entities
and the OCC in:
(i) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(ii) Monitoring the banking entity's covered trading activities;
(iii) Identifying covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading activities of
trading desks engaged in market making-related activities subject to
Sec. 44.4(b) are consistent with the requirements governing
permitted market making-related activities;
(v) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. Sec. 44.4, 44.5, or 44.6(a)-(b) (i.e., underwriting and market
making-related related activity, risk-mitigating hedging, or trading
in certain
[[Page 33561]]
government obligations) are consistent with the requirement that
such activity not result, directly or indirectly, in a material
exposure to high-risk assets or high-risk trading strategies;
(vi) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the OCC of such activities; and
(vii) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. Information that must be furnished pursuant to this appendix
is not intended to serve as a dispositive tool for the
identification of permissible or impermissible activities.
d. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 44.20. The effectiveness of particular
quantitative measurements may differ based on the profile of the
banking entity's businesses in general and, more specifically, of
the particular trading desk, including types of instruments traded,
trading activities and strategies, and history and experience (e.g.,
whether the trading desk is an established, successful market maker
or a new entrant to a competitive market). In all cases, banking
entities must ensure that they have robust measures in place to
identify and monitor the risks taken in their trading activities, to
ensure that the activities are within risk tolerances established by
the banking entity, and to monitor and examine for compliance with
the proprietary trading restrictions in this part.
e. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 44.4 through 44.6(a)-(b), or that result
in a material exposure to high-risk assets or high-risk trading
strategies, must be escalated within the banking entity for review,
further analysis, explanation to the OCC, and remediation, where
appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 44.2 and 44.3. In addition, for purposes of this
appendix, the following definitions apply:
Applicability identifies the trading desks for which a banking
entity is required to calculate and report a particular quantitative
measurement based on the type of covered trading activity conducted
by the trading desk.
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. Sec. 44.4, 44.5, 44.6(a), or 44.6(b). A banking
entity may include in its covered trading activity trading conducted
under Sec. Sec. 44.3(e), 44.6(c), 44.6(d), or 44.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading day means a calendar day on which a trading desk is open
for trading.
III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each banking entity made subject
to this appendix by Sec. 44.20 must furnish the following
quantitative measurements, as applicable, for each trading desk of
the banking entity engaged in covered trading activities and
calculate these quantitative measurements in accordance with this
appendix:
i. Risk and Position Limits and Usage;
ii. Risk Factor Sensitivities;
iii. Value-at-Risk and Stressed Value-at-Risk;
iv Comprehensive Profit and Loss Attribution;
v. Positions;
vi. Transaction Volumes; and
vii. Securities Inventory Aging.
2. Trading desk information. Each banking entity made subject to
this appendix by Sec. 44.20 must provide certain descriptive
information, as further described in this appendix, regarding each
trading desk engaged in covered trading activities.
3. Quantitative measurements identifying information. Each
banking entity made subject to this appendix by Sec. 44.20 must
provide certain identifying and descriptive information, as further
described in this appendix, regarding its quantitative measurements.
4. Narrative statement. Each banking entity made subject to this
appendix by Sec. 44.20 must provide a separate narrative statement,
as further described in this appendix.
5. File identifying information. Each banking entity made
subject to this appendix by Sec. 44.20 must provide file
identifying information in each submission to the OCC pursuant to
this appendix, including the name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the Board, and
identification of the reporting period and creation date and time.
b. Trading Desk Information
1. Each banking entity must provide descriptive information
regarding each trading desk engaged in covered trading activities,
including:
i. Name of the trading desk used internally by the banking
entity and a unique identification label for the trading desk;
ii. Identification of each type of covered trading activity in
which the trading desk is engaged;
iii. Brief description of the general strategy of the trading
desk;
iv. A list of the types of financial instruments and other
products purchased and sold by the trading desk; an indication of
which of these are the main financial instruments or products
purchased and sold by the trading desk; and, for trading desks
engaged in market making-related activities under Sec. 44.4(b),
specification of whether each type of financial instrument is
included in market-maker positions or not included in market-maker
positions. In addition, indicate whether the trading desk is
including in its quantitative measurements products excluded from
the definition of ``financial instrument'' under Sec. 44.3(d)(2)
and, if so, identify such products;
v. Identification by complete name of each legal entity that
serves as a booking entity for covered trading activities conducted
by the trading desk; and indication of which of the identified legal
entities are the main booking entities for covered trading
activities of the trading desk;
vi. For each legal entity that serves as a booking entity for
covered trading activities, specification of any of the following
applicable entity types for that legal entity:
A. National bank, Federal branch or Federal agency of a foreign
bank, Federal savings association, Federal savings bank;
B. State nonmember bank, foreign bank having an insured branch,
State savings association;
C. U.S.-registered broker-dealer, U.S.-registered security-based
swap dealer, U.S.-registered major security-based swap participant;
D. Swap dealer, major swap participant, derivatives clearing
organization, futures commission merchant, commodity pool operator,
commodity trading advisor, introducing broker, floor trader, retail
foreign exchange dealer;
E. State member bank;
F. Bank holding company, savings and loan holding company;
G. Foreign banking organization as defined in 12 CFR 211.21(o);
H. Uninsured State-licensed branch or agency of a foreign bank;
or
I. Other entity type not listed above, including a subsidiary of
a legal entity described above where the subsidiary itself is not an
entity type listed above;
vii. Indication of whether each calendar date is a trading day
or not a trading day for the trading desk; and
viii. Currency reported and daily currency conversion rate.
c. Quantitative Measurements Identifying Information
1. Each banking entity must provide the following information
regarding the quantitative measurements:
i. A Risk and Position Limits Information Schedule that provides
identifying and descriptive information for each limit
[[Page 33562]]
reported pursuant to the Risk and Position Limits and Usage
quantitative measurement, including the name of the limit, a unique
identification label for the limit, a description of the limit,
whether the limit is intraday or end-of-day, the unit of measurement
for the limit, whether the limit measures risk on a net or gross
basis, and the type of limit;
ii. A Risk Factor Sensitivities Information Schedule that
provides identifying and descriptive information for each risk
factor sensitivity reported pursuant to the Risk Factor
Sensitivities quantitative measurement, including the name of the
sensitivity, a unique identification label for the sensitivity, a
description of the sensitivity, and the sensitivity's risk factor
change unit;
iii. A Risk Factor Attribution Information Schedule that
provides identifying and descriptive information for each risk
factor attribution reported pursuant to the Comprehensive Profit and
Loss Attribution quantitative measurement, including the name of the
risk factor or other factor, a unique identification label for the
risk factor or other factor, a description of the risk factor or
other factor, and the risk factor or other factor's change unit;
iv. A Limit/Sensitivity Cross-Reference Schedule that cross-
references, by unique identification label, limits identified in the
Risk and Position Limits Information Schedule to associated risk
factor sensitivities identified in the Risk Factor Sensitivities
Information Schedule; and
v. A Risk Factor Sensitivity/Attribution Cross-Reference
Schedule that cross-references, by unique identification label, risk
factor sensitivities identified in the Risk Factor Sensitivities
Information Schedule to associated risk factor attributions
identified in the Risk Factor Attribution Information Schedule.
d. Narrative Statement
1. Each banking entity made subject to this appendix by Sec.
44.20 must submit in a separate electronic document a Narrative
Statement to the OCC describing any changes in calculation methods
used, a description of and reasons for changes in the banking
entity's trading desk structure or trading desk strategies, and when
any such change occurred. The Narrative Statement must include any
information the banking entity views as relevant for assessing the
information reported, such as further description of calculation
methods used.
2. If a banking entity does not have any information to report
in a Narrative Statement, the banking entity must submit an
electronic document stating that it does not have any information to
report in a Narrative Statement.
e. Frequency and Method of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report the
Narrative Statement, the Trading Desk Information, the Quantitative
Measurements Identifying Information, and each applicable
quantitative measurement electronically to the OCC on the reporting
schedule established in Sec. 44.20 unless otherwise requested by
the OCC. A banking entity must report the Trading Desk Information,
the Quantitative Measurements Identifying Information, and each
applicable quantitative measurement to the OCC in accordance with
the XML Schema specified and published on the OCC's website.
f. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the OCC pursuant to this appendix and Sec. 44.20(d),
create and maintain records documenting the preparation and content
of these reports, as well as such information as is necessary to
permit the OCC to verify the accuracy of such reports, for a period
of five years from the end of the calendar year for which the
measurement was taken. A banking entity must retain the Narrative
Statement, the Trading Desk Information, and the Quantitative
Measurements Identifying Information for a period of five years from
the end of the calendar year for which the information was reported
to the OCC.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. 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
value of the trading desk's risk or positions that are accounted for
by the current activity of the desk. Risk and position limits and
their usage are key risk management tools used to control and
monitor risk taking and include, but are not limited to, the limits
set out in Sec. 44.4 and Sec. 44.5. A number of the metrics that
are described below, including ``Risk Factor Sensitivities'' and
``Value-at-Risk,'' relate to a trading desk's risk and position
limits and are useful in evaluating and setting these limits in the
broader context of the trading desk's overall activities,
particularly for the market making activities under Sec. 44.4(b)
and hedging activity under Sec. 44.5. Accordingly, the limits
required under Sec. 44.4(b)(2)(iii) and Sec. 44.5(b)(1)(i)(A) must
meet the applicable requirements under Sec. 44.4(b)(2)(iii) and
Sec. 44.5(b)(1)(i)(A) and also must include appropriate metrics for
the trading desk limits including, at a minimum, the ``Risk Factor
Sensitivities'' and ``Value-at-Risk'' metrics except to the extent
any of the ``Risk Factor Sensitivities'' or ``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.
A. A banking entity must provide the following information for
each limit reported pursuant to this quantitative measurement: The
unique identification label for the limit reported in the Risk and
Position Limits Information Schedule, the limit size (distinguishing
between an upper and a lower limit), and the value of usage of the
limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
2. 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. 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. 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 banking entity must provide the following information
for each sensitivity that is reported pursuant to this quantitative
measurement: The unique identification label for the risk factor
sensitivity listed in the Risk Factor Sensitivities Information
Schedule, the change in risk factor used to determine the risk
factor sensitivity, and the aggregate change in value across all
positions of the desk given the change in risk factor.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
3. Value-at-Risk and Stressed Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the measurement of the risk of future financial loss in
the value of a trading desk's aggregated positions at the ninety-
nine percent confidence level over a one-day period, based on
current market conditions. For purposes of this appendix, Stressed
Value-at-Risk (``Stressed VaR'') is the measurement of the risk of
future financial loss in the value of a trading desk's aggregated
positions at the ninety-nine percent confidence level over a one-day
period, based on market conditions during a period of significant
financial stress.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: For VaR, all trading desks engaged in covered
trading activities. For Stressed VaR, all trading desks engaged in
covered trading activities, except trading desks whose covered
trading activity is conducted exclusively to hedge products excluded
from the definition of ``financial instrument'' under Sec.
44.3(d)(2).
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into three categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); (ii) profit and loss attributable to new
positions resulting from the current day's trading activity (``new
positions''); and (iii) residual profit and loss that cannot be
specifically
[[Page 33563]]
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.
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. For the attribution of comprehensive profit and loss from
existing positions to specific risk factors and other factors, a
banking entity must provide the following information for the
factors that explain the preponderance of the profit or loss changes
due to risk factor changes: The unique identification label for the
risk factor or other factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss due to the risk factor
or other factor change.
C. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and loss 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. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
c. Positions, Transaction Volumes, and Securities Inventory Aging
Measurements
1. Positions
i. Description: For purposes of this appendix, Positions is the
value of securities and derivatives positions managed by the trading
desk. For purposes of the Positions quantitative measurement, do not
include in the Positions calculation for ``securities'' those
securities that are also ``derivatives,'' as those terms are defined
under subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \418\ A banking entity must
separately report the trading desk's market value of long securities
positions, market value of short securities positions, market value
of derivatives receivables, market value of derivatives payables,
notional value of derivatives receivables, and notional value of
derivatives payables.
---------------------------------------------------------------------------
\418\ See Sec. Sec. 44.2(i), (bb). For example, under this
part, a security-based swap is both a ``security'' and a
``derivative.'' For purposes of the Positions quantitative
measurement, security-based swaps are reported as derivatives rather
than securities.
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 44.4(a)
or Sec. 44.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
2. Transaction Volumes
i. Description: For purposes of this appendix, Transaction
Volumes measures four exclusive categories of covered trading
activity conducted by a trading desk. A banking entity is required
to report the value and number of security and derivative
transactions conducted by the trading desk with: (i) Customers,
excluding internal transactions; (ii) non-customers, excluding
internal transactions; (iii) trading desks and other organizational
units where the transaction is booked in the same banking entity;
and (iv) trading desks and other organizational units where the
transaction is booked into an affiliated banking entity. For
securities, value means gross market value. For derivatives, value
means gross notional value. For purposes of calculating the
Transaction Volumes quantitative measurement, do not include in the
Transaction Volumes calculation for ``securities'' those securities
that are also ``derivatives,'' as those terms are defined under
subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \419\ Further, for purposes of the
Transaction Volumes quantitative measurement, a customer of a
trading desk that relies on Sec. 44.4(a) to conduct underwriting
activity is a market participant identified in Sec. 44.4(a)(7), and
a customer of a trading desk that relies on Sec. 44.4(b) to conduct
market making-related activity is a market participant identified in
Sec. 44.4(b)(3).
---------------------------------------------------------------------------
\419\ See Sec. Sec. 44.2(i), (bb).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 44.4(a)
or Sec. 44.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
3. Securities Inventory Aging
i. Description: For purposes of this appendix, Securities
Inventory Aging generally describes a schedule of the market value
of the trading desk's securities positions and the amount of time
that those securities positions have been held. Securities Inventory
Aging must measure the age profile of a trading desk's securities
positions for the following periods: 0-30 calendar days; 31-60
calendar days; 61-90 calendar days; 91-180 calendar days; 181-360
calendar days; and greater than 360 calendar days. Securities
Inventory Aging includes two schedules, a security asset-aging
schedule, and a security liability-aging schedule. For purposes of
the Securities Inventory Aging quantitative measurement, do not
include securities that are also ``derivatives,'' as those terms are
defined under subpart A.\420\
---------------------------------------------------------------------------
\420\ See Sec. Sec. 44.2(i), (bb).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 44.4(a)
or Sec. 44.4(b) to conduct underwriting activity or market-making
related activity, respectively.
BOARD OF GOVERNORS OF THE FEDERAL RESERVE
12 CFR Chapter II
Authority and Issuance
For the reasons set forth in the Common Preamble the Board proposes
to amend chapter II of title 12 of the Code of Federal Regulations as
follows:
PART 248--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS (REGULATION VV)
0
14. The authority citation for part 248 continues to read as follows:
Authority: 12 U.S.C. 1851, 12 U.S.C. 221 et seq., 12 U.S.C.
1818, 12 U.S.C. 1841 et seq., and 12 U.S.C. 3103 et seq.
Subpart A--Authority and Definitions
0
15. Section 248.2 is revised as follows:
Sec. 248.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) 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.
(c) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(d) Banking entity. (1) Except as provided in paragraph (d)(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 (d)(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 (d)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section
[[Page 33564]]
4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H), (I)), or any
portfolio concern, as defined under 13 CFR 107.50, that is controlled
by a small business investment company, as defined in section 103(3) of
the Small Business Investment Act of 1958 (15 U.S.C. 662), so long as
the portfolio company or portfolio concern is not itself a banking
entity under paragraphs (d)(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.
(e) Board means the Board of Governors of the Federal Reserve
System.
(f) CFTC means the Commodity Futures Trading Commission.
(g) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(h) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(i) Derivative. (1) Except as provided in paragraph (i)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, guidance, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(j) Employee includes a member of the immediate family of the
employee.
(k) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(l) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(m) FDIC means the Federal Deposit Insurance Corporation.
(n) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(o) 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.
(p) 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.
(q) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(r) 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).
(s) 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)).
(t) Limited trading assets and liabilities means, with respect to a
banking entity, that:
(1) The banking entity has, together with its affiliates and
subsidiaries on a worldwide consolidated basis, 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 over the previous
consecutive four quarters, as measured as of the last day of each of
the four previous calendar quarters, is less than $1,000,000,000; and
(2) The Board has not determined pursuant to Sec. 248.20(g) or (h)
of this part that the banking entity should not be treated as having
limited trading assets and liabilities.
(u) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(v) Moderate trading assets and liabilities means, with respect to
a banking entity, that the banking entity does not have significant
trading assets and liabilities or limited trading assets and
liabilities.
(w) 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)).
(x) 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.
(y) 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)).
(z) SEC means the Securities and Exchange Commission.
(aa) 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
[[Page 33565]]
transfer or conveyance of, or extinguishing of rights or obligations
under, a derivative, as the context may require.
(bb) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(cc) 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)).
(dd) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(ee) 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.
(ff) Significant trading assets and liabilities.
(1) Significant trading assets and liabilities means, with respect
to a banking entity, that:
(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, equals or
exceeds $10,000,000,000; or
(ii) The Board has determined pursuant to Sec. 248.20(h) of this
part that the banking entity should be treated as having significant
trading assets and liabilities.
(2) With respect to a banking entity other than a banking entity
described in paragraph (3), trading assets and liabilities for purposes
of this paragraph (ff) means 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) on a worldwide
consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (ff) means the
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) of the combined U.S. operations of
the top-tier foreign banking organization (including all subsidiaries,
affiliates, branches, and agencies of the foreign banking organization
operating, located, or organized in the United States).
(ii) For purposes of paragraph (ff)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(gg) 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.
(hh) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(ii) 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.
(jj) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
Subpart B--Proprietary Trading
0
16. Amend Sec. 248.3 by:
0
a. Revising paragraph (b);
0
b. Redesignating paragraphs (c) through (e) as paragraphs (d) through
(f);
0
c. Adding a new paragraph (c);
0
d. Revising paragraph (e)(3);
0
e. Adding paragraph (e)(10);
0
f. Redesignating paragraphs (f)(5) through (f)(13) as paragraphs (f)(6)
through (f)(14);
0
g. Adding a new paragraph (f)(5); and
0
h. Adding a new paragraph (g).
The revisions and additions read as follows:
Sec. 248.3 Prohibition on proprietary trading.
* * * * *
(b) Definition of trading account. Trading account means any
account that is used by a banking entity to:
(1)(i) Purchase or sell one or more financial instruments that are
both market risk capital rule covered positions and trading positions
(or hedges of other market risk capital rule covered positions), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule; or
(ii) With respect to a banking entity that is not, and is not
controlled directly or indirectly by a banking entity that is, located
in or organized under the laws of the United States or any State,
purchase or sell one or more financial instruments that are subject to
capital requirements under a market risk framework established by the
home-country supervisor that is consistent with the market risk
framework published by the Basel Committee on Banking Supervision, as
amended from time to time.
(2) Purchase or sell one or more financial instruments for any
purpose, if the banking entity:
(i) 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
(ii) 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; or
(3) Purchase or sell one or more financial instruments, with
respect to a financial instrument that is recorded at fair value on a
recurring basis under applicable accounting standards.
(c) Presumption of compliance. (1)(i) Each trading desk that does
not purchase or sell financial instruments for a trading account
defined in paragraphs (b)(1) or (b)(2) of this section may calculate
the net gain or net loss on the trading desk's portfolio of financial
instruments each business day, reflecting realized and unrealized gains
and losses since the previous business day, based on the banking
entity's fair value for such financial instruments.
(ii) If the sum of the absolute values of the daily net gain and
loss figures determined in accordance with paragraph (c)(1)(i) of this
section for the preceding 90-calendar-day period does not exceed $25
million, the activities of the trading desk shall be presumed to be in
compliance with the prohibition in paragraph (a) of this section.
(2) The Board may rebut the presumption of compliance in paragraph
(c)(1)(ii) of this section by providing written notice to the banking
entity that the Board has determined that one or more of the banking
entity's activities violates the prohibitions under subpart B.
(3) If a trading desk operating pursuant to paragraph (c)(1)(ii) of
this section exceeds the $25 million threshold in that paragraph at any
point, the banking entity shall, in accordance
[[Page 33566]]
with any policies and procedures adopted by the Board:
(i) Promptly notify the Board;
(ii) Demonstrate that the trading desk's purchases and sales of
financial instruments comply with subpart B; and
(iii) Demonstrate, with respect to the trading desk, how the
banking entity will maintain compliance with subpart B on an ongoing
basis.
* * * * *
(e) * * *
(3) Any purchase or sale of a security, foreign exchange forward
(as that term is defined in section 1a(24) of the Commodity Exchange
Act (7 U.S.C. 1a(24)), foreign exchange swap (as that term is defined
in section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)), or
physically-settled cross-currency swap, by a banking entity for the
purpose of liquidity management in accordance with a documented
liquidity management plan of the banking entity that, with respect to
such financial instruments:
(i) Specifically contemplates and authorizes the particular
financial instruments to be used for liquidity management purposes, the
amount, types, and risks of these financial instruments that are
consistent with liquidity management, and the liquidity circumstances
in which the particular financial instruments may or must be used;
(ii) Requires that any purchase or sale of financial instruments
contemplated and authorized by the plan be principally for the purpose
of managing the liquidity of the banking entity, and not for the
purpose of short-term resale, benefitting from actual or expected
short-term price movements, realizing short-term arbitrage profits, or
hedging a position taken for such short-term purposes;
(iii) Requires that any financial instruments purchased or sold for
liquidity management purposes be highly liquid and limited to financial
instruments the market, credit, and other risks of which the banking
entity does not reasonably expect to give rise to appreciable profits
or losses as a result of short-term price movements;
(iv) Limits any financial instruments purchased or sold for
liquidity management purposes, together with any other instruments
purchased or sold for such purposes, to an amount that is consistent
with the banking entity's near-term funding needs, including deviations
from normal operations of the banking entity or any affiliate thereof,
as estimated and documented pursuant to methods specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of financial instruments that are not permitted under Sec. Sec.
248.6(a) or (b) of this subpart are for the purpose of liquidity
management and in accordance with the liquidity management plan
described in paragraph (e)(3) of this section; and
(vi) Is consistent with the Board's supervisory requirements,
guidance, and expectations regarding liquidity management;
* * * * *
(10) Any purchase (or sale) of one or more financial instruments
that was made in error by a banking entity in the course of conducting
a permitted or excluded activity or is a subsequent transaction to
correct such an error, and the erroneously purchased (or sold)
financial instrument is promptly transferred to a separately-managed
trade error account for disposition.
(f) * * *
(5) Cross-currency swap means a swap in which one party exchanges
with another party principal and interest rate payments in one currency
for principal and interest rate payments in another currency, and the
exchange of principal occurs on the date the swap is entered into, with
a reversal of the exchange of principal at a later date that is agreed
upon when the swap is entered into.
* * * * *
(g) Reservation of Authority: (1) The Board may determine, on a
case-by-case basis, that a purchase or sale of one or more financial
instruments by a banking entity either is or is not for the trading
account as defined at 12 U.S.C. 1851(h)(6).
(2) Notice and Response Procedures.
(i) Notice. When the Board determines that the purchase or sale of
one or more financial instruments is for the trading account under
paragraph (g)(1) of this section, the Board will notify the banking
entity in writing of the determination and provide an explanation of
the determination.
(ii) Response.
(A) The banking entity may respond to any or all items in the
notice. The response should include any matters that the banking entity
would have the Boardconsider in deciding whether the purchase or sale
is for the trading account. The response must be in writing and
delivered to the designated Board official within 30 days after the
date on which the banking entity received the notice. The Board may
shorten the time period when, in the opinion of the Board, the
activities or condition of the banking entity so requires, provided
that the banking entity is informed promptly of the new time period, or
with the consent of the banking entity. In its discretion, the Board
may extend the time period for good cause.
(B) Failure to respond within 30 days or such other time period as
may be specified by the Board shall constitute a waiver of any
objections to the Board's determination.
(iii) After the close of banking entity's response period, the
Board will decide, based on a review of the banking entity's response
and other information concerning the banking entity, whether to
maintain the Board's determination that the purchase or sale of one or
more financial instruments is for the trading account. The banking
entity will be notified of the decision in writing. The notice will
include an explanation of the decision.
0
17. Section 248.4 is amended by:
0
a. Revising paragraph (a)(2);
0
b. Adding paragraph (a)(8);
0
c. Revising paragraph (b)(2);
0
d. Revising the introductory language of paragraph (b)(3)(i);
0
e. In paragraph (b)(5) revising the references to ``inventory'' to read
``positions''; and
0
f. Adding a new paragraph (b)(6).
