i

Conformed to Federal Register Version

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 44

Docket No. OCC-2011-0014

RIN: 1557-AD44

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

12 CFR Part 248

Docket No. R-1432

RIN: 7100 AD82

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 351

RIN: 3064-AD85

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 255

Release No. BHCA-1; File No. S7-41-11

RIN: 3235-AL07

Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and 

Relationships With, Hedge Funds and Private Equity Funds 

AGENCIES: Office of the Comptroller of the Currency, Treasury (“OCC”); Board of 

Governors of the Federal Reserve System (“Board”); Federal Deposit Insurance Corporation 

(“FDIC”); and Securities and Exchange Commission (“SEC”).

ACTION: Final Rule.

SUMMARY: The OCC, Board, FDIC, and SEC (individually, an “Agency,” and collectively, 

“the Agencies”) are adopting a rule that would implement section 13 of the BHC Act, which was 

added by section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act 

(“Dodd-Frank Act”). Section 13 contains certain prohibitions and restrictions on the ability of a 
ii

banking entity and nonbank financial company supervised by the Board to engage in proprietary 

trading and have certain interests in, or relationships with, a hedge fund or private equity fund.

DATES: The final rule is effective April 1, 2014.

FOR FURTHER INFORMATION CONTACT: 

OCC: Ursula Pfeil, Counsel, or Deborah Katz, Assistant Director, Legislative and Regulatory 

Activities Division, (202) 649-5490; Ted Dowd, Assistant Director, or Roman Goldstein, Senior 

Attorney, Securities and Corporate Practices Division, (202) 649-5510; Kurt Wilhelm, Director 

for Financial Markets Group, (202) 649-6360; Stephanie Boccio, Technical Expert for Credit and 

Market Risk Group, (202) 649-6360, Office of the Comptroller of the Currency, 250 E Street 

SW., Washington, DC 20219.

Board: Christopher M. Paridon, Counsel, (202) 452-3274, or Anna M. Harrington, Senior 

Attorney, Legal Division, (202) 452-6406; Mark E. Van Der Weide, Deputy Director, Division 

of Bank Supervision and Regulation, (202) 452-2263; or Sean D. Campbell, Deputy Associate 

Director, Division of Research and Statistics, (202) 452-3760, Board of Governors of the Federal 

Reserve System, 20th and C Streets, NW., Washington, DC 20551.

FDIC: Bobby R. Bean, Associate Director, bbean@fdic.gov, or Karl R. Reitz, Chief, Capital 

Markets Strategies Section, kreitz@fdic.gov, Capital Markets Branch, Division of Risk 

Management Supervision, (202) 898-6888; Michael B. Phillips, Counsel, mphillips@fdic.gov, or 

Gregory S. Feder, Counsel, gfeder@fdic.gov, Legal Division, Federal Deposit Insurance 

Corporation, 550 17th Street, NW., Washington, DC 20429. 

SEC: Josephine J. Tao, Assistant Director, Angela R. Moudy, Branch Chief, John Guidroz, 

Branch Chief, Jennifer Palmer or Lisa Skrzycki, Attorney Advisors, Office of Trading Practices,
iii

Catherine McGuire, Counsel, Division of Trading and Markets, (202) 551-5777; W. Danforth 

Townley, Attorney Fellow, Jane H. Kim, Brian McLaughlin Johnson or Marian Fowler, Senior 

Counsels, Division of Investment Management, (202) 551-6787; David Beaning, Special 

Counsel, Office of Structured Finance, Division of Corporation Finance, (202) 551-3850; John 

Cross, Office of Municipal Securities, (202) 551-5680; or Adam Yonce, Assistant Director, or 

Matthew Kozora, Financial Economist, Division of Economic and Risk Analysis, (202) 551-

6600, U.S. Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

II. Notice of Proposed Rulemaking: 

III. Overview of Final Rule

A. General Approach and Summary of Final Rule

B. Proprietary Trading Restrictions

C. Restrictions on Covered Fund Activities and Investments

D. Metrics Reporting Requirement

E. Compliance Program Requirement

IV.Final Rule

A. Subpart B – Proprietary Trading Restrictions

1. Section __.3: Prohibition on Proprietary Trading and Related Definitions

a. Definition of “Trading Account”

b. Rebuttable Presumption for the Short-Term Trading Account

c. Definition of “Financial Instrument”

d. Proprietary Trading Exclusions

1. Repurchase and reverse repurchase arrangements and securities lending

2. Liquidity management activities

3. Transactions of derivatives clearing organizations and clearing agencies
iv

4. Excluded clearing-related activities of clearinghouse members

5. Satisfying an existing delivery obligation

6. Satisfying an obligation in connection with a judicial, administrative, selfregulatory organization, or arbitration proceeding

7. Acting solely as agent, broker, or custodian

8. Purchases or sales through a deferred compensation or similar plan

9. Collecting a debt previously contracted

10. Other requested exclusions

2. Section __.4(a): Underwriting Exemption

a. Introduction

b. Overview

1. Proposed underwriting exemption

2. Comments on proposed underwriting exemption

3. Final underwriting exemption

c. Detailed Explanation of the Underwriting Exemption

1. Acting as an underwriter for a distribution of securities

a. Proposed requirements that the purchase or sale be effected solely in 

connection with a distribution of securities for which the banking entity acts 

as an underwriter and that the covered financial position be a security95

i. Proposed definition of “distribution”

ii. Proposed definition of “underwriter”

iii. Proposed requirement that the covered financial position be a 

security

b. Comments on the proposed requirements that the trade be effected solely in 

connection with a distribution for which the banking entity is acting as an 

underwriter and that the covered financial position be a security

i. Definition of “distribution”

ii. Definition of “underwriter”

iii. “Solely in connection with” standard

c. Final requirement that the banking entity act as an underwriter for a 

distribution of securities and the trading desk’s underwriting position be 

related to such distribution

i. Definition of “underwriting position”
v

ii. Definition of “trading desk”

iii. Definition of “distribution”

iv. Definition of “underwriter”

v. Activities conducted “in connection with” a distribution

2. Near term customer demand requirement

a. Proposed near term customer demand requirement

b. Comments regarding the proposed near term customer demand requirement

c. Final near term customer demand requirement

3. Compliance program requirement

a. Proposed compliance program requirement

b. Comments on the proposed compliance program requirement

c. Final compliance program requirement

4. Compensation requirement

a. Proposed compensation requirement

b. Comments on the proposed compensation requirement

c. Final compensation requirement

5. Registration requirement

a. Proposed registration requirement

b. Comments on proposed registration requirement

c. Final registration requirement

6. Source of revenue requirement

a. Proposed source of revenue requirement

b. Comments on the proposed source of revenue requirement

c. Final rule’s approach to assessing source of revenue

3. Section __.4(b): Market-Making Exemption

a. Introduction

b. Overview

1. Proposed market-making exemption

2. Comments on the proposed market-making exemption

a. Comments on the overall scope of the proposed exemption

b. Comments regarding the potential market impact of the proposed exemption
vi

3. Final market-making exemption

c. Detailed Explanation of the Market-Making Exemption

1. Requirement to routinely stand ready to purchase and sell

a. Proposed requirement to hold self out

b. Comments on the proposed requirement to hold self out

i. The proposed indicia

ii. Treatment of block positioning activity

iii. Treatment of anticipatory market making

iv. High-frequency trading

c. Final requirement to routinely stand ready to purchase and sell

i. Definition of “trading desk”

ii. Definitions of “financial exposure” and “market-maker 

inventory”

iii. Routinely standing ready to buy and sell

2. Near term customer demand requirement

a. Proposed near term customer demand requirement

b. Comments Regarding the Proposed Near Term Customer Demand 

Requirement

i. The proposed guidance for determining compliance with the 

near term customer demand requirement

ii. Potential inventory restrictions and differences across asset 

classes

iii. Predicting near term customer demand

iv. Potential definitions of “client,” “customer,” or “counterparty”

v. Interdealer trading and trading for price discovery or to test 

market depth

vi. Inventory management

vii. Acting as an authorized participant or market maker in 

exchange-traded funds

viii. Arbitrage or other activities that promote price transparency 

and liquidity

ix. Primary dealer activities

x. New or bespoke products or customized hedging contracts
vii

c. Final near term customer demand requirement

i. Definition of “client,” “customer,” and “counterparty”

ii. Impact of the liquidity, maturity, and depth of the market on 

the analysis

iii. Demonstrable analysis of certain factors

iv. Relationship to required limits

3. Compliance program requirement

a. Proposed compliance program requirement

b. Comments on the proposed compliance program requirement

c. Final compliance program requirement

4. Market making-related hedging

a. Proposed treatment of market making-related hedging

b. Comments on the proposed treatment of market making-related hedging

c. Treatment of market making-related hedging in the final rule

5. Compensation requirement

a. Proposed compensation requirement

b. Comments regarding the proposed compensation requirement

c. Final compensation requirement

6. Registration requirement

a. Proposed registration requirement

b. Comments on the proposed registration requirement

c. Final registration requirement

7. Source of revenue analysis

a. Proposed source of revenue requirement

b. Comments regarding the proposed source of revenue requirement

i. Potential restrictions on inventory, increased costs for 

customers, and other changes to market-making services

ii. Certain price appreciation-related profits are an inevitable or 

important component of market making

iii. Concerns regarding the workability of the proposed standard in 

certain markets or asset classes

iv. Suggested modifications to the proposed requirement
viii

v. General support for the proposed requirement or for placing 

greater restrictions on a market maker’s sources of revenue

c. Final rule’s approach to assessing revenues

8. Appendix B of the proposed rule

a. Proposed Appendix B requirement

b. Comments on proposed Appendix B

c. Determination to not adopt proposed Appendix B

9. Use of quantitative measurements

4. Section __.5: Permitted Risk-Mitigating Hedging Activities

a. Summary of Proposal’s Approach to Implementing the Hedging Exemption

b. Manner of Evaluating Compliance with the Hedging Exemption

c. Comments on the Proposed Rule and Approach to Implementing the Hedging 

Exemption.

d. Final Rule

1. Compliance program requirement

2. Hedging of specific risks and demonstrable reduction of risk

3. Compensation

4. Documentation requirement

5. Section __.6(a)-(b): Permitted Trading in Certain Government and Municipal 

Obligations

a. Permitted Trading in U.S. Government Obligations

b. Permitted Trading in Foreign Government Obligations

c. Permitted Trading in Municipal Securities

d. Determination to Not Exempt Proprietary Trading in Multilateral Development 

Bank Obligations

6. Section __.6(c): Permitted Trading on Behalf of Customers

a. Proposed Exemption for Trading on Behalf of Customers

b. Comments on the Proposed Rule

c. Final Exemption for Trading on Behalf of Customers

7. Section __.6(d): Permitted Trading by a Regulated Insurance Company

8. Section __.6(e): Permitted Trading Activities of a Foreign Banking Entity

a. Foreign Banking Entities Eligible for the Exemption
ix

b. Permitted Trading Activities of a Foreign Banking Entity

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

a. Scope of “Material Conflict of Interest”

1. Proposed rule

2. Comments on the proposed limitation on material conflicts of interest

a. Disclosure

b. Information barriers

3. Final rule

b. Definition of “High-Risk Asset” and “High-Risk Trading Strategy”

1. Proposed rule

2. Comments on proposed limitations on high-risk assets and trading 

strategies

3. Final rule

c. Limitations on Permitted Activities that Pose a Threat to Safety and Soundness 

of the Banking Entity or the Financial Stability of the United States

B. Subpart C – Covered Fund Activities and Investments

1. Section __.10: Prohibition on Acquisition or Retention of Ownership Interests in, 

and Certain Relationships with, a Covered Fund

a. Prohibition Regarding Covered Fund Activities and Investments

b. “Covered Fund” Definition

1. Foreign covered funds

2. Commodity pools

3. Entities regulated under the Investment Company Act

c. Entities Excluded from Definition of Covered Fund

1. Foreign public funds

2. Wholly-owned subsidiaries

3. Joint ventures

4. Acquisition vehicles

5. Foreign pension or retirement funds

6. Insurance company separate accounts

7. Bank owned life insurance separate accounts

8. Exclusion for loan securitizations and definition of loan
x

a. Definition of loan

b. Loan securitizations

i. Loans

ii. Contractual rights or assets

iii. Derivatives

iv. SUBIs and collateral certificates

v. Impermissible assets

9. Asset-backed commercial paper conduits

10. Covered bonds

11. Certain permissible public welfare and similar funds

12. Registered investment companies and excluded entities

13. Other excluded entities

d. Entities Not Specifically Excluded from the Definition of Covered Fund

1. Financial market utilities

2. Cash collateral pools

3. Pass-through REITS

4. Municipal securities tender option bond transactions

5. Venture capital funds

6. Credit funds

7. Employee securities companies

e. Definition of “Ownership Interest”

f. Definition of “Resident of the United States”

g. Definition of “Sponsor”

2. Section __.11: Activities Permitted in Connection with Organizing and Offering a 

Covered Fund

a. Scope of Exemption

1. Fiduciary services

2. Compliance with investment limitations

3. Compliance with section 13(f) of the BHC Act

4. No guarantees or insurance of fund performance

5. Limitation on name sharing with a covered fund
xi

6. Limitation on ownership by directors and employees

7. Disclosure requirements

b. Organizing and Offering an Issuing Entity of Asset-Backed Securities

c. Underwriting and Market Making for a Covered Fund

3. Section __.12: Permitted Investment in a Covered Fund

a. Proposed Rule

b. Duration of Seeding Period for New Covered Funds

c. Limitations on Investments in a Single Covered Fund (“Per-Fund Limitation”)

d. Limitation on Aggregate Permitted Investments in all Covered funds 

(“Aggregate Funds Limitation”)

e. Capital Treatment of an Investment in a Covered Fund

f. Attribution of Ownership Interests to a Banking Entity

g. Calculation of Tier 1 Capital

h. Extension of Time to Divest Ownership Interest in a Single Fund

4. Section __.13: Other permitted covered fund activities

a. Permitted Risk-Mitigating Hedging Activities

b. Permitted Covered Fund Activities and Investments Outside of the United 

States

1. Foreign banking entities eligible for the exemption

2. Activities or investments solely outside of the United States

3. Offered for sale or sold to a resident of the United States

4. Definition of “resident of the United States”

c. Permitted Covered Fund Interests and Activities by a Regulated Insurance 

Company

5. Section __.14: Limitations on Relationships With a Covered Fund

a. Scope of Application

b. Transactions that Would Be a “Covered Transaction”

c. Certain Transactions and Relationships Permitted

1. Permitted investments and ownerships interests

2. Prime brokerage transactions

d. Restrictions on Transactions With Any Permitted Covered Fund

6. Section __.15: Other limitations on permitted covered fund activities
xii

C. Subpart D and Appendices A and B – Compliance Program, 

Reporting, and Violations

1. Section __.20: Compliance Program Mandate

a. Program Requirement

b. Compliance Program Elements

c. Simplified Programs for Less Active Banking Entities

d. Threshold for Application of Enhanced Minimum Standards

2. Appendix B: Enhanced Minimum Standards for Compliance Programs

a. Proprietary Trading Activities

b. Covered Fund Activities or Investments

c. Enterprise-Wide Programs

d. Responsibility and Accountability

e. Independent Testing

f. Training

g. Recordkeeping

3. Section __.20(d) and Appendix A: Reporting and Recordkeeping Requirements 

Applicable to Trading Activities

a. Approach to Reporting and Recordkeeping Requirements under the Proposal

b. General Comments on the Proposed Metrics

c. Approach of the Final Rule

d. Proposed Quantitative Measurements and Comments on Specific Metrics

4. Section __.21: Termination of Activities or Investments; Authorities for 

Violations

V. Administrative Law Matters

A. Use of Plain Language

B. Paperwork Reduction Act Analysis

C. Regulatory Flexibility Act Analysis

D. OCC Unfunded Mandates Reform Act of 1995 Determination
1

I. Background

The Dodd-Frank Act was enacted on July 21, 2010.1

 Section 619 of the DoddFrank Act added a new section 13 to the Bank Holding Company Act of 1956 (“BHC 

Act”) (codified at 12 U.S.C. 1851) that generally prohibits any banking entity from 

engaging in proprietary trading or from acquiring or retaining an ownership interest in, 

sponsoring, or having certain relationships with a hedge fund or private equity fund 

(“covered fund”), subject to certain exemptions.2 New section 13 of the BHC Act also 

provides that a nonbank financial company designated by the Financial Stability 

Oversight Council (“FSOC”) for supervision by the Board (while not a banking entity 

under section 13 of the BHC Act) would be subject to additional capital requirements, 

quantitative limits, or other restrictions if the company engages in certain proprietary 

trading or covered fund activities.3

Section 13 of the BHC Act generally prohibits banking entities from engaging as 

principal in proprietary trading for the purpose of selling financial instruments in the near 

term or otherwise with the intent to resell in order to profit from short-term price 

movements.4 Section 13(d)(1) expressly exempts from this prohibition, subject to 

conditions, certain activities, including:

 

1

 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010).

2

 See 12 U.S.C. 1851.

3

 See 12 U.S.C. 1851(a)(2) and (f)(4). The Agencies note that two of the three companies currently designated 

by FSOC for supervision by the Board are affiliated with insured depository institutions, and are therefore 

currently banking entities for purposes of section 13 of the BHC Act. The Agencies are continuing to review 

whether the remaining company engages in any activity subject to section 13 of the BHC Act and what, if any, 

requirements apply under section 13. 

4

 See 12 U.S.C. 1851(a)(1)(A) and (B).
2

• 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.5 

Section 13 of the BHC Act also generally prohibits banking entities from 

acquiring or retaining an ownership interest in, or sponsoring, a hedge fund or private 

equity fund. Section 13 contains several exemptions that permit banking entities to make 

limited investments in hedge funds and private equity funds, subject to a number of 

restrictions designed to ensure that banking entities do not rescue investors in these funds 

from loss and are not themselves exposed to significant losses from investments or other 

relationships with these funds.

Section 13 of the BHC Act does not prohibit a nonbank financial company 

supervised by the Board from engaging in proprietary trading, or from having the types 

of ownership interests in or relationships with a covered fund that a banking entity is 

prohibited or restricted from having under section 13 of the BHC Act. However, section 

13 of the BHC Act provides that these activities be subject to additional capital charges, 

quantitative limits, or other restrictions.6

 

5

 See id. at 1851(d)(1). 

6

 See 12 U.S.C. 1851(a)(2) and (d)(4).
3

II. Notice of Proposed Rulemaking: Summary of General Comments

Authority for developing and adopting regulations to implement the prohibitions 

and restrictions of section 13 of the BHC Act is divided among the Board, the Federal 

Deposit Insurance Corporation (“FDIC”), the Office of the Comptroller of the Currency 

(“OCC”), the Securities and Exchange Commission (“SEC”), and the Commodity 

Futures Trading Commission (“CFTC”).7

 As required by section 13(b)(2) of the BHC 

Act, the Board, OCC, FDIC, and SEC in October 2011 invited the public to comment on 

proposed rules implementing that section’s requirements.8 The period for filing public 

comments on this proposal was extended for an additional 30 days, until February 13, 

2012.

9

 In January 2012, the CFTC requested comment on a proposal for the same 

common rule to implement section 13 with respect to those entities for which it is the 

primary financial regulatory agency and invited public comment on its proposed 

implementing rule through April 16, 2012.10 The statute requires the Agencies, in 

developing and issuing implementing rules, to consult and coordinate with each other, as 

appropriate, for the purposes of assuring, to the extent possible, that such rules are 

 

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 76 FR 68846 (Nov. 7, 2011) (“Joint Proposal”). 

9

 See 77 FR 23 (Jan. 23, 2012) (extending the comment period to February 13, 2012).

10 See 77 FR 8332 (Feb. 14, 2012) (“CFTC Proposal”).
4

comparable and provide for consistent application and implementation of the applicable 

provisions of section 13 of the BHC Act.11 

The proposed rules invited comment on a multi-faceted regulatory framework to 

implement section 13 consistent with the statutory language. In addition, the Agencies 

invited comments on the potential economic impacts of the proposed rule and posed a 

number of questions seeking information on the costs and benefits associated with each 

aspect of the proposal, as well as on any significant alternatives that would minimize the 

burdens or amplify the benefits of the proposal in a manner consistent with the statute. 

The Agencies also encouraged commenters to provide quantitative information and data 

about the impact of the proposal on entities subject to section 13, as well as on their 

clients, customers, and counterparties, specific markets or asset classes, and any other 

entities potentially affected by the proposed rule, including non-financial small and midsize businesses. 

The Agencies received over 18,000 comments addressing a wide variety of 

aspects of the proposal, including definitions used by the proposal and the exemptions for 

market making-related activities, risk-mitigating hedging activities, covered fund 

activities and investments, the use of quantitative metrics, and the reporting proposals. 

The vast majority of these comments were from individuals using a version of a short 

form letter to express support for the proposed rule. More than 600 comment letters were 

unique comment letters, including from members of Congress, domestic and foreign 

banking entities and other financial services firms, trade groups representing banking, 

 

11 See 12 U.S.C. 1851(b)(2)(B)(ii). The Secretary of the Treasury, as Chairperson of the FSOC, is 

responsible for coordinating the Agencies’ rulemakings under section 13 of the BHC Act. See id. 
5

insurance, and the broader financial services industry, U.S. state and foreign 

governments, consumer and public interest groups, and individuals. To improve 

understanding of the issues raised by commenters, the Agencies met with a number of 

these commenters to discuss issues relating to the proposed rule, and summaries of these 

meetings are available on each of the Agency’s public websites.12 The CFTC staff also 

hosted a public roundtable on the proposed rule.13 Many of the commenters generally 

expressed support for the broader goals of the proposed rule. At the same time, many 

commenters expressed concerns about various aspects of the proposed rule. Many of 

these commenters requested that one or more aspects of the proposed rule be modified in 

some manner in order to reflect their viewpoints and to better accommodate the scope of 

activities that they argued were encompassed within section 13 of the BHC Act. The 

comments addressed all major sections of the proposed rule. 

Section 13 of the BHC Act also required the FSOC to conduct a study (“FSOC 

study”) and make recommendations to the Agencies by January 21, 2011 on the 

implementation of section 13 of the BHC Act. The FSOC study was issued on January 

18, 2011. The FSOC study included a detailed discussion of key issues related to 

implementation of section 13 and recommended that the Agencies consider taking a 

 

12 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). 

13 See Commodity Futures Trading Commission, CFTC STAFF TO HOST A PUBLIC ROUNDTABLE TO 

DISCUSS THE PROPOSED VOLCKER RULE (May 24, 2012), available at

http://www.cftc.gov/PressRoom/PressReleases/pr6263-12; transcript available at

http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/transcript053112.pdf.
6

number of specified actions in issuing rules under section 13 of the BHC Act.14 The 

FSOC study also recommended that the Agencies adopt a four-part implementation and 

supervisory framework for identifying and preventing prohibited proprietary trading, 

which included a programmatic compliance regime requirement for banking entities, 

analysis and reporting of quantitative metrics by banking entities, supervisory review and 

oversight by the Agencies, and enforcement procedures for violations.15 The Agencies 

carefully considered the FSOC study and its recommendations.

In formulating this final rule, the Agencies carefully reviewed all comments 

submitted in connection with the rulemaking and considered the suggestions and issues 

they raise in light of the statutory restrictions and provisions as well as the FSOC study. 

The Agencies have sought to reasonably respond to all of the significant issues 

commenters raised. The Agencies believe they have succeeded in doing so 

notwithstanding the complexities involved. The Agencies also carefully considered 

different options suggested by commenters in light of potential costs and benefits in order 

to effectively implement section 13 of the BHC Act. The Agencies made numerous 

changes to the final rule in response to the issues and information provided by 

commenters. These modifications to the rule and explanations that address comments are 

described in more detail in the section-by-section description of the final rule. To 

 

14 See Financial Stability Oversight Counsel, Study and Recommendations on Prohibitions on Proprietary 

Trading and Certain Relationships with Hedge Funds and Private Equity Funds (Jan. 18, 2011), available at

http://www.treasury.gov/initiatives/Documents/Volcker%20sec%20619%20study%20final%201%2018%2011

%20rg.pdf. (“FSOC study”). See 12 U.S.C. 1851(b)(1). Prior to publishing its study, FSOC requested public 

comment on a number of issues to assist in conducting its study. See 75 FR 61,758 (Oct. 6, 2010). 

Approximately 8,000 comments were received from the public, including from members of Congress, trade 

associations, individual banking entities, consumer groups, and individuals. 

15 See FSOC study at 5-6. 
7

enhance uniformity in both rules that implement section 13 and administration of the 

requirements of that section, the Agencies have been regularly consulting with each other 

in the development of this final rule. 

Some commenters requested that the Agencies repropose the rule and/or delay 

adoption pending the collection of additional information.16 As described in part above, 

the Agencies have provided many and various types of opportunities for commenters to 

provide input on implementation of section 13 of the BHC Act and have collected 

substantial information in the process. In addition to the official comment process 

described above, members of the public submitted comment letters in advance of the 

official comment period for the proposed rules and met with staff of the Agencies to 

explain issues of concern; the public also provided substantial comment in response to a 

request for comment from the FSOC regarding its findings and recommendations for 

implementing section 13.17 The Agencies provided a detailed proposal and posed 

numerous questions in the preamble to the proposal to solicit and explore alternative 

approaches in many areas. In addition, the Agencies have continued to receive comment 

letters after the extended comment period deadline, which the Agencies have considered. 

Thus, the Agencies believe interested parties have had ample opportunity to review the 

proposed rules, as well as the comments made by others, and to provide views on the 

proposal, other comment letters, and data to inform our consideration of the final rules. 

 

16 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); ABA (Keating); Chamber (Nov. 2011); Chamber 

(Nov. 2013); Members of Congress (Dec. 2011); IIAC; Real Estate Roundtable; Ass’n. of German Banks; 

Allen & Overy (Clearing); JPMC; Goldman (Prop. Trading); BNY Mellon et al.; State Street (Feb. 2012); 

ICI Global; Chamber (Feb. 2012); Société Générale; HSBC; Western Asset Mgmt.; Abbott Labs et al.

(Feb. 2012); PUC Texas; Columbia Mgmt.; ICI (Feb. 2012); IIB/EBF; British Bankers’ Ass’n.; ISDA (Feb. 

2012); Comm. on Capital Markets Regulation; Ralph Saul (Apr. 2012); BPC. 

17 See 75 FR 61,758 (Oct. 6, 2010).
8

In addition, the Agencies have been mindful of the importance of providing 

certainty to banking entities and financial markets and of providing sufficient time for 

banking entities to understand the requirements of the final rule and to design, test, and 

implement compliance and reporting systems. The further substantial delay that would 

necessarily be entailed by reproposing the rule would extend the uncertainty that banking 

entities would face, which could prove disruptive to banking entities and the financial

markets. 

The Agencies note, as discussed more fully below, that the final rule incorporates 

a number of modifications designed to address the issues raised by commenters in a 

manner consistent with the statute. The preamble below also discusses many of the 

issues raised by commenters and explains the Agencies’ response to those comments. 

To achieve the purpose of the statute, without imposing unnecessary costs, the 

final rule builds on the multi-faceted approach in the proposal, which includes 

development and implementation of a compliance program at each banking entity 

engaged in trading activities or that makes investments subject to section 13 of the BHC 

Act; the collection and evaluation of data regarding these activities as an indicator of 

areas meriting additional attention by the banking entity and the relevant agency; 

appropriate limits on trading, hedging, investment and other activities; and supervision by 

the Agencies. To allow banking entities sufficient time to develop appropriate systems, 

the Agencies have provided for a phased-in schedule for the collection of data, limited 

data reporting requirements only to banking entities that engage in significant trading 

activity, and agreed to review the merits of the data collected and revise the data 

collection as appropriate over the next 21 months. Importantly, as explained in detail 
9

below, the Agencies have also reduced the compliance burden for banking entities with 

total assets of less than $10 billion. The final rule also eliminates compliance burden for 

firms that do not engage in covered activities or investments beyond investing in U.S. 

government obligations, agency guaranteed obligations, or municipal obligations. 

Moreover, the Agencies believe the data that will be collected in connection with 

the final rule, as well as the compliance efforts made by banking entities and the 

supervisory experience that will be gained by the Agencies in reviewing trading and 

investment activity under the final rule, will provide valuable insights into the 

effectiveness of the final rule in achieving the purpose of section 13 of the BHC Act. The 

Agencies remain committed to implementing the final rule, and revisiting and revising 

the rule as appropriate, in a manner designed to ensure that the final rule faithfully 

implements the requirements and purposes of the statute.18 

Finally, the Board has determined, in accordance with section 13 of the BHC Act, 

to provide banking entities with additional time to conform their activities and 

investments to the statute and the final rule. The restrictions and prohibitions of section 

13 of the BHC Act became effective on July 21, 2012.19 The statute provided banking 

entities a period of two years to conform their activities and investments to the 

requirement of the statute, until July 21, 2014. Section 13 also permits the Board to 

extend this conformance period, one year at a time, for a total of no more than three 

 

18 If any provision of this rule, or the application thereof to any person or circumstance, is held to be 

invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or 

circumstances that can be given effect without the invalid provision or application.

19 See 12 U.S.C. 1851(c)(1).
10

additional years.20 Pursuant to this authority and in connection with this rulemaking, the 

Board has in a separate action extended the conformance period for an additional year 

until July 21, 2015.21 The Board will continue to monitor developments to determine 

whether additional extensions of the conformance period are in the public interest, 

consistent with the statute. Accordingly, the Agencies do not believe that a reproposal or 

further delay is necessary or appropriate.

Commenters have differing views on the overall economic impacts of section 13 

of the BHC Act.

Some commenters remarked that proprietary trading restrictions will have 

detrimental impacts on the economy such as: reduction in efficiency of markets, 

economic growth, and in employment due to a loss in liquidity.22 In particular, a 

commenter expressed concern that there may be high transition costs as non-banking 

entities replace some of the trading activities currently performed by banking entities.23 

Another commenter focused on commodity markets remarked about the potential 

reduction in commercial output and curtailed resource exploration due to a lack of 

hedging counterparties.24 Several commenters stated that section 13 of the BHC Act will 

reduce access to debt markets – especially for smaller companies – raising the costs of 

 

20 See 12 U.S.C. 1851(c)(2); See also, A Conformance Period for Entities Engaged in Prohibited Proprietary 

Trading or Private Equity Fund or Hedge Fund Activities, 76 FR 8265 (Feb. 14, 2011) (citing 156 Cong. Rec. 

S5898 (daily ed. July 15, 2010) (statement of Sen. Merkley)).

21 See, Board Order Approving Extension of Conformance Period, available at 

http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20131210b1.pdf . 

22 See, e.g., Oliver Wyman (Dec. 2011); Chamber (Dec. 2011); Thakor Study; Prof. Duffie; IHS.

23 See Prof. Duffie.

24 See IHS.
11

capital for firms and lowering the returns on certain investments.25 Further, some 

commenters mentioned that U.S. banks may be competitively disadvantaged relative to 

foreign banks due to proprietary trading restrictions and compliance costs.26

On the other hand, other commenters stated that restricting proprietary trading 

activity by banking entities may reduce systemic risk emanating from the financial 

system and help to lower the probability of the occurrence of another financial crisis.27 

One commenter contended that large banking entities may have a moral hazard incentive 

to engage in risky activities without allocating sufficient capital to them, especially if 

market participants believe these institutions will not be allowed to fail.28 Commenters 

argued that large banking entities may engage in activities that increase the upside return 

at the expense of downside loss exposure which may ultimately be borne by Federal 

taxpayers29 and that subsidies associated with bank funding may create distorted 

economic outcomes.30 Furthermore, some commenters remarked that non-banking 

entities may fill much of the void in liquidity provision left by banking entities if banking 

entities reduce their current trading activities.31 Finally, some commenters mentioned that 

 

25 See, e.g., Chamber (Dec. 2011); Thakor Study; Oliver Wyman (Dec. 2011); IHS.

26 See, e.g., RBC; Citigroup (Feb. 2012); Goldman (Covered Funds).

27 See, e.g., Profs. Admati & Pfleiderer; AFR (Nov. 2012); Better Markets (Dec. 2011); 

Better Markets (Feb. 2012); Occupy; Johnson & Prof. Stiglitz; Paul Volcker.

28 See Occupy.

29 See Profs. Admati & Pfleiderer; Better Markets (Feb. 2012); Occupy; Johnson & Prof. Stiglitz; 

Paul Volcker.

30 See Profs. Admati & Pfleiderer; Johnson & Prof. Stiglitz.

31 See AFR et al. (Feb. 2012); Better Markets (Apr. 16, 2012); David McClean; Public Citizen; Occupy.
12

hyper-liquidity that arises from, for instance, speculative bubbles, may harm the 

efficiency and price discovery function of markets.32

The Agencies have taken these concerns into account in the final rule. As 

described below with respect to particular aspects of the final rule, the Agencies have 

addressed these issues by reducing burdens where appropriate, while at the same time 

ensuring that the final rule serves its purpose of promoting healthy economic activity. In 

that regard, the Agencies have sought to achieve the balance intended by Congress under 

section 13 of the BHC Act. Several comments suggested that a costs and benefits 

analysis be performed by the Agencies.33 On the other hand, some commenters34

correctly stated that a costs and benefits analysis is not legally required.35 However, the 

Agencies find certain of the information submitted by commenters concerning costs and 

benefits and economic effects to be relevant to consideration of the rule, and so have 

considered this information as appropriate, and, on the basis of these and other 

considerations, sought to achieve the balance intended by Congress in section 619 of the 

Dodd-Frank Act. The relevant comments are addressed therein.

 

32 See Johnson & Prof. Stiglitz (citing Thomas Phillipon (2011)); AFR et al. (Feb. 2012); Occupy.

33 See SIFMA et al. (Covered Funds) (Feb. 2012); BoA; ABA (Keating); Chamber (Feb. 2012); Société 

Générale; FTN; SVB; ISDA (Feb. 2012); Comm. on Capital Market Regulation; Real Estate 

Roundtable.

34 See, e.g., Better Markets (Feb. 2012); Randel Pilo.

35 For example, with respect to the CFTC, Section 15(a) of the CEA requires such consideration only when 

“promulgating a regulation under this [Commodity Exchange] Act.” This final rule is not promulgated 

under the CEA, but under the BHC Act. CEA section 15(a), therefore, does not apply.
13

III. Overview of Final Rule

The Agencies are adopting this final rule to implement section 13 of the BHC Act 

with a number of changes to the proposal, as described further below. The final rule 

adopts a risk-based approach to implementation that relies on a set of clearly articulated 

characteristics of both prohibited and permitted activities and investments and is designed 

to effectively accomplish the statutory purpose of reducing risks posed to banking entities 

by proprietary trading activities and investments in or relationships with covered funds. 

As explained more fully below in the section-by-section analysis, the final rule has been 

designed to ensure that banking entities do not engage in prohibited activities or 

investments and to ensure that banking entities engage in permitted trading and 

investment activities in a manner designed to identify, monitor and limit the risks posed 

by these activities and investments. For instance, the final rule requires that any banking 

entity that is engaged in activity subject to section 13 develop and administer a 

compliance program that is appropriate to the size, scope and risk of its activities and 

investments. The rule requires the largest firms engaged in these activities to develop 

and implement enhanced compliance programs and regularly report data on trading 

activities to the Agencies. The Agencies believe this will permit banking entities to 

effectively engage in permitted activities, and the Agencies to enforce compliance with 

section 13 of the BHC Act. In addition, the enhanced compliance programs will help 

both the banking entities and the Agencies identify, monitor, and limit risks of activities 

permitted under section 13, particularly involving banking entities posing the greatest risk 

to financial stability. 
14

A. General Approach and Summary of Final Rule

The Agencies have designed the final rule to achieve the purposes of section 13 of 

the BHC Act, which include prohibiting banking entities from engaging in proprietary 

trading or acquiring or retaining an ownership interest in, or having certain relationships 

with, a covered fund, while permitting banking entities to continue to provide, and to 

manage and limit the risks associated with providing, client-oriented financial services 

that are critical to capital generation for businesses of all sizes, households and 

individuals, and that facilitate liquid markets. These client-oriented financial services, 

which include underwriting, market making, and asset management services, are 

important to the U.S. financial markets and the participants in those markets. At the same 

time, providing appropriate latitude to banking entities to provide such client-oriented 

services need not and should not conflict with clear, robust, and effective implementation 

of the statute’s prohibitions and restrictions. 

As noted above, the final rule takes a multi-faceted approach to implementing 

section 13 of the BHC Act. In particular, the final rule includes a framework that clearly 

describes the key characteristics of both prohibited and permitted activities. The final 

rule also requires banking entities to establish a comprehensive compliance program 

designed to ensure compliance with the requirements of the statute and rule in a way that 

takes into account and reflects the banking entity’s activities, size, scope and complexity. 

With respect to proprietary trading, the final rule also requires the large firms that are 

active participants in trading activities to calculate and report meaningful quantitative 

data that will assist both banking entities and the Agencies in identifying particular 
15

activity that warrants additional scrutiny to distinguish prohibited proprietary trading 

from otherwise permissible activities. 

As a matter of structure, the final rule is generally divided into four subparts and 

contains two appendices, as follows:

• Subpart A of the final rule describes the authority, scope, purpose, and 

relationship to other authorities of the rule and defines terms used commonly throughout 

the rule;

• Subpart B of the final rule prohibits proprietary trading, defines terms 

relevant to covered trading activity, establishes exemptions from the prohibition on 

proprietary trading and limitations on those exemptions, and requires certain banking 

entities to report quantitative measurements with respect to their trading activities;

• Subpart C of the final rule prohibits or restricts acquiring or retaining an 

ownership interest in, and certain relationships with, a covered fund, defines terms 

relevant to covered fund activities and investments, as well as establishes exemptions 

from the restrictions on covered fund activities and investments and limitations on those 

exemptions;

• Subpart D of the final rule generally requires banking entities to establish 

a compliance program regarding compliance with section 13 of the BHC Act and the 

final rule, including written policies and procedures, internal controls, a management 

framework, independent testing of the compliance program, training, and recordkeeping;

• Appendix A of the final rule details the quantitative measurements that 

certain banking entities may be required to compute and report with respect to certain 

trading activities;

• Appendix B of the final rule details the enhanced minimum standards for 

programmatic compliance that certain banking entities must meet with respect to their 

compliance program, as required under subpart D.

B. Proprietary Trading Restrictions

Subpart B of the final rule implements the statutory prohibition on proprietary 

trading and the various exemptions to this prohibition included in the statute. Section 

__.3 of the final rule contains the core prohibition on proprietary trading and defines a 
16

number of related terms, including “proprietary trading” and “trading account.” The final 

rule’s definition of proprietary trading generally parallels the statutory definition and 

covers engaging as principal for the trading account of a banking entity in any transaction 

to purchase or sell specified types of financial instruments.36

The final rule’s definition of trading account also is consistent with the statutory 

definition.37 In particular, the definition of trading account in the final rule includes three 

classes of positions. First, the definition includes the purchase or sale of one or more 

financial instruments taken principally for the purpose of short-term resale, benefitting 

from short-term price movements, realizing short-term arbitrage profits, or hedging 

another trading account position.38 For purposes of this part of the definition, the final 

rule also contains a rebuttable presumption that the purchase or sale of a financial 

instrument by a banking entity is for the trading account of the banking entity if the 

banking entity holds the financial instrument for fewer than 60 days or substantially 

transfers the risk of the financial instrument within 60 days of purchase (or sale).39 

Second, with respect to a banking entity subject to the Federal banking agencies’ Market 

Risk Capital Rules, the definition includes the purchase or sale of one or more financial 

instruments subject to the prohibition on proprietary trading that are treated as “covered 

positions and trading positions” (or hedges of other market risk capital rule covered 

positions) under those capital rules, other than certain foreign exchange and commodities 

 

36 See final rule § __.3(a).

37 See final rule § __.3(b).

38 See final rule § __.3(b)(1)(i).

39 See final rule § __.3(b)(2). 
17

positions.40 Third, the definition includes the purchase or sale of one or more financial 

instruments by a banking entity that is licensed or registered or required to be licensed or 

registered to engage in the business of a dealer, swap dealer, or security-based swap 

dealer to the extent the instrument is purchased or sold in connection with the activities 

that require the banking entity to be licensed or registered as such or is engaged in those 

businesses outside of the United States, to the extent the instrument is purchased or sold 

in connection with the activities of such business.41 

The definition of proprietary trading also contains clarifying exclusions for certain 

purchases and sales of financial instruments that generally do not involve the requisite 

short-term trading intent, such as the purchase and sale of financial instruments arising 

under certain repurchase and reverse repurchase arrangements or securities lending 

transactions and securities acquired or taken for bona fide liquidity management 

purposes.

42

In Section __.3, the final rule also defines a number of other relevant terms, 

including the term “financial instrument.” This term is used to define the scope of 

financial instruments subject to the prohibition on proprietary trading. Consistent with 

the statutory language, such financial instruments include securities, derivatives, 

 

40 See final rule § __.3(b)(1)(ii).

41 See final rule § __.3(b)(1)(iii).

42 See final rule § __.3(d).
18

commodity futures, and options on such instruments, but do not include loans, spot 

foreign exchange or spot physical commodities.43

In Section __.4, the final rule implements the statutory exemptions for 

underwriting and market making-related activities. For each of these permitted activities, 

the final rule defines the exempt activity and provides a number of requirements that 

must be met in order for a banking entity to rely on the applicable exemption. As more 

fully discussed below, these include establishment and enforcement of a compliance 

program targeted to the activity; limits on positions, inventory and risk exposure 

addressing the requirement that activities be designed not to exceed the reasonably 

expected near term demands of clients, customers, or counterparties; limits on the 

duration of holdings and positions; defined escalation procedures to change or exceed 

limits; analysis justifying established limits; internal controls and independent testing of 

compliance with limits; senior management accountability and limits on incentive 

compensation. In addition, the final rule requires firms with significant market-making 

or underwriting activities to report data involving several metrics that may be used by the 

banking entity and the Agencies to identify trading activity that may warrant more 

detailed compliance review. 

These requirements are generally designed to ensure that the banking entity’s 

trading activity is limited to underwriting and market making-related activities and does 

not include prohibited proprietary trading.44 These requirements are also intended to 

 

43 See final rule § __.3(c).

44 See final rule § __.4(a), (b).
19

work together to ensure that banking entities identify, monitor and limit the risks 

associated with these activities. 

In Section __.5, the final rule implements the statutory exemption for riskmitigating hedging. As with the underwriting and market-making exemptions, § __.5 of 

the final rule contains a number of requirements that must be met in order for a banking 

entity to rely on the exemption. These requirements are generally designed to ensure that 

the banking entity’s hedging activity is limited to risk-mitigating hedging in purpose and 

effect.45 Section __.5 also requires banking entities to document, at the time the 

transaction is executed, the hedging rationale for certain transactions that present 

heightened compliance risks.46 As with the exemptions for underwriting and market 

making-related activity, these requirements form part of a broader implementation 

approach that also includes the compliance program requirement and the reporting of 

quantitative measurements.

In Section __.6, the final rule implements statutory exemptions for trading in 

certain government obligations, trading on behalf of customers, trading by a regulated 

insurance company, and trading by certain foreign banking entities outside of the United 

States. Section __.6(a) of the final rule describes the government obligations in which a 

banking entity may trade, which include U.S. government and agency obligations, 

obligations and other instruments of specified government sponsored entities, and State 

 

45 See final rule § __.5.

46 See final rule § __.5(c).
20

and municipal obligations.47 Section __.6(b) of the final rule permits trading in certain 

foreign government obligations by affiliates of foreign banking entities in the United 

State and foreign affiliates of a U.S. banking entity abroad.48 Section __.6(c) of the final 

rule describes permitted trading on behalf of customers and identifies the types of 

transactions that would qualify for the exemption.49 Section __.6(d) of the final rule 

describes permitted trading by a regulated insurance company or an affiliate thereof for 

the general account of the insurance company, and also permits those entities to trade for 

a separate account of the insurance company.50 Finally, § __.6(e) of the final rule 

describes trading permitted outside of the United States by a foreign banking entity.51 

The exemption in the final rule clarifies when a foreign banking entity will qualify to 

engage in such trading pursuant to sections 4(c)(9) or 4(c)(13) of the BHC Act, as 

required by the statute, including with respect to a foreign banking entity not currently 

subject to the BHC Act. As explained in detail below, the exemption also provides that 

the risk as principal, the decision-making, and the accounting for this activity must occur 

solely outside of the United States, consistent with the statute.

In Section __.7, the final rule prohibits a banking entity from relying on any 

exemption to the prohibition on proprietary trading if the permitted activity would 

involve or result in a material conflict of interest, result in a material exposure to highrisk assets or high-risk trading strategies, or pose a threat to the safety and soundness of 

 

47 See final rule § __.6(a).

48 See final rule § __.6(b).

49 See final rule § __.6(c).

50 See final rule § __.6(d).

51 See final rule § __.6(e).
21

the banking entity or to the financial stability of the United States.52 This section also 

describes the terms material conflict of interest, high-risk asset, and high-risk trading 

strategy for these purposes.

C. Restrictions on Covered Fund Activities and Investments

Subpart C of the final rule implements the statutory prohibition on, directly or 

indirectly, acquiring and retaining an ownership interest in, or having certain 

relationships with, a covered fund, as well as the various exemptions to this prohibition 

included in the statute. Section __.10 of the final rule contains the core prohibition on 

covered fund activities and investments and defines a number of related terms, including 

“covered fund” and “ownership interest.”53 The definition of covered fund contains a 

number of exclusions for entities that may rely on exclusions from the Investment 

Company Act of 1940 contained in section 3(c)(1) or 3(c)(7) of that Act but that are not 

engaged in investment activities of the type contemplated by section 13 of the BHC Act. 

These include, for example, exclusions for wholly owned subsidiaries, joint ventures,

foreign pension or retirement funds, insurance company separate accounts, and public 

welfare investment funds. The final rule also implements the statutory rule of 

construction in section 13(g)(2) and provides that a securitization of loans, which would 

 

52 See final rule § __.7.

53 See final rule § __.10(b).
22

include loan securitization, qualifying asset backed commercial paper conduit, and 

qualifying covered bonds, is not covered by section 13 or the final rule.54

The definition of “ownership interest” in the final rule provides further guidance 

regarding the types of interests that would be considered to be an ownership interest in a 

covered fund.55 As described in this Supplementary Information, these interests may take 

various forms. The definition of ownership interest also explicitly excludes from the 

definition “restricted profit interest” that is solely performance compensation for services 

provided to the covered fund by the banking entity (or an employee or former employee 

thereof), under certain circumstances.56 Section __.10 of the final rule also defines a 

number of other relevant terms, including the terms “prime brokerage transaction,” 

“sponsor,” and “trustee.”

Section __.11 of the final rule implements the exemption for organizing and 

offering a covered fund provided for under section 13(d)(1)(G) of the BHC Act. Section 

__.11(a) of the final rule outlines the conditions that must be met in order for a banking 

entity to organize and offer a covered fund under this authority. These requirements are 

contained in the statute and are intended to allow a banking entity to engage in certain 

traditional asset management and advisory businesses, subject to certain limits contained 

 

54 The Agencies believe that most securitization transactions are currently structured so that the issuing 

entity with respect to the securitization is not an affiliate of a banking entity under the BHC Act. However, 

with respect to any securitization that is an affiliate of a banking entity and that does not meet the 

requirements of the loan securitization exclusion, the related banking entity will need to determine how to 

bring the securitization into compliance with this rule.

55 See final rule § __.10(d)(6).

56 See final rule § __.10(b)(6)(ii).
23

in section 13 of the BHC Act.57 The requirements are discussed in detail in Part IV.B.2.

of this Supplementary Information. Section __.11 also explains how these requirements 

apply to covered funds that are issuing entities of asset-backed securities, as well as 

implements the statutory exemption for underwriting and market-making ownership 

interests of a covered fund, including explaining the limitations imposed on such 

activities under the final rule. 

In Section __.12, the final rule permits a banking entity to acquire and retain, as 

an investment in a covered fund, an ownership interest in a covered fund that the banking 

entity organizes and offers or holds pursuant to other authority under § __.11.58 This 

section implements section 13(d)(4) of the BHC Act and related provisions. Section 

13(d)(4)(A) of the BHC Act permits a banking entity to make an investment in a covered

fund that the banking entity organizes and offers, or for which it acts as sponsor, for the 

purposes of (i) establishing the covered fund and providing the fund with sufficient initial 

equity for investment to permit the fund to attract unaffiliated investors, or (ii) making a 

de minimis investment in the covered fund in compliance with applicable requirements. 

Section __.12 of the final rule implements this authority and related limitations, including 

limitations regarding the amount and value of any individual per-fund investment and the 

aggregate value of all such permitted investments. In addition, § __.12 requires that the 

aggregate value of all investments in covered funds, plus any earnings on these 

investments, be deducted from the capital of the banking entity for purposes of the 

regulatory capital requirements, and explains how that deduction must occur. Section 

 

57 See 156 Cong. Rec. S5889 (daily ed. July 15, 2010) (statement of Sen. Hagan).

58 See final rule § __.12.
24

__.12 of the final rule also clarifies how a banking entity must calculate its compliance 

with these investment limitations (including by deducting such investments from 

applicable capital, as relevant), and sets forth how a banking entity may request an 

extension of the period of time within which it must conform an investment in a single 

covered fund. This section also explains how a banking entity must apply the covered 

fund investment limits to a covered fund that is an issuing entity of asset backed 

securities or a covered fund that is part of a master-feeder or fund-of-funds structure. 

In Section __.13, the final rule implements the statutory exemptions described in 

sections 13(d)(1)(C), (D), (F), and (I) of the BHC Act that permit a banking entity: (i) to 

acquire and retain an ownership interest in a covered fund as a risk-mitigating hedging 

activity related to employee compensation; (ii) in the case of a non-U.S. banking entity, 

to acquire and retain an ownership interest in, or act as sponsor to, a covered fund solely 

outside the United States; and (iii) to acquire and retain an ownership interest in, or act as 

sponsor to, a covered fund by an insurance company for its general or separate 

accounts.59 

In Section __.14, the final rule implements section 13(f) of the BHC Act and 

generally prohibits a banking entity from entering into certain transactions with a covered 

fund that would be a covered transaction as defined in section 23A of the Federal Reserve 

Act.60 Section __.14(a)(2) of the final rule describes the transactions between a banking 

entity and a covered fund that remain permissible under the statute and the final rule. 

 

59 See final rule § __.13(a) – (c).

60 See 12 U.S.C. 371c; see also final rule § __.14.
25

Section __.14(b) of the final rule implements the statute’s requirement that any 

transaction permitted under section 13(f) of the BHC Act (including a prime brokerage 

transaction) between the banking entity and a covered fund is subject to section 23B of 

the Federal Reserve Act,61 which, in general, requires that the transaction be on market 

terms or on terms at least as favorable to the banking entity as a comparable transaction 

by the banking entity with an unaffiliated third party.

In Section __.15, the final rule prohibits a banking entity from relying on any 

exemption to the prohibition on acquiring and retaining an ownership interest in, acting 

as sponsor to, or having certain relationships with, a covered fund, if the permitted 

activity or investment would involve or result in a material conflict of interest, result in a 

material exposure to high-risk assets or high-risk trading strategies, or pose a threat to the 

safety and soundness of the banking entity or to the financial stability of the United 

States.62 This section also describes material conflict of interest, high-risk asset, and 

high-risk trading strategy for these purposes.

D. Metrics Reporting Requirement

Under the final rule, a banking entity that meets relevant thresholds specified in 

the rule must furnish the following quantitative measurements for each of its trading 

desks engaged in covered trading activity calculated in accordance with Appendix A:

• Risk and Position Limits and Usage;

 

61 12 U.S.C. 371c-1.

62 See final rule § __.15.
26

• Risk Factor Sensitivities;

• Value-at-Risk and Stress VaR;

• Comprehensive Profit and Loss Attribution;

• Inventory Turnover;

• Inventory Aging; and 

• Customer Facing Trade Ratio. 

The final rule raises the threshold for metrics reporting from the proposal to 

capture only firms that engage in significant trading activity, identified at specified 

aggregate trading asset and liability thresholds, and delays the dates for reporting metrics 

through a phased-in approach based on the size of trading assets and liabilities. 

Specifically, the Agencies have delayed the reporting of metrics until June 30, 2014 for 

the largest banking entities that, together with their affiliates and subsidiaries, have 

trading assets and liabilities the average gross sum of which equal or exceed $50 billion 

on a worldwide consolidated basis over the previous four calendar quarters (excluding 

trading assets and liabilities involving obligations of or guaranteed by the United States 

or any agency of the United States). Banking entities with $25 billion or more in trading 

assets and liabilities and banking entities with $10 billion or more in trading assets and 

liabilities would also be required to report these metrics beginning on April 30, 2016, and 

December 31, 2016, respectively. 

Under the final rule, a banking entity required to report metrics must calculate any 

applicable quantitative measurement for each trading day. Each banking entity required 

to report must report each applicable quantitative measurement to its primary supervisory 

Agency on the reporting schedule established in the final rule unless otherwise requested 
27

by the primary supervisory Agency for the entity. The largest banking entities with $50 

billion in consolidated trading assets and liabilities must report the metrics on a monthly 

basis. Other banking entities required to report metrics must do so on a quarterly basis. 

All quantitative measurements for any calendar month must be reported no later than 10 

days after the end of the calendar month required by the final rule unless another time is 

requested by the primary supervisory Agency for the entity except for a transitional six 

month period during which reporting will be required no later than 30 days after the end 

of the calendar month. Banking entities subject to quarterly reporting will be required to 

report quantitative measurements within 30 days of the end of the quarter, unless another 

time is requested by the primary supervisory Agency for the entity in writing.63 

E. Compliance Program Requirement

Subpart D of the final rule requires a banking entity engaged in covered trading 

activities or covered fund activities to develop and implement a program reasonably 

designed to ensure and monitor compliance with the prohibitions and restrictions on 

covered trading activities and covered fund activities and investments set forth in section 

13 of the BHC Act and the final rule.64 To reduce the overall burden of the rule, the final 

rule provides that a banking entity that does not engage in covered trading activities 

(other than trading in U.S. government or agency obligations, obligations of specified 

government sponsored entities, and state and municipal obligations) or covered fund 

 

63 See final rule § __.20(d)(3). The final rule includes a shorter period of time for reporting quantitative 

measurements than was proposed for the largest banking entities. Like the monthly reporting requirement 

for these firms, this is intended to allow for more effective supervision of their large-scale trading 

operations.