The revisions and additions read as follows:
Sec. 248.4 Permitted underwriting and market making-related
activities.
(a) * * *
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii)(A) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
taking into account the liquidity, maturity, and depth of the market
for the relevant type of security, and (B) reasonable efforts are made
to sell or otherwise reduce the underwriting position within a
reasonable period, taking into account the liquidity, maturity, and
depth of the market for the relevant type of security;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
[[Page 33567]]
ensure the banking entity's compliance with the requirements of
paragraph (a) of this section, including reasonably designed written
policies and procedures, internal controls, analysis, and independent
testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, in accordance with paragraph
(a)(8)(i) of this section;
(C) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(D) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis of the basis for any temporary
or permanent increase to a trading desk's limit(s), and independent
review of such demonstrable analysis and approval;
(iv) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(v) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
* * * * *
(8) Rebuttable presumption of compliance.--(i) Risk limits. (A) A
banking entity shall be presumed to meet the requirements of paragraph
(a)(2)(ii)(A) of this section with respect to the purchase or sale of a
financial instrument if the banking entity has established and
implements, maintains, and enforces the limits described in paragraph
(a)(8)(i)(B) and does not exceed such limits.
(B) The presumption described in paragraph (8)(i)(A) of this
section shall be available with respect to limits for each trading desk
that are designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties, based on the nature
and amount of the trading desk's underwriting activities, on the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.
(ii) Supervisory review and oversight. The limits described in
paragraph (a)(8)(i) of this section shall be subject to supervisory
review and oversight by the Board on an ongoing basis. Any review of
such limits will include assessment of whether the limits are designed
not to exceed the reasonably expected near term demands of clients,
customers, or counterparties.
(iii) Reporting. With respect to any limit identified pursuant to
paragraph (a)(8)(i) of this section, a banking entity shall promptly
report to the Board (A) to the extent that any limit is exceeded and
(B) any temporary or permanent increase to any limit(s), in each case
in the form and manner as directed by the Board.
(iv) Rebutting the presumption. The presumption in paragraph
(a)(8)(i) of this section may be rebutted by the Board if the Board
determines, based on all relevant facts and circumstances, that a
trading desk is engaging in activity that is not based on the
reasonably expected near term demands of clients, customers, or
counterparties. The Board will provide notice of any such determination
to the banking entity in writing.
(b) * * *
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The trading desk's market-making related activities are
designed not to exceed, on an ongoing basis, the reasonably expected
near term demands of clients, customers, or counterparties, based on
the liquidity, maturity, and depth of the market for the relevant types
of financial instrument(s).
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (b) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and positions; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, in accordance with paragraph
(b)(6)(i) of this section;
(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) In the case of a banking entity with significant trading
assets and liabilities, 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) * * *
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with the methodology described in
definition of ``significant trading assets and liabilities'' contained
in Sec. 248.2 of this part, unless:
* * * * *
[[Page 33568]]
(6) Rebuttable presumption of compliance.
(i) Risk limits.
(A) A banking entity shall be presumed to meet the requirements of
paragraph (b)(2)(ii) of this section with respect to the purchase or
sale of a financial instrument if the banking entity has established
and implements, maintains, and enforces the limits described in
paragraph (b)(6)(i)(B) and does not exceed such limits.
(B) The presumption described in paragraph (6)(i)(A) of this
section shall be available with respect to limits for each trading desk
that are designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties, based on the nature
and amount of the trading desk's market making-related activities, on
the:
(1) Amount, types, and risks of its market-maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.
(ii) Supervisory review and oversight. The limits described in
paragraph (b)(6)(i) of this section shall be subject to supervisory
review and oversight by the Board on an ongoing basis. Any review of
such limits will include assessment of whether the limits are designed
not to exceed the reasonably expected near term demands of clients,
customers, or counterparties.
(iii) Reporting. With respect to any limit identified pursuant to
paragraph (b)(6)(i) of this section, a banking entity shall promptly
report to the Board (A) to the extent that any limit is exceeded and
(B) any temporary or permanent increase to any limit(s), in each case
in the form and manner as directed by the Board.
(iv) Rebutting the presumption. The presumption in paragraph
(b)(6)(i) of this section may be rebutted by the Board if the Board
determines, based on all relevant facts and circumstances, that a
trading desk is engaging in activity that is not based on the
reasonably expected near term demands of clients, customers, or
counterparties. The Board will provide notice of any such determination
to the banking entity in writing.
0
18. Amend Sec. 248.5 by revising paragraph (b), the introductory text
of paragraph (c)(1); and adding paragraph (c)(4) to read as follows:
Sec. 248.5 Permitted risk-mitigating hedging activities.
* * * * *
(b) Requirements.
(1) The risk-mitigating hedging activities of a banking entity that
has significant trading assets and liabilities are permitted under
paragraph (a) of this section only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(C) The conduct of analysis and independent testing designed to
ensure that the positions, techniques and strategies that may be used
for hedging may reasonably be expected to reduce or otherwise
significantly mitigate the specific, identifiable risk(s) being hedged;
(ii) The risk-mitigating hedging activity:
(A) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(B) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(D) Is subject to continuing review, monitoring and management by
the banking entity that:
(1) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1)(i) of this section;
(2) Is designed to reduce or otherwise significantly mitigate the
specific, identifiable risks that develop over time from the risk-
mitigating hedging activities undertaken under this section and the
underlying positions, contracts, and other holdings of the banking
entity, based upon the facts and circumstances of the underlying and
hedging positions, contracts and other holdings of the banking entity
and the risks and liquidity thereof; and
(3) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(1)(ii) of this section and is not
prohibited proprietary trading; and
(iii) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(2) The risk-mitigating hedging activities of a banking entity that
does not have significant trading assets and liabilities are permitted
under paragraph (a) of this section only if the risk-mitigating hedging
activity:
(i) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading.
(c) * * * (1) A banking entity that has significant trading assets
and liabilities must comply with the requirements of paragraphs (c)(2)
and (3) of this section, unless the requirements of paragraph (c)(4) of
this section are met, with respect to any purchase or sale of financial
instruments made in reliance
[[Page 33569]]
on this section for risk-mitigating hedging purposes that is:
* * * * *
(4) The requirements of paragraphs (c)(2) and (3) of this section
do not apply to the purchase or sale of a financial instrument
described in paragraph (c)(1) of this section if:
(i) The financial instrument purchased or sold is identified on a
written list of pre-approved financial instruments that are commonly
used by the trading desk for the specific type of hedging activity for
which the financial instrument is being purchased or sold; and
(ii) At the time the financial instrument is purchased or sold, the
hedging activity (including the purchase or sale of the financial
instrument) complies with written, pre-approved hedging limits for the
trading desk purchasing or selling the financial instrument for hedging
activities undertaken for one or more other trading desks. The hedging
limits shall be appropriate for the:
(A) Size, types, and risks of the hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased and sold for hedging activities
by the trading desk; and
(C) Levels and duration of the risk exposures being hedged.
0
19. Amend Sec. 248.6 by revising paragraph (e)(3) and removing
paragraph (e)(6) to read as follows:
Sec. 248.6 Other permitted proprietary trading activities.
* * * * *
(e) * * *
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
* * * * *
Subpart C--Covered Funds Activities and Investments
Sec. 248.10 [Amended]
0
20. Section 248.10 is amended by:
0
a. In paragraph (c)(8)(i)(A) revising the reference to ``Sec.
248.2(s)'' to read ``Sec. 248.2(u)'';
0
b. Removing paragraph (d)(1);
0
c. Redesignating paragraphs (d)(2) through (d)(10) as paragraphs (d)(1)
through (d)(9);
0
d. In paragraph (d)(5)(i)(G) revising the reference to ``(d)(6)(i)(A)''
to read ``(d)(5)(i)(A)''; and
0
e. In paragraph (d)(9) revising the reference to ``(d)(9)'' to read
``(d)(8)'' and the reference to ``(d)(10)(i)(A)'' to read
``(d)(9)(i)(A)'' and the reference to ``(d)(10)(i)'' to read
``(d)(9)(i)''
0
21. Section 248.11 is amended by revising paragraph (c) as follows:
Sec. 248.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
* * * * *
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 248.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 248.4(a) or Sec. 248.4(b) of subpart B,
respectively; and
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; or acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C. 78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section, then in each such case any ownership
interests acquired or retained by the banking entity and its affiliates
in connection with underwriting and market making related activities
for that particular covered fund are included in the calculation of
ownership interests permitted to be held by the banking entity and its
affiliates under the limitations of Sec. 248.12(a)(2)(ii); Sec.
248.12(a)(2)(iii), and Sec. 248.12(d) of this subpart.
Sec. 248.12 (Amended)
0
22. Section 248.12 is amended by
0
a. In paragraphs (c)(1) and (d) removing the references to ``Sec.
248.10(d)(6)(ii)'' and replacing with ``Sec. 248.10(d)(5)(ii)'';
0
b. Removing paragraph (e)(2)(vii); and
0
c. Redesignating the second instance of paragraph (e)(2)(vi) as
paragraph (e)(2)(vii).
0
23. Section 248.13 is amended by revising paragraphs (a) and (b)(3) and
removing paragraph (b)(4)(iv) to read as follows:
Sec. 248.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 248.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks to the banking
entity in connection with:
(i) A compensation arrangement with an employee of the banking
entity or an affiliate thereof that directly provides investment
advisory, commodity trading advisory or other services to the covered
fund; or
(ii) A position taken by the banking entity when acting as
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund.
(2) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program in accordance with subpart
D of this part that is reasonably designed to ensure the banking
entity's compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures,
and internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks arising (1) out of a transaction conducted solely to accommodate
a specific customer request with respect to the covered fund
[[Page 33570]]
or (2) in connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) With respect to risk-mitigating hedging activity conducted
pursuant to paragraph (a)(1)(i), the compensation arrangement relates
solely to the covered fund in which the banking entity or any affiliate
has acquired an ownership interest pursuant to paragraph (a)(1)(i) and
such compensation arrangement provides that any losses incurred by the
banking entity on such ownership interest will be offset by
corresponding decreases in amounts payable under such compensation
arrangement.
* * * * *
(b) * * *
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is not sold and has not been
sold pursuant to an offering that targets residents of the United
States in which the banking entity or any affiliate of the banking
entity participates. If the banking entity or an affiliate sponsors or
serves, directly or indirectly, as the investment manager, investment
adviser, commodity pool operator or commodity trading advisor to a
covered fund, then the banking entity or affiliate will be deemed for
purposes of this paragraph (b)(3) to participate in any offer or sale
by the covered fund of ownership interests in the covered fund.
* * * * *
0
24. Section 248.14 is amended by revising paragraph (a)(2)(ii)(B) as
follows:
Sec. 248.14 Limitations on relationships with a covered fund.
* * * * *
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually no later than March 31 to
the Board (with a duty to update the certification if the information
in the certification materially changes) that the banking entity does
not, directly or indirectly, guarantee, assume, or otherwise insure the
obligations or performance of the covered fund or of any covered fund
in which such covered fund invests; and
* * * * *
Subpart D--Compliance Program Requirement; Violations
0
25. Section 248.20 is amended by:
0
a. Revising paragraph (a);
0
b. Revising the introductory language of paragraph (b);
0
c. Revising paragraph (c);
0
d. Revising paragraph (d);
0
e. Revising the introductory language of paragraph (e);
0
f. Revising paragraph (f)(2); and
0
g. Adding new paragraphs (g) and (h).
The revisions are as follows:
Sec. 248.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities) shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
(b) Banking entities with significant trading assets and
liabilities. With respect to a banking entity with significant trading
assets and liabilities, the compliance program required by paragraph
(a) of this section, at a minimum, shall include:
* * * * *
(c) CEO attestation. (1) The CEO of a banking entity described in
paragraph (2) must, based on a review by the CEO of the banking entity,
attest in writing to the Board, each year no later than March 31, that
the banking entity has in place processes reasonably designed to
achieve compliance with section 13 of the BHC Act and this part. In the
case of a U.S. branch or agency of a foreign banking entity, the
attestation may be provided for the entire U.S. operations of the
foreign banking entity by the senior management officer of the U.S.
operations of the foreign banking entity who is located in the United
States.
(2) The requirements of paragraph (c)(1) of this section apply to a
banking entity if:
(i) The banking entity does not have limited trading assets and
liabilities; or
(ii) The Board notifies the banking entity in writing that it must
satisfy the requirements contained in paragraph (c)(1) of this section.
(d) Reporting requirements under the Appendix to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B shall comply with the reporting requirements described in the
Appendix, if:
(i) The banking entity has significant trading assets and
liabilities; or
(ii) The Board notifies the banking entity in writing that it must
satisfy the reporting requirements contained in the Appendix.
(2) Frequency of reporting. Unless the Board notifies the banking
entity in writing that it must report on a different basis, a banking
entity with $50 billion or more in trading assets and liabilities (as
calculated in accordance with the methodology described in the
definition of ``significant trading assets and liabilities'' contained
in Sec. 248.2 of this part of this part) shall report the information
required by the Appendix for each calendar month within 20 days of the
end of each calendar month. Any other banking entity subject to the
Appendix shall report the information required by the Appendix for each
calendar quarter within 30 days of the end of that calendar quarter
unless the Board notifies the banking entity in writing that it must
report on a different basis.
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities shall maintain records
that include:
* * * * *
(f) * * *
(2) Banking entities with moderate trading assets and liabilities.
A banking entity with moderate trading assets and liabilities may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope, and complexity of the
banking entity.
(g) Rebuttable presumption of compliance for banking entities with
limited trading assets and liabilities.
(1) Rebuttable presumption. Except as otherwise provided in this
paragraph, a banking entity with limited trading assets and liabilities
shall be presumed to be compliant with subpart B and subpart C and
shall have no obligation to demonstrate compliance with this part on an
ongoing basis.
(2) Rebuttal of presumption. (i) If upon examination or audit, the
Board determines that the banking entity has engaged in proprietary
trading or
[[Page 33571]]
covered fund activities that are otherwise prohibited under subpart B
or subpart C, the Board may require the banking entity to be treated
under this part as if it did not have limited trading assets and
liabilities.
(ii) Notice and Response Procedures.
(A) Notice. The Board will notify the banking entity in writing of
any determination pursuant to paragraph (g)(2)(i) of this section to
rebut the presumption described in this paragraph (g) and will provide
an explanation of the determination.
(B) Response. (1) The banking entity may respond to any or all
items in the notice described in paragraph (g)(2)(ii)(A) of this
section. The response should include any matters that the banking
entity would have the Board consider in deciding whether the banking
entity has engaged in proprietary trading or covered fund activities
prohibited under subpart B or subpart C. The response must be in
writing and delivered to the designated Board official within 30 days
after the date on which the banking entity received the notice. The
Board may shorten the time period when, in the opinion of the Board,
the activities or condition of the banking entity so requires, provided
that the banking entity is informed promptly of the new time period, or
with the consent of the banking entity. In its discretion, the Board
may extend the time period for good cause.
(2) Failure to respond within 30 days or such other time period as
may be specified by the Board shall constitute a waiver of any
objections to the Board's determination.
(C) After the close of banking entity's response period, the Board
will decide, based on a review of the banking entity's response and
other information concerning the banking entity, whether to maintain
the Board's determination that banking entity has engaged in
proprietary trading or covered fund activities prohibited under subpart
B or subpart C. The banking entity will be notified of the decision in
writing. The notice will include an explanation of the decision.
(h) Reservation of authority. Notwithstanding any other provision
of this part, the Board retains its authority to require a banking
entity without significant trading assets and liabilities to apply any
requirements of this part that would otherwise apply if the banking
entity had significant or moderate trading assets and liabilities if
the Board determines that the size or complexity of the banking
entity's trading or investment activities, or the risk of evasion of
subpart B or subpart C, does not warrant a presumption of compliance
under paragraph (g) of this section or treatment as a banking entity
with moderate trading assets and liabilities, as applicable.
0
26. Remove Appendix A and Appendix B to Part 248 and add Appendix to
Part 248--Reporting and Recordkeeping Requirements for Covered Trading
Activities to read as follows:
Appendix to Part 248--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
248.20(d), this appendix applies to a banking entity that, together
with its affiliates and subsidiaries, has significant trading assets
and liabilities. These entities are required to (i) furnish periodic
reports to the Board regarding a variety of quantitative
measurements of their covered trading activities, which vary
depending on the scope and size of covered trading activities, and
(ii) create and maintain records documenting the preparation and
content of these reports. The requirements of this appendix must be
incorporated into the banking entity's internal compliance program
under Sec. 248.20.
b. The purpose of this appendix is to assist banking entities
and the Board in:
(i) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(ii) Monitoring the banking entity's covered trading activities;
(iii) Identifying covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading activities of
trading desks engaged in market making-related activities subject to
Sec. 248.4(b) are consistent with the requirements governing
permitted market making-related activities;
(v) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. Sec. 248.4; 248.5, or 248.6(a)-(b) (i.e., underwriting and
market making-related related activity, risk-mitigating hedging, or
trading in certain government obligations) are consistent with the
requirement that such activity not result, directly or indirectly,
in a material exposure to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the Board of such activities; and
(vii) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. Information that must be furnished pursuant to this appendix
is not intended to serve as a dispositive tool for the
identification of permissible or impermissible activities.
d. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 248.20. The effectiveness of particular
quantitative measurements may differ based on the profile of the
banking entity's businesses in general and, more specifically, of
the particular trading desk, including types of instruments traded,
trading activities and strategies, and history and experience (e.g.,
whether the trading desk is an established, successful market maker
or a new entrant to a competitive market). In all cases, banking
entities must ensure that they have robust measures in place to
identify and monitor the risks taken in their trading activities, to
ensure that the activities are within risk tolerances established by
the banking entity, and to monitor and examine for compliance with
the proprietary trading restrictions in this part.
e. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 248.4 through 248.6(a)-(b), or that
result in a material exposure to high-risk assets or high-risk
trading strategies, must be escalated within the banking entity for
review, further analysis, explanation to the Board, and remediation,
where appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 248.2 and 248.3. In addition, for purposes of
this appendix, the following definitions apply:
Applicability identifies the trading desks for which a banking
entity is required to calculate and report a particular quantitative
measurement based on the type of covered trading activity conducted
by the trading desk.
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. Sec. 248.4, 248.5, 248.6(a), or 248.6(b). A banking
entity
[[Page 33572]]
may include in its covered trading activity trading conducted under
Sec. Sec. 248.3(e), 248.6(c), 248.6(d), or 248.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading day means a calendar day on which a trading desk is open
for trading.
III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each banking entity made subject
to this appendix by Sec. 248.20 must furnish the following
quantitative measurements, as applicable, for each trading desk of
the banking entity engaged in covered trading activities and
calculate these quantitative measurements in accordance with this
appendix:
i. Risk and Position Limits and Usage;
ii. Risk Factor Sensitivities;
iii. Value-at-Risk and Stressed Value-at-Risk;
iv. Comprehensive Profit and Loss Attribution;
v. Positions;
vi. Transaction Volumes; and
vii. Securities Inventory Aging.
2. Trading desk information. Each banking entity made subject to
this appendix by Sec. __.20 must provide certain descriptive
information, as further described in this appendix, regarding each
trading desk engaged in covered trading activities. Quantitative
measurements identifying information. Each banking entity made
subject to this appendix by Sec. 248.20 must provide certain
identifying and descriptive information, as further described in
this appendix, regarding its quantitative measurements.
4. Narrative statement. Each banking entity made subject to this
appendix by Sec. 248.20 must provide a separate narrative
statement, as further described in this appendix.
5. File identifying information. Each banking entity made
subject to this appendix by Sec. 248.20 must provide file
identifying information in each submission to the Board pursuant to
this appendix, including the name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the Board, and
identification of the reporting period and creation date and time.
b. Trading Desk Information
1. Each banking entity must provide descriptive information
regarding each trading desk engaged in covered trading activities,
including:
i. Name of the trading desk used internally by the banking
entity and a unique identification label for the trading desk;
ii. Identification of each type of covered trading activity in
which the trading desk is engaged;
iii. Brief description of the general strategy of the trading
desk;
iv. A list of the types of financial instruments and other
products purchased and sold by the trading desk; an indication of
which of these are the main financial instruments or products
purchased and sold by the trading desk; and, for trading desks
engaged in market making-related activities under Sec. 248.4(b),
specification of whether each type of financial instrument is
included in market-maker positions or not included in market-maker
positions. In addition, indicate whether the trading desk is
including in its quantitative measurements products excluded from
the definition of ``financial instrument'' under Sec. 248.3(d)(2)
and, if so, identify such products;
v. Identification by complete name of each legal entity that
serves as a booking entity for covered trading activities conducted
by the trading desk; and indication of which of the identified legal
entities are the main booking entities for covered trading
activities of the trading desk;
vi. For each legal entity that serves as a booking entity for
covered trading activities, specification of any of the following
applicable entity types for that legal entity:
A. National bank, Federal branch or Federal agency of a foreign
bank, Federal savings association, Federal savings bank;
B. State nonmember bank, foreign bank having an insured branch,
State savings association;
C. U.S.-registered broker-dealer, U.S.-registered security-based
swap dealer, U.S.-registered major security-based swap participant;
D. Swap dealer, major swap participant, derivatives clearing
organization, futures commission merchant, commodity pool operator,
commodity trading advisor, introducing broker, floor trader, retail
foreign exchange dealer;
E. State member bank;
F. Bank holding company, savings and loan holding company;
G. Foreign banking organization as defined in 12 CFR 211.21(o);
H. Uninsured State-licensed branch or agency of a foreign bank;
or
I. Other entity type not listed above, including a subsidiary of
a legal entity described above where the subsidiary itself is not an
entity type listed above;
2. Indication of whether each calendar date is a trading day or
not a trading day for the trading desk; and
3. Currency reported and daily currency conversion rate.
c. Quantitative Measurements Identifying Information
1. Each banking entity must provide the following information
regarding the quantitative measurements:
i. A Risk and Position Limits Information Schedule that provides
identifying and descriptive information for each limit reported
pursuant to the Risk and Position Limits and Usage quantitative
measurement, including the name of the limit, a unique
identification label for the limit, a description of the limit,
whether the limit is intraday or end-of-day, the unit of measurement
for the limit, whether the limit measures risk on a net or gross
basis, and the type of limit;
ii. A Risk Factor Sensitivities Information Schedule that
provides identifying and descriptive information for each risk
factor sensitivity reported pursuant to the Risk Factor
Sensitivities quantitative measurement, including the name of the
sensitivity, a unique identification label for the sensitivity, a
description of the sensitivity, and the sensitivity's risk factor
change unit;
iii. A Risk Factor Attribution Information Schedule that
provides identifying and descriptive information for each risk
factor attribution reported pursuant to the Comprehensive Profit and
Loss Attribution quantitative measurement, including the name of the
risk factor or other factor, a unique identification label for the
risk factor or other factor, a description of the risk factor or
other factor, and the risk factor or other factor's change unit;
iv. A Limit/Sensitivity Cross-Reference Schedule that cross-
references, by unique identification label, limits identified in the
Risk and Position Limits Information Schedule to associated risk
factor sensitivities identified in the Risk Factor Sensitivities
Information Schedule; and
v. A Risk Factor Sensitivity/Attribution Cross-Reference
Schedule that cross-references, by unique identification label, risk
factor sensitivities identified in the Risk Factor Sensitivities
Information Schedule to associated risk factor attributions
identified in the Risk Factor Attribution Information Schedule.
d. Narrative Statement
Each banking entity made subject to this appendix by Sec.
248.20 must submit in a separate electronic document a Narrative
Statement to the Board describing any changes in calculation methods
used, a description of and reasons for changes in the banking
entity's trading desk structure or trading desk strategies, and when
any such change occurred. The Narrative Statement must include any
information the banking entity views as relevant for assessing the
information reported, such as further description of calculation
methods used.
If a banking entity does not have any information to report in a
Narrative Statement, the banking entity must submit an electronic
document stating that it does not have any information to report in
a Narrative Statement.
e. Frequency and Method of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report the
Narrative Statement, the Trading Desk Information, the Quantitative
Measurements Identifying Information, and each applicable
quantitative measurement electronically to the Board on the
reporting schedule established in Sec. __.20 unless otherwise
requested by the Board. A banking entity must report the Trading
Desk Information, the Quantitative Measurements Identifying
Information, and each applicable quantitative measurement to the
Board in accordance with the XML Schema specified and published on
the Board's website.
f. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the Board pursuant to this appendix and Sec.