64 See final rule § __.20. 
28

activities and investments need only establish a compliance program prior to becoming 

engaged in such activities or making such investments.65 In addition, to reduce the 

burden on smaller banking entities, a banking entity with total consolidated assets of $10 

billion or less that engages in covered trading activities and/or covered fund activities or 

investments may satisfy the requirements of the final rule by including in its existing 

compliance policies and procedures appropriate references to the requirements of section 

13 and the final rule and adjustments as appropriate given the activities, size, scope and 

complexity of the banking entity.66

For banking entities with total assets greater than $10 billion and less than $50 

billion, the final rule specifies six elements that each compliance program established 

under subpart D must, at a minimum, include. These requirements focus on written 

policies and procedures reasonably designed to ensure compliance with the final rules, 

including limits on underwriting and market–making; a system of internal controls; clear 

accountability for compliance and review of limits, hedging, incentive compensation, and 

other matters; independent testing and audits; additional documentation for covered 

funds; training; and recordkeeping requirements. 

A banking entity with $50 billion or more total consolidated assets (or a foreign 

banking entity that has total U.S. assets of $50 billion or more) or that is required to 

report metrics under Appendix A is required to adopt an enhanced compliance program 

with more detailed policies, limits, governance processes, independent testing and 

 

65 See final rule § __.20(f)(1). 

66 See final rule § __.20(f)(2). 
29

reporting. In addition, the Chief Executive Officer of these larger banking entities must 

attest that the banking entity has in place a program reasonably designed to achieve 

compliance with the requirements of section 13 of the BHC Act and the final rule. 

The application of detailed minimum standards for these types of banking entities 

is intended to reflect the heightened compliance risks of large covered trading activities 

and covered fund activities and investments and to provide clear, specific guidance to 

such banking entities regarding the compliance measures that would be required for 

purposes of the final rule. 

IV. Final Rule

A. Subpart B – Proprietary Trading Restrictions

1. Section __.3: Prohibition on Proprietary Trading and Related Definitions

Section 13(a)(1)(A) of the BHC Act prohibits a banking entity from engaging in 

proprietary trading unless otherwise permitted in section 13.67 Section 13(h)(4) of the 

BHC Act defines proprietary trading, in relevant part, as engaging as principal for the 

trading account of the banking entity in any transaction to purchase or sell, or otherwise 

acquire or dispose of, a security, derivative, contract of sale of a commodity for future 

delivery, or other financial instrument that the Agencies include by rule.68 

Section __.3(a) of the proposed rule implemented section 13(a)(1)(A) of the BHC 

Act by prohibiting a banking entity from engaging in proprietary trading unless otherwise 

 

67 12 U.S.C. 1851(a)(1)(A).

68 12 U.S.C. 1851(h)(4).
30

permitted under §§ __.4 through __.6 of the proposed rule. Section __.3(b)(1) of the 

proposed rule defined proprietary trading in accordance with section 13(h)(4) of the BHC 

Act and clarified that proprietary trading does not include acting solely as agent, broker, 

or custodian for an unaffiliated third party. The preamble to the proposed rule explained 

that acting in these types of capacities does not involve trading as principal.69

Several commenters expressed concern about the breadth of the ban on 

proprietary trading.70 Some of these commenters stated that proprietary trading must be 

carefully and narrowly defined to avoid prohibiting activities that Congress did not intend 

to limit and to preclude significant, unintended consequences for capital markets, capital 

formation, and the broader economy.71 Some commenters asserted that the proposed 

definition could result in banking entities being unwilling to take principal risk to provide 

liquidity for institutional investors; could unnecessarily constrain liquidity in secondary 

markets, forcing asset managers to service client needs through alternative non-U.S. 

markets; could impose substantial costs for all institutions, especially smaller and midsize institutions; and could drive risk-taking to the shadow banking system.72 Others 

urged the Agencies to determine that trading as agent, broker, or custodian for an affiliate 

was not proprietary trading.73 

 

69 See Joint Proposal, 76 FR at 68,857.

70 See, e.g., Ass'n. of Institutional Investors (Feb. 2012); Capital Group; Comm. on Capital Markets 

Regulation; IAA; SIFMA et al. (Prop.Trading) (Feb. 2012); SVB; Chamber (Feb. 2012); Wellington. 

71 See Ass'n. of Institutional Investors (Feb. 2012); GE (Feb. 2012); Invesco; Sen. Corker; Chamber (Feb. 

2012). 

72 See Chamber (Feb. 2012).

73 See Japanese Bankers Ass'n. 
31

Commenters also suggested alternative approaches for defining proprietary 

trading. In general, these approaches sought to provide a bright-line definition to provide 

increased certainty to banking entities74 or make the prohibition easier to apply in 

practice.75 One commenter stated the Agencies should focus on the economics of 

banking entities’ transactions and ban trading if the banking entity is exposed to market 

risk for a significant period of time or is profiting from changes in the value of the 

asset.76 Several commenters, including individual members of the public, urged the 

Agencies to prohibit banking entities from engaging in any kind of proprietary trading 

and require separation of trading from traditional banking activities.77 After carefully 

considering comments, the Agencies are defining proprietary trading as engaging as 

principal for the trading account of the banking entity in any purchase or sale of one or 

more financial instruments.78 The Agencies believe this effectively restates the statutory 

definition. The Agencies are not adopting commenters’ suggested modifications to the 

proposed definition of proprietary trading or the general prohibition on proprietary 

trading because they generally appear to be inconsistent with Congressional intent. For 

 

74 See, e.g., ABA (Keating); Ass'n. of Institutional Investors (Feb. 2012); BOK; George Bollenbacher; 

Credit Suisse (Seidel); NAIB et al.; SSgA (Feb. 2012); JPMC. 

75 See Public Citizen.

76 See Sens. Merkley & Levin (Feb. 2012).

77 See generally Occupy; Public Citizen; AFR et al. (Feb. 2012). The Agencies received over fifteen 

thousand form letters in support of a rule with few exemptions, many of which expressed a desire to return 

to the regulatory scheme as governed by the Glass-Steagall affiliation provisions of the U.S. Banking Act 

of 1933, as repealed through the Graham-Leach-Bliley Act of 1999. See generally Sarah McGee; 

Christopher Wilson; Michael Itlis; Barry Rein; Edward Bright. Congress rejected such an approach, 

however, opting instead for the more narrowly tailored regulatory approach embodied in section 13 of the 

BHC Act. 

78 See final rule §__.3(a). The final rule also replaces all references to the proposed term “covered 

financial position” with the term “financial instrument.” This change has no substantive impact because 

the definition of “financial instrument” is substantially identical to the proposed definition of “covered 

financial position.” Consistent with this change, the final rule replaces the undefined verbs “acquire” or 

“take” with the defined terms “purchase” or “sale” and “sell.” See final rule §§ __.3(c), __.2(u), (x).
32

instance, some commenters appeared to suggest an approach to defining proprietary 

trading that would capture only bright-line, speculative proprietary trading and treat the 

activities covered by the statutory exemptions as completely outside the rule.79 However, 

such an approach would appear to be inconsistent with Congressional intent because, for 

instance, it would not give effect to the limitations on permitted activities in section 13(d) 

of the BHC Act.80 For similar reasons, the Agencies are not adopting a bright-line 

definition of proprietary trading.81 

A number of commenters expressed concern that, as a whole, the proposed rule 

may result in certain negative economic impacts, including: (i) reduced market 

liquidity;82 (ii) wider spreads or otherwise increased trading costs;83 (iii) higher 

borrowing costs for businesses or increased cost of capital;84 and/or (iv) greater market 

 

79 See, e.g., Ass'n. of Institutional Investors (Feb. 2012); GE (Feb. 2012); Invesco; Sen. Corker; Chamber 

(Feb. 2012); JPMC.

80 See 156 Cong. Rec. S5895-96 (daily ed. July 15, 2010) (statement of Sen. Merkley) (stating the statute 

“permits underwriting and market-making-related transactions that are technically trading for the account 

of the firm but, in fact, facilitate the provision of near-term client-oriented financial services.”).

81 See ABA (Keating); Ass'n. of Institutional Investors (Feb. 2012); BOK; George Bollenbacher; Credit 

Suisse (Seidel); NAIB et al.; SSgA (Feb. 2012); JPMC.

82 See, e.g., AllianceBernstein; Obaid Syed; Rep. Bachus et al.; EMTA; NASP; Sen. Hagan; Investure; 

Lord Abbett; Sumitomo Trust; EFAMA; Morgan Stanley; Barclays; BoA; Citigroup (Feb. 2012); STANY; 

ABA (Keating); ICE; ICSA; SIFMA (Asset Mgmt.) (Feb. 2012); Putnam; ACLI (Feb. 2012); Wells Fargo 

(Prop. Trading); Capital Group; RBC; Columbia Mgmt.; SSgA (Feb. 2012); Fidelity; ICI (Feb. 2012); 

ISDA (Feb. 2012); Comm. on Capital Markets Regulation; Clearing House Ass'n.; Thakor Study. See also

CalPERS (acknowledging that the systemic protections afforded by the Volcker Rule come at a price, 

including reduced liquidity to all markets). 

83 See, e.g., AllianceBernstein; Obaid Syed; NASP; Investure; Lord Abbett; CalPERS; Credit Suisse 

(Seidel); Citigroup (Feb. 2012); ABA (Keating); SIFMA (Asset Mgmt.) (Feb. 2012); Putnam; Wells Fargo 

(Prop. Trading); Comm. on Capital Markets Regulation. 

84 See, e.g., Rep. Bachus et al.; Members of Congress (Dec. 2011); Lord Abbett; Morgan Stanley; 

Barclays; BoA; Citigroup (Feb. 2012); ABA (Abernathy); ICSA; SIFMA (Asset Mgmt.) (Feb. 2012); 

Chamber (Feb. 2012); Putnam; ACLI (Feb. 2012); UBS; Wells Fargo (Prop. Trading); Capital Group; Sen. 

Carper et al.; Fidelity; Invesco; Clearing House Ass'n.; Thakor Study.
33

volatility.85 The Agencies have carefully considered commenters’ concerns about the 

proposed rule’s potential impact on overall market liquidity and quality. As discussed in 

more detail in Parts IV.A.2. and IV.A.3., the final rule will permit banking entities to 

continue to provide beneficial market-making and underwriting services to customers, 

and therefore provide liquidity to customers and facilitate capital-raising. However, the 

statute upon which the final rule is based prohibits proprietary trading activity that is not 

exempted. As such, the termination of non-exempt proprietary trading activities of 

banking entities may lead to some general reductions in liquidity of certain asset classes.

Although the Agencies cannot say with any certainty, there is good reason to believe that 

to a significant extent the liquidity reductions of this type may be temporary since the 

statute does not restrict proprietary trading activities of other market participants.86 Thus, 

over time, non-banking entities may provide much of the liquidity that is lost by 

restrictions on banking entities’ trading activities. If so, eventually, the detrimental 

effects of increased trading costs, higher costs of capital, and greater market volatility 

should be mitigated. 

 

85 See, e.g., CalPERS (expressing the belief that a decline in banking entity proprietary trading will 

increase the volatility of the corporate bond market, especially during times of economic weakness or 

periods where risk taking declines, but noting that portfolio managers have experienced many different 

periods of market illiquidity and stating that the market will adapt post-implementation (e.g., portfolio 

managers will increase their use of CDS to reduce economic risk to specific bond positions as the 

liquidation process of cash bonds takes more time, alternative market matching networks will be 

developed)); Morgan Stanley; Capital Group; Fidelity; British Bankers' Ass'n.; Invesco.

86 See David McClean; Public Citizen; Occupy. In response to commenters who expressed concern about 

risks associated with proprietary trading activities moving to non-banking entities, the Agencies note that 

section 13’s prohibition on proprietary trading and related exemptions apply only to banking entities. See,

e.g., Chamber (Feb. 2012).
34

To respond to concerns raised by commenters while remaining consistent with 

Congressional intent, the final rule has been modified to provide that certain purchases 

and sales are not proprietary trading as described in more detail below.87 

a. Definition of “Trading Account”

As explained above, section 13 defines proprietary trading as engaging as 

principal “for the trading account of the banking entity” in certain types of transactions. 

Section 13(h)(6) of the BHC Act defines trading account as any account used for 

acquiring or taking positions in financial instruments principally for the purpose of 

selling in the near-term (or otherwise with the intent to resell in order to profit from shortterm price movements), and any such other accounts as the Agencies may, by rule, 

determine.88 

The proposed rule defined trading account to include three separate accounts. 

First, the proposed definition of trading account included, consistent with the statute, any 

account that is used by a banking entity to acquire or take one or more covered financial 

positions for short-term trading purposes (the “short-term trading account”).89 The 

proposed rule identified four purposes that would indicate short-term trading intent: (i) 

short-term resale; (ii) benefitting from actual or expected short-term price movements; 

(iii) realizing short-term arbitrage profits; or (iv) hedging one or more positions described 

in (i), (ii) or (iii). The proposed rule presumed that an account is a trading account if it is 

 

87 See final rule § __.3(d). 

88 See 12 U.S.C. 1851(h)(6).

89 See proposed rule § __.3(b)(2)(i)(A).
35

used to acquire or take a covered financial position (other than a position in the market 

risk rule trading account or the dealer trading account) that the banking entity holds for 

60 days or less.90 

Second, the proposed definition of trading account included, for certain entities, 

any account that contains positions that qualify for trading book capital treatment under 

the banking agencies’ market risk capital rules other than positions that are foreign 

exchange derivatives, commodity derivatives or contracts of sale of a commodity for 

delivery (the “market risk rule trading account”).91 “Covered positions” under the 

banking agencies’ market-risk capital rules are positions that are generally held with the 

intent of sale in the short-term.

Third, the proposed definition of trading account included any account used by a 

banking entity that is a securities dealer, swap dealer, or security-based swap dealer to 

acquire or take positions in connection with its dealing activities (the “dealer trading 

account”).92 The proposed rule also included as a trading account any account used to 

acquire or take any covered financial position by a banking entity in connection with the 

activities of a dealer, swap dealer, or security-based swap dealer outside of the United 

States.93 Covered financial positions held by banking entities that register or file notice 

as securities or derivatives dealers as part of their dealing activity were included because 

 

90 See proposed rule § __.3(b)(2)(ii).

91 See proposed rule §§ __.3(b)(2)(i)(B); __.3(b)(3). 

92 See proposed rule § __.3(b)(2)(i)(C).

93 See proposed rule § __.3(b)(2)(i)(C)(5).
36

such positions are generally held for sale to customers upon request or otherwise support 

the firm’s trading activities (e.g., by hedging its dealing positions).94 

The proposed rule also set forth four clarifying exclusions from the definition of 

trading account. The proposed rule provided that no account is a trading account to the 

extent that it is used to acquire or take certain positions under repurchase or reverse 

repurchase arrangements, positions under securities lending transactions, positions for 

bona fide liquidity management purposes, or positions held by derivatives clearing 

organizations or clearing agencies.95 

Overall, commenters did not raise significant concerns with or objections to the 

short-term trading account. Several commenters argued that the definition of trading 

account should be limited to only this portion of the proposed definition of trading 

account.96 However, a few commenters raised concerns regarding the treatment of 

arbitrage trading under the proposed rule.97 Several commenters asserted that the 

proposed definition of trading account was too broad and covered trading not intended to 

be covered by the statute.98 Some of these commenters maintained that the Agencies 

exceeded their statutory authority under section 13 of the BHC Act in defining trading 

account to include the market risk rule trading account and dealer trading account, and 

 

94 See Joint Proposal, 76 FR 68,860.

95 See proposed rule § __.3(b)(2)(iii).

96 See ABA (Keating); JPMC.

97 See AFR et al. (Feb. 2012); Paul Volcker; Credit Suisse (Seidel); ISDA (Feb. 2012); Japanese Bankers Ass'n.

98 See ABA (Keating); Allen & Overy (on behalf of Large Int'l Banks with U.S. Operations); Am. Express; 

BoA; Goldman (Prop. Trading); ISDA (Feb. 2012); Japanese Bankers Ass'n.; JPMC; SIFMA et al.

(Prop.Trading) (Feb. 2012); State Street (Feb. 2012).
37

argued that the definition should be limited to the short-term trading account definition.99 

Commenters argued, for example, that an overly broad definition of trading account may 

cause traditional bank activities important to safety and soundness of a banking entity to 

fall within the prohibition on proprietary trading to the detriment of banking 

organizations, customers, and financial markets.100 A number of commenters suggested 

modifying and narrowing the trading account definition to remove the implicit negative 

presumption that any position creates a trading account, or that all principal trading 

constitutes prohibited proprietary trading unless it qualifies for a narrowly tailored 

exemption, and to clearly exempt activities important to safety and soundness.101 For 

example, one commenter recommended that a covered financial position be considered a 

trading account position only if it qualifies as a GAAP trading position.102 A few 

commenters requested the Agencies define the phrase “short term” in the rule.103

Several commenters argued that the market risk rule should not be referenced as 

part of the definition of trading account.104 A few of these commenters argued instead 

that the capital treatment of a position be used only as an indicative factor rather than a 

dispositive test.105 One commenter thought that the market risk rule trading account was 

 

99 See ABA (Keating); JPMC; SIFMA et al. (Prop.Trading) (Feb. 2012); State Street (Feb. 2012). 

100 See ABA (Keating); Credit Suisse (Seidel). 

101 See ABA (Keating); Ass'n .of Institutional Investors (Feb. 2012); BoA; Capital Group; IAA; Credit 

Suisse (Seidel); ICI (Feb. 2012); ISDA (Feb. 2012); NAIB et al.; SIFMA et al. (Prop.Trading) (Feb. 2012); 

SVB; Wellington. 

102 See ABA (Keating). 

103 See NAIB et al.; Occupy; but See Alfred Brock.

104 See ABA; BoA; Goldman (Prop. Trading); ISDA (Feb. 2012); JPMC; SIFMA et al. (Prop.Trading) (Feb. 2012). 

105 See BoA; SIFMA et al. (Prop.Trading) (Feb. 2012).
38

redundant because it includes only positions that have short-term trading intent.106 

Commenters also contended that it was difficult to consider and comment on this aspect 

of the proposal because the market risk capital rules had not been finalized.107 

A number of commenters objected to the dealer trading account prong of the 

definition.108 Commenters asserted that this prong was an unnecessary and unhelpful 

addition that went beyond the requirements of section 13 of the BHC Act, and that it 

made the trading account determination more complex and difficult.109 In particular, 

commenters argued that the dealer trading account was too broad and introduced 

uncertainty because it presumed that dealers always enter into positions with short-term 

intent.110 Commenters also expressed concern about the difficulty of applying this test 

outside the United States and requested that, if this account is retained, the final rule be 

explicit about how it applies to a swap dealer outside the United States and treat U.S. 

swap dealers consistently.111

 

106 See ISDA (Feb. 2012).

107 See ABA (Keating); BoA; Goldman (Prop. Trading); ISDA (Feb. 2012); JPMC. The banking agencies 

adopted a final rule that amends their respective market risk capital rules on August 30, 2012. See 77 FR 

53,060 (Aug. 30, 2012). The Agencies continued to receive and consider comments on the proposed rule to 

implement section 13 of the BHC Act after that time. 

108 See ABA (Keating); Allen & Overy (on behalf of Large Int'l Banks with U.S. Operations); Am.

Express; Goldman (Prop. Trading); ISDA (Feb. 2012); Japanese Bankers Ass'n.; JPMC; SIFMA et al.

(Prop.Trading) (Feb. 2012).

109 See ABA (Keating); Allen & Overy (on behalf of Large Int'l Banks with U.S. Operations); JPMC; State 

Street (Feb. 2012); ISDA (Feb. 2012); SIFMA et al. (Prop.Trading) (Feb. 2012). 

110 See ABA (Keating); Am. Express; Goldman (Prop. Trading); ISDA (Feb. 2012); JPMC. 

111 See Allen & Overy (on behalf of Large Int'l Banks with U.S. Operations); Am. Express; JPMC.
39

In contrast, other commenters contended that the proposed rule’s definition of 

trading account was too narrow, particularly in its focus on short-term positions,112or 

should be simplified.113 One commenter argued that the breadth of the trading account 

definition was critical because positions excluded from the trading account definition 

would not be subject to the proposed rule.114 One commenter supported the proposed 

definition of trading account.115 Other commenters believed that reference to the marketrisk rule was an important addition to the definition of trading account. Some expressed 

the view that it should include all market risk capital rule covered positions and not just 

those requiring short-term trading intent.116

Certain commenters proposed alternate definitions. Several commenters argued 

against using the term “account” and instead advocated applying the prohibition on 

proprietary trading to trading positions.117 Foreign banks recommended applying the 

definition of trading account applicable to such banks in their home country, if the home 

country provided a clear definition of this term.118 These commenters argued that new 

definitions in the proposed rule, like trading account, would require foreign banking 

entities to develop new and complex procedures and expensive systems.119

 

112 See Sens. Merkley & Levin (Feb. 2012); Occupy.

113 See, e.g., Public Citizen.

114 See AFR et al. (Feb. 2012).

115 See Alfred Brock.

116 See AFR et al. (Feb. 2012).

117 See ABA (Keating); Goldman (Prop. Trading); NAIB et al.

118 See Japanese Bankers Ass'n.; Norinchukin.

119 See Japanese Bankers Ass'n.
40

Commenters also argued that various types of trading activities should be 

excluded from the trading account definition. For example, one commenter asserted that 

arbitrage trading should not be considered trading account activity,120 while other 

commenters argued that arbitrage positions and strategies are proprietary trading and 

should be included in the definition of trading account and prohibited by the final rule.121 

Another commenter argued that the trading account should include only positions 

primarily intended, when the position is entered into, to profit from short-term changes in 

the value of the assets, and that liquidity investments that do not have price changes and 

that can be sold whenever the banking entity needs cash should be excluded from the 

trading account definition.122 

After carefully reviewing the comments, the Agencies have determined to retain 

in the final rule the proposed approach for defining trading account that includes the 

short-term, market risk rule, and dealer trading accounts with modifications to address 

issues raised by commenters. The Agencies believe that this multi-prong approach is 

consistent with both the language and intent of section 13 of the BHC Act, including the 

express statutory authority to include “any such other account” as determined by the 

Agencies.123 The final definition effectuates Congress’s purpose to generally focus on 

short-term trading while addressing commenters’ desire for greater certainty regarding 

 

120 See Alfred Brock.

121 See AFR et al. (Feb. 2012); Paul Volcker. 

122 See NAIB et al. See infra Part IV.A.1.d.2. (discussing the liquidity management exclusion).

123 12 U.S.C. 1851(h)(6).
41

the definition of the trading account.124 In addition, the Agencies believe commenters’ 

concerns about the scope of the proposed definition of trading account are substantially 

addressed by the refined exemptions in the final rule for customer-oriented activities, 

such as market making-related activities, and the exclusions from proprietary trading.125 

Moreover, the Agencies believe that it is appropriate to focus on the economics of a 

banking entity’s trading activity to help determine whether it is engaged in proprietary 

trading, as discussed further below.126 

As explained above, the short-term trading prong of the definition largely 

incorporates the statutory provisions. This prong covers trading involving short-term 

resale, price movements, and arbitrage profits, and hedging positions that result from 

these activities. Specifically, the reference to short-term resale is taken from the statute’s 

definition of trading account. The Agencies continue to believe it is also appropriate to 

include in the short-term trading prong an account that is used by a banking entity to 

purchase or sell one or more financial instruments principally for the purpose of 

benefitting from actual or expected short-term price movements, realizing short-term 

arbitrage profits, or hedging one or more positions captured by the short-term trading 

 

124 In response to commenters’ concerns about the meaning of account, the Agencies note the term “trading 

account” is a statutory concept and does not necessarily refer to an actual account. Trading account is 

simply nomenclature for the set of transactions that are subject to the final rule’s restrictions on proprietary 

trading. See ABA (Keating); Goldman (Prop. Trading); NAIB et al.

125 For example, several commenters’ concerns about the potential impact of the proposed definition of 

trading account were tied to the perceived narrowness of the proposed exemptions. See ABA (Keating); 

Ass'n. of Institutional Investors (Feb. 2012); BoA; Capital Group; IAA; Credit Suisse (Seidel); ICI (Feb. 

2012); ISDA (Feb. 2012); NAIB et al.; SIFMA et al. (Prop.Trading) (Feb. 2012); SVB; Wellington.

126 See Sens. Merkley & Levin (Feb. 2012). However, as discussed in this Supplementary Information, 

the Agencies are not prohibiting any trading that involves profiting from changes in the value of the asset, 

as suggested by this commenter, because permitted activities, such as market making, can involve price 

appreciation-related revenues. See infra Part IV.A.3. (discussing the final market-making exemption).
42

prong. The provisions regarding price movements and arbitrage focus on the intent to 

engage in transactions to benefit from short-term price movements (e.g., entering into a 

subsequent transaction in the near term to offset or close out, rather than sell, the risks of 

a position held by the banking entity to benefit from a price movement occurring between 

the acquisition of the underlying position and the subsequent offsetting transaction) or to 

benefit from differences in multiple market prices, including scenarios where movement 

in those prices is not necessary to realize the intended profit.127 These types of 

transactions are economically equivalent to transactions that are principally for the 

purpose of selling in the near term or with the intent to resell to profit from short-term 

price movements, which are expressly covered by the statute’s definition of trading 

account. Thus, the Agencies believe it is necessary to include these provisions in the 

final rule’s short-term trading prong to provide clarity about the scope of the definition 

and to prevent evasion of the statute and final rule.128 In addition, like the proposed rule, 

the final rule’s short-term trading prong includes hedging one or more of the positions 

captured by this prong because the Agencies assume that a banking entity generally 

intends to hold the hedging position for only so long as the underlying position is held. 

The remaining two prongs to the trading account definition apply to types of 

entities that engage actively in trading activities. Each prong focuses on analogous or 

parallel short-term trading activities. A few commenters stated these prongs were 

duplicative of the short-term trading prong, and argued the Agencies should not include 

these prongs in the definition of trading account, or should only consider them as non-

 

127 See Joint Proposal, 76 FR at 68,857-68,858. 

128 As a result, the Agencies are not excluding arbitrage trading from the trading account definition, as 

suggested by at least one commenter. See, e.g., Alfred Brock.
43

determinative factors.129 To the extent that an overlap exists between the prongs of this 

definition, the Agencies believe they are mutually reinforcing, strengthen the rule’s 

effectiveness, and may help simplify the analysis of whether a purchase or sale is 

conducted for the trading account.130

The market risk capital prong covers trading positions that are covered positions 

for purposes of the banking agency market-risk capital rules, as well as hedges of those 

positions. Trading positions under those rules are positions held by the covered entity 

“for the purpose of short-term resale or with the intent of benefitting from actual or 

expected short-term price movements, or to lock-in arbitrage profits.”131 This definition 

largely parallels the provisions of section 13(h)(4) of the BHC Act and mirrors the shortterm trading account prong of both the proposed and final rules. Covered positions are 

trading positions under the rule that subject the covered entity to risks and exposures that 

must be actively managed and limited – a requirement consistent with the purposes of the 

section 13 of the BHC Act. 

Incorporating this prong into the trading account definition reinforces the 

consistency between governance of the types of positions that banking entities identify as 

“trading” for purposes of the market risk capital rules and those that are trading for 

purposes of the final rule under section 13 of the BHC Act. Moreover, this aspect of the 

final rule reduces the compliance burden on banking entities with substantial trading 

 

129 See ISDA (Feb. 2012); JPMC; ABA (Keating); BoA; SIFMA et al. (Prop.Trading) (Feb. 2012).

130 See Occupy.

131 12 CFR 225, Appendix E.
44

activities by establishing a clear, bright-line rule for determining that a trade is within the 

trading account.132 

After reviewing comments, the Agencies also continue to believe that financial 

instruments purchased or sold by registered dealers in connection with their dealing 

activity are generally held with short-term intent and should be captured within the 

trading account. The Agencies believe the scope of the dealer prong is appropriate 

because, as noted in the proposal, positions held by a registered dealer in connection 

with its dealing activity are generally held for sale to customers upon request or otherwise 

support the firm’s trading activities (e.g., by hedging its dealing positions), which is 

indicative of short-term intent.133 Moreover, the final rule includes a number of 

exemptions for the activities in which securities dealers, swap dealers, and security-based 

swap dealers typically engage, such as market making, hedging, and underwriting. Thus, 

the Agencies believe the broad scope of the dealer trading account is balanced by the 

exemptions that are designed to permit dealer entities to continue to engage in customeroriented trading activities, consistent with the statute. This approach is designed to 

ensure that registered dealer entities are engaged in permitted trading activities, rather 

than prohibited proprietary trading. 

The final rule adopts the dealer trading account substantially as proposed,134 with 

streamlining that eliminates the specific references to different types of securities and 

derivatives dealers. The final rule adopts the proposed approach to covering trading 

 

132 Accordingly, the Agencies are not using a position’s capital treatment as merely an indicative factor, as 

suggested by a few commenters.

133 See Joint Proposal, 76 FR at 68,860.

134 See final rule § __.3(b)(1)(iii).
45

accounts of banking entities that regularly engage in the business of a dealer, swap dealer, 

or security-based swap dealer outside of the United States. In the case of both domestic 

and foreign entities, this provision applies only to financial instruments purchased or sold 

in connection with the activities that require the banking entity to be licensed or 

registered to engage in the business of dealing, which is not necessarily all of the 

activities of that banking entity.135 Activities of a banking entity that are not covered by 

the dealer prong may, however, be covered by the short-term or market risk rule trading 

accounts if the purchase or sale satisfies the requirements of §§ __.3(b)(1)(i) or (ii).

136

A few commenters stated that they do not currently analyze whether a particular

activity would require dealer registration, so the dealer prong of the trading account 

definition would require banking entities to engage in a new type of analysis.137 The 

Agencies recognize that banking entities that are registered dealers may not currently 

engage in such an analysis with respect to their current trading activities and, thus, this 

may represent a new regulatory requirement for these entities. If the regulatory analysis 

otherwise engaged in by banking entities is substantially similar to the dealer prong 

 

135 An insured depository institution may be registered as a swap dealer, but only the swap dealing 

activities that require it to be so registered are covered by the dealer trading account. If an insured 

depository institution purchases or sells a financial instrument in connection with activities of the insured 

depository institution that do not trigger registration as a swap dealer, such as lending, deposit-taking, the 

hedging of business risks, or other end-user activity, the financial instrument is included in the trading 

account only if the instrument falls within the statutory trading account under § __.3(b)(1)(i) or the market 

risk rule trading account under § __.3(b)(1)(ii) of the final rule.

136 See final rule §§ __.3(b)(1)(i) and (ii).

137 See, e.g., SIFMA et al. (Prop.Trading) (Feb. 2012); Goldman (Prop. Trading).
46

analysis required under the trading account definition, then any increased compliance 

burden could be small or insubstantial.138

In response to commenters’ concerns regarding the application of this prong to 

banking entities acting as dealers in jurisdictions outside the United States,139 the 

Agencies continue to believe including the activities of a banking entity engaged in the 

business of a dealer, swap dealer, or 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, is appropriate. As noted above, dealer activity generally involves shortterm trading. Further, the Agencies are concerned that differing requirements for U.S. 

and foreign dealers may lead to regulatory arbitrage. For foreign banking entities acting 

as dealers outside of the United States that are eligible for the exemption for trading 

conducted by foreign banking entities, the Agencies believe the risk-based approach to 

this exemption in the final rule should help address the concerns about the scope of this 

prong of the definition.140 

In response to one commenter’s suggestion that the Agencies define the term 

trading account to allow a foreign banking entity to use of the relevant foreign regulator’s 

definition of this term, where available, the Agencies are concerned such an approach 

could lead to regulatory arbitrage and otherwise inconsistent applications of the rule.141 

 

138 See, e.g., Goldman (Prop. Trading) (“For instance, a banking entity’s market making-related activities 

with respect to credit trading may involve making a market in bonds (traded in a broker-dealer), singlename CDSs (in a security-based swap dealer) and CDS indexes (in a swap dealer). For regulatory or other 

reasons, these transactions could take place in different legal entities...”). 

139 See SIFMA et al. (Prop.Trading) (Feb. 2012); JPMC; Allen & Overy (on behalf of Large Int'l Banks 

with U.S. Operations).

140 See final rule § __.6(e).

141 See Japanese Bankers Ass'n.
47

The Agencies believe this commenter’s general concern about the impact of the statute 

and rule on foreign banking entities’ activities outside the United States should be 

substantially addressed by the exemption for trading conducted by foreign banking 

entities under § __.6(e) of the final rule.

Finally, the Agencies have declined to adopt one commenter’s recommendation 

that a position in a financial instrument be considered a trading account position only if it 

qualifies as a GAAP trading position.142 The Agencies continue to believe that formally 

incorporating accounting standards governing trading securities is not appropriate 

because: (i) the statutory proprietary trading provisions under section 13 of the BHC Act 

applies to financial instruments, such as derivatives, to which the trading security 

accounting standards may not apply; (ii) these accounting standards permit companies to 

classify, at their discretion, assets as trading securities, even where the assets would not 

otherwise meet the definition of trading securities; and (iii) these accounting standards 

could change in the future without consideration of the potential impact on section 13 of 

the BHC Act and these rules.143

b. Rebuttable Presumption for the Short-Term Trading Account

The proposed rule included a rebuttable presumption clarifying when a covered 

financial position, by reason of its holding period, is traded with short-term intent for 

purposes of the short-term trading account. The Agencies proposed this presumption 

primarily to provide guidance to banking entities that are not subject to the market risk 

capital rules or are not covered dealers or swap entities and accordingly may not have 

 

142 See ABA (Keating).

143 See Joint Proposal, 76 FR at 68,859.
48

experience evaluating short-term trading intent. In particular, § __.3(b)(2)(ii) of the 

proposed rule provided that an account would be presumed to be a short-term trading 

account if it was used to acquire or take a covered financial position that the banking 

entity held for a period of 60 days or less. 

Several commenters supported the rebuttable presumption, but suggested either 

shortening the holding period to 30 days or less,144 or extending the period to 90 days,145

to several months,146 or to one year.147 Some of these commenters argued that specifying 

an overly short holding period would be contrary to the statute, invite gamesmanship,148

and miss speculative positions held for longer than the specified period.149 Commenters 

also suggested turning the presumption into a safe harbor150 or into guidance.151 

Other commenters opposed the inclusion of the rebuttable presumption for a 

number of reasons and requested that it be removed.152 For example, these commenters 

argued that the presumption had no statutory basis;153 was arbitrary;154 was not supported 

 

144 See Japanese Bankers Ass'n.

145 See Capital Group.

146 See AFR et al. (Feb. 2012).

147 See Sens. Merkley & Levin (Feb. 2012); Public Citizen (arguing that one-year demarks tax law 

covering short term capital gains).

148 See Sens. Merkley & Levin (Feb. 2012). 

149 See Occupy.

150 See Capital Group.

151 See SIFMA et al. (Prop.Trading) (Feb. 2012).

152 See ABA (Keating); Am. Express; Business Roundtable; Capital Group; ICI (Feb. 2012); Investure; 

JPMC; Liberty Global; STANY; Chamber (Feb. 2012). 

153 See ABA (Keating); JPMC; Chamber (Feb. 2012).

154 See Am. Express; ICI (Feb. 2012).
49

by data, facts, or analysis;155 would dampen market-making and underwriting activity;156

or did not take into account the nature of trading in different types of securities.157 Some 

commenters also questioned whether the Agencies would interpret rebuttals of the 

presumption consistently,158 and stressed the difficulty and costliness of rebutting the 

presumption,159 such as enhanced documentation or other administrative burdens.160 One 

foreign banking association also argued that requiring foreign banking entities to rebut a 

U.S. regulatory requirement would be costly and inappropriate given that the trading 

activities of the banking entity are already reviewed by home country supervisors.161 

This commenter also contended that the presumption could be problematic for financial 

instruments purchased for long-term investment purposes that are closed within 60 days 

due to market fluctuations or other changed circumstances.162

After carefully considering the comments received, the Agencies continue to 

believe the rebuttable presumption is appropriate to generally define the meaning of 

 

155 See ABA (Keating); Chamber (Feb. 2012).

156 See AllianceBernstein; Business Roundtable; ICI (Feb. 2012); Investure; Liberty Global; STANY. 

Because the rebuttable presumption does not impact the availability of the exemptions for underwriting, 

market making, and other permitted activities, the Agencies do not believe this provision creates any 

additional burdens on permissible activities.

157 See Am. Express (noting that most foreign exchange forward transactions settle in less than one week 

and are used as commercial payment instruments, and not speculative trades); Capital Group. 

158 See ABA (Keating). As discussed below in Part IV.C., the Agencies expect to continue to coordinate 

their supervisory efforts related to section 13 of the BHC Act and to share information as appropriate in 

order to effectively implement the requirements of that section and the final rule.

159 See ABA (Keating); AllianceBernstein; Capital Group; Japanese Bankers Ass'n.; Liberty Global; 

JPMC.

160 See NAIB et al.; Capital Group.

161 See Japanese Bankers Ass'n. As noted above, the Agencies believe concerns about the impacts of the 

definition of trading account on foreign banking entity trading activity outside of the United States are 

substantially addressed by the final rule’s exemption for proprietary trading conducted by foreign banking 

entities in final rule § __.6(e).

162 Id.
50

“short-term” for purposes of the short-term trading account, especially for small and 

regional banking entities that are not subject to the market risk capital rules and are not 

registered dealers or swap entities. The range of comments the Agencies received on 

what “short-term” should mean – from 30 days to one year – suggests that a clear 

presumption would ensure consistency in interpretation and create a level playing field 

for all banking entities with covered trading activities subject to the short-term trading 

account. Based on their supervisory experience, the Agencies find that 60 days is an 

appropriate cut off for a regulatory presumption.163 Further, because the purpose of the 

rebuttable presumption is to simplify the process of evaluating whether individual 

positions are included in the trading account, the Agencies believe that implementing 

different holding periods based on the type of financial instrument would insert 

unnecessary complexity into the presumption.164 The Agencies are not providing a safe 

harbor or a reverse presumption (i.e., a presumption for positions that are outside of the 

trading account), as suggested by some commenters, in recognition that some proprietary 

trading could occur outside of the 60 day period.165

Adopting a presumption allows the Agencies and affected banking entities to 

evaluate all the facts and circumstances surrounding trading activity in determining 

whether the activity implicates the purpose of the statute. For example, trading in a 

financial instrument for long-term investment that is disposed of within 60 days because 

 

163 See final rule §__.3(b)(2). Commenters did not provide persuasive evidence of the benefits associated 

with a rebuttable presumption for positions held for greater or fewer than 60 days.

164 See, e.g., Am. Express; Capital Group; Sens. Merkley & Levin (Feb. 2012).

165 See Capital Group; AFR et al. (Feb. 2012); Sens. Merkley & Levin (Feb. 2012); Public Citizen; 

Occupy.
51

of unexpected developments (e.g., an unexpected increase in the financial instrument’s 

volatility or a need to liquidate the instrument to meet unexpected liquidity demands) 

may not be trading activity covered by the statute. To reduce the costs and burdens of 

rebutting the presumption, the Agencies will allow a banking entity to rebut the 

presumption for a group of related positions.166 

The final rule provides three clarifying changes to the proposed rebuttable 

presumption. First, in response to comments, the final rule replaces the reference to an 

“account” that is presumed to be a trading account with the purchase or sale of a 

“financial instrument.”167 This change clarifies that the presumption only applies to the 

purchase or sale of a financial instrument that is held for fewer than 60 days, and not the 

entire account that is used to make the purchase or sale. Second, the final rule clarifies 

that basis trades, in which a banking entity buys one instrument and sells a substantially 

similar instrument (or otherwise transfers the first instrument’s risk), are subject to the 

rebuttable presumption.168 Third, in order to maintain consistency with definitions used 

throughout the final rule, the references to “acquire” or “take” a financial position have 

been replaced with references to “purchase” or “sell” a financial instrument.169 

 

166 The Agencies believe this should help address commenters’ concerns about the burdens associated with 

rebutting the presumption. See ABA (Keating); AllianceBernstein; Capital Group; Japanese Bankers 

Ass'n.; Liberty Global; JPMC; NAIB et al.; Capital Group.

167 See, e.g., ABA (Keating); Clearing House Ass'n.; JPMC.

168 The rebuttable presumption covered these trades in the proposal, but the final rule’s use of “financial 

instrument” rather than “covered financial position” necessitated clarifying this point in the rule text. See

final rule § __.3(b)(2). See also Public Citizen.

169 The Agencies do not believe these revisions have a substantive effect on the operation or scope of the 

final rule in comparison to the statute or proposed rule.
52

c. Definition of “Financial Instrument”

Section 13 of the BHC Act generally prohibits proprietary trading, which is 

defined in section 13(h)(4) to mean engaging as principal for the trading account in any 

purchase or sale of any security, any derivative, any contract of sale of a commodity for 

future delivery, any option on any such security, derivative, or contract, or any other 

security or financial instruments that the Agencies may, by rule, determine.170 The 

proposed rule defined the term “covered financial position” to reference the instruments 

listed in section 13(h)(4), including: (i) a security, including an option on a security; (ii) a 

derivative, including an option on a derivative; or (iii) a contract of sale of a commodity 

for future delivery, or an option on such a contract.171 To provide additional clarity, the 

proposed rule also provided that, consistent with the statute, any position that is itself a 

loan, a commodity, or foreign exchange or currency was not a covered financial 

position.172 

The proposal also defined a number of other terms used in the definition of covered 

financial position, including commodity, derivative, loan, and security.173 These terms 

were generally defined by reference to the federal securities laws or the Commodity 

Exchange Act because these existing definitions are generally well-understood by market 

participants and have been subject to extensive interpretation in the context of securities,

commodities, and derivatives trading.

 

170 See 12 U.S.C. 1851(h)(4).

171 See proposed rule § __.3(c)(3)(i).

172 See proposed rule § __.3(c)(3)(ii).

173 See proposed rule § __.2(l), (q), (w); § __.3(c)(1) and (2).
53

As noted above, the proposed rule included derivatives within the definition of 

covered financial position. Derivative was defined to include any swap (as that term is 

defined in the Commodity Exchange Act) and security-based swap (as that term is 

defined in the Exchange Act), in each case as further defined by the CFTC and SEC by 

joint regulation, interpretation, guidance, or other action, in consultation with the Board 

pursuant to section 712(d) of the Dodd-Frank Act.174 The proposed rule also included 

within the definition of derivative certain other transactions that, although not included 

within the definition of swap or security-based swap, also appear to be, or operate in 

economic substance as, derivatives, and which if not included could permit banking 

entities to engage in proprietary trading that is inconsistent with the purpose of section 13 

of the BHC Act. Specifically, the proposed definition also included: (i) any purchase or 

sale of a nonfinancial commodity for deferred shipment or delivery that is intended to be 

physically settled; (ii) any foreign exchange forward or foreign exchange swap (as those 

terms are defined in the Commodity Exchange Act);175 (iii) any agreement, contract, or 

transaction in foreign currency described in section 2(c)(2)(C)(i) of the Commodity 

Exchange Act;176 (iv) any agreement, contract, or transactions in a commodity other than 

foreign currency described in section 2(c)(2)(D)(i) of the Commodity Exchange Act;177

and (v) any transactions authorized under section 19 of the Commodity Exchange Act.178 

In addition, the proposed rule excluded from the definition of derivative (i) any 

 

174 See 7 U.S.C. 1a(47) (defining “swap”); 15 U.S.C. 78c(a)(68) (defining “security-based swap”).

175 7 U.S.C. 1a(24), (25).

176 7 U.S.C. 2(c)(2)(C)(i).

177 7 U.S.C. 2(c)(2)(D)(i).

178 7 U.S.C. 23.
54

consumer, commercial, or other agreement, contract, or transaction that the CFTC and 

SEC have further defined by joint regulation, interpretation, guidance, or other action as 

not within the definition of swap or security-based swap, and (ii) any identified banking 

product, as defined in section 402(b) of the Legal Certainty for Bank Products Act of 

2000 (7 U.S.C. 27(b)), that is subject to section 403(a) of that Act (7 U.S.C. 27a(a)).

Commenters expressed a variety of views regarding the definition of covered 

financial position, as well as other defined terms used in that definition. For instance, 

some commenters argued that the definition should be expanded to include transactions 

in spot commodities or foreign currency, even though those instruments are not included 

by the statute.179 Other commenters strongly supported the exclusion of spot commodity 

and foreign currency transactions as consistent with the statute, arguing that these 

instruments are part of the traditional business of banking and do not represent the types 

of instruments that Congress designed section 13 to address. These commenters argued 

that including spot commodities and foreign exchange within the definition of covered 

financial position in the final rule would put U.S. banking entities at a competitive 

disadvantage and prevent them from conducting routine banking operations.180 One 

commenter argued that the proposed definition of covered financial position was 

effective and recommended that the definition should not be expanded.181 Another 

commenter argued that an instrument be considered to be a spot foreign exchange 

transaction, and thus not a covered financial position, if it settles within 5 days of 

 

179 See Sens. Merkley & Levin (Feb. 2012); Public Citizen; Occupy.

180 See Northern Trust; Morgan Stanley; JPMC; Credit Suisse (Seidel); Am. Express; See also AFR et al.

(Feb. 2012) (arguing that the final rule should explicitly exclude “spot” commodities and foreign 

exchange).

181 See Alfred Brock.
55

purchase.182 Another commenter argued that covered financial positions used in 

interaffiliate transactions should expressly be excluded because they are used for internal 

risk management purposes and not for proprietary trading.183

Some commenters requested that the final rule exclude additional instruments from 

the definition of covered financial position. For instance, some commenters requested 

that the Agencies exclude commodity and foreign exchange futures, forwards, and swaps, 

arguing that these instruments typically have a commercial and not financial purpose and 

that making them subject to the prohibitions of section 13 would negatively affect the 

spot market for these instruments.184 A few commenters also argued that foreign 

exchange swaps and forwards are used in many jurisdictions to provide U.S. dollarfunding for foreign banking entities and that these instruments should be excluded since 

they contribute to the stability and liquidity of the market for spot foreign exchange.185 

Other commenters contended that foreign exchange swaps and forwards should be 

excluded because they are an integral part of banking entities’ ability to provide trust and 

custody services to customers and are necessary to enable banking entities to deal in the 

exchange of currencies for customers.186

One commenter argued that the inclusion of certain instruments within the definition 

of derivative, such as purchases or sales of nonfinancial commodities for deferred 

 

182 See Credit Suisse (Seidel).

183 See GE (Feb. 2012).

184 See JPMC; BoA; Citigroup (Feb. 2012).

185 See Govt. of Japan/Bank of Japan; Japanese Bankers Ass'n.; See also Norinchukin.

186 See Northern Trust; Citigroup (Feb. 2012).
56

shipment or delivery that are intended to be physically settled, was inappropriate.187 This 

commenter alleged that these instruments are not derivatives but should instead be 

viewed as contracts for purchase of specific commodities to be delivered at a future date. 

This commenter also argued that the Agencies do not have authority under section 13 to 

include these instruments as “other securities or financial instruments” subject to the 

prohibition on proprietary trading.188

Some commenters also argued that, because the CFTC and SEC had not yet finalized 

their definitions of swap and security-based swap, it was inappropriate to use those 

definitions as part of the proposed definition of derivative.189 One commenter argued 

that the definition of derivative was effective, although this commenter argued that the 

final rule should not cross-reference the definition of swap and security-based swap under 

the federal commodities and securities laws.190

After carefully considering the comments received on the proposal, the final rule 

continues to apply the prohibition on proprietary trading to the same types of instruments 

as listed in the statute and the proposal, which the final rule defines as “financial 

instrument.” Under the final rule, a financial instrument is defined as: (i) a security, 

including an option on a security;191 (ii) a derivative, including an option on a derivative; 

or (iii) a contract of sale of a commodity for future delivery, or option on a contract of 

 

187 See SIFMA et al. (Prop.Trading) (Feb. 2012).

188 See id.

189 See SIFMA et al. (Prop.Trading) (Feb. 2012); ISDA (Feb. 2012).

190 See Alfred Brock.

191 The definition of security under the final rule is the same as under the proposal. See final rule § __.2(y).
57

sale of a commodity for future delivery.192 The final rule excludes from the definition of 

financial instrument: (i) a loan;193 (ii) a commodity that is not an excluded commodity

(other than foreign exchange or currency), a derivative, a contract of sale of a commodity 

for future delivery, or an option on a contract of sale of a commodity for future delivery; 

or (iii) foreign exchange or currency.

194 An excluded commodity is defined to have the 

same meaning as in section 1a(19) of the Commodity Exchange Act.

The Agencies continue to believe that these instruments and transactions, which 

are consistent with those referenced in section 13(h)(4) of the BHC Act as part of the 

statutory definition of proprietary trading, represent the type of financial instruments 

which the proprietary trading prohibition of section 13 was designed to cover. While 

some commenters requested that this definition be expanded to include spot 

transactions195 or loans196, the Agencies do not believe that it is appropriate at this time to 

expand the scope of instruments subject to the ban on proprietary trading.197 Similarly, 

while some commenters requested that certain other instruments, such as foreign 

 

192 See final rule § __.3(c)(1).

193 The definition of loan, as well as comments received regarding that definition, is discussed in detail 

below in Part IV.B.1.c.8.a.

194 See final rule § __.3(c)(2).

195 See Sens. Merkley & Levin (Feb. 2012); Public Citizen; Occupy.

196 See Occupy.

197 Several commenters supported the exclusion of spot commodity and foreign currency transactions as 

consistent with the statute. See Northern Trust; Morgan Stanley; State Street (Feb. 2012); JPMC; Credit 

Suisse (Seidel); Am. Express; See also AFR et al. (Feb. 2012) (arguing that the final rule should explicitly 

exclude “spot” commodities and foreign exchange). One commenter stated that the proposed definition 

should not be expanded. See Alfred Brock. With respect to the exclusion for loans, the Agencies note this 

is generally consistent with the rule of statutory construction regarding the sale and securitization of loans. 

See 12 U.S.C. 1851(g)(2).
58

exchange swaps and forwards, be excluded from the definition of financial instrument,198

the Agencies believe that these instruments appear to be, or operate in economic 

substance as, derivatives (which are by statute included within the scope of instruments 

subject to the prohibitions of section 13). If these instruments were not included within 

the definition of financial instrument, banking entities could use them to engage in 

proprietary trading that is inconsistent with the purpose and design of section 13 of the 

BHC Act.

As under the proposal, loans, commodities, and foreign exchange or currency are 

not included within the scope of instruments subject to section 13. The exclusion of these 

types of instruments is intended to eliminate potential confusion by making clear that the 

purchase and sale of loans, commodities, and foreign exchange or currency – none of 

which are referred to in section 13(h)(4) of the BHC Act – are outside the scope of 

transactions to which the proprietary trading restrictions apply. For example, the spot 

purchase of a commodity would meet the terms of the exclusion, but the acquisition of a 

futures position in the same commodity would not qualify for the exclusion.

The final rule also adopts the definitions of security and derivative as proposed.

199 These definitions, which reference existing definitions under the federal securities 

and commodities laws, are generally well-understood by market participants and have 

been subject to extensive interpretation in the context of securities and commodities 

trading activities. While some commenters argued that it would be inappropriate to use 

the definition of swap and security-based swap because those terms had not yet been 

 

198 See JPMC; BAC; Citigroup (Feb. 2012); Govt. of Japan/Bank of Japan; Japanese Bankers Ass'n.; 

Northern Trust; See also Norinchukin.

199 See final rule §§ __.2(h), (y).
59

finalized pursuant to public notice and comment,200 the CFTC and SEC have 

subsequently finalized those definitions after receiving extensive public comment on the 

rulemakings.201 The Agencies believe that this notice and comment process provided 

adequate opportunity for market participants to comment on and understand those terms, 

and as such they are incorporated in the definition of derivative under this final rule. 

While some commenters requested that foreign exchange swaps and forwards be 

excluded from the definition of derivative or financial instrument, the Agencies have not 

done so for the reasons discussed above. However, as explained below in Part IV.A.1.d., 

the Agencies note that to the extent a banking entity purchases or sells a foreign exchange 

forward or swap, or any other financial instrument, in a manner that meets an exclusion 

from proprietary trading, that transaction would not be considered to be proprietary 

trading and thus would not be subject to the requirements of section 13 of the BHC Act 

and the final rule. This includes, for instance, the purchase or sale of a financial 

instrument by a banking entity acting solely as agent, broker, or custodian, or the 

purchase or sale of a security as part of a bona fide liquidity management plan.

d. Proprietary Trading Exclusions 

The proposed rule contained four exclusions from the definition of trading 

account for categories of transactions that do not fall within the scope of section 13 of the 

BHC Act because they do not involve short-term trading activities subject to the statutory 

prohibition on proprietary trading. These exclusions covered the purchase or sale of a 

 

200 See SIFMA et al. (Prop.Trading) (Feb. 2012); ISDA (Feb. 2012).

201 See CFTC and SEC, Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap 

Agreement”; Mixed swaps; Security Based Swap Agreement Recordkeeping, 78 FR 48,208 (Aug. 13, 

2012).
60

financial instrument under certain repurchase and reverse repurchase agreements and 

securities lending arrangements, for bona fide liquidity management purposes, and by a 

clearing agency or derivatives clearing organization in connection with clearing 

activities.

As discussed below, the final rule provides exclusions for the purchase or sale of a 

financial instrument under certain repurchase and reverse repurchase agreements and 

securities lending agreements; for bona fide liquidity management purposes; by certain 

clearing agencies, derivatives clearing organizations in connection with clearing 

activities; by a member of a clearing agency, derivatives clearing organization, or 

designated financial market utility engaged in excluded clearing activities; to satisfy 

existing delivery obligations; to satisfy an obligation of the banking entity in connection 

with a judicial, administrative, self-regulatory organization, or arbitration proceeding; 

solely as broker, agent, or custodian; through a deferred compensation or similar plan; 

and to satisfy a debt previously contracted. After considering comments on these issues, 

which are discussed in more detail below, the Agencies believe that providing clarifying 

exclusions for these non-proprietary activities will likely promote more cost-effective 

financial intermediation and robust capital formation. Overly narrow exclusions for these 

activities would potentially increase the cost of core banking services, while overly broad 

exclusions would increase the risk of allowing the types of trades the statute was 

designed to prohibit. The Agencies considered these issues in determining the 

appropriate scope of these exclusions. Because the Agencies do not believe these 

excluded activities involve proprietary trading, as defined by the statute and the final rule, 

the Agencies do not believe it is necessary to use our exemptive authority in section 
61

13(d)(1)(J) of the BHC Act to deem these activities a form of permitted proprietary 

trading.

1. Repurchase and reverse repurchase arrangements and securities lending

The proposed rule’s definition of trading account excluded an account used to 

acquire or take one or more covered financial positions that arise under (i) a repurchase 

or reverse repurchase agreement pursuant to which the banking entity had simultaneously 

agreed, in writing at the start of the transaction, to both purchase and sell a stated asset, at 

stated prices, and on stated dates or on demand with the same counterparty,202 or (ii) a 

transaction in which the banking entity lends or borrows a security temporarily to or from 

another party pursuant to a written securities lending agreement under which the lender 

retains the economic interests of an owner of such security and has the right to terminate 

the transaction and to recall the loaned security on terms agreed to by the parties.203 

Positions held under these agreements operate in economic substance as a secured loan 

and are not based on expected or anticipated movements in asset prices. Accordingly, 

these types of transactions do not appear to be of the type the statutory definition of 

trading account was designed to cover.204 

 

202 See proposed rule § __.3(b)(2)(iii)(A). 

203 See proposed rule § __.3(b)(2)(iii)(B). The language that described securities lending transactions in 

the proposed rule generally mirrored that contained in Rule 3a5-3 under the Exchange Act. See 17 CFR 

240.3a5-3.

204 See Joint Proposal, 76 FR at 68,862.
62

Several commenters expressed support for these exclusions and requested that the 

Agencies expand them.205 For example, one commenter requested clarification that all 

types of repurchase transactions qualify for the exclusion.206 Some commenters 

requested expanding this exclusion to cover all positions financed by, or transactions 

related to, repurchase and reverse repurchase agreements.207 Other commenters 

requested that the exclusion apply to all transactions that are analogous to extensions of 

credit and are not based on expected or anticipated movements in asset prices, arguing 

that the exclusion would be too limited in scope to achieve its objective if it is based on 

the legal form of the underlying contract.208 Additionally, some commenters suggested 

expanding the exclusion to cover transactions that are for funding purposes, including 

prime brokerage transactions, or for the purpose of asset-liability management.209 

Commenters also recommended expanding the exclusion to include re-hypothecation of 

customer securities, which can produce financing structures that, like a repurchase 

agreement, are functionally loans.210 

In contrast, other commenters argued that there was no statutory or policy 

justification for excluding repurchase and reverse repurchase agreements from the trading 

 

205 See generally ABA (Keating); Alfred Brock; Citigroup (Feb. 2012); GE (Feb. 2012); Goldman (Prop. 

Trading); ICBA; Japanese Bankers Ass'n.; JPMC; Norinchukin; RBC; RMA; SIFMA et al. (Prop.Trading) 

(Feb. 2012); State Street (Feb. 2012); T. Rowe Price; UBS; Wells Fargo (Prop. Trading). See infra Part 

IV.A.d.10. for the discussion of commenters’ requests for additional exclusions from the trading account. 

206 See SIFMA et al. (Prop.Trading) (Feb. 2012). 

207 See FIA; SIFMA et al. (Prop.Trading) (Feb. 2012). 

208 See Goldman (Prop. Trading); JPMC; UBS. 

209 See Goldman (Prop. Trading); UBS. For example, one commenter suggested that fully collateralized 

swap transactions should be exempted from the definition of trading account because they serve as funding 

transactions and are economically similar to repurchase agreements. See SIFMA et al. (Prop.Trading) 

(Feb. 2012).

210 See Goldman (Prop. Trading).
63

account, and requested that this exclusion be removed from the final rule.211 Some of 

these commenters argued that repurchase agreements could be used for prohibited 

proprietary trading212 and suggested that, if repurchase agreements are excluded from the 

trading account, documentation detailing the use of liquidity derived from repurchase 

agreements should be required.213 These commenters suggested that unless the liquidity 

is used to secure a position for a willing customer, repurchase agreements should be 

regarded as a strong indicator of proprietary trading.214 As an alternative, commenters 

suggested that the Agencies instead use their exemptive authority pursuant to section 

13(d)(1)(J) of the BHC Act to permit repurchase and reverse repurchase transactions so 

that such transactions must comply with the statutory limits on material conflicts of 

interests and high-risks assets and trading strategies, and compliance requirements under 

the final rule.215 These commenters urged the Agencies to specify permissible collateral 

types, haircuts, and contract terms for securities lending agreements and require that the 

investment of proceeds from securities lending transactions be limited to high-quality 

liquid assets in order to limit potential risks of these activities.216

After considering the comments received, the Agencies have determined to 

exclude repurchase and reverse repurchase agreements and securities lending agreements 

from the definition of proprietary trading under the final rule. The final rule defines these 

 

211 See AFR et al. (Feb. 2012); Occupy; Public Citizen; Sens. Merkley & Levin (Feb. 2012).

212 See AFR et al. (Feb. 2012). 

213 See Public Citizen. 

214 See Public Citizen. 

215 See AFR et al. (Feb. 2012); Occupy.

216 See AFR et al. (Feb. 2012); Occupy. 
64

terms subject to the same conditions as were in the proposal. This determination 

recognizes that repurchase and reverse repurchase agreements and securities lending 

agreements excluded from the definition operate in economic substance as secured loans 

and do not in normal practice represent proprietary trading.217 The Agencies will, 

however, monitor these transactions to ensure this exclusion is not used to engage in 

prohibited proprietary trading activities. 

To avoid evasion of the rule, the Agencies note that, in contrast to certain 

commenters’ requests,218 only the transactions pursuant to the repurchase agreement, 

reverse repurchase agreement, or securities lending agreement are excluded. For 

example, the collateral or position that is being financed by the repurchase or reverse 

repurchase agreement is not excluded and may involve proprietary trading. The 

Agencies further note that if a banking entity uses a repurchase or reverse repurchase 

agreement to finance a purchase of a financial instrument, other transactions involving 

that financial instrument may not qualify for this exclusion.

219 Similarly, short positions 

resulting from securities lending agreements cannot rely upon this exclusion and may 

involve proprietary trading.

Additionally, the Agencies have determined not to exclude all transactions, in 

whatever legal form that may be construed to be an extension of credit, as suggested by 

 

217 Congress recognized that repurchase agreements and securities lending agreements are loans or 

extensions of credit by including them in the legal lending limit. See Dodd–Frank Act section 610

(amending 12 U.S.C. 84b). The Agencies believe the conditions of the final rule’s exclusions for 

repurchase agreements and securities lending agreements identify those activities that do not in normal 

practice represent proprietary trading and, thus, the Agencies decline to provide additional requirements for 

these activities, as suggested by some commenters. See Public Citizen; AFR et al. (Feb. 2012); Occupy. 

218 See Goldman (Prop. Trading); JPMC; UBS.

219 See CFTC Proposal, 77 FR at 8348.
65

commenters, because such a broad exclusion would be too difficult to assess for 

compliance and would provide significant opportunity for evasion of the prohibitions in 

section 13 of the BHC Act. 

2. Liquidity management activities

The proposed definition of trading account excluded an account used to acquire or 

take a position for the purpose of bona fide liquidity management, subject to certain 

requirements.220 The preamble to the proposed rule explained that bona fide liquidity 

management seeks to ensure that the banking entity has sufficient, readily-marketable 

assets available to meet its expected near-term liquidity needs, not to realize short-term 

profit or benefit from short-term price movements.221 

To curb abuse, the proposed rule required that a banking entity acquire or take a 

position for liquidity management in accordance with a documented liquidity 

management plan that meets five criteria.222 Moreover, the Agencies stated in the 

preamble that liquidity management positions that give rise to appreciable profits or 

losses as a result of short-term price movements would be subject to significant Agency 

scrutiny and, absent compelling explanatory facts and circumstances, would be 

considered proprietary trading.

223

 

220 See proposed rule § __.3(b)(2)(iii)(C).

221 Id.

222 See proposed rule § __.3(b)(2)(iii)(C)(1)-(5). 

223 See Joint Proposal, 76 FR at 68,862.
66

The Agencies received a number of comments regarding the exclusion. Many 

commenters supported the exclusion of liquidity management activities from the 

definition of trading account as appropriate and necessary. At the same time, some 

commenters expressed the view that the exclusion was too narrow and should be replaced 

with a broader exclusion permitting trading activity for asset-liability management 

(“ALM”). Commenters argued that two aspects of the proposed rule’s definition of 

“trading account” would cause ALM transactions to fall within the prohibition on 

proprietary trading – the 60-day rebuttable presumption and the reference to the market 

risk rule trading account.224 For example, commenters expressed concern that hedging 

transactions associated with a banking entity’s residential mortgage pipeline and 

mortgage servicing rights, and managing credit risk, earnings at risk, capital, assetliability mismatches, and foreign exchange risks would be among positions that may be 

held for 60 days or less.225 These commenters contended that the exclusion for liquidity 

management and the activity exemptions for risk-mitigating hedging and trading in U.S. 

government obligations would not be sufficient to permit a wide variety of ALM 

activities.226 These commenters contended that prohibiting trading for ALM purposes 

would be contrary to the goals of enhancing sound risk management, the safety and 

 

224 See ABA (Keating); BoA; CH/ABASA; JPMC. See supra Part IV.A.1.b. (discussing the rebuttable 

presumption under §_3.(b)(2) of the final rule); See also supra Part IV.A.1.a. (discussing the market risk 

rule trading account under §_3.(b)(1)(ii) of the final rule). 

225 See CH/ABASA; Wells Fargo (Prop. Trading).

226 See CH/ABASA; JPMC; State Street (Feb. 2012); Wells Fargo (Prop. Trading). See also

BaFin/Deutsche Bundesbank.
67

soundness of banking entities, and U.S. financial stability,227 and would limit banking 

entities’ ability to manage liquidity.228 

Some commenters argued that the requirements of the exclusion would not 

provide a banking entity with sufficient flexibility to respond to liquidity needs arising 

from changing economic conditions.229 Some commenters argued the requirement that 

any position taken for liquidity management purposes be limited to the banking entity’s 

near-term funding needs failed to account for longer-term liquidity management 

requirements.230 These commenters further argued that the requirements of the liquidity 

management exclusion might not be synchronized with the Basel III framework, 

particularly with respect to the liquidity coverage ratio if “near-term” is considered less 

than 30 days.231 

Commenters also requested clarification on a number of other issues regarding the 

exclusion. For example, one commenter requested clarification that purchases and sales 

of U.S. registered mutual funds sponsored by a banking entity would be permissible.232 

Another commenter requested clarification that the deposits resulting from providing 

custodial services that are invested largely in high-quality securities in conformance with 

the banking entity’s ALM policy would not be presumed to be “short-term trading” under 

 

227 See BoA; JPMC; RBC. 

228 See ABA (Keating); Allen & Overy (on behalf of Canadian Banks); JPMC; NAIB et al.; State Street 

(Feb. 2012); T. Rowe Price.

229 See ABA (Keating); CH/ABASA; JPMC. 

230 See ABA (Keating); BoA; CH/ABASA; JPMC.

231 See ABA (Keating); Allen & Overy (on behalf of Canadian Banks); BoA; CH/ABASA

232 See T. Rowe Price. 
68

the final rule.233 Commenters also urged that the final rule not prohibit interaffiliate 

transactions essential to the ALM function.234

In contrast, other commenters supported the liquidity management exclusion 

criteria235 and suggested tightening these requirements. For example, one commenter 

recommended that the rule require that investments made under the liquidity management 

exclusion consist only of high-quality liquid assets.236 Other commenters argued that the 

exclusion for liquidity management should be eliminated.237 One commenter argued that 

there was no need to provide a special exemption for liquidity management or ALM 

activities given the exemptions for trading in government obligations and risk-mitigating 

hedging activities.238 

After carefully reviewing the comments received, the Agencies have adopted the 

proposed exclusion for liquidity management with several important modifications. As 

limited below, liquidity management activity serves the important prudential purpose, 

recognized in other provisions of the Dodd-Frank Act and in rules and guidance of the 

 

233 See State Street (Feb. 2012). 

234 See State Street (Feb. 2012); JPMC. See also Part IV.A.1.d.10. (discussing commenter requests to 

exclude inter-affiliate transactions).

235 See AFR et al. (Feb. 2012); Occupy.

236 See Occupy. 

237 See Sens. Merkley & Levin (Feb. 2012). 

238 See Sens. Merkley & Levin (Feb. 2012).
69

Agencies, of ensuring banking entities have sufficient liquidity to manage their shortterm liquidity needs.239

To ensure that this exclusion is not misused for the purpose of proprietary trading, 

the final rule imposes a number of requirements. First, the liquidity management plan of 

the banking entity must be limited to securities (in keeping with the liquidity 

management requirements proposed by the Federal banking agencies) and specifically 

contemplate and authorize the particular securities to be used for liquidity management 

purposes; describe the amount, types, and risks of securities that are consistent with the 

entity’s liquidity management; and the liquidity circumstances in which the particular 

securities may or must be used.240 Second, any purchase or sale of securities 

contemplated and authorized by the plan must be principally for the purpose of managing 

the liquidity of the banking entity, and not for the purpose of short-term resale, 

benefitting from actual or expected short-term price movements, realizing short-term 

arbitrage profits, or hedging a position taken for such short-term purposes. Third, the 

plan must require that any securities purchased or sold for liquidity management purposes 

be highly liquid and limited to instruments the market, credit and other risks of which the 

banking entity does not reasonably expect to give rise to appreciable profits or losses as a 

 

239 See section 165(b)(1)(A)(ii) of the Dodd-Frank Act; Enhanced Prudential Standards, 77 FR 644 at 645 

(Jan. 5, 2012), available at http://www.gpo.gov/fdsys/pkg/FR-2012-01-05/pdf/2011-33364.pdf; See also

Enhanced Prudential Standards, 77 FR 76,678 at 76,682 (Dec. 28, 2012), available at

http://www.gpo.gov/fdsys/pkg/FR-2012-12-28/pdf/2012-30734.pdf. 

240 To ensure sufficient flexibility to respond to liquidity needs arising from changing economic times, a 

banking entity should envision and address a range of liquidity circumstances in its liquidity management 

plan, and provide a mechanism for periodically reviewing and revising the liquidity management plan. 
70

result of short-term price movements.241 Fourth, the plan must limit any securities 

purchased or sold for liquidity management purposes to an amount that is consistent with 

the banking entity’s near-term funding needs, including deviations from normal 

operations of the banking entity or any affiliate thereof, as estimated and documented 

pursuant to methods specified in the plan.242 Fifth, the banking entity must incorporate 

into its compliance program internal controls, analysis and independent testing designed 

to ensure that activities undertaken for liquidity management purposes are conducted in 

accordance with the requirements of the final rule and the entity’s liquidity management 

plan. Finally, the plan must be consistent with the supervisory requirements, guidance 

and expectations regarding liquidity management of the Agency responsible for 

regulating the banking entity.

The final rule retains the provision that the financial instruments purchased and 

sold as part of a liquidity management plan be highly liquid and not reasonably expected 

to give rise to appreciable profits or losses as a result of short-term price movements. 

This requirement is consistent with the Agencies’ expectation for liquidity management 

plans in the supervisory context. It is not intended to prevent firms from recognizing 

 

241 The requirement to use highly liquid instruments is consistent with the focus of the clarifying exclusion 

on a banking entity’s near-term liquidity needs. Thus, the final rules do not include commenters’ suggested 

revisions to this requirement. See Clearing House Ass'n.; See also Occupy; Sens. Merkley & Levin (Feb. 

2012). The Agencies decline to identify particular types of securities that will be considered highly liquid 

for purposes of the exclusion, as requested by some commenters, in recognition that such a determination 

will depend on the facts and circumstances. See T. Rowe Price; State Street (Feb. 2012). 

242 The Agencies plan to construe “near-term funding needs” in a manner that is consistent with the laws, 

regulations, and issuances related to liquidity risk management. See, e.g., Liquidity Coverage Ratio: 

Liquidity Risk Measurement, Standards, and Monitoring, 78 FR 71,818 (Nov. 29, 2013); Basel Committee 

on Bank Supervision, Basel III: The Liquidity Coverage Ratio and Liquidity Risk Management Tools 

(January 2013) available at http://www.bis.org/publ/bcbs238.htm. The Agencies believe this should help 

address commenters’ concerns about the proposed requirement. See, e.g., ABA (Keating); Allen & Overy 

(on behalf of Canadian Banks); CH/ABASA; BoA; JPMC. 
71

profits (or losses) on instruments purchased and sold for liquidity management purposes. 

Instead, this requirement is intended to underscore that the purpose of these transactions 

must be liquidity management. Thus, the timing of purchases and sales, the types and 

duration of positions taken and the incentives provided to managers of these purchases 

and sales must all indicate that managing liquidity, and not taking short-term profits (or 

limiting short-term losses), is the purpose of these activities.

The exclusion as adopted does not apply to activities undertaken with the stated 

purpose or effect of hedging aggregate risks incurred by the banking entity or its affiliates 

related to asset-liability mismatches or other general market risks to which the entity or 

affiliates may be exposed. Further, the exclusion does not apply to any trading activities 

that expose banking entities to substantial risk from fluctuations in market values, 

unrelated to the management of near-term funding needs, regardless of the stated purpose 

of the activities.243 

Overall, the Agencies do not believe that the final rule will stand as an obstacle to 

or otherwise impair the ability of banking entities to manage the risks of their businesses 

and operate in a safe and sound manner. Banking entities engaging in bona fide liquidity 

management activities generally do not purchase or sell financial instruments for the 

purpose of short-term resale or to benefit from actual or expected short-term price 

movements. The Agencies have determined, in contrast to certain commenters’ requests, 

 

243 See, e.g., STAFF OF S. COMM. ON HOMELAND SEC. & GOVERNMENTAL AFFAIRS PERMANENT 

SUBCOMM. ON INVESTIGATIONS, 113TH CONG., REPORT: JPMORGAN CHASE WHALE TRADES: A CASE 

HISTORY OF DERIVATIVES RISKS AND ABUSES (Apr. 11, 2013), available at

http://www.hsgac.senate.gov/download/report-jpmorgan-chase-whale-trades-a-case-history-of-derivativesrisks-and-abuses-march-15-2013.
72

not to expand this liquidity management provision to broadly allow asset-liability 

management, earnings management, or scenario hedging.244 To the extent these activities 

are for the purpose of profiting from short-term price movements or to hedge risks not 

related to short-term funding needs, they represent proprietary trading subject to section 

13 of the BHC Act and the final rule; the activity would then be permissible only if it 

meets all of the requirements for an exemption, such as the risk-mitigating hedging 

exemption, the exemption for trading in U.S. government securities, or another 

exemption.

3. Transactions of derivatives clearing organizations and clearing agencies

A banking entity that is a central counterparty for clearing and settlement 

activities engages in the purchase and sale of financial instruments as an integral part of 

clearing and settling those instruments. The proposed definition of trading account 

excluded an account used to acquire or take one or more covered financial positions by a 

derivatives clearing organization registered under the Commodity Exchange Act or a 

clearing agency registered under the Securities Exchange Act of 1934 in connection with 

clearing derivatives or securities transactions.

245 The preamble to the proposed rule 

noted that the purpose of these transactions is to provide a clearing service to third 

parties, not to profit from short-term resale or short-term price movements.246

 

244 See, e.g., ABA (Keating); BoA; CH/ABASA; JPMC.

245 See proposed rule § __.3(b)(2)(iii)(D).

246 See Joint Proposal, 76 FR at 68,863.
73

Several commenters supported the proposed exclusion for derivatives clearing 

organizations and urged the Agencies to expand the exclusion to cover a banking entity’s 

clearing-related activities, such as clearing a trade for a customer, trading with a 

clearinghouse, or accepting positions of a defaulting member, on grounds that these 

activities are not proprietary trades and reduce systemic risk.247 One commenter 

recommended expanding the exclusion to non-U.S. central counterparties 248 In contrast, 

one commenter argued that the exclusion for derivatives clearing organizations and 

clearing agencies had no statutory basis and should instead be a permitted activity under 

section 13(d)(1)(J).249 

After considering the comments received, the final rule retains the exclusion for 

purchases and sales of financial instruments by a banking entity that is a clearing agency 

or derivatives clearing organization in connection with its clearing activities.250 In 

response to comments,251 the Agencies have also incorporated two changes to the rule. 

First, the final rule applies the exclusion to the purchase and sale of financial instruments 

by a banking entity that is a clearing agency or derivatives clearing organization in 

 

247 See Allen & Overy (Clearing); Goldman (Prop. Trading); SIFMA et al. (Prop.Trading) (Feb. 2012); 

State Street (Feb. 2012). 

248 See IIB/EBF. 

249 See Sens. Merkley & Levin (Feb. 2012).

250 “Clearing agency” is defined in the final rule with reference to the definition of this term in the 

Exchange Act. See final rule § __.3(e)(2). “Derivatives clearing organization” is defined in the final rule 

as (i) a derivatives clearing organization registered under section 5b of the Commodity Exchange Act; 

(ii) a derivatives clearing organization that, pursuant to CFTC regulation, is exempt from the registration 

requirements under section 5b of the Commodity Exchange Act; or (iii) a foreign derivatives clearing 

organization that, pursuant to CFTC regulation, is permitted to clear for a foreign board of trade that is 

registered with the CFTC.

251 See IIB/EBF; BNY Mellon et al.; SIFMA et al. (Prop.Trading) (Feb. 2012); Allen & Overy (Clearing); 

Goldman (Prop. Trading).
74

connection with clearing financial instrument transactions. Second, in response to 

comments,252 the exclusion in the final rule is not limited to clearing agencies or 

derivatives clearing organizations that are subject to SEC or CFTC registration 

requirements and, instead, certain foreign clearing agencies and foreign derivatives 

clearing organizations will be permitted to rely on the exclusion if they are banking 

entities. 

The Agencies believe that clearing and settlement activity is not designed to 

create short-term trading profits. Moreover, excluding clearing and settlement activities 

prevents the final rule from inadvertently hindering the Dodd–Frank Act’s goal of 

promoting central clearing of financial transactions. The Agencies have narrowly 

tailored this exclusion by allowing only central counterparties to use it and only with 

respect to their clearing and settlement activity. 

4. Excluded clearing-related activities of clearinghouse members

In addition to the exclusion for trading activities of a derivatives clearing 

organization or clearing agency, some commenters requested an additional exclusion 

from the definition of “trading account” for clearing-related activities of members of 

these entities.253 These commenters noted that the proposed definition of “trading 

account” provides an exclusion for positions taken by registered derivatives clearing 

 

252 See IIB/EBF; Allen & Overy (Clearing).

253 See SIFMA et al. (Prop.Trading) (Feb. 2012); Allen & Overy (Clearing); Goldman (Prop. Trading); 

State Street (Feb. 2012).
75

organizations and registered clearing agencies254 and requested a corresponding 

exclusion for certain clearing-related activities of banking entities that are members of a 

clearing agency or members of a derivatives clearing organization (collectively, “clearing 

members”).255

Several commenters argued that certain aspects of the clearing process may 

require a clearing member to engage in principal transactions. For example, some 

commenters argued that a clearinghouse’s default management process may require 

clearing members to take positions in financial instruments upon default of another 

clearing member.256 According to commenters, default management processes can 

involve: (i) collection of initial and variation margin from customers under an “agency 

model” of clearing; (ii) porting, where a defaulting clearing member’s customer positions 

and margin are transferred to another non-defaulting clearing member;257 (iii) hedging, 

where the clearing house looks to clearing members and third parties to enter into riskreducing transactions and to flatten the market risk associated with the defaulting clearing 

member’s house positions and non-ported customer positions; (iv) unwinding, where the 

defaulting member’s open positions may be allocated to other clearing members, 

affiliates, or third parties pursuant to a mandatory auction process or forced allocation;258

 

254 See proposed rule §__.3(b)(2)(iii)(D).

255 See SIFMA et al. (Prop.Trading) (Feb. 2012); Allen & Overy (Clearing); Goldman (Prop. Trading); 

State Street (Feb. 2012).

256 See SIFMA et al. (Prop.Trading) (Feb. 2012); Allen & Overy (Clearing); State Street (Feb. 2012). 

See also ISDA (Feb. 2012).

257 See SIFMA et al. (Prop.Trading) (Feb. 2012); Allen & Overy (Clearing).

258 See Allen & Overy (Clearing).
76

and (v) imposing certain obligations on clearing members upon exhaustion of a guaranty 

fund.259

Commenters argued that, absent an exclusion from the definition of “trading 

account,” some of these clearing-related activities could be considered prohibited 

proprietary trading under the proposal. Two commenters specifically contended that the 

dealer prong of the definition of “trading account” may cause certain of these activities to 

be considered proprietary trading.260 Some commenters suggested alternative avenues 

for permitting such clearing-related activity under the rules.261 Commenters argued that 

such clearing-related activities of banking entities should not be subject to the rule 

because they are risk-reducing, beneficial for the financial system, required by law under 

certain circumstances (e.g., central clearing requirements for swaps and security-based 

swaps under Title VII of the Dodd-Frank Act), and not used by banking entities to engage 

in proprietary trading.262

Commenters further argued that certain activities undertaken as part of a clearing 

house’s daily risk management process may be impacted by the rule, including 

unwinding self-referencing transactions through a mandatory auction (e.g., where a firm 

acquired credit default swap (“CDS”) protection on itself as a result of a merger with 

 

259 See SIFMA et al. (Prop.Trading) (Feb. 2012).

260 See SIFMA et al. (Prop.Trading) (Feb. 2012) (arguing that the SEC has suggested that entities that 

collect margins from customers for cleared swaps may be required to be registered as broker-dealers); State 

Street (Feb. 2012).

261 See Goldman (Prop. Trading); SIFMA et al. (Prop.Trading) (Feb. 2012); ISDA (Feb. 2012).

262 See SIFMA et al. (Prop.Trading) (Feb. 2012); Goldman (Prop. Trading); State Street (Feb. 2012); Allen 

& Overy (Clearing).
77

another firm)263 and trade crossing, a mechanism employed by certain clearing houses to 

ensure the accuracy of the price discovery process in the course of, among other things, 

calculating settlement prices and margin requirements.264

The Agencies do not believe that certain core clearing-related activities conducted 

by a clearing member, often as required by regulation or the rules and procedures of a 

clearing agency, derivatives clearing organization, or designated financial market utility, 

represent proprietary trading as contemplated by the statute. For example, the clearing 

and settlement activities discussed above are not conducted for the purpose of profiting 

from short-term price movements. The Agencies believe that these clearing-related 

activities provide important benefits to the financial system.265 In particular, central 

clearing reduces counterparty credit risk,266 which can lead to a host of other benefits, 

 

263 See Allen & Overy (Clearing).

264 See Allen & Overy (Clearing); SIFMA et al. (Prop.Trading) (Feb. 2012). These commenters stated 

that, in order to ensure that a clearing member is providing accurate end-of-day prices for its open 

positions, a clearing house may require the member to provide firm bids for such positions, which may be 

tested through a “forced trade” with another member. See id.; See also ISDA (Feb. 2012).

265 For example, Title VII of the Dodd-Frank Act mandates the central clearing of swaps and securitybased swaps, and requires that banking entities that are swap dealers, security-based swap dealers, major 

swap participants or major security-based swap participants collect variation margin from many 

counterparties on a daily basis for their swap or security-based swap activity. See 7 U.S.C. 2(h); 15 U.S.C. 

78c-3; 7 U.S.C. 6s(e); 15 U.S.C. 78o-10(e); Margin Requirements for Uncleared Swaps for Swap Dealers 

and Major Swap Participants, 76 FR 23,732 (Apr. 28, 2011). Additionally, the SEC’s Rule 17Ad22(d)(11) requires that each registered clearing agency establish, implement, maintain and enforce policies 

and procedures that set forth the clearing agency’s default management procedures. See 17 CFR 

240.17Ad-22(d)(11). See also Exchange Act Release No. 68,080 (Oct. 12, 2012), 77 FR 66,220, 66,283 

(Nov. 2, 2012).

266 Centralized clearing affects counterparty risk in three basic ways. First, it redistributes counterparty 

risk among members through mutualization of losses, reducing the likelihood of sequential counterparty 

failure and contagion. Second, margin requirements and monitoring reduce moral hazard, reducing 

counterparty risk. Finally, clearing may reallocate counterparty risk outside of the clearing agency because 

netting may implicitly subordinate outside creditors’ claims relative to other clearing member claims.
78

including lower hedging costs, increased market participation, greater liquidity, more 

efficient risk sharing that promotes capital formation, and reduced operational risk.267 

Accordingly, in response to comments, the final rule provides that proprietary 

trading does not include specified excluded clearing activities by a banking entity that is a 

member of a clearing agency, a member of a derivatives clearing organization, or a 

member of a designated financial market utility.268 “Excluded clearing activities” is 

defined in the rule to identify particular core clearing-related activities, many of which 

were raised by commenters.269 Specifically, the final rule will exclude the following 

activities by clearing members: (i) any purchase or sale necessary to correct error trades 

made by or on behalf of customers with respect to customer transactions that are cleared, 

provided the purchase or sale is conducted in accordance with certain regulations, rules, 

or procedures; (ii) any purchase or sale related to the management of a default or 

threatened imminent default of a customer, subject to certain conditions, another clearing 

member, or the clearing agency, derivatives clearing organization, or designated financial 

market utility itself;270 and (iii) any purchase or sale required by the rules or procedures 

of a clearing agency, derivatives clearing organization, or designated financial market 

utility that mitigates risk to such agency, organization, or utility that would result from 

 

267 See Proposed Rule, Cross-Border Security-Based Swap Activities, Exchange Act Release No. 69490 

(May 1, 2013), 78 FR 30,968, 31,162-31,163 (May 23, 2013).

268 See final rule § __.3(d)(5).

269 See final rule § __.3(e)(7).

270 A number of commenters discussed the default management process and requested an exclusion for 

such activities. See SIFMA et al. (Prop.Trading) (Feb. 2012); Allen & Overy (Clearing); State Street (Feb. 

2012). See also ISDA (Feb. 2012).
79

the clearing by a clearing member of security-based swaps that references the member or 

an affiliate of the member.

271 

The Agencies are identifying specific activities in the rule to limit the potential for 

evasion that may arise from a more generalized approach. However, the relevant 

supervisory Agencies will be prepared to provide further guidance or relief, if 

appropriate, to ensure that the terms of the exclusion do not limit the ability of clearing 

agencies, derivatives clearing organizations, or designated financial market utilities to 

effectively manage their risks in accordance with their rules and procedures. In 

response to commenters requesting that the exclusion be available when a clearing 

member is required by rules of a clearing agency, derivatives clearing organization, or 

designated financial market utility to purchase or sell a financial instrument as part of 

establishing accurate prices to be used by the clearing agency, derivatives clearing 

organization, or designated financial market utility in its end of day settlement process,272

the Agencies note that whether this is an excluded clearing activity depends on the facts 

and circumstances. Similarly, the availability of other exemptions to the rule, such as the 

market-making exemption, depend on the facts and circumstances. This exclusion applies 

only to excluded clearing activities of clearing members. It does not permit a banking 

entity to engage in proprietary trading and claim protection for that activity because 

trades are cleared or settled through a central counterparty. 

 

271 See Allen & Overy (Clearing) (discussing rules that require unwinding self-referencing transactions 

through a mandatory auction (e.g., where a firm acquired CDS protection on itself as a result of a merger 

with another firm)).

272 See Allen & Overy (Clearing); SIFMA et al. (Prop.Trading) (Feb. 2012); See also ISDA (Feb. 2012).
80

5. Satisfying an existing delivery obligation

A few commenters requested additional or expanded exclusions from the 

definition of “trading account” for covering short sales or failures to deliver.273 These 

commenters alleged that a banking entity engages in this activity for purposes other than 

to benefit from short term price movements and that it is not proprietary trading as 

defined in the statute. In response to these comments, the final rule provides that a 

purchase or sale by a banking entity that satisfies an existing delivery obligation of the 

banking entity or its customers, including to prevent or close out a failure to deliver, in 

connection with delivery, clearing, or settlement activity is not proprietary trading. 

Among other things, this exclusion will allow a banking entity that is an SECregistered broker-dealer to take action to address failures to deliver arising from its own 

trading activity or the trading activity of its customers.274 In certain circumstances, SECregistered broker-dealers are required to take such action under SEC rules.275 In addition, 

buy-in procedures of a clearing agency, securities exchange, or national securities 

association may require a banking entity to deliver securities if a party with a fail to 

receive position takes certain action.276 When a banking entity purchases securities to 

 

273 See SIFMA et al. (Prop.Trading) (Feb. 2012); Goldman (Prop. Trading). 

274 In order to qualify for this exclusion, a banking entity’s principal trading activity that results in its own 

failure to deliver must have been conducted in compliance with these rules. 

275 See, e.g., 17 CFR 242.204 (requiring, among other things, that a participant of a registered clearing 

agency or, upon reasonable allocation, a broker-dealer for which the participant clears trades or from which 

the participant receives trades for settlement, take action to close out a fail to deliver position in any equity 

security by borrowing or purchasing securities of like kind and quantity); 17 CFR 240.15c3-3(m) 

(providing that, if a broker-dealer executes a sell order of a customer and does not obtain possession of the 

securities from the customer within 10 business days after settlement, the broker-dealer must immediately 

close the transaction with the customer by purchasing securities of like kind and quantity).

276 See, e.g., NSCC Rule 11, NASDAQ Rule 11810, FINRA Rule 11810.
81

meet an existing delivery obligation, it is engaging in activity that facilitates timely 

settlement of securities transactions and helps provide a purchaser of the securities with 

the benefits of ownership (e.g., voting and lending rights). In addition, a banking entity 

has limited discretion to determine when and how to take action to meet an existing 

delivery obligation.277 Providing a limited exclusion for this activity will avoid the 

potential for SEC-registered broker-dealers being subject to conflicting or inconsistent 

regulatory requirements with respect to activity required to meet the broker-dealer’s 

existing delivery obligations. 

6. Satisfying an obligation in connection with a judicial, administrative, selfregulatory organization, or arbitration proceeding

The Agencies recognize that, under certain circumstances, a banking entity may 

be required to purchase or sell a financial instrument at the direction of a judicial or 

regulatory body. For example, an administrative agency or self-regulatory organization 

(“SRO”) may require a banking entity to purchase or sell a financial instrument in the 

course of disciplinary proceedings against that banking entity.278 A banking entity may 

also be obligated to purchase or sell a financial instrument in connection with a judicial 

 

277 See, e.g., 17 CFR 242.204 (requiring action to close out a fail to deliver position in an equity security 

within certain specified timeframes); 17 CFR 240.15c3-3(m) (requiring a broker-dealer to “immediately” 

close a transaction under certain circumstances).

278 For example, an administrative agency or SRO may require a broker-dealer to offer to buy securities 

back from customers where the agency or SRO finds the broker-dealer fraudulently sold securities to those 

customers. See, e.g., In re Raymond James & Assocs., Exchange Act Release No. 64767, 101 S.E.C. 

Docket 1749 (June 29, 2011); FINRA Dep’t of Enforcement v. Pinnacle Partners Fin. Corp., Disciplinary 

Proceeding No. 2010021324501 (Apr. 25, 2012); FINRA Dep’t of Enforcement v. Fifth Third Sec., Inc., 

No. 2005002244101 (Press Rel. Apr. 14, 2009).
82

or arbitration proceeding.279 Such transactions do not represent trading for short-term 

profit or gain and do not constitute proprietary trading under the statute.

Accordingly, the Agencies have determined to adopt a provision clarifying that a 

purchase or sale of one or more financial instruments that satisfies an obligation of the 

banking entity in connection with a judicial, administrative, self-regulatory organization, 

or arbitration proceeding is not proprietary trading for purposes of these rules. This 

clarification will avoid the potential for conflicting or inconsistent legal requirements for 

banking entities.

7. Acting solely as agent, broker, or custodian

The proposal clarified that proprietary trading did not include acting solely as 

agent, broker, or custodian for an unaffiliated third party.280 Commenters generally 

supported this aspect of the proposal. One commenter suggested that acting as agent, 

broker, or custodian for affiliates should be explicitly excluded from the definition of 

proprietary trading in the same manner as acting as agent, broker, or custodian for 

unaffiliated third parties.281 

Like the proposal, the final rule expressly provides that the purchase or sale of 

one or more financial instruments by a banking entity acting solely as agent, broker, or 

custodian is not proprietary trading because acting in these types of capacities does not 

 

279 For instance, section 29 of the Exchange Act may require a broker-dealer to rescind a contract with a 

customer that was made in violation of the Exchange Act. Such rescission relief may involve the brokerdealer’s repurchase of a financial instrument from a customer. See 15 U.S.C. 78cc; Reg’l Props., Inc. v. 

Fin. & Real Estate Consulting Co., 678 F.2d 552 (5th Cir. 1982); Freeman v. Marine Midland Bank N.Y., 

419 F.Supp. 440 (E.D.N.Y. 1976).

280 See proposed rule § __.3(b)(1). 

281 See Japanese Bankers Ass'n.
83

involve trading as principal, which is one of the requisite aspects of the statutory 

definition of proprietary trading.282 The final rule has been modified to include acting 

solely as agent, broker, or custodian on behalf of an affiliate. However, the affiliate must 

comply with section 13 of the BHC Act and the final implementing rule; and may not 

itself engage in prohibited proprietary trading. To the extent a banking entity acts in both 

a principal and agency capacity for a purchase or sale, it may only use this exclusion for 

the portion of the purchase or sale for which it is acting as agent. The banking entity 

must use a separate exemption or exclusion, if applicable, to the extent it is acting in a 

principal capacity. 

8. Purchases or sales through a deferred compensation or similar plan

While the proposed rule provided that the prohibition on covered fund activities 

and investments did not apply to certain instances where the banking entity acted through

or on behalf of a pension or similar deferred compensation plan, no such similar 

treatment was given for proprietary trading. One commenter argued that the proposal 

restricted a banking entity’s ability to engage in principal-based trading as an asset 

manager that serves the needs of the institutional investors, such as through ERISA 

pension and 401(k) plans.283

 

282 See 12 U.S.C. 1851(h)(4). A common or collective investment fund that is an investment company 

under section 3(c)(3) or 3(c)(11) will not be deemed to be acting as principal within the meaning of

§__.3(a) because the fund is performing a traditional trust activity and purchases and sells financial 

instruments solely on behalf of customers as trustee or in a similar fiduciary capacity, as evidenced by its 

regulation under 12 CFR part 9 (Fiduciary Activities of National Banks) or similar state laws.

283 See Ass'n. of Institutional Investors (Nov. 2012).
84

To address these concerns, the final rule provides that proprietary trading does not 

include the purchase or sale of one or more financial instruments through a deferred 

compensation, stock-bonus, profit-sharing, or pension plan of the banking entity that is 

established and administered in accordance with the laws of the United States or a foreign 

sovereign, if the purchase or sale is made directly or indirectly by the banking entity as 

trustee for the benefit of the employees of the banking entity or members of their 

immediate family. Banking entities often establish and act as trustee to pension or 

similar deferred compensation plans for their employees and, as part of managing these 

plans, may engage in trading activity. The Agencies believe that purchases or sales by a 

banking entity when acting through pension and similar deferred compensation plans 

generally occur on behalf of beneficiaries of the plan and consequently do not constitute 

the type of principal trading that is covered by the statute.

The Agencies note that if a banking entity engages in trading activity for an 

unaffiliated pension or similar deferred compensation plan, the trading activity of the 

banking entity would not be proprietary trading under the final rule to the extent the 

banking entity was acting solely as agent, broker, or custodian.

9. Collecting a debt previously contracted

Several commenters argued that the final rule should exclude collecting and 

disposing of collateral in satisfaction of debts previously contracted from the definition of 

proprietary trading.284 Commenters argued that acquiring and disposing of collateral in 

satisfaction of debt previously contracted does not involve trading with the intent of 

 

284 See LSTA (Feb. 2012); JPMC; Goldman (Prop. Trading); SIFMA et al. (Prop.Trading) (Feb. 2012). 
85

profiting from short-term price movements and, thus, should not be proprietary trading 

for purposes of this rule. Rather, this activity is a prudent and desirable part of lending 

and debt collection activities. 

The Agencies believe that the purchase and sale of a financial instrument in 

satisfaction of a debt previously contracted does not constitute proprietary trading. The 

Agencies believe an exclusion for purchases and sales in satisfaction of debts previously 

contracted is necessary for banking entities to continue to lend to customers, because it 

allows banking entities to continue lending activity with the knowledge that they will not 

be penalized for recouping losses should a customer default. Accordingly, the final rule 

provides that proprietary trading does not include the purchase or sale of one or more 

financial instruments in the ordinary course of collecting a debt previously contracted in 

good faith, provided that the banking entity divests the financial instrument as soon as 

practicable within the time period permitted or required by the appropriate financial 

supervisory agency.285

As a result of this exclusion, banking entities, including SEC-registered brokerdealers, will be able to continue providing margin loans to their customers and may take 

possession of margined collateral following a customer’s default or failure to meet a 

margin call under applicable regulatory requirements.286 Similarly, a banking entity that 

is a CFTC-registered swap dealer or SEC-registered security-based swap dealer may take, 

 

285 See final rule § __.3(d)(9). 

286 For example, if any margin call is not met in full within the time required by Regulation T, then 

Regulation T requires a broker-dealer to liquidate securities sufficient to meet the margin call or to 

eliminate any margin deficiency existing on the day such liquidation is required, whichever is less. 

See 12 CFR 220.4(d).
86

hold, and exchange any margin collateral as counterparty to a cleared or uncleared swap 

or security-based swap transaction, in accordance with the rules of the Agencies.287 This 

exclusion will allow banking entities to comply with existing regulatory requirements 

regarding the divestiture of collateral taken in satisfaction of a debt. 

10. Other requested exclusions

Commenters requested a number of additional exclusions from the trading 

account and, in turn, the prohibition on proprietary trading. In order to avoid potential 

evasion of the final rule, the Agencies decline to adopt any exclusions from the trading 

account other than the exclusions described above.288 The Agencies believe that various 

modifications to the final rule, including in particular to the exemption for marketmaking related activities, address many of commenters’ concerns regarding unintended 

consequences of the prohibition on proprietary trading.

2. Section __.4(a): Underwriting Exemption

a. Introduction

 

287 See SEC Proposed Rule, Capital, Margin, Segregation, Reporting and Recordkeeping Requirements for 

Security-Based Swap Dealers, Exchange Act Release No. 68071, 77 FR 70,214 (Nov. 23, 2012); CFTC 

Proposed Rule, Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap 

Participants, 76 FR 23,732 (Apr. 28, 2011); Banking Agencies’ Proposed Rule, Margin and Capital 

Requirements for Covered Swap Entities, 76 FR 27,564 (May 11, 2011).

288 See, e.g., SIFMA et al. (Prop.Trading) (Feb. 2012) (transactions that are not based on expected or 

anticipated movements in asset prices, such as fully collateralized swap transactions that serve funding 

purposes); Norinchukin and Wells Fargo (Prop. Trading) (derivatives that qualify for hedge accounting); 

GE (Feb. 2012) (transactions related to commercial contracts); Citigroup (Feb. 2012) (FX swaps and FX 

forwards); SIFMA et al. (Prop.Trading) (Feb. 2012) (interaffiliate transactions); T. Rowe Price (purchase 

and sale of shares in sponsored mutual funds); RMA (cash collateral pools); Alfred Brock (arbitrage 

trading); ICBA (securities traded pursuant to 12 U.S.C. 1831a(f)). The Agencies are concerned that these 

exclusions could be used to conduct impermissible proprietary trading, and the Agencies believe some of 

these exclusions are more appropriately addressed by other provisions of the rule. For example, derivatives 

qualifying for hedge accounting may be permitted under the hedging exemption. 
87

After carefully considering comments on the proposed underwriting exemption, 

the Agencies are adopting the proposed underwriting exemption substantially as 

proposed, but with certain refinements and clarifications to the proposed approach to 

better reflect the range of securities offerings that an underwriter may help facilitate on 

behalf of an issuer or selling security holder and the types of activities an underwriter 

may undertake in connection with a distribution of securities to facilitate the distribution 

process and provide important benefits to issuers, selling security holders, or purchasers 

in the distribution. The Agencies are adopting such an approach because the statute 

specifically permits banking entities to continue providing these beneficial services to 

clients, customers, and counterparties. At the same time, to reduce the potential for 

evasion of the general prohibition on proprietary trading, the Agencies are requiring, 

among other things, that the trading desk make reasonable efforts to sell or otherwise 

reduce its underwriting position (accounting for the liquidity, maturity, and depth of the 

market for the relevant type of security) and be subject to a robust risk limit structure that 

is designed to prevent a trading desk from having an underwriting position that exceeds 

the reasonably expected near term demands of clients, customers, or counterparties. 

b. Overview

1. Proposed underwriting exemption

Section 13(d)(1)(B) of the BHC Act provides an exemption from the prohibition 

on proprietary trading for the purchase, sale, acquisition, or disposition of securities and 

certain other instruments in connection with underwriting activities, to the extent that 
88

such activities are designed not to exceed the reasonably expected near term demands of 

clients, customers, or counterparties.289

Section __.4(a) of the proposed rule would have implemented this exemption by 

requiring that a banking entity’s underwriting activities comply with seven requirements. 

As discussed in more detail below, the proposed underwriting exemption required that: 

(i) a banking entity establish a compliance program under § __.20; (ii) the covered 

financial position be a security; (iii) the purchase or sale be effected solely in connection 

with a distribution of securities for which the banking entity is acting as underwriter; (iv) 

the banking entity meet certain dealer registration requirements, where applicable; (v) the 

underwriting activities be designed not to exceed the reasonably expected near term 

demands of clients, customers, or counterparties; (vi) the underwriting activities be 

designed to generate revenues primarily from fees, commissions, underwriting spreads, 

or other income not attributable to appreciation in the value of covered financial positions 

or to hedging of covered financial positions; and (vii) the compensation arrangements of 

persons performing underwriting activities be designed not to reward proprietary risktaking.290 The proposal explained that these seven criteria were proposed so that any 

banking entity relying on the underwriting exemption would be engaged in bona fide

underwriting activities and would conduct those activities in a way that would not be 

susceptible to abuse through the taking of speculative, proprietary positions as part of, or 

mischaracterized as, underwriting activity.291

 

289 12 U.S.C. 1851(d)(1)(B).

290 See proposed rule § __.4(a).

291 See Joint Proposal, 76 FR at 68,866; CFTC Proposal, 77 FR at 8352.
89

2. Comments on proposed underwriting exemption

As a general matter, a few commenters expressed overall support for the proposed 

underwriting exemption.292 Some commenters indicated that the proposed exemption is 

too narrow and may negatively impact capital markets.293 As discussed in more detail 

below, many commenters expressed views on the effectiveness of specific requirements 

of the proposed exemption. Further, some commenters requested clarification or 

expansion of the proposed exemption for certain activities that may be conducted in the 

course of underwriting. 

Several commenters suggested alternative approaches to implementing the 

statutory exemption for underwriting activities.294 More specifically, commenters 

recommended that the Agencies: (i) provide a safe harbor for low risk, standard 

underwritings;295 (ii) better incorporate the statutory limitations on high-risk activity or 

conflicts of interest;296 (iii) prohibit banking entities from underwriting illiquid 

 

292 See Barclays (stating that the proposed exemption generally effectuates the aims of the statute while 

largely avoiding undue interference, although the commenter also requested certain technical changes to 

the rule text); Alfred Brock.

293 See, e.g., Lord Abbett; BoA; Fidelity; Chamber (Feb. 2012).

294 See Sens. Merkley & Levin (Feb. 2012); BoA; Fidelity; Occupy; AFR et al. (Feb. 2012).

295 See Sens. Merkley & Levin (Feb. 2012) (suggesting a safe harbor for underwriting efforts that meet 

certain low-risk criteria, including that: the underwriting be in plain vanilla stock or bond offerings, 

including commercial paper, for established business and governments; and the distribution be completed 

within relevant time periods, as determined by asset classes, with relevant factors being the size of the 

issuer and the market served); Johnson & Prof. Stiglitz (expressing support for a narrow safe harbor for 

underwriting of basic stocks and bonds that raise capital for real economy firms).

296 See Sens. Merkley & Levin (Feb. 2012) (suggesting that, for example, the exemption plainly prevent 

high-risk, conflict ridden underwritings of securitizations and structured products and cross-reference 

Section 621 of the Dodd-Frank Act, which prohibits certain material conflicts of interest in connection with 

asset-backed securities).
90

securities;297 (iv) prohibit banking entities from participating in private placements;298 (v) 

place greater emphasis on adequate internal compliance and risk management 

procedures;299 or (vi) make the exemption as broad as possible.300

3. Final underwriting exemption

After considering the comments received, the Agencies are adopting the 

underwriting exemption substantially as proposed, but with important modifications to 

clarify provisions or to address commenters’ concerns. As discussed above, some 

commenters were generally supportive of the proposed approach to implementing the 

underwriting exemption, but noted certain areas of concern or uncertainty. The 

underwriting exemption the Agencies are adopting addresses these issues by further 

clarifying the scope of activities that qualify for the exemption. In particular, the 

Agencies are refining the proposed exemption to better capture the broad range of 

capital-raising activities facilitated by banking entities acting as underwriters on behalf of 

issuers and selling security holders.

The final underwriting exemption includes the following components:

• A framework that recognizes the differences in underwriting activities across 

markets and asset classes by establishing criteria that will be applied flexibly 

 

297 See AFR et al. (Feb. 2012) (recommending that the Agencies prohibit banking entities from acting as 

underwriter for assets classified as Level 3 under FAS 157, which would prohibit underwriting of illiquid 

and opaque securities without a genuine external market, and representing that such a restriction would be 

consistent with the statutory limitation on exposures to high-risk assets).

298 See Occupy. 

299 See BoA (recommending that the Agencies establish a strong presumption that all of a banking entity’s 

activities related to underwriting are permitted under the rules as long as the banking entity has adequate 

compliance and risk management procedures).

300 See Fidelity (suggested that the rules be revised to “provide the broadest exemptions possible under the 

statute” for underwriting and certain other permitted activities).
91

based on the liquidity, maturity, and depth of the market for the particular type 

of security.

• A general focus on the “underwriting position” held by a banking entity or its 

affiliate, and managed by a particular trading desk, in connection with the 

distribution of securities for which such banking entity or affiliate is acting as an 

underwriter.301

• A definition of the term “trading desk” that focuses on the functionality of the 

desk rather than its legal status, and requirements that apply at the trading desk 

level of organization within a banking entity or across two or more affiliates.302 

• Five standards for determining whether a banking entity is engaged in permitted 

underwriting activities. Many of these criteria have similarities to those included 

in the proposed rule, but with important modifications in response to comments. 

These standards require that: 

o The banking entity act as an “underwriter” for a “distribution” of 

securities and the trading desk’s underwriting position be related to such 

distribution. The final rule includes refined definitions of “distribution” 

and “underwriter” to better capture the broad scope of securities offerings 

used by issuers and selling security holders and the range of roles that a 

banking entity may play as intermediary in such offerings.303

o The amount and types of securities in the trading desk’s underwriting 

position be designed not to exceed the reasonably expected near term 

demands of clients, customers, or counterparties, and reasonable efforts 

be made to sell or otherwise reduce the underwriting position within a 

reasonable period, taking into account the liquidity, maturity, and depth 

of the market for the relevant type of security.304

o The banking entity establish, implement, maintain, and enforce an internal 

compliance program that is reasonably designed to ensure the banking 

entity’s compliance with the requirements of the underwriting 

exemption, including reasonably designed written policies and 

procedures, internal controls, analysis, and independent testing 

identifying and addressing: 

 

301 See infra Part IV.A.2.c.1.c. 

302 See infra Part IV.A.2.c.1.c. The term “trading desk” is defined in final rule § __.3(e)(13) as “the 

smallest discrete unit of organization of a banking entity that purchases or sells financial instruments for the 

trading account of the banking entity or an affiliate thereof.”

303 See final rule §§ __.4(a)(2)(i), __.4(a)(3), __.4(a)(4); See also infra Part IV.A.2.c.1.c.

304 See final rule § __.4(a)(2)(ii); See also infra Part IV.A.2.c.2.c.
92

 The products, instruments, or exposures each trading desk may 

purchase, sell, or manage as part of its underwriting activities; 

 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; 

 Internal controls and ongoing monitoring and analysis of each 

trading desk’s compliance with its limits; and 

 Authorization procedures, including escalation procedures that 

require review and approval of any trade that would exceed a 

trading desk’s limit(s), demonstrable analysis 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.305

o The compensation arrangements of persons performing the banking 

entity’s underwriting activities are designed not to reward or incentivize 

prohibited proprietary trading.306

o The banking entity is licensed or registered to engage in the activity 

described in the underwriting exemption in accordance with applicable 

law.307

After considering commenters’ suggested alternative approaches to implementing 

the statute’s underwriting exemption, the Agencies have determined to retain the general 

structure of the proposed underwriting exemption. For instance, two commenters 

suggested providing a safe harbor for “plain vanilla” or “basic” underwritings of stocks 

and bonds.308 The Agencies do not believe that a safe harbor is necessary to provide 

 

305 See final rule § __.4(a)(2)(iii); See also infra Part IV.A.2.c.3.c.

306 See final rule § __.4(a)(2)(iv); See also infra Part IV.A.2.c.4.c.

307 See final rule § __.4(a)(2)(v); See also infra Part IV.A.2.c.5.c.

308 See Sens. Merkley & Levin (Feb. 2012); Johnson & Prof. Stiglitz. One of these commenters also 

suggested that the Agencies better incorporate the statutory limitations on material conflicts of interest and 

high-risk activities in the underwriting exemption by including additional provisions in the exemption to 

refer to these limitations. See Sens. Merkley & Levin (Feb. 2012). The Agencies note that these 
93

certainty that a banking entity may act as an underwriter in these particular types of 

offerings. This is because “plain vanilla” or “basic” underwriting activity should be able 

to meet the requirements of the final rule. For example, the final definition of 

“distribution” includes any offering of securities made pursuant to an effective 

registration statement under the Securities Act.309 

Further, in response to one commenter’s request that the final rule prohibit a 

banking entity from acting as an underwriter in illiquid assets that are determined to not 

have observable price inputs under accounting standards,310 the Agencies continue to 

believe that it would be inappropriate to incorporate accounting standards in the rule 

because accounting standards could change in the future without consideration of the 

potential impact on the final rule.311 Moreover, the Agencies do not believe it is 

necessary to differentiate between liquid and less liquid securities for purposes of 

determining whether a banking entity may underwrite a distribution of securities because, 

in either case, a banking entity must have a reasonable expectation of purchaser demand 

for the securities and must make reasonable efforts to sell or otherwise reduce its 

underwriting position within a reasonable period under the final rule.312 

Another commenter suggested that the Agencies establish a strong presumption 

that all of a banking entity’s activities related to underwriting are permitted under the rule 

 

limitations are adopted in § __.7 of the final rules, and this provision will apply to underwriting activities, 

as well as all other exempted activities. 

309 See final rule § __.4(a)(3). 

310 See AFR et al. (Feb. 2012).

311 See Joint Proposal, 76 FR at 68,859 n.101 (explaining why the Agencies declined to incorporate certain 

accounting standards in the proposed rule); CFTC Proposal, 77 FR at 8344 n.107.