248.20(d), create and maintain records documenting the preparation
and content of these reports, as
[[Page 33573]]
well as such information as is necessary to permit the Board to
verify the accuracy of such reports, for a period of five years from
the end of the calendar year for which the measurement was taken. A
banking entity must retain the Narrative Statement, the Trading Desk
Information, and the Quantitative Measurements Identifying
Information for a period of five years from the end of the calendar
year for which the information was reported to the Board.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. 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
value of the trading desk's risk or positions that are accounted for
by the current activity of the desk. Risk and position limits and
their usage are key risk management tools used to control and
monitor risk taking and include, but are not limited to, the limits
set out in Sec. 248.4 and Sec. 248.5. A number of the metrics that
are described below, including ``Risk Factor Sensitivities'' and
``Value-at-Risk,'' relate to a trading desk's risk and position
limits and are useful in evaluating and setting these limits in the
broader context of the trading desk's overall activities,
particularly for the market making activities under Sec. 248.4(b)
and hedging activity under Sec. 248.5. Accordingly, the limits
required under Sec. 248.4(b)(2)(iii) and Sec. 248.5(b)(1)(i)(A)
must meet the applicable requirements under Sec. 248.4(b)(2)(iii)
and Sec. 248.5(b)(1)(i)(A) and also must include appropriate
metrics for the trading desk limits including, at a minimum, the
``Risk Factor Sensitivities'' and ``Value-at-Risk'' metrics except
to the extent any of the ``Risk Factor Sensitivities'' or ``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.
A. A banking entity must provide the following information for
each limit reported pursuant to this quantitative measurement: The
unique identification label for the limit reported in the Risk and
Position Limits Information Schedule, the limit size (distinguishing
between an upper and a lower limit), and the value of usage of the
limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
2. 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. 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. 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 banking entity must provide the following information
for each sensitivity that is reported pursuant to this quantitative
measurement: The unique identification label for the risk factor
sensitivity listed in the Risk Factor Sensitivities Information
Schedule, the change in risk factor used to determine the risk
factor sensitivity, and the aggregate change in value across all
positions of the desk given the change in risk factor.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
3. Value-at-Risk and Stressed Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the measurement of the risk of future financial loss in
the value of a trading desk's aggregated positions at the ninety-
nine percent confidence level over a one-day period, based on
current market conditions. For purposes of this appendix, Stressed
Value-at-Risk (``Stressed VaR'') is the measurement of the risk of
future financial loss in the value of a trading desk's aggregated
positions at the ninety-nine percent confidence level over a one-day
period, based on market conditions during a period of significant
financial stress.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: For VaR, all trading desks engaged in covered
trading activities. For Stressed VaR, all trading desks engaged in
covered trading activities, except trading desks whose covered
trading activity is conducted exclusively to hedge products excluded
from the definition of ``financial instrument'' under Sec.
248.3(d)(2).
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into three categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); (ii) profit and loss attributable to new
positions resulting from the current day's trading activity (``new
positions''); and (iii) residual profit and loss that cannot be
specifically attributed to existing positions or new positions. The
sum of (i), (ii), and (iii) must equal the trading desk's
comprehensive profit and loss at each point in time.
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. For the attribution of comprehensive profit and loss from
existing positions to specific risk factors and other factors, a
banking entity must provide the following information for the
factors that explain the preponderance of the profit or loss changes
due to risk factor changes: The unique identification label for the
risk factor or other factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss due to the risk factor
or other factor change.
C. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and loss 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. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
c. Positions, Transaction Volumes, and Securities Inventory Aging
Measurements
1. Positions
i. Description: For purposes of this appendix, Positions is the
value of securities and derivatives positions managed by the trading
desk. For purposes of the Positions quantitative measurement, do not
include in the Positions calculation for ``securities'' those
securities that are also ``derivatives,'' as those terms are defined
under subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \421\ A banking entity must
separately report the trading desk's market value of long securities
positions, market value of short securities positions, market value
of derivatives receivables, market value of derivatives payables,
notional value of derivatives receivables, and notional value of
derivatives payables.
---------------------------------------------------------------------------
\421\ See Sec. Sec. 248.2(i), (bb). For example, under this
part, a security-based swap is both a ``security'' and a
``derivative.'' For purposes of the Positions quantitative
measurement, security-based swaps are reported as derivatives rather
than securities.
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 248.4(a)
or Sec. 248.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
2. Transaction Volumes
i. Description: For purposes of this appendix, Transaction
Volumes measures four exclusive categories of covered trading
[[Page 33574]]
activity conducted by a trading desk. A banking entity is required
to report the value and number of security and derivative
transactions conducted by the trading desk with: (i) Customers,
excluding internal transactions; (ii) non-customers, excluding
internal transactions; (iii) trading desks and other organizational
units where the transaction is booked in the same banking entity;
and (iv) trading desks and other organizational units where the
transaction is booked into an affiliated banking entity. For
securities, value means gross market value. For derivatives, value
means gross notional value. For purposes of calculating the
Transaction Volumes quantitative measurement, do not include in the
Transaction Volumes calculation for ``securities'' those securities
that are also ``derivatives,'' as those terms are defined under
subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \422\ Further, for purposes of the
Transaction Volumes quantitative measurement, a customer of a
trading desk that relies on Sec. 248.4(a) to conduct underwriting
activity is a market participant identified in Sec. 248.4(a)(7),
and a customer of a trading desk that relies on Sec. 248.4(b) to
conduct market making-related activity is a market participant
identified in Sec. 248.4(b)(3).
---------------------------------------------------------------------------
\422\ See Sec. Sec. 248.2(i), (bb).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 248.4(a)
or Sec. 248.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
3. Securities Inventory Aging
i. Description: For purposes of this appendix, Securities
Inventory Aging generally describes a schedule of the market value
of the trading desk's securities positions and the amount of time
that those securities positions have been held. Securities Inventory
Aging must measure the age profile of a trading desk's securities
positions for the following periods: 0-30 Calendar days; 31-60
calendar days; 61-90 calendar days; 91-180 calendar days; 181-360
calendar days; and greater than 360 calendar days. Securities
Inventory Aging includes two schedules, a security asset-aging
schedule, and a security liability-aging schedule. For purposes of
the Securities Inventory Aging quantitative measurement, do not
include securities that are also ``derivatives,'' as those terms are
defined under subpart A.\423\
---------------------------------------------------------------------------
\423\ See Sec. Sec. 248.2(i), (bb).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 248.4(a)
or Sec. 248.4(b) to conduct underwriting activity or market-making
related activity, respectively.
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Chapter III
Authority and Issuance
For the reasons set forth in the Common Preamble, the Federal
Deposit Insurance Corporation proposes to amend chapter III of Title
12, Code of Federal Regulations as follows:
PART 351--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
0
27. The authority citation for Part 351 continues to read as follows:
Authority: 12 U.S.C. 1851; 1811 et seq.; 3101 et seq.; and
5412.
0
28. Revise Sec. 351.2 to read as follows:
Sec. 351.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) 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.
(c) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(d) Banking entity. (1) Except as provided in paragraph (d)(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 (d)(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 (d)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraphs (d)(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.
(e) Board means the Board of Governors of the Federal Reserve
System.
(f) CFTC means the Commodity Futures Trading Commission.
(g) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(h) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(i) Derivative. (1) Except as provided in paragraph (i)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, guidance, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(j) Employee includes a member of the immediate family of the
employee.
(k) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(l) Excluded commodity has the same meaning as in section 1a(19) of
the
[[Page 33575]]
Commodity Exchange Act (7 U.S.C. 1a(19)).
(m) FDIC means the Federal Deposit Insurance Corporation.
(n) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(o) 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.
(p) 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.
(q) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(r) 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).
(s) 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)).
(t) Limited trading assets and liabilities means, with respect to a
banking entity, that:
(1) The banking entity has, together with its affiliates and
subsidiaries on a worldwide consolidated basis, 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 over the previous
consecutive four quarters, as measured as of the last day of each of
the four previous calendar quarters, is less than $1,000,000,000; and
(2) The FDIC has not determined pursuant to Sec. 351.20(g) or (h)
of this part that the banking entity should not be treated as having
limited trading assets and liabilities.
(u) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(v) Moderate trading assets and liabilities means, with respect to
a banking entity, that the banking entity does not have significant
trading assets and liabilities or limited trading assets and
liabilities.
(w) 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)).
(x) 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.
(y) 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)).
(z) SEC means the Securities and Exchange Commission.
(aa) 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.
(bb) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(cc) 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)).
(dd) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(ee) 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.
(ff) Significant trading assets and liabilities.
(1) Significant trading assets and liabilities means, with respect
to a banking entity, that:
(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, equals or
exceeds $10,000,000,000; or
(ii) The FDIC has determined pursuant to Sec. 351.20(h) of this
part that the banking entity should be treated as having significant
trading assets and liabilities.
(2) With respect to a banking entity other than a banking entity
described in paragraph (3), trading assets and liabilities for purposes
of this paragraph (ff) means 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) on a worldwide
consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (ff) means the
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) of the combined U.S. operations of
the top-tier foreign banking organization (including all subsidiaries,
affiliates, branches, and agencies of the foreign banking organization
operating, located, or organized in the United States).
(ii) For purposes of paragraph (ff)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(gg) State means any State, the District of Columbia, the
Commonwealth of Puerto Rico, Guam, American Samoa, the United States
Virgin Islands, and the
[[Page 33576]]
Commonwealth of the Northern Mariana Islands.
(hh) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(ii) 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.
(jj) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
0
29. Amend Sec. 351.3 by:
0
a. Revising paragraph (b);
0
b. Redesignating paragraphs (c) through (e) as paragraphs (d) through
(f);
0
c. Adding a new paragraph (c);
0
d. Revising paragraph (e)(3);
0
e. Adding paragraph (e)(10);
0
f. Redesignating paragraphs (f)(5) through (f)(13) as paragraphs (f)(6)
through (f)(14);
0
g. Adding a new paragraph (f)(5); and
0
h. Adding paragraph (g).
The revisions and additions read as follows:
Sec. 351.3 Prohibition on proprietary trading.
* * * * *
(b) Definition of trading account. Trading account means any
account that is used by a banking entity to:
(1)(i) Purchase or sell one or more financial instruments that are
both market risk capital rule covered positions and trading positions
(or hedges of other market risk capital rule covered positions), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule; or
(ii) With respect to a banking entity that is not, and is not
controlled directly or indirectly by a banking entity that is, located
in or organized under the laws of the United States or any State,
purchase or sell one or more financial instruments that are subject to
capital requirements under a market risk framework established by the
home-country supervisor that is consistent with the market risk
framework published by the Basel Committee on Banking Supervision, as
amended from time to time.
(2) Purchase or sell one or more financial instruments for any
purpose, if the banking entity:
(i) 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
(ii) 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; or
(3) Purchase or sell one or more financial instruments, with
respect to a financial instrument that is recorded at fair value on a
recurring basis under applicable accounting standards.
(c) Presumption of compliance. (1)(i) Each trading desk that does
not purchase or sell financial instruments for a trading account
defined in paragraphs (b)(1) or (b)(2) of this section may calculate
the net gain or net loss on the trading desk's portfolio of financial
instruments each business day, reflecting realized and unrealized gains
and losses since the previous business day, based on the banking
entity's fair value for such financial instruments.
(ii) If the sum of the absolute values of the daily net gain and
loss figures determined in accordance with paragraph (c)(1)(i) of this
section for the preceding 90-calendar-day period does not exceed $25
million, the activities of the trading desk shall be presumed to be in
compliance with the prohibition in paragraph (a) of this section.
(2) The FDIC may rebut the presumption of compliance in paragraph
(c)(1)(ii) of this section by providing written notice to the banking
entity that the FDIC has determined that one or more of the banking
entity's activities violates the prohibitions under subpart B.
(3) If a trading desk operating pursuant to paragraph (c)(1)(ii) of
this section exceeds the $25 million threshold in that paragraph at any
point, the banking entity shall, in accordance with any policies and
procedures adopted by the FDIC:
(i) Promptly notify the FDIC;
(ii) Demonstrate that the trading desk's purchases and sales of
financial instruments comply with subpart B; and
(iii) Demonstrate, with respect to the trading desk, how the
banking entity will maintain compliance with subpart B on an ongoing
basis.
* * * * *
(e) * * *
(3) Any purchase or sale of a security, foreign exchange forward
(as that term is defined in section 1a(24) of the Commodity Exchange
Act (7 U.S.C. 1a(24)), foreign exchange swap (as that term is defined
in section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)), or
physically-settled cross-currency swap, by a banking entity for the
purpose of liquidity management in accordance with a documented
liquidity management plan of the banking entity that, with respect to
such financial instruments:
(i) Specifically contemplates and authorizes the particular
financial instruments to be used for liquidity management purposes, the
amount, types, and risks of these financial instruments that are
consistent with liquidity management, and the liquidity circumstances
in which the particular financial instruments may or must be used;
(ii) Requires that any purchase or sale of financial instruments
contemplated and authorized by the plan be principally for the purpose
of managing the liquidity of the banking entity, and not for the
purpose of short-term resale, benefitting from actual or expected
short-term price movements, realizing short-term arbitrage profits, or
hedging a position taken for such short-term purposes;
(iii) Requires that any financial instruments purchased or sold for
liquidity management purposes be highly liquid and limited to financial
instruments the market, credit, and other risks of which the banking
entity does not reasonably expect to give rise to appreciable profits
or losses as a result of short-term price movements;
(iv) Limits any financial instruments purchased or sold for
liquidity management purposes, together with any other instruments
purchased or sold for such purposes, to an amount that is consistent
with the banking entity's near-term funding needs, including deviations
from normal operations of the banking entity or any affiliate thereof,
as estimated and documented pursuant to methods specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of financial instruments that are not permitted under Sec. Sec.
351.6(a) or (b) of this subpart are for the purpose of liquidity
management and in accordance with the liquidity management plan
described in paragraph (e)(3) of this section; and
(vi) Is consistent with the FDIC's supervisory requirements,
guidance, and expectations regarding liquidity management;
* * * * *
(10) Any purchase (or sale) of one or more financial instruments
that was made in error by a banking entity in the course of conducting
a permitted or excluded activity or is a subsequent
[[Page 33577]]
transaction to correct such an error, and the erroneously purchased (or
sold) financial instrument is promptly transferred to a separately-
managed trade error account for disposition.
(f) * * *
(5) Cross-currency swap means a swap in which one party exchanges
with another party principal and interest rate payments in one currency
for principal and interest rate payments in another currency, and the
exchange of principal occurs on the date the swap is entered into, with
a reversal of the exchange of principal at a later date that is agreed
upon when the swap is entered into.
* * * * *
(g) Reservation of Authority: (1) The FDIC may determine, on a
case-by-case basis, that a purchase or sale of one or more financial
instruments by a banking entity either is or is not for the trading
account as defined at 12 U.S.C. 1851(h)(6).
(2) Notice and Response Procedures.
(i) Notice. When the FDIC determines that the purchase or sale of
one or more financial instruments is for the trading account under
paragraph (g)(1) of this section, the [Agency] will notify the banking
entity in writing of the determination and provide an explanation of
the determination.
(ii) Response.
(A) The banking entity may respond to any or all items in the
notice. The response should include any matters that the banking entity
would have the FDIC consider in deciding whether the purchase or sale
is for the trading account. The response must be in writing and
delivered to the designated FDIC official within 30 days after the date
on which the banking entity received the notice. The FDIC may shorten
the time period when, in the opinion of the FDIC, the activities or
condition of the banking entity so requires, provided that the banking
entity is informed promptly of the new time period, or with the consent
of the banking entity. In its discretion, the FDIC may extend the time
period for good cause.
(B) Failure to respond within 30 days or such other time period as
may be specified by the FDIC shall constitute a waiver of any
objections to the FDIC's determination.
(iii) After the close of banking entity's response period, the FDIC
will decide, based on a review of the banking entity's response and
other information concerning the banking entity, whether to maintain
the FDIC's determination that the purchase or sale of one or more
financial instruments is for the trading account. The banking entity
will be notified of the decision in writing. The notice will include an
explanation of the decision.
0
30. Amend Sec. 351.4 is amended by:
0
a. Revising paragraph (a)(2);
0
b. Adding paragraph (a)(8);
0
c. Revising paragraph (b)(2);
0
d. Revising the introductory text of paragraph (b)(3)(i);
0
e. In paragraph (b)(5) removing ``inventory'' wherever it appears and
adding ``positions'' in its place; and
0
f. Adding paragraph (b)(6).
The revisions and additions read as follows:
Sec. 351.4 Permitted underwriting and market making-related
activities.
(a) * * *
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii)(A) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
taking into account the liquidity, maturity, and depth of the market
for the relevant type of security, and
(B) reasonable efforts are made to sell or otherwise reduce the
underwriting position within a reasonable period, taking into account
the liquidity, maturity, and depth of the market for the relevant type
of security;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (a) of this section, including reasonably designed written
policies and procedures, internal controls, analysis, and independent
testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, in accordance with paragraph
(a)(8)(i) of this section;
(C) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(D) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis of the basis for any temporary
or permanent increase to a trading desk's limit(s), and independent
review of such demonstrable analysis and approval;
(iv) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(v) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
* * * * *
(8) Rebuttable presumption of compliance.
(i) Risk limits.
(A) A banking entity shall be presumed to meet the requirements of
paragraph (a)(2)(ii)(A) of this section with respect to the purchase or
sale of a financial instrument if the banking entity has established
and implements, maintains, and enforces the limits described in
paragraph (a)(8)(i)(B) and does not exceed such limits.
(B) The presumption described in paragraph (8)(i)(A) of this
section shall be available with respect to limits for each trading desk
that are designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties, based on the nature
and amount of the trading desk's underwriting activities, on the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.
(ii) Supervisory review and oversight. The limits described in
paragraph (a)(8)(i) of this section shall be subject to supervisory
review and oversight by the FDIC on an ongoing basis. Any review of
such limits will include assessment of whether the limits are designed
not to exceed the reasonably expected near term demands of clients,
customers, or counterparties.
(iii) Reporting. With respect to any limit identified pursuant to
paragraph (a)(8)(i) of this section, a banking entity shall promptly
report to the FDIC (A) to the extent that any limit is exceeded and (B)
any temporary or permanent increase to any limit(s), in each case in
the form and manner as directed by the FDIC.
(iv) Rebutting the presumption. The presumption in paragraph
(a)(8)(i) of this section may be rebutted by the FDIC if the FDIC
determines, based on all
[[Page 33578]]
relevant facts and circumstances, that a trading desk is engaging in
activity that is not based on the reasonably expected near term demands
of clients, customers, or counterparties. The FDIC will provide notice
of any such determination to the banking entity in writing.
(b) * * *
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The trading desk's market-making related activities are
designed not to exceed, on an ongoing basis, the reasonably expected
near term demands of clients, customers, or counterparties, based on
the liquidity, maturity, and depth of the market for the relevant types
of financial instrument(s).
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (b) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and positions; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, in accordance with paragraph
(b)(6)(i) of this section;
(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) In the case of a banking entity with significant trading
assets and liabilities, 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 paragraph (b) of this section in accordance with
applicable law.
(3) * * *
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with the methodology described in
definition of ``significant trading assets and liabilities'' contained
in Sec. 351.2 of this part, unless:
* * * * *
(6) Rebuttable presumption of compliance.--(i) Risk limits. (A) A
banking entity shall be presumed to meet the requirements of paragraph
(b)(2)(ii) of this section with respect to the purchase or sale of a
financial instrument if the banking entity has established and
implements, maintains, and enforces the limits described in paragraph
(b)(6)(i)(B) and does not exceed such limits.
(B) The presumption described in paragraph (6)(i)(A) of this
section shall be available with respect to limits for each trading desk
that are designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties, based on the nature
and amount of the trading desk's market making-related activities, on
the:
(1) Amount, types, and risks of its market-maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.
(ii) Supervisory review and oversight. The limits described in
paragraph (b)(6)(i) of this section shall be subject to supervisory
review and oversight by the FDIC on an ongoing basis. Any review of
such limits will include assessment of whether the limits are designed
not to exceed the reasonably expected near term demands of clients,
customers, or counterparties.
(iii) Reporting. With respect to any limit identified pursuant to
paragraph (b)(6)(i) of this section, a banking entity shall promptly
report to the FDIC (A) to the extent that any limit is exceeded and (B)
any temporary or permanent increase to any limit(s), in each case in
the form and manner as directed by the FDIC.
(iv) Rebutting the presumption. The presumption in paragraph
(b)(6)(i) of this section may be rebutted by the FDIC if the FDIC
determines, based on all relevant facts and circumstances, that a
trading desk is engaging in activity that is not based on the
reasonably expected near term demands of clients, customers, or
counterparties. The FDIC will provide notice of any such determination
to the banking entity in writing.
0
31. Amend Sec. 351.5 by revising paragraph (b), the introductory text
of paragraph (c)(1), and adding paragraph (c)(4) to read as follows:
Sec. 351.5 Permitted risk-mitigating hedging activities.
* * * * *
(b) Requirements. (1) The risk-mitigating hedging activities of a
banking entity that has significant trading assets and liabilities are
permitted under paragraph (a) of this section only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that
[[Page 33579]]
may be used for hedging, including documentation indicating what
positions, contracts or other holdings a particular trading desk may
use in its risk-mitigating hedging activities, as well as position and
aging limits with respect to such positions, contracts or other
holdings;
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(C) The conduct of analysis and independent testing designed to
ensure that the positions, techniques and strategies that may be used
for hedging may reasonably be expected to reduce or otherwise
significantly mitigate the specific, identifiable risk(s) being hedged;
(ii) The risk-mitigating hedging activity:
(A) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(B) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(D) Is subject to continuing review, monitoring and management by
the banking entity that:
(1) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1)(i) of this section;
(2) Is designed to reduce or otherwise significantly mitigate the
specific, identifiable risks that develop over time from the risk-
mitigating hedging activities undertaken under this section and the
underlying positions, contracts, and other holdings of the banking
entity, based upon the facts and circumstances of the underlying and
hedging positions, contracts and other holdings of the banking entity
and the risks and liquidity thereof; and
(3) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(1)(ii) of this section and is not
prohibited proprietary trading; and
(iii) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(2) The risk-mitigating hedging activities of a banking entity that
does not have significant trading assets and liabilities are permitted
under paragraph (a) of this section only if the risk-mitigating hedging
activity:
(i) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading.
(c) * * * (1) A banking entity that has significant trading assets
and liabilities must comply with the requirements of paragraphs (c)(2)
and (3) of this section, unless the requirements of paragraph (c)(4) of
this section are met, with respect to any purchase or sale of financial
instruments made in reliance on this section for risk-mitigating
hedging purposes that is:
* * * * *
(4) The requirements of paragraphs (c)(2) and (3) of this section
do not apply to the purchase or sale of a financial instrument
described in paragraph (c)(1) of this section if:
(i) The financial instrument purchased or sold is identified on a
written list of pre-approved financial instruments that are commonly
used by the trading desk for the specific type of hedging activity for
which the financial instrument is being purchased or sold; and
(ii) At the time the financial instrument is purchased or sold, the
hedging activity (including the purchase or sale of the financial
instrument) complies with written, pre-approved hedging limits for the
trading desk purchasing or selling the financial instrument for hedging
activities undertaken for one or more other trading desks. The hedging
limits shall be appropriate for the:
(A) Size, types, and risks of the hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased and sold for hedging activities
by the trading desk; and
(C) Levels and duration of the risk exposures being hedged.
0
32. Amend Sec. 351.6 by revising paragraph (e)(3), and removing
paragraph (e)(6) to read as follows:
Sec. 351.6 Other permitted proprietary trading activities.
* * * * *
(e) * * *
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
* * * * *
Sec. 351.10 [Amended]
0
33. Amend Sec. 351.10 by:
0
a. In paragraph (c)(8)(i)(A) removing Sec. 351.2(s)'' and adding Sec.
351.2(u)'' in its place;
0
b. Removing paragraph (d)(1);
0
c. Redesignating paragraphs (d)(2) through (d)(10) as paragraphs (d)(1)
through (d)(9);
0
d. In paragraph (d)(5)(i)(G) revising the reference to
``(d)(6)(i)(A)'' to read ``(d)(5)(i)(A)''; and
0
e. In paragraph (d)(9) revising the reference to ``(d)(9)'' to read
``(d)(8)'' and the reference to ``(d)(10)(i)(A)'' to read
``(d)(9)(i)(A)'' and the reference to ``(d)(10)(i)'' to read
``(d)(9)(i)''.