312 See infra Part IV.A.2.c.2.c.
94

as long as the banking entity has adequate compliance and risk management 

procedures.313 While strong compliance and risk management procedures are important 

for banking entities’ permitted activities, the Agencies believe that an approach focused 

solely on the establishment of a compliance program would likely increase the potential 

for evasion of the general prohibition on proprietary trading. Similarly, the Agencies are 

not adopting an exemption that is unlimited, as requested by one commenter, because the 

Agencies believe controls are necessary to prevent potential evasion of the statute

through, among other things, retaining an unsold allotment when there is sufficient 

customer interest for the securities and to limit the risks associated with these 

activities.314

Underwriters play an important role in facilitating issuers’ access to funding, and 

thus underwriters are important to the capital formation process and economic growth.315 

Obtaining new financing can be expensive for an issuer because of the natural 

information advantage that less well-known issuers have over investors about the quality 

of their future investment opportunities. An underwriter can help reduce these costs by 

mitigating the information asymmetry between an issuer and its potential investors. The 

underwriter does this based in part on its familiarity with the issuer and other similar 

issuers as well as by collecting information about the issuer. This allows investors to 

look to the reputation and experience of the underwriter as well as its ability to provide 

information about the issuer and the underwriting. For these and other reasons, most U.S. 

 

313 See BoA.

314 See Fidelity.

315 See, e.g., BoA (“The underwriting activities of U.S. banking entities are essential to capital formation 

and, therefore, economic growth and job creation.”); Goldman (Prop. Trading); Sens. Merkley & Levin 

(Feb. 2012).
95

issuers rely on the services of an underwriter when raising funds through public offerings. 

As recognized in the statute, the exemption is intended to permit banking entities to 

continue to perform the underwriting function, which contributes to capital formation and 

its positive economic effects.

c. Detailed Explanation of the Underwriting Exemption

1. Acting as an underwriter for a distribution of securities

a. Proposed requirements that the purchase or sale be effected solely in 

connection with a distribution of securities for which the banking entity acts 

as an underwriter and that the covered financial position be a security

Section __.4(a)(2)(iii) of the proposed rule required that the purchase or sale be 

effected solely in connection with a distribution of securities for which a banking entity is 

acting as underwriter.316 As discussed below, the Agencies proposed to define the terms 

“distribution” and “underwriter” in the proposed rule. The proposed rule also required 

that the covered financial position being purchased or sold by the banking entity be a 

security.317 

i. Proposed definition of “distribution”

The proposed definition of “distribution” mirrored the definition of this term used 

in the SEC’s Regulation M under the Exchange Act.318 More specifically, the proposed 

rule defined “distribution” as “an offering of securities, whether or not subject to 

registration under the Securities Act, that is distinguished from ordinary trading 

transactions by the magnitude of the offering and the presence of special selling efforts 

 

316 See proposed rule § __.4(a)(2)(iii).

317 See proposed rule § __.4(a)(2)(ii).

318 See Joint Proposal, 76 FR at 68,866-68,867; CFTC Proposal, 77 FR at 8352; 17 CFR 242.101; proposed 

rule § __.4(a)(3).
96

and selling methods.”319 The Agencies did not propose to define the terms “magnitude” 

and “special selling efforts and selling methods,” but stated that the Agencies would 

expect to rely on the same factors considered in Regulation M for assessing these 

elements.320 The Agencies noted that “magnitude” does not imply that a distribution 

must be large and, therefore, this factor would not preclude small offerings or private 

placements from qualifying for the proposed underwriting exemption.321

ii. Proposed definition of “underwriter”

Like the proposed definition of “distribution,” the Agencies proposed to define 

“underwriter” in a manner similar to the definition of this term in the SEC’s Regulation 

M.322 The definition of “underwriter” in the proposed rule was: (i) any person who has 

agreed with an issuer or selling security holder to: (a) purchase securities for distribution; 

(b) engage in a distribution of securities for or on behalf of such issuer or selling security 

holder; or (c) manage a distribution of securities for or on behalf of such issuer or selling 

security holder; and (ii) a person who has an agreement with another person described in 

 

319 See proposed rule § __.4(a)(3).

320 See Joint Proposal, 76 FR at 68,867 (“For example, the number of shares to be sold, the percentage of 

the outstanding shares, public float, and trading volume that those shares represent are all relevant to an 

assessment of magnitude. In addition, delivering a sales document, such as a prospectus, and conducting 

road shows are generally indicative of special selling efforts and selling methods. Another indicator of 

special selling efforts and selling methods is compensation that is greater than that for secondary trades but 

consistent with underwriting compensation for an offering.”); CFTC Proposal, 77 FR at 8352; Review of 

Antimanipulation Regulation of Securities Offering, Exchange Act Release No. 33924 (Apr. 19, 1994), 59 

FR 21,681, 21,684-21,685 (Apr. 26, 1994).

321 See Joint Proposal, 76 FR at 68,867; CFTC Proposal, 77 FR at 8352.

322 See Joint Proposal, 76 FR at 68,866-68,867; CFTC Proposal, 77 FR at 8352; 17 CFR 242.101; proposed 

rule § __.4(a)(4).
97

the preceding provisions to engage in a distribution of such securities for or on behalf of 

the issuer or selling security holder.323 

In connection with this proposed requirement, the Agencies noted that the precise 

activities performed by an underwriter may vary depending on the liquidity of the 

securities being underwritten and the type of distribution being conducted. To determine 

whether a banking entity is acting as an underwriter as part of a distribution of securities, 

the Agencies proposed to take into consideration the extent to which a banking entity is 

engaged in the following activities:

• Assisting an issuer in capital-raising;

• Performing due diligence;

• Advising the issuer on market conditions and assisting in the preparation 

of a registration statement or other offering document;

• Purchasing securities from an issuer, a selling security holder, or an 

underwriter for resale to the public;

• Participating in or organizing a syndicate of investment banks;

• Marketing securities; and

• Transacting to provide a post-issuance secondary market and to facilitate 

price discovery.324

The proposal recognized that there may be circumstances in which an underwriter would 

hold securities that it could not sell in the distribution for investment purposes. The 

Agencies stated that if the unsold securities were acquired in connection with 

 

323 See proposed rule § __.4(a)(4). As noted in the proposal, the proposed rule’s definition differed from 

the definition in Regulation M because the proposed rule’s definition would also include a person who has 

an agreement with another underwriter to engage in a distribution of securities for or on behalf of an issuer 

or selling security holder. See Joint Proposal, 76 FR at 68,867; CFTC Proposal, 77 FR at 8352.

324 See Joint Proposal, 76 FR at 68,867; CFTC Proposal, 77 FR at 8352.
98

underwriting under the proposed exemption, then the underwriter would be able to 

dispose of such securities at a later time.325

iii. Proposed requirement that the covered financial position be a security

Pursuant to § __.4(a)(2)(ii) of the proposed exemption, a banking entity would be 

permitted to purchase or sell a covered financial position that is a security only in 

connection with its underwriting activities.326 The proposal stated that this requirement 

was meant to reflect the common usage and understanding of the term “underwriting.”327 

It was noted, however, that a derivative or commodity future transaction may be 

otherwise permitted under another exemption (e.g., the exemptions for market makingrelated or risk-mitigating hedging activities).328

b. Comments on the proposed requirements that the trade be effected solely in 

connection with a distribution for which the banking entity is acting as an 

underwriter and that the covered financial position be a security

In response to the proposed requirement that a purchase or sale be “effected solely 

in connection with a distribution of securities” for which the “banking entity is acting as 

underwriter,” commenters generally focused on the proposed definitions of “distribution” 

and “underwriter” and the types of activities that should be permitted under the “in 

connection with” standard. Commenters did not directly address the requirement in § 

__.4(a)(2)(ii) of the proposed rule, which provided that the covered financial position 

purchased or sold under the exemption must be a security. A number of commenters 

 

325 See id.

326 See proposed rule § __.4(a)(2)(ii).

327 See Joint Proposal, 76 FR at 68,866; CFTC Proposal, 77 FR at 8352.

328 See Joint Proposal, 76 FR at 68,866 n.132; CFTC Proposal, 77 FR at 8352 n.138.
99

expressed general concern that the proposed underwriting exemption’s references to a 

“purchase or sale of a covered financial position” could be interpreted to require 

compliance with the proposed rule on a transaction-by-transaction basis. These 

commenters indicated that such an approach would be overly burdensome.329

i. Definition of “distribution”

Several commenters stated that the proposed definition of “distribution” is too 

narrow,330 while one commenter stated that the proposed definition is too broad.331 

Commenters who viewed the proposed definition as too narrow stated that it may exclude 

important capital-raising and financing transactions that do not appear to involve “special 

selling efforts and selling methods” or “magnitude.”332 In particular, these commenters 

stated that the proposed definition of “distribution” may preclude a banking entity from 

participating in commercial paper issuances,333 bridge loans,334 “at-the-market” offerings 

or “dribble out” programs conducted off issuer shelf registrations,335 offerings in 

response to reverse inquiries,336 offerings through an automated execution system,337

 

329 See, e.g., Goldman (Prop. Trading); SIFMA et al. (Prop. Trading) (Feb. 2012).

330 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Wells Fargo (Prop. Trading); 

RBC.

331 See Occupy.

332 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Wells Fargo (Prop. Trading); RBC.

333 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Wells Fargo (Prop. Trading). 

In addition, one commenter expressed general concern that the proposed rule would cause a reduction in 

underwriting services with respect to commercial paper, which would reduce liquidity in commercial paper 

markets and raise the costs of capital in already tight credit markets. See Chamber (Feb. 2012).

334 See Goldman (Prop. Trading); Wells Fargo (Prop. Trading); RBC; LSTA (Feb. 2012).

335 See Goldman (Prop. Trading).

336 See SIFMA et al. (Prop. Trading) (Feb. 2012).

337 See SIFMA et al. (Prop. Trading) (Feb. 2012).
100

small private offerings,338 or selling security holders’ sales of securities of issuers with 

large market capitalizations that are executed as underwriting transactions in the normal 

course.339 

Several commenters suggested that the proposed definition be modified to include 

some or all of these types of offerings.340 For example, two commenters requested that 

the definition explicitly include all offerings of securities by an issuer.341 One of these 

commenters further requested a broader definition that would include any offering by a 

selling security holder that is registered under the Securities Act or that involves an 

offering document prepared by the issuer.342 Another commenter suggested that the rule 

explicitly authorize certain forms of offerings, such as offerings under Rule 144A, 

Regulation S, Rule 101(b)(10) of Regulation M, or the so-called “section 4(11⁄2)” of the 

Securities Act, as well as transactions on behalf of selling security holders.343 Two 

commenters proposed approaches that would include the resale of notes or other debt 

securities received by a banking entity from a borrower to replace or refinance a bridge 

 

338 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Wells Fargo (Prop. Trading).

339 See RBC.

340 See Goldman (Prop. Trading); SIFMA et al. (Prop. Trading) (Feb. 2012); RBC.

341 See Goldman (Prop. Trading) (stating that this would capture, among other things, commercial paper 

issuances, issuer “dribble out” programs, and small private offerings, which involve the purchase of 

securities directly from an issuer with a view toward resale, but may not always be clearly distinguished by 

“special selling efforts and selling methods” or by “magnitude”); SIFMA et al. (Prop. Trading) (Feb. 2012).

342 See SIFMA et al. (Prop. Trading) (Feb. 2012). This commenter indicated that expanding the definition 

of “distribution” to include both offerings of securities by an issuer and offerings by a selling security 

holder that are registered under the Securities Act or that involve an offering document prepared by the 

issuer would “include, for example, an offering of securities by an issuer or a selling security holder where 

securities are sold through an automated order execution system, offerings in response to reverse inquiries 

and commercial paper issuances.” Id.

343 See RBC.
101

loan.344 One of these commenters stated that permitting a banking entity to receive and 

resell notes or other debt securities from a borrower to replace or refinance a bridge loan 

would preserve the ability of a banking entity to extend credit and offer customers a 

range of financing options. This commenter further represented that such an approach 

would be consistent with the exclusion of loans from the proposed definition of “covered 

financial position” and the commenter’s recommended exclusion from the definition of 

“trading account” for collecting debts previously contracted.345 

One commenter, however, stated that the proposed definition of “distribution” is 

too broad. This commenter suggested that the underwriting exemption should only be 

available for registered offerings, and the rule should preclude a banking entity from 

participating in a private placement. According to the commenter, permitting a banking 

entity to participate in a private placement may facilitate evasion of the prohibition on 

proprietary trading.346

ii. Definition of “underwriter”

Several commenters stated that the proposed definition of “underwriter” is too 

narrow.347 Other commenters, however, stated that the proposed definition is too broad, 

particularly due to the proposed inclusion of selling group members.348 

 

344 See Goldman (Prop. Trading); RBC. In addition, one commenter requested the Agencies clarify that 

permitted underwriting activities include the acquisition and resale of securities issued in lieu of or to 

refinance bridge loan facilities, irrespective of whether such activities qualify as “distributions” under the 

proposal. See LSTA (Feb. 2012).

345 See Goldman (Prop. Trading).

346 See Occupy.

347 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Wells Fargo (Prop. Trading).
102

Commenters requesting a broader definition generally stated that the Agencies 

should instead use the Regulation M definition of “distribution participant” or otherwise 

revise the definition of “underwriter” to incorporate the concept of a “distribution 

participant,” as defined under Regulation M.349 According to these commenters, using 

the term “distribution participant” would better reflect current market practice and would 

include dealers that participate in an offering but that do not deal directly with the issuer 

or selling security holder and do not have a written agreement with the underwriter.350 

One commenter further represented that the proposed provision for selling group 

members may be less inclusive than the Agencies intended because individual selling 

dealers or dealer groups may or may not have written agreements with an underwriter in 

privity of contract with the issuer.351 Another commenter requested that, if the 

“distribution participant” concept is not incorporated into the rule, the proposed definition 

of “underwriter” be modified to include a person who has an agreement with an affiliate 

of an issuer or selling security holder (e.g., an agreement with a parent company to 

distribute the issuer’s securities).352

 348 See AFR et al. (Feb. 2012); Public Citizen; Occupy (suggesting that the Agencies exceeded their 

statutory authority by incorporating the Regulation M definition of “underwriter,” rather than the Securities 

Act definition of “underwriter”).

349 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Wells Fargo (Prop. Trading). 

The term “distribution participant” is defined in Rule 100 of Regulation M as “an underwriter, prospective 

underwriter, broker, dealer, or other person who has agreed to participate or is participating in a 

distribution.” 17 CFR 242.100.

350 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Wells Fargo (Prop. Trading).

351 See Goldman (Prop. Trading).

352 See SIFMA et al. (Prop. Trading) (Feb. 2012). This commenter also requested a technical amendment 

to proposed rule § __.4(a)(4)(ii) to clarify that the person is “participating” in a distribution, not “engaging” 

in a distribution. See id.
103

Other commenters opposed the inclusion of selling group members in the 

proposed definition of “underwriter.” These commenters stated that because selling 

group members do not provide a price guarantee to an issuer, they do not provide services 

to a customer and their activities should not qualify for the underwriting exemption.353

A number of commenters stated that it is unclear whether the proposed 

underwriting exemption would permit a banking entity to act as an authorized participant 

(“AP”) to an ETF issuer, particularly with respect to the creation and redemption of ETF 

shares or “seeding” an ETF for a short period of time when it is initially launched.354 For 

example, a few commenters noted that APs typically do not perform some or all of the 

activities that the Agencies proposed to consider to help determine whether a banking 

entity is acting as an underwriter in connection with a distribution of securities, including 

due diligence, advising an issuer on market conditions and assisting in preparation of a 

registration statement or offering documents, and participating in or organizing a 

syndicate of investment banks.355

However, one commenter appeared to oppose applying the underwriting 

exemption to certain AP activities. According to this commenter, APs are generally 

reluctant to concede that they are statutory underwriters because they do not perform all 

the activities associated with the underwriting of an operating company’s securities. 

Further, this commenter expressed concern that, if an AP had to rely on the proposed 

 

353 See AFR et al. (Feb. 2012); Public Citizen.

354 See BoA; ICI Global; Vanguard; ICI (Feb. 2012); SSgA (Feb. 2012). As one commenter explained, an 

AP may “seed” an ETF for a short period of time at its inception by entering into several initial creation 

transactions with the ETF issuer and refraining from selling those shares to investors or redeeming them for 

a period of time to facilitate the ETF achieving its liquidity launch goals. See BoA.

355 See ICI Global; ICI (Feb. 2012); Vanguard.
104

underwriting exemption, the AP could be subject to heightened risk of incurring 

underwriting liability on the issuance of ETF shares traded by the AP. As a result of 

these considerations, the commenter believed that a banking entity may be less willing to 

act as an AP for an ETF issuer if it were required to rely on the underwriting 

exemption.356

iii. “Solely in connection with” standard

To qualify for the underwriting exemption, the proposed rule required a purchase 

or sale of a covered financial position to be effected “solely in connection with” a 

distribution of securities for which the banking entity is acting as underwriter. Several 

commenters expressed concern that the word “solely” in this provision may result in an 

overly narrow interpretation of permissible activities. In particular, these commenters 

indicated that the “solely in connection with” standard creates uncertainty about certain 

activities that are currently conducted in the course of an underwriting, such as customary 

underwriting syndicate activities.357 One commenter represented that such activities are 

traditionally undertaken to: support the success of a distribution; mitigate risk to issuers, 

investors, and underwriters; and facilitate an orderly aftermarket.358 A few commenters 

further stated that requiring a trade to be “solely” in connection with a distribution by an 

 

356 See SSgA (Feb. 2012).

357 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); BoA; Wells Fargo (Prop. 

Trading); Comm. on Capital Markets Regulation.

358 See Goldman (Prop. Trading).
105

underwriter would be inconsistent with the statute,359 may reduce future innovation in the 

capital-raising process,360 and could create market disruptions.361

A number of commenters stated that it is unclear whether certain activities would 

qualify for the proposed underwriting exemption and requested that the Agencies adopt 

an exemption that is broad enough to permit such activities.362 Commenters stated that 

there are a number of activities that should be permitted under the underwriting 

exemption, including: (i) creating a naked or covered syndicate short position in 

connection with an offering;363 (ii) creating a stabilizing bid;364 (iii) acquiring positions 

via overallotments365 or trading in the market to close out short positions in connection 

with an overallotment option or in connection with other stabilization activities;366 (iv) 

using call spread options in a convertible debt offering to mitigate dilution of existing 

shareholders;367 (v) repurchasing existing debt securities of an issuer in the course of 

underwriting a new series of debt securities in order to stimulate demand for the new 

 

359 See Goldman (Prop. Trading); Wells Fargo (Prop. Trading); SIFMA et al. (Prop. Trading) (Feb. 2012).

360 See Goldman (Prop. Trading).

361 See SIFMA et al. (Prop. Trading) (Feb. 2012).

362 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Wells Fargo (Prop. Trading); 

RBC.

363 See SIFMA et al. (Prop. Trading) (Feb. 2012) (“The reason for creating the short positions (covered and 

naked) is to facilitate an orderly aftermarket and to reduce price volatility of newly offered securities. This 

provides significant value to issuers and selling security holders, as well as to investors, by giving the 

syndicate buying power that helps protect against immediate volatility in the aftermarket.”); RBC; 

Goldman (Prop. Trading).

364 See SIFMA et al. (Prop. Trading) (Feb. 2012) (“Underwriters may also engage in stabilization activities 

under Regulation M by creating a stabilizing bid to prevent or slow a decline in the market price of a 

security. These activities should be encouraged rather than restricted by the Volcker Rule because they 

reduce price volatility and facilitate the orderly pricing and aftermarket trading of underwritten securities, 

thereby contributing to capital formation.”).

365 See RBC.

366 See Goldman (Prop. Trading).

367 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading) (stating that the call spread 

arrangement “may make a wider range of financing options feasible for the issuer of the convertible debt” 

and “can help it to raise more capital at more attractive prices”).
106

issuance;368 (vi) purchasing debt securities of comparable issuers as a price discovery 

mechanism in connection with underwriting a new debt security;369 (vii) hedging the 

underwriter’s exposure to a derivative strategy engaged in with an issuer;370 (viii) 

organizing and assembling a resecuritized product, including, for example, sourcing bond 

collateral over a period of time in anticipation of issuing new securities;371 and (ix) 

selling a security to an intermediate entity as part of the creation of certain structured 

products.372

c. Final requirement that the banking entity act as an underwriter for a distribution 

of securities and the trading desk’s underwriting position be related to such 

distribution

The final rule requires that the banking entity act as an underwriter for a 

distribution of securities and the trading desk’s underwriting position be related to such 

distribution.373 This requirement is substantially similar to the proposed rule,374 but with 

 

368 See Wells Fargo (Prop. Trading). The commenter further stated that the need to purchase the issuer’s 

other debt securities from investors may arise if an investor has limited risk tolerance to the issuer’s credit 

or has portfolio restrictions. According to the commenter, the underwriter would typically sell the debt 

securities it purchased from existing investors to new investors. See id.

369 See Wells Fargo (Prop. Trading).

370 See Goldman (Prop. Trading).

371 See ASF (Feb. 2012) (stating that, for example, a banking entity may respond to customer or general 

market demand for highly-rated mortgage paper by accumulating residential mortgage-backed securities 

over time and holding such securities in inventory until the transaction can be organized and assembled).

372 See ICI (Feb. 2012) (stating that the sale of assets to an intermediate asset-backed commercial paper or 

tender option bond program should be permitted under the underwriting exemption if the sale is part of the 

creation of a structured security). See also AFR et al. (Feb. 2012) (stating that the treatment of a sale to an 

intermediate entity should depend on whether the banking entity or an external client is the driver of the 

demand and, if the banking entity is the driver of the demand, then the near term demand requirement 

should not be met). Two commenters stated that the underwriting exemption should not permit a banking 

entity to sell a security to an intermediate entity in the course of creating a structured product. See Occupy; 

Alfred Brock. These commenters were generally responding to a question on this issue in the proposal. 

See Joint Proposal, 76 FR at 68,868 – 68,869 (question 78); CFTC Proposal, 77 FR at 8354 (question 78).

373 Final rule § __.4(a)(2)(i). The terms “distribution” and “underwriter” are defined in final rule § 

__.4(a)(3) and § __.4(a)(4), respectively.
107

five key refinements. First, to address commenters’ confusion about whether the 

underwriting exemption applies on a transaction-by-transaction basis, the phrase 

“purchase or sale” has been modified to instead refer to the trading desk’s “underwriting 

position.” Second, to balance this more aggregated position-based approach, the final 

rule specifies that the trading desk is the organizational level of a banking entity (or 

across one or more affiliated banking entities) at which the requirements of the 

underwriting exemption will be assessed. Third, the Agencies have made important 

modifications to the definition of “distribution” to better capture the various types of 

private and registered offerings a banking entity may be asked to underwrite by an issuer 

or selling security holder. Fourth, the definition of “underwriter” has been refined to 

clarify that both members of the underwriting syndicate and selling group members may 

qualify as underwriters for purposes of this exemption. Finally, the word “solely” has 

been removed to clarify that a broader scope of activities conducted in connection with 

underwriting (e.g., stabilization activities) are permitted under this exemption. These 

issues are discussed in turn below.

i. Definition of “underwriting position”

In response to commenters’ concerns about transaction-by-transaction analyses,375

the Agencies are modifying the exemption to clarify the level at which compliance with 

certain provisions will be assessed. The proposal was not intended to impose a 

transaction-by-transaction approach, and the final rule’s requirements generally focus on 

 374 Proposed rule § __.4(a)(2)(iii) required that “[t]he purchase or sale is effected solely in connection with 

a distribution of securities for which the covered banking entity is acting as underwriter.”

375 See, e.g., Goldman (Prop. Trading); SIFMA et al. (Prop. Trading) (Feb. 2012).
108

the long or short positions in one or more securities held by a banking entity or its 

affiliate, and managed by a particular trading desk, in connection with a particular 

distribution of securities for which such banking entity or its affiliate is acting as an 

underwriter. Like § __.4(a)(2)(ii) of the proposed rule, the definition of “underwriting 

position” is limited to positions in securities because the common usage and 

understanding of the term “underwriting” is limited to activities in securities. 

A trading desk’s underwriting position constitutes the securities positions that are 

acquired in connection with a single distribution for which the relevant banking entity is 

acting as an underwriter. A trading desk may not aggregate securities positions acquired 

in connection with two or more distributions to determine its “underwriting position.” A 

trading desk may, however, have more than one “underwriting position” at a particular 

point in time if the banking entity is acting as an underwriter for more than one 

distribution. As a result, the underwriting exemption’s requirements pertaining to a 

trading desk’s underwriting position will apply on a distribution-by-distribution basis. 

A trading desk’s underwriting position can include positions in securities held at 

different affiliated legal entities, provided the banking entity is able to provide 

supervisors or examiners of any Agency that has regulatory authority over the banking 

entity pursuant to section 13(b)(2)(B) of the BHC Act with records, promptly upon 

request, that identify any related positions held at an affiliated entity that are being 

included in the trading desk’s underwriting position for purposes of the underwriting 

exemption. Banking entities should be prepared to provide all records that identify all of 

the positions included in a trading desk’s underwriting position and where such positions 

are held.
109

The Agencies believe that a distribution-by-distribution approach is appropriate 

due to the relatively distinct nature of underwriting activities for a single distribution on 

behalf of an issuer or selling security holder. The Agencies do not believe that a 

narrower transaction-by-transaction analysis is necessary to determine whether a banking 

entity is engaged in permitted underwriting activities. The Agencies also decline to take 

a broader approach, which would allow a banking entity to aggregate positions from 

multiple distributions for which it is acting as an underwriter, because it would be more 

difficult for the banking entity’s internal compliance personnel and Agency supervisors 

and examiners to review the trading desk’s positions to assess the desk’s compliance with 

the underwriting exemption. A more aggregated approach would increase the number of 

positions in different types of securities that could be included in the underwriting 

position, which would make it more difficult to determine that an individual position is 

related to a particular distribution of securities for which the banking entity is acting as an 

underwriter and, in turn, increase the potential for evasion of the general prohibition on 

proprietary trading. 

ii. Definition of “trading desk”

The proposed underwriting exemption would have applied certain requirements 

across an entire banking entity. To promote consistency with the market-making 

exemption and address potential evasion concerns, the final rule applies the requirements 

of the underwriting exemption at the trading desk level of organization.376 This approach 

will result in the requirements of the underwriting exemption applying to the aggregate 

 

376 See infra Part IV.A.3.c. (discussing the final market-making exemption). 
110

trading activities of a relatively limited group of employees on a single desk. Applying 

requirements at the trading desk level should facilitate banking entity and Agency 

monitoring and review of compliance with the exemption by limiting the location where 

underwriting activity may occur and allowing better identification of the aggregate 

trading volume that must be reviewed to determine whether the desk’s activities are being 

conducted in a manner that is consistent with the underwriting exemption, while also 

allowing adequate consideration of the particular facts and circumstances of the desk’s 

trading activities.

The trading desk should be managed and operated as an individual unit and 

should reflect the level at which the profit and loss of employees engaged in underwriting 

activities is attributed. The term “trading desk” in the underwriting context is intended to 

encompass what is commonly thought of as an underwriting desk. A trading desk 

engaged in underwriting activities would not necessarily be an active market participant 

that engages in frequent trading activities. 

A trading desk may manage an underwriting position that includes positions held 

by different affiliated legal entities.377 Similarly, a trading desk may include employees 

working on behalf of multiple affiliated legal entities or booking trades in multiple 

affiliated entities. The geographic location of individual traders is not dispositive for 

purposes of determining whether the employees are engaged in activities for a single 

trading desk.

iii. Definition of “distribution”

 

377 See supra note 302 and accompanying text.
111

The term “distribution” is defined in the final rule as: (i) an offering of securities, 

whether or not subject to registration under the Securities Act, that is distinguished from 

ordinary trading transactions by the presence of special selling efforts and selling 

methods; or (ii) an offering of securities made pursuant to an effective registration 

statement under the Securities Act.378 In response to comments, the proposed definition 

has been revised to eliminate the need to consider the “magnitude” of an offering and 

instead supplements the definition with an alternative prong for registered offerings under 

the Securities Act.379

The proposed definition’s reference to magnitude caused some commenter 

concern with respect to whether it could be interpreted to preclude a banking entity from 

intermediating a small private placement. After considering comments, the Agencies 

have determined that the requirement to have special selling efforts and selling methods 

is sufficient to distinguish between permissible securities offerings and prohibited 

proprietary trading, and the additional magnitude factor is not needed to further this 

objective.380 As proposed, the Agencies will rely on the same factors considered under 

Regulation M to analyze the presence of special selling efforts and selling methods.381 

Indicators of special selling efforts and selling methods include delivering a sales 

 

378 Final rule § __.4(a)(3). 

379 Proposed rule § __.4(a)(3) defined “distribution” as “an offering of securities, whether or not subject to 

registration under the Securities Act, that is distinguished from ordinary trading transactions by the 

magnitude of the offering and the presence of special selling efforts and selling methods.”

380 The policy goals of this rule differ from those of the SEC’s Regulation M, which is an antimanipulation rule. The focus on magnitude is appropriate for that regulation because it helps identify 

offerings that can give rise to an incentive to condition the market for the offered security. To the contrary, 

this rule is intended to allow banking entities to continue to provide client-oriented financial services, 

including underwriting services. The SEC emphasizes that this rule does not have any impact on 

Regulation M. 

381 See Joint Proposal, 76 FR at 68,867; CFTC Proposal, 77 FR at 8352.
112

document (e.g., a prospectus), conducting road shows, and receiving compensation that is 

greater than that for secondary trades but consistent with underwriting compensation.382 

For purposes of the final rule, each of these factors need not be present under all 

circumstances. Offerings that qualify as distributions under this prong of the definition 

include, among others, private placements in which resales may be made in reliance on 

the SEC’s Rule 144A or other available exemptions383 and, to the extent the commercial 

paper being offered is a security, commercial paper offerings that involve the underwriter 

receiving special compensation.384

The Agencies are also adopting a second prong to this definition, which will 

independently capture all offerings of securities that are made pursuant to an effective 

registration statement under the Securities Act.385 The registration prong of the definition 

is intended to provide another avenue by which an offering of securities may be 

conducted under the exemption, absent other special selling efforts and selling methods 

or a determination of whether such efforts and methods are being conducted. The 

Agencies believe this prong reduces potential administrative burdens by providing a 

bright-line test for what constitutes a distribution for purposes of the final rule. In 

 

382 See Joint Proposal, 76 FR at 68,867; CFTC Proposal, 77 FR at 8352; Review of Antimanipulation 

Regulation of Securities Offering, Exchange Act Release No. 33924 (Apr. 19, 1994), 59 FR 21,681, 

21,684-21,685 (Apr. 26, 1994).

383 The final rule does not provide safe harbors for particular distribution techniques. A safe harbor-based 

approach would provide certainty for specific types of offerings, but may not account for evolving market 

practices and distribution techniques that could technically satisfy a safe harbor but that might implicate the 

concerns that led Congress to enact section 13 of the BHC Act. See RBC. 

384 This clarification is intended to address commenters’ concern regarding potential limitations on banking 

entities’ ability to facilitate commercial paper offerings under the proposed underwriting exemption. See

supra Part IV.A.2.c.1.b.i.

385 See, e.g., Form S-1 (17 CFR 239.11); Form S-3 (17 CFR 239.13); Form S-8 (17 CFR 239.16b); Form 

F-1 (17 CFR 239.31); Form F-3 (17 CFR 239.33).
113

addition, this prong is consistent with the purpose and goals of the statute because it 

reflects a common type of securities offering and does not raise evasion concerns as it is 

unlikely that an entity would go through the registration process solely to facilitate or 

engage in speculative proprietary trading.386 This prong would include, among other 

things, the following types of registered securities offerings: offerings made pursuant to 

a shelf registration statement (whether on a continuous or delayed basis),387 bought 

deals,388 at the market offerings,389 debt offerings, asset-backed security offerings, initial 

public offerings, and other registered offerings. An offering can be a distribution for 

purposes of either § __.4(a)(3)(i) or § __.4(a)(3)(ii) of the final rule regardless of whether 

the offering is issuer driven, selling security holder driven, or arises as a result of a 

 

386 Although the Agencies are providing an additional prong to the definition of “distribution” for 

registered offerings, the final rule does not limit the availability of the underwriting exemption to registered 

offerings, as suggested by one commenter. The statute does not include such an express limitation, and the 

Agencies decline to construe the statute to require such an approach. In response to the commenter stating

that permitting a banking entity to participate in a private placement may facilitate evasion of the 

prohibition on proprietary trading, the Agencies believe this concern is addressed by the provision in the 

final rule requiring that a trading desk have a reasonable expectation of demand from other market 

participants for the amount and type of securities to be acquired from an issuer or selling security holder for 

distribution and make reasonable efforts to sell its underwriting position within a reasonable period. As 

discussed below, the Agencies believe this requirement in the final rule appropriately addresses evasion 

concerns that a banking entity may retain an unsold allotment for purely speculative purposes. Further, the 

Agencies believe that preventing a banking entity from facilitating a private offering could unnecessarily 

hinder capital-raising without providing commensurate benefits because issuers use private offerings to 

raise capital in a variety of situations and the underwriting exemption’s requirements limit the potential for 

evasion for both registered and private offerings, as noted above.

387 See Securities Offering Reform, Securities Act Release No. 8591 (July 19, 2005), 70 FR 44,722 (Aug. 

3, 2005); 17 CFR 230.405 (defining “automatic shelf registration statement” as a registration statement 

filed on Form S-3 (17 CFR 239.13) or Form F-3 (17 CFR 239.33) by a well-known seasoned issuer 

pursuant to General Instruction I.D. or I.C. of such forms, respectively); 17 CFR 230.415.

388 A bought deal is a distribution technique whereby an underwriter makes a bid for securities without 

engaging in a preselling effort, such as book building or distribution of a preliminary prospectus. See, e.g.,

Delayed or Continuous Offering and Sale of Securities, Securities Act Release No. 6470 (June 9, 1983), n.5.

389 See, e.g., 17 CFR 230.415(a)(4) (defining “at the market offering” as “an offering of equity securities 

into an existing trading market for outstanding shares of the same class at other than a fixed price”). At the 

market offerings may also be referred to as “dribble out” programs. 
114

reverse inquiry.390 Provided the definition of distribution is met, an offering can be a 

distribution for purposes of this rule regardless of how it is conducted, whether by direct 

communication, exchange transactions, or automated execution system.391

As discussed above, some commenters expressed concern that the proposed 

definition of “distribution” would prevent a banking entity from acquiring and reselling 

securities issued in lieu of or to refinance bridge loan facilities in reliance on the 

underwriting exemption. Bridge financing arrangements can be structured in many 

different ways, depending on the context and the specific objectives of the parties 

involved. As a result, the treatment of securities acquired in lieu of or to refinance a 

bridge loan and the subsequent sale of such securities under the final rule depends on the 

facts and circumstances. A banking entity may meet the terms of the underwriting 

exemption for its bridge loan activity, or it may be able to rely on the market-making 

exemption. If the banking entity’s bridge loan activity does not qualify for an exemption 

under the rule, then it would not be permitted to engage in such activity.

iv. Definition of “underwriter” 

In response to comments, the Agencies are adopting certain modifications to the 

proposed definition of “underwriter” to better capture selling group members and to more 

closely resemble the definition of “distribution participant” in Regulation M. In 

particular, the Agencies are defining “underwriter” as: (i) a person who has agreed with 

 

390 Under the “reverse inquiry” process, an investor may be allowed to purchase securities from the issuer 

through an underwriter that is not designated in the prospectus as the issuer's agent by having such 

underwriter approach the issuer with an interest from the investor. See Joseph McLaughlin and Charles J. 

Johnson, Jr., “Corporate Finance and the Securities Laws” (4th ed. 2006, supplemented 2012).

391 See SIFMA et al. (Prop. Trading) (Feb. 2012).
115

an issuer or selling security holder to: (A) purchase securities from the issuer or selling 

security holder for distribution; (B) engage in a distribution of securities for or on behalf 

of the issuer or selling security holder; or (C) manage a distribution of securities for or on 

behalf of the issuer or selling security holder; or (ii) a person who has agreed to 

participate or is participating in a distribution of such securities for or on behalf of the 

issuer or selling security holder.392 

A number of commenters requested that the Agencies broaden the underwriting 

exemption to permit activities in connection with a distribution of securities by any 

distribution participant. A few of these commenters interpreted the proposed definition 

of “underwriter” as requiring a selling group member to have a written agreement with 

the underwriter to participate in the distribution.393 These commenters noted that such a 

written agreement may not exist under all circumstances. The Agencies did not intend to 

require that members of the underwriting syndicate or the lead underwriter have a written 

agreement with all selling group members for each offering or that they be in privity of 

contract with the issuer or selling security holder. To provide clarity on this issue, the 

Agencies have modified the language of subparagraph (ii) of the definition to include 

firms that, while not members of the underwriting syndicate, have agreed to participate or 

 

392 See final rule §__.4(a)(4).

393 The basic documents in firm commitment underwritten securities offerings generally are: (i) the 

agreement among underwriters, which establishes the relationship among the managing underwriter, any 

co-managers, and the other members of the underwriting syndicate; (ii) the underwriting (or “purchase”) 

agreement, in which the underwriters commit to purchase the securities from the issuer or selling security 

holder; and (iii) the selected dealers agreement, in which selling group members agree to certain provisions 

relating to the distribution. See Joseph McLaughlin and Charles J. Johnson, Jr., “Corporate Finance and the 

Securities Laws” (4th ed. 2006, supplemented 2012), Ch. 2. The Agencies understand that two firms may 

enter into a master agreement that governs all offerings in which both firms participate as members of the 

underwriting syndicate or as a member of the syndicate and a selling group member. See, e.g., SIFMA 

Master Selected Dealers Agreement (June 10, 2011), available at www.sifma.org.
116

are participating in a distribution of securities for or on behalf of the issuer or selling 

security holder. 

The final rule does not adopt a narrower definition of “underwriter,” as suggested 

by two commenters.394 Although selling group members do not have a direct relationship 

with the issuer or selling security holder, they do help facilitate the successful distribution 

of securities to a wider variety of purchasers, such as regional or retail purchasers that 

members of the underwriting syndicate may not be able to access as easily. Thus, the 

Agencies believe it is consistent with the purpose of the statutory underwriting exemption 

and beneficial to recognize and allow the current market practice of an underwriting 

syndicate and selling group members collectively facilitating a distribution of securities. 

The Agencies note that because banking entities that are selling group members will be 

underwriters under the final rule, they will be subject to all the requirements of the 

underwriting exemption.

As provided in the preamble to the proposed rule, engaging in the following 

activities may indicate that a banking entity is acting as an underwriter under § __.4(a)(4) 

as part of a distribution of securities:

• Assisting an issuer in capital-raising;

• Performing due diligence;

• Advising the issuer on market conditions and assisting in the preparation 

of a registration statement or other offering document;

• Purchasing securities from an issuer, a selling security holder, or an 

underwriter for resale to the public;

 

394 See AFR et al. (Feb. 2012); Public Citizen. 
117

• Participating in or organizing a syndicate of investment banks;

• Marketing securities; and

• Transacting to provide a post-issuance secondary market and to facilitate 

price discovery.395

The Agencies continue to take the view that the precise activities performed by an 

underwriter will vary depending on the liquidity of the securities being underwritten and 

the type of distribution being conducted. A banking entity is not required to engage in 

each of the above-noted activities to be considered an underwriter for purposes of this 

rule. In addition, the Agencies note that, to the extent a banking entity does not meet the 

definition of “underwriter” in the final rule, it may be able to rely on the market-making 

exemption in the final rule for its trading activity. In response to comments noting that 

APs for ETFs do not engage in certain of these activities and inquiring whether an AP 

would be able to qualify for the underwriting exemption for certain of its activities, the 

Agencies believe that many AP activities, such as conducting general creations and 

redemptions of ETF shares, are better suited for analysis under the market-making 

exemption because they are driven by the demands of other market participants rather 

than the issuer, the ETF.396 Whether an AP may rely on the underwriting exemption for 

its activities in an ETF will depend on the facts and circumstances, including, among 

other things, whether the AP meets the definition of “underwriter” and the offering of 

ETF shares qualifies as a “distribution.” 

 

395 See Joint Proposal, 76 FR at 68,867; CFTC Proposal, 77 FR at 8352. Post-issuance secondary market 

activity is expected to be conducted in accordance with the market-making exemption.

396 See infra Part IV.A.3.
118

To provide further clarity about the scope of the definition of “underwriter,” the 

Agencies are defining the terms “selling security holder” and “issuer” in the final rule. 

The Agencies are using the definition of “issuer” from the Securities Act because this 

definition is commonly used in the context of securities offerings and is well understood 

by market participants.397 A “selling security holder” is defined as “any person, other 

than an issuer, on whose behalf a distribution is made.”398 This definition is consistent 

with the definition of “selling security holder” found in the SEC’s Regulation M.399

v. Activities conducted “in connection with” a distribution

As discussed above, several commenters expressed concern that the proposed 

underwriting exemption would not allow a banking entity to engage in certain auxiliary 

activities that may be conducted in connection with acting as an underwriter for a 

distribution of securities in the normal course. These commenters’ concerns generally 

arose from the use of the word “solely” in § __.4(a)(2)(iii) of the proposed rule, which 

 

397 See final rule § __.3(e)(9) (defining the term “issuer” for purposes of the proprietary trading provisions 

in subpart B of the final rule). Under section 2(a)(4) of the Securities Act, “issuer” is defined as “every 

person who issues or proposes to issue any security; except that with respect to certificates of deposit, 

voting-trust certificates, or collateral-trust certificates, or with respect to certificates of interest or shares in 

an unincorporated investment trust not having a board of directors (or persons performing similar 

functions) or of the fixed, restricted management, or unit type, the term ‘issuer’ means the person or 

persons performing the acts and assuming the duties of depositor or manager pursuant to the provisions of 

the trust or other agreement or instrument under which such securities are issued; except that in the case of 

an unincorporated association which provides by its articles for limited liability of any or all of its 

members, or in the case of a trust, committee, or other legal entity, the trustees or members thereof shall not 

be individually liable as issuers of any security issued by the association, trust, committee, or other legal 

entity; except that with respect to equipment- trust certificates or like securities, the term ‘issuer’ means the 

person by whom the equipment or property is or is to be used; and except that with respect to fractional 

undivided interests in oil, gas, or other mineral rights, the term ‘issuer’ means the owner of any such right 

or of any interest in such right (whether whole or fractional) who creates fractional interests therein for the 

purpose of public offering.” 15 U.S.C. 77b(a)(4).

398 Final rule § __.4(a)(5).

399 See 17 CFR 242.100(b).
119

commenters noted was not included in the statute’s underwriting exemption.400 In 

addition, a number of commenters discussed particular activities they believed should be 

permitted under the underwriting exemption and indicated the term “solely” created 

uncertainty about whether such activities would be permitted.401 

To reduce uncertainty in response to comments, the final rule requires a trading 

desk’s underwriting position to be “held ... and managed ... in connection with” a single 

distribution for which the relevant banking entity is acting as an underwriter, rather than 

requiring that a purchase or sale be “effected solely in connection with” such a 

distribution. Importantly, for purposes of establishing an underwriting position in 

reliance on the underwriting exemption, a trading desk may only engage in activities that 

are related to a particular distribution of securities for which the banking entity is acting 

as an underwriter. Activities that may be permitted under the underwriting exemption 

include stabilization activities,402 syndicate shorting and aftermarket short covering,403

holding an unsold allotment when market conditions may make it impracticable to sell 

 

400 See supra Part IV.A.2.c.1.b.iii.

401 See supra notes 357, 358, 363-372 and accompanying text.

402 See SIFMA et al. (Prop. Trading) (Feb. 2012). See Anti-Manipulation Rules Concerning Securities 

Offerings, Exchange Act Release No. 38067 (Dec. 20, 1996), 62 FR 520, 535 (Jan. 3, 1997) (“Although 

stabilization is price-influencing activity intended to induce others to purchase the offered security, when 

appropriately regulated it is an effective mechanism for fostering an orderly distribution of securities and 

promotes the interests of shareholders, underwriters, and issuers.”).

403 See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC; Goldman (Prop. Trading). See Proposed

Amendments to Regulation M: Anti-Manipulation Rules Concerning Securities Offerings, Exchange Act 

Release No. 50831 (Dec. 9, 2004), 69 FR 75,774, 75,780 (Dec. 17, 2004) (“In the typical offering, the 

syndicate agreement allows the managing underwriter to ‘oversell’ the offering, i.e., establish a short 

position beyond the number of shares to which the underwriting commitment relates. The underwriting 

agreement with the issuer often provides for an ‘overallotment option’ whereby the syndicate can purchase 

additional shares from the issuer or selling shareholders in order to cover its short position. To the extent 

that the syndicate short position is in excess of the overallotment option, the syndicate is said to have taken 

an ‘uncovered’ short position. The syndicate short position, up to the amount of the overallotment option, 

may be covered by exercising the option or by purchasing shares in the market once secondary trading 

begins.”).
120

the entire allotment at a reasonable price at the time of the distribution and selling such 

position when it is reasonable to do so,404 and helping the issuer mitigate its risk exposure 

arising from the distribution of its securities (e.g., entering into a call-spread option with 

an issuer as part of a convertible debt offering to mitigate dilution to existing 

shareholders).405 Such activities should be intended to effectuate the distribution process 

and provide benefits to issuers, selling security holders, or purchasers in the distribution. 

Existing laws, regulations, and self-regulatory organization rules limit or place certain 

requirements around many of these activities. For example, an underwriter’s subsequent 

sale of an unsold allotment must comply with applicable provisions of the federal 

securities laws and the rules thereunder. Moreover, any position resulting from these 

activities must be included in the trading desk’s underwriting position, which is subject to 

a number of restrictions in the final rule. Specifically, as discussed in more detail below, 

the trading desk must make reasonable efforts to sell or otherwise reduce its underwriting 

position within a reasonable period,406 and each trading desk must have robust limits on, 

among other things, the amount, types, and risks of its underwriting position and the 

period of time a security may be held.407 Thus, in general, the underwriting exemption 

would not permit a trading desk, for example, to acquire a position as part of its 

stabilization activities and hold that position for an extended period. 

 

404 See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC; BoA; BDA (Feb. 2012).

405 See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC; Goldman (Prop. Trading). 

406 See final rule § __.4(a)(2)(ii); infra Part IV.A.2.c.2.c. (discussing the requirement to make reasonable 

efforts to sell or otherwise reduce the underwriting position).

407 See final rule § __.4(a)(2)(iii)(B); infra Part IV.A.2.c.3.c. (discussing the required limits for trading 

desks engaged in underwriting activity).
121

This approach does not mean that any activity that is arguably connected to a 

distribution of securities is permitted under the underwriting exemption. Certain 

activities noted by commenters are not core to the underwriting function and, thus, are 

not permitted under the final underwriting exemption. However, a banking entity may be 

able to rely on another exemption for such activities (e.g., the market-making or hedging 

exemptions), if applicable. For example, a trading desk would not be able to use the 

underwriting exemption to purchase a financial instrument from a customer to facilitate 

the customer’s ability to buy securities in the distribution.408 Further, purchasing another 

financial instrument to help determine how to price the securities that are subject to a 

distribution would not be permitted under the underwriting exemption.409 These two 

activities may be permitted under the market-making exemption, depending on the facts 

and circumstances. In response to one commenter’s suggestion that hedging the 

underwriter’s risk exposure be permissible under this exemption, the Agencies emphasize 

that hedging the underwriter’s risk exposure is not permitted under the underwriting 

exemption.410 A banking entity must comply with the hedging exemption for such 

activity. 

 

408 See Wells Fargo (Prop. Trading). The Agencies do not believe this activity is consistent with 

underwriting activity because it could result in an underwriting desk holding a variety of positions over 

time that are not directly related to a distribution of securities the desk is conducting on behalf of an issuer 

or selling security holder. Further, the Agencies believe this activity may be more appropriately analyzed 

under the market-making exemption because market makers generally purchase or sell a financial 

instrument at the request of customers and otherwise routinely stand ready to purchase and sell a variety of 

related financial instruments.

409 See id. The Agencies view this activity as inconsistent with underwriting because underwriters 

typically engage in other activities, such as book-building and other marketing efforts, to determine the 

appropriate price for a security and these activities do not involve taking positions that are unrelated to the 

securities subject to distribution. See infra IV.A.2.c.2.

410 Although one commenter suggested that an underwriter’s hedging activity be permitted under the 

underwriting exemption, we do not believe the requirements in the proposed hedging exemption would be 
122

In response to comments about the sale of a security to an intermediate entity in 

connection with a structured finance product,411 the Agencies have not modified the 

underwriting exemption. Underwriting is distinct from product development. Thus, 

parties must adjust activities associated with developing structured finance products or 

meet the terms of other available exemptions. Similarly, the accumulation of securities 

or other assets in anticipation of a securitization or resecuritization is not an activity 

conducted “in connection with” underwriting for purposes of the exemption.412 This 

activity is typically engaged in by an issuer or sponsor of a securitized product in that 

capacity, rather than in the capacity of an underwriter. The underwriting exemption only 

permits a banking entity’s activities when it is acting as an underwriter. 

2. Near term customer demand requirement

a. Proposed near term customer demand requirement

Like the statute, § __.4(a)(2)(v) of the proposed rule required that the 

underwriting activities of the banking entity with respect to the covered financial position 

 

unworkable or overly burdensome in the context of an underwriter’s hedging activity. See Goldman (Prop. 

Trading). As noted above, underwriting activity is of a relatively distinct nature, which is substantially 

different from market-making activity, which is more dynamic and involves more frequent trading activity 

giving rise to a variety of positions that may naturally hedge the risks of certain other positions. The 

Agencies believe it is appropriate to require that a trading desk comply with the requirements of the 

hedging exemption when it is hedging the risks of its underwriting position, while allowing a trading desk’s 

market making-related hedging under the market-making exemption.

411 See ICI (Feb. 2012); AFR et al. (Feb. 2012); Occupy; Alfred Brock.

412 A banking entity may accumulate loans in anticipation of securitization because loans are not financial 

instruments under the final rule. See supra Part IV.A.1.c.
123

be designed not to exceed the reasonably expected near term demands of clients, 

customers, or counterparties.413

b. Comments regarding the proposed near term customer demand requirement

Both the statute and the proposed rule require a banking entity’s underwriting 

activity to be “designed not to exceed the reasonably expected near term demands of 

clients, customers, or counterparties.”414 Several commenters requested that this standard 

be interpreted in a flexible manner to allow a banking entity to participate in an offering 

that may require it to retain an unsold allotment for a period of time.415 In addition, one 

commenter stated that the final rule should provide flexibility in this standard by 

recognizing that the concept of “near term” differs between asset classes and depends on 

the liquidity of the market.416 Two commenters expressed views on how the near term 

customer demand requirement should work in the context of a securitization or creating 

what the commenters characterized as “structured products” or “structured 

instruments.”417 

Many commenters expressed concern that the proposed requirement, if narrowly 

interpreted, could prevent an underwriter from holding a residual position for which there 

 

413 See proposed rule § __.4(a)(2)(v); Joint Proposal, 76 FR at 68,867; CFTC Proposal, 77 FR at 8353.

414 See supra Part IV.A.2.c.2.a.

415 See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA; BDA (Feb. 2012); RBC. Another commenter 

requested that this requirement be eliminated or changed to “underwriting activities of the banking entity 

with respect to the covered financial position must be designed to meet the near-term demands of clients, 

customers, or counterparties.” See Japanese Bankers Ass’n. . 

416 See RBC (stating that the Board has found acceptable the retention of assets acquired in connection 

with underwriting activities for a period of 90 to 180 days and has further permitted holding periods of up 

to a year in certain circumstances, such as for less liquid securities).

417 See AFR et al. (Feb. 2012); Sens. Merkley & Levin (Feb. 2012).
124

is no immediate demand from clients, customers, or counterparties.418 Commenters 

noted that there are a variety of offerings that present some risk of an underwriter having 

to hold a residual position that cannot be sold in the initial distribution, including “bought 

deals,”419 rights offerings,420 and fixed-income offerings.421 A few commenters noted 

that similar scenarios can arise in the case of an AP creating more shares of an ETF than 

it can sell422 and bridge loans.423 Two commenters indicated that if the rule does not 

provide greater clarity and flexibility with respect to the near term customer demand 

requirement, a banking entity may be less inclined to participate in a distribution where 

there is the potential risk of an unsold allotment, may price such risk into the fees charged 

to underwriting clients, or may be forced into a “fire sale” of the unsold allotment.424 

 

418 See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA; BDA (Feb. 2012); RBC. 

419 See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA; RBC. These commenters generally stated that an 

underwriter for a “bought deal” may end up with an unsold allotment because, pursuant to this type of 

offering, an underwriter makes a commitment to purchase securities from an issuer or selling security 

holder, without pre-commitment marketing to gauge customer interest, in order to provide greater speed 

and certainty of execution. See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC. 

420 See SIFMA et al. (Prop. Trading) (Feb. 2012) (representing that because an underwriter generally 

backstops a rights offering by committing to exercise any rights not exercised by shareholders, the 

underwriter may end up holding a residual portion of the offering if investors do not exercise all of the 

rights).

421 See BDA (Feb. 2012). This commenter stated that underwriters frequently underwrite bonds in the 

fixed-income market knowing that they may need to retain unsold allotments in their inventory. The 

commenter indicated that this scenario arises because the fixed-income market is not as deep as other 

markets, so underwriters frequently cannot sell bonds when they go to market; instead, the underwriters 

will retain the bonds until a sufficient amount of liquidity is available in the market. See id.

422 See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA.

423 See BoA; RBC; LSTA (Feb. 2012). One of these commenters stated that, in the case of securities 

issued in lieu of or to refinance bridge loan facilities, market conditions or investor demand may change 

during the period of time between extension of the bridge commitment and when the bridge loan is required 

to be funded or such securities are required to be issued. As a result, this commenter requested that the 

near term demands of clients, customers, or counterparties be measured at the time of the initial extension 

of the bridge commitment. See LSTA (Feb. 2012).

424 See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC.
125

Several other commenters provided views on whether a banking entity should be 

able to hold a residual position from an offering pursuant to the underwriting exemption, 

although they did not generally link their comments to the proposed near term demand 

requirement.425 Many of these commenters expressed concern about permitting a 

banking entity to retain a portion of an underwriting and noted potential risks that may 

arise from such activity.426 For example, some of these commenters stated that retention 

or warehousing of underwritten securities can be an indication of impermissible 

proprietary trading intent (particularly if systematic), or may otherwise result in high-risk 

exposures or conflicts of interests.427 One of these commenters recommended the 

Agencies use a metric to monitor the size of residual positions retained by an 

underwriter,428 while another commenter suggested adding a requirement to the proposed 

exemption to provide that a “substantial” unsold or retained allotment would be an 

indication of prohibited proprietary trading.429 Similarly, one commenter recommended 

that the Agencies consider whether there are sufficient provisions in the proposed rule to 

reduce the risks posed by banking entities retaining or warehousing underwritten 

instruments, such as subprime mortgages, collateralized debt obligation tranches, and 

 

425 See AFR et al. (Feb. 2012); CalPERS; Occupy; Public Citizen; Goldman (Prop. Trading); Fidelity; 

Japanese Bankers Ass’n.; Sens. Merkley & Levin (Feb. 2012); Alfred Brock.

426 See AFR et al. (Feb. 2012); CalPERS; Occupy; Public Citizen; Alfred Brock.

427 See AFR et al. (Feb. 2012) (recognizing, however, that a small portion of an underwriting may 

occasionally be “hung”); CalPERS; Occupy (stating that a banking entity’s retention of unsold allotments 

may result in potential conflicts of interest).

428 See AFR et al. (Feb. 2012).

429 See Occupy (stating that the meaning of the term “substantial” would depend on the circumstances of 

the particular offering). 
126

high yield debt of leveraged buyout issuers, which poses heightened financial risk at the 

top of economic cycles.430

Other commenters indicated that undue restrictions on an underwriter’s ability to 

retain a portion of an offering may result in certain harms to the capital-raising process. 

These commenters represented that unclear or negative treatment of residual positions 

will make banking entities averse to the risk of an unsold allotment, which may result in 

banking entities underwriting smaller offerings, less capital generation for issuers, or 

higher underwriting discounts, which would increase the cost of raising capital for 

businesses.431 One of these commenters suggested that a banking entity be permitted to 

hold a residual position under the underwriting exemption as long as it continues to take 

reasonable steps to attempt to dispose of the residual position in light of existing market 

conditions.432

In addition, in response to a question in the proposal, one commenter expressed 

the view that the rule should not require documentation with respect to residual positions 

held by an underwriter.433 In the case of securitizations, one commenter stated that if the 

underwriter wishes to retain some of the securities or bonds in its longer-term investment 

book, such decisions should be made by a separate officer, subject to different standards 

and compensation.434 

 

430 See CalPERS.

431 See Goldman (Prop. Trading); Fidelity (expressing concern that this may result in a more concentrated 

supply of securities and, thus, decrease the opportunity for diversification in the portfolios of shareholders’ 

funds).

432 See Goldman (Prop. Trading).

433 See Japanese Bankers Ass’n.

434 See Sens. Merkley & Levin (Feb. 2012).
127

Two commenters discussed how the near term customer demand requirement 

should apply in the context of a banking entity acting as an underwriter for a 

securitization or structured product.435 One of these commenters indicated that the near 

term demand requirement should be interpreted to require that a distribution of securities 

facilitate pre-existing client demand. This commenter stated that a banking entity should 

not be considered to meet the terms of the proposed requirement if, on the firm’s own 

initiative, it designs and structures a complex, novel instrument and then seeks customers 

for the instrument, while retaining part of the issuance on its own book. The commenter 

further emphasized that underwriting should involve two-way demand – clients who want 

assistance in marketing their securities and customers who may wish to purchase the 

securities – with the banking entity serving as an intermediary.436 Another commenter 

indicated that an underwriting should likely be seen as a distribution of all, or nearly all, 

of the securities related to a securitization (excluding any amount required for credit risk 

retention purposes) along a time line designed not to exceed reasonably expected near 

term demands of clients, customers, or counterparties. According to the commenter, this 

approach would serve to minimize the arbitrage and risk concentration possibilities that 

can arise through the securitization and sale of some tranches and the retention of other 

tranches.437

One commenter expressed concern that the proposed near term customer demand 

requirement may impact a banking entity’s ability to act as primary dealer because some 

 

435 See AFR et al. (Feb. 2012); Sens. Merkley & Levin (Feb. 2012).

436 See AFR et al. (Feb. 2012)

437 See Sens. Merkley & Levin (Feb. 2012).
128

primary dealers are obligated to bid on each issuance of a government’s sovereign debt, 

without regard to expected customer demand.438 Two other commenters expressed 

general concern that the proposed underwriting exemption may be too narrow to permit 

banking entities that act as primary dealers in or for foreign jurisdictions to continue to 

meet the relevant jurisdiction’s primary dealer requirements.439

c. Final near term customer demand requirement

The final rule requires that the amount and types of the securities in the trading 

desk’s underwriting position be designed not to exceed the reasonably expected near term 

demands of clients, customers, or counterparties, and reasonable efforts be made to sell or 

otherwise reduce the underwriting position within a reasonable period, taking into 

account the liquidity, maturity, and depth of the market for the relevant type of 

security.440 As noted above, the near term demand standard originates from section 

13(d)(1)(B) of the BHC Act, and a similar requirement was included in the proposed 

rule.441 The Agencies are making certain modifications to the proposed approach in 

response to comments. 

 

438 See Banco de México.

439 See SIFMA et al. (Prop. Trading) (Feb. 2012); IIB/EBF. One of these commenters represented that 

many banking entities serve as primary dealers in jurisdictions in which they operate, and primary dealers 

often: (i) are subject to minimum purchase and other obligations in the jurisdiction’s foreign sovereign 

debt; (ii) play important roles in underwriting and market making in State, provincial, and municipal debt 

issuances; and (iii) act as intermediaries through which a government’s financial and monetary policies 

operate. This commenter stated that, due to these considerations, restrictions on the ability of banking 

entities to act as primary dealer are likely to harm the governments they serve. See IIB/EBF.

440 Final rule § __.4(a)(2)(ii).

441 The proposed rule required the underwriting activities of the banking entity with respect to the covered 

financial position to be designed not to exceed the reasonably expected near term demands of clients, 

customers, or counterparties. See proposed rule § __.4(a)(2)(v).
129

In particular, the Agencies are clarifying the operation of this requirement, 

particularly with respect to unsold allotments.442 Under this requirement, a trading desk 

must have a reasonable expectation of demand from other market participants for the 

amount and type of securities to be acquired from an issuer or selling security holder for 

distribution.443 Such reasonable expectation may be based on factors such as current 

market conditions and prior experience with similar offerings of securities. A banking 

entity is not required to engage in book-building or similar marketing efforts to determine 

investor demand for the securities pursuant to this requirement, although such efforts may 

form the basis for the trading desk’s reasonable expectation of demand. While an issuer 

or selling security holder can be considered to be a client, customer, or counterparty of a 

banking entity acting as an underwriter for its distribution of securities, this requirement 

cannot be met by accounting solely for the issuer’s or selling security holder’s desire to 

sell the securities.444 However, the expectation of demand does not require a belief that 

 

442 See supra Part IV.A.2.c.2.b. (discussing commenters’ concerns that the proposed near term customer 

demand requirement may limit a banking entity’s ability to retain an unsold allotment).

443 A banking entity may not structure a complex instrument on its own initiative using the underwriting 

exemption. It may use the underwriting exemption only with respect to distributions of securities that 

comply with the final rule. The Agencies believe this requirement addresses one commenter’s concern that 

a banking entity could rely on the underwriting exemption without regard to anticipated customer demand. 

See AFR et al. (Feb. 2012) In addition, a trading desk hedging the risks of an underwriting position in a 

complex, novel instrument must comply with the hedging exemption in the final rule.

444 An issuer or selling security holder for purposes of this rule may include, among others, corporate 

issuers, sovereign issuers for which the banking entity acts as primary dealer (or functional equivalent), or 

any other person that is an issuer, as defined in final rule § __.3(e)(9), or a selling security holder, as 

defined in final rule § __.4(a)(5). The Agencies believe that the underwriting exemption in the final rule 

should generally allow a primary dealer (or functional equivalent) to act as an underwriter for a sovereign 

government’s issuance of its debt because, similar to other underwriting activities, this involves a banking 

entity agreeing to distribute securities for an issuer (in this case, the foreign sovereign) and engaging in a 

distribution of such securities. See SIFMA et al. (Prop. Trading) (Feb. 2012); IIB/EBF; Banco de México. 

A banking entity acting as primary dealer (or functional equivalent) may also be able to rely on the marketmaking exemption or other exemptions for some of its activities. See infra Part IV.A.3.c.2.c. The final rule 

defines “client, customer, or counterparty” for purposes of the underwriting exemption as “market 

participants that may transact with the banking entity in connection with a particular distribution for which 

the banking entity is acting as underwriter.” Final rule § __.4(a)(7).
130

the securities will be placed immediately. The time it takes to carry out a distribution 

may differ based on the liquidity, maturity, and depth of the market for the type of 

security.445 

This requirement is not intended to prevent a trading desk from distributing an 

offering over a reasonable time consistent with market conditions or from retaining an 

unsold allotment of the securities acquired from an issuer or selling security holder where 

holding such securities is necessary due to circumstances such as less-than-expected 

purchaser demand at a given price.446 An unsold allotment is, however, subject to the 

 

445 One commenter stated that, in the case of a securitization, an underwriting should be Seen as a 

distribution of all, or nearly all, of the securities related to a securitization (excluding the amount required 

for credit risk retention purposes) along a time line designed not to exceed the reasonably expected near

term demands of clients, customers, or counterparties. See Sens. Merkley & Levin (Feb. 2012). The final 

rule’s near term customer demand requirement considers the liquidity, maturity, and depth of the market for 

the type of security and recognizes that the amount of time a trading desk may need to hold an underwriting 

position may vary based on these factors. The final rule does not, however, adopt a standard that applies 

differently based solely on the particular type of security being distributed (e.g., an asset-backed security 

versus an equity security) or that precludes certain types of securities from being distributed by a banking 

entity acting as an underwriter in accordance with the requirements of this exemption because the Agencies

believe the statute is best read to permit a banking entity to engage in underwriting activity to facilitate 

distributions of securities by issuers and selling security holders, regardless of type, to provide clientoriented financial services. That reading is consistent with the statute’s language and finds support in the 

legislative history. See 156 Cong. Rec. S5895-S5896 (daily ed. July 15, 2010) (statement of Sen. Merkley) 

(stating that the underwriting exemption permits “transactions that are technically trading for the account of 

the firm but, in fact, facilitate the provision of near-term client-oriented financial services”). In addition, 

with respect to this commenter’s statement regarding credit risk retention requirements, the Agencies note 

that compliance with the credit risk retention requirements of Section 15G of the Exchange Act would not 

impact the availability of the underwriting exemption in the final rule.

446 This approach should help address commenters’ concerns that an inflexible interpretation of the near 

term demand requirement could result in fire sales, higher fees for underwriting services, or reluctance to 

act as an underwriter for certain types of distributions that present a greater risk of unsold allotments. See

SIFMA et al. (Prop. Trading) (Feb. 2012); RBC. Further, the Agencies believe this should reduce 

commenters’ concerns that, to the extent a delayed distribution of securities, which are acquired as a result 

of an outstanding bridge loan, is able to qualify for the underwriting exemption, a stringent interpretation of 

the near term demand requirement could prevent a banking entity from retaining such securities if market 

conditions are suboptimal or marketing efforts are not entirely successful. See RBC; BoA; LSTA (Feb. 

2012). In response to one commenter’s request that the Agencies allow a banking entity to assess near term 

demand at the time of the initial extension of the bridge commitment, the Agencies believe it could be 

appropriate to determine whether the banking entity has a reasonable expectation of demand from other 

market participants for the amount and type of securities to be acquired at that time, but note that the 

trading desk would continue to be subject to the requirement to make reasonable efforts to sell the resulting 
131

requirement to make reasonable efforts to sell or otherwise reduce the underwriting 

position.447 The definition of “underwriting position” includes, among other things, any 

residual position from the distribution that is managed by the trading desk. The final rule 

includes the requirement to make reasonable efforts to sell or otherwise reduce the 

trading desk’s underwriting position in order to respond to comments on the issue of 

when a banking entity may retain an unsold allotment when it is acting as an underwriter, 

as discussed in more detail below, and ensure that the exemption is available only for 

activities that involve underwriting activities, and not prohibited proprietary trading.448 

As a general matter, commenters expressed differing views on whether an 

underwriter should be permitted to hold an unsold allotment for a certain period of time 

 underwriting position at the time of the initial distribution and for the remaining time the securities are in 

its inventory. See LSTA (Feb. 2012).

447 The Agencies believe that requiring a trading desk to make reasonable efforts to sell or otherwise 

reduce its underwriting position addresses commenters’ concerns about the risks associated with unsold 

allotments or the retention of underwritten instruments because this requirement is designed to prevent a 

trading desk from retaining an unsold allotment for speculative purposes when there is customer buying 

interest for the relevant security at commercially reasonable prices. Thus, the Agencies believe this 

obviates the need for certain additional requirements suggested by commenters. See, e.g., Occupy; AFR et 

al. (Feb. 2012); CalPERS. The final rule strikes an appropriate balance between the concerns raised by 

these commenters and those noted by other commenters regarding the potential market impacts of strict 

requirements against holding an unsold allotment, such as higher fees to underwriting clients, fire sales of 

unsold allotments, or general reluctance to participate in any distribution that presents a risk of an unsold 

allotment. The requirement to make reasonable efforts to sell or otherwise reduce the underwriting position 

should not cause the market impacts predicted by these commenters because it does not prevent an 

underwriter from retaining an unsold allotment for a reasonable period or impose strict holding period 

limits on unsold allotments. See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC; Goldman (Prop. 

Trading); Fidelity.

448 This approach is generally consistent with one commenter’s suggested approach to addressing the issue 

of unsold allotments. See, e.g., Goldman (Prop. Trading) (suggesting that a banking entity be permitted to 

hold a residual position under the underwriting exemption as long as it continues to take reasonable steps to 

attempt to dispose of the residual position in light of existing market conditions). In addition, allowing an 

underwriter to retain an unsold allotment under certain circumstances is consistent with the proposal. See

Joint Proposal, 76 FR at 68,867 (“There may be circumstances in which an underwriter would hold 

securities that it could not sell in the distribution for investment purposes. If the acquisition of such unsold 

securities were in connection with the underwriting pursuant to the permitted underwriting activities 

exemption, the underwriter would also be able to dispose of such securities at a later time.”); CFTC 

Proposal, 77 FR at 8352. A number of commenters raised questions about whether the rule would permit

retaining an unsold allotment. See Goldman (Prop. Trading); Fidelity; SIFMA et al. (Prop. Trading) (Feb. 

2012); BoA; RBC; AFR et al. (Feb. 2012); CalPERS; Occupy; Public Citizen; Alfred Brock.
132

after the initial distribution. For example, a few commenters suggested that limitations 

on retaining an unsold allotment would increase the cost of raising capital449 or would 

negatively impact certain types of securities offerings (e.g., bought deals, rights offerings, 

and fixed-income offerings).450 Other commenters, however, expressed concern that the 

proposed exemption would allow a banking entity to retain a portion of a distribution for 

speculative purposes.451 

The Agencies believe the requirement to make reasonable efforts to sell or 

otherwise reduce the underwriting position appropriately addresses both sets of 

comments. More specifically, this standard clarifies that an underwriter generally may 

retain an unsold allotment that it was unable to sell to purchasers as part of the initial 

distribution of securities, provided it had a reasonable expectation of buying interest and 

engaged in reasonable selling efforts.452 This should reduce the potential for the negative 

impacts of a more stringent approach predicted by commenters, such as increased fees for 

underwriting, greater costs to businesses for raising capital, and potential fire sales of 

unsold allotments.453 However, to address concerns that a banking entity may retain an 

unsold allotment for purely speculative purposes, the Agencies are requiring that 

reasonable efforts be made to sell or otherwise reduce the underwriting position, which 

includes any unsold allotment, within a reasonable period. The Agencies agree with 

 

449 See Goldman (Prop. Trading); Fidelity. 

450 See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA; RBC. 

451 See AFR et al. (Feb. 2012); CalPERS; Occupy; Public Citizen; Alfred Brock.

452 To the extent that an AP for an ETF is able to meet the terms of the underwriting exemption for its 

activity, it may be able to retain ETF shares that it created if it had a reasonable expectation of buying 

interest in the ETF shares and engages in reasonable efforts to sell the ETF shares. See SIFMA et al. (Prop. 

Trading) (Feb. 2012); BoA.

453 See Goldman (Prop. Trading); Fidelity; SIFMA et al. (Prop. Trading) (Feb. 2012); RBC.
133

these commenters that systematic retention of an underwriting position, without engaging 

in efforts to sell the position and without regard to whether the trading desk is able to sell 

the securities at a commercially reasonable price, would be indicative of impermissible 

proprietary trading intent.454 The Agencies recognize that the meaning of “reasonable 

period” may differ based on the liquidity, maturity, and depth of the market for the 

relevant type of securities. For example, an underwriter may be more likely to retain an 

unsold allotment in a bond offering because liquidity in the fixed-income market is 

generally not as deep as that in the equity market. If a trading desk retains an 

underwriting position for a period of time after the distribution, the trading desk must 

manage the risk of its underwriting position in accordance with its inventory and risk 

limits and authorization procedures. As discussed above, hedging transactions 

undertaken in connection with such risk management activities must be conducted in 

compliance with the hedging exemption in § __.5 of the final rule. 

The Agencies emphasize that the requirement to make reasonable efforts to sell or 

otherwise reduce the underwriting position applies to the entirety of the trading desk’s 

underwriting position. As a result, this requirement applies to a number of different 

scenarios in which an underwriter may hold a long or short position in the securities that 

are the subject of a distribution for a period of time. For example, if an underwriter is 

facilitating a distribution of securities for which there is sufficient investor demand to 

purchase the securities at the offering price, this requirement would prevent the 

underwriter from retaining a portion of the allotment for its own account instead of 

selling the securities to interested investors. If instead there was insufficient investor 

 

454 See AFR et al. (Feb. 2012); CalPERS; Occupy.
134

demand at the time of the initial offering, this requirement would recognize that it may be 

appropriate for the underwriter to hold an unsold allotment for a reasonable period of 

time. Under these circumstances, the underwriter would need to make reasonable efforts 

to sell the unsold allotment when there is sufficient market demand for the securities.455 

This requirement would also apply in situations where the underwriters sell securities in 

excess of the number of securities to which the underwriting commitment relates, 

resulting in a syndicate short position in the same class of securities that were the subject 

of the distribution.456 This provision of the final exemption would require reasonable 

efforts to reduce any portion of the syndicate short position attributable to the banking

entity that is acting as an underwriter. Such reduction could be accomplished if, for 

example, the managing underwriter exercises an overallotment option or shares are 

purchased in the secondary market to cover the short position. 

The near term demand requirement, including the requirement to make reasonable 

efforts to reduce the underwriting position, represents a new regulatory requirement for 

banking entities engaged in underwriting. At the margins, this requirement could alter 

the participation decision for some banking entities with respect to certain types of 

distributions, such as distributions that are more likely to result in the banking entity 

retaining an underwriting position for a period of time.457 However, the Agencies 

 

455 The trading desk’s retention and sale of the unsold allotment must comply with the federal securities 

laws and regulations, but is otherwise permitted under the underwriting exemption.

456 See supra note 403.

457 For example, some commenters suggested that the proposed underwriting exemption could have a 

chilling effect on banking entities’ willingness to engage in underwriting activities. See, e.g., Lord Abbett; 

Fidelity. Further, some commenters expressed concern that the proposed near term customer demand 

requirement might negatively impact certain forms of capital-raising if the requirement is interpreted 

narrowly or inflexibly. See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA; BDA (Feb. 2012); RBC.
135

recognize that liquidity, maturity, and depth of the market vary across types of securities, 

and the Agencies expect that the express recognition of these differences in the rule 

should help mitigate any incentive to exit the underwriting business for certain types of 

securities or types of distributions.

3. Compliance program requirement

a. Proposed compliance program requirement

Section __.4(a)(2)(i) of the proposed exemption required a banking entity to 

establish an internal compliance program, as required by § __.20 of the proposed rule, 

that is designed to ensure the banking entity’s compliance with the requirements of the 

underwriting exemption, including reasonably designed written policies and procedures, 

internal controls, and independent testing.458 This requirement was proposed so that any 

banking entity relying on the underwriting exemption would have reasonably designed 

written policies and procedures, internal controls, and independent testing in place to 

support its compliance with the terms of the exemption.459

b. Comments on the proposed compliance program requirement

Commenters did not directly address the proposed compliance program 

requirement in the underwriting exemption. Comments on the proposed compliance 

program requirement of § __.20 of the proposed rule are discussed in Part IV.C., below.

 

458 See proposed rule § __.4(a)(2)(i).

459 See Joint Proposal, 76 FR at 68,866; CFTC Proposal, 77 FR at 8352.
136

c. Final compliance program requirement

The final rule includes a compliance program requirement that is similar to the 

proposed requirement, but the Agencies are making certain enhancements to emphasize 

the importance of a strong internal compliance program. More specifically, the final rule 

requires that a banking entity’s compliance program specifically include reasonably 

designed written policies and procedures, internal controls, analysis and independent 

testing460 identifying and addressing: (i) the products, instruments or exposures each 

trading desk may purchase, sell, or manage as part of its underwriting activities;461 (ii) 

limits for each trading desk, based on the nature and amount of the trading desk’s 

underwriting activities, including the reasonably expected near term demands of clients, 

customers, or counterparties;462 (iii) internal controls and ongoing monitoring and 

analysis of each trading desk’s compliance with its limits;463 and (iv) authorization 

procedures, including escalation procedures that require review and approval of any trade 

that would exceed one or more of a trading desk’s limits, demonstrable analysis of the 

basis for any temporary or permanent increase to one or more of a trading desk’s limits, 

and independent review (i.e., by risk managers and compliance officers at the appropriate 

level independent of the trading desk) of such demonstrable analysis and approval.464 

 

460 The independent testing standard is discussed in more detail in Part IV.C., which discusses the 

compliance program requirement in § __.20 of the final rule.

461 See final rule § __.4(a)(2)(iii)(A).

462 See final rule § __.4(a)(2)(iii)(B). A trading desk must have limits on the amount, types, and risk of the 

securities in its underwriting position, level of exposures to relevant risk factors arising from its 

underwriting position, and period of time a security may be held. See id.

463 See final rule § __.4(a)(2)(iii)(C). 

464 See final rule § __.4(a)(2)(iii)(D).
137

As noted above, the proposed compliance program requirement did not include 

the four specific elements listed above in the proposed underwriting exemption, although 

each of these provisions was included in some form in the detailed compliance program 

requirement under Appendix C of the proposed rule.465 The Agencies are moving these 

particular requirements, with certain enhancements, into the underwriting exemption 

because the Agencies believe these are core elements of a program to ensure compliance 

with the underwriting exemption. These compliance procedures must be established, 

implemented, maintained, and enforced for each trading desk engaged in underwriting 

activity under § __.4(a) of the final rule. Each of the requirements in paragraphs 

(a)(2)(iii)(A) through (D) must be appropriately tailored to the individual trading 

activities and strategies of each trading desk.

The compliance program requirement in the underwriting exemption is 

substantially similar to the compliance program requirement in the market-making 

exemption, except that the Agencies are requiring more detailed risk management 

procedures in the market-making exemption due to the nature of that activity.466 The 

Agencies believe including similar compliance program requirements in the underwriting 

and market-making exemptions may reduce burdens associated with building and 

maintaining compliance programs for each trading desk. 

 

465 See Joint Proposal, 76 FR at 68,963-68,967 (requiring certain banking entities to establish, maintain, 

and enforce compliance programs with, among other things: (i) written policies and procedures that 

describe a trading unit’s authorized instruments and products; (ii) internal controls for each trading unit, 

including risk limits for each trading unit and surveillance procedures; and (iii) a management framework, 

including management procedures for overseeing compliance with the proposed rule). 

466 See final rule §§ __.4(a)(2)(iii), __.4(b)(2)(iii).
138

Identifying in the compliance program the relevant products, instruments, and 

exposures in which a trading desk is permitted to trade will facilitate monitoring and 

oversight of compliance with the underwriting exemption. For example, this requirement 

should prevent an individual trader on an underwriting desk from establishing positions 

in instruments that are unrelated to the desk’s underwriting function. Further, the 

identification of permissible products, instruments, and exposures will help form the 

basis for the specific types of position and risk limits that the banking entity must 

establish and is relevant to considerations throughout the exemption regarding the 

liquidity, maturity, and depth of the market for the relevant type of security.

A trading desk must have limits on the amount, types, and risk of the securities in 

its underwriting position, level of exposures to relevant risk factors arising from its 

underwriting position, and period of time a security may be held. Limits established 

under this provision, and any modifications to these limits made through the required 

escalation procedures, must account for the nature and amount of the trading desk’s 

underwriting activities, including the reasonably expected near term demands of clients, 

customers, or counterparties. Among other things, these limits should be designed to 

prevent a trading desk from systematically retaining unsold allotments even when there is 

customer demand for the positions that remain in the trading desk’s inventory. The 

Agencies recognize that trading desks’ limits may differ across types of securities and 

acknowledge that trading desks engaged in underwriting activities in less liquid 

securities, such as corporate bonds, may require different inventory, risk exposure, and 

holding period limits than trading desks engaged in underwriting activities in more liquid 

securities, such as certain equity securities. A trading desk hedging the risks of an 
139

underwriting position must comply with the hedging exemption, which provides for 

compliance procedures regarding risk management.467

Furthermore, a banking entity must establish internal controls and ongoing 

monitoring and analysis of each trading desk’s compliance with its limits, including the 

frequency, nature, and extent of a trading desk exceeding its limits.468 This may include 

the use of management and exception reports. Moreover, the compliance program must 

set forth a process for determining the circumstances under which a trading desk’s limits 

may be modified on a temporary or permanent basis (e.g., due to market changes). 

As noted above, a banking entity’s compliance program for trading desks engaged 

in underwriting activity must also include escalation procedures that require review and 

approval of any trade that would exceed one or more of a trading desk’s limits, 

demonstrable analysis that the basis for any temporary or permanent increase to one or 

more of a trading desk’s limits is consistent with the near term customer demand 

requirement, and independent review of such demonstrable analysis and approval.469 

Thus, to increase a limit of a trading desk, there must be an analysis of why such increase 

would be appropriate based on the reasonably expected near term demands of clients, 

customers, or counterparties, which must be independently reviewed. A banking entity 

also must maintain documentation and records with respect to these elements, consistent 

with the requirement of § __.20(b)(6).

 

467 See final rule § __.5.

468 See final rule § __.4(a)(2)(iii)(C).

469 See final rule § __.4(a)(2)(iii)(D).
140

As discussed in more detail in Part IV.C., the Agencies recognize that the 

compliance program requirements in the final rule will impose certain costs on banking 

entities but, on balance, the Agencies believe such requirements are necessary to facilitate 

compliance with the statute and the final rule and to reduce the risk of evasion.470

4. Compensation requirement

a. Proposed compensation requirement

Another provision of the proposed underwriting exemption required that the 

compensation arrangements of persons performing underwriting activities at the banking 

entity must be designed not to encourage proprietary risk-taking.471 In connection with 

this requirement, the proposal clarified that although a banking entity relying on the 

underwriting exemption may appropriately take into account revenues resulting from 

movements in the price of securities that the banking entity underwrites to the extent that 

such revenues reflect the effectiveness with which personnel have managed underwriting 

risk, the banking entity should provide compensation incentives that primarily reward 

client revenues and effective client service, not proprietary risk-taking.472

b. Comments on the proposed compensation requirement

A few commenters expressed general support for the proposed requirement, but 

suggested certain modifications that they believed would enhance the requirement and 

 

470 See Part IV.C. (discussing the compliance program requirement in § __.20 of the final rule).

471 See proposed rule § __.4(a)(2)(vii); Joint Proposal, 76 FR at 68,868; CFTC Proposal, 77 FR at 8353.

472 See id.
141

make it more effective.473 Specifically, one commenter suggested tailoring the 

requirement to underwriting activity by, for example, ensuring that personnel involved in 

underwriting are given compensation incentives for the successful distribution of 

securities off the firm’s balance sheet and are not rewarded for profits associated with 

securities that are not successfully distributed (although losses from such positions should 

be taken into consideration in determining the employee’s compensation). This 

commenter further recommended that bonus compensation for a deal be withheld until all 

or a high percentage of the relevant securities are distributed.474 Finally, one commenter 

suggested that the term “designed” should be removed from this provision.475

c. Final compensation requirement

Similar to the proposed rule, the underwriting exemption in the final rule requires 

that the compensation arrangements of persons performing the banking entity’s 

underwriting activities, as described in the exemption, be designed not to reward or 

incentivize prohibited proprietary trading.476 The Agencies do not intend to preclude an 

employee of an underwriting desk from being compensated for successful underwriting, 

which involves some risk-taking.

Consistent with the proposal, activities for which a banking entity has established 

a compensation incentive structure that rewards speculation in, and appreciation of, the 

market value of securities underwritten by the banking entity are inconsistent with the 

 

473 See Occupy; AFR et al. (Feb. 2012); Better Markets (Feb. 2012).

474 See AFR et al. (Feb. 2012).

475 See Occupy.

476 See final rule § __.4(a)(2)(iv); proposed rule § __.4(a)(2)(vii). This is consistent with the final 

compensation requirements in the market-making and hedging exemptions. See final rule § __.4(b)(2)(v); 

final rule § __.5(b)(3).
142

underwriting exemption. A banking entity may, however, take into account revenues 

resulting from movements in the price of securities that the banking entity underwrites to 

the extent that such revenues reflect the effectiveness with which personnel have 

managed underwriting risk. The banking entity should provide compensation incentives 

that primarily reward client revenues and effective client services, not prohibited 

proprietary trading. For example, a compensation plan based purely on net profit and 

loss with no consideration for inventory control or risk undertaken to achieve those 

profits would not be consistent with the underwriting exemption.

The Agencies are not adopting an approach that prevents an employee from 

receiving any compensation related to profits arising from an unsold allotment, as 

suggested by one commenter, because the Agencies believe the final rule already 

includes sufficient controls to prevent a trading desk from intentionally retaining an 

unsold allotment to make a speculative profit when such allotment could be sold to 

customers.477 The Agencies also are not requiring compensation to be vested for a period 

of time, as recommended by one commenter to reduce traders’ incentives for undue risktaking. The Agencies believe the final rule includes sufficient controls around risk-taking 

activity without a compensation vesting requirement because a banking entity must 

establish limits for a trading desk’s underwriting position and the trading desk must make 

reasonable efforts to sell or otherwise reduce the underwriting position within a 

reasonable period.478 The Agencies continue to believe it is appropriate to focus on the 

design of a banking entity’s compensation structure, so the Agencies are not removing 

 

477 See AFR et al. (Feb. 2012); supra Part IV.A.2.c.2.c. (discussing the requirement to make reasonable 

efforts to sell or otherwise reduce the underwriting position).

478 See AFR et al. (Feb. 2012).
143

the term “designed” from this provision.479 This retains an objective focus on actions 

that the banking entity can control – the design of its incentive compensation program –

and avoids a subjective focus on whether an employee feels incentivized by 

compensation, which may be more difficult to assess. In addition, the framework of the 

final compensation requirement will allow banking entities to better plan and control the 

design of their compensation arrangements, which should reduce costs and uncertainty 

and enhance monitoring, than an approach focused solely on individual outcomes.

5. Registration requirement

a. Proposed registration requirement

Section __.4(a)(2)(iv) of the proposed rule would have required that a banking 

entity have the appropriate dealer registration or be exempt from registration or excluded 

from regulation as a dealer to the extent that, in order to underwrite the security at issue, a 

person must generally be a registered securities dealer, municipal securities dealer, or 

government securities dealer.480 Further, if the banking entity was engaged in the 

business of a dealer outside the United States in a manner for which no U.S. registration 

is required, the proposed rule would have required the banking entity to be subject to 

substantive regulation of its dealing business in the jurisdiction in which the business is 

located.

 

479 See Occupy.

480 See proposed rule § __.4(a)(2)(iv); Joint Proposal, 76 FR at 68,867; CFTC Proposal, 77 FR at 8353. 

The proposal clarified that, in the case of a financial institution that is a government securities dealer, such 

institution must have filed notice of that status as required by section 15C(a)(1)(B) of the Exchange Act. 

See Joint Proposal, 76 FR at 68,867; CFTC Proposal, 77 FR at 8353.
144

b. Comments on proposed registration requirement

Commenters generally did not address the proposed dealer requirement in the 

underwriting exemption. However, as discussed below in Part IV.A.3.c.2.b., a number of 

commenters addressed a similar requirement in the proposed market-making exemption.

c. Final registration requirement

The requirement in § __.4(a)(2)(vi) of the underwriting exemption, which 

provides that the banking entity must be licensed or registered to engage in underwriting 

activity in accordance with applicable law, is substantively similar to the proposed dealer 

registration requirement in § __.4(a)(2)(iv) of the proposed rule. The primary difference 

between the proposed requirement and the final requirement is that the Agencies have 

simplified the language of the rule. The Agencies have also made conforming changes to 

the corresponding requirement in the market-making exemption to promote consistency 

across the exemptions, where appropriate.481

As was proposed, this provision will require a U.S. banking entity to be an SECregistered dealer in order to rely on the underwriting exemption in connection with a 

distribution of securities – other than exempted securities, security-based swaps, 

commercial paper, bankers acceptances or commercial bills – unless the banking entity is 

exempt from registration or excluded from regulation as a dealer.482 To the extent that a 

banking entity relies on the underwriting exemption in connection with a distribution of 

 

481 See Part IV.A.3.c.6. (discussing the registration requirement in the market-making exemption).

482 For example, if a banking entity is a bank engaged in underwriting asset-backed securities for which it 

would be required to register as a securities dealer but for the exclusion contained in section 3(a)(5)(C)(iii) 

of the Exchange Act, the final rule would not require the banking entity to be a registered securities dealer 

to underwrite the asset-backed securities. See 15 U.S.C. 78c(a)(5)(C)(iii).
145

municipal securities or government securities, rather than the exemption in § __.6(a) of 

the final rule, this provision may require the banking entity to be registered or licensed as 

a municipal securities dealer or government securities dealer, if required by applicable 

law. However, this provision does not require a banking entity to register in order to 

qualify for the underwriting exemption if the banking entity is not otherwise required to 

register by applicable law.

The Agencies have determined that, for purposes of the underwriting exemption, 

rather than require a banking entity engaged in the business of a securities dealer outside 

the United States to be subject to substantive regulation of its dealing business in the 

jurisdiction in which the business is located, a banking entity’s dealing activity outside 

the U.S. should only be subject to licensing or registration provisions if required under 

applicable foreign law (provided no U.S. registration or licensing requirements apply to 

the banking entity’s activities). In response to comments, the final rule recognizes that 

certain foreign jurisdictions may not provide for substantive regulation of dealing 

businesses.483 The Agencies do not believe it is necessary to preclude banking entities 

from engaging in underwriting activities in such foreign jurisdictions to achieve the goals 

of section 13 of the BHC Act because these banking entities would continue to be subject 

to the other requirements of the underwriting exemption.

 

483 See infra Part IV.A.3.c.6.c. (discussing comments on this issue with respect to the proposed dealer 

registration requirement in the market-making exemption).
146

6. Source of revenue requirement

a. Proposed source of revenue requirement

Under § __.4(a)(2)(vi) of the proposed rule, the underwriting activities of a 

banking entity would have been required to be designed to generate revenues primarily 

from fees, commissions, underwriting spreads, or other income not attributable to 

appreciation in the value of covered financial positions or hedging of covered financial 

positions.484 The proposal clarified that underwriting spreads would include any “gross 

spread” (i.e., the difference between the price an underwriter sells securities to the public 

and the price it purchases them from the issuer) designed to compensate the underwriter 

for its services.485 This requirement provided that activities conducted in reliance on the 

underwriting exemption should demonstrate patterns of revenue generation and 

profitability consistent with, and related to, the services an underwriter provides to its 

customers in bringing securities to market, rather than changes in the market value of the 

underwritten securities.486

b. Comments on the proposed source of revenue requirement

A few commenters requested certain modifications to the proposed source of 

revenue requirement. These commenters’ suggested revisions were generally intended 

either to refine the standard to better account for certain activities or to make it more 

 

484 See proposed rule § __.4(a)(2)(vi); Joint Proposal, 76 FR at 68,867-68,868; CFTC Proposal, 77 FR at 

8353.

485 See Joint Proposal, 76 FR at 68,867-68,868 n.142; CFTC Proposal, 77 FR at 8353 n.148.

486 See Joint Proposal, 76 FR at 68,867-68,868; CFTC Proposal, 77 FR at 8353.
147

stringent.487 Three commenters expressed concern that the proposed source of revenue 

requirement would negatively impact a banking entity’s ability to act as a primary dealer 

or in a similar capacity.488 

With respect to suggested modifications, one commenter recommended that 

“customer revenue” include revenues attributable to syndicate activities, hedging 

activities, and profits and losses from sales of residual positions, as long as the 

underwriter makes a reasonable effort to dispose of any residual position in light of 

existing market conditions.489 Another commenter indicated that the rule would better 

address securitization if it required compensation to be linked in part to risk minimization 

for the securitizer and in part to serving customers. This commenter suggested that such 

a framework would be preferable because, in the context of securitizations, fee-based 

compensation structures did not previously prevent banking entities from accumulating 

large and risky positions with significant market exposure.490 

To strengthen the proposed requirement, one commenter requested that the terms 

“designed” and “primarily” be removed and replaced by the word “solely.”491 Two other 

commenters requested that this requirement be interpreted to prevent a banking entity 

 

487 See Goldman (Prop. Trading); Occupy; Sens. Merkley & Levin (Feb. 2012).

488 See Banco de México (stating that primary dealers need to profit from resulting proprietary positions in 

foreign sovereign debt, including by holding significant positions in anticipation of future price 

movements, in order to make the primary dealer business financially attractive); IIB/EBF (noting that 

primary dealers may actively seek to profit from price and interest rate movements of their holdings, which 

the relevant sovereign entity supports because such activity provides much-needed liquidity for securities 

that are otherwise largely purchased pursuant to buy-and-hold strategies by institutional investors and other 

entities seeking safe returns and liquidity buffers); Japanese Bankers Ass’n.

489 See Goldman (Prop. Trading).

490 See Sens. Merkley & Levin (Feb. 2012).

491 See Occupy (requesting that the rule require automatic disgorgement of any profits arising from 

appreciation in the value of positions in connection with underwriting activities).
148

from acting as an underwriter for a distribution of securities if such securities lack a 

discernible and sufficiently liquid pre-existing market and a foreseeable market price.492

c. Final rule’s approach to assessing source of revenue

The Agencies believe the final rule includes sufficient controls around an 

underwriter’s source of revenue and have determined not to adopt the additional 

requirement included in proposed rule § __.4(a)(2)(vi). The Agencies believe that 

removing this requirement addresses commenters’ concerns that the proposed 

requirement did not appropriately reflect certain revenue sources from underwriting 

activity493 or may impact primary dealer activities.494 At the same time, the final rule 

continues to include provisions that focus on whether an underwriter is generating 

underwriting-related revenue and that should limit an underwriter’s ability to generate 

revenues purely from price appreciation. In particular, the requirement to make 

reasonable efforts to sell or otherwise reduce the underwriting position within a 

reasonable period, which was not included in the proposed rule, should limit an 

underwriter’s ability to gain revenues purely from price appreciation related to its 

underwriter position. Similarly, the determination of whether an underwriter receives 

special compensation for purposes of the definition of “distribution” takes into account 

whether a banking entity is generating underwriting-related revenue. 

The final rule does not adopt a requirement that prevents an underwriter from 

generating any revenue from price appreciation out of concern that such a requirement 

 

492 See AFR et al. (Feb. 2012); Public Citizen.

493 See Goldman (Prop. Trading).

494 See Banco de México; IIB/EBF; Japanese Bankers Ass’n.
149

could prevent an underwriter from retaining an unsold allotment under any 

circumstances, which would be inconsistent with other provisions of the exemption.495 

Similarly, the Agencies are not adopting a source of revenue requirement that would 

prevent a banking entity from acting as underwriter for a distribution of securities if such 

securities lack a discernible and sufficiently liquid pre-existing market and a foreseeable 

market price, as suggested by two commenters.496 The Agencies believe these 

commenters’ concern is mitigated by the near term demand requirement, which requires a 

trading desk to have a reasonable expectation of demand from other market participants 

for the amount and type of securities to be acquired from an issuer or selling security 

holder for distribution.497 Further, one commenter recommended a revenue requirement 

directed at securitization activities to prevent banking entities from accumulating large 

and risky positions with significant market exposure.498 The Agencies believe the 

requirement to make reasonable efforts to sell or otherwise reduce the underwriting 

position should achieve this stated goal and, thus, the Agencies do not believe an 

additional revenue requirement for securitization activity is needed.499

3. Section __.4(b): Market-Making Exemption 

a. Introduction

 

495 See Occupy; supra Part IV.A.2.c.2. (discussing comments on unsold allotments and the requirement in 

the final rule to make reasonable efforts to sell or otherwise reduce the underwriting position).

496 See AFR et al. (Feb. 2012); Public Citizen.

497 See supra Part IV.A.2.c.2.

498 See Sens. Merkley & Levin (Feb. 2012).

499 See final rule § __.4(a)(2)(ii). Further, as noted above, this exemption does not permit the accumulation 

of assets for securitization. See supra Part IV.A.2.c.1.c.v.
150

In adopting the final rule, the Agencies are striving to balance two goals of 

section 13 of the BHC Act: to allow market making, which is important to wellfunctioning markets as well as to the economy, and simultaneously to prohibit proprietary 

trading, unrelated to market making or other permitted activities, that poses significant 

risks to banking entities and the financial system. In response to comments on the 

proposed market-making exemption, the Agencies are adopting certain modifications to 

the proposed exemption to better account for the varying characteristics of market 

making-related activities across markets and asset classes, while requiring that banking 

entities maintain a robust set of risk controls for their market making-related activities. A 

flexible approach to this exemption is appropriate because the activities a market maker 

undertakes to provide important intermediation and liquidity services will differ based on 

the liquidity, maturity, and depth of the market for a given type of financial instrument. 

The statute specifically permits banking entities to continue to provide these beneficial 

services to their clients, customers, and counterparties.500 Thus, the Agencies are 

adopting an approach that recognizes the full scope of market making-related activities 

banking entities currently undertake and requires that these activities be subject to clearly 

defined, verifiable, and monitored risk parameters. 

b. Overview

 

500 As discussed in Part IV.A.3.c.2.c.i., infra, the terms “client,” “customer,” and “counterparty” are 

defined in the same manner in the final rule. Thus, the Agencies use these terms synonymously throughout 

this discussion and sometimes use the term “customer” to refer to all entities that meet the definition of 

“client, customer, and counterparty” in the final rule’s market-making exemption. 
151

1. Proposed market-making exemption

Section 13(d)(1)(B) of the BHC Act provides an exemption from the prohibition 

on proprietary trading for the purchase, sale, acquisition, or disposition of securities, 

derivatives, contracts of sale of a commodity for future delivery, and options on any of 

the foregoing in connection with market making-related activities, to the extent that such 

activities are designed not to exceed the reasonably expected near term demands of 

clients, customers, or counterparties.501

Section __.4(b) of the proposed rule would have implemented this statutory 

exemption by requiring that a banking entity’s market making-related activities comply 

with seven standards. As discussed in the proposal, these standards were designed to 

ensure that any banking entity relying on the exemption would be engaged in bona fide

market making-related activities and, further, would conduct such activities in a way that 

was not susceptible to abuse through the taking of speculative, proprietary positions as a 

part of, or mischaracterized as, market making-related activities. The Agencies proposed 

to use additional regulatory and supervisory tools in conjunction with the proposed 

market-making exemption, including quantitative measurements for banking entities 

engaged in significant covered trading activity in proposed Appendix A, commentary on 

how the Agencies proposed to distinguish between permitted market making-related 

activity and prohibited proprietary trading in proposed Appendix B, and a compliance 

regime in proposed § __.20 and, where applicable, Appendix C of the proposal. This 

 

501 12 U.S.C. 1851(d)(1)(B).
152

multi-faceted approach was intended to address the complexities of differentiating 

permitted market making-related activities from prohibited proprietary trading.502 

2. Comments on the proposed market-making exemption

The Agencies received significant comment regarding the proposed marketmaking exemption. In this Part, the Agencies highlight the main issues, concerns, and 

suggestions raised by commenters with respect to the proposed market-making 

exemption. As discussed in greater detail below, commenters’ views on the effectiveness 

of the proposed exemption varied. Commenters discussed a broad range of topics related 

to the proposed market-making exemption including, among others: the overall scope of 

the proposed exemption and potential restrictions on market making in certain markets or 

asset classes; the potential market impact of the proposed market-making exemption; the 

appropriate level of analysis for compliance with the proposed exemption; the 

effectiveness of the individual requirements of the proposed exemption; and specific 

activities that should or should not be considered permitted market making-related 

activity under the rule. 

a. Comments on the overall scope of the proposed exemption

With respect to the general scope of the exemption, a number of commenters 

expressed concern that the proposed approach to implementing the market-making 

exemption is too narrow or restrictive, particularly with respect to less liquid markets. 

These commenters expressed concern that the proposed exemption would not be 

workable in many markets and asset classes and does not take into account how market-

 

502 See Joint Proposal, 76 FR at 68,869; CFTC Proposal, 77 FR at 8354-8355.
153

making services are provided in those markets and asset classes.503 Some commenters 

expressed particular concern that the proposed exemption may restrict or limit certain 

activities currently conducted by market makers (e.g., holding inventory or interdealer 

trading).504 Several commenters stated that the proposed exemption would create too 

much uncertainty regarding compliance505 and, further, may have a chilling effect on 

banking entities’ market making-related activities.506 Due to the perceived restrictions 

and burdens of the proposed exemption, many commenters indicated that the rule may 

 

503 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012) (stating that the proposed exemption “seems to 

view market making based on a liquid, exchange-traded equity model in which market makers are simple 

intermediaries akin to agents” and that “[t]his view does not fit market making even in equity markets and 

widely misses the mark for the vast majority of markets and asset classes”); SIFMA (Asset Mgmt.) (Feb. 

2012); Credit Suisse (Seidel); ICI (Feb. 2012); BoA; Columbia Mgmt.; Comm. on Capital Markets

Regulation; Invesco; ASF (Feb. 2012) (“The seven criteria in the proposed rule, and the related criterion for 

identifying permitted hedging, are overly restrictive and will make it impractical for dealers to continue 

making markets in most securitized products.”); Chamber (Feb. 2012) (expressing particular concern about 

the commercial paper market).

504 Several commenters stated that the proposed rule would limit a market maker’s ability to maintain 

inventory. See, e.g., NASP; Oliver Wyman (Dec. 2011); Wellington; Prof. Duffie; Standish Mellon; 

MetLife; Lord Abbett; NYSE Euronext; CIEBA; British Columbia; SIFMA et al. (Prop. Trading) (Feb. 

2012); Shadow Fin. Regulatory Comm.; Credit Suisse (Seidel); Morgan Stanley; Goldman (Prop. Trading); 

BoA; STANY; SIFMA (Asset Mgmt.) (Feb. 2012); Chamber (Feb. 2012); IRSG; Abbott Labs et al. (Feb. 

14, 2012); Abbott Labs et al. (Feb. 21, 2012); Australian Bankers Ass’n. (Feb. 2012); FEI; ASF (Feb. 

2012); RBC; PUC Texas; Columbia Mgmt.; SSgA (Feb. 2012); PNC et al.; Fidelity; ICI (Feb. 2012); 

British Bankers’ Ass’n.; Comm. on Capital Markets Regulation; IHS; Oliver Wyman (Feb. 2012); Thakor 

Study (stating that by artificially constraining the security holdings that a banking entity can have in its 

inventory for market making or proprietary trading purposes, section 13 of the BHC Act will make bank 

risk management less efficient and may adversely impact the diversified financial services business model 

of banks). However, some commenters stated that market makers should seek to minimize their inventory 

or should not need large inventories. See, e.g., AFR et al. (Feb. 2012); Public Citizen; Johnson & Prof. 

Stiglitz. Other commenters expressed concern that the proposed rule could limit interdealer trading. See,

e.g., Prof. Duffie; Credit Suisse (Seidel); JPMC; Morgan Stanley; Goldman (Prop. Trading); Chamber 

(Feb. 2012); Oliver Wyman (Dec. 2011).

505 See, e.g., BlackRock; Putnam; Fixed Income Forum/Credit Roundtable; ACLI (Feb. 2012); MetLife; 

IAA; Wells Fargo (Prop. Trading); T. Rowe Price; Sen. Bennet; Sen. Corker; PUC Texas; Fidelity; ICI 

(Feb. 2012); Invesco.

506 See, e.g., Wellington; Prof. Duffie; Standish Mellon; Commissioner Barnier; NYSE Euronext; BoA; 

Citigroup (Feb. 2012); STANY; ICE; Chamber (Feb. 2012); BDA (Feb. 2012); Putnam; FTN; Fixed 

Income Forum/Credit Roundtable; ACLI (Feb. 2012); IAA; CME Group; Capital Group; PUC Texas; 

Columbia Mgmt.; SSgA (Feb. 2012); Eaton Vance; ICI (Feb. 2012); Invesco; Comm. on Capital Markets

Regulation; Oliver Wyman (Feb. 2012); SIFMA (Asset Mgmt.) (Feb. 2012); Thakor Study.
154

change the way in which market-making services are provided.507 A number of 

commenters expressed the view that the proposed exemption is inconsistent with 

Congressional intent because it would restrict and reduce banking entities’ current market 

making-related activities.508

Other commenters, however, stated that the proposed exemption was too broad 

and recommended that the rule place greater restrictions on market making, particularly 

in illiquid, nontransparent markets.509 Many of these commenters suggested that the 

exemption should only be available for traditional market-making activity in relatively 

safe, “plain vanilla” instruments.510 Two commenters represented that the proposed 

exemption would have little to no impact on banking entities’ current market makingrelated services.511 

Commenters expressed differing views regarding the ease or difficulty of 

distinguishing permitted market making-related activity from prohibited proprietary 

 

507 For example, some commenters stated that market makers may revert to an agency or “special order” 

model. See, e.g., Barclays; Goldman (Prop. Trading); ACLI (Feb. 2012); Vanguard; RBC. In addition, 

some commenters stated that new systems will be developed, such as alternative market matching 

networks, but these commenters disagreed about whether such changes would happen in the near term. 

See, e.g., CalPERS; BlackRock; Stuyvesant; Comm. on Capital Markets Regulation. Other commenters 

stated that it is unlikely that new systems will be developed. See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Oliver Wyman (Feb. 2012). One commenter stated that the proposed rule may cause a banking 

organization that engages in significant market-making activity to give up its banking charter or spin off its 

market-making operations to avoid compliance with the proposed exemption. See Prof. Duffie.

508 See, e.g., NASP; Wellington; JPMC; Morgan Stanley; Credit Suisse (Seidel); BoA; Goldman (Prop. 

Trading); Citigroup (Feb. 2012); STANY; SIFMA (Asset Mgmt.) (Feb. 2012); Chamber (Feb. 2012); 

Putnam; ICI (Feb. 2012); Wells Fargo (Prop. Trading); NYSE Euronext; Sen. Corker; Invesco.

509 See, e.g., Better Markets (Feb. 2012); Sens. Merkley & Levin (Feb. 2012); Occupy; AFR et al. (Feb. 

2012); Public Citizen; Johnson & Prof. Stiglitz.

510 See, e.g., Johnson & Prof. Stiglitz; Sens. Merkley & Levin (Feb. 2012); Occupy; AFR et al. (Feb. 

2012); Public Citizen.

511 See Occupy (“[I]t is unclear that this rule, as written, will markedly alter the current customer-serving 

business. Indeed, this rule has gone to excessive lengths to protect the covered banking entities’ ability to 

maintain responsible customer-facing business.”); Alfred Brock.
155

trading. A number of commenters represented that it is difficult or impossible to 

distinguish prohibited proprietary trading from permitted market making-related 

activity.512 With regard to this issue, several commenters recommended that the 

Agencies not try to remove all aspects of proprietary trading from market making-related 

activity because doing so would likely restrict certain legitimate market-making 

activity.513 

Other commenters were of the view that it is possible to differentiate between 

prohibited proprietary trading and permitted market making-related activity.514 For 

example, one commenter stated that, while the analysis may involve subtle distinctions, 

the fundamental difference between a banking entity’s market-making activities and 

proprietary trading activities is the emphasis in market making on seeking to meet 

customer needs on a consistent and reliable basis throughout a market cycle.515 

According to another commenter, holding substantial securities in a trading book for an 

extended period of time assumes the character of a proprietary position and, while there 

may be occasions when a customer-oriented purchase and subsequent sale extend over 

 

512 See, e.g., Rep. Bachus et al.; IIF; Morgan Stanley (stating that beyond walled-off proprietary trading, 

the line is hard to draw, particularly because both require principal risk-taking and the features of market 

making vary across markets and asset classes and become more pronounced in times of market stress); 

CFA Inst. (representing that the distinction is particularly difficult in the fixed-income market); ICFR; Prof. 

Duffie; WR Hambrecht.

513 See, e.g., Chamber (Feb. 2012) (citing an article by Stephen Breyer stating that society should not 

expend disproportionate resources trying to reduce or eliminate “the last 10 percent” of the risks of a 

certain problem); JPMC; RBC; ICFR; Sen. Hagan. One of these commenters indicated that any concerns 

that banking entities would engage in speculative trading as a result of an expansive market-making 

exemption would be addressed by other reform initiatives (e.g., Basel III implementation will provide 

laddered disincentives to holding positions as principal as a result of capital and liquidity requirements). 

See RBC.

514 See Wellington; Paul Volcker; Better Markets (Feb. 2012); Occupy.

515 See Wellington.
156

days and cannot be more quickly executed or hedged, substantial holdings of this 

character should be relatively rare and limited to less liquid markets.516

Several commenters expressed general concern that the proposed exemption may 

be applied on a transaction-by-transaction basis and explained the burdens that may result 

from such an approach.517 Commenters appeared to attribute these concerns to language 

in the proposed exemption referring to a “purchase or sale of a [financial instrument]”518

or to language in Appendix B indicating that the Agencies may assess certain factors and 

criteria at different levels, including a “single significant transaction.”519 With respect to 

the burdens of a transaction-by-transaction analysis, some commenters noted that 

banking entities can engage in a large volume of market-making transactions daily, which 

would make it burdensome to apply the exemption to each trade.520 A few commenters 

indicated that, even if the Agencies did not intend to require transaction-by-transaction 

analysis, the proposed rule’s language can be read to imply such a requirement. These 

commenters indicated that ambiguity on this issue could have a chilling effect on market 

making or could allow some examiners to rigidly apply the requirements of the 

 

516 See Paul Volcker.

517 See Wellington; SIFMA et al. (Prop. Trading) (Feb. 2012); Barclays; Goldman (Prop. Trading); HSBC; 

Fixed Income Forum/Credit Roundtable; ACLI (Feb. 2012); PUC Texas; ERCOT; Invesco. See also IAA 

(stating that it is unclear whether the requirements must be applied on a transaction-by-transaction basis or 

if compliance with the requirements is based on overall activities). This issue is addressed in Part 

IV.A.3.c.1.c., infra.