0
34. Amend Sec. 351. by revising paragraph (c) to read as follows:
[[Page 33580]]
Sec. 351.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
* * * * *
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 351.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 351.4(a) or Sec. 351.4(b) of subpart B,
respectively; and
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; or acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C. 78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section, then in each such case any ownership
interests acquired or retained by the banking entity and its affiliates
in connection with underwriting and market making related activities
for that particular covered fund are included in the calculation of
ownership interests permitted to be held by the banking entity and its
affiliates under the limitations of Sec. 351.12(a)(2)(ii); Sec.
351.12(a)(2)(iii), and Sec. 351.12(d) of this subpart.
Sec. 351.12 [Amended]
0
35. Amend Sec. 351.12 by:
0
a. In paragraphs (c)(1) and (d) removing ``Sec. 351.10(d)(6)(ii)'' to
adding ``Sec. 351.10(d)(5)(ii)'' in its place;
0
b. Removing paragraph (e)(2)(vii); and
0
c. Redesignating the second instance of paragraph (e)(2)(vi) as
paragraph (e)(2)(vii).
Sec. 351.13 [Amended]
0
36. Amend Sec. 351.13 by revising paragraphs (a) and (b)(3) and
removing paragraph (b)(4)(iv) to read as follows:
Sec. 351.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 351.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks to the banking
entity in connection with:
(i) A compensation arrangement with an employee of the banking
entity or an affiliate thereof that directly provides investment
advisory, commodity trading advisory or other services to the covered
fund; or
(ii) A position taken by the banking entity when acting as
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund.
(2) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program in accordance with subpart
D of this part that is reasonably designed to ensure the banking
entity's compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures,
and internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks arising:
(1) out of a transaction conducted solely to accommodate a specific
customer request with respect to the covered fund; or
(2) in connection with the compensation arrangement with the
employee that directly provides investment advisory, commodity trading
advisory, or other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) With respect to risk-mitigating hedging activity conducted
pursuant to paragraph (a)(1)(i), the compensation arrangement relates
solely to the covered fund in which the banking entity or any affiliate
has acquired an ownership interest pursuant to paragraph (a)(1)(i) and
such compensation arrangement provides that any losses incurred by the
banking entity on such ownership interest will be offset by
corresponding decreases in amounts payable under such compensation
arrangement.
* * * * *
(b) * * *
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is not sold and has not been
sold pursuant to an offering that targets residents of the United
States in which the banking entity or any affiliate of the banking
entity participates. If the banking entity or an affiliate sponsors or
serves, directly or indirectly, as the investment manager, investment
adviser, commodity pool operator or commodity trading advisor to a
covered fund, then the banking entity or affiliate will be deemed for
purposes of this paragraph (b)(3) to participate in any offer or sale
by the covered fund of ownership interests in the covered fund.
* * * * *
0
37. Section 351.14 is amended by revising paragraph (a)(2)(ii)(B) as
follows:
Sec. 351.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually no later than March 31 to
the FDIC (with a duty to update the certification if the information in
the certification materially changes) that the banking entity does not,
directly or indirectly, guarantee, assume, or otherwise insure the
obligations or performance of the covered fund or of any covered fund
in which such covered fund invests; and
* * * * *
0
38. Section 351.20 is amended by:
0
a. Revising paragraph (a);
0
b. Revising the introductory language of paragraph (b);
0
c. Revising paragraph (c);
0
d. Revising paragraph (d);
0
e. Revising the introductory language of paragraph (e);
0
f. Revising paragraph (f)(2); and
0
g. Adding new paragraphs (g) and (h).
The revisions read as follows:
Sec. 351.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and
[[Page 33581]]
liabilities) shall develop and provide for the continued administration
of a compliance program reasonably designed to ensure and monitor
compliance with the prohibitions and restrictions on proprietary
trading and covered fund activities and investments set forth in
section 13 of the BHC Act and this part. The terms, scope, and detail
of the compliance program shall be appropriate for the types, size,
scope, and complexity of activities and business structure of the
banking entity.
(b) Banking entities with significant trading assets and
liabilities. With respect to a banking entity with significant trading
assets and liabilities, the compliance program required by paragraph
(a) of this section, at a minimum, shall include:
* * * * *
(c) CEO attestation.
(1) The CEO of a banking entity described in paragraph (2) must,
based on a review by the CEO of the banking entity, attest in writing
to the FDIC, each year no later than March 31, that the banking entity
has in place processes reasonably designed to achieve compliance with
section 13 of the BHC Act and this part. In the case of a U.S. branch
or agency of a foreign banking entity, the attestation may be provided
for the entire U.S. operations of the foreign banking entity by the
senior management officer of the U.S. operations of the foreign banking
entity who is located in the United States.
(2) The requirements of paragraph (c)(1) apply to a banking entity
if:
(i) The banking entity does not have limited trading assets and
liabilities; or
(ii) The FDIC notifies the banking entity in writing that it must
satisfy the requirements contained in paragraph (c)(1).
(d) Reporting requirements under the Appendix to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B shall comply with the reporting requirements described in the
Appendix, if:
(i) The banking entity has significant trading assets and
liabilities; or
(ii) The FDIC notifies the banking entity in writing that it must
satisfy the reporting requirements contained in the Appendix.
(2) Frequency of reporting: Unless the FDIC notifies the banking
entity in writing that it must report on a different basis, a banking
entity with $50 billion or more in trading assets and liabilities (as
calculated in accordance with the methodology described in the
definition of ``significant trading assets and liabilities'' contained
in Sec. 351.2 of this part of this part) shall report the information
required by the Appendix for each calendar month within 20 days of the
end of each calendar month. Any other banking entity subject to the
Appendix shall report the information required by the Appendix for each
calendar quarter within 30 days of the end of that calendar quarter
unless the FDIC notifies the banking entity in writing that it must
report on a different basis.
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities shall maintain records
that include:
* * * * *
(f) * * *
(2) Banking entities with moderate trading assets and liabilities.
A banking entity with moderate trading assets and liabilities may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope, and complexity of the
banking entity.
(g) Rebuttable presumption of compliance for banking entities with
limited trading assets and liabilities.
(1) Rebuttable presumption. Except as otherwise provided in this
paragraph, a banking entity with limited trading assets and liabilities
shall be presumed to be compliant with subpart B and subpart C and
shall have no obligation to demonstrate compliance with this part on an
ongoing basis.
(2) Rebuttal of presumption.
(i) If upon examination or audit, the FDIC determines that the
banking entity has engaged in proprietary trading or covered fund
activities that are otherwise prohibited under subpart B or subpart C,
the FDIC may require the banking entity to be treated under this part
as if it did not have limited trading assets and liabilities.
(ii) Notice and Response Procedures.
(A) Notice. The FDIC will notify the banking entity in writing of
any determination pursuant to paragraph (g)(2)(i) of this section to
rebut the presumption described in this paragraph (g) and will provide
an explanation of the determination.
(B) Response.
(1) The banking entity may respond to any or all items in the
notice described in paragraph (g)(2)(ii)(A) of this section. The
response should include any matters that the banking entity would have
the FDIC consider in deciding whether the banking entity has engaged in
proprietary trading or covered fund activities prohibited under subpart
B or subpart C. The response must be in writing and delivered to the
designated FDIC official within 30 days after the date on which the
banking entity received the notice. The FDIC may shorten the time
period when, in the opinion of the FDIC, the activities or condition of
the banking entity so requires, provided that the banking entity is
informed promptly of the new time period, or with the consent of the
banking entity. In its discretion, the FDIC may extend the time period
for good cause.
(2) Failure to respond within 30 days or such other time period as
may be specified by the FDIC shall constitute a waiver of any
objections to the FDIC's determination.
(C) After the close of banking entity's response period, the FDIC
will decide, based on a review of the banking entity's response and
other information concerning the banking entity, whether to maintain
the FDIC's determination that banking entity has engaged in proprietary
trading or covered fund activities prohibited under subpart B or
subpart C. The banking entity will be notified of the decision in
writing. The notice will include an explanation of the decision.
(h) Reservation of authority. Notwithstanding any other provision
of this part, the FDIC retains its authority to require a banking
entity without significant trading assets and liabilities to apply any
requirements of this part that would otherwise apply if the banking
entity had significant or moderate trading assets and liabilities if
the FDIC determines that the size or complexity of the banking entity's
trading or investment activities, or the risk of evasion of subpart B
or subpart C, does not warrant a presumption of compliance under
paragraph (g) of this section or treatment as a banking entity with
moderate trading assets and liabilities, as applicable.
0
39. Remove Appendix A and Appendix B to Part 351 and add Appendix to
Part 351--Reporting and Recordkeeping Requirements for Covered Trading
Activities to read as follows:
Appendix to Part 351--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
351.20(d), this appendix applies to a banking entity that, together
with its affiliates and subsidiaries,
[[Page 33582]]
has significant trading assets and liabilities. These entities are
required to (i) furnish periodic reports to the FDIC regarding a
variety of quantitative measurements of their covered trading
activities, which vary depending on the scope and size of covered
trading activities, and (ii) create and maintain records documenting
the preparation and content of these reports. The requirements of
this appendix must be incorporated into the banking entity's
internal compliance program under Sec. 351.20.
b. The purpose of this appendix is to assist banking entities
and the FDIC in:
(i) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(ii) Monitoring the banking entity's covered trading activities;
(iii) Identifying covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading activities of
trading desks engaged in market making-related activities subject to
Sec. 351.4(b) are consistent with the requirements governing
permitted market making-related activities;
(v) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. Sec. 351.4, 351.5, or 351.6(a)-(b) (i.e., underwriting and
market making-related related activity, risk-mitigating hedging, or
trading in certain government obligations) are consistent with the
requirement that such activity not result, directly or indirectly,
in a material exposure to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the FDIC of such activities; and
(vii) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. Information that must be furnished pursuant to this appendix
is not intended to serve as a dispositive tool for the
identification of permissible or impermissible activities.
d. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 351.20. The effectiveness of particular
quantitative measurements may differ based on the profile of the
banking entity's businesses in general and, more specifically, of
the particular trading desk, including types of instruments traded,
trading activities and strategies, and history and experience (e.g.,
whether the trading desk is an established, successful market maker
or a new entrant to a competitive market). In all cases, banking
entities must ensure that they have robust measures in place to
identify and monitor the risks taken in their trading activities, to
ensure that the activities are within risk tolerances established by
the banking entity, and to monitor and examine for compliance with
the proprietary trading restrictions in this part.
e. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 351.4 through 351.6(a)-(b), or that
result in a material exposure to high-risk assets or high-risk
trading strategies, must be escalated within the banking entity for
review, further analysis, explanation to the FDIC, and remediation,
where appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 351.2 and 351.3. In addition, for purposes of
this appendix, the following definitions apply:
Applicability identifies the trading desks for which a banking
entity is required to calculate and report a particular quantitative
measurement based on the type of covered trading activity conducted
by the trading desk.
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. Sec. 351.4, 351.5, 351.6(a), or 351.6(b). A banking
entity may include in its covered trading activity trading conducted
under Sec. Sec. 351.3(e), 351.6(c), 351.6(d), or 351.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading day means a calendar day on which a trading desk is open
for trading.
III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each banking entity made subject
to this appendix by Sec. 351.20 must furnish the following
quantitative measurements, as applicable, for each trading desk of
the banking entity engaged in covered trading activities and
calculate these quantitative measurements in accordance with this
appendix:
i. Risk and Position Limits and Usage;
ii. Risk Factor Sensitivities;
iii. Value-at-Risk and Stressed Value-at-Risk;
iv. Comprehensive Profit and Loss Attribution;
v. Positions;
vi. Transaction Volumes; and
vii. Securities Inventory Aging.
2. Trading desk information. Each banking entity made subject to
this appendix by Sec. 351.20 must provide certain descriptive
information, as further described in this appendix, regarding each
trading desk engaged in covered trading activities.
3. Quantitative measurements identifying information. Each
banking entity made subject to this appendix by Sec. 351.20 must
provide certain identifying and descriptive information, as further
described in this appendix, regarding its quantitative measurements.
4. Narrative statement. Each banking entity made subject to this
appendix by Sec. 351.20 must provide a separate narrative
statement, as further described in this appendix.
5. File identifying information. Each banking entity made
subject to this appendix by Sec. 351.20 must provide file
identifying information in each submission to the FDIC pursuant to
this appendix, including the name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the Board, and
identification of the reporting period and creation date and time.
b. Trading Desk Information
Each banking entity must provide descriptive information
regarding each trading desk engaged in covered trading activities,
including:
1. Name of the trading desk used internally by the banking
entity and a unique identification label for the trading desk;
2. Identification of each type of covered trading activity in
which the trading desk is engaged;
3. Brief description of the general strategy of the trading
desk;
4. A list of the types of financial instruments and other
products purchased and sold by the trading desk; an indication of
which of these are the main financial instruments or products
purchased and sold by the trading desk; and, for trading desks
engaged in market making-related activities under Sec. 351.4(b),
specification of whether each type of financial instrument is
included in market-maker positions or not included in market-maker
positions. In addition, indicate whether the trading desk is
including in its quantitative measurements products excluded from
the definition of ``financial instrument'' under Sec. 351.3(d)(2)
and, if so, identify such products;
5. Identification by complete name of each legal entity that
serves as a booking entity for covered trading activities conducted
by the trading desk; and indication of which of the identified legal
entities are the main booking entities for covered trading
activities of the trading desk;
6. For each legal entity that serves as a booking entity for
covered trading activities, specification of any of the following
applicable entity types for that legal entity:
i. National bank, Federal branch or Federal agency of a foreign
bank, Federal savings association, Federal savings bank;
ii. State nonmember bank, foreign bank having an insured branch,
State savings association;
[[Page 33583]]
iii. U.S.-registered broker-dealer, U.S.-registered security-
based swap dealer, U.S.-registered major security-based swap
participant;
iv. Swap dealer, major swap participant, derivatives clearing
organization, futures commission merchant, commodity pool operator,
commodity trading advisor, introducing broker, floor trader, retail
foreign exchange dealer;
v. State member bank;
vi. Bank holding company, savings and loan holding company;
vii. Foreign banking organization as defined in 12 CFR
211.21(o);
viii. Uninsured State-licensed branch or agency of a foreign
bank; or
ix. Other entity type not listed above, including a subsidiary
of a legal entity described above where the subsidiary itself is not
an entity type listed above;
7. Indication of whether each calendar date is a trading day or
not a trading day for the trading desk; and
8. Currency reported and daily currency conversion rate.
c. Quantitative Measurements Identifying Information
Each banking entity must provide the following information
regarding the quantitative measurements:
1. A Risk and Position Limits Information Schedule that provides
identifying and descriptive information for each limit reported
pursuant to the Risk and Position Limits and Usage quantitative
measurement, including the name of the limit, a unique
identification label for the limit, a description of the limit,
whether the limit is intraday or end-of-day, the unit of measurement
for the limit, whether the limit measures risk on a net or gross
basis, and the type of limit;
2. A Risk Factor Sensitivities Information Schedule that
provides identifying and descriptive information for each risk
factor sensitivity reported pursuant to the Risk Factor
Sensitivities quantitative measurement, including the name of the
sensitivity, a unique identification label for the sensitivity, a
description of the sensitivity, and the sensitivity's risk factor
change unit;
3. A Risk Factor Attribution Information Schedule that provides
identifying and descriptive information for each risk factor
attribution reported pursuant to the Comprehensive Profit and Loss
Attribution quantitative measurement, including the name of the risk
factor or other factor, a unique identification label for the risk
factor or other factor, a description of the risk factor or other
factor, and the risk factor or other factor's change unit;
4. A Limit/Sensitivity Cross-Reference Schedule that cross-
references, by unique identification label, limits identified in the
Risk and Position Limits Information Schedule to associated risk
factor sensitivities identified in the Risk Factor Sensitivities
Information Schedule; and
5. A Risk Factor Sensitivity/Attribution Cross-Reference
Schedule that cross-references, by unique identification label, risk
factor sensitivities identified in the Risk Factor Sensitivities
Information Schedule to associated risk factor attributions
identified in the Risk Factor Attribution Information Schedule.
d. Narrative Statement
Each banking entity made subject to this appendix by Sec.
351.20 must submit in a separate electronic document a Narrative
Statement to the FDIC describing any changes in calculation methods
used, a description of and reasons for changes in the banking
entity's trading desk structure or trading desk strategies, and when
any such change occurred. The Narrative Statement must include any
information the banking entity views as relevant for assessing the
information reported, such as further description of calculation
methods used.
If a banking entity does not have any information to report in a
Narrative Statement, the banking entity must submit an electronic
document stating that it does not have any information to report in
a Narrative Statement.
e. Frequency and Method of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report the
Narrative Statement, the Trading Desk Information, the Quantitative
Measurements Identifying Information, and each applicable
quantitative measurement electronically to the FDIC on the reporting
schedule established in Sec. 351.20 unless otherwise requested by
the FDIC. A banking entity must report the Trading Desk Information,
the Quantitative Measurements Identifying Information, and each
applicable quantitative measurement to the FDIC in accordance with
the XML Schema specified and published on the FDIC's website.
f. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the FDIC pursuant to this appendix and Sec. 351.20(d),
create and maintain records documenting the preparation and content
of these reports, as well as such information as is necessary to
permit the FDIC to verify the accuracy of such reports, for a period
of five years from the end of the calendar year for which the
measurement was taken. A banking entity must retain the Narrative
Statement, the Trading Desk Information, and the Quantitative
Measurements Identifying Information for a period of five years from
the end of the calendar year for which the information was reported
to the FDIC.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. 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
value of the trading desk's risk or positions that are accounted for
by the current activity of the desk. Risk and position limits and
their usage are key risk management tools used to control and
monitor risk taking and include, but are not limited to, the limits
set out in Sec. 351.4 and Sec. 351.5. A number of the metrics that
are described below, including ``Risk Factor Sensitivities'' and
``Value-at-Risk,'' relate to a trading desk's risk and position
limits and are useful in evaluating and setting these limits in the
broader context of the trading desk's overall activities,
particularly for the market making activities under Sec. 351.4(b)
and hedging activity under Sec. 351.5. Accordingly, the limits
required under Sec. 351.4(b)(2)(iii) and Sec. 351.5(b)(1)(i)(A)
must meet the applicable requirements under Sec. 351.4(b)(2)(iii)
and Sec. 351.5(b)(1)(i)(A) and also must include appropriate
metrics for the trading desk limits including, at a minimum, the
``Risk Factor Sensitivities'' and ``Value-at-Risk'' metrics except
to the extent any of the ``Risk Factor Sensitivities'' or ``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.
A. A banking entity must provide the following information for
each limit reported pursuant to this quantitative measurement: The
unique identification label for the limit reported in the Risk and
Position Limits Information Schedule, the limit size (distinguishing
between an upper and a lower limit), and the value of usage of the
limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
2. 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. 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. 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 banking entity must provide the following information
for each sensitivity that is reported pursuant to this quantitative
measurement: The unique identification label for the risk factor
sensitivity listed in the Risk Factor Sensitivities Information
Schedule, the change in risk factor used to determine the risk
factor sensitivity, and the aggregate change in value across all
positions of the desk given the change in risk factor.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
3. Value-at-Risk and Stressed Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the measurement of the risk of future financial loss in
the value of a trading desk's aggregated positions at the ninety-
nine percent confidence level over a one-day period, based on
current market conditions. For purposes of this appendix, Stressed
[[Page 33584]]
Value-at-Risk (``Stressed VaR'') is the measurement of the risk of
future financial loss in the value of a trading desk's aggregated
positions at the ninety-nine percent confidence level over a one-day
period, based on market conditions during a period of significant
financial stress.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: For VaR, all trading desks engaged in covered
trading activities. For Stressed VaR, all trading desks engaged in
covered trading activities, except trading desks whose covered
trading activity is conducted exclusively to hedge products excluded
from the definition of ``financial instrument'' under Sec.
__.3(d)(2).
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into three categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); (ii) profit and loss attributable to new
positions resulting from the current day's trading activity (``new
positions''); and (iii) residual profit and loss that cannot be
specifically attributed to existing positions or new positions. The
sum of (i), (ii), and (iii) must equal the trading desk's
comprehensive profit and loss at each point in time.
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. For the attribution of comprehensive profit and loss from
existing positions to specific risk factors and other factors, a
banking entity must provide the following information for the
factors that explain the preponderance of the profit or loss changes
due to risk factor changes: The unique identification label for the
risk factor or other factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss due to the risk factor
or other factor change.
C. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and loss 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. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
c. Positions, Transaction Volumes, and Securities Inventory Aging
Measurements
1. Positions
i. Description: For purposes of this appendix, Positions is the
value of securities and derivatives positions managed by the trading
desk. For purposes of the Positions quantitative measurement, do not
include in the Positions calculation for ``securities'' those
securities that are also ``derivatives,'' as those terms are defined
under subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \1\ A banking entity must separately
report the trading desk's market value of long securities positions,
market value of short securities positions, market value of
derivatives receivables, market value of derivatives payables,
notional value of derivatives receivables, and notional value of
derivatives payables.
---------------------------------------------------------------------------
\1\ See Sec. Sec. 351.2(i), (bb). For example, under this part,
a security-based swap is both a ``security'' and a ``derivative.''
For purposes of the Positions quantitative measurement, security-
based swaps are reported as derivatives rather than securities.
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 351.4(a)
or Sec. 351.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
2. Transaction Volumes
i. Description: For purposes of this appendix, Transaction
Volumes measures four exclusive categories of covered trading
activity conducted by a trading desk. A banking entity is required
to report the value and number of security and derivative
transactions conducted by the trading desk with: (i) Customers,
excluding internal transactions; (ii) non-customers, excluding
internal transactions; (iii) trading desks and other organizational
units where the transaction is booked in the same banking entity;
and (iv) trading desks and other organizational units where the
transaction is booked into an affiliated banking entity. For
securities, value means gross market value. For derivatives, value
means gross notional value. For purposes of calculating the
Transaction Volumes quantitative measurement, do not include in the
Transaction Volumes calculation for ``securities'' those securities
that are also ``derivatives,'' as those terms are defined under
subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \2\ Further, for purposes of the
Transaction Volumes quantitative measurement, a customer of a
trading desk that relies on Sec. 351.4(a) to conduct underwriting
activity is a market participant identified in Sec. 351.4(a)(7),
and a customer of a trading desk that relies on Sec. 351.4(b) to
conduct market making-related activity is a market participant
identified in Sec. 351.4(b)(3).
---------------------------------------------------------------------------
\2\ See Sec. Sec. 351.2(i), (bb).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 351.4(a)
or Sec. 351.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
3. Securities Inventory Aging
i. Description: For purposes of this appendix, Securities
Inventory Aging generally describes a schedule of the market value
of the trading desk's securities positions and the amount of time
that those securities positions have been held. Securities Inventory
Aging must measure the age profile of a trading desk's securities
positions for the following periods: 0-30 calendar days; 31-60
calendar days; 61-90 calendar days; 91-180 calendar days; 181-360
calendar days; and greater than 360 calendar days. Securities
Inventory Aging includes two schedules, a security asset-aging
schedule, and a security liability-aging schedule. For purposes of
the Securities Inventory Aging quantitative measurement, do not
include securities that are also ``derivatives,'' as those terms are
defined under subpart A.\3\
---------------------------------------------------------------------------
\3\ See Sec. Sec. 351.2(i), (bb).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 351.4(a)
or Sec. 351.4(b) to conduct underwriting activity or market-making
related activity, respectively.
SECURITIES AND EXCHANGE COMMISSION
17 CFR Chapter II
Authority and Issuance
For the reasons set forth in the Common Preamble, the Securities
and Exchange Commission proposes to amend Part 255 to chapter II of
Title 17 of the Code of Federal Regulations as follows:
PART 255--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
0
40. The authority for part 255 continues to read as follows:
Authority: 12 U.S.C. 1851
0
41. Revise Sec. 255.2 to read as follows:
Sec. 255.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Applicable accounting standards means U.S. generally accepted
[[Page 33585]]
accounting principles, or such other accounting standards applicable to
a banking entity that the SEC determines are appropriate and that the
banking entity uses in the ordinary course of its business in preparing
its consolidated financial statements.
(c) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(d) Banking entity. (1) Except as provided in paragraph (d)(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 (d)(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 (d)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraphs (d)(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.
(e) Board means the Board of Governors of the Federal Reserve
System.
(f) CFTC means the Commodity Futures Trading Commission.
(g) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(h) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(i) Derivative. (1) Except as provided in paragraph (i)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, guidance, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)),
that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).
(j) Employee includes a member of the immediate family of the
employee.
(k) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(l) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(m) FDIC means the Federal Deposit Insurance Corporation.
(n) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(o) 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.
(p) 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.
(q) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(r) 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).
(s) 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)).
(t) Limited trading assets and liabilities means, with respect to a
banking entity, that:
(1) The banking entity has, together with its affiliates and
subsidiaries on a worldwide consolidated basis, 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 over the previous
consecutive four quarters, as measured as of the last day of each of
the four previous calendar quarters, is less than $1,000,000,000; and
(2) The SEC has not determined pursuant to Sec. 255.20(g) or (h)
of this part that the banking entity should not be treated as having
limited trading assets and liabilities.
(u) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(v) Moderate trading assets and liabilities means, with respect to
a banking entity, that the banking entity does not have significant
trading assets and liabilities or limited trading assets and
liabilities.
(w) 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)).
(x) 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
[[Page 33586]]
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.
(y) 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)).
(z) SEC means the Securities and Exchange Commission.
(aa) 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.
(bb) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(cc) 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)).
(dd) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(ee) 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.
(ff) Significant trading assets and liabilities.
(1) Significant trading assets and liabilities means, with respect
to a banking entity, that:
(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, equals or
exceeds $10,000,000,000; or
(ii) The SEC has determined pursuant to Sec. 255.20(h) of this
part that the banking entity should be treated as having significant
trading assets and liabilities.
(2) With respect to a banking entity other than a banking entity
described in paragraph (3), trading assets and liabilities for purposes
of this paragraph (ff) means 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) on a worldwide
consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (ff) means the
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) of the combined U.S. operations of
the top-tier foreign banking organization (including all subsidiaries,
affiliates, branches, and agencies of the foreign banking organization
operating, located, or organized in the United States).
(ii) For purposes of paragraph (ff)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not considered to be located in the
United States solely by virtue of operating or controlling the U.S.
branch, agency, or subsidiary.
(gg) 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.
(hh) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(ii) 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.
(jj) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
0
42. Amend Sec. 255.3 is amended by:
0
a. Revising paragraph (b);
0
b. Redesignating paragraphs (c) through (e) as paragraphs (d) through
(f);
0
c. Adding a new paragraph (c);
0
d. Revising paragraph (e)(3);
0
e. Adding paragraph (e)(10);
0
f. Redesignating paragraphs (f)(5) through (f)(13) as paragraphs (f)(6)
through (f)(14);
0
g. Adding a new paragraph (f)(5); and
0
h. Adding paragraph (g).
The revisions and additions read as follows:
Sec. 255.3 Prohibition on proprietary trading.
* * * * *
(b) Definition of trading account. Trading account means any
account that is used by a banking entity to:
(1)(i) Purchase or sell one or more financial instruments that are
both market risk capital rule covered positions and trading positions
(or hedges of other market risk capital rule covered positions), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule; or
(ii) With respect to a banking entity that is not, and is not
controlled directly or indirectly by a banking entity that is, located
in or organized under the laws of the United States or any State,
purchase or sell one or more financial instruments that are subject to
capital requirements under a market risk framework established by the
home-country supervisor that is consistent with the market risk
framework published by the Basel Committee on Banking Supervision, as
amended from time to time.
(2) Purchase or sell one or more financial instruments for any
purpose, if the banking entity:
(i) 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
(ii) 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; or
(3) Purchase or sell one or more financial instruments, with
respect to a financial instrument that is recorded at fair value on a
recurring basis under applicable accounting standards.
(c) Presumption of compliance. (1)(i) Each trading desk that does
not purchase or sell financial instruments for a trading account
defined in paragraphs (b)(1) or (b)(2) of this section may calculate
the net gain or net loss on the trading desk's portfolio of financial
instruments each business day,
[[Page 33587]]
reflecting realized and unrealized gains and losses since the previous
business day, based on the banking entity's fair value for such
financial instruments.
(ii) If the sum of the absolute values of the daily net gain and
loss figures determined in accordance with paragraph (c)(1)(i) of this
section for the preceding 90-calendar-day period does not exceed $25
million, the activities of the trading desk shall be presumed to be in
compliance with the prohibition in paragraph (a) of this section.
(2) The SEC may rebut the presumption of compliance in paragraph
(c)(1)(ii) of this section by providing written notice to the banking
entity that the SEC has determined that one or more of the banking
entity's activities violates the prohibitions under subpart B.
(3) If a trading desk operating pursuant to paragraph (c)(1)(ii) of
this section exceeds the $25 million threshold in that paragraph at any
point, the banking entity shall, in accordance with any policies and
procedures adopted by the SEC:
(i) Promptly notify the SEC;
(ii) Demonstrate that the trading desk's purchases and sales of
financial instruments comply with subpart B; and
(iii) Demonstrate, with respect to the trading desk, how the
banking entity will maintain compliance with subpart B on an ongoing
basis.
* * * * *
(e) * * *
(3) Any purchase or sale of a security, foreign exchange forward
(as that term is defined in section 1a(24) of the Commodity Exchange
Act (7 U.S.C. 1a(24)), foreign exchange swap (as that term is defined
in section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)), or
physically-settled cross-currency swap, by a banking entity for the
purpose of liquidity management in accordance with a documented
liquidity management plan of the banking entity that, with respect to
such financial instruments:
(i) Specifically contemplates and authorizes the particular
financial instruments to be used for liquidity management purposes, the
amount, types, and risks of these financial instruments that are
consistent with liquidity management, and the liquidity circumstances
in which the particular financial instruments may or must be used;
(ii) Requires that any purchase or sale of financial instruments
contemplated and authorized by the plan be principally for the purpose
of managing the liquidity of the banking entity, and not for the
purpose of short-term resale, benefitting from actual or expected
short-term price movements, realizing short-term arbitrage profits, or
hedging a position taken for such short-term purposes;
(iii) Requires that any financial instruments purchased or sold for
liquidity management purposes be highly liquid and limited to financial
instruments the market, credit, and other risks of which the banking
entity does not reasonably expect to give rise to appreciable profits
or losses as a result of short-term price movements;
(iv) Limits any financial instruments purchased or sold for
liquidity management purposes, together with any other instruments
purchased or sold for such purposes, to an amount that is consistent
with the banking entity's near-term funding needs, including deviations
from normal operations of the banking entity or any affiliate thereof,
as estimated and documented pursuant to methods specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of financial instruments that are not permitted under Sec. Sec.
255.6(a) or (b) of this subpart are for the purpose of liquidity
management and in accordance with the liquidity management plan
described in paragraph (e)(3) of this section; and
(vi) Is consistent with the SEC's supervisory requirements,
guidance, and expectations regarding liquidity management;
* * * * *
(10) Any purchase (or sale) of one or more financial instruments
that was made in error by a banking entity in the course of conducting
a permitted or excluded activity or is a subsequent transaction to
correct such an error, and the erroneously purchased (or sold)
financial instrument is promptly transferred to a separately-managed
trade error account for disposition.
(f) * * *
(5) Cross-currency swap means a swap in which one party exchanges
with another party principal and interest rate payments in one currency
for principal and interest rate payments in another currency, and the
exchange of principal occurs on the date the swap is entered into, with
a reversal of the exchange of principal at a later date that is agreed
upon when the swap is entered into.
* * * * *
(g) Reservation of Authority: (1) The SEC may determine, on a case-
by-case basis, that a purchase or sale of one or more financial
instruments by a banking entity either is or is not for the trading
account as defined at 12 U.S.C. 1851(h)(6).
(2) Notice and Response Procedures. (i) Notice. When the SEC
determines that the purchase or sale of one or more financial
instruments is for the trading account under paragraph (g)(1) of this
section, the SEC will notify the banking entity in writing of the
determination and provide an explanation of the determination.
(ii) Response. (A) The banking entity may respond to any or all
items in the notice. The response should include any matters that the
banking entity would have the SEC consider in deciding whether the
purchase or sale is for the trading account. The response must be in
writing and delivered to the designated SEC official within 30 days
after the date on which the banking entity received the notice. The SEC
may shorten the time period when, in the opinion of the SEC, the
activities or condition of the banking entity so requires, provided
that the banking entity is informed promptly of the new time period, or
with the consent of the banking entity. In its discretion, the SEC may
extend the time period for good cause.
(B) Failure to respond within 30 days or such other time period as
may be specified by the SEC shall constitute a waiver of any objections
to the SEC's determination.
(iii) After the close of banking entity's response period, the SEC
will decide, based on a review of the banking entity's response and
other information concerning the banking entity, whether to maintain
the SEC's determination that the purchase or sale of one or more
financial instruments is for the trading account. The banking entity
will be notified of the decision in writing. The notice will include an
explanation of the decision.
0
43. Amend Sec. 255.4 by:
0
a. Revising paragraph (a)(2);
0
b. Adding paragraph (a)(8);
0
c. Revising paragraph (b)(2);
0
d. Revising the introductory text of paragraph (b)(3)(i);
0
e. In paragraph (b)(5) removing the references to ``inventory'' and
replacing them with ``positions''; and
0
f. Adding paragraph (b)(6).
The revisions and additions read as follows:
Sec. 255.4 Permitted underwriting and market making-related
activities.
(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
[[Page 33588]]
securities and the trading desk's underwriting position is related to
such distribution;
(ii) (A) The amount and type of the securities in the trading
desk's underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
taking into account the liquidity, maturity, and depth of the market
for the relevant type of security, and (B) reasonable efforts are made
to sell or otherwise reduce the underwriting position within a
reasonable period, taking into account the liquidity, maturity, and
depth of the market for the relevant type of security;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (a) of this section, including reasonably designed written
policies and procedures, internal controls, analysis, and independent
testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, in accordance with paragraph
(a)(8)(i) of this section;
(C) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(D) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis of the basis for any temporary
or permanent increase to a trading desk's limit(s), and independent
review of such demonstrable analysis and approval;
(iv) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(v) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
* * * * *
(8) Rebuttable presumption of compliance.
(i) Risk limits.
(A) A banking entity shall be presumed to meet the requirements of
paragraph (a)(2)(ii)(A) of this section with respect to the purchase or
sale of a financial instrument if the banking entity has established
and implements, maintains, and enforces the limits described in
paragraph (a)(8)(i)(B) and does not exceed such limits.
(B) The presumption described in paragraph (8)(i)(A) of this
section shall be available with respect to limits for each trading desk
that are designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties, based on the nature
and amount of the trading desk's underwriting activities, on the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.
(ii) Supervisory review and oversight. The limits described in
paragraph (a)(8)(i) of this section shall be subject to supervisory
review and oversight by the SEC on an ongoing basis. Any review of such
limits will include assessment of whether the limits are designed not
to exceed the reasonably expected near term demands of clients,
customers, or counterparties.
(iii) Reporting. With respect to any limit identified pursuant to
paragraph (a)(8)(i) of this section, a banking entity shall promptly
report to the SEC (A) to the extent that any limit is exceeded and (B)
any temporary or permanent increase to any limit(s), in each case in
the form and manner as directed by the SEC.
(iv) Rebutting the presumption. The presumption in paragraph
(a)(8)(i) of this section may be rebutted by the SEC if the SEC
determines, based on all relevant facts and circumstances, that a
trading desk is engaging in activity that is not based on the
reasonably expected near term demands of clients, customers, or
counterparties. The SEC will provide notice of any such determination
to the banking entity in writing.
(b) * * *
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The trading desk's market-making related activities are
designed not to exceed, on an ongoing basis, the reasonably expected
near term demands of clients, customers, or counterparties, based on
the liquidity, maturity, and depth of the market for the relevant types
of financial instrument(s).
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (b) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and positions; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, in accordance with paragraph
(b)(6)(i) of this section;
(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) In the case of a banking entity with significant trading
assets and liabilities, 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
[[Page 33589]]
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) * * *
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with the methodology described in
definition of ``significant trading assets and liabilities'' contained
in Sec. 255.2 of this part, unless:
* * * * *
(6) Rebuttable presumption of compliance.
(i) Risk limits.
(A) A banking entity shall be presumed to meet the requirements of
paragraph (b)(2)(ii) of this section with respect to the purchase or
sale of a financial instrument if the banking entity has established
and implements, maintains, and enforces the limits described in
paragraph (b)(6)(i)(B) and does not exceed such limits.
(B) The presumption described in paragraph (6)(i)(A) of this
section shall be available with respect to limits for each trading desk
that are designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties, based on the nature
and amount of the trading desk's market making-related activities, on
the:
(1) Amount, types, and risks of its market-maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.
(ii) Supervisory review and oversight. The limits described in
paragraph (b)(6)(i) of this section shall be subject to supervisory
review and oversight by the SEC on an ongoing basis. Any review of such
limits will include assessment of whether the limits are designed not
to exceed the reasonably expected near term demands of clients,
customers, or counterparties.
(iii) Reporting. With respect to any limit identified pursuant to
paragraph (b)(6)(i) of this section, a banking entity shall promptly
report to the SEC (A) to the extent that any limit is exceeded and (B)
any temporary or permanent increase to any limit(s), in each case in
the form and manner as directed by the SEC.
(iv) Rebutting the presumption. The presumption in paragraph
(b)(6)(i) of this section may be rebutted by the SEC if the SEC
determines, based on all relevant facts and circumstances, that a
trading desk is engaging in activity that is not based on the
reasonably expected near term demands of clients, customers, or
counterparties. The SEC will provide notice of any such determination
to the banking entity in writing.
0
45. Amend Sec. 255.5 by revising paragraph (b), the introductory text
of paragraph (c)(1), and adding paragraph (c)(4) to read as follows:
Sec. 255.5 Permitted risk-mitigating hedging activities.
* * * * *
(b) Requirements.
(1) The risk-mitigating hedging activities of a banking entity that
has significant trading assets and liabilities are permitted under
paragraph (a) of this section only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(C) The conduct of analysis and independent testing designed to
ensure that the positions, techniques and strategies that may be used
for hedging may reasonably be expected to reduce or otherwise
significantly mitigate the specific, identifiable risk(s) being hedged;
(ii) The risk-mitigating hedging activity:
(A) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(B) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(D) Is subject to continuing review, monitoring and management by
the banking entity that:
(1) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1)(i) of this section;
(2) Is designed to reduce or otherwise significantly mitigate the
specific, identifiable risks that develop over time from the risk-
mitigating hedging activities undertaken under this section and the
underlying positions, contracts, and other holdings of the banking
entity, based upon the facts and circumstances of the underlying and
hedging positions, contracts and other holdings of the banking entity
and the risks and liquidity thereof; and
(3) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(1)(ii) of this section and is not
prohibited proprietary trading; and
(iii) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(2) The risk-mitigating hedging activities of a banking entity that
does not have significant trading assets and liabilities are permitted
under paragraph (a) of this section only if the risk-mitigating hedging
activity:
(i) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to
[[Page 33590]]
identified positions, contracts, or other holdings of the banking
entity, based upon the facts and circumstances of the identified
underlying and hedging positions, contracts or other holdings and the
risks and liquidity thereof; and
(ii) Is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading.
(c) * * * (1) A banking entity that has significant trading assets
and liabilities must comply with the requirements of paragraphs (c)(2)
and (3) of this section, unless the requirements of paragraph (c)(4) of
this section are met, with respect to any purchase or sale of financial
instruments made in reliance on this section for risk-mitigating
hedging purposes that is:
* * * * *
(4) The requirements of paragraphs (c)(2) and (3) of this section
do not apply to the purchase or sale of a financial instrument
described in paragraph (c)(1) of this section if:
(i) The financial instrument purchased or sold is identified on a
written list of pre-approved financial instruments that are commonly
used by the trading desk for the specific type of hedging activity for
which the financial instrument is being purchased or sold; and
(ii) At the time the financial instrument is purchased or sold, the
hedging activity (including the purchase or sale of the financial
instrument) complies with written, pre-approved hedging limits for the
trading desk purchasing or selling the financial instrument for hedging
activities undertaken for one or more other trading desks. The hedging
limits shall be appropriate for the:
(A) Size, types, and risks of the hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased and sold for hedging activities
by the trading desk; and
(C) Levels and duration of the risk exposures being hedged.
0
46. Amend Sec. 255.6 by revising paragraph (e)(3), and removing
paragraph (e)(6) to read as follows:
Sec. 255.6 Other permitted proprietary trading activities.
* * * * *
(e) * * *
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
* * * * *
Sec. 255.10 [Amended]
0
47. Amend Sec. 255.10 by:
0
a. In paragraph (c)(8)(i)(A) revising the reference to ``Sec.
255.2(s)'' to read ``Sec. 255.2(u)'';
0
b. Removing paragraph (d)(1);
0
c. Redesignating paragraphs (d)(2) through (d)(10) as paragraphs (d)(1)
through (d)(9);
0
d. In paragraph (d)(5)(i)(G) revising the reference to ``(d)(6)(i)(A)''
to read ``(d)(5)(i)(A)''; and
0
e. In paragraph (d)(9) revising the reference to ``(d)(9)'' to read
``(d)(8)'' and the reference to ``(d)(10)(i)(A)'' to read
``(d)(9)(i)(A)'' and the reference to ``(d)(10)(i)'' to read
``(d)(9)(i)''.
0
48. Amend Sec. 255.11 by revising paragraph (c) to read as follows:
Sec. 255.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
* * * * *
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 255.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 255.4(a) or Sec. 255.4(b) of subpart B,
respectively; and
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; or acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C.78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section, then in each such case any ownership
interests acquired or retained by the banking entity and its affiliates
in connection with underwriting and market making related activities
for that particular covered fund are included in the calculation of
ownership interests permitted to be held by the banking entity and its
affiliates under the limitations of Sec. 255.12(a)(2)(ii); Sec.
255.12(a)(2)(iii), and Sec. 255.12(d) of this subpart.4
Sec. 255.12 [Amended]
0
49. Amend Sec. 255.12 by:
0
a. In paragraphs (c)(1) and (d) revising the references to ``Sec.
255.10(d)(6)(ii)'' to read ``Sec. 255.10(d)(5)(ii)'';
0
b. Removing paragraph (e)(2)(vii); and
0
c. Redesignating the second instance of paragraph (e)(2)(vi) as
paragraph (e)(2)(vii).
0
50. Amend Sec. 255.13 by revising paragraphs (a) and (b)(3), and
removing paragraph (b)(4)(iv) to read as follows:
Sec. 255.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 255.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks to the banking
entity in connection with:
(i) A compensation arrangement with an employee of the banking
entity or an affiliate thereof that directly provides investment
advisory, commodity trading advisory or other services to the covered
fund; or
(ii) A position taken by the banking entity when acting as
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund.
(2) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program in accordance with subpart
D of this part that is reasonably designed to ensure the banking
entity's compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
[[Page 33591]]
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures,
and internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks arising (1) out of a transaction conducted solely to accommodate
a specific customer request with respect to the covered fund or (2) in
connection with the compensation arrangement with the employee that
directly provides investment advisory, commodity trading advisory, or
other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) With respect to risk-mitigating hedging activity conducted
pursuant to paragraph (a)(1)(i), the compensation arrangement relates
solely to the covered fund in which the banking entity or any affiliate
has acquired an ownership interest pursuant to paragraph (a)(1)(i) and
such compensation arrangement provides that any losses incurred by the
banking entity on such ownership interest will be offset by
corresponding decreases in amounts payable under such compensation
arrangement.
* * * * *
(b) * * *
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is not sold and has not been
sold pursuant to an offering that targets residents of the United
States in which the banking entity or any affiliate of the banking
entity participates. If the banking entity or an affiliate sponsors or
serves, directly or indirectly, as the investment manager, investment
adviser, commodity pool operator or commodity trading advisor to a
covered fund, then the banking entity or affiliate will be deemed for
purposes of this paragraph (b)(3) to participate in any offer or sale
by the covered fund of ownership interests in the covered fund.
* * * * *
0
51. Amend Sec. 255.14 by revising paragraph (a)(2)(ii)(B) as follows:
Sec. 255.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually no later than March 31 to
the SEC (with a duty to update the certification if the information in
the certification materially changes) that the banking entity does not,
directly or indirectly, guarantee, assume, or otherwise insure the
obligations or performance of the covered fund or of any covered fund
in which such covered fund invests; and
* * * * *
0
52. Amend Sec. 255.20 by:
0
a. Revising paragraphs (a), (c), (d), and (f)(2);
0
b. Revising the introductory text of paragraphs (b) and (e);
0
c. Adding new paragraphs (g) and (h).
The revisions read as follows:
Sec. 255.20 Program for compliance; reporting.
* * * * *
(a) Program requirement. Each banking entity (other than a banking
entity with limited trading assets and liabilities) shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
(b) Banking entities with significant trading assets and
liabilities. With respect to a banking entity with significant trading
assets and liabilities, the compliance program required by paragraph
(a) of this section, at a minimum, shall include:
* * * * *
(c) CEO attestation.
(1) The CEO of a banking entity described in paragraph (2) must,
based on a review by the CEO of the banking entity, attest in writing
to the SEC, each year no later than March 31, that the banking entity
has in place processes reasonably designed to achieve compliance with
section 13 of the BHC Act and this part. In the case of a U.S. branch
or agency of a foreign banking entity, the attestation may be provided
for the entire U.S. operations of the foreign banking entity by the
senior management officer of the U.S. operations of the foreign banking
entity who is located in the United States.
(2) The requirements of paragraph (c)(1) apply to a banking entity
if:
(i) The banking entity does not have limited trading assets and
liabilities; or
(ii) The SEC notifies the banking entity in writing that it must
satisfy the requirements contained in paragraph (c)(1).
(d) Reporting requirements under the Appendix to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B shall comply with the reporting requirements described in the
Appendix, if:
(i) The banking entity has significant trading assets and
liabilities; or
(ii) The SEC notifies the banking entity in writing that it must
satisfy the reporting requirements contained in the Appendix.
(2) Frequency of reporting: Unless the SEC notifies the banking
entity in writing that it must report on a different basis, a banking
entity with $50 billion or more in trading assets and liabilities (as
calculated in accordance with the methodology described in the
definition of ``significant trading assets and liabilities'' contained
in Sec. 255.2 of this part) shall report the information required by
the Appendix for each calendar month within 20 days of the end of each
calendar month. Any other banking entity subject to the Appendix shall
report the information required by the Appendix for each calendar
quarter within 30 days of the end of that calendar quarter unless the
SEC notifies the banking entity in writing that it must report on a
different basis.
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities shall maintain records
that include:
* * * * *
(f) * * *
(2) Banking entities with moderate trading assets and liabilities.
A banking entity with moderate trading assets and liabilities may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope, and complexity of the
banking entity.
(g) Rebuttable presumption of compliance for banking entities with
limited trading assets and liabilities.
(1) Rebuttable presumption. Except as otherwise provided in this
paragraph, a banking entity with limited trading assets and liabilities
shall be presumed to be compliant with subpart B and
[[Page 33592]]
subpart C and shall have no obligation to demonstrate compliance with
this part on an ongoing basis.
(2) Rebuttal of presumption.
(i) If upon examination or audit, the SEC determines that the
banking entity has engaged in proprietary trading or covered fund
activities that are otherwise prohibited under subpart B or subpart C,
the SEC may require the banking entity to be treated under this part as
if it did not have limited trading assets and liabilities.
(ii) Notice and Response Procedures.
(A) Notice. The SEC will notify the banking entity in writing of
any determination pursuant to paragraph (g)(2)(i) of this section to
rebut the presumption described in this paragraph (g) and will provide
an explanation of the determination.
(B) Response.
(I) The banking entity may respond to any or all items in the
notice described in paragraph (g)(2)(ii)(A) of this section. The
response should include any matters that the banking entity would have
the SEC consider in deciding whether the banking entity has engaged in
proprietary trading or covered fund activities prohibited under subpart
B or subpart C. The response must be in writing and delivered to the
designated SEC official within 30 days after the date on which the
banking entity received the notice. The SEC may shorten the time period
when, in the opinion of the SEC, the activities or condition of the
banking entity so requires, provided that the banking entity is
informed promptly of the new time period, or with the consent of the
banking entity. In its discretion, the SEC may extend the time period
for good cause.
(II) Failure to respond within 30 days or such other time period as
may be specified by the SEC shall constitute a waiver of any objections
to the SEC's determination.