518 See, e.g., Barclays; SIFMA et al. (Prop. Trading) (Feb. 2012). As explained above, the term “covered 

financial position” from the proposal has been replaced by the term “financial instrument” in the final rule. 

Because the types of instruments included in both definitions are identical, the term “financial instrument” 

is used throughout this Part.

519 See, e.g., Goldman (Prop. Trading); Wellington.

520 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Barclays (stating that “hundreds or thousands of 

trades can occur in a single day in a single trading unit”).
157

exemption on a trade-by-trade basis.521 Other commenters indicated that it would be 

difficult to determine whether a particular trade was or was not a market-making trade 

without consideration of the relevant unit’s overall activities.522 One commenter 

elaborated on this point by stating that “an analysis that seeks to characterize specific 

transactions as either market making...or prohibited activity does not accord with the 

way in which modern trading units operate, which generally view individual positions as 

a bundle of characteristics that contribute to their complete portfolio.”523 This 

commenter noted that a position entered into as part of market making-related activities 

may serve multiple functions at one time, such as responding to customer demand, 

hedging a risk, and building inventory. The commenter also expressed concern that 

individual transactions or positions may not be severable or separately identifiable as 

serving a market-making purpose.524 Two commenters suggested that the requirements 

in the market-making exemption be applied at the portfolio level rather than the trade 

level.525

Moreover, commenters also set forth their views on the organizational level at 

which the requirements of the proposed market-making exemption should apply.526 The 

proposed exemption generally applied requirements to a “trading desk or other 

organizational unit” of a banking entity. In response to this proposed approach, 

 

521 See, e.g., ICI (Feb. 2012); Barclays; Goldman (Prop. Trading).

522 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading).

523 SIFMA et al. (Prop. Trading) (Feb. 2012).

524 See id. (suggesting that the Agencies “give full effect to the statutory intent to allow market making by 

viewing the permitted activity on a holistic basis”).

525 See ACLI (Feb. 2012); Fixed Income Forum/Credit Roundtable.

526 See Wellington; Morgan Stanley; SIFMA et al. (Prop. Trading) (Feb. 2012); ACLI (Feb. 2012); Fixed 

Income Forum/Credit Roundtable. The Agencies address this topic in Part IV.A.3.c.1.c., infra.
158

commenters stated that compliance should be assessed at each trading desk or 

aggregation unit527 or at each trading unit.528 

Several commenters suggested alternative or additive means of implementing the 

statutory exemption for market making-related activity.529 Commenters’ recommended 

approaches varied, but a number of commenters requested approaches involving one or 

more of the following elements: (i) safe harbors,530 bright lines,531 or presumptions of 

compliance with the exemption based on the existence of certain factors (e.g., compliance 

program, metrics, general customer focus or orientation, providing liquidity, and/or 

exchange registration as a market maker);532 (ii) a focus on metrics or other objective 

 

527 See Wellington. This commenter did not provide greater specificity about how it would define “trading 

desk” or “aggregation unit.” See id.

528 See Morgan Stanley (stating that “trading unit” should be defined as “each organizational unit that is 

used to structure and control the aggregate risk-taking activities and employees that are engaged in the 

coordinated implementation of a customer-facing revenue generation strategy and that participate in the 

execution of any covered trading activity”); SIFMA et al. (Prop. Trading) (Feb. 2012). One of these 

commenters discussed its suggested definition of “trading unit” in the context of the proposed requirement 

to record and report certain quantitative measurements, but it is unclear that the commenter was also 

suggesting that this definition be used for purposes of the market-making exemption. For example, this 

commenter expressed support for a multi-level approach to defining “trading unit,” and it is not clear how a 

definition that captures multiple organizational levels across a banking organization would work in the 

context of the market-making exemption. See SIFMA et al. (Prop. Trading) (Feb. 2012) (suggested that 

“trading unit” be defined “at a level that presents its activities in the context of the whole” and noting that 

the appropriate level may differ depending on the structure of the banking entity).

529 See, e.g., Wellington; Japanese Bankers Ass’n.; Prof. Duffie; IR&M; G2 FinTech; MetLife; NYSE 

Euronext; Anthony Flynn and Koral Fusselman; IIF; CalPERS; SIFMA et al. (Prop. Trading) (Feb. 2012); 

Sens. Merkley & Levin (Feb. 2012); Shadow Fin. Regulatory Comm.; John Reed; Prof. Richardson; Credit 

Suisse (Seidel); JPMC; Morgan Stanley; Barclays; Goldman (Prop. Trading); BoA; Citigroup (Feb. 2012); 

STANY; ICE; BlackRock; Johnson & Prof. Stiglitz; Fixed Income Forum/Credit Roundtable; ACLI (Feb. 

2012); Wells Fargo (Prop. Trading); WR Hambrecht; Vanguard; Capital Group; PUC Texas; SSgA (Feb. 

2012); PNC et al.; Fidelity; Occupy; AFR et al. (Feb. 2012); Invesco; ISDA (Feb. 2012); Stephen Roach; 

Oliver Wyman (Feb. 2012). The Agencies respond to these comments in Part IV.A.3.b.3., infra.

530 See, e.g., Sens. Merkley & Levin (Feb. 2012); John Reed; Prof. Richardson; Johnson & Prof. Stiglitz; 

Capital Group; Invesco; BDA (Feb. 2012) (Oct. 2012) (suggesting a safe harbor for any trading desk that 

effects more than 50 percent of its transactions through sales representatives).

531 See, e.g., Flynn & Fusselman; Prof. Colesanti et al.

532 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); IIF; NYSE Euronext; Credit Suisse (Seidel); 

JPMC; Barclays; BoA; Wells Fargo (Prop. Trading) (suggesting that the rule: (i) provide a general grant of 

authority to engage in any transactions entered into as part of a banking entity's market-making business, 
159

factors;533 (iii) guidance on permitted market making-related activity, rather than rule 

requirements;534 (iv) risk management structures and/or risk limits;535 (v) adding a new 

customer-facing criterion or focusing on client-related activities;536 (vi) capital and 

liquidity requirements;537 (vii) development of individualized plans for each banking 

entity, in coordination with regulators;538 (viii) ring fencing affiliates engaged in market 

making-related activity;539 (ix) margin requirements;540 (x) a compensation-focused 

approach;541 (xi) permitting all swap dealing activity;542 (xii) additional provisions 

regarding material conflicts of interest and high-risk assets and trading strategies;543

and/or (xiii) making the exemption as broad as possible under the statute.544

 where “market making” is defined as “the business of being willing to facilitate customer purchases and 

sales of [financial instruments] as an intermediary over time and in size, including by holding positions in 

inventory;” and (ii) allow banking entities to monitor compliance with this exemption internally through 

their compliance and risk management infrastructure); PNC et al.; Oliver Wyman (Feb. 2012).

533 See, e.g., Goldman (Prop. Trading); Morgan Stanley; Barclays; Wellington; CalPERS; BlackRock; 

SSgA (Feb. 2012); Invesco.

534 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012) (suggesting that this guidance could be incorporated 

in banking entities’ policies and procedures for purposes of complying with the rule, in addition to the 

establishment of risk limits, controls, and metrics); JPMC; BoA; PUC Texas; SSgA (Feb. 2012); PNC et 

al.; Wells Fargo (Prop. Trading).

535 See, e.g., Japanese Bankers Ass’n.; Citigroup (Feb. 2012).

536 See, e.g., Morgan Stanley; Stephen Roach.

537 See, e.g., Prof. Duffie; CalPERS; STANY; ICE; Vanguard; Capital Group. 

538 See MetLife; Fixed Income Forum/Credit Roundtable; ACLI (Feb. 2012).

539 See, e.g., Prof. Duffie; Shadow Fin. Regulatory Comm. See also Wedbush.

540 See WR Hambrecht.

541 See G2 FinTech. 

542 See ISDA (Feb. 2012); ISDA (Apr. 2012).

543 See Sens. Merkley & Levin (Feb. 2012) (stating that the exemption should expressly mention the 

conflicts provision and provide examples to warn against particular conflicts, such as recommending clients 

buy poorly performing assets in order to remove them from the banking entity’s book or attempting to 

move market prices in favor of trading positions a banking entity has built up in order to make a profit); 

Stephen Roach (suggesting that the exemption integrate the limitations on permitted activities). 

544 See Fidelity (stating that the exemption needs to be as broad as possible to account for customer-facing 

principal trades, block trades, and market making in OTC derivatives). See also STANY (stating that it is 

better to make the exemption too broad than too narrow).
160

b. Comments regarding the potential market impact of the proposed exemption

As discussed above, several commenters stated that the proposed rule would 

impact a banking entity’s ability to engage in market making-related activity. Many of 

these commenters represented that, as a result, the proposed exemption would likely 

result in reduced liquidity,545 wider bid-ask spreads,546 increased market volatility,547

reduced price discovery or price transparency,548 increased costs of raising capital or 

higher financing costs,549 greater costs for investors or consumers,550 and slower 

 

545 See, e.g., AllianceBernstein; Rep. Bachus et al. (Dec. 2011); EMTA; NASP; Wellington; Japanese 

Bankers Ass’n.; Sen. Hagan; Prof. Duffie; Investure; Standish Mellon; IR&M; MetLife; Lord Abbett; 

Commissioner Barnier; Quebec; IIF; Sumitomo Trust; Liberty Global; NYSE Euronext; CIEBA; EFAMA; 

SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); JPMC; Morgan Stanley; Barclays; 

Goldman (Prop. Trading); BoA; Citigroup (Feb. 2012); STANY; ICE; BlackRock; SIFMA (Asset Mgmt.) 

(Feb. 2012); BDA (Feb. 2012); Putnam; Fixed Income Forum/Credit Roundtable; Western Asset Mgmt.;

ACLI (Feb. 2012); IAA; CME Group; Wells Fargo (Prop. Trading); Abbott Labs et al. (Feb. 14, 2012); 

Abbott Labs et al. (Feb. 21, 2012); T. Rowe Price; Australian Bankers Ass’n. (Feb. 2012); FEI; AFMA; 

Sen. Carper et al.; PUC Texas; ERCOT; IHS; Columbia Mgmt.; SSgA (Feb. 2012); PNC et al.; Eaton 

Vance; Fidelity; ICI (Feb. 2012); British Bankers’ Ass’n.; Comm. on Capital Markets Regulation; Union 

Asset; Sen. Casey; Oliver Wyman (Dec. 2011); Oliver Wyman (Feb. 2012) (providing estimated impacts 

on asset valuation, borrowing costs, and transaction costs in the corporate bond market based on 

hypothetical liquidity reduction scenarios); Thakor Study. The Agencies respond to comments regarding 

the potential market impact of the rule in Part IV.A.3.b.3., infra.

546 See, e.g., AllianceBernstein; Wellington; Investure; Standish Mellon; MetLife; Lord Abbett; Barclays; 

Goldman (Prop. Trading); Citigroup (Feb. 2012); BlackRock; Putnam; ACLI (Feb. 2012); Abbott Labs et 

al. (Feb. 14, 2012); Abbott Labs et al. (Feb. 21, 2012); T. Rowe Price; Sen. Carper et al.; IHS; Columbia 

Mgmt.; ICI (Feb. 2012) British Bankers’ Ass’n.; Comm. on Capital Markets Regulation; Thakor Study 

(stating that section 13 of the BHC Act will likely result in higher bid-ask spreads by causing at least some 

retrenchment of banks from market making, resulting in fewer market makers and less competition).

547 See, e.g., Wellington; Prof. Duffie; Standish Mellon; Lord Abbett; IIF; SIFMA et al. (Prop. Trading) 

(Feb. 2012); Barclays; Goldman (Prop. Trading); BDA (Feb. 2012); IHS; FTN; IAA; Wells Fargo (Prop. 

Trading); T. Rowe Price; Columbia Mgmt.; SSgA (Feb. 2012); Eaton Vance; British Bankers’ Ass’n.; 

Comm. on Capital Markets Regulation.

548 See, e.g., Prof. Duffie (arguing that, for example, “during the financial crisis of 2007-2009, the reduced 

market making capacity of major dealer banks caused by their insufficient capital levels resulted in 

dramatic downward distortions in corporate bond prices”); IIF; Barclays; IAA; Vanguard; Wellington; 

FTN.

549 See, e.g., AllianceBernstein; Chamber (Dec. 2011); Members of Congress (Dec. 2011); Wellington; 

Sen. Hagan; Prof. Duffie; IR&M; MetLife; Lord Abbett; Liberty Global; NYSE Euronext; SIFMA et al.

(Prop. Trading) (Feb. 2012); NCSHA; ASF (Feb. 2012) (stating that “[f]ailure to permit the activities 

necessary for banking entities to act in [a] market-making capacity [in asset-backed securities] would have 

a dramatic adverse effect on the ability of securitizers to access the asset-backed securities markets and thus 
161

execution times.551 Some commenters expressed particular concern about potential 

impacts on institutional investors (e.g., mutual funds and pension funds)552 or on small or 

midsized companies.553 A number of commenters discussed the interrelationship 

 

to obtain the debt financing necessary to ensure a vibrant U.S. economy” ); Credit Suisse (Seidel); JPMC; 

Morgan Stanley; Barclays; Goldman (Prop. Trading); BoA; Citigroup (Feb. 2012); STANY; BlackRock; 

Chamber (Feb. 2012); IHS; BDA (Feb. 2012); Fixed Income Forum/Credit Roundtable; ACLI (Feb. 2012); 

Wells Fargo (Prop. Trading); Abbott Labs et al. (Feb. 14, 2012); Abbott Labs et al. (Feb. 21, 2012); T. 

Rowe Price; FEI; AFMA; SSgA (Feb. 2012); PNC et al.; ICI (Feb. 2012); British Bankers’ Ass’n.; Oliver 

Wyman (Dec. 2011); Oliver Wyman (Feb. 2012); GE (Feb. 2012); Thakor Study (stating that when a firm’s 

cost of capital goes up, it invests less—resulting in lower economic growth and lower employment—and 

citing supporting data indicating that a 1 percent increase in the cost of capital would lead to a $55 to $82.5 

billion decline in aggregate annual capital spending by U.S. nonfarm firms and job losses between 550,000 

and 1.1 million per year in the nonfarm sector). One commenter further noted that a higher cost of capital 

can lead a firm to make riskier, short-term investments. See Thakor Study.

550 See, e.g., Wellington; Standish Mellon; IR&M; MetLife; Lord Abbett; NYSE Euronext; CIEBA; 

Barclays; Goldman (Prop. Trading); BoA; Citigroup (Feb. 2012); STANY; ICE; BlackRock; Fixed Income 

Forum/Credit Roundtable; ACLI (Feb. 2012); IAA; Abbott Labs et al. (Feb. 14, 2012); Abbott Labs et al.

(Feb. 21, 2012); T. Rowe Price; Vanguard; Australian Bankers Ass’n. (Feb. 2012); FEI; Sen. Carper et al.; 

Columbia Mgmt.; SSgA (Feb. 2012); ICI (Feb. 2012); Comm. on Capital Markets Regulation; TMA Hong 

Kong; Sen. Casey; IHS; Oliver Wyman (Dec. 2011); Oliver Wyman (Feb. 2012); Thakor Study.

551 See, e.g., Barclays; FTN; Abbott Labs et al. (Feb. 14, 2012); Abbott Labs et al. (Feb. 21, 2012).

552 See, e.g., AllianceBernstein (stating that, to the extent the rule reduces liquidity provided by market 

makers, open end mutual funds that are largely driven by the need to respond to both redemptions and 

subscriptions will be immediately impacted in terms of higher trading costs); Wellington (indicating that 

periods of extreme market stress are likely to exacerbate costs and challenges, which could force investors 

such as mutual funds and pension funds to accept distressed prices to fund redemptions or pay current 

benefits); Lord Abbett (stating that certain factors, such as reduced bank capital to support market-making 

businesses and economic uncertainty, have already reduced liquidity and caused asset managers to have an 

increased preference for highly liquid credits and expressing concern that, if section 13 of the BHC Act 

further reduces liquidity, then: (i) asset managers’ increased preference for highly liquid credit could lead 

to unhealthy portfolio concentrations, and (ii) asset managers will maintain a larger cash cushion in 

portfolios that may be subject to redemption, which will likely result in investors getting poorer returns); 

EFAMA; BlackRock (stating that investment decisions are heavily dependent on a liquidity factor input, so 

as liquidity dissipates, investment strategies become more limited and returns to investors are diminished 

by wider spreads and higher transaction costs); CFA Inst. (noting that a mutual fund that tries to liquidate 

holdings to meet redemptions may have difficulty selling at acceptable prices, thus impairing the fund’s 

NAV for both redeeming investors and for those that remain in the fund); Putnam; Fixed Income 

Forum/Credit Roundtable; ACLI; T. Rowe Price; Vanguard; IAA; FEI; Sen. Carper et al.; Columbia 

Mgmt.; ICI (Feb. 2012); Invesco; Union Asset; Standish Mellon; Morgan Stanley; SIFMA (Asset Mgmt.) 

(Feb. 2012).

553 See, e.g., CIEBA (stating that for smaller issuers in particular, market makers need to have incentives to 

make markets, and the proposal removes important incentives); ACLI (indicating that lower liquidity will 

most likely result in higher costs for issuers of debt and, for lesser known or lower quality issuers, this cost 

may be significant and in some cases prohibitive because the cost will vary depending on the credit quality 

of the issuer, the amount of debt it has in the market, and the maturity of the security); PNC et al.

(expressing concern that a regional bank’s market-making activity for small and middle market customers 

is more likely to be inappropriately characterized as impermissible proprietary trading due to lower trading 
162

between primary and secondary market activity and indicated that restrictions on market 

making would impact the underwriting process.554 

A few commenters expressed the view that reduced liquidity would not 

necessarily be a negative result.555 For example, two commenters noted that liquidity is 

vulnerable to liquidity spirals, in which a high level of market liquidity during one period 

feeds a sharp decline in liquidity during the next period by initially driving asset prices 

upward and supporting increased leverage. The commenters explained that liquidity 

spirals lead to “fire sales” by market speculators when events reveal that assets are 

overpriced and speculators must sell their assets to reduce their leverage.556 According to 

another commenter, banking entities’ access to the safety net allows them to distort 

market prices and, arguably, produce excess liquidity. The commenter further 

represented that it would be preferable to allow the discipline of the market to choose the 

pricing of securities and the amount of liquidity.557 Some commenters cited an economic 

study indicating that the U.S. financial system has become less efficient in generating 

economic growth in recent years, despite increased trading volumes.558 

 volume involving less liquid securities); Morgan Stanley; Chamber (Feb. 2012); Abbott Labs et al. (Feb. 

14, 2012); Abbott Labs et al. (Feb. 21, 2012); FEI; ICI (Feb. 2012); TMA Hong Kong; Sen. Casey.

554 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC; RBC; NYSE Euronext; Credit Suisse (Seidel).

555 See, e.g., Paul Volcker; AFR et al. (Feb. 2012); Public Citizen; Prof. Richardson; Johnson & Prof. 

Stiglitz; Better Markets (Feb. 2012); Prof. Johnson.

556 See AFR et al. (Feb. 2012); Public Citizen. See also Paul Volcker (stating that at some point, greater 

liquidity, or the perception of greater liquidity, may encourage more speculative trading).

557 See Prof. Richardson.

558 See, e.g., Johnson & Prof. Stiglitz (citing Thomas Phillippon, Has the U.S. Finance Industry Become 

Less Efficient?, NYU Working Paper, Nov. 2011); AFR et al. (Feb. 2012); Public Citizen; Better Markets 

(Feb. 2012); Prof. Johnson.
163

Some commenters stated that it is unlikely the proposed rule would result in the 

negative market impacts identified above, such as reduced market liquidity.559 For 

example, a few commenters stated that other market participants, who are not subject to 

section 13 of the BHC Act, may enter the market or increase their trading activities to 

make up for any reduction in banking entities’ market-making activity or other trading 

activity.560 For instance, one of these commenters suggested that the revenue and profits 

from market making will be sufficient to attract capital and competition to that activity.561 

In addition, one commenter expressed the view that prohibiting proprietary trading may 

support more liquid markets by ensuring that banking entities focus on providing 

liquidity as market makers, rather than taking liquidity from the market in the course of 

“trading to beat” institutional buyers like pension funds, university endowments, and 

mutual funds.562 Another commenter stated that, while section 13 of the BHC Act may 

temporarily reduce trading volume and excessive liquidity at the peak of market bubbles, 

 

559 See, e.g., Sens. Merkley & Levin (Feb. 2012) (stating that there is no convincing, independent evidence 

that the rule would increase trading costs or reduce liquidity, and the best evidence available suggests that 

the buy-side firms would greatly benefit from the competitive pressures that transparency can bring); Better 

Markets (Feb. 2012) (“Industry’s claim that [section 13 of the BHC Act] will ‘reduce market liquidity, 

capital formation, and credit availability, and thereby hamper economic growth and job creation’ disregard 

the fact that the financial crisis did more damage to those concerns than any rule or reform possibly 

could.”); Profs. Stout & Hastings; Prof. Johnson; Occupy; Public Citizen; Profs. Admati & Pfleiderer; 

Better Markets (June 2012); AFR et al. (Feb. 2012). One commenter stated that the proposed rule would 

improve market liquidity, efficiency, and price transparency. See Alfred Brock.

560 See, e.g., Sens. Merkley & Levin (Feb. 2012); Prof. Richardson; Better Markets (Feb. 2012); Profs. 

Stout & Hastings; Prof. Johnson; Occupy; Public Citizen; Profs. Admati & Pfleiderer; Better Markets (June 

2012). Similarly, one commenter indicated that non-banking entity market participants could fill the 

current role of banking entities in the market if implementation of the rule is phased in. See ACLI (Feb. 

2012).

561 See Better Markets (Feb. 2012).

562 See Prof. Johnson.
164

it should increase the long-run stability of the financial system and render genuine 

liquidity and credit availability more reliable over the long term.563

Other commenters, however, indicated that it is uncertain or unlikely that nonbanking entities will enter the market or increase their trading activities, particularly in 

the short term.564 For example, one commenter noted the investment that banking entities 

have made in infrastructure for trading and compliance would take smaller or new firms 

years and billions of dollars to replicate.565 Another commenter questioned whether 

other market participants, such as hedge funds, would be willing to dedicate capital to 

fully serving customer needs, which is required to provide ongoing liquidity.566 One 

commenter stated that even if non-banking entities move in to replace lost trading activity 

from banking entities, the value of the current interdealer network among market makers 

will be reduced due to the exit of banking entities.567 Several commenters expressed the 

view that migration of market making-related activities to firms outside the banking 

system would be inconsistent with Congressional intent and would have potentially 

adverse consequences for the safety and soundness of the U.S. financial system.568 

 

563 See AFR et al. (Feb. 2012).

564 See, e.g., Wellington; Prof. Duffie; Investure; IIF; Liberty Global; SIFMA et al. (Prop. Trading) (Feb. 

2012); Credit Suisse (Seidel); JPMC; Morgan Stanley; Barclays; BoA; STANY; SIFMA (Asset Mgmt.) 

(Feb. 2012); FTN; Western Asset Mgmt.; IAA; PUC Texas; ICI (Feb. 2012); IIB/EBF; Invesco. In 

addition, some commenters recognized that other market participants are likely to fill banking entities’ 

roles in the long term, but not in the short term. See, e.g., ICFR; Comm. on Capital Markets Regulation; 

Oliver Wyman (Feb. 2012).

565 See Oliver Wyman (Feb. 2012) (“Major bank-affiliated market makers have large capital bases, balance 

sheets, technology platforms, global operations, relationships with clients, sales forces, risk infrastructure, 

and management processes that would take smaller or new dealers years and billions of dollars to 

replicate.”).

566 See SIFMA et al. (Prop. Trading) (Feb. 2012).

567 See Thakor Study.

568 See, e.g., Prof. Duffie; Oliver Wyman (Feb. 2012).
165

Many commenters requested additional clarification on how the proposed marketmaking exemption would apply to certain asset classes and markets or to particular types 

of market making-related activities. In particular, commenters requested greater clarity 

regarding the permissibility of: (i) interdealer trading,569 including trading for price 

discovery purposes or to test market depth;570 (ii) inventory management;571 (iii) block 

positioning activity;572 (iv) acting as an authorized participant or market maker in 

ETFs;573 (v) arbitrage or other activities that promote price transparency and liquidity;574

(vi) primary dealer activity;575 (vii) market making in futures and options;576 (viii) market 

making in new or bespoke products or customized hedging contracts;577 and (ix) inter-

 

569 See, e.g., MetLife; SIFMA et al. (Prop. Trading) (Feb. 2012); RBC; Credit Suisse (Seidel); JPMC; 

BoA; ACLI (Feb. 2012); AFR et al. (Feb. 2012); ISDA (Feb. 2012); Goldman (Prop. Trading); Oliver 

Wyman (Feb. 2012).

570 See SIFMA et al. (Prop. Trading) (Feb. 2012); Chamber (Feb. 2012); Goldman (Prop. Trading).

571 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); Goldman (Prop. Trading); 

MFA; RBC.

572 See infra Part IV.A.3.c.1.b.ii. (discussing commenters’ requests for greater clarity regarding the 

permissibility of block positioning activity).

573 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); BoA; ICI (Feb. 2012); ICI Global; Vanguard; SSgA (Feb. 2012).

574 See SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. Trading); 

FTN; RBC; ISDA (Feb. 2012).

575 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC; Goldman (Prop. Trading); Banco de 

México; IIB/EBF.

576 See CME Group (requesting clarification that the market-making exemption permits a banking entity to 

engage in market making in exchange-traded futures and options because the dealer registration requirement in 

§ __.4(b)(2)(iv) of the proposed rule did not refer to such instruments and stating that lack of an explicit 

exemption would reduce market-making activities in these instruments, which would decrease liquidity). But

See Johnson & Prof. Stiglitz (stating that the Agencies should pay special attention to options trading and other 

derivatives because they are highly volatile assets that are difficult if not impossible to effectively hedge, except 

through a completely matched position, and suggesting that options and similar derivatives may need to be 

required to be sold only as riskless principal under § __.6(b)(1)(ii) of the proposed rule or significantly limited 

through capital charges); Sens. Merkley & Levin (Feb. 2012) (stating that asset classes that are particularly hard 

to hedge, such as options, should be given special attention under the hedging exemption).
166

affiliate transactions.578 As discussed in more detail in Part IV.B.2.c., a number of 

commenters requested that the market-making exemption apply to the restrictions on 

acquiring or retaining an ownership interest in a covered fund.579 Some commenters 

stated that no other activities should be considered permitted market making-related 

activity under the rule.580 In addition, a few commenters requested clarification that 

high-frequency trading would not qualify for the market-making exemption.581 

3. Final market-making exemption

After carefully considering comment letters, the Agencies are adopting certain 

refinements to the proposed market-making exemption. The Agencies are adopting a 

market-making exemption that is consistent with the statutory exemption for this activity 

and designed to permit banking entities to continue providing intermediation and 

liquidity services. The Agencies note that, while all market-making activity should 

ultimately be related to the intermediation of trading, whether directly to individual 

customers through bilateral transactions or more broadly to a given marketplace, certain 

 577 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); SIFMA (Asset Mgmt.) (Feb. 2012). Other commenters, however, stated that banking entities 

should be limited in their ability to rely on the market-making exemption to conduct transactions in 

bespoke or customized derivatives. See, e.g., AFR et al. (Feb. 2012); Public Citizen.

578 See, e.g., Japanese Bankers Ass’n. (stating that transactions with affiliates and subsidiaries and related 

to hedging activities are a type of market making-related activity or risk-mitigating hedging activity that 

should be exempted by the rule); SIFMA et al. (Prop. Trading) (Feb. 2012). According to one of these 

commenters, inter-affiliate transactions should be viewed as part of a coordinated activity for purposes of 

determining whether a banking entity qualifies for an exemption. This commenter stated that, for example, 

if a market maker shifts positions held in inventory to an affiliate that is better able to manage the risk of 

such positions, both the market maker and its affiliate would be engaged in permitted market makingrelated activity. This commenter further represented that fitting the inter-affiliate swap into the exemption 

may be difficult (e.g., one of the affiliates entering into the swap may not be holding itself out as a willing 

counterparty). See SIFMA et al. (Prop. Trading) (Feb. 2012).

579 See, e.g., Cleary Gottlieb; JPMC; BoA; Credit Suisse (Williams).

580 See, e.g., Occupy; Alfred Brock.

581 See, e.g., Occupy; AFR et al. (Feb. 2012); Public Citizen; Johnson & Prof. Stiglitz; Sens. Merkley & 

Levin (Feb. 2012); John Reed.
167

characteristics of a market-making business may differ among markets and asset 

classes.582 The final rule is intended to account for these differences to allow banking 

entities to continue to engage in market making-related activities by providing customer 

intermediation and liquidity services across markets and asset classes, if such activities 

do not violate the statutory limitations on permitted activities (e.g., by involving or 

resulting in a material conflict of interest with a client, customer, or counterparty) and are 

conducted in conformance with the exemption. 

At the same time, the final rule requires development and implementation of 

trading, risk and inventory limits, risk management strategies, analyses of how the 

specific market making-related activities are designed not to exceed the reasonably 

expected near term demands of customers, compensation standards, and monitoring and 

review requirements that are consistent with market-making activities.583 These 

requirements are designed to distinguish exempt market making-related activities from 

impermissible proprietary trading. In addition, these requirements are designed to ensure 

that a banking entity is aware of, monitors, and limits the risks of its exempt activities 

consistent with the prudent conduct of market making-related activities. 

 

582 Consistent with the FSOC study and the proposal, the final rule recognizes that the precise nature of a 

market maker’s activities often varies depending on the liquidity, trade size, market infrastructure, trading 

volumes and frequency, and geographic location of the market for any particular type of financial 

instrument. See Joint Proposal, 76 FR at 68,870; CFTC Proposal, 77 FR at 8356; FSOC study (stating that 

“characteristics of permitted activities in one market or asset class may not be the same in another market 

(e.g., permitted activities in a liquid equity securities market may vary significantly from an illiquid overthe-counter derivatives market)”). 

583 Certain of these requirements, like the requirements to have risk and inventory limits, risk management 

strategies, and monitoring and review requirements were included in the enhanced compliance program 

requirement in proposed Appendix C, but were not separately included in the proposed market-making 

exemption. Like the statute, the proposed rule would have required that market making-related activities be 

designed not to exceed the reasonably expected near term demand of clients, customers, or counterparties. 

The Agencies are adding an explicit requirement in the final rule that a trading desk conduct analyses of 

customer demand for purposes of complying with this statutory requirement. 
168

As described in detail below, the final market-making exemption consists of the 

following elements:

• A framework that recognizes the differences in market making-related activities 

across markets and asset classes by establishing criteria that can be applied based 

on the liquidity, maturity, and depth of the market for the particular type of 

financial instrument.

• A general focus on analyzing the overall “financial exposure” and “market-maker 

inventory” held by any given trading desk rather than a transaction-bytransaction analysis. The “financial exposure” reflects the aggregate risks of the 

financial instruments, and any associated loans, commodities, or foreign 

exchange or currency, held by a banking entity or its affiliate and managed by a 

particular trading desk as part of its market making-related activities. The 

“market-maker inventory” means all of the positions, in the financial instruments 

for which the trading desk stands ready to make a market that are managed by 

the trading desk, including the trading desk’s open positions or exposures arising 

from open transactions.584

• A definition of the term “trading desk” that focuses on the operational 

functionality of the desk rather than its legal status, and requirements that apply 

at the trading desk level of organization within a single banking entity or across 

two or more affiliates.585 

 

584 See infra Part IV.A.3.c.1.c.ii. See also final rule §§ __.4(b)(4), (5). 

585 See infra Part IV.A.3.c.1.c.i. The term “trading desk” is defined as “the smallest discrete unit of 

organization of a banking entity that buys or sells financial instruments for the trading account of the 

banking entity or an affiliate thereof.” Final rule § __.3(e)(13).
169

• Five requirements for determining whether a banking entity is engaged in 

permitted market making-related activities. Many of these criteria have 

similarities to the factors included in the proposed rule, but with important 

modifications in response to comments. These standards require that:

o The trading desk that establishes and manages a financial exposure 

routinely stands ready to purchase and sell one or more types of financial 

instruments related to its financial exposure and is willing and available 

to quote, buy and sell, or otherwise enter into long and short positions in 

those types of financial instruments for its own account, in commercially 

reasonable amounts and throughout market cycles, on a basis appropriate 

for the liquidity, maturity, and depth of the market for the relevant types 

of financial instruments;586

o 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;587

o 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 

 

586 See final rule § __.4(b)(2)(i); infra Part IV.A.3.c.1.c.iii.

587 See final rule § __.4(b)(2)(ii); infra Part IV.A.3.c.2.c. In addition, the Agencies are adopting a 

definition of the terms “client,” “customer,” and “counterparty” in § __.4(b)(3) of the final rule.
170

reasonably designed written policies and procedures, internal controls, 

analysis, and independent testing identifying and addressing: 

 The financial instruments each trading desk stands ready to 

purchase and sell in accordance with § __.4(b)(2)(i) of the final 

rule; 

 The actions the trading desk will take to demonstrably reduce or 

otherwise significantly mitigate promptly the risks of its financial 

exposure consistent with its established limits; the products, 

instruments, and exposures each trading desk may use for risk 

management purposes; the techniques and strategies each trading 

desk may use to manage the risks of its market making-related 

activities and inventory; and the process, strategies, and personnel 

responsible for ensuring that the actions taken by the trading desk 

to mitigate these risks are and continue to be effective;588

 Limits for each trading desk, based on the nature and amount of 

the trading desk’s market making-related activities, including 

factors used to determine the reasonably expected near term 

demands of clients, customers, or counterparties, on: the amount, 

types, and risks of its market-maker inventory; the amount, types, 

and risks of the products, instruments, and exposures the trading 

 

588 Routine market making-related risk management activity by a trading desk is permitted under the 

market-making exemption and, provided the standards of the exemption are met, is not required to 

separately meet the requirements of the hedging exemption. The circumstances under which risk 

management activity relating to the trading desk’s financial exposure is permitted under the market-making 

exemption or must separately comply with the hedging exemption are discussed in more detail in Parts

IV.A.3.c.1.c.ii. and IV.A.3.c.4., infra.
171

desk uses for risk management purposes; the level of exposures to 

relevant risk factors arising from its financial exposure; and the 

period of time a financial instrument may be held; 

 Internal controls and ongoing monitoring and analysis of each 

trading desk’s compliance with its limits; and 

 Authorization procedures, including escalation procedures that

require review and approval of any trade that would exceed a 

trading desk’s limit(s), demonstrable analysis that the basis for 

any temporary or permanent increase to a trading desk’s limit(s) 

is consistent with the requirements of the market-making 

exemption, and independent review of such demonstrable 

analysis and approval;589 

o To the extent that any limit identified above is exceeded, the trading desk 

takes action to bring the trading desk into compliance with the limits as 

promptly as possible after the limit is exceeded;590

o The compensation arrangements of persons performing market makingrelated activities are designed not to reward or incentivize prohibited 

proprietary trading;591 and

o The banking entity is licensed or registered to engage in market makingrelated activities in accordance with applicable law.592

 

589 See final rule § __.4(b)(2)(iii); infra Part IV.A.3.c.3.

590 See final rule § __.4(b)(2)(iv).

591 See final rule § __.4(b)(2)(v); infra Part IV.A.3.c.5.
172

• The use of quantitative measurements to highlight activities that warrant further 

review for compliance with the exemption.593 As discussed further in Part

IV.C.3., the Agencies have reduced some of the compliance burdens by adopting 

a more tailored subset of metrics than was proposed to better focus on those 

metrics that the Agencies believe are most germane to the evaluation of the 

activities that firms conduct under the market-making exemption. 

In refining the proposed approach to implementing the statute’s market-making 

exemption, the Agencies closely considered the various alternative approaches suggested 

by commenters.594 However, like the proposed approach, the final market-making 

exemption continues to adhere to the statutory mandate that provides for an exemption to 

the prohibition on proprietary trading for market making-related activities. Therefore, the 

final rule focuses on providing a framework for assessing whether trading activities are 

consistent with market making. The Agencies believe this approach is consistent with the 

statute595 and strikes an appropriate balance between commenters’ desire for both clarity 

and flexibility. For example, while a bright-line or safe harbor based approach would 

generally provide a high degree of certainty about whether an activity qualifies for the 

 592 See final rule § __.4(b)(2)(vi); infra Part IV.A.3.c.6. As discussed further below, this provision pertains 

to legal registration or licensing requirements that may apply to an entity engaged in market making-related 

activities, depending on the facts and circumstances. This provision would not require a banking entity to 

comply with registration requirements that are not required by law, such as discretionary registration with a 

national securities exchange as a market maker on that exchange.

593 See infra Part IV.C.3.

594 See supra Part IV.A.3.b.2.

595 Certain approaches suggested by commenters, such as relying solely on capital requirements, requiring 

ring fencing, permitting all swap dealing activity, or focusing solely on how traders are compensated do not 

appear to be consistent with the statutory language because they do not appear to limit market makingrelated activity to that which is designed not to exceed the reasonably expected near term demands of 

clients, customers, or counterparties, as required by the statute. See Prof. Duffie; STANY; ICE; Shadow 

Fin. Regulatory Comm.; ISDA (Feb. 2012); ISDA (Apr. 2012); G2 FinTech.
173

market-making exemption, it would also provide less flexibility to recognize the 

differences in market-making activities across markets and asset classes.596 In addition, 

any bright-line approach would be more likely to be subject to gaming and avoidance as 

new products and types of trading activities are developed than other approaches to 

implementing the market-making exemption.597 Although a purely guidance-based 

approach would provide greater flexibility, it would also provide less clarity, which could 

make it difficult for trading personnel, internal compliance personnel, and Agency 

supervisors and examiners to determine whether an activity complies with the rule and 

would lead to an increased risk of evasion of the statutory requirements.598 

Some commenters suggested an approach to implementing the market-making 

exemption that would focus on metrics or other objective factors.599 As discussed below, 

 

596 While an approach establishing a number of safe harbors that are each tailored to a specific asset class 

would address the need to recognize differences across asset classes, such an approach may also increase 

the complexity of the final rule. Further, commenters did not provide sufficient information to determine 

the appropriate parameters of a safe harbor-based approach.

597 As noted above, a number of commenters suggested the Agencies adopt a bright-line rule, provide a 

safe harbor for certain types of activities, or establish a presumption of compliance based on certain factors. 

See, e.g., Sens. Merkley & Levin (Feb. 2012); John Reed; Prof. Richardson; Johnson & Prof. Stiglitz; 

Capital Group; Invesco; BDA (Oct. 2012); Flynn & Fusselman; Prof. Colesanti et al.; SIFMA et al. (Prop. 

Trading) (Feb. 2012); IIF; NYSE Euronext; Credit Suisse (Seidel); JPMC; Barclays; BoA; Wells Fargo 

(Prop. Trading); PNC et al.; Oliver Wyman (Feb. 2012). Many of these commenters expressed general 

concern that the proposed market-making exemption may create uncertainty for individual traders engaged 

in market making-related activity and suggested that their proposed approach would alleviate such concern. 

The Agencies believe that the enhanced focus on risk and inventory limits for each trading desk (which 

must be tied to the near term customer demand requirement) and the clarification that the final marketmaking exemption does not require a trade-by-trade analysis should address concerns about individual 

traders having to assess whether they are complying with the market-making exemption on a trade-by-trade 

basis.

598 Several commenters suggested a guidance-based approach, rather than requirements in the final rule. 

See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012) (suggesting that this guidance could then be 

incorporated in banking entities’ policies and procedures for purposes of complying with the rule, in 

addition to the establishment of risk limits, controls, and metrics); JPMC; BoA; PUC Texas; SSgA (Feb. 

2012); PNC et al.; Wells Fargo (Prop. Trading).

599 See, e.g., Goldman (Prop. Trading); Morgan Stanley; Barclays; Wellington; CalPERS; BlackRock; 

SSgA (Feb. 2012); Invesco.
174

a number of commenters expressed support for using the metrics as a tool to monitor 

trading activity and not to determine compliance with the rule.600 While the Agencies 

agree that quantitative measurements are useful for purposes of monitoring a trading 

desk’s activities and are requiring certain banking entities to calculate, record, and report 

quantitative measurements to the Agencies in the final rule, the Agencies do not believe 

that quantitative measurements should be used as a dispositive tool for determining 

compliance with the market-making exemption.601 

In response to two commenters’ request that the final rule focus on a banking 

entity’s risk management structures or risk limits and not on attempting to define marketmaking activities,602 the Agencies do not believe that management of risk, on its own, is 

sufficient to differentiate permitted market making-related activities from impermissible 

proprietary trading. For example, the existence of a risk management framework or risk 

limits, while important, would not ensure that a trading desk is acting as a market maker 

by engaging in customer-facing activity and providing intermediation and liquidity 

services.603 The Agencies also decline to take an approach to implementing the marketmaking exemption that would require the development of individualized plans for each 

banking entity in coordination with the Agencies, as suggested by a few commenters.604 

 

600 See infra Part IV.C.3. (discussing the final rule’s metrics requirement). See SIFMA et al. (Prop. 

Trading) (Feb. 2012); Wells Fargo (Prop. Trading); RBC; ICI (Feb. 2012); Occupy (stating that there are 

serious limits to the capabilities of the metrics and the potential for abuse and manipulation of the input 

data is significant); Alfred Brock.

601 See infra Part IV.C.3. (discussing the final metrics requirement).

602 See, e.g., Japanese Bankers Ass’n.; Citigroup (Feb. 2012).

603 However, as discussed below, the Agencies believe risk limits can be a useful tool when they must 

account for the nature and amount of a particular trading desk’s market making-related activities, including 

the reasonably expected near term demands of clients, customers, or counterparties.

604 See MetLife; Fixed Income Forum/Credit Roundtable; ACLI (Feb. 2012).
175

The Agencies believe it is useful to establish a consistent framework that will apply to all 

banking entities to reduce the potential for unintended competitive impacts that could 

arise if each banking entity is subject to an individualized plan that is tailored to its 

specific organizational structure and trading activities and strategies. 

Although the Agencies are not in the final rule modifying the basic structure of 

the proposed market-making exemption, certain general items suggested by commenters, 

such as enhanced compliance program elements and risk limits, have been incorporated 

in the final rule text for the market-making exemption, instead of a separate appendix.605 

Moreover, as described below, the final market-making exemption includes specific 

substantive changes in response to a wide variety of commenter concerns. 

The Agencies understand that the economics of market making – and financial 

intermediation in general – require a market maker to be active in markets. In 

determining the appropriate scope of the market-making exemption, the Agencies have 

been mindful of commenters’ views on market making and liquidity. Several 

commenters stated that the proposed rule would impact a banking entity’s ability to 

engage in market making-related activity, with corresponding reductions in market 

 

605 The Agencies are not, however, adding certain additional requirements suggested by commenters, such 

as a new customer-facing criterion, margin requirements, or additional provisions regarding material 

conflicts of interest or high-risk assets or trading strategies. See, e.g., Morgan Stanley; Stephen Roach; WR 

Hambrecht; Sens. Merkley & Levin (Feb. 2012). The Agencies believe that the final rule includes

sufficient requirements to ensure that a trading desk relying on the market-making exemption is engaged in 

customer-facing activity (for example, the final rule requires the trading desk to stand ready to buy and sell 

a type of financial instrument as market maker and that the trading desk’s market-maker inventory is 

designed not to exceed the reasonably expected near term demands of clients, customers, or counterparties). 

The Agencies decline to include margin requirements in the final exemption because banking entities are 

currently subject to a number of different margin requirements, including those applicable to, among 

others: SEC-registered broker-dealers; CFTC-registered swap dealers; SEC-registered security-based swap 

dealers: and foreign dealer entities. Further, the Agencies are not providing new requirements regarding 

material conflicts of interest and high-risk assets and trading strategies in the market-making exemption 

because the Agencies believe these issues are adequately addressed in § __.7 of the final rule. The 

limitations in § __.7 will apply to market making-related activities and all other exempted activities. 
176

liquidity.606 However, commenters disagreed about whether reduced liquidity would be 

beneficial or detrimental to the market, or if any such reductions would even 

materialize.607 Many commenters stated that reduced liquidity could lead to other 

negative market impacts, such as wider spreads, higher transaction costs, greater market 

volatility, diminished price discovery, and increased cost of capital. 

The Agencies understand that market makers play an important role in providing 

and maintaining liquidity throughout market cycles and that restricting market-making 

activity may result in reduced liquidity, with corresponding negative market impacts. For 

instance, absent a market maker who stands ready to buy and sell, investors may have to 

make large price concessions or otherwise expend resources searching for counterparties. 

By stepping in to intermediate trades and provide liquidity, market makers thus add value 

to the financial system by, for example, absorbing supply and demand imbalances. This 

often means taking on financial exposures, in a principal capacity, to satisfy reasonably 

expected near term customer demand, as well as to manage the risks associated with 

meeting such demand. 

The Agencies recognize that, as noted by commenters, liquidity can be associated 

with narrower spreads, lower transaction costs, reduced volatility, greater price discovery, 

 

606 See supra note 545 and accompanying text. The Agencies acknowledge that reduced liquidity can be 

costly. One commenter provided estimated impacts on asset valuation, borrowing costs, and transaction 

costs in the corporate bond market based on certain hypothetical scenarios of reduced market liquidity. 

This commenter noted that its hypothetical liquidity shifts of 5, 10, and 15 percentile points were 

“necessarily arbitrary” but judged “to be realistic potential outcomes of the proposed rule.” Oliver Wyman 

(Feb. 2012). Because the Agencies have made significant modifications to the proposed rule in response to 

comments, the Agencies believe this commenter’s concerns about the market impacts of the proposed rule 

have been substantially addressed.

607 As noted above, a few commenters stated that reduced liquidity may provide certain benefits. See, e.g.,

Paul Volcker; AFR et al. (Feb. 2012); Public Citizen; Prof. Richardson; Johnson & Prof. Stiglitz; Better 

Markets (Feb. 2012); Prof. Johnson. However, a number of commenters stated that reduced liquidity 

would have negative market impacts. See supra note 545 and accompanying text.
177

and lower costs of capital.608 The Agencies agree with these commenters that liquidity 

provides important benefits to the financial system, as more liquid markets are 

characterized by competitive market makers, narrow bid-ask spreads, and frequent 

trading, and that a narrowly tailored market-making exemption could negatively impact 

the market by, as described above, forcing investors to make price concessions or 

unnecessarily expend resources searching for counterparties.609 For example, while bidask spreads compensate market makers for providing liquidity when asset values are 

uncertain, under competitive forces, dealers compete with respect to spreads, thus 

lowering their profit margins on a per trade basis and benefitting investors.610 Volatility 

is driven by both uncertainty about fundamental value and the liquidity needs of 

investors. When markets are illiquid, participants may have to make large price 

concessions to find a counterparty willing to trade, increasing the importance of the 

liquidity channel for addressing volatility. If liquidity-based volatility is not 

diversifiable, investors will require a risk premium for holding liquidity risk, increasing 

 

608 See supra Part IV.A.3.b.2.b.

609 See supra Part IV.A.3.b.2.b. As discussed above, a few other commenters suggested that to the extent 

liquidity is vulnerable to destabilizing liquidity spirals, any reduced liquidity stemming from section 13 of 

the BHC Act and its implementing rules would not necessarily be a negative result. See AFR et al. (Feb. 

2012); Public Citizen. See also Paul Volcker. These commenters also suggested that the Agencies adopt 

stricter conditions in the market-making exemption, as discussed throughout this Part IV.A.3. However, 

liquidity – essentially, the ease with which assets can be converted into cash – is not destabilizing in and of 

itself. Rather, liquidity spirals are a function of how firms are funded. During market downturns, when 

margin requirements tend to increase, firms that fund their operations with leverage face higher costs of 

providing liquidity; firms that run up against their maximum leverage ratios may be forced to retreat from 

market making, contributing to the liquidity spiral. Viewed in this light, it is institutional features of 

financial markets – in particular, leverage – rather than liquidity itself that contributes to liquidity spirals.

610 Wider spreads can be costly for investors. For example, one commenter estimated that a 10 basis point 

increase in spreads in the corporate bond market would cost investors $29 billion per year. See Wellington. 

Wider spreads can also be particularly costly for open-end mutual funds, which must trade in and out of the 

fund’s portfolio holdings on a daily basis in order to satisfy redemptions and subscriptions. See

Wellington; AllianceBernstein.
178

the cost of capital.611 Commenters additionally suggested that the effects of diminished 

liquidity could be concentrated in securities markets for small or midsize companies or 

for lesser-known issuers, where trading is already infrequent.612 Volume in these markets 

can be low, increasing the inventory risk of market makers. The Agencies recognize that, 

if the final rule creates disincentives for banking entities to provide liquidity, these low 

volume markets may be impacted first. 

As discussed above, the Agencies received several comments suggesting that the 

negative consequences associated with reduced liquidity would be unlikely to materialize 

under the proposed rule. For example, a few commenters stated that non-bank financial 

intermediaries, who are not subject to section 13 of the BHC Act, may increase their 

market-making activities in response to any reduction in market making by banking 

entities, a topic the Agencies discuss in more detail below.613 In addition, some 

commenters suggested that the restrictions on proprietary trading would support liquid 

markets by encouraging banking entities to focus on financial intermediation activities 

that supply liquidity, rather than proprietary trades that demand liquidity, such as 

speculative trades or trades that front-run institutional investors.614 The statute prohibits

 

611 A higher cost of capital increases financing costs and translates into reduced capital investment. While 

one commenter estimated that a one percent increase in the cost of capital would lead to a $55 to $82.5 

billion decline in capital investments by U.S. nonfarm firms, the Agencies cannot independently verify 

these potential costs. Further, this commenter did not indicate what aspect of the proposed rule could cause 

a one percent increase in the cost of capital. See Thakor Study. In any event, the Agencies have made 

significant changes to the proposed approach to implementing the market-making exemption that should 

help address this commenter’s concern.

612 See, e.g., CIEBA; ACLI; PNC et al.; Morgan Stanley; Chamber (Feb. 2012); Abbott Labs et al. (Feb. 

14, 2012); FEI; ICI (Feb. 2012); TMA Hong Kong; Sen. Casey.

613 See, e.g., Sens. Merkley & Levin (Feb. 2012); Prof. Richardson; Better Markets (Feb. 2012); Profs. 

Stout & Hastings; Prof. Johnson; Occupy; Public Citizen; Profs. Admati & Pfleiderer; Better Markets (June 

2012).

614 See, e.g., Prof. Johnson.
179

proprietary trading activity that is not exempted. As such, the termination of nonexempt 

proprietary trading activities of banking entities may lead to some general reductions in 

liquidity of certain asset classes. Although the Agencies cannot say with any certainty, 

there is good reason to believe that to a significant extent the liquidity reductions of this 

type may be temporary since the statute does not restrict proprietary trading activities of 

other market participants. Thus, over time, non-banking entities may provide much of 

the liquidity that is lost by restrictions on banking entities’ trading activities. If so, 

eventually, the detrimental effects of increased trading costs, higher costs of capital, and 

greater market volatility should be mitigated.

Based on the many detailed comments provided, the Agencies have made 

substantive refinements to the market-making exemption that the Agencies believe will 

reduce the likelihood that the rule, as implemented, will negatively impact the ability of 

banking entities to engage in the types of market making-related activities permitted 

under the statute and, therefore, will continue to promote the benefits to investors and 

other market participants described above, including greater market liquidity, narrower 

bid-ask spreads, reduced price concessions and price impact, lower volatility, and 

reduced counterparty search costs, thus reducing the cost of capital. For instance, the 

final market-making exemption does not require a trade-by-trade analysis, which was a 

significant source of concern from commenters who represented, among other things, that 

a trade-by-trade analysis could have a chilling effect on individual traders’ willingness to 

engage in market-making activities.615 Rather, the final rule has been crafted around the 

overall market making-related activities of individual trading desks, with various 

 

615 See supra note 517 (discussing commenters’ concerns regarding a trade-by-trade analysis).
180

requirements that these activities be demonstrably related to satisfying reasonably 

expected near term customer demands and other market-making activities. The Agencies 

believe that applying certain requirements to the aggregate risk exposure of a trading 

desk, along with the requirement to establish risk and inventory limits to routinize a 

trading desk’s compliance with the near term customer demand requirement, will reduce 

negative potential impacts on individual traders’ decision-making process in the normal 

course of market making.616 In addition, in response to a large number of comments 

expressing concern that the proposed market-making exemption would restrict or prohibit 

market making-related activities in less liquid markets, the Agencies are clarifying that 

the application of certain requirements in the final rule, such as the frequency of required 

quoting and the near term demand requirement, will account for the liquidity, maturity, 

and depth of the market for a given type of financial instrument. Thus, banking entities 

will be able to continue to engage in market making-related activities across markets and 

asset classes. 

At the same time, the Agencies recognize that an overly broad market-making 

exemption may allow banking entities to mask speculative positions as liquidity 

provision or related hedges. The Agencies believe the requirements included in the final 

rule are necessary to prevent such evasion of the market-making exemption, ensure 

compliance with the statute, and facilitate internal banking entity and external Agency 

reviews of compliance with the final rule. Nevertheless, the Agencies acknowledge that 

 

616 For example, by clarifying that individual trades will not be viewed in isolation and requiring strong 

compliance procedures, this approach will generally allow an individual trader to operate within the 

compliance framework established for his or her trading desk without having to assess whether each 

individual transaction complies with all requirements of the market-making exemption.
181

these additional costs may have an impact on banking entities’ willingness to engage in 

market making-related activities. Banking entities will incur certain compliance costs in 

connection with their market making-related activities under the final rule. For example, 

banking entities may not currently limit their trading desks’ market-maker inventory to 

that which is designed not to exceed reasonably expected near term customer demand, as 

required by the statute. 

As discussed above, commenters presented diverging views on whether nonbanking entities are likely to enter the market or increase their market-making activities if 

the final rule should cause banking entities to reduce their market-making activities.617 

The Agencies note that prior to the Gramm-Leach-Bliley Act of 1999, market-making 

services were more commonly provided by non-bank-affiliated broker-dealers than by 

banking entities. As discussed above, by intermediating and facilitating trading, market 

makers provide value to the markets and profit from providing liquidity. Should banking 

entities retreat from making markets, the profit opportunities available from providing 

liquidity will provide an incentive for non-bank-affiliated broker-dealers to enter the 

market and intermediate trades. The Agencies are unable to assess the likely effect with 

any certainty, but the Agencies recognize that a market-making operation requires certain 

infrastructure and capital, which will impact the ability of non-banking entities to enter 

the market-making business or to increase their presence. Therefore, should banking 

 

617 See supra notes 560 and 564 and accompanying text (discussing comments on the issue of whether nonbanking entities are likely to enter the market or increase their trading activities in response to reduced 

trading activity by banking entities). For example, one commenter stated that broker-dealers that are not 

affiliated with a bank would have reduced access to lender-of-last resort liquidity from the central bank, 

which could limit their ability to make markets during times of market stress or when capital buffers are 

small. See Prof. Duffie. However, another commenter noted that the presence and evolution of market 

making after the enactment of the Glass-Steagall Act mutes this particular concern. See Prof. Richardson.
182

entities retreat from making markets, there could be a transition period with reduced 

liquidity as non-banking entities build up the needed infrastructure and obtain capital. 