(C) After the close of banking entity's response period, the SEC
will decide, based on a review of the banking entity's response and
other information concerning the banking entity, whether to maintain
the SEC's determination that banking entity has engaged in proprietary
trading or covered fund activities prohibited under subpart B or
subpart C. The banking entity will be notified of the decision in
writing. The notice will include an explanation of the decision.
(h) Reservation of authority. Notwithstanding any other provision
of this part, the SEC retains its authority to require a banking entity
without significant trading assets and liabilities to apply any
requirements of this part that would otherwise apply if the banking
entity had significant or moderate trading assets and liabilities if
the SEC determines that the size or complexity of the banking entity's
trading or investment activities, or the risk of evasion of subpart B
or subpart C, does not warrant a presumption of compliance under
paragraph (g) of this section or treatment as a banking entity with
moderate trading assets and liabilities, as applicable.
0
53. Remove Appendix A and Appendix B to part 255 and add Appendix to
Part 255--Reporting and Recordkeeping Requirements for Covered Trading
Activities to read as follows:
Appendix to Part 255--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
255.20(d), this appendix applies to a banking entity that, together
with its affiliates and subsidiaries, has significant trading assets
and liabilities. These entities are required to (i) furnish periodic
reports to the SEC regarding a variety of quantitative measurements
of their covered trading activities, which vary depending on the
scope and size of covered trading activities, and (ii) create and
maintain records documenting the preparation and content of these
reports. The requirements of this appendix must be incorporated into
the banking entity's internal compliance program under Sec. 255.20.
b. The purpose of this appendix is to assist banking entities
and the SEC in:
(i) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(ii) Monitoring the banking entity's covered trading activities;
(iii) Identifying covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading activities of
trading desks engaged in market making-related activities subject to
Sec. 255.4(b) are consistent with the requirements governing
permitted market making-related activities;
(v) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. Sec. 255.4, 255.5, or 255.6(a)-(b) (i.e., underwriting and
market making-related related activity, risk-mitigating hedging, or
trading in certain government obligations) are consistent with the
requirement that such activity not result, directly or indirectly,
in a material exposure to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the SEC of such activities; and
(vii) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. Information that must be furnished pursuant to this appendix
is not intended to serve as a dispositive tool for the
identification of permissible or impermissible activities.
d. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 255.20. The effectiveness of particular
quantitative measurements may differ based on the profile of the
banking entity's businesses in general and, more specifically, of
the particular trading desk, including types of instruments traded,
trading activities and strategies, and history and experience (e.g.,
whether the trading desk is an established, successful market maker
or a new entrant to a competitive market). In all cases, banking
entities must ensure that they have robust measures in place to
identify and monitor the risks taken in their trading activities, to
ensure that the activities are within risk tolerances established by
the banking entity, and to monitor and examine for compliance with
the proprietary trading restrictions in this part.
e. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 255.4 through 255.6(a)-(b), or that
result in a material exposure to high-risk assets or high-risk
trading strategies, must be escalated within the banking entity for
review, further analysis, explanation to the SEC, and remediation,
where appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 255.2 and 255.3. In addition, for purposes of
this appendix, the following definitions apply:
Applicability identifies the trading desks for which a banking
entity is required to calculate and report a particular quantitative
measurement based on the type of covered trading activity conducted
by the trading desk.
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material
[[Page 33593]]
sources of trading revenue over a specific period of time,
including, for example, any increase or decrease in the market value
of a trading desk's holdings, dividend income, and interest income
and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. Sec. 255.4, 255.5, 255.6(a), or 255.6(b). A banking
entity may include in its covered trading activity trading conducted
under Sec. Sec. 255.3(e), 255.6(c), 255.6(d), or 255.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading day means a calendar day on which a trading desk is open
for trading.
III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each banking entity made subject
to this appendix by Sec. 255.20 must furnish the following
quantitative measurements, as applicable, for each trading desk of
the banking entity engaged in covered trading activities and
calculate these quantitative measurements in accordance with this
appendix:
i. Risk and Position Limits and Usage;
ii. Risk Factor Sensitivities;
iii. Value-at-Risk and Stressed Value-at-Risk;
iv. Comprehensive Profit and Loss Attribution;
v. Positions;
vi. Transaction Volumes; and
vii. Securities Inventory Aging.
2. Trading desk information. Each banking entity made subject to
this appendix by Sec. 255.20 must provide certain descriptive
information, as further described in this appendix, regarding each
trading desk engaged in covered trading activities.
3. Quantitative measurements identifying information. Each
banking entity made subject to this appendix by Sec. 255.20 must
provide certain identifying and descriptive information, as further
described in this appendix, regarding its quantitative measurements.
4. Narrative statement. Each banking entity made subject to this
appendix by Sec. 255.20 must provide a separate narrative
statement, as further described in this appendix.
5. File identifying information. Each banking entity made
subject to this appendix by Sec. 255.20 must provide file
identifying information in each submission to the SEC pursuant to
this appendix, including the name of the banking entity, the RSSD ID
assigned to the top-tier banking entity by the Board, and
identification of the reporting period and creation date and time.
b. Trading Desk Information
Each banking entity must provide descriptive information
regarding each trading desk engaged in covered trading activities,
including:
1. Name of the trading desk used internally by the banking
entity and a unique identification label for the trading desk;
2. Identification of each type of covered trading activity in
which the trading desk is engaged;
3. Brief description of the general strategy of the trading
desk;
4. A list of the types of financial instruments and other
products purchased and sold by the trading desk; an indication of
which of these are the main financial instruments or products
purchased and sold by the trading desk; and, for trading desks
engaged in market making-related activities under Sec. 255.4(b),
specification of whether each type of financial instrument is
included in market-maker positions or not included in market-maker
positions. In addition, indicate whether the trading desk is
including in its quantitative measurements products excluded from
the definition of ``financial instrument'' under Sec. 255.3(d)(2)
and, if so, identify such products;
5. Identification by complete name of each legal entity that
serves as a booking entity for covered trading activities conducted
by the trading desk; and indication of which of the identified legal
entities are the main booking entities for covered trading
activities of the trading desk;
6. For each legal entity that serves as a booking entity for
covered trading activities, specification of any of the following
applicable entity types for that legal entity:
i. National bank, Federal branch or Federal agency of a foreign
bank, Federal savings association, Federal savings bank;
ii. State nonmember bank, foreign bank having an insured branch,
State savings association;
iii. U.S.-registered broker-dealer, U.S.-registered security-
based swap dealer, U.S.-registered major security-based swap
participant;
iv. Swap dealer, major swap participant, derivatives clearing
organization, futures commission merchant, commodity pool operator,
commodity trading advisor, introducing broker, floor trader, retail
foreign exchange dealer;
v. State member bank;
vi. Bank holding company, savings and loan holding company;
vii. Foreign banking organization as defined in 12 CFR
211.21(o);
viii. Uninsured State-licensed branch or agency of a foreign
bank; or
ix. Other entity type not listed above, including a subsidiary
of a legal entity described above where the subsidiary itself is not
an entity type listed above;
7. Indication of whether each calendar date is a trading day or
not a trading day for the trading desk; and
8. Currency reported and daily currency conversion rate.
c. Quantitative Measurements Identifying Information
Each banking entity must provide the following information
regarding the quantitative measurements:
1. A Risk and Position Limits Information Schedule that provides
identifying and descriptive information for each limit reported
pursuant to the Risk and Position Limits and Usage quantitative
measurement, including the name of the limit, a unique
identification label for the limit, a description of the limit,
whether the limit is intraday or end-of-day, the unit of measurement
for the limit, whether the limit measures risk on a net or gross
basis, and the type of limit;
2. A Risk Factor Sensitivities Information Schedule that
provides identifying and descriptive information for each risk
factor sensitivity reported pursuant to the Risk Factor
Sensitivities quantitative measurement, including the name of the
sensitivity, a unique identification label for the sensitivity, a
description of the sensitivity, and the sensitivity's risk factor
change unit;
3. A Risk Factor Attribution Information Schedule that provides
identifying and descriptive information for each risk factor
attribution reported pursuant to the Comprehensive Profit and Loss
Attribution quantitative measurement, including the name of the risk
factor or other factor, a unique identification label for the risk
factor or other factor, a description of the risk factor or other
factor, and the risk factor or other factor's change unit;
4. A Limit/Sensitivity Cross-Reference Schedule that cross-
references, by unique identification label, limits identified in the
Risk and Position Limits Information Schedule to associated risk
factor sensitivities identified in the Risk Factor Sensitivities
Information Schedule; and
5. A Risk Factor Sensitivity/Attribution Cross-Reference
Schedule that cross-references, by unique identification label, risk
factor sensitivities identified in the Risk Factor Sensitivities
Information Schedule to associated risk factor attributions
identified in the Risk Factor Attribution Information Schedule.
d. Narrative Statement
Each banking entity made subject to this appendix by Sec.
255.20 must submit in a separate electronic document a Narrative
Statement to the SEC describing any changes in calculation methods
used, a description of and reasons for changes in the banking
entity's trading desk structure or trading desk strategies, and when
any such change occurred. The Narrative Statement must include any
information the banking entity views as relevant for assessing the
information reported, such as further description of calculation
methods used.
If a banking entity does not have any information to report in a
Narrative Statement, the banking entity must submit an electronic
document stating that it does not have any information to report in
a Narrative Statement.
e. Frequency and Method of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report the
Narrative Statement, the Trading Desk Information, the Quantitative
Measurements Identifying Information, and each applicable
quantitative measurement electronically to the SEC on the reporting
schedule established in Sec. 255.20 unless otherwise requested by
the SEC. A banking entity must report the Trading Desk Information,
the Quantitative Measurements Identifying Information, and each
applicable quantitative measurement to the SEC in accordance with
the XML Schema specified and published on the SEC's website.
[[Page 33594]]
f. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the SEC pursuant to this appendix and Sec. 255.20(d),
create and maintain records documenting the preparation and content
of these reports, as well as such information as is necessary to
permit the SEC to verify the accuracy of such reports, for a period
of five years from the end of the calendar year for which the
measurement was taken. A banking entity must retain the Narrative
Statement, the Trading Desk Information, and the Quantitative
Measurements Identifying Information for a period of five years from
the end of the calendar year for which the information was reported
to the SEC.
IV. Quantitative Measurements
a. Risk-Management Measurements
1. 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
value of the trading desk's risk or positions that are accounted for
by the current activity of the desk. Risk and position limits and
their usage are key risk management tools used to control and
monitor risk taking and include, but are not limited to, the limits
set out in Sec. 255.4 and Sec. 255.5. A number of the metrics that
are described below, including ``Risk Factor Sensitivities'' and
``Value-at-Risk,'' relate to a trading desk's risk and position
limits and are useful in evaluating and setting these limits in the
broader context of the trading desk's overall activities,
particularly for the market making activities under Sec. 255.4(b)
and hedging activity under Sec. 255.5. Accordingly, the limits
required under Sec. 255.4(b)(2)(iii) and Sec. 255.5(b)(1)(i)(A)
must meet the applicable requirements under Sec. 255.4(b)(2)(iii)
and Sec. 255.5(b)(1)(i)(A) and also must include appropriate
metrics for the trading desk limits including, at a minimum, the
``Risk Factor Sensitivities'' and ``Value-at-Risk'' metrics except
to the extent any of the ``Risk Factor Sensitivities'' or ``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.
A. A banking entity must provide the following information for
each limit reported pursuant to this quantitative measurement: The
unique identification label for the limit reported in the Risk and
Position Limits Information Schedule, the limit size (distinguishing
between an upper and a lower limit), and the value of usage of the
limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
2. 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. 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. 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 banking entity must provide the following information
for each sensitivity that is reported pursuant to this quantitative
measurement: The unique identification label for the risk factor
sensitivity listed in the Risk Factor Sensitivities Information
Schedule, the change in risk factor used to determine the risk
factor sensitivity, and the aggregate change in value across all
positions of the desk given the change in risk factor.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
3. Value-at-Risk and Stressed Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the measurement of the risk of future financial loss in
the value of a trading desk's aggregated positions at the ninety-
nine percent confidence level over a one-day period, based on
current market conditions. For purposes of this appendix, Stressed
Value-at-Risk (``Stressed VaR'') is the measurement of the risk of
future financial loss in the value of a trading desk's aggregated
positions at the ninety-nine percent confidence level over a one-day
period, based on market conditions during a period of significant
financial stress.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: For VaR, all trading desks engaged in covered
trading activities. For Stressed VaR, all trading desks engaged in
covered trading activities, except trading desks whose covered
trading activity is conducted exclusively to hedge products excluded
from the definition of ``financial instrument'' under Sec.
255.3(d)(2).
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into three categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); (ii) profit and loss attributable to new
positions resulting from the current day's trading activity (``new
positions''); and (iii) residual profit and loss that cannot be
specifically attributed to existing positions or new positions. The
sum of (i), (ii), and (iii) must equal the trading desk's
comprehensive profit and loss at each point in time.
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. For the attribution of comprehensive profit and loss from
existing positions to specific risk factors and other factors, a
banking entity must provide the following information for the
factors that explain the preponderance of the profit or loss changes
due to risk factor changes: The unique identification label for the
risk factor or other factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss due to the risk factor
or other factor change.
C. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and loss 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. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
c. Positions, Transaction Volumes, and Securities Inventory Aging
Measurements
1. Positions
i. Description: For purposes of this appendix, Positions is the
value of securities and derivatives positions managed by the trading
desk. For purposes of the Positions quantitative measurement, do not
include in the Positions calculation for ``securities'' those
securities that are also ``derivatives,'' as those terms are defined
under subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \1\ A banking entity must separately
report the trading desk's market value of long securities positions,
market value of short securities positions, market value of
derivatives receivables, market value of derivatives payables,
notional value of derivatives receivables, and notional value of
derivatives payables.
---------------------------------------------------------------------------
\1\ See Sec. Sec. 255.2(i), (bb). For example, under this part,
a security-based swap is both a ``security'' and a ``derivative.''
For purposes of the Positions quantitative measurement, security-
based swaps are reported as derivatives rather than securities.
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 255.4(a)
or Sec. 255.4(b) to conduct
[[Page 33595]]
underwriting activity or market-making-related activity,
respectively.
2. Transaction Volumes
i. Description: For purposes of this appendix, Transaction
Volumes measures four exclusive categories of covered trading
activity conducted by a trading desk. A banking entity is required
to report the value and number of security and derivative
transactions conducted by the trading desk with: (i) Customers,
excluding internal transactions; (ii) non-customers, excluding
internal transactions; (iii) trading desks and other organizational
units where the transaction is booked in the same banking entity;
and (iv) trading desks and other organizational units where the
transaction is booked into an affiliated banking entity. For
securities, value means gross market value. For derivatives, value
means gross notional value. For purposes of calculating the
Transaction Volumes quantitative measurement, do not include in the
Transaction Volumes calculation for ``securities'' those securities
that are also ``derivatives,'' as those terms are defined under
subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \2\ Further, for purposes of the
Transaction Volumes quantitative measurement, a customer of a
trading desk that relies on Sec. 255.4(a) to conduct underwriting
activity is a market participant identified in Sec. 255.4(a)(7),
and a customer of a trading desk that relies on Sec. 255.4(b) to
conduct market making-related activity is a market participant
identified in Sec. 255.4(b)(3).
---------------------------------------------------------------------------
\2\ See Sec. Sec. 255.2(i), (bb).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 255.4(a)
or Sec. 255.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
3. Securities Inventory Aging
i. Description: For purposes of this appendix, Securities
Inventory Aging generally describes a schedule of the market value
of the trading desk's securities positions and the amount of time
that those securities positions have been held. Securities Inventory
Aging must measure the age profile of a trading desk's securities
positions for the following periods: 0-30 Calendar days; 31-60
calendar days; 61-90 calendar days; 91-180 calendar days; 181-360
calendar days; and greater than 360 calendar days. Securities
Inventory Aging includes two schedules, a security asset-aging
schedule, and a security liability-aging schedule. For purposes of
the Securities Inventory Aging quantitative measurement, do not
include securities that are also ``derivatives,'' as those terms are
defined under subpart A.\3\
---------------------------------------------------------------------------
\3\ See Sec. Sec. 255.2(i), (bb).
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 255.4(a)
or Sec. 255.4(b) to conduct underwriting activity or market-making
related activity, respectively.
COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
Authority and Issuance
For the reasons set forth in the Common Preamble, the Commodity
Futures Trading Commission proposes to amend Part 75 to chapter I of
Title 17 of the Code of Federal Regulations as follows:
PART 75--PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND
RELATIONSHIPS WITH COVERED FUNDS
0
54. The authority for part 75 continues to read as follows:
Authority: 12 U.S.C. 1851.
0
55. Revise Sec. 75.2 to read as follows:
Sec. 75.2 Definitions.
Unless otherwise specified, for purposes of this part:
(a) Affiliate has the same meaning as in section 2(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(k)).
(b) Applicable accounting standards means U.S. generally accepted
accounting principles, or such other accounting standards applicable to
a banking entity that the Commission determines are appropriate and
that the banking entity uses in the ordinary course of its business in
preparing its consolidated financial statements.
(c) Bank holding company has the same meaning as in section 2 of
the Bank Holding Company Act of 1956 (12 U.S.C. 1841).
(d) Banking entity. (1) Except as provided in paragraph (d)(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 (d)(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 (d)(1)(i), (ii), or (iii) of this section;
(ii) A portfolio company held under the authority contained in
section 4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H),
(I)), or any portfolio concern, as defined under 13 CFR 107.50, that is
controlled by a small business investment company, as defined in
section 103(3) of the Small Business Investment Act of 1958 (15 U.S.C.
662), so long as the portfolio company or portfolio concern is not
itself a banking entity under paragraphs (d)(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.
(e) Board means the Board of Governors of the Federal Reserve
System.
(f) CFTC means the Commodity Futures Trading Commission.
(g) Dealer has the same meaning as in section 3(a)(5) of the
Exchange Act (15 U.S.C. 78c(a)(5)).
(h) Depository institution has the same meaning as in section 3(c)
of the Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
(i) Derivative. (1) Except as provided in paragraph (i)(2) of this
section, derivative means:
(i) Any swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68));
(ii) Any purchase or sale of a commodity, that is not an excluded
commodity, for deferred shipment or delivery that is intended to be
physically settled;
(iii) Any foreign exchange forward (as that term is defined in
section 1a(24) of the Commodity Exchange Act (7 U.S.C. 1a(24)) or
foreign exchange swap (as that term is defined in section 1a(25) of the
Commodity Exchange Act (7 U.S.C. 1a(25));
(iv) Any agreement, contract, or transaction in foreign currency
described in section 2(c)(2)(C)(i) of the Commodity Exchange Act (7
U.S.C. 2(c)(2)(C)(i));
(v) Any agreement, contract, or transaction in a commodity other
than foreign currency described in section 2(c)(2)(D)(i) of the
Commodity Exchange Act (7 U.S.C. 2(c)(2)(D)(i)); and
(vi) Any transaction authorized under section 19 of the Commodity
Exchange Act (7 U.S.C. 23(a) or (b));
(2) A derivative does not include:
(i) Any consumer, commercial, or other agreement, contract, or
transaction that the CFTC and SEC have further defined by joint
regulation, interpretation, guidance, or other action as not within the
definition of swap, as that term is defined in section 1a(47) of the
Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as
that term is defined in section 3(a)(68) of the Exchange Act (15 U.S.C.
78c(a)(68)); or
(ii) Any identified banking product, as defined in section 402(b)
of the Legal Certainty for Bank Products Act of 2000
[[Page 33596]]
(7 U.S.C. 27(b)), that is subject to section 403(a) of that Act (7
U.S.C. 27a(a)).
(j) Employee includes a member of the immediate family of the
employee.
(k) Exchange Act means the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.).
(l) Excluded commodity has the same meaning as in section 1a(19) of
the Commodity Exchange Act (7 U.S.C. 1a(19)).
(m) FDIC means the Federal Deposit Insurance Corporation.
(n) Federal banking agencies means the Board, the Office of the
Comptroller of the Currency, and the FDIC.
(o) 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.
(p) 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.
(q) General account means all of the assets of an insurance company
except those allocated to one or more separate accounts.
(r) 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).
(s) 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)).
(t) Limited trading assets and liabilities means, with respect to a
banking entity, that:
(1) The banking entity has, together with its affiliates and
subsidiaries on a worldwide consolidated basis, 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 over the previous
consecutive four quarters, as measured as of the last day of each of
the four previous calendar quarters, is less than $1,000,000,000; and
(2) The Commission has not determined pursuant to Sec. 75.20(g) or
(h) of this part that the banking entity should not be treated as
having limited trading assets and liabilities.
(u) Loan means any loan, lease, extension of credit, or secured or
unsecured receivable that is not a security or derivative.
(v) Moderate trading assets and liabilities means, with respect to
a banking entity, that the banking entity does not have significant
trading assets and liabilities or limited trading assets and
liabilities.
(w) 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)).
(x) 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.
(y) 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)).
(z) SEC means the Securities and Exchange Commission.
(aa) 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.
(bb) Security has the meaning specified in section 3(a)(10) of the
Exchange Act (15 U.S.C. 78c(a)(10)).
(cc) 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)).
(dd) Security future has the meaning specified in section 3(a)(55)
of the Exchange Act (15 U.S.C. 78c(a)(55)).
(ee) 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.
(ff) Significant trading assets and liabilities.
(1) Significant trading assets and liabilities means, with respect
to a banking entity, that:
(i) The banking entity has, together with its affiliates and
subsidiaries, trading assets and liabilities the average gross sum of
which over the previous consecutive four quarters, as measured as of
the last day of each of the four previous calendar quarters, equals or
exceeds $10,000,000,000; or
(ii) The Commission has determined pursuant to Sec. 75.20(h) of
this part that the banking entity should be treated as having
significant trading assets and liabilities.
(2) With respect to a banking entity other than a banking entity
described in paragraph (3), trading assets and liabilities for purposes
of this paragraph (ff) means 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) on a worldwide
consolidated basis.
(3)(i) With respect to a banking entity that is a foreign banking
organization or a subsidiary of a foreign banking organization, trading
assets and liabilities for purposes of this paragraph (ff) means the
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) of the combined U.S. operations of
the top-tier foreign banking organization (including all subsidiaries,
affiliates, branches, and agencies of the foreign banking organization
operating, located, or organized in the United States).
(ii) For purposes of paragraph (ff)(3)(i) of this section, a U.S.
branch, agency, or subsidiary of a banking entity is located in the
United States; however, the foreign bank that operates or controls that
branch, agency, or subsidiary is not
[[Page 33597]]
considered to be located in the United States solely by virtue of
operating or controlling the U.S. branch, agency, or subsidiary.
(gg) 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.
(hh) Subsidiary has the same meaning as in section 2(d) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1841(d)).
(ii) 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.
(jj) Swap dealer has the same meaning as in section 1(a)(49) of the
Commodity Exchange Act (7 U.S.C. 1a(49)).
0
56. Amend Sec. 75.3 by:
0
a. Revising paragraph (b);
0
b. Redesignating paragraphs (c) through (e) as paragraphs (d) through
(f);
0
c. Adding a new paragraph (c);
0
d. Revising paragraph (e)(3);
0
e. Adding paragraph (e)(10);
0
f. Redesignating paragraphs (f)(5) through (f)(13) as paragraphs (f)(6)
through (f)(14);
0
g. Adding a new paragraph (f)(5); and
0
h. Adding paragraph (g).
The revisions and additions read as follows:
Sec. 75.3 Prohibition on proprietary trading.
* * * * *
(b) Definition of trading account. Trading account means any
account that is used by a banking entity to:
(1)(i) Purchase or sell one or more financial instruments that are
both market risk capital rule covered positions and trading positions
(or hedges of other market risk capital rule covered positions), if the
banking entity, or any affiliate of the banking entity, is an insured
depository institution, bank holding company, or savings and loan
holding company, and calculates risk-based capital ratios under the
market risk capital rule; or
(ii) With respect to a banking entity that is not, and is not
controlled directly or indirectly by a banking entity that is, located
in or organized under the laws of the United States or any State,
purchase or sell one or more financial instruments that are subject to
capital requirements under a market risk framework established by the
home-country supervisor that is consistent with the market risk
framework published by the Basel Committee on Banking Supervision, as
amended from time to time.
(2) Purchase or sell one or more financial instruments for any
purpose, if the banking entity:
(i) 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
(ii) 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; or
(3) Purchase or sell one or more financial instruments, with
respect to a financial instrument that is recorded at fair value on a
recurring basis under applicable accounting standards.
(c) Presumption of compliance. (1)(i) Each trading desk that does
not purchase or sell financial instruments for a trading account
defined in paragraphs (b)(1) or (b)(2) of this section may calculate
the net gain or net loss on the trading desk's portfolio of financial
instruments each business day, reflecting realized and unrealized gains
and losses since the previous business day, based on the banking
entity's fair value for such financial instruments.
(ii) If the sum of the absolute values of the daily net gain and
loss figures determined in accordance with paragraph (c)(1)(i) of this
section for the preceding 90-calendar-day period does not exceed $25
million, the activities of the trading desk shall be presumed to be in
compliance with the prohibition in paragraph (a) of this section.
(2) The Commission may rebut the presumption of compliance in
paragraph (c)(1)(ii) of this section by providing written notice to the
banking entity that the Commission has determined that one or more of
the banking entity's activities violates the prohibitions under subpart
B.
(3) If a trading desk operating pursuant to paragraph (c)(1)(ii) of
this section exceeds the $25 million threshold in that paragraph at any
point, the banking entity shall, in accordance with any policies and
procedures adopted by the Commission:
(i) Promptly notify the Commission;
(ii) Demonstrate that the trading desk's purchases and sales of
financial instruments comply with subpart B; and
(iii) Demonstrate, with respect to the trading desk, how the
banking entity will maintain compliance with subpart B on an ongoing
basis.
* * * * *
(e) * * *
(3) Any purchase or sale of a security, foreign exchange forward
(as that term is defined in section 1a(24) of the Commodity Exchange
Act (7 U.S.C. 1a(24)), foreign exchange swap (as that term is defined
in section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)), or
physically-settled cross-currency swap, by a banking entity for the
purpose of liquidity management in accordance with a documented
liquidity management plan of the banking entity that, with respect to
such financial instruments:
(i) Specifically contemplates and authorizes the particular
financial instruments to be used for liquidity management purposes, the
amount, types, and risks of these financial instruments that are
consistent with liquidity management, and the liquidity circumstances
in which the particular financial instruments may or must be used;
(ii) Requires that any purchase or sale of financial instruments
contemplated and authorized by the plan be principally for the purpose
of managing the liquidity of the banking entity, and not for the
purpose of short-term resale, benefitting from actual or expected
short-term price movements, realizing short-term arbitrage profits, or
hedging a position taken for such short-term purposes;
(iii) Requires that any financial instruments purchased or sold for
liquidity management purposes be highly liquid and limited to financial
instruments the market, credit, and other risks of which the banking
entity does not reasonably expect to give rise to appreciable profits
or losses as a result of short-term price movements;
(iv) Limits any financial instruments purchased or sold for
liquidity management purposes, together with any other instruments
purchased or sold for such purposes, to an amount that is consistent
with the banking entity's near-term funding needs, including deviations
from normal operations of the banking entity or any affiliate thereof,
as estimated and documented pursuant to methods specified in the plan;
(v) Includes written policies and procedures, internal controls,
analysis, and independent testing to ensure that the purchase and sale
of financial instruments that are not permitted under Sec. Sec.
75.6(a) or (b) of this subpart are for the purpose of liquidity
management and in accordance with the liquidity management plan
described in paragraph (e)(3) of this section; and
(vi) Is consistent with the Commission's supervisory requirements,
guidance, and
[[Page 33598]]
expectations regarding liquidity management;
* * * * *
(10) Any purchase (or sale) of one or more financial instruments
that was made in error by a banking entity in the course of conducting
a permitted or excluded activity or is a subsequent transaction to
correct such an error, and the erroneously purchased (or sold)
financial instrument is promptly transferred to a separately-managed
trade error account for disposition.
(f) * * *
(5) Cross-currency swap means a swap in which one party exchanges
with another party principal and interest rate payments in one currency
for principal and interest rate payments in another currency, and the
exchange of principal occurs on the date the swap is entered into, with
a reversal of the exchange of principal at a later date that is agreed
upon when the swap is entered into.
* * * * *
(g) Reservation of Authority: (1) The Commission may determine, on
a case-by-case basis, that a purchase or sale of one or more financial
instruments by a banking entity either is or is not for the trading
account as defined at 12 U.S.C. 1851(h)(6).
(2) Notice and Response Procedures.--(i) Notice. When the
Commission determines that the purchase or sale of one or more
financial instruments is for the trading account under paragraph (g)(1)
of this section, the Commission will notify the banking entity in
writing of the determination and provide an explanation of the
determination.
(ii) Response. (A) The banking entity may respond to any or all
items in the notice. The response should include any matters that the
banking entity would have the Commission consider in deciding whether
the purchase or sale is for the trading account. The response must be
in writing and delivered to the designated Commission official within
30 days after the date on which the banking entity received the notice.
The Commission may shorten the time period when, in the opinion of the
Commission, the activities or condition of the banking entity so
requires, provided that the banking entity is informed promptly of the
new time period, or with the consent of the banking entity. In its
discretion, the Commission may extend the time period for good cause.
(B) Failure to respond within 30 days or such other time period as
may be specified by the Commission shall constitute a waiver of any
objections to the Commission's determination.
(iii) After the close of banking entity's response period, the
Commission will decide, based on a review of the banking entity's
response and other information concerning the banking entity, whether
to maintain the Commission's determination that the purchase or sale of
one or more financial instruments is for the trading account. The
banking entity will be notified of the decision in writing. The notice
will include an explanation of the decision.
0
57. Amend Sec. 75.4 by:
0
a. Revising paragraph (a)(2);
0
b. Adding paragraph (a)(8);
0
c. Revising paragraph (b)(2);
0
d. Revising the introductory text of paragraph (b)(3)(i);
0
e. In paragraph (b)(5) revising the references to ``inventory'' to read
``positions''; and
0
f. Adding paragraph (b)(6).
The revisions and additions to read as follows:
Sec. 75.4 Permitted underwriting and market making-related
activities.
(a) * * *
(2) Requirements. The underwriting activities of a banking entity
are permitted under paragraph (a)(1) of this section only if:
(i) The banking entity is acting as an underwriter for a
distribution of securities and the trading desk's underwriting position
is related to such distribution;
(ii)(A) The amount and type of the securities in the trading desk's
underwriting position are designed not to exceed the reasonably
expected near term demands of clients, customers, or counterparties,
taking into account the liquidity, maturity, and depth of the market
for the relevant type of security, and (B) reasonable efforts are made
to sell or otherwise reduce the underwriting position within a
reasonable period, taking into account the liquidity, maturity, and
depth of the market for the relevant type of security;
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (a) of this section, including reasonably designed written
policies and procedures, internal controls, analysis, and independent
testing identifying and addressing:
(A) The products, instruments or exposures each trading desk may
purchase, sell, or manage as part of its underwriting activities;
(B) Limits for each trading desk, in accordance with paragraph
(a)(8)(i) of this section;
(C) Internal controls and ongoing monitoring and analysis of each
trading desk's compliance with its limits; and
(D) Authorization procedures, including escalation procedures that
require review and approval of any trade that would exceed a trading
desk's limit(s), demonstrable analysis of the basis for any temporary
or permanent increase to a trading desk's limit(s), and independent
review of such demonstrable analysis and approval;
(iv) The compensation arrangements of persons performing the
activities described in this paragraph (a) are designed not to reward
or incentivize prohibited proprietary trading; and
(v) The banking entity is licensed or registered to engage in the
activity described in this paragraph (a) in accordance with applicable
law.
* * * * *
(8) Rebuttable presumption of compliance.
(i) Risk limits.
(A) A banking entity shall be presumed to meet the requirements of
paragraph (a)(2)(ii)(A) of this section with respect to the purchase or
sale of a financial instrument if the banking entity has established
and implements, maintains, and enforces the limits described in
paragraph (a)(8)(i)(B) and does not exceed such limits.
(B) The presumption described in paragraph (8)(i)(A) of this
section shall be available with respect to limits for each trading desk
that are designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties, based on the nature
and amount of the trading desk's underwriting activities, on the:
(1) Amount, types, and risk of its underwriting position;
(2) Level of exposures to relevant risk factors arising from its
underwriting position; and
(3) Period of time a security may be held.
(ii) Supervisory review and oversight. The limits described in
paragraph (a)(8)(i) of this section shall be subject to supervisory
review and oversight by the Commission on an ongoing basis. Any review
of such limits will include assessment of whether the limits are
designed not to exceed the reasonably expected near term demands of
clients, customers, or counterparties.
(iii) Reporting. With respect to any limit identified pursuant to
paragraph (a)(8)(i) of this section, a banking entity shall promptly
report to the Commission (A) to the extent that any
[[Page 33599]]
limit is exceeded and (B) any temporary or permanent increase to any
limit(s), in each case in the form and manner as directed by the
Commission.
(iv) Rebutting the presumption. The presumption in paragraph
(a)(8)(i) of this section may be rebutted by the Commission if the
Commission determines, based on all relevant facts and circumstances,
that a trading desk is engaging in activity that is not based on the
reasonably expected near term demands of clients, customers, or
counterparties. The Commission will provide notice of any such
determination to the banking entity in writing.
(b) * * *
(2) Requirements. The market making-related activities of a banking
entity are permitted under paragraph (b)(1) of this section only if:
(i) The trading desk that establishes and manages the financial
exposure routinely stands ready to purchase and sell one or more types
of financial instruments related to its financial exposure and is
willing and available to quote, purchase and sell, or otherwise enter
into long and short positions in those types of financial instruments
for its own account, in commercially reasonable amounts and throughout
market cycles on a basis appropriate for the liquidity, maturity, and
depth of the market for the relevant types of financial instruments;
(ii) The trading desk's market-making related activities are
designed not to exceed, on an ongoing basis, the reasonably expected
near term demands of clients, customers, or counterparties, based on
the liquidity, maturity, and depth of the market for the relevant types
of financial instrument(s).
(iii) In the case of a banking entity with significant trading
assets and liabilities, the banking entity has established and
implements, maintains, and enforces an internal compliance program
required by subpart D of this part that is reasonably designed to
ensure the banking entity's compliance with the requirements of
paragraph (b) of this section, including reasonably designed written
policies and procedures, internal controls, analysis and independent
testing identifying and addressing:
(A) The financial instruments each trading desk stands ready to
purchase and sell in accordance with paragraph (b)(2)(i) of this
section;
(B) The actions the trading desk will take to demonstrably reduce
or otherwise significantly mitigate promptly the risks of its financial
exposure consistent with the limits required under paragraph
(b)(2)(iii)(C) of this section; the products, instruments, and
exposures each trading desk may use for risk management purposes; the
techniques and strategies each trading desk may use to manage the risks
of its market making-related activities and positions; and the process,
strategies, and personnel responsible for ensuring that the actions
taken by the trading desk to mitigate these risks are and continue to
be effective;
(C) Limits for each trading desk, in accordance with paragraph
(b)(6)(i) of this section;
(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) In the case of a banking entity with significant trading
assets and liabilities, 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) * * *
(i) A trading desk or other organizational unit of another banking
entity is not a client, customer, or counterparty of the trading desk
if that other entity has trading assets and liabilities of $50 billion
or more as measured in accordance with the methodology described in
definition of ``significant trading assets and liabilities'' contained
in Sec. 75.2 of this part, unless:
* * * * *
(6) Rebuttable presumption of compliance.--(i) Risk limits. (A) A
banking entity shall be presumed to meet the requirements of paragraph
(b)(2)(ii) of this section with respect to the purchase or sale of a
financial instrument if the banking entity has established and
implements, maintains, and enforces the limits described in paragraph
(b)(6)(i)(B) of this section and does not exceed such limits.
(B) The presumption described in paragraph (6)(i)(A) of this
section shall be available with respect to limits for each trading desk
that are designed not to exceed the reasonably expected near term
demands of clients, customers, or counterparties, based on the nature
and amount of the trading desk's market making-related activities, on
the:
(1) Amount, types, and risks of its market-maker positions;
(2) Amount, types, and risks of the products, instruments, and
exposures the trading desk may use for risk management purposes;
(3) Level of exposures to relevant risk factors arising from its
financial exposure; and
(4) Period of time a financial instrument may be held.
(ii) Supervisory review and oversight. The limits described in
paragraph (b)(6)(i) of this section shall be subject to supervisory
review and oversight by the Commission on an ongoing basis. Any review
of such limits will include assessment of whether the limits are
designed not to exceed the reasonably expected near term demands of
clients, customers, or counterparties.
(iii) Reporting. With respect to any limit identified pursuant to
paragraph (b)(6)(i) of this section, a banking entity shall promptly
report to the Commission (A) to the extent that any limit is exceeded
and (B) any temporary or permanent increase to any limit(s), in each
case in the form and manner as directed by the Commission.
(iv) Rebutting the presumption. The presumption in paragraph
(b)(6)(i) of this section may be rebutted by the Commission if the
Commission determines, based on all relevant facts and circumstances,
that a trading desk is engaging in activity that is not based on the
reasonably expected near term demands of clients, customers, or
counterparties. The Commission will provide notice of any such
determination to the banking entity in writing.
0
58. Amend Sec. 75.5 by revising paragraph (b), the introductory text
of paragraph (c)(1), and adding paragraph (c)(4) to read as follows:
Sec. 75.5 Permitted risk-mitigating hedging activities.
* * * * *
(b) Requirements. (1) The risk-mitigating hedging activities of a
banking entity that has significant trading assets and liabilities are
permitted under paragraph (a) of this section only if:
[[Page 33600]]
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program required by subpart D of
this part that is reasonably designed to ensure the banking entity's
compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures regarding
the positions, techniques and strategies that may be used for hedging,
including documentation indicating what positions, contracts or other
holdings a particular trading desk may use in its risk-mitigating
hedging activities, as well as position and aging limits with respect
to such positions, contracts or other holdings;
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(C) The conduct of analysis and independent testing designed to
ensure that the positions, techniques and strategies that may be used
for hedging may reasonably be expected to reduce or otherwise
significantly mitigate the specific, identifiable risk(s) being hedged;
(ii) The risk-mitigating hedging activity:
(A) Is conducted in accordance with the written policies,
procedures, and internal controls required under this section;
(B) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section;
(D) Is subject to continuing review, monitoring and management by
the banking entity that:
(1) Is consistent with the written hedging policies and procedures
required under paragraph (b)(1)(i) of this section;
(2) Is designed to reduce or otherwise significantly mitigate the
specific, identifiable risks that develop over time from the risk-
mitigating hedging activities undertaken under this section and the
underlying positions, contracts, and other holdings of the banking
entity, based upon the facts and circumstances of the underlying and
hedging positions, contracts and other holdings of the banking entity
and the risks and liquidity thereof; and
(3) Requires ongoing recalibration of the hedging activity by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(1)(ii) of this section and is not
prohibited proprietary trading; and
(iii) The compensation arrangements of persons performing risk-
mitigating hedging activities are designed not to reward or incentivize
prohibited proprietary trading.
(2) The risk-mitigating hedging activities of a banking entity that
does not have significant trading assets and liabilities are permitted
under paragraph (a) of this section only if the risk-mitigating hedging
activity:
(i) At the inception of the hedging activity, including, without
limitation, any adjustments to the hedging activity, is designed to
reduce or otherwise significantly mitigate one or more specific,
identifiable risks, including market risk, counterparty or other credit
risk, currency or foreign exchange risk, interest rate risk, commodity
price risk, basis risk, or similar risks, arising in connection with
and related to identified positions, contracts, or other holdings of
the banking entity, based upon the facts and circumstances of the
identified underlying and hedging positions, contracts or other
holdings and the risks and liquidity thereof; and
(ii) Is subject, as appropriate, to ongoing recalibration by the
banking entity to ensure that the hedging activity satisfies the
requirements set out in paragraph (b)(2) of this section and is not
prohibited proprietary trading.
(c) * * * (1) A banking entity that has significant trading assets
and liabilities must comply with the requirements of paragraphs (c)(2)
and (3) of this section, unless the requirements of paragraph (c)(4) of
this section are met, with respect to any purchase or sale of financial
instruments made in reliance on this section for risk-mitigating
hedging purposes that is:
* * * * *
(4) The requirements of paragraphs (c)(2) and (3) of this section
do not apply to the purchase or sale of a financial instrument
described in paragraph (c)(1) of this section if:
(i) The financial instrument purchased or sold is identified on a
written list of pre-approved financial instruments that are commonly
used by the trading desk for the specific type of hedging activity for
which the financial instrument is being purchased or sold; and
(ii) At the time the financial instrument is purchased or sold, the
hedging activity (including the purchase or sale of the financial
instrument) complies with written, pre-approved hedging limits for the
trading desk purchasing or selling the financial instrument for hedging
activities undertaken for one or more other trading desks. The hedging
limits shall be appropriate for the:
(A) Size, types, and risks of the hedging activities commonly
undertaken by the trading desk;
(B) Financial instruments purchased and sold for hedging activities
by the trading desk; and
(C) Levels and duration of the risk exposures being hedged.
0
59. Amend Sec. 75.6 by revising paragraph (e)(3) and removing
paragraph (e)(6) to read as follows:
Sec. 75.6 Other permitted proprietary trading activities.
* * * * *
(e) * * *
(3) A purchase or sale by a banking entity is permitted for
purposes of this paragraph (e) if:
(i) The banking entity engaging as principal in the purchase or
sale (including relevant personnel) is not located in the United States
or organized under the laws of the United States or of any State;
(ii) The banking entity (including relevant personnel) that makes
the decision to purchase or sell as principal is not located in the
United States or organized under the laws of the United States or of
any State; and
(iii) The purchase or sale, including any transaction arising from
risk-mitigating hedging related to the instruments purchased or sold,
is not accounted for as principal directly or on a consolidated basis
by any branch or affiliate that is located in the United States or
organized under the laws of the United States or of any State.
* * * * *
Sec. 75.10 [Amended]
0
60. Amend Sec. 75.10 by:
0
a. In paragraph (c)(8)(i)(A) revising the reference to ``Sec.
75.2(s)'' to read ``Sec. 75.2(u)'';
0
b. Removing paragraph (d)(1);
0
c. Redesignating paragraphs (d)(2) through (d)(10) as paragraphs (d)(1)
through (d)(9);
0
d. In paragraph (d)(5)(i)(G) revising the reference to ``(d)(6)(i)(A)''
to read ``(d)(5)(i)(A)''; and
[[Page 33601]]
0
e. In paragraph (d)(9) revising the reference to ``(d)(9)'' to read
``(d)(8)'' and the reference to ``(d)(10)(i)(A)'' to read
``(d)(9)(i)(A)'' and the reference to ``(d)(10)(i)'' to read
``(d)(9)(i)''.
0
61. Amend Sec. 75.11 by revising paragraph (c) to read as follows:
Sec. 75.11 Permitted organizing and offering, underwriting, and
market making with respect to a covered fund.
* * * * *
(c) Underwriting and market making in ownership interests of a
covered fund. The prohibition contained in Sec. 75.10(a) of this
subpart does not apply to a banking entity's underwriting activities or
market making-related activities involving a covered fund so long as:
(1) Those activities are conducted in accordance with the
requirements of Sec. 75.4(a) or Sec. 75.4(b) of subpart B,
respectively; and
(2) With respect to any banking entity (or any affiliate thereof)
that: Acts as a sponsor, investment adviser or commodity trading
advisor to a particular covered fund or otherwise acquires and retains
an ownership interest in such covered fund in reliance on paragraph (a)
of this section; or acquires and retains an ownership interest in such
covered fund and is either a securitizer, as that term is used in
section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)), or is
acquiring and retaining an ownership interest in such covered fund in
compliance with section 15G of that Act (15 U.S.C. 78o-11) and the
implementing regulations issued thereunder each as permitted by
paragraph (b) of this section, then in each such case any ownership
interests acquired or retained by the banking entity and its affiliates
in connection with underwriting and market making related activities
for that particular covered fund are included in the calculation of
ownership interests permitted to be held by the banking entity and its
affiliates under the limitations of Sec. 75.12(a)(2)(ii); Sec.
75.12(a)(2)(iii), and Sec. 75.12(d) of this subpart.
Sec. 75.12 [Amended]
0
62. In subpart C, section 75.12 is amended by:
0
a. In paragraphs (c)(1) and (d) revising the references to ``Sec.
75.10(d)(6)(ii)'' to read ``Sec. 75.10(d)(5)(ii)'';
0
b. Removing paragraph (e)(2)(vii); and
0
c. Redesignating the second instance of paragraph (e)(2)(vi) as
paragraph (e)(2)(vii).
0
63. Amend Sec. 75.13 by revising paragraphs (a) and (b)(3) and
removing (b)(4)(iv) to read as follows:
Sec. 75.13 Other permitted covered fund activities and investments.
(a) Permitted risk-mitigating hedging activities. (1) The
prohibition contained in Sec. 75.10(a) of this subpart does not apply
with respect to an ownership interest in a covered fund acquired or
retained by a banking entity that is designed to reduce or otherwise
significantly mitigate the specific, identifiable risks to the banking
entity in connection with:
(i) A compensation arrangement with an employee of the banking
entity or an affiliate thereof that directly provides investment
advisory, commodity trading advisory or other services to the covered
fund; or
(ii) A position taken by the banking entity when acting as
intermediary on behalf of a customer that is not itself a banking
entity to facilitate the exposure by the customer to the profits and
losses of the covered fund.
(2) Requirements. The risk-mitigating hedging activities of a
banking entity are permitted under this paragraph (a) only if:
(i) The banking entity has established and implements, maintains
and enforces an internal compliance program in accordance with subpart
D of this part that is reasonably designed to ensure the banking
entity's compliance with the requirements of this section, including:
(A) Reasonably designed written policies and procedures; and
(B) Internal controls and ongoing monitoring, management, and
authorization procedures, including relevant escalation procedures; and
(ii) The acquisition or retention of the ownership interest:
(A) Is made in accordance with the written policies, procedures,
and internal controls required under this section;
(B) At the inception of the hedge, is designed to reduce or
otherwise significantly mitigate one or more specific, identifiable
risks arising (1) out of a transaction conducted solely to accommodate
a specific customer request with respect to the covered fund or (2) in
connection with the compensation arrangement with the employee that
directly provides investment advisory, commodity trading advisory, or
other services to the covered fund;
(C) Does not give rise, at the inception of the hedge, to any
significant new or additional risk that is not itself hedged
contemporaneously in accordance with this section; and
(D) Is subject to continuing review, monitoring and management by
the banking entity.
(iii) With respect to risk-mitigating hedging activity conducted
pursuant to paragraph (a)(1)(i), the compensation arrangement relates
solely to the covered fund in which the banking entity or any affiliate
has acquired an ownership interest pursuant to paragraph (a)(1)(i) and
such compensation arrangement provides that any losses incurred by the
banking entity on such ownership interest will be offset by
corresponding decreases in amounts payable under such compensation
arrangement.
* * * * *
(b) * * *
(3) An ownership interest in a covered fund is not offered for sale
or sold to a resident of the United States for purposes of paragraph
(b)(1)(iii) of this section only if it is not sold and has not been
sold pursuant to an offering that targets residents of the United
States in which the banking entity or any affiliate of the banking
entity participates. If the banking entity or an affiliate sponsors or
serves, directly or indirectly, as the investment manager, investment
adviser, commodity pool operator or commodity trading advisor to a
covered fund, then the banking entity or affiliate will be deemed for
purposes of this paragraph (b)(3) to participate in any offer or sale
by the covered fund of ownership interests in the covered fund.
* * * * *
0
64. Amend Sec. 75.14 by revising paragraph (a)(2)(ii)(B) as follows:
Sec. 75.14 Limitations on relationships with a covered fund.
(a) * * *
(2) * * *
(ii) * * *
(B) The chief executive officer (or equivalent officer) of the
banking entity certifies in writing annually no later than March 31 to
the Commission (with a duty to update the certification if the
information in the certification materially changes) that the banking
entity does not, directly or indirectly, guarantee, assume, or
otherwise insure the obligations or performance of the covered fund or
of any covered fund in which such covered fund invests; and
* * * * *
0
65. Amend Sec. 75.20 by:
0
a. Revising paragraphs (a), (c), (d), and (f)(2);
0
b. Revising the introductory text of paragraphs (b) and (e)
0
c. Adding paragraphs (g) and (h).
The revisions amd additions to read as follows:
Sec. 75.20 Program for compliance; reporting.