However, because the Agencies have substantially modified this exemption in response 

to comments to ensure that market making related to near-term customer demand is 

permitted as contemplated by the statute, the Agencies do not believe the final rule 

should significantly impact currently-available market-making services.618 

c. Detailed Explanation of the Market-Making Exemption

1. Requirement to routinely stand ready to purchase and sell

a. Proposed requirement to hold self out

Section __.4(b)(2)(ii) of the proposed rule would have required the trading desk 

or other organizational unit that conducts the purchase or sale in reliance on the marketmaking exemption to hold itself out as being willing to buy and sell, including through 

entering into long and short positions in, the financial instrument for its own account on a 

regular or continuous basis.619 The proposal stated that a banking entity could rely on the 

 

618 Certain non-banking entities, such as some SEC-registered broker-dealers that are not banking entities 

subject to the final rule, currently engage in market-making activities and, thus, should have the needed 

infrastructure and may attract additional capital. If the final rule has a marginal impact on banking entities’ 

willingness to engage in market making-related activities, these non-banking entities should be able to 

respond by increasing their market making-related activities. The Agencies recognize, however, that firms 

that do not have existing infrastructure or sufficient capital are unlikely to be able to act as market makers 

shortly after the final rule is implemented. Nevertheless, because some non-bank-affiliated broker-dealers 

currently operate market-making desks, and because it was the dominant model prior to the Gramm-LeachBliley Act, the Agencies believe that non-bank-affiliated financial intermediaries will be able to provide 

market-making services longer term. 

619 See proposed rule § __.4(b)(2)(ii). 
183

proposed exemption only for the type of financial instrument that the entity actually made 

a market in.620

The proposal recognized that the precise nature of a market maker’s activities 

often varies depending on the liquidity, trade size, market infrastructure, trading volumes 

and frequency, and geographic location of the market for any particular financial 

instrument.621 To account for these variations, the Agencies proposed indicia for 

assessing compliance with this requirement that differed between relatively liquid 

markets and less liquid markets. Further, the Agencies recognized that the proposed 

indicia could not be applied at all times and under all circumstances because some may 

be inapplicable to the specific asset class or market in which the market making-related 

activity is conducted. 

In particular, the proposal stated that a trading desk or other organizational unit’s 

market making-related activities in relatively liquid markets, such as equity securities or 

other exchange-traded instruments, should generally include: (i) making continuous, twosided quotes and holding oneself out as willing to buy and sell on a continuous basis; (ii) 

a pattern of trading that includes both purchases and sales in roughly comparable 

amounts to provide liquidity; (iii) making continuous quotations that are at or near the 

market on both sides; and (iv) providing widely accessible and broadly disseminated 

 

620 See Joint Proposal, 76 FR at 68,870 (“Notably, this criterion requires that a banking entity relying on 

the exemption with respect to a particular transaction must actually make a market in the [financial 

instrument] involved; simply because a banking entity makes a market in one type of [financial instrument] 

does not permit it to rely on the market-making exemption for another type of [financial instrument].”); 

CFTC Proposal, 77 FR at 8355-8356.

621 See Joint Proposal, 76 FR at 68,870; CFTC Proposal, 77 FR at 8356.
184

quotes.622 With respect to market making in less liquid markets, the proposal noted that 

the appropriate indicia of market making-related activities will vary, but should generally 

include: (i) holding oneself out as willing and available to provide liquidity by providing 

quotes on a regular (but not necessarily continuous) basis;623 (ii) with respect to 

securities, regularly purchasing securities from, or selling securities to, clients, customers, 

or counterparties in the secondary market; and (iii) transaction volumes and risk 

proportionate to historical customer liquidity and investments needs.624 

In discussing this proposed requirement, the Agencies stated that bona fide market 

making-related activity may include certain block positioning and anticipatory positiontaking. More specifically, the proposal indicated that the bona fide market makingrelated activity described in § __.4(b)(2)(ii) of the proposed rule would include: (i) block 

positioning if undertaken by a trading desk or other organizational unit of a banking 

entity for the purpose of intermediating customer trading;625 and (ii) taking positions in 

securities in anticipation of customer demand, so long as any anticipatory buying or 

 

622 See Joint Proposal, 76 FR at 68,870-68,871; CFTC Proposal, 77 FR at 8356. These proposed factors 

are generally consistent with the indicia used by the SEC to assess whether a broker-dealer is engaged in 

bona fide market making for purposes of Regulation SHO under the Exchange Act. See Joint Proposal, 76 

FR at 68,871 n.148; CFTC Proposal, 77 FR at 8356 n.155.

623 The Agencies noted that, with respect to this factor, the frequency of regular quotations will vary, as 

moderately illiquid markets may involve quotations on a daily or more frequent basis, while highly illiquid 

markets may trade only by appointment. See Joint Proposal, 76 FR at 68,871 n.149; CFTC Proposal, 77 FR 

at 8356 n.156.

624 See Joint Proposal, 76 FR at 68,871; CFTC Proposal, 77 FR at 8356.

625 In the preamble to the proposed rule, the Agencies stated that the SEC’s definition of “qualified block 

positioner” may serve as guidance in determining whether a block positioner engaged in block positioning 

is engaged in bona fide market making for purposes of § __.4(b)(2)(ii) of the proposed rule. See Joint 

Proposal, 76 FR at 68,871 n.151; CFTC Proposal, 77 FR at 8356 n.157.
185

selling activity is reasonable and related to clear, demonstrable trading interest of clients, 

customers, or counterparties.626

b. Comments on the proposed requirement to hold self out

Commenters raised many issues regarding § __.4(b)(2)(ii) of the proposed 

exemption, which would require a trading desk or other organizational unit to hold itself 

out as willing to buy and sell the financial instrument for its own account on a regular or 

continuous basis. As discussed below, some commenters viewed the proposed 

requirement as too restrictive, while other commenters stated that the requirement was 

too permissive. Two commenters expressed support for the proposed requirement.627 A 

number of commenters provided views on statements in the proposal regarding indicia of 

bona fide market making in more and less liquid markets and the permissibility of block 

positioning and anticipatory position-taking. 

Several commenters represented that the proposed requirement was too 

restrictive.628 For example, a number of these commenters expressed concern that the 

proposed requirement may limit a banking entity’s ability to act as a market maker under 

certain circumstances, including in less liquid markets, for instruments lacking a twosided market, or in customer-driven, structured transactions.629 In addition, a few 

 

626 See Joint Proposal, 76 FR at 68,871; CFTC Proposal, 77 FR at 8356-8357.

627 See Sens. Merkley & Levin (Feb. 2012); Alfred Brock.

628 See infra Part IV.A.3.c.1.c.iii. (addressing these concerns).

629 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Morgan Stanley; Barclays; Goldman (Prop. 

Trading); ABA; Chamber (Feb. 2012); BDA (Feb. 2012); Fixed Income Forum/Credit Roundtable; ACLI 

(Feb. 2012); T. Rowe Price; PUC Texas; PNC; MetLife; RBC; IHS; SSgA (Feb. 2012).
186

commenters expressed specific concern about how this requirement would impact more 

limited market-making activity conducted by banks.630 

Many commenters indicated that it was unclear whether this provision would 

require a trading desk or other organizational unit to regularly or continuously quote 

every financial instrument in which a market is made, but expressed concern that the 

proposed language could be interpreted in this manner.631 These commenters noted that 

there are thousands of individual instruments within a given asset class, such as corporate 

bonds, and that it would be burdensome for a market maker to provide quotes in such a 

large number of instruments on a regular or continuous basis.632 One of these 

commenters represented that, because customer demand may be infrequent in a particular 

instrument, requiring a banking entity to provide regular or continuous quotes in the 

instrument may not provide a benefit to its customers.633 A few commenters requested 

that the Agencies provide further guidance on this issue or modify the proposed standard 

 

630 See, e.g., PNC (stating that the proposed rule needs to account for market making by regional banks on 

behalf of small and middle-market customers whose securities are less liquid); ABA (stating that the rule 

should continue to permit banks to provide limited liquidity by buying securities that they feel are suitable 

for their retail and institutional customer base by stating that a bank is “holding itself out” when it buys and 

sells securities that are suitable for its customers).

631 This issue is further discussed in Part IV.A.3.c.1.c.iii., infra.

632 See, e.g., Goldman (Prop. Trading) (stating that it would be burdensome for a U.S. credit marketmaking business to be required to produce and disseminate quotes for thousands of individual bond 

CUSIPs that trade infrequently and noting that a market maker in credit markets will typically disseminate 

indicative prices for the most liquid instruments but, for the thousands of other instruments that trade 

infrequently, the market maker will generally provide a price for a trade upon request from another market 

participant); Morgan Stanley; SIFMA et al. (Prop. Trading) (Feb. 2012); RBC. See also BDA (Feb. 2012); 

FTN (stating that in some markets, such as the markets for residential mortgage-backed securities and 

investment grade corporate debt, a market maker will hold itself out in a subset of instruments (e.g.,

particular issues in the investment grade corporate debt market with heavy trading volume or that are in the 

midst of particular credit developments), but will trade in other instruments within the group or sector upon 

inquiry from customers and other dealers); Oliver Wyman (Feb. 2012) (discussing data regarding the 

number of U.S. corporate bonds and frequency of trading in such bonds in 2009). 

633 See Goldman (Prop. Trading).
187

to state that holding oneself out in a range of similar instruments will be considered to be 

within the scope of permitted market making-related activities.634 

To address concerns about the restrictiveness of this requirement, commenters 

suggested certain modifications. For example, some commenters suggested adding 

language to the requirement to account for market making in markets that do not typically 

involve regular or continuous, or two-sided, quoting.635 In addition, a few commenters 

requested that the requirement expressly include transactions in new instruments or 

transactions in instruments that occur infrequently to address situations where a banking 

entity may not have previously had the opportunity to hold itself out as willing to buy and 

sell the applicable instrument.636 Other commenters supported alternative criteria for 

 

634 See, e.g., RBC (recommending that the Agencies clarify that a trading desk is required to hold itself out 

as willing to buy and sell a particular type of “product”); SIFMA et al. (Prop. Trading) (Feb. 2012)

(suggesting that the Agencies use the term “instrument,” rather than “covered financial position,” to 

provide greater clarity); CIEBA (supporting alternative criteria that would require a banking entity to hold 

itself out generally as a market maker for the relevant asset class, but not for every instrument it purchases 

and sells); Goldman (Prop. Trading). One of these commenters recommended that the Agencies recognize 

and permit the following kinds of activity in related financial instruments: (i) options market makers should 

be deemed to be engaged in market making in all put and call series related to a particular underlying 

security and should be permitted to trade the underlying security regardless of whether such trade qualifies 

for the hedging exemption; (ii) convertible bond traders should be permitted to trade in the associated 

equity security; (iii) a market maker in one issuer’s bonds should be considered a market maker in similar 

bonds of other issuers; and (iv) a market maker in standardized interest rate swaps should be considered to 

be engaged in market making-related activity if it engages in a customized interest rate swap with a 

customer upon request. See RBC.

635 See, e.g., Morgan Stanley (suggesting that the Agencies add the phrase “or, in markets where regular or 

continuous quotes are not typically provided, the trading unit stands ready to provide quotes upon 

request”); Barclays (suggesting addition of the phrase “to the extent that two-sided markets are typically 

made by market makers in a given product,” as well as changing the reference to “purchase or sale” to 

“market making-related activity” to avoid any inference of a trade-by-trade analysis). See also Fixed 

Income Forum/Credit Roundtable. To address concerns about the requirement’s application to bespoke 

products, one commenter suggested that the rule clearly state that a banking entity fulfills this requirement 

if it markets structured transactions to its client base and stands ready to enter into such transactions with 

customers, even though transactions may occur on a relatively infrequent basis. See JPMC.

636 See Wells Fargo (Prop. Trading); RBC (supporting this approach as an alternative to removing the 

requirement from the rule, but primarily supporting its removal). See also ISDA (Feb. 2012) (stating that 

the analysis of compliance with the proposed requirement must carefully consider the degree of presence a 

market maker wishes to have in a given market, which may include being a leader in certain types of 

instruments, having a secondary presence in others, and potentially leaving or entering other submarkets).
188

assessing whether a banking entity is acting as a market maker, such as: (i) a willingness 

to respond to customer demand by providing prices upon request;637 (ii) being in the 

business of providing prices upon request for that financial instrument or other financial 

instruments in the same or similar asset class or product class;638 or (iii) a historical test 

of market-making activity, with compliance judged on the basis of actual trades.639 

Finally, two commenters stated that this requirement should be moved to Appendix B of 

the rule,640 which, according to one of these commenters, would provide the Agencies 

greater flexibility to consider the facts and circumstances of a particular activity.641 

Other commenters took the view that the proposed requirement was too 

permissive.642 For example, one commenter stated that the proposed standard provided 

too much room for interpretation and would be difficult to measure and monitor. This 

commenter expressed particular concern that a trading desk or other organizational unit 

could meet this requirement by regularly or continuously making wide, out of context 

quotes that do not present any real risk of execution and do not contribute to market 

liquidity.643 Some commenters suggested the Agencies place greater restrictions on a 

banking entity’s ability to rely on the market-making exemption in certain illiquid 

markets, such as assets that cannot be reliably valued, products that do not have a genuine 

 

637 See SIFMA et al. (Prop. Trading) (Feb. 2012). This commenter also suggested that such test be assessed 

at the “trading unit” level. See id.

638 See Goldman (Prop. Trading).

639 See FTN. 

640 See Flynn & Fusselman; JPMorgan.

641 See JPMC.

642 See, e.g., Occupy; AFR et al. (Feb. 2012); Public Citizen; Johnson & Prof. Stiglitz; John Reed. See

infra note 746 and accompanying text (responding to these comments).

643 See Occupy.
189

external market, or instruments for which a banking entity does not expect to have 

customers wishing to both buy and sell.644 In support of these requests, commenters 

stated that trading in illiquid products raises certain concerns under the rule, including: a 

lack of reliable data for purposes of using metrics to monitor a banking entity’s market 

making-related activity (e.g., products whose valuations are determined by an internal 

model that can be manipulated, rather than an observable market price);645 relation to the 

last financial crisis;646 lack of important benefits to the real economy;647 similarity to 

prohibited proprietary trading;648 and inconsistency with the statute’s requirements that 

market making-related activity must be “designed not to exceed the reasonably expected 

near term demands of clients, customers, or counterparties” and must not result in a 

material exposure to high-risk assets or high-risk trading strategies.649 

These commenters also requested that the proposed requirement be modified in 

certain ways. In particular, several commenters stated that the proposed exemption 

should only permit market making in assets that can be reliably valued through external 

market transactions.650 In order to implement such a limitation, three commenters 

 

644 See Occupy; AFR et al. (Feb. 2012); Public Citizen; Johnson & Prof. Stiglitz; Sens. Merkley & Levin 

(Feb. 2012); John Reed.

645 See AFR et al. (Feb. 2012); Occupy.

646 See Occupy.

647 See John Reed.

648 See Johnson & Prof. Stiglitz.

649 See Sens. Merkley & Levin (Feb. 2012) (stating that a banking entity must have or reasonably expect at 

least two customers—one for each side of the trade—and must have a reasonable expectation of the second 

customer coming to take the position or risk off its books in the “near term”); AFR et al. (Feb. 2012); 

Public Citizen.

650 See AFR et al. (Feb. 2012) (stating that the rule should ban market making in illiquid and opaque 

securities with no genuine external market, but permit market making in somewhat illiquid securities, such 

as certain corporate bonds, as long as the securities can be reliably valued with reference to other extremely 

similar securities that are regularly traded in liquid markets and the financial outcome of the transaction is 
190

suggested that the Agencies prohibit banking entities from market making in assets 

classified as Level 3 under FAS 157.651 One of these commenters explained that Level 3 

assets are generally highly illiquid assets whose fair value cannot be determined using 

either market prices or models.652 In addition, a few commenters suggested that banking 

entities be subject to additional capital charges for market making in illiquid products.653 

Another commenter stated that the Agencies should require all market making-related 

activity to be conducted on a multilateral organized electronic trading platform or 

exchange to make it possible to monitor and confirm certain trading data.654 Two 

commenters emphasized that their recommended restrictions on market making in illiquid 

markets should not prohibit banking entities from making markets in corporate bonds.655

i. The proposed indicia

 reasonably predictable); Johnson & Prof. Stiglitz (recommending that permitted market making be limited 

to assets that can be reliably valued in, at a minimum, a moderately liquid market evidenced by trading 

within a reasonable period, such as a week, through a real transaction and not simply with interdealer 

trades); Public Citizen (stating that market making should be limited to assets that can be reliably valued in 

a market where transactions take place on a weekly basis).

651 See AFR et al. (Feb. 2012) (stating that such a limitation would be consistent with the proposed 

limitation on “high-risk assets” and the discussion of this limitation in proposed Appendix C); Public 

Citizen; Prof. Richardson.

652 See Prof. Richardson.

653 Two commenters recommended that banking entities be required to treat trading in assets that cannot be 

reliably valued and that trade only by appointment, such as bespoke derivatives and structured products, as 

providing an illiquid bespoke loan, which are subject to higher capital charges under the Federal banking 

agencies’ capital rules. See Johnson & Prof. Stiglitz; John Reed. Another commenter suggested that, if not 

directly prohibited, trading in bespoke instruments that cannot be reliably valued should be assessed an 

appropriate capital charge. See Public Citizen.

654 See Occupy. This commenter further suggested that the exemption exclude all activities that include: 

(i) assets whose changes in value cannot be mitigated by effective hedges; (ii) new products with rapid 

growth, including those that do not have a market history; (iii) assets or strategies that include significant 

imbedded leverage; (iv) assets or strategies that have demonstrated significant historical volatility; (v) 

assets or strategies for which the application of capital and liquidity standards would not adequately 

account for the risk; and (vi) assets or strategies that result in large and significant concentrations to sectors, 

risk factors, or counterparties. See id.

655 See AFR et al. (Feb. 2012); Johnson & Prof. Stiglitz.
191

As noted above, the proposal set forth certain indicia of bona fide market makingrelated activity in liquid and less liquid markets that the Agencies proposed to apply 

when evaluating whether a banking entity was eligible for the proposed exemption.656 

Several commenters provided their views regarding the effectiveness of the proposed 

indicia.

With respect to the proposed indicia for liquid markets, a few commenters 

expressed support for the proposed indicia.657 One of these commenters stated that while 

the proposed factors are reasonably consistent with bona fide market making, the 

Agencies should add two other factors: (i) a willingness to transact in reasonable 

quantities at quoted prices, and (ii) inventory turnover.658 

Other commenters, however, stated that the proposed use of factors from the 

SEC’s analysis of bona fide market making under Regulation SHO was inappropriate in 

this context. In particular, these commenters represented that bona fide market making 

for purposes of Regulation SHO is a purposefully narrow concept that permits a subset of 

market makers to qualify for an exception from the “locate” requirement in Rule 203 of 

Regulation SHO. The commenters further expressed the belief that the policy goals of 

section 13 of the BHC Act do not necessitate a similarly narrow interpretation of market 

making.659 

 

656 See supra Part IV.A.3.c.1.a.

657 See Occupy; AFR et al. (Feb. 2012); NYSE Euronext (expressing support for the indicia set forth in the 

FSOC study, which are substantially the same as the indicia in the proposal); Alfred Brock.

658 See AFR et al. (Feb. 2012).

659 See Goldman (Prop. Trading); SIFMA et al. (Prop. Trading) (Feb. 2012).
192

A few commenters expressed particular concern about how the factor regarding

patterns of purchases and sales in roughly comparable amounts would apply to market 

making in exchange-traded funds (“ETFs”). According to these commenters, 

demonstrating this factor could be difficult because ETF market making involves a 

pattern of purchases and sales of groups of equivalent securities (i.e., the ETF shares and 

the basket of securities and cash that is exchanged for them), not a single security. In 

addition, the commenters were unsure whether this factor could be demonstrated in times 

of limited trading in ETF shares.660

The preamble to the proposed rule also provided certain proposed indicia of bona 

fide market making-related activity in less liquid markets.661 As discussed above, 

commenters had differing views about whether the exemption for market making-related 

activity should permit banking entities to engage in market making in some or all illiquid 

markets. Thus, with respect to the proposed indicia for market making in less liquid 

markets, commenters generally stated that the indicia should be broader or narrower, 

depending on the commenter’s overall view on the issue of market making in illiquid 

markets. One commenter stated that the proposed indicia are effective.662 

The first proposed factor of market making-related activity in less liquid markets 

was holding oneself out as willing and available to provide liquidity by providing quotes 

on a regular (but not necessarily continuous) basis. As noted above, several commenters 

expressed concern about a requirement that market makers provide regular quotations in 

 

660 See ICI (Feb. 2012); ICI Global.

661 See supra Part IV.A.3.c.1.a.

662 See Alfred Brock.
193

less liquid instruments, including in fixed income markets and bespoke, customized 

derivatives.663 With respect to the interaction between the rule language requiring 

“regular” quoting and the proposal’s language permitting trading by appointment under 

certain circumstances, some of these commenters expressed uncertainty about how a 

market maker trading only by appointment would be able to satisfy the proposed rule’s 

regular quotation requirement.664 In addition, another commenter stated that the 

proposal’s recognition of trading by appointment does not alleviate concerns about 

applying the “regular” quotation requirement to market making in less liquid instruments 

in markets that are not, as a whole, highly illiquid, such as credit and interest rate 

markets.665

Other commenters expressed concern about only requiring a market maker to 

provide regular quotations or permitting trading by appointment to qualify for the marketmaking exemption. With respect to regular quotations, some commenters stated that such 

a requirement enables evasion of the prohibition on proprietary trading because a 

proprietary trader may post a quote at a time of little interest in a financial product or may 

post wide, out of context quotes on a regular basis with no real risk of execution.666 

Several commenters stated that trading only by appointment should not qualify as market 

 

663 See supra note 629 accompanying text. With respect to this factor, one commenter requested that the 

Agencies delete the parenthetical of “but not necessarily continuous” from the proposed factor as part of a 

broader effort to recognize the relative illiquidity of swap markets. See ISDA (Feb. 2012).

664 See SIFMA et al. (Prop. Trading) (Feb. 2012); CIEBA. These commenters requested greater clarity or 

guidance on the meaning of “regular” in the instance of a market maker trading only by appointment. See

id.

665 See Goldman (Prop. Trading).

666 See Public Citizen; Occupy. One of these commenters further noted that most markets lack a structural 

framework that would enable monitoring of compliance with this requirement. See Occupy.
194

making for purposes of the proposed rule.667 Some of these commenters stated that there 

is no “market” for assets that trade only by appointment, such as customized, structured 

products and OTC derivatives.668

The second proposed criterion for market making-related activity in less liquid 

markets was, with respect to securities, regularly purchasing securities from, or selling 

securities to, clients, customers, or counterparties in the secondary market. Two 

commenters expressed concern about this proposed factor.669 In particular, one of these 

commenters stated that the language is fundamentally inconsistent with market making 

because it contemplates that only taking one side of the market is sufficient, rather than 

both buying and selling an instrument.670 The other commenter expressed concern that 

banking entities would be allowed to accumulate a significant amount of illiquid risk 

because the indicia for market making-related activity in less liquid markets did not 

require a market maker to buy and sell in comparable amounts (as required by the indicia 

for liquid markets).671

Finally, the third proposed factor of market making in less liquid markets would 

consider transaction volumes and risk proportionate to historical customer liquidity and 

investment needs. A few commenters indicated that there may not be sufficient 

information available for a banking entity to conduct such an analysis.672 For example, 

 

667 See, e.g., Sens. Merkley & Levin (Feb. 2012); Johnson & Prof. Stiglitz; John Reed; Public Citizen.

668 See, e.g., John Reed; Public Citizen.

669 See AFR et al. (Feb. 2012); Occupy.

670 See AFR et al. (Feb. 2012)

671 See Occupy.

672 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Occupy.
195

one commenter stated that historical information may not necessarily be available for 

new businesses or developing markets in which a market maker may seek to establish 

trading operations.673 Another commenter expressed concern that this factor would not 

help differentiate market making from prohibited proprietary trading because most 

illiquid markets do not have a source for such historical risk and volume data.674

ii. Treatment of block positioning activity

The proposal provided that the activity described in § __.4(b)(2)(ii) of the 

proposed rule would include block positioning if undertaken by a trading desk or other 

organizational unit of a banking entity for the purpose of intermediating customer 

trading.675

A number of commenters supported the general language in the proposal 

permitting block positioning, but expressed concern about the reference to the definition 

of “qualified block positioner” in SEC Rule 3b-8(c).676 With respect to using Rule 3b8(c) as guidance under the proposed rule, these commenters represented that Rule 3b8(c)’s requirement to resell block positions “as rapidly as possible” would cause negative 

results (e.g., fire sales) or create market uncertainty (e.g., when, if ever, a longer unwind 

would be permitted).677 According to one of these commenters, gradually disposing of a 

 

673 See Goldman (Prop. Trading).

674 See Occupy.

675 See Joint Proposal, 76 FR at 68,871.

676 See, e.g., RBC; SIFMA (Asset Mgmt.) (Feb. 2012); Goldman (Prop. Trading). See also infra note 735

(responding to these comments).

677 See RBC (expressing concern about fire sales); SIFMA (Asset Mgmt.) (Feb. 2012) (expressing concern 

about fire sales, particularly in less liquid markets where a block position would overwhelm the market and 

undercut the price a market maker can obtain); Goldman (Prop. Trading) (representing that this requirement 
196

large long position purchased from a customer may be the best means of reducing near 

term price volatility associated with the supply shock of trying to sell the position at 

once.678 Another commenter expressed concern about the second requirement of Rule 

3b-8(c), which provides that the dealer must determine in the exercise of reasonable 

diligence that the block cannot be sold to or purchased from others on equivalent or better 

terms. This commenter stated that this kind of determination would be difficult in less 

liquid markets because those markets do not have widely disseminated quotes that dealers 

can use for purposes of comparison.679

Beyond the reference to Rule 3b-8(c), a few commenters expressed more general 

concern about the proposed rule’s application to block positioning activity.680 One 

commenter noted that the proposal only discussed block positioning in the context of the 

proposed requirement to hold oneself out, which implies that block positioning activity 

also must meet the other requirements of the market-making exemption. This commenter 

requested an explicit recognition that banking entities meet the requirements of the 

market-making exemption when they enter into block trades for customers, including 

related trades entered to support the block, such as hedging transactions.681 Finally, one 

commenter expressed concern that the inventory metrics in proposed Appendix A would 

 

could create uncertainty about whether a longer unwind would be permissible and, if so, under what 

circumstances).

678 See Goldman (Prop. Trading).

679 See RBC.

680 See SIFMA (Asset Mgmt.) (Feb. 2012); Fidelity (requesting that the Agencies explicitly recognize that 

block trades qualify for the market-making exemption); Oliver Wyman (Feb. 2012).

681 See SIFMA (Asset Mgmt.) (Feb. 2012).
197

make dealers reluctant to execute large, principal transactions because such trades would 

have a transparent impact on inventory metrics in the relevant asset class.682 

iii. Treatment of anticipatory market making

In the proposal, the Agencies proposed that “bona fide market making-related 

activity may include taking positions in securities in anticipation of customer demand, so 

long as any anticipatory buying or selling activity is reasonable and related to clear, 

demonstrable trading interest of clients, customers, or counterparties.”683 Many 

commenters indicated that the language in the proposal is inconsistent with the statute’s 

language regarding near term demands of clients, customers, or counterparties. 

According to these commenters, the statute’s “designed” and “reasonably expected” 

language expressly acknowledges that a market maker may need to accumulate inventory 

before customer demand manifests itself. Commenters further represented that the 

proposed standard may unduly limit a banking entity’s ability to accumulate inventory in 

anticipation of customer demand.684 

 

682 See Oliver Wyman (Feb. 2012). This commenter estimated that investors trading out of large block 

positions on their own, without a market maker directly providing liquidity, would have to pay incremental 

transaction costs between $1.7 and $3.4 billion per year. This commenter estimated a block trading size of 

$850 billion, based on a haircut of total block trading volume reported for NYSE and Nasdaq. The 

commenter then estimated, based on market interviews and analysis of standard market impact models 

provided by dealers, that the market impact of executing large block orders without direct market maker 

liquidity provision would be the difference between the market impact costs of executing a block trade over 

a 5-day period versus a 1-day period – which would be approximately 20 to 50 basis points, depending on 

the size of the trade. See id. 

683 Joint Proposal, 76 FR at 68,871; CFTC Proposal, 77 FR at 8356-8357.

684 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012) (expressing concern that requiring trades to be 

related to clear demonstrable trading interest could curtail the market-making function by removing a 

market maker’s discretion to develop inventory to best serve its customers and adversely restrict liquidity); 

Goldman (Prop. Trading); Chamber (Feb. 2012); Comm. on Capital Markets Regulation. See also Morgan 

Stanley (requesting certain revisions to more closely track the statute); SIFMA (Asset Mgmt.) (Feb. 2012)

(expressing general concern that the standard creates limitations on a market maker’s inventory). These 

comments are addressed in Part IV.A.3.c.2., infra.
198

In addition, two commenters expressed concern that the proposal’s language 

would effectively require a banking entity to engage in impermissible front running.685 

One of these commenters indicated that the Agencies should not restrict anticipatory 

trading to such a short time period.686 To the contrary, the other commenter stated that 

anticipatory accumulation of inventory should be considered to be prohibited proprietary 

trading.687 A few commenters noted that the standard in the proposal explicitly refers to 

securities and requested that the reference be changed to encompass the full scope of 

financial instruments covered by the rule to avoid ambiguity.688 Several commenters 

recommended that the language be eliminated689 or modified690 to address the concerns 

discussed above.

iv. High-frequency trading

 

685 See Goldman (Prop. Trading); Occupy. See also Public Citizen (expressing general concern that 

accumulating positions in anticipation of demand opens issues of front running).

686 See Goldman (Prop. Trading).

687 See Occupy.

688 See Goldman (Prop. Trading); ISDA (Feb. 2012); SIFMA et al. (Prop. Trading) (Feb. 2012).

689 See BoA (stating that a market maker must acquire inventory in advance of express customer demand 

and customers expect a market maker’s inventory to include not only the financial instruments in which 

customers have previously traded, but also instruments that the banking entity believes they may want to 

trade); Occupy.

690 See Morgan Stanley (suggesting a new standard providing that a purchase or sale must be “reasonably 

consistent with observable customer demand patterns and, in the case of new asset classes or markets, with 

reasonably expected future developments on the basis of the trading unit’s client relationships”); Chamber 

(Feb. 2012) (requesting that the final rule permit market makers to make individualized assessments of 

anticipated customer demand based on their expertise and experience in the markets and make trades 

according to those assessments); Goldman (Prop. Trading) (recommending that the Agencies instead focus 

on how trading activities are “designed” to meet the reasonably expected near term demands of clients over 

time, rather than whether those demands have actually manifested themselves at a given point in time); 

ISDA (Feb. 2012) (stating that the Agencies should clarify this language to recognize differences between 

liquid and illiquid markets and noting that illiquid and low volume markets necessitate that swap dealers 

take a longer and broader view than dealers in liquid markets).
199

A few commenters stated that high-frequency trading should be considered 

prohibited proprietary trading under the rule, not permitted market making-related 

activity.691 For example, one commenter stated that the Agencies should not confuse 

high volume trading and market making. This commenter emphasized that algorithmic 

traders in general – and high-frequency traders in particular – do not hold themselves out 

in the manner required by the proposed rule, but instead only offer to buy and sell when 

they think it is profitable.692 Another commenter suggested the Agencies impose a 

resting period on any order placed by a banking entity in reliance on any exemption in the 

rule by, for example, prohibiting a banking entity from buying and subsequently selling a 

position within a span of two seconds.693

c. Final requirement to routinely stand ready to purchase and sell

Section __.4(b)(2)(i) of the final rule provides that the trading desk that 

establishes and manages the financial exposure must routinely stand ready to purchase 

and sell one or more types of financial instruments related to its financial exposure and be 

willing and available to quote, buy and sell, or otherwise enter into long and short 

positions in those types of financial instruments for its own account, in commercially 

reasonable amounts and throughout market cycles, on a basis appropriate for the 

liquidity, maturity, and depth of the market for the relevant types of financial instruments. 

As discussed in more detail below, the standard of “routinely” standing ready to purchase 

and sell one or more types of financial instruments will be interpreted to account for 

 

691 See, e.g., Better Markets (Feb. 2012); Occupy; Public Citizen.

692 See Better Markets (Feb. 2012). See also infra note 742 (addressing this issue).

693 See Occupy.
200

differences across markets and asset classes. In addition, this requirement provides that a 

trading desk must be willing and available to provide quotations and transact in the 

particular types of financial instruments in commercially reasonable amounts and 

throughout market cycles. Thus, a trading desk’s activities would not meet the terms of 

the market-making exemption if, for example, the trading desk only provides wide 

quotations on one or both sides of the market relative to prevailing market conditions or 

is only willing to trade on an irregular, intermittent basis. 

While this provision of the market-making exemption has some similarity to the 

requirement to hold oneself out in § __.4(b)(2)(ii) of the proposed rule, the Agencies have 

made a number of refinements in response to comments. Specifically, a number of 

commenters expressed concern that the proposed requirement did not sufficiently account 

for differences between markets and asset classes and would unduly limit certain types of 

market making by requiring “regular or continuous” quoting in a particular instrument.694 

The explanation of this requirement in the proposal was intended to address many of 

these concerns. For example, the Agencies stated that the proposed “indicia cannot be 

applied at all times and under all circumstances because some may be inapplicable to the 

specific asset class or market in which the market-making activity is conducted.”695 

Nonetheless, the Agencies believe that certain modifications are warranted to clarify the 

rule and to prevent a potential chilling effect on market making-related activities 

conducted by banking entities. 

 

694 See supra Part IV.A.3.c.1.b. (discussing comments on this issue). The Agencies did not intend for the 

reference to “covered financial position” in the proposed rule to imply a single instrument, although 

commenters contended that the proposal may not have been sufficiently clear on this point.

695 Joint Proposal, 76 FR at 68,871; CFTC Proposal, 77 FR at 8356.
201

Commenters represented that the requirement that a trading desk hold itself out as 

being willing to buy and sell “on a regular or continuous basis,” as was originally 

proposed, was impossible to meet or impractical in the context of many markets, 

especially less liquid markets.696 Accordingly, the final rule requires a trading desk that 

establishes and manages the financial exposure to “routinely” stand ready to trade one or 

more types of financial instruments related to its financial exposure. As discussed below, 

the meaning of “routinely” will account for the liquidity, maturity, and depth of the 

market for a type of financial instrument, which should address commenter concern that 

the proposed standard would not work in less liquid markets and would have a chilling 

effect on banking entities’ ability to act as market makers in less liquid markets. A 

concept of market making that is applicable across securities, commodity futures, and 

derivatives markets has not previously been defined by any of the Agencies. Thus, while 

this standard is based generally on concepts from the securities laws and is consistent 

with the CFTC’s and SEC’s description of market making in swaps,697 the Agencies note 

 

696 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Morgan Stanley; Barclays; Goldman (Prop. 

Trading); ABA; Chamber (Feb. 2012); BDA (Feb. 2012); Fixed Income Forum/Credit Roundtable; ACLI 

(Feb. 2012); T. Rowe Price; PUC Texas; PNC; MetLife; RBC; SSgA (Feb. 2012). Some commenters 

suggested alternative criteria, such as providing prices upon request, using a historical test of market 

making, or a purely guidance-based approach. See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman 

(Prop. Trading); FTN; Flynn & Fusselman; JPMC. The Agencies are not adopting a requirement that the 

trading desk only provide prices upon request because the Agencies believe it would be inconsistent with 

market making in liquid exchange-traded instruments where market makers regularly or continuously post 

quotes on an exchange. With respect to one commenter’s suggested approach of a historical test of market 

making, this commenter did not provide enough information about how such a test would work for the 

Agencies’ consideration. Finally, the final rule does not adopt a purely guidance-based approach because, 

as discussed further above, the Agencies believe it could lead to an increased risk of evasion.

697 See Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” 

“Major Security-Based Swap Participant” and “Eligible Contract Participant”, 77 FR 30596, 30609 (May 

23, 2012) (describing market making in swaps as “routinely standing ready to enter into swaps at the 

request or demand of a counterparty”).
202

that it is not directly based on an existing definition of market making.698 Instead, the 

approach taken in the final rule is intended to take into account and accommodate the 

conditions in the relevant market for the financial instrument in which the banking entity 

is making a market. 

i. Definition of “trading desk”

The Agencies are adopting a market-making exemption with requirements that 

generally focus on a financial exposure managed by a “trading desk” of a banking entity 

and such trading desk’s market-maker inventory. The market-making exemption as 

originally proposed would have applied to “a trading desk or other organizational unit” of 

a banking entity. In addition, for purposes of the proposed requirement to report and 

record certain quantitative measurements, the proposal defined the term “trading unit” as 

each of the following units of organization of a banking entity: (i) each discrete unit that 

is engaged in the coordinated implementation of a revenue-generation strategy and that 

participates in the execution of any covered trading activity; (ii) each organizational unit 

that is used to structure and control the aggregate risk-taking activities and employees of 

one or more trading units described in paragraph (i); and (iii) all trading operations, 

collectively.699 

 

698 As a result, activity that is considered market making under this final rule may not necessarily be 

considered market making for purposes of other laws or regulations, such as the U.S. securities laws, the 

rules and regulations thereunder, or self-regulatory organization rules. In addition, the Agencies note that a 

banking entity acting as an underwriter would continue to be treated as an underwriter for purposes of the 

securities laws and the regulations thereunder, including any liability arising under the securities laws as a 

result of acting in such capacity, regardless of whether it is able to meet the terms of the market-making 

exemption for its activities. See Sens. Merkley & Levin (Feb. 2012).

699 See Joint Proposal, 76 FR at 68,957; CFTC Proposal, 77 FR at 8436.
203

The Agencies received few comments regarding the organizational level at which 

the requirements of the market-making exemption should apply, and many of the 

commenters that addressed this issue did not describe their suggested approach in 

detail.700 One commenter suggested that the market-making exemption apply to each 

“trading unit” of a banking entity, defined as “each organizational unit that is used to 

structure and control the aggregate risk-taking activities and employees that are engaged 

in the coordinated implementation of a customer-facing revenue generation strategy and 

that participate in the execution of any covered trading activity.”701 This suggested 

approach is substantially similar to the second prong of the Agencies’ proposed definition 

of “trading unit” in Appendix A of the proposal. The Agencies described this prong as 

generally including management or reporting divisions, groups, sub-groups, or other 

intermediate units of organization used by the banking entity to manage one or more 

discrete trading units (e.g., “North American Credit Trading,” “Global Credit Trading,” 

etc.).702 The Agencies are concerned that this commenter’s suggested approach, or any 

other approach applying the exemption’s requirements to a higher level of organization 

than the trading desk, would impede monitoring of market making-related activity and 

detection of impermissible proprietary trading by combining a number of different 

trading strategies and aggregating a larger volume of trading activities.703 Further, key 

requirements in the market-making exemption, such as the required limits and risk 

 

700 See Wellington; SIFMA et al. (Prop. Trading) (Feb. 2012).

701 Morgan Stanley.

702 See Joint Proposal, 76 FR at 68,957 n.2.

703 See, e.g., Occupy (expressing concern that, with respect to the proposed definition of “trading unit,” an 

“oversized” unit could combine significantly unrelated trading desks, which would impede detection of 

proprietary trading activity).
204

management procedures, are generally used by banking entities for risk control and 

applied at the trading desk level. Thus, applying them at a broader organizational level 

than the trading desk would create a separate system for compliance with this exemption 

designed to permit a banking entity to aggregate disparate trading activities and apply 

limits more generally. Applying the conditions of the exemption at a more aggregated 

level would allow banking entities more flexibility in trading and could result in a higher 

volume of trading that could contribute modestly to liquidity.704 Instead of taking that 

approach, the Agencies have determined to permit a broader range of market makingrelated activities that can be effectively controlled by building on risk controls used by 

trading desks for business purposes. This will allow an individual trader to use 

instruments or strategies within limits established in the compliance program to 

confidently trade in the type of financial instruments in which his or her trading desk 

makes a market. The Agencies believe this addresses concerns that uncertainty would 

negatively impact liquidity. It also addresses concerns that applying the market-making 

exemption at a higher level of organization would reduce the effectiveness of the 

requirements in the final rule aimed at ensuring that the quality and character of trading is 

consistent with market making-related activity and would increase the risk of evasion. 

Moreover, several provisions of the final rule are intended to account for the liquidity, 

maturity, and depth of the market for a given type of financial instrument in which the 

trading desk makes a market. The final rule takes account of these factors to, among 

 

704 The Agencies recognize that the proposed rule’s application to a trading desk “or other organizational 

unit” would have provided banking entities with this type of flexibility to determine the level of 

organization at which the market-making exemption should apply based on the entity’s particular business 

structure and trading strategies, which would likely reduce the burdens of this aspect of the final rule. 

However, for the reasons noted above regarding application of this exemption to a higher organizational 

level than the trading desk, the Agencies are not adopting the “or other organizational unit” language.
205

other things, respond to commenters’ concerns about the proposed rule’s potential impact 

on market making in less liquid markets. Applying these requirements at an 

organizational level above the trading desk would be more likely to result in aggregation 

of trading in various types of instruments with differing levels of liquidity, which would 

make it more difficult for these market factors to be taken into account for purposes of 

the exemption (for example, these factors are considered for purposes of tailoring the 

analysis of reasonably expected near term demands of customers and establishing risk, 

inventory, and duration limits). 

Thus, the Agencies continue to believe that certain requirements of the exemption 

should apply to a relatively granular level of organization within a banking entity (or 

across two or more affiliated banking entities). These requirements of the final marketmaking exemption have been formulated to best reflect the nature of activities at the 

trading desk level of granularity. 

As explained below, the Agencies are applying certain requirements to a “trading 

desk” of a banking entity and adopting a definition of this term in the final rule.705 The 

definition of “trading desk” is similar to the first prong of the proposed definition of 

“trading unit.” The Agencies are not adopting the proposed “or other organizational unit” 

language because the Agencies are concerned that approach would have provided 

banking entities with too much discretion to independently determine the organizational 

level at which the requirements should apply, including a more aggregated level of 

organization, which could lead to evasion of the general prohibition on proprietary 

trading and the other concerns noted above. The Agencies believe that adopting an 

 

705 See final rule § __.3(e)(13).
206

approach focused on the trading desk level will allow banking entities and the Agencies 

to better distinguish between permitted market making-related activities and trading that 

is prohibited by section 13 of the BHC Act and, thus, will prevent evasion of the statutory 

requirements, as discussed in more detail below. Further, as discussed below, the 

Agencies believe that applying requirements at the trading desk level is balanced by the 

financial exposure-based approach, which will address commenters’ concerns about the 

burdens of trade-by-trade analyses. 

In the final rule, trading desk is defined to mean the smallest discrete unit of 

organization of a banking entity that buys or sells financial instruments for the trading 

account of the banking entity or an affiliate thereof. The Agencies expect that a trading 

desk would be managed and operated as an individual unit and should reflect the level at 

which the profit and loss of market-making traders is attributed.706 The geographic 

location of individual traders is not dispositive for purposes of the analysis of whether the 

traders may comprise a single trading desk. For instance, a trading desk making markets 

in U.S. investment grade telecom corporate credits may use trading personnel in both 

New York (to trade U.S. dollar-denominated bonds issued by U.S.-incorporated telecom 

companies) and London (to trade Euro-denominated bonds issued by the same type of 

companies). This approach allows more effective management of risks of trading activity 

by requiring the establishment of limits, management oversight, and accountability at the 

level where trading activity actually occurs. It also allows banking entities to tailor the 

 

706 For example, the Agencies expect a banking entity may determine the foreign exchange options desk to 

be a trading desk; however, the Agencies do not expect a banking entity to consider an individual Japanese 

Yen options trader (i.e., the trader in charge of all Yen-based options trades) as a trading desk, unless the 

banking entity manages its profit and loss, market making, and hedging in Japanese Yen options 

independently of all other financial instruments.
207

limits and procedures to the type of instruments traded and markets served by each 

trading desk. 

In response to comments, and as discussed below in the context of the “financial 

exposure” definition, a trading desk may manage a financial exposure that includes 

positions in different affiliated legal entities.707 Similarly, a trading desk may include 

employees working on behalf of multiple affiliated legal entities or booking trades in 

multiple affiliated entities. Using the previous example, the U.S. investment grade 

telecom corporate credit trading desk may include traders working for or booking into a 

broker-dealer entity (for corporate bond trades), a security-based swap dealer entity (for 

single-name CDS trades), and/or a swap dealer entity (for index CDS or interest rate 

swap hedges). To clarify this issue, the definition of “trading desk” specifically provides 

that the desk can buy or sell financial instruments “for the trading account of a banking 

entity or an affiliate thereof.” Thus, a trading desk need not be constrained to a single 

legal entity, although it is permissible for a trading desk to only trade for a single legal 

entity. A trading desk booking positions in different affiliated legal entities must have 

records that identify all positions included in the trading desk’s financial exposure and 

where such positions are held, as discussed below.

708

The Agencies believe that establishing a defined organizational level at which 

many of the market-making exemption’s requirements apply will address potential 

evasion concerns. Applying certain requirements of the market-making exemption at the 

 

707 See infra note 724 and accompanying text. Several commenters noted that market-making activities 

may be conducted across separate affiliated legal entities. See, e.g., SIFMA et al. (Prop. Trading) (Feb. 

2012); Goldman (Prop. Trading).

708 See infra note 727 and accompanying text.
208

trading desk level will strengthen their effectiveness and prevent evasion of the 

exemption by ensuring that the aggregate trading activities of a relatively limited group 

of traders on a single desk are conducted in a manner that is consistent with the 

exemption’s standards. In particular, because many of the requirements in the marketmaking exemption look to the specific type(s) of financial instruments in which a market 

is being made, and such requirements are designed to take into account differences 

among markets and asset classes, the Agencies believe it is important that these 

requirements be applied to a discrete and identifiable unit engaged in, and operated by 

personnel whose responsibilities relate to, making a market in a specific set or type of 

financial instruments. Further, applying requirements at the trading desk level should 

facilitate banking entity monitoring and review of compliance with the exemption by 

limiting the aggregate trading volume that must be reviewed, as well as allowing 

consideration of the particular facts and circumstances of the desk’s trading activities 

(e.g., the liquidity, maturity, and depth of the market for the relevant types of financial 

instruments). As discussed above, the Agencies believe that applying the requirements of 

the market-making exemption to a higher level of organization would reduce the ability 

to consider the liquidity, maturity, and depth of the market for a type of financial 

instrument, would impede effective monitoring and compliance reviews, and would 

increase the risk of evasion. 

ii. Definitions of “financial exposure” and “market-maker inventory”
209

Certain requirements of the proposed market-making exemption referred to a 

“purchase or sale of a [financial instrument].”709 Even though the Agencies did not 

intend to require a trade-by-trade review, a significant number of commenters expressed 

concern that this language could be read to require compliance with the proposed marketmaking exemption on a transaction-by-transaction basis.710 In response to these

concerns, the Agencies are modifying the exemption to clarify the manner in which 

compliance with certain provisions will be assessed. In particular, rather than a 

transaction-by-transaction focus, the market-making exemption in the final rule focuses 

on two related aspects of market-making activity: a trading desk’s “market-maker 

inventory” and its overall “financial exposure.”711

The Agencies are adopting an approach that focuses on both a trading desk’s 

financial exposure and market-maker inventory in recognition that market making-related 

activity is best viewed in a holistic manner and that, during a single day, a trading desk 

may engage in a large number of purchases and sales of financial instruments. While all 

these transactions must be conducted in compliance with the market-making exemption, 

the Agencies recognize that they involve financial instruments for which the trading desk 

acts as market maker (i.e., by standing ready to purchase and sell that type of financial 

 

709 See proposed rule § __.4(b). 

710 Some commenters also contended that language in proposed Appendix B raised transaction-bytransaction implications. See supra notes 517 to 524 and accompanying text (discussing commenters’ 

transaction-by-transaction concerns). 

711 The Agencies are not adopting a transaction-by-transaction approach because the Agencies are 

concerned that such an approach would be unduly burdensome or impractical and inconsistent with the 

manner in which bona fide market making-related activity is conducted. Additionally, the Agencies are 

concerned that the burdens of such an approach would cause banking entities to significantly reduce or 

cease market making-related activities, which would cause negative market impacts harmful to both 

investors and issuers, as well as the financial system generally. 
210

instrument) and instruments that are acquired to manage the risks of positions in financial 

instruments for which the desk acts as market maker, but in which the desk is not itself a 

market maker.712 

The final rule requires that activity by a trading desk under the market-making 

exemption be evaluated by a banking entity through monitoring and setting limits for the 

trading desk’s market-maker inventory and financial exposure. The market-maker 

inventory of a trading desk includes the positions in financial instruments, including 

derivatives, in which the trading desk acts as market maker. The financial exposure of 

the trading desk includes the aggregate risks of financial instruments in the market-maker 

inventory of the trading desk plus the financial instruments, including derivatives, that are 

acquired to manage the risks of the positions in financial instruments for which the 

trading desk acts as a market maker, but in which the trading desk does not itself make a 

market, as well as any associated loans, commodities, and foreign exchange that are 

acquired as incident to acting as a market maker. In addition, the trading desk generally 

must maintain its market-maker inventory and financial exposure within its market-maker 

inventory limit and its financial exposure limit, respectively and, to the extent that any 

limit of the trading desk is exceeded, the trading desk must take action to bring the 

trading desk into compliance with the limits as promptly as possible after the limit is 

exceeded.

713 Thus, if market movements cause a trading desk’s financial exposure to 

exceed one or more of its risk limits, the trading desk must promptly take action to reduce 

 

712 See Joint Proposal, 76 FR at 68,870 n.146 (“The Agencies note that a market maker may often make a 

market in one type of [financial instrument] and hedge its activities using different [financial instruments] 

in which it does not make a market.”); CFTC Proposal, 77 FR at 8356 n.152.

713 See final rule § __.4(b)(2)(iv).
211

its financial exposure or obtain approval for an increase to its limits through the required 

escalation procedures, detailed below. A trading desk may not, however, enter into a 

trade that would cause it to exceed its limits without first receiving approval through its 

escalation procedures.714

Under the final rule, the term market-maker inventory is defined to mean all of 

the positions, in the financial instruments for which the trading desk stands ready to make 

a market in accordance with paragraph (b)(2)(i) of this section, that are managed by the 

trading desk, including the trading desk’s open positions or exposures arising from open 

transactions.

715 Those financial instruments in which a trading desk acts as market maker 

must be identified in the trading desk’s compliance program under § __.4(b)(2)(iii)(A) of 

the final rule. As used throughout this Supplementary Information, the term 

“inventory” refers to both the retention of financial instruments (e.g., securities) and, in 

the context of derivatives trading, the risk exposures arising out of market-making related 

activities.716 Consistent with the statute, the final rule requires that the market-maker 

inventory of a trading desk be designed not to exceed, on an ongoing basis, the 

reasonably expected near term demands of clients, customers, or counterparties. 

The financial exposure concept is broader in scope than market-maker inventory 

and reflects the aggregate risks of the financial instruments (as well as any associated 

loans, spot commodities, or spot foreign exchange or currency) the trading desk manages 

 

714 See final rule § __.4(b)(2)(iii)(E).

715 See final rule § __.4(b)(5).

716 As noted in the proposal, certain types of market making-related activities, such as market making in 

derivatives, involves the retention of principal exposures rather than the retention of actual financial 

instruments. See Joint Proposal, 76 FR at 68,869 n.143; CFTC Proposal, 77 FR at 8354 n.149. This type 

of activity would be included under the concept of “inventory” in the final rule.
212

as part of its market making-related activities.717 Thus, a trading desk’s financial 

exposure will take into account a trading desk’s positions in instruments for which it does 

not act as a market maker, but which are established as part of its market making-related 

activities, which includes risk mitigation and hedging. For instance, a trading desk that 

acts as a market maker in Euro-denominated corporate bonds may, in addition to Eurodenominated bonds, enter into credit default swap transactions on individual European 

corporate bond issuers or an index of European corporate bond issuers in order to hedge 

its exposure arising from its corporate bond inventory, in accordance with its documented 

hedging policies and procedures. Though only the corporate bonds would be considered 

as part of the trading desk’s market-maker inventory, its overall financial exposure would 

also include the credit default swaps used for hedging purposes. 

As noted above, the Agencies believe the extent to which a trading desk is 

engaged in permitted market making-related activities is best determined by evaluating 

both the financial exposure that results from the desk’s trading activity and the amount, 

types, and risks of the financial instruments in the desk’s market-maker inventory. Both 

concepts are independently valuable and will contribute to the effectiveness of the 

market-making exemption. Specifically, a trading desk’s financial exposure will 

highlight the net exposure and risks of its positions and, along with an analysis of the 

 

717 The Agencies recognize that under the statute a banking entity’s positions in loans, spot commodities, 

and spot foreign exchange or currency are not subject to the final rule’s restrictions on proprietary trading. 

Thus, a banking entity’s trading in these instruments does not need to comply with the market-making 

exemption or any other exemption to the prohibition on proprietary trading. A banking entity may, 

however, include exposures in loans, spot commodities, and spot foreign exchange or currency that are 

related to the desk’s market-making activities in determining the trading desk’s financial exposure and in 

turn, the desk’ s financial exposure limits under the market-making exemption. The Agencies believe this 

will provide a more accurate picture of the trading desk’s financial exposure. For example, a market maker 

in foreign exchange forwards or swaps may mitigate the risks of its market-maker inventory with spot 

foreign exchange.
213

actions the trading desk will take to demonstrably reduce or otherwise significantly 

mitigate promptly the risks of that exposure consistent with its limits, the extent to which 

it is appropriately managing the risk of its market-maker inventory consistent with 

applicable limits, all of which are significant to an analysis of whether a trading desk is 

engaged in market making-related activities. An assessment of the amount, types, and 

risks of the financial instruments in a trading desk’s market-maker inventory will identify 

the aggregate amount of the desk’s inventory in financial instruments for which it acts as 

market maker, the types of these financial instruments that the desk holds at a particular 

time, and the risks arising from such holdings. Importantly, an analysis of a trading 

desk’s market-maker inventory will inform the extent to which this inventory is related to 

the reasonably expected near term demands of clients, customers, or counterparties. 

Because the market-maker inventory concept is more directly related to the 

financial instruments that a trading desk buys and sells from customers than the financial 

exposure concept, the Agencies believe that requiring review and analysis of a trading 

desk’s market-maker inventory, as well as its financial exposure, will enhance 

compliance with the statute’s near-term customer demand requirement. While the 

amount, types, and risks of a trading desk’s market-maker inventory are constrained by 

the near-term customer demand requirement, any other positions in financial instruments 

managed by the trading desk as part of its market making-related activities (i.e., those 

reflected in the trading desk’s financial exposure, but not included in the trading desk’s 

market-maker inventory) are also constrained because they must be consistent with the 

market-maker inventory or, if taken for hedging purposes, designed to reduce the risks of 

the trading desk’s market-maker inventory. 
214

The Agencies note that disaggregating the trading desk’s market-maker inventory 

from its other exposures also allows for better identification of the trading desk’s hedging 

positions in instruments for which the trading desk does not make a market. As a result, 

a banking entity’s systems should be able to readily identify and monitor the trading 

desk’s hedging positions that are not in its market-maker inventory. As discussed in Part 

IV.A.3.c.3., a trading desk must have certain inventory and risk limits on its marketmaker inventory, the products, instruments, and exposures the trading desk may use for 

risk management purposes, and its financial exposure that are designed to facilitate the 

trading desk’s compliance with the exemption and that are based on the nature and 

amount of the trading desk’s market making-related activities, including analyses 

regarding the reasonably expected near term demands of customers.718 

The final rule also requires these policies and procedures to contain escalation 

procedures if a trade would exceed the limits set for the trading desk. However, the final 

rule does not permit a trading desk to exceed the limits solely based on customer demand. 

Rather, before executing a trade that would exceed the desk’s limits or changing the 

desk’s limits, a trading desk must first follow the relevant escalation procedures, which 

may require additional approval within the banking entity and provide demonstrable 

analysis that the basis for any temporary or permanent increase in limits is consistent with 

the reasonably expected near term demands of customers. 

Due to these considerations, the Agencies believe the final rule should result in 

more efficient compliance analyses on the part of both banking entities and Agency 

supervisors and examiners and should be less costly for banking entities to implement 

 

718 See infra Part IV.A.3.c.2.c.; final rule § __.4(b)(2)(iii)(C).
215

than a transaction-by-transaction or instrument-by-instrument approach. For example, 

the Agencies believe that some banking entities already compute and monitor most 

trading desks’ financial exposures for risk management or other purposes.719 The 

Agencies also believe that focusing on the financial exposure and market-maker 

inventory of a trading desk, as opposed to each separate individual transaction, is 

consistent with the statute’s goal of reducing proprietary trading risk in the banking 

system and its exemption for market making-related activities. The Agencies recognize 

that banking entities may not currently disaggregate trading desks’ market-maker 

inventory from their financial exposures and that, to the extent banking entities do not 

currently separately identify trading desks’ market-maker inventory, requiring such 

disaggregation for purposes of this rule will impose certain costs. In addition, the 

Agencies understand that an approach focused solely on the aggregate of all the unit’s 

trading positions, as suggested by some commenters, would present fewer burdens.720 

However, for the reasons discussed above, the Agencies believe such disaggregation is 

necessary to give full effect to the statute’s near term customer demand requirement. 

The Agencies note that whether a financial instrument or exposure stemming 

from a derivative is considered to be market-maker inventory is based only on whether 

the desk makes a market in the financial instrument, regardless of the type of 

counterparty or the purpose of the transaction. Thus, the Agencies believe that banking 

 

719 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012) (stating that modern trading units generally view 

individual positions as a bundle of characteristics that contribute to their complete portfolio). See also

Federal Reserve Board, Trading and Capital-Markets Activities Manual §2000.1 (Feb. 1998) (“The riskmeasurement system should also permit disaggregation of risk by type and by customer, instrument, or 

business unit to effectively support the management and control of risks.”).

720 See ACLI (Feb. 2012); Fixed Income Forum/Credit Roundtable; SIFMA et al. (Prop. Trading) (Feb. 

2012).
216

entities should be able to develop a standardized methodology for identifying a trading 

desk’s positions and exposures in the financial instruments for which it acts as a market 

maker. As further discussed in this Part, a trading desk’s financial exposure must reflect 

the aggregate risks managed by the trading desk as part of its market making-related 

activities,721 and a banking entity should be able to demonstrate that the financial 

exposure of a trading desk is related to its market-making activities.

The final rule defines “financial exposure” to mean the “aggregate risks of one or 

more financial instruments and any associated loans, commodities, or foreign exchange 

or currency, held by a banking entity or its affiliate and managed by a particular trading 

desk as part of the trading desk’s market making-related activities.”722 In this context, 

the term “aggregate” does not imply that a long exposure in one instrument can be 

combined with a short exposure in a similar or related instrument to yield a total exposure 

of zero. Instead, such a combination may reduce a trading desk’s economic exposure to 

certain risk factors that are common to both instruments, but it would still retain any basis 

risk between those financial instruments or potentially generate a new risk exposure in

the case of purposeful hedging. 

With respect to the frequency with which a trading desk should determine its 

financial exposure and the amount, types, and risks of the financial instruments in its 

market-maker inventory, a trading desk’s financial exposure and market-maker inventory 

should be evaluated and monitored at a frequency that is appropriate for the trading 

 

721 See final rule § __.4(b)(4).

722 Final rule § __.4(b)(4). For example, in the case of derivatives, a trading desk’s financial position will 

be the residual risks of the trading desk’s open positions. For instance, an options desk may have 

thousands of open trades at any given time, including hedges, but the desk will manage, among other risk 

factors, the trading desk’s portfolio delta, gamma, rho, and volatility. 
217

desk’s trading strategies and the characteristics of the financial instruments the desk 

trades, including historical intraday volatility. For example, a trading desk that 

repeatedly acquired and then terminated significant financial exposures throughout the 

day but that had little or no financial exposure at the end of the day should assess its 

financial exposure based on its intraday activities, not simply its end-of-day financial 

exposure. The frequency with which a trading desk’s financial exposure and marketmaker inventory will be monitored and analyzed should be specified in the trading desk’s 

compliance program. 

A trading desk’s financial exposure reflects its aggregate risk exposures. The 

types of “aggregate risks” identified in the trading desk’s financial exposure should 

reflect consideration of all significant market factors relevant to the financial instruments 

in which the trading desk acts as market maker or that the desk uses for risk management 

purposes pursuant to this exemption, including the liquidity, maturity, and depth of the 

market for the relevant types of financial instruments. Thus, market factors reflected in a 

trading desk’s financial exposure should include all significant and relevant factors 

associated with the products and instruments in which the desk trades as market maker or 

for risk management purposes, including basis risk arising from such positions.723 

Similarly, an assessment of the risks of the trading desk’s market-maker inventory must 

reflect consideration of all significant market factors relevant to the financial instruments 

in which the trading desk makes a market. Importantly, a trading desk’s financial 

 

723 As discussed in Part IV.A.3.c.3., a banking entity must establish, implement, maintain, and enforce 

policies and procedures, internal controls, analysis, and independent testing regarding the financial 

instruments each trading desk stands ready to purchase and sell and the products, instruments, or exposures 

each trading desk may use for risk management purposes. See final rule § __.4(b)(2)(iii).
218

exposure and the risks of its market-maker inventory will change based on the desk’s 

trading activity (e.g., buying an instrument that it did not previously hold, increasing its 

position in an instrument, or decreasing its position in an instrument) as well as changing 

market conditions related to instruments or positions managed by the trading desk. 

Because the final rule defines “trading desk” based on operational functionality 

rather than corporate formality, a trading desk’s financial exposure may include positions 

that are booked in different affiliated legal entities.724 The Agencies understand that 

positions may be booked in different legal entities for a variety of reasons, including 

regulatory reasons. For example, a trading desk that makes a market in corporate bonds 

may book its corporate bond positions in an SEC-registered broker-dealer and may book 

index CDS positions acquired for hedging purposes in a CFTC-registered swap dealer. A 

financial exposure that reflects both the corporate bond position and the index CDS 

position better reflects the economic reality of the trading desk’s risk exposure (i.e., by 

showing that the risk of the corporate bond position has been reduced by the index CDS 

position). 

In addition, a trading desk engaged in market making-related activities in 

compliance with the final rule may direct another organizational unit of the banking 

entity or an affiliate to execute a risk-mitigating transaction on the trading desk’s 

behalf.725 The other organizational unit may rely on the market-making exemption for 

these purposes only if: (i) the other organizational unit acts in accordance with the trading 

 

724 Other statutory or regulatory requirements, including those based on prudential safety and soundness 

concerns, may prevent or limit a banking entity from booking hedging positions in a legal entity other than 

the entity taking the underlying position. 

725 See infra Part IV.A.3.c.4.
219

desk’s risk management policies and procedures established in accordance with § 

__.4(b)(2)(iii) of the final rule; and (ii) the resulting risk-mitigating position is attributed 

to the trading desk’s financial exposure (and not the other organizational unit’s financial 

exposure) and is included in the trading desk’s daily profit and loss calculation. If 

another organizational unit of the banking entity or an affiliate establishes a riskmitigating position for the trading desk on its own accord (i.e., not at the direction of the 

trading desk) or if the risk-mitigating position is included in the other organizational 

unit’s financial exposure or daily profit and loss calculation, then the other organizational 

unit must comply with the requirements of the hedging exemption for such activity.726 It 

may not rely on the market-making exemption under these circumstances. If a trading 

desk engages in a risk-mitigating transaction with a second trading desk of the banking 

entity or an affiliate that is also engaged in permissible market making-related activities, 

then the risk-mitigating position would be included in the first trading desk’s financial 

exposure and the contra-risk would be included in the second trading desk’s marketmaker inventory and financial exposure. The Agencies believe the net effect of the final 

rule is to allow individual trading desks to efficiently manage their own hedging and risk 

mitigation activities on a holistic basis, while only allowing for external hedging directed 

by staff outside of the trading desk under the additional requirements of the hedging 

exemption.

To include in a trading desk’s financial exposure either positions held at an 

affiliated legal entity or positions established by another organizational unit on the 

 

726 Under these circumstances, the other organizational unit would also be required to meet the hedging 

exemption’s documentation requirement for the risk-mitigating transaction. See final rule § __.5(c). 
220

trading desk’s behalf, a banking entity must be able to provide supervisors or examiners 

of any Agency that has regulatory authority over the banking entity pursuant to section 

13(b)(2)(B) of the BHC Act with records, promptly upon request, that identify any 

related positions held at an affiliated entity that are being included in the trading desk’s 

financial exposure for purposes of the market-making exemption. Similarly, the 

supervisors and examiners of any Agency that has supervisory authority over the banking 

entity that holds financial instruments that are being included in another trading desk’s 

financial exposure for purposes of the market-making exemption must have the same 

level of access to the records of the trading desk.727 Banking entities should be prepared 

to provide all records that identify all positions included in a trading desk’s financial 

exposure and where such positions are held. 

As an example of how a trading desk’s market-maker inventory and financial 

exposure will be analyzed under the market-making exemption, assume a trading desk 

makes a market in a variety of U.S. corporate bonds and hedges its aggregated positions 

with a combination of exposures to corporate bond indexes and specific name CDS in 

which the desk does not make a market. To qualify for the market-making exemption, 

the trading desk would have to demonstrate, among other things, that: (i) the desk

routinely stands ready to purchase and sell the U.S. corporate bonds, consistent with the 

requirement of § __.4(b)(2)(i) of the final rule, and these instruments (or category of 

instruments) are identified in the trading desk’s compliance program; (ii) the trading 

desk’s market-maker inventory in U.S. corporate bonds is designed not to exceed, on an 

 

727 A banking entity must be able to provide such records when a related position is held at an affiliate, 

even if the affiliate and the banking entity are not subject to the same Agency’s regulatory jurisdiction.
221

ongoing basis, the reasonably expected near term demands of clients, customers, or 

counterparties, consistent with the analysis and limits established by the banking entity 

for the trading desk; (iii) the trading desk’s exposures to corporate bond indexes and 

single name CDS are designed to mitigate the risk of its financial exposure, are consistent 

with the products, instruments, or exposures and the techniques and strategies that the 

trading desk may use to manage its risk effectively (and such use continues to be 

effective), and do not exceed the trading desk’s limits on the amount, types, and risks of 

the products, instruments, and exposures the trading desk uses for risk management 

purposes; and (iv) the aggregate risks of the trading desk’s exposures to U.S. corporate 

bonds, corporate bond indexes, and single name CDS do not exceed the trading desk’s 

limits on the level of exposures to relevant risk factors arising from its financial exposure. 

Our focus on the financial exposure of a trading desk, rather than a trade-by-trade 

requirement, is designed to give banking entities the flexibility to acquire not only 

market-maker inventory, but positions that facilitate market making, such as positions 

that hedge market-maker inventory.728 As commenters pointed out, a trade-by-trade 

requirement would view trades in isolation and could fail to recognize that certain trades 

that are not customer-facing are nevertheless integral to market making and financial 

intermediation.729 The Agencies understand that the risk-reducing effects of combining 

large diverse portfolios could, in certain instances, mask otherwise prohibited proprietary 

 

728 The Agencies believe it is appropriate to apply the requirements of the exemption to the financial 

exposure of a “trading desk,” rather than the portfolio of a higher level of organization, for the reasons 

discussed above, including our concern that aggregating a large number of disparate positions and 

exposures across a range of trading desks could increase the risk of evasion. See supra Part IV.A.3.c.1.c.i.

(discussing the determination to apply requirements at the trading desk level).

729 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012).
222

trading.730 However, the Agencies do not believe that taking a transaction-by-transaction 

approach is necessary to address this concern. Rather, the Agencies believe that the 

broader definitions of “financial exposure” and “market-maker inventory” coupled with 

the tailored definition of “trading desk” facilitates the analysis of aggregate risk 

exposures and positions in a manner best suited to apply and evaluate the market-making 

exemption.

In short, this approach is designed to mitigate the costs of a trade-by-trade 

analysis identified by commenters. The Agencies recognize, however, that this approach 

is only effective at achieving the goals of the section 13 of the BHC Act – promoting 

financial intermediation and limiting speculative risks within banking entities – if there 

are limits on a trading desk’s financial exposure. That is, a permissive market-making 

exemption that gives banking entities maximum discretion in acquiring positions to 

provide liquidity runs the risk of also allowing banking entities to engage in speculative 

trades. As discussed more fully in the following Parts of this Supplementary

Information, the final market-making exemption provides a number of controls on a 

trading desk’s financial exposure. These controls include, among others, a provision 

requiring that a trading desk’s market-maker inventory be designed not to exceed, on an 

ongoing basis, the reasonably expected near term demands of customers and that any 

other financial instruments managed by the trading desk be designed to mitigate the risk 

of such desk’s market-maker inventory. In addition, the final market-making exemption 

requires the trading desk’s compliance program to include appropriate risk and inventory 

limits tied to the near term demand requirement, as well as escalation procedures if a 

 

730 See, e.g., Occupy.
223

trade would exceed such limits. The compliance program, which includes internal 

controls and independent testing, is designed to prevent instances where transactions not 

related to providing financial intermediation services are part of a desk’s financial 

exposure.

iii. Routinely standing ready to buy and sell

The requirement to routinely stand ready to buy and sell a type of financial 

instrument in the final rule recognizes that market making-related activities differ based 

on the liquidity, maturity, and depth of the market for the relevant type of financial 

instrument. For example, a trading desk acting as a market maker in highly liquid 

markets would engage in more regular quoting activity than a market maker in less liquid 

markets. Moreover, the Agencies recognize that the maturity and depth of the market 

also play a role in determining the character of a market maker’s activity. 

As noted above, the standard of “routinely” standing ready to buy and sell will 

differ across markets and asset classes based on the liquidity, maturity, and depth of the 

market for the type of financial instrument. For instance, a trading desk that is a market 

maker in liquid equity securities generally should engage in very regular or continuous 

quoting and trading activities on both sides of the market. In less liquid markets, a 

trading desk should engage in regular quoting activity across the relevant type(s) of 

financial instruments, although such quoting may be less frequent than in liquid equity 

markets.731 Consistent with the CFTC’s and SEC’s interpretation of market making in 

swaps and security-based swaps for purposes of the definitions of “swap dealer” and 

 

731 Indeed, in the most specialized situations, such quotations may only be provided upon request. See

infra note 735 and accompanying text (discussing permissible block positioning).
224

“security-based swap dealer,” “routinely” in the swap market context means that the 

trading desk should stand ready to enter into swaps or security-based swaps at the request 

or demand of a counterparty more frequently than occasionally.732 The Agencies note 

that a trading desk may routinely stand ready to enter into derivatives on both sides of the 

market, or it may routinely stand ready to enter into derivatives on either side of the 

market and then enter into one or more offsetting positions in the derivatives market or 

another market, particularly in the case of relatively less liquid derivatives. While a 

trading desk may respond to requests to trade certain products, such as custom swaps, 

even if it does not normally quote in the particular product, the trading desk should hedge 

against the resulting exposure in accordance with its financial exposure and hedging 

limits.733 Further, the Agencies continue to recognize that market makers in highly 

illiquid markets may trade only intermittently or at the request of particular customers, 

which is sometimes referred to as trading by appointment.734 A trading desk’s block 

positioning activity would also meet the terms of this requirement provided that, from 

time to time, the desk engages in block trades (i.e., trades of a large quantity or with a 

high dollar value) with customers.735 

 

732 The Agencies will consider factors similar to those identified by the CFTC and SEC in connection with 

this standard. See Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap 

Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant”, 77 FR 30596, 

30609 (May 23, 2012)

733 The Agencies recognize that, as noted by commenters, preventing a banking entity from conducting 

customized transactions with customers may impact customers’ risk exposures or transaction costs. See

Goldman (Prop. Trading); SIFMA (Asset Mgmt.) (Feb. 2012). The Agencies are not prohibiting this 

activity under the final rule, as discussed in this Part.

734 The Agencies have considered comments on the issue of whether trading by appointment should be 

permitted under the final market-making exemption. The Agencies believe it is appropriate to permit 

trading by appointment to the extent that there is customer demand for liquidity in the relevant products.

735 As noted in the preamble to the proposed rule, the size of a block will vary among different asset

classes. The Agencies also stated in the proposal that the SEC’s definition of “qualified block positioner” 
225

Regardless of the liquidity, maturity, and depth of the market for a particular type 

of financial instrument, a trading desk should have a pattern of providing price 

indications on either side of the market and a pattern of trading with customers on each 

side of the market. In particular, in the case of relatively illiquid derivatives or structured 

instruments, it would not be sufficient to demonstrate that a trading desk on occasion 

creates a customized instrument or provides a price quote in response to a customer 

 

in Rule 3b-8(c) under the Exchange Act may serve as guidance for determining whether block positioning 

activity qualifies for the market-making exemption. In referencing that rule as guidance, the Agencies did 

not intend to imply that a banking entity engaged in block positioning activity would be required to meet all 

terms of the “qualified block positioner” definition at all times. Nonetheless, a number of commenters 

indicated that it was unclear when a banking entity would need to act as a qualified block positioner in 

accordance with Rule 3b-8(c) and expressed concern that uncertainty could have a chilling effect on a 

banking entity’s willingness to facilitate customer block trades. See, e.g., RBC; SIFMA (Asset Mgmt.) 

(Feb. 2012); Goldman (Prop. Trading). For example, a few commenters stated that certain requirements in 

Rule 3b-8(c) could cause fire sales or general market uncertainty. See id. After considering comments, the 

Agencies have decided that the reference to Rule 3b-8(c) is unnecessary for purposes of the final rule. In 

particular, the Agencies believe that the requirements in the market-making exemption provide sufficient 

safeguards, and the additional requirements of the “qualified block positioner” definition may present 

unnecessary burdens or redundancies with the rule, as adopted. For example, the Agencies believe that 

there is some overlap between § __.4(b)(2)(ii) of the exemption, which provides that the amount, types, and 

risks of the financial instruments in the trading desk’s market-maker inventory must be designed not to 

exceed the reasonably expected near term demands of clients, customers, or counterparties, and Rule 3b8(c)(iii), which requires the sale of the shares comprising the block as rapidly as possible commensurate 

with the circumstances. In other words, the market-making exemption would require a banking entity to 

appropriately manage its inventory when engaged in block positioning activity, but would not speak 

directly to the timing element given the diversity of markets to which the exemption applies.

As noted above, one commenter analyzed the potential market impact of a complete restriction on a market 

maker’s ability to provide direct liquidity to help a customer execute a large block trade. See supra note 

682 and accompanying text. Because the Agencies are not restricting a banking entity’s ability to engage 

in block positioning in the manner suggested by this commenter, the Agencies do not believe that the final 

rule will cause the cited market impact of incremental transaction costs between $1.7 and $3.4 billion per 

year. The Agencies address this commenter’s concern about the impact of inventory metrics on a banking 

entity’s willingness to engage in block trading in Part IV.C.3. (discussing the metrics requirement in the 

final rule and noting that metrics will not be used to determine compliance with the rule but, rather, will be 

monitored for patterns over time to identify activities that may warrant further review).

One commenter appeared to request that block trading activity not be subject to all requirements of the 

market-making exemption. See SIFMA (Asset Mgmt.) (Feb. 2012). Any activity conducted in reliance on 

the market-making exemption, including block trading activity, must meet the requirements of the marketmaking exemption. The Agencies believe the requirements in the final rule are workable for block 

positioning activity and do not believe it would be appropriate to subject block positioning to lesser 

requirements than general market-making activity. For example, trading in large block sizes can expose a 

trading desk to greater risk than market making in smaller sizes, particularly absent risk management 

requirements. Thus, the Agencies believe it is important for block positioning activity to be subject to the 

same requirements, including the requirements to establish risk limits and risk management procedures, as 

general market-making activity. 
226

request. Instead, the trading desk would need to be able to demonstrate a pattern of 

taking these actions in response to demand from multiple customers with respect to both 

long and short risk exposures in identified types of instruments. 

This requirement of the final rule applies to a trading desk’s activity in one or 

more “types” of financial instruments.736 The Agencies recognize that, in some markets, 

such as the corporate bond market, a market maker may regularly quote a subset of 

instruments (generally the more liquid instruments), but may not provide regular quotes 

in other related but less liquid instruments that the market maker is willing and available 

to trade. Instead, the market maker would provide a price for those instruments upon 

request.737 The trading desk’s activity, in the aggregate for a particular type of financial 

instrument, indicates whether it is engaged in activity that is consistent with § 

__.4(b)(2)(i) of the final rule. 

Notably, this requirement provides that the types of financial instruments for 

which the trading desk routinely stands ready to purchase and sell must be related to its 

authorized market-maker inventory and it authorized financial exposure. Thus, the types 

of financial instruments for which the desk routinely stands ready to buy and sell should 

compose a significant portion of its overall financial exposure. The only other financial 

instruments contributing to the trading desk’s overall financial exposure should be those 

designed to hedge or mitigate the risk of the financial instruments for which the trading 

desk is making a market. It would not be consistent with the market-making exemption 

 

736 This approach is generally consistent with commenters’ requested clarification that a trading desk’s 

quoting activity will not be assessed on an instrument-by-instrument basis, but rather across a range of 

similar instruments for which the trading desk acts as a market maker. See, e.g., RBC; SIFMA et al. (Prop. 

Trading) (Feb. 2012); CIEBA; Goldman (Prop. Trading).

737 See, e.g., Goldman (Prop. Trading); Morgan Stanley; RBC; SIFMA et al. (Prop. Trading) (Feb. 2012).
227

for a trading desk to hold only positions in, or be exposed to, financial instruments for 

which the trading desk is not a market maker.738

A trading desk’s routine presence in the market for a particular type of financial 

instrument would not, on its own, be sufficient grounds for relying on the market-making 

exemption. This is because the frequency at which a trading desk is active in a particular 

market would not, on its own, distinguish between permitted market making-related 

activity and impermissible proprietary trading. In response to comments, the final rule 

provides that a trading desk also must be willing and available to quote, buy and sell, or 

otherwise enter into long and short positions in the relevant type(s) of financial 

instruments for its own account in commercially reasonable amounts and throughout 

market cycles.739 Importantly, a trading desk would not meet the terms of this 

requirement if it provides wide quotations relative to prevailing market conditions and is 

not engaged in other activity that evidences a willingness or availability to provide 

intermediation services.740 Under these circumstances, a trading desk would not be 

standing ready to purchase and sell because it is not genuinely quoting or trading with 

customers. 

 

738 The Agencies recognize that there could be limited circumstances under which a trading desk’s 

financial exposure does not relate to the types of financial instruments that it is standing ready to buy and 

sell for a short period of time. However, the Agencies would expect for such occurrences to be minimal. 

For example, this scenario could occur if a trading desk unwinds a hedge position after the market-making 

position has already been unwound or if a trading desk acquires an anticipatory hedge position prior to 

acquiring a market-making position. As discussed more thoroughly in Part IV.A.3.c.3., a banking entity 

must establish written policies and procedures, internal controls, analysis, and independent testing that 

establish appropriate parameters around such activities.

739 See, e.g., Occupy; Better Markets (Feb. 2012).

740 One commenter expressed concern that a banking entity may be able to rely on the market-making 

exemption when it is providing only wide, out of context quotes. See Occupy.
228

In the context of this requirement, “commercially reasonable amounts” means that 

the desk generally must be willing to quote and trade in sizes requested by other market 

participants.741 For trading desks that engage in block trading, this would include block 

trades requested by customers, and this language is not meant to restrict a trading desk 

from acting as a block positioner. Further, a trading desk must act as a market maker on 

an appropriate basis throughout market cycles and not only when it is most favorable for 

it to do so.742 For example, a trading desk should be facilitating customer needs in both 

upward and downward moving markets. 

As discussed further in Part IV.A.3.c.3., the financial instruments the trading desk 

stands ready to buy and sell must be identified in the trading desk’s compliance 

program.743 Certain requirements in the final exemption apply to the amount, types, and 

risks of these financial instruments that a trading desk can hold in its market-maker 

inventory, including the near term customer demand requirement744 and the need to have 

certain risk and inventory limits.745 

In response to the proposed requirement that a trading desk or other 

organizational unit hold itself out, some commenters requested that the Agencies limit the 

 

741 As discussed below, this may include providing quotes in the interdealer trading market. 

742 Algorithmic trading strategies that only trade when market factors are favorable to the strategy’s 

objectives or that otherwise frequently exit the market would not be considered to be standing ready to 

purchase or sell a type of financial instrument throughout market cycles and, thus, would not qualify for the 

market-making exemption. The Agencies believe this addresses commenters’ concerns about highfrequency trading activities that are only active in the market when it is believed to be profitable, rather 

than to facilitate customers. See, e.g., Better Markets (Feb. 2012). The Agencies are not, however, 

prohibiting all high-frequency trading activities under the final rule or otherwise limiting high-frequency 

trading by banking entities by imposing a resting period on their orders, as requested by certain 

commenters. See, e.g., Better Markets (Feb. 2012); Occupy; Public Citizen.

743 See final rule § __.4(b)(2)(iii)(A).

744 See final rule § __.4(b)(2)(ii).

745 See final rule § __.4(b)(2)(iii)(C).
229

availability of the market-making exemption to trading in particular asset classes or 

trading on particular venues (e.g., organized trading platforms). The Agencies are not 

limiting the availability of the market-making exemption in the manner requested by 

these commenters.746 Provided there is customer demand for liquidity in a type of 

financial instrument, the Agencies do not believe the availability of the market-making 

exemption should depend on the liquidity of that type of financial instrument or the 

ability to trade such instruments on an organized trading platform. The Agencies see no 

basis in the statutory text for either approach and believe that the likely harms to 

investors seeking to trade affected instruments (e.g., reduced ability to purchase or sell a 

particular instrument, potentially higher transaction costs) and market quality (e.g., 

reduced liquidity) that would arise under such an approach would not be justified,747

particularly in light of the minimal benefits that might result from restricting or 

eliminating a banking entity’s ability to hold less liquid assets in connection with its 

market making-related activities. The Agencies believe these commenters’ concerns are 

adequately addressed by the final rule’s requirements in the market-making exemption 

 

746 For example, a few commenters requested that the rule prohibit banking entities from market making in 

assets classified as Level 3 under FAS 157. See supra note 651 and accompanying text. The Agencies 

continue to believe that it would be inappropriate to incorporate accounting standards in the rule because 

accounting standards could change in the future without consideration of the potential impact on the final

rule. See Joint Proposal, 76 FR at 68,859 n.101 (explaining why the Agencies declined to incorporate 

certain accounting standards in the proposed rule); CFTC Proposal, 77 FR at 8344 n.107.

Further, a few commenters suggested that the exemption should only be available for trading on an 

organized trading facility. This type of limitation would require significant and widespread market 

structure changes (with associated systems and infrastructure costs) in a relatively short period of time, as 

market making in certain assets is primarily or wholly conducted in the OTC market, and organized trading 

platforms may not currently exist for these assets. The Agencies do not believe that the costs of such 

market structure changes would be warranted for purposes of this rule. 

747 As discussed above, a number of commenters expressed concern about the potential market impacts of 

the perceived restrictions on market making under the proposed rule, particularly with respect to less liquid 

markets, such as the corporate bond market. See, e.g., Prof. Duffie; Wellington; BlackRock; ICI. 
230

that are designed to ensure that a trading desk cannot hold risk in excess of what is 

appropriate to provide intermediation services designed not to exceed, on an ongoing 

basis, the reasonably expected near term demands of clients, customers, or counterparties. 

In response to comments on the proposed interpretation regarding anticipatory 

position-taking,748 the Agencies note that the near term demand requirement in the final 

rule addresses when a trading desk may take positions in anticipation of reasonably 

expected near term customer demand.749 The Agencies believe this approach is generally 

consistent with the comments the Agencies received on this issue.750 In addition, the 

Agencies note that modifications to the proposed near term demand requirement in the 

final rule also address commenters concerns on this issue.751 

2. Near term customer demand requirement

a. Proposed near term customer demand requirement

Consistent with the statute, the proposed rule required that the trading desk or 

other organizational unit’s market making-related activities be, with respect to the 

 

748 Joint Proposal, 76 FR at 68,871 (stating that “bona fide market making-related activity may include 

taking positions in securities in anticipation of customer demand, so long as any anticipatory buying or 

selling activity is reasonable and related to clear, demonstrable trading interest of clients, customers, or 

counterparties”); CFTC Proposal, 77 FR at 8356-8357; See also Morgan Stanley (requesting certain 

revisions to more closely track the statute); SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. 

Trading); Chamber (Feb. 2012); Comm. on Capital Markets Regulation; SIFMA (Asset Mgmt.) (Feb. 

2012).

749 See final rule § __.4(b)(2)(ii); infra Part IV.A.3.c.2.c.

750 See BoA; SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Morgan Stanley; 

Chamber (Feb. 2012); Comm. on Capital Markets Regulation; SIFMA (Asset Mgmt.) (Feb. 2012).

751 For example, some commenters suggested that the final rule allow market makers to make 

individualized assessments of anticipated customer demand, based on their expertise and experience, and 

account for differences between liquid and less liquid markets. See Chamber (Feb. 2012); ISDA (Feb. 

2012). The final rule allows such assessments, based on historical customer demand and other relevant 

factors, and recognizes that near term demand may differ based on the liquidity, maturity, and depth of the 

market for a particular type of financial instrument. See infra Part IV.A.3.c.2.c.iii. 
231

financial instrument, designed not to exceed the reasonably expected near term demands 

of clients, customers, or counterparties.752 This requirement is intended to prevent a 

trading desk from taking a speculative proprietary position that is unrelated to customer 

needs as part of the desk’s purported market making-related activities.753

In the proposal, the Agencies stated that a banking entity’s expectations of near 

term customer demand should generally be based on the unique customer base of the 

banking entity’s specific market-making business lines and the near term demand of 

those customers based on particular factors, beyond a general expectation of price 

appreciation. The Agencies further stated that they would not expect the activities of a 

trading desk or other organizational unit to qualify for the market-making exemption if 

the trading desk or other organizational unit is engaged wholly or principally in trading 

that is not in response to, or driven by, customer demands, regardless of whether those 

activities promote price transparency or liquidity. The proposal stated that, for example, 

a trading desk or other organizational unit of a banking entity that is engaged wholly or 

principally in arbitrage trading with non-customers would not meet the terms of the 

proposed rule’s market-making exemption.754 

With respect to market making in a security that is executed on an exchange or 

other organized trading facility, the proposal provided that a market maker’s activities are 

generally consistent with reasonably expected near term customer demand when such 

activities involve passively providing liquidity by submitting resting orders that interact 

 

752 See proposed rule § __.4(b)(2)(iii).

753 See Joint Proposal, 76 FR at 68,871; CFTC Proposal, 77 FR at 8357.

754 See id.
232

with the orders of others in a non-directional or market-neutral trading strategy and the 

market maker is registered, if the exchange or organized trading facility registers market 

makers. Under the proposal, activities on an exchange or other organized trading facility 

that primarily take liquidity, rather than provide liquidity, would not qualify for the 

market-making exemption, even if conducted by a registered market maker.755

b. Comments Regarding the Proposed Near Term Customer Demand Requirement

As noted above, the proposed near term customer demand requirement would 

implement language found in the statute’s market-making exemption.756 Some 

commenters expressed general support for this requirement.757 For example, these 

commenters emphasized that the proposed near term demand requirement is an important 

component that restricts disguised position-taking or market making in illiquid 

markets.758 Several other commenters expressed concern that the proposed requirement 

is too restrictive759 because, for example, it may impede a market maker’s ability to build 

or retain inventory760 or may impact a market maker’s willingness to engage in block 

 

755 See Joint Proposal, 76 FR at 68,871-68,872; CFTC Proposal, 77 FR at 8357.

756 See supra Part IV.A.3.c.2.a.

757 See, e.g., Sens. Merkley & Levin (Feb. 2012); Flynn & Fusselman; Better Markets (Feb. 2012).

758 See Better Markets (Feb. 2012); Sens. Merkley & Levin (Feb. 2012).

759 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Chamber (Feb. 2012); T. Rowe Price; SIFMA 

(Asset Mgmt.) (Feb. 2012); ACLI (Feb. 2012); MetLife; Comm. on Capital Markets Regulation; CIEBA; 

Credit Suisse (Seidel); SSgA (Feb. 2012); IAA (stating that the proposed requirement is too subjective and 

would be difficult to administer in a range of scenarios); Barclays; Prof. Duffie.

760 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); T. Rowe Price; CIEBA; Credit Suisse (Seidel); 

Barclays; Wellington; MetLife; Chamber (Feb. 2012); RBC; Prof. Duffie; ICI (Feb. 2012); SIFMA (Asset 

Mgmt.) (Feb. 2012). The Agencies respond to these comments in Part IV.A.3.c.2.c., infra. For a 

discussion of comments regarding inventory management activity conducted in connection with market 

making, See Part IV.A.3.c.2.b.vi., infra.
233

trading.761 Comments on particular aspects of this proposed requirement are discussed 

below, including the proposed interpretation of this requirement in the proposal, the 

requirement’s potential impact on market maker inventory, potential differences in this 

standard across asset classes, whether it is possible to predict near term customer 

demand, and whether the terms “client,” “customer,” or “counterparty” should be defined 

for purposes of the exemption. 

i. The proposed guidance for determining compliance with the near term customer 

demand requirement

As discussed in more detail above, the proposal set forth proposed guidance on 

how a banking entity may comply with the proposed near term customer demand 

requirement.762 With respect to the language indicating that a banking entity’s 

determination of near term customer demand should generally be based on the unique 

customer base of a specific market-making business line (and not merely an expectation 

of future price appreciation), one commenter stated that it is unclear how a banking entity 

would be able to make such determinations in markets where trades occur infrequently 

and customer demand is hard to predict.763 

 

761 See, e.g., ACLI (Feb. 2012); MetLife; Comm. on Capital Markets Regulation (noting that a market 

maker may need to hold significant inventory to accommodate potential block trade requests). Two of 

these commenters stated that a market maker may provide a worse price or may be unwilling to 

intermediate a large customer position if the market maker has to determine whether holding such position 

will meet the near term demand requirement, particularly if the market maker would be required to sell the 

block position over a short period of time. See ACLI (Feb. 2012); MetLife. These comments are addressed 

in Part IV.A.3.c.2.c.iii., infra. 

762 See supra Part IV.A.3.c.2.a.

763 See SIFMA et al. (Prop. Trading) (Feb. 2012). Another commenter suggested that the Agencies 

“establish clear criteria that reflect appropriate revenue from changes in the bid-ask spread,” noting that a 

legitimate market maker should be both selling and buying in a rising market (or, likewise, in a declining 

market). Public Citizen.
234

Several commenters expressed concern about the proposal’s statement that a 

trading desk or other organizational unit engaged wholly or principally in trading that is 

not in response to, or driven by, customer demands (e.g., arbitrage trading with noncustomers) would not qualify for the exemption, regardless of whether the activities 

promote price transparency or liquidity.764 In particular, commenters stated that it would 

be difficult for a market-making business to try to divide its activities that are in response 

to customer demand (e.g., customer intermediation and hedging) from activities that 

promote price transparency and liquidity (e.g., interdealer trading to test market depth or 

arbitrage trading) in order to determine their proportionality.765 Another commenter 

stated that, as a matter of organizational efficiency, firms will often restrict arbitrage 

trading strategies to certain specific individual traders within the market-making 

organization, who may sometimes be referred to as a “desk,” and expressed concern that 

this would be prohibited under the rule.766

In response to the proposed interpretation regarding market making on an 

exchange or other organized trading facility (and certain similar language in proposed 

Appendix B),767 several commenters indicated that the reference to passive submission of 

resting orders may be too restrictive and provided examples of scenarios where market 

 

764 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop.

Trading); BoA; ICI (Feb. 2012); ICI Global; Vanguard; SSgA (Feb. 2012); See also infra Part 

IV.A.3.c.2.b.viii. (discussing comments on whether arbitrage trading should be permitted under the marketmaking exemption under certain circumstances).

765 See Goldman (Prop. Trading); RBC. One of these commenters agreed, however, that a trading desk 

that is “wholly” engaged in trading that is unrelated to customer demand should not qualify for the 

proposed market-making exemption. See Goldman (Prop. Trading).

766 See JPMC.

767 See Joint Proposal, 76 FR at 68,871-68,872; CFTC Proposal, 77 FR at 8357.
235

makers may need to use market or marketable limit orders.768 For example, many of 

these commenters stated that market makers may need to enter market or marketable 

limit orders to: (i) build or reduce inventory;769 (ii) address order imbalances on an 

exchange by, for example, using market orders to lessen volatility and restore pricing 

equilibrium; (iii) hedge market-making positions; (iv) create markets;770 (v) test the depth 

of the markets; (vi) ensure that ETFs, American depositary receipts (“ADRs”), options, 

and other instruments remain appropriately priced;771 and (vii) respond to movements in 

prices in the markets.772 Two commenters noted that distinctions between limit and 

market or marketable limit orders may not be workable in the international context, 

where exchanges may not use the same order types as U.S. trading facilities.773

A few commenters also addressed the proposed use of a market maker’s exchange 

registration status as part of the analysis.774 Two commenters stated that the proposed 

rule should not require a market maker to be registered with an exchange to qualify for 

the proposed market-making exemption. According to these commenters, there are a 

large number of exchanges and organized trading facilities on which market makers may 

 

768 See, e.g., NYSE Euronext; SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); RBC. 

Comments on proposed Appendix B are discussed further in Part IV.A.3.c.8.b., infra. This issue is 

addressed in note 939 and its accompanying text, infra.

769 Some commenters stated that market makers may need to use market or marketable limit orders to build 

inventory in anticipation of customer demand or in connection with positioning a block trade for a 

customer. See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC; Goldman (Prop. Trading). Two of these 

commenters noted that these order types may be needed to dispose of positions taken into inventory as part 

of market making. See RBC; Goldman (Prop. Trading).

770 See NYSE Euronext.

771 See Goldman (Prop. Trading).

772 See SIFMA et al. (Prop. Trading) (Feb. 2012).

773 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading).

774 See NYSE Euronext; SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Occupy. 

See also infra notes 940 to 941 and accompanying text (addressing these comments).
236

need to trade to maintain liquidity across the markets and to provide customers with 

favorable prices. These commenters indicated that any restrictions or burdens on such 

trading may decrease liquidity or make it harder to provide customers with the best price 

for their trade.775 One commenter, however, stated that the exchange registration 

requirement is reasonable and further supported adding a requirement that traders 

demonstrate adherence to the same or commensurate standards in markets where 

registration is not possible.776 

Some commenters recommended certain modifications to the proposed analysis. 

For example, a few commenters requested that the rule presume that a trading unit is 

engaged in permitted market making-related activity if it is registered as a market maker 

on a particular exchange or organized trading facility.777 In support of this 

recommendation, one commenter represented that it would be warranted because 

registered market makers directly contribute to maintaining liquid and orderly markets 

 

775 See SIFMA et al. (Prop. Trading) (Feb. 2012) (stating that trading units may currently register as 

market makers with particular, primary exchanges on which they trade, but will serve in a market-making 

capacity on other trading venues from time to time); Goldman (Prop. Trading) (noting that there are more 

than 12 exchanges and 40 alternative trading systems currently trading U.S. equities).

776 See Occupy. In the alternative, this commenter would require all market making to be performed on an 

exchange or organized trading facility. See id.

777 See NYSE Euronext (recognizing that registration status is not necessarily conclusive of engaging in 

market making-related activities); SIFMA et al. (Prop. Trading) (Feb. 2012) (stating that to the extent a 

trading unit is registered on a particular exchange or organized trading facility for any type of financial 

instrument, all of its activities on that exchange or organized trading facility should be presumed to be 

market making); Goldman (Prop. Trading). See also infra note 940 (responding to these comments). Two 

commenters noted that certain exchange rules may require market makers to deal for their own account 

under certain circumstances in order to maintain fair and orderly markets. See NYSE Euronext (discussing 

NYSE rules); Goldman (Prop. Trading) (discussing NYSE and CBOE rules). For example, according to 

these commenters, NYSE Rule 104(f)(ii) requires a market maker to maintain fair and orderly markets, 

which may involve dealing for their own account when there is a lack of price continuity, lack of depth, or 

if a disparity between supply and demand exists or is reasonably anticipated. See id.
237

and are subject to extensive regulatory requirements in that capacity.778 Another 

commenter suggested that the Agencies instead use metrics to compare, in the aggregate 

and over time, the liquidity that a market maker makes rather than takes as part of a 

broader consideration of the market-making character of the relevant trading activity.779

ii. Potential inventory restrictions and differences across asset classes

A number of commenters expressed concern that the proposed requirement may 

unduly restrict a market maker’s ability to manage its inventory.780 Several of these 

commenters stated that limitations on inventory would be especially problematic for 

market making in less liquid markets, like the fixed-income market, where customer 

demand is more intermittent and positions may need to be held for a longer period of 

time.781 Some commenters stated that the Agencies’ proposed interpretation of this 

requirement would restrict a market maker’s inventory in a manner that is inconsistent 

with the statute. These commenters indicated that the “designed” and “reasonably 

expected” language of the statute seem to recognize that market makers must anticipate 

customer requests and accumulate sufficient inventory to meet those reasonably expected 

 

778 See Goldman (Prop. Trading). This commenter further stated that trading activities of exchange market 

makers may be particularly difficult to evaluate with customer-facing metrics (because “specialist” market 

makers may not have “customers”), so conferring a positive presumption of compliance on such market 

makers would ensure that they can continue to contribute to liquidity, which benefits customers. This 

commenter noted that, for example, NYSE designated market makers (“DMMs”) are generally prohibited 

from dealing with customers and companies must “wall off” any trading units that act as DMMs. See id.

(citing NYSE Rule 98).

779 See id. (stating that spread-related metrics, such as Spread Profit and Loss, may be useful for this 

purpose).

780 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); T. Rowe Price; CIEBA; Credit Suisse (Seidel); 

Barclays; Wellington; MetLife; Chamber (Feb. 2012); RBC; Prof. Duffie; ICI (Feb. 2012); SIFMA (Asset 

Mgmt.) (Feb. 2012). These concerns are addressed in Part IV.A.3.c.2.c., infra. 

781 See, e.g., SIFMA (Asset Mgmt.) (Feb. 2012); T. Rowe Price; CIEBA; ICI (Feb. 2012); RBC.
238

demands.782 In addition, one commenter represented that a market maker must have 

wide latitude and incentives for initiating trades, rather than merely reacting to customer 

requests for quotes, to properly risk manage its positions or to prepare for anticipated 

customer demand or supply.783 Many commenters requested certain modifications to the

proposed requirement to limit its impact on market maker inventory.784 Commenters’ 

views on the importance of permitting inventory management activity in connection with 

market making are discussed below in Part IV.A.3.c.2.b.vi. 

Several commenters requested that the Agencies recognize that near term 

customer demand may vary across different markets and asset classes and implement this 

requirement flexibly.785 In particular, many of these commenters emphasized that the 

concept of “near term demand” should be different for less liquid markets, where 

transactions may occur infrequently, and for liquid markets, where transactions occur 

 

782 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Chamber (Feb. 2012).

783 See Prof. Duffie. However, another commenter stated that a legitimate market maker should respond to 

customer demand rather than initiate transactions, which is indicative of prohibited proprietary trading. See

Public Citizen.

784 See Credit Suisse (Seidel) (suggesting that the rule allow market makers to build inventory in products 

where they believe customer demand will exist, regardless of whether the inventory can be tied to a 

particular customer in the near term or to historical trends in customer demand); Barclays (recommending 

the rule require that “the market making-related activity is conducted by each trading unit such that its 

activities (including the maintenance of inventory) are designed not to exceed the reasonably expected near 

term demands of clients, customers, or counterparties consistent with the market and trading patterns of the 

relevant product, and consistent with the reasonable judgment of the banking entity where such demand 

cannot be determined with reasonable accuracy”); CIEBA. In addition, some commenters suggested an 

interpretation that would provide greater discretion to market makers to enter into trades based on factors 

such as experience and expertise dealing in the market and market exigencies. See SIFMA et al. (Prop. 

Trading) (Feb. 2012); Chamber (Feb. 2012). Two commenters suggested that the proposed requirement 

should be interpreted to permit market-making activity as it currently exists. See MetLife; ACLI (Feb. 

2012). One commenter requested that the proposed requirement be moved to Appendix B of the rule to 

provide greater flexibility to consider facts and circumstances of a particular activity. See JPMC. 

785 See CIEBA; Morgan Stanley; RBC; ICI (Feb. 2012); ISDA (Feb. 2012); Comm. on Capital Markets 

Regulation; Alfred Brock. The Agencies respond to these comments in Part IV.A.3.c.2.c.ii., infra.
239

more often.786 One commenter requested that the Agencies add the phrase “based on the 

characteristics of the relevant market and asset class” to the end of the requirement to 

explicitly acknowledge these differences.787

iii. Predicting near term customer demand

Commenters provided views on whether and, if so how, a banking entity may be 

able to predict near term customer demand for purposes of the proposed requirement.788 

For example, two commenters suggested ways in which a banking entity could predict 

near term customer demand.789 One of these commenters indicated that banking entities 

should be able to utilize current risk management tools to predict near term customer 

demand, although these tools may need to be adapted to comply with the rule’s 

requirements. According to this commenter, dealers commonly assess the following 

factors across product lines, which can relate to expected customer demand: (i) recent 

volumes and customer trends; (ii) trading patterns of specific customers; (iii) analysis of 

whether the firm has an ability to win new customer business; (iv) comparison of the 

current market conditions to prior similar periods; (v) liquidity of large investors; and (vi) 

the schedule of maturities in customers’ existing positions.790 Another commenter stated 

 

786 See ICI (Feb. 2012); CIEBA (stating that, absent a different interpretation for illiquid instruments, 

market makers will err on the side of holding less inventory to avoid sanctions for violating the rule); RBC.

787 See Morgan Stanley.

788 See Wellington; MetLife; SIFMA et al. (Prop. Trading) (Feb. 2012); Sens. Merkley & Levin (Feb. 

2012); Chamber (Feb. 2012); FTN; RBC; Alfred Brock. These comments are addressed in Part 

IV.A.3.c.2.c.iii., infra.

789 See Sens. Merkley & Levin (Feb. 2012); FTN.

790 See FTN. The commenter further indicated that errors in estimating customer demand are managed 

through kick-out rules and oversight by risk managers and committees, with latitude in decisions being 

closely related to expected or empirical costs of hedging positions until they result in trading with 

counterparties. See id.
240

that the reasonableness of a market maker’s inventory can be measured by looking to the 

specifics of the particular market, the size of the customer base being served, and 

expected customer demand, which banking entities should be required to take into 

account in both their inventory practices and policies and their actual inventories. This 

commenter recommended that the rule permit a banking entity to assume a position under 

the market-making exemption if it can demonstrate a track record or reasonable 

expectation that it can dispose of a position in the near term.791

Some commenters, however, emphasized that reasonably expected near term 

customer demand cannot always be accurately predicted.792 Several of these commenters 

requested the Agencies clarify that banking entities will not be subject to regulatory 

sanctions if reasonably anticipated near term customer demand does not materialize.793 

One commenter further noted that a banking entity entering a new market, or gaining or 

losing customers, may need greater flexibility in applying the near term demand 

requirement because its anticipated demand may fluctuate.794

iv. Potential definitions of “client,” “customer,” or “counterparty”

 

791 See Sens. Merkley & Levin (Feb. 2012) (stating that banking entities should be required to collect 

inventory data, evaluate the data, develop policies on how to handle particular positions, and make regular 

adjustments to ensure a turnover of assets commensurate with near term demand of customers). This 

commenter also suggested that the rule specify the types of inventory metrics that should be collected and 

suggested that the rate of inventory turnover would be helpful. See id.

792 See MetLife; Chamber (Feb. 2012); RBC; CIEBA; Wellington; ICI (Feb. 2012); Alfred Brock. This 

issue is addressed in Part IV.A.3.c.2.c.iii., infra.

793 See ICI (Feb. 2012); CIEBA; RBC; Wellington; Invesco.

794 See CIEBA.
241

Appendix B of the proposal discussed the proposed meaning of the term 

“customer” in the context of permitted market making-related activity.795 In addition, the 

proposal inquired whether the terms “client,” “customer,” or “counterparty” should be 

defined in the rule for purposes of the market-making exemption.796 Commenters 

expressed varying views on the proposed interpretations in the proposal and on whether 

these terms should be defined in the final rule.797

With respect to the proposed interpretations of the term “customer” in Appendix 

B, one commenter agreed with the proposed interpretations and expressed the belief that 

the interpretations will allow interdealer market making where brokers or other dealers 

act as customers. However, this commenter also requested that the Agencies expressly 

incorporate providing liquidity to other brokers and dealers into the rule text.798 Another 

commenter similarly stated that instead of focusing solely on customer demand, the rule

 

795 See Joint Proposal, 76 FR at 68,960; CFTC Proposal, 77 FR at 8439. More specifically, Appendix B 

stated: “In the context of market making in a security that is executed on an organized trading facility or an 

exchange, a ‘customer’ is any person on behalf of whom a buy or sell order has been submitted by a 

broker-dealer or any other market participant. In the context of market making in a [financial instrument] in 

an OTC market, a ‘customer’ generally would be a market participant that makes use of the market maker’s 

intermediation services, either by requesting such services or entering into a continuing relationship with 

the market maker with respect to such services.” Id. On this last point, the proposal elaborated that in 

certain cases, depending on the conventions of the relevant market (e.g., the OTC derivatives market), such 

a “customer” may consider itself or refer to itself more generally as a “counterparty.” See Joint Proposal, 

76 FR at 68,960 n.2; CFTC Proposal, 77 FR at 8439 n.2.

796 See Joint Proposal, 76 FR at 68,874; CFTC Proposal, 77 FR at 8359. In particular, Question 99 states: 

“Should the terms ‘client,’ ‘customer,’ or ‘counterparty’ be defined for purposes of the market making 

exemption? If so, how should these terms be defined? For example, would an appropriate definition of 

‘customer’ be: (i) A continuing relationship in which the banking entity provides one or more financial 

products or services prior to the time of the transaction; (ii) a direct and substantive relationship between 

the banking entity and a prospective customer prior to the transaction; (iii) a relationship initiated by the 

banking entity to a prospective customer to induce transactions; or (iv) a relationship initiated by the 

prospective customer with a view to engaging in transactions?” Id.

797 Comments on this issue are addressed in Part IV.A.3.c.2.c.i., infra.

798 See SIFMA et al. (Prop. Trading) (Feb. 2012). See also Credit Suisse (Seidel); RBC (requesting that 

the Agencies recognize “wholesale” market making as permissible and representing that “[i]t is irrelevant 

to an investor whether market liquidity is provided by a broker-dealer with whom the investor maintains a 

customer account, or whether that broker-dealer looks to another dealer for market liquidity”).
242

should be clarified to reflect that demand can come from other dealers or future 

customers.799

In response to the proposal’s question about whether the terms “client,” 

“customer,” and “counterparty” should be further defined, a few commenters stated that 

that the terms should not be defined in the rule.800 Other commenters indicated that 

further definition of these terms would be appropriate.801 Some of these commenters 

suggested that there should be greater limitations on who can be considered a “customer” 

under the rule.802 These commenters generally indicated that a “customer” should be a 

person or institution with whom the banking entity has a continuing, or a direct and 

substantive, relationship prior to the time of the transaction.803 In the case of a new 

customer, some of these commenters suggested requiring a relationship initiated by the 

prospective customer with a view to engaging in transactions.804 A few commenters 

indicated that a party should not be considered a client, customer, or counterparty if the 

banking entity: (i) originates a financial product and then finds a counterparty to take the 

other side of the transaction;805 or (ii) engages in transactions driven by algorithmic 

 

799 See Comm. on Capital Markets Regulation.

800 See FTN; ISDA (Feb. 2012); Alfred Brock.

801 See Japanese Bankers Ass’n.; Credit Suisse (Seidel); Occupy; AFR et al. (Feb. 2012); Public Citizen.

802 See AFR et al. (Feb. 2012); Occupy; Public Citizen. One of these commenters also requested that the 

Agencies remove the terms “client” and “counterparty” from the proposed near term demand requirement. 

See Occupy.

803 See AFR et al. (Feb. 2012); Occupy; Public Citizen. These commenters stated that other banking 

entities should never be “customers” under the rule. See id. In addition, one of these commenters would 

further prevent a banking entity’s employees and covered funds from being “customers” under the rule. 

See AFR et al. (Feb. 2012)

804 See AFR et al. (Feb. 2012) (providing a similar definition