(a) Program requirement. Each banking entity (other than a banking
[[Page 33602]]
entity with limited trading assets and liabilities) shall develop and
provide for the continued administration of a compliance program
reasonably designed to ensure and monitor compliance with the
prohibitions and restrictions on proprietary trading and covered fund
activities and investments set forth in section 13 of the BHC Act and
this part. The terms, scope, and detail of the compliance program shall
be appropriate for the types, size, scope, and complexity of activities
and business structure of the banking entity.
(b) Banking entities with significant trading assets and
liabilities. With respect to a banking entity with significant trading
assets and liabilities, the compliance program required by paragraph
(a) of this section, at a minimum, shall include:
* * * * *
(c) CEO attestation.
(1) The CEO of a banking entity described in paragraph (2) must,
based on a review by the CEO of the banking entity, attest in writing
to the Commission, each year no later than March 31, that the banking
entity has in place processes reasonably designed to achieve compliance
with section 13 of the BHC Act and this part. In the case of a U.S.
branch or agency of a foreign banking entity, the attestation may be
provided for the entire U.S. operations of the foreign banking entity
by the senior management officer of the U.S. operations of the foreign
banking entity who is located in the United States.
(2) The requirements of paragraph (c)(1) apply to a banking entity
if:
(i) The banking entity does not have limited trading assets and
liabilities; or
(ii) The Commission notifies the banking entity in writing that it
must satisfy the requirements contained in paragraph (c)(1).
(d) Reporting requirements under the Appendix to this part. (1) A
banking entity engaged in proprietary trading activity permitted under
subpart B shall comply with the reporting requirements described in the
Appendix, if:
(i) The banking entity has significant trading assets and
liabilities; or
(ii) The Commission notifies the banking entity in writing that it
must satisfy the reporting requirements contained in the Appendix.
(2) Frequency of reporting: Unless the Commission notifies the
banking entity in writing that it must report on a different basis, a
banking entity with $50 billion or more in trading assets and
liabilities (as calculated in accordance with the methodology described
in the definition of ``significant trading assets and liabilities''
contained in Sec. 75.2 of this part of this part) shall report the
information required by the Appendix for each calendar month within 20
days of the end of each calendar month. Any other banking entity
subject to the Appendix shall report the information required by the
Appendix for each calendar quarter within 30 days of the end of that
calendar quarter unless the Commission notifies the banking entity in
writing that it must report on a different basis.
(e) Additional documentation for covered funds. A banking entity
with significant trading assets and liabilities shall maintain records
that include:
* * * * *
(f) * * *
(2) Banking entities with moderate trading assets and liabilities.
A banking entity with moderate trading assets and liabilities may
satisfy the requirements of this section by including in its existing
compliance policies and procedures appropriate references to the
requirements of section 13 of the BHC Act and this part and adjustments
as appropriate given the activities, size, scope, and complexity of the
banking entity.
(g) Rebuttable presumption of compliance for banking entities with
limited trading assets and liabilities.
(1) Rebuttable presumption. Except as otherwise provided in this
paragraph, a banking entity with limited trading assets and liabilities
shall be presumed to be compliant with subpart B and subpart C and
shall have no obligation to demonstrate compliance with this part on an
ongoing basis.
(2) Rebuttal of presumption.
(i) If upon examination or audit, the Commission determines that
the banking entity has engaged in proprietary trading or covered fund
activities that are otherwise prohibited under subpart B or subpart C,
the Commission may require the banking entity to be treated under this
part as if it did not have limited trading assets and liabilities.
(ii) Notice and Response Procedures.
(A) Notice. The Commission will notify the banking entity in
writing of any determination pursuant to paragraph (g)(2)(i) of this
section to rebut the presumption described in this paragraph (g) and
will provide an explanation of the determination.
(B) Response.
(I) The banking entity may respond to any or all items in the
notice described in paragraph (g)(2)(ii)(A) of this section. The
response should include any matters that the banking entity would have
the Commission consider in deciding whether the banking entity has
engaged in proprietary trading or covered fund activities prohibited
under subpart B or subpart C. The response must be in writing and
delivered to the designated Commission official within 30 days after
the date on which the banking entity received the notice. The
Commission may shorten the time period when, in the opinion of the
Commission, the activities or condition of the banking entity so
requires, provided that the banking entity is informed promptly of the
new time period, or with the consent of the banking entity. In its
discretion, the Commission may extend the time period for good cause.
(II) Failure to respond within 30 days or such other time period as
may be specified by the Commission shall constitute a waiver of any
objections to the Commission's determination.
(C) After the close of banking entity's response period, the
Commission will decide, based on a review of the banking entity's
response and other information concerning the banking entity, whether
to maintain the Commission's determination that banking entity has
engaged in proprietary trading or covered fund activities prohibited
under subpart B or subpart C. The banking entity will be notified of
the decision in writing. The notice will include an explanation of the
decision.
(h) Reservation of authority. Notwithstanding any other provision
of this part, the Commission retains its authority to require a banking
entity without significant trading assets and liabilities to apply any
requirements of this part that would otherwise apply if the banking
entity had significant or moderate trading assets and liabilities if
the Commission determines that the size or complexity of the banking
entity's trading or investment activities, or the risk of evasion of
subpart B or subpart C, does not warrant a presumption of compliance
under paragraph (g) of this section or treatment as a banking entity
with moderate trading assets and liabilities, as applicable.
0
66. Revise the Appendix to Part 75 to read as follows:
Appendix to Part 75--Reporting and Recordkeeping Requirements for
Covered Trading Activities
I. Purpose
a. This appendix sets forth reporting and recordkeeping
requirements that certain banking entities must satisfy in
connection with the restrictions on proprietary trading set forth in
subpart B (``proprietary trading restrictions''). Pursuant to Sec.
75.20(d), this appendix applies to a banking entity that, together
with its affiliates and subsidiaries, has significant trading assets
and liabilities.
[[Page 33603]]
These entities are required to (i) furnish periodic reports to the
Commission regarding a variety of quantitative measurements of their
covered trading activities, which vary depending on the scope and
size of covered trading activities, and (ii) create and maintain
records documenting the preparation and content of these reports.
The requirements of this appendix must be incorporated into the
banking entity's internal compliance program under Sec. 75.20.
b. The purpose of this appendix is to assist banking entities
and the Commission in:
(i) Better understanding and evaluating the scope, type, and
profile of the banking entity's covered trading activities;
(ii) Monitoring the banking entity's covered trading activities;
(iii) Identifying covered trading activities that warrant
further review or examination by the banking entity to verify
compliance with the proprietary trading restrictions;
(iv) Evaluating whether the covered trading activities of
trading desks engaged in market making-related activities subject to
Sec. 75.4(b) are consistent with the requirements governing
permitted market making-related activities;
(v) Evaluating whether the covered trading activities of trading
desks that are engaged in permitted trading activity subject to
Sec. Sec. 75.4, 75.5, or 75.6(a)-(b) (i.e., underwriting and market
making-related related activity, risk-mitigating hedging, or trading
in certain government obligations) are consistent with the
requirement that such activity not result, directly or indirectly,
in a material exposure to high-risk assets or high-risk trading
strategies;
(vi) Identifying the profile of particular covered trading
activities of the banking entity, and the individual trading desks
of the banking entity, to help establish the appropriate frequency
and scope of examination by the Commission of such activities; and
(vii) Assessing and addressing the risks associated with the
banking entity's covered trading activities.
c. Information that must be furnished pursuant to this appendix
is not intended to serve as a dispositive tool for the
identification of permissible or impermissible activities.
d. In addition to the quantitative measurements required in this
appendix, a banking entity may need to develop and implement other
quantitative measurements in order to effectively monitor its
covered trading activities for compliance with section 13 of the BHC
Act and this part and to have an effective compliance program, as
required by Sec. 75.20. The effectiveness of particular
quantitative measurements may differ based on the profile of the
banking entity's businesses in general and, more specifically, of
the particular trading desk, including types of instruments traded,
trading activities and strategies, and history and experience (e.g.,
whether the trading desk is an established, successful market maker
or a new entrant to a competitive market). In all cases, banking
entities must ensure that they have robust measures in place to
identify and monitor the risks taken in their trading activities, to
ensure that the activities are within risk tolerances established by
the banking entity, and to monitor and examine for compliance with
the proprietary trading restrictions in this part.
e. On an ongoing basis, banking entities must carefully monitor,
review, and evaluate all furnished quantitative measurements, as
well as any others that they choose to utilize in order to maintain
compliance with section 13 of the BHC Act and this part. All
measurement results that indicate a heightened risk of impermissible
proprietary trading, including with respect to otherwise-permitted
activities under Sec. Sec. 75.4 through 75.6(a)-(b), or that result
in a material exposure to high-risk assets or high-risk trading
strategies, must be escalated within the banking entity for review,
further analysis, explanation to the Commission, and remediation,
where appropriate. The quantitative measurements discussed in this
appendix should be helpful to banking entities in identifying and
managing the risks related to their covered trading activities.
II. Definitions
The terms used in this appendix have the same meanings as set
forth in Sec. Sec. 75.2 and 75.3. In addition, for purposes of this
appendix, the following definitions apply:
Applicability identifies the trading desks for which a banking
entity is required to calculate and report a particular quantitative
measurement based on the type of covered trading activity conducted
by the trading desk.
Calculation period means the period of time for which a
particular quantitative measurement must be calculated.
Comprehensive profit and loss means the net profit or loss of a
trading desk's material sources of trading revenue over a specific
period of time, including, for example, any increase or decrease in
the market value of a trading desk's holdings, dividend income, and
interest income and expense.
Covered trading activity means trading conducted by a trading
desk under Sec. Sec. 75.4, 75.5, 75.6(a), or 75.6(b). A banking
entity may include in its covered trading activity trading conducted
under Sec. Sec. 75.3(e), 75.6(c), 75.6(d), or 75.6(e).
Measurement frequency means the frequency with which a
particular quantitative metric must be calculated and recorded.
Trading day means a calendar day on which a trading desk is open
for trading.
III. Reporting and Recordkeeping
a. Scope of Required Reporting
1. Quantitative measurements. Each banking entity made subject
to this appendix by Sec. 75.20 must furnish the following
quantitative measurements, as applicable, for each trading desk of
the banking entity engaged in covered trading activities and
calculate these quantitative measurements in accordance with this
appendix:
i. Risk and Position Limits and Usage;
ii. Risk Factor Sensitivities;
iii. Value-at-Risk and Stressed Value-at-Risk;
iv. Comprehensive Profit and Loss Attribution;
v. Positions;
vi. Transaction Volumes; and
vii. Securities Inventory Aging.
2. Trading desk information. Each banking entity made subject to
this appendix by Sec. 75.20 must provide certain descriptive
information, as further described in this appendix, regarding each
trading desk engaged in covered trading activities.
3. Quantitative measurements identifying information. Each
banking entity made subject to this appendix by Sec. 75.20 must
provide certain identifying and descriptive information, as further
described in this appendix, regarding its quantitative measurements.
4. Narrative statement. Each banking entity made subject to this
appendix by Sec. 75.20 must provide a separate narrative statement,
as further described in this appendix.
5. File identifying information. Each banking entity made
subject to this appendix by Sec. 75.20 must provide file
identifying information in each submission to the Commission
pursuant to this appendix, including the name of the banking entity,
the RSSD ID assigned to the top-tier banking entity by the Board,
and identification of the reporting period and creation date and
time.
b. Trading Desk Information
1. Each banking entity must provide descriptive information
regarding each trading desk engaged in covered trading activities,
including:
i. Name of the trading desk used internally by the banking
entity and a unique identification label for the trading desk;
ii. Identification of each type of covered trading activity in
which the trading desk is engaged;
iii. Brief description of the general strategy of the trading
desk;
iv. A list of the types of financial instruments and other
products purchased and sold by the trading desk; an indication of
which of these are the main financial instruments or products
purchased and sold by the trading desk; and, for trading desks
engaged in market making-related activities under Sec. 75.4(b),
specification of whether each type of financial instrument is
included in market-maker positions or not included in market-maker
positions. In addition, indicate whether the trading desk is
including in its quantitative measurements products excluded from
the definition of ``financial instrument'' under Sec. 75.3(d)(2)
and, if so, identify such products;
v. Identification by complete name of each legal entity that
serves as a booking entity for covered trading activities conducted
by the trading desk; and indication of which of the identified legal
entities are the main booking entities for covered trading
activities of the trading desk;
vii. For each legal entity that serves as a booking entity for
covered trading activities, specification of any of the following
applicable entity types for that legal entity:
A. National bank, Federal branch or Federal agency of a foreign
bank, Federal savings association, Federal savings bank;
B. State nonmember bank, foreign bank having an insured branch,
State savings association;
C. U.S.-registered broker-dealer, U.S.-registered security-based
swap dealer, U.S.-
[[Page 33604]]
registered major security-based swap participant;
D. Swap dealer, major swap participant, derivatives clearing
organization, futures commission merchant, commodity pool operator,
commodity trading advisor, introducing broker, floor trader, retail
foreign exchange dealer;
E. State member bank;
F. Bank holding company, savings and loan holding company;
G. Foreign banking organization as defined in 12 CFR 211.21(o);
H. Uninsured State-licensed branch or agency of a foreign bank;
or
I. Other entity type not listed above, including a subsidiary of
a legal entity described above where the subsidiary itself is not an
entity type listed above;
2. Indication of whether each calendar date is a trading day or
not a trading day for the trading desk; and
3. Currency reported and daily currency conversion rate.
c. Quantitative Measurements Identifying Information
Each banking entity must provide the following information
regarding the quantitative measurements:
1. A Risk and Position Limits Information Schedule that provides
identifying and descriptive information for each limit reported
pursuant to the Risk and Position Limits and Usage quantitative
measurement, including the name of the limit, a unique
identification label for the limit, a description of the limit,
whether the limit is intraday or end-of-day, the unit of measurement
for the limit, whether the limit measures risk on a net or gross
basis, and the type of limit;
2. A Risk Factor Sensitivities Information Schedule that
provides identifying and descriptive information for each risk
factor sensitivity reported pursuant to the Risk Factor
Sensitivities quantitative measurement, including the name of the
sensitivity, a unique identification label for the sensitivity, a
description of the sensitivity, and the sensitivity's risk factor
change unit;
3. A Risk Factor Attribution Information Schedule that provides
identifying and descriptive information for each risk factor
attribution reported pursuant to the Comprehensive Profit and Loss
Attribution quantitative measurement, including the name of the risk
factor or other factor, a unique identification label for the risk
factor or other factor, a description of the risk factor or other
factor, and the risk factor or other factor's change unit;
4. A Limit/Sensitivity Cross-Reference Schedule that cross-
references, by unique identification label, limits identified in the
Risk and Position Limits Information Schedule to associated risk
factor sensitivities identified in the Risk Factor Sensitivities
Information Schedule; and
5. A Risk Factor Sensitivity/Attribution Cross-Reference
Schedule that cross-references, by unique identification label, risk
factor sensitivities identified in the Risk Factor Sensitivities
Information Schedule to associated risk factor attributions
identified in the Risk Factor Attribution Information Schedule.
d. Narrative Statement
Each banking entity made subject to this appendix by Sec. 75.20
must submit in a separate electronic document a Narrative Statement
to the Commission describing any changes in calculation methods
used, a description of and reasons for changes in the banking
entity's trading desk structure or trading desk strategies, and when
any such change occurred. The Narrative Statement must include any
information the banking entity views as relevant for assessing the
information reported, such as further description of calculation
methods used. If a banking entity does not have any information to
report in a Narrative Statement, the banking entity must submit an
electronic document stating that it does not have any information to
report in a Narrative Statement.
e. Frequency and Method of Required Calculation and Reporting
A banking entity must calculate any applicable quantitative
measurement for each trading day. A banking entity must report the
Narrative Statement, the Trading Desk Information, the Quantitative
Measurements Identifying Information, and each applicable
quantitative measurement electronically to the Commission on the
reporting schedule established in Sec. 75.20 unless otherwise
requested by the Commission. A banking entity must report the
Trading Desk Information, the Quantitative Measurements Identifying
Information, and each applicable quantitative measurement to the
Commission in accordance with the XML Schema specified and published
on the Commission's website.
f. Recordkeeping
A banking entity must, for any quantitative measurement
furnished to the Commission pursuant to this appendix and Sec.
75.20(d), create and maintain records documenting the preparation
and content of these reports, as well as such information as is
necessary to permit the Commission to verify the accuracy of such
reports, for a period of five years from the end of the calendar
year for which the measurement was taken. A banking entity must
retain the Narrative Statement, the Trading Desk Information, and
the Quantitative Measurements Identifying Information for a period
of five years from the end of the calendar year for which the
information was reported to the Commission.
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
value of the trading desk's risk or positions that are accounted for
by the current activity of the desk. Risk and position limits and
their usage are key risk management tools used to control and
monitor risk taking and include, but are not limited to, the limits
set out in Sec. 75.4 and Sec. 75.5. A number of the metrics that
are described below, including ``Risk Factor Sensitivities'' and
``Value-at-Risk,'' relate to a trading desk's risk and position
limits and are useful in evaluating and setting these limits in the
broader context of the trading desk's overall activities,
particularly for the market making activities under Sec. 75.4(b)
and hedging activity under Sec. 75.5. Accordingly, the limits
required under Sec. 75.4(b)(2)(iii) and Sec. 75.5(b)(1)(i)(A) must
meet the applicable requirements under Sec. 75.4(b)(2)(iii) and
Sec. 75.5(b)(1)(i)(A) and also must include appropriate metrics for
the trading desk limits including, at a minimum, the ``Risk Factor
Sensitivities'' and ``Value-at-Risk'' metrics except to the extent
any of the ``Risk Factor Sensitivities'' or ``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.
A. A banking entity must provide the following information for
each limit reported pursuant to this quantitative measurement: the
unique identification label for the limit reported in the Risk and
Position Limits Information Schedule, the limit size (distinguishing
between an upper and a lower limit), and the value of usage of the
limit.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
2. 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. 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. 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 banking entity must provide the following information
for each sensitivity that is reported pursuant to this quantitative
measurement: The unique identification label for the risk factor
sensitivity listed in the Risk Factor Sensitivities Information
Schedule, the change in risk factor used to determine the risk
factor sensitivity, and the aggregate change in value across all
positions of the desk given the change in risk factor.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
3. Value-at-Risk and Stressed Value-at-Risk
i. Description: For purposes of this appendix, Value-at-Risk
(``VaR'') is the measurement of the risk of future financial loss in
the value of a trading desk's aggregated positions at the ninety-
nine percent confidence level over a one-day period, based on
current market conditions. For purposes of this appendix, Stressed
Value-at-Risk (``Stressed VaR'') is the
[[Page 33605]]
measurement of the risk of future financial loss in the value of a
trading desk's aggregated positions at the ninety-nine percent
confidence level over a one-day period, based on market conditions
during a period of significant financial stress.
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: For VaR, all trading desks engaged in covered
trading activities. For Stressed VaR, all trading desks engaged in
covered trading activities, except trading desks whose covered
trading activity is conducted exclusively to hedge products excluded
from the definition of ``financial instrument'' under Sec.
75.3(d)(2).
b. Source-of-Revenue Measurements
1. Comprehensive Profit and Loss Attribution
i. Description: For purposes of this appendix, Comprehensive
Profit and Loss Attribution is an analysis that attributes the daily
fluctuation in the value of a trading desk's positions to various
sources. First, the daily profit and loss of the aggregated
positions is divided into three categories: (i) Profit and loss
attributable to a trading desk's existing positions that were also
positions held by the trading desk as of the end of the prior day
(``existing positions''); (ii) profit and loss attributable to new
positions resulting from the current day's trading activity (``new
positions''); and (iii) residual profit and loss that cannot be
specifically attributed to existing positions or new positions. The
sum of (i), (ii), and (iii) must equal the trading desk's
comprehensive profit and loss at each point in time.
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. For the attribution of comprehensive profit and loss from
existing positions to specific risk factors and other factors, a
banking entity must provide the following information for the
factors that explain the preponderance of the profit or loss changes
due to risk factor changes: the unique identification label for the
risk factor or other factor listed in the Risk Factor Attribution
Information Schedule, and the profit or loss due to the risk factor
or other factor change.
C. The comprehensive profit and loss attributed to new positions
must reflect commissions and fee income or expense and market gains
or losses associated with transactions executed on the applicable
day. New positions include purchases and sales of financial
instruments and other assets/liabilities and negotiated amendments
to existing positions. The comprehensive profit and loss from new
positions may be reported in the aggregate and does not need to be
further attributed to specific sources.
D. The portion of comprehensive profit and loss 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. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks engaged in covered trading
activities.
c. Positions, Transaction Volumes, and Securities Inventory Aging
Measurements
1. Positions
i. Description: For purposes of this appendix, Positions is the
value of securities and derivatives positions managed by the trading
desk. For purposes of the Positions quantitative measurement, do not
include in the Positions calculation for ``securities'' those
securities that are also ``derivatives,'' as those terms are defined
under subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \1\ A banking entity must separately
report the trading desk's market value of long securities positions,
market value of short securities positions, market value of
derivatives receivables, market value of derivatives payables,
notional value of derivatives receivables, and notional value of
derivatives payables.
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\1\ See Sec. Sec. 75.2(i), (bb). For example, under this part,
a security-based swap is both a ``security'' and a ``derivative.''
For purposes of the Positions quantitative measurement, security-
based swaps are reported as derivatives rather than securities.
---------------------------------------------------------------------------
ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 75.4(a)
or Sec. 75.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
2. Transaction Volumes
i. Description: For purposes of this appendix, Transaction
Volumes measures four exclusive categories of covered trading
activity conducted by a trading desk. A banking entity is required
to report the value and number of security and derivative
transactions conducted by the trading desk with: (i) Customers,
excluding internal transactions; (ii) non-customers, excluding
internal transactions; (iii) trading desks and other organizational
units where the transaction is booked in the same banking entity;
and (iv) trading desks and other organizational units where the
transaction is booked into an affiliated banking entity. For
securities, value means gross market value. For derivatives, value
means gross notional value. For purposes of calculating the
Transaction Volumes quantitative measurement, do not include in the
Transaction Volumes calculation for ``securities'' those securities
that are also ``derivatives,'' as those terms are defined under
subpart A; instead, report those securities that are also
derivatives as ``derivatives.'' \2\ Further, for purposes of the
Transaction Volumes quantitative measurement, a customer of a
trading desk that relies on Sec. 75.4(a) to conduct underwriting
activity is a market participant identified in Sec. 75.4(a)(7), and
a customer of a trading desk that relies on Sec. 75.4(b) to conduct
market making-related activity is a market participant identified in
Sec. 75.4(b)(3).
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\2\ See Sec. Sec. 75.2(i), (bb).
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ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 75.4(a)
or Sec. 75.4(b) to conduct underwriting activity or market-making-
related activity, respectively.
3. Securities Inventory Aging
i. Description: For purposes of this appendix, Securities
Inventory Aging generally describes a schedule of the market value
of the trading desk's securities positions and the amount of time
that those securities positions have been held. Securities Inventory
Aging must measure the age profile of a trading desk's securities
positions for the following periods: 0-30 calendar days; 31-60
calendar days; 61-90 calendar days; 91-180 calendar days; 181-360
calendar days; and greater than 360 calendar days. Securities
Inventory Aging includes two schedules, a security asset-aging
schedule, and a security liability-aging schedule. For purposes of
the Securities Inventory Aging quantitative measurement, do not
include securities that are also ``derivatives,'' as those terms are
defined under subpart A.\3\
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\3\ See Sec. Sec. 75.2(i), (bb).
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ii. Calculation Period: One trading day.
iii. Measurement Frequency: Daily.
iv. Applicability: All trading desks that rely on Sec. 75.4(a)
or Sec. 75.4(b) to conduct underwriting activity or market-making
related activity, respectively.
Dated: May 31, 2018.
Joseph M. Otting,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System, May 30, 2018.
Ann E. Misback,
Secretary of the Board.
Dated at Washington, DC, on May 31, 2018.
By order of the Board of Directors.
Federal Deposit Insurance Corporation.
Valerie Jean Best,
Assistant Executive Secretary.
By the Securities and Exchange Commission.
Dated: June 5, 2018.
Brent J. Fields,
Secretary.
Issued in Washington, DC, on June 11, 2018, by the Commodity
Futures Trading Commission.
Robert Sidman,
Deputy Secretary of the Commodity Futures Trading Commission.
[FR Doc. 2018-13502 Filed 7-16-18; 8:45 am]
BILLING CODE 4810-33-P; 6210-01-P; 6714-01-P; 8011-01-P; 6351-01-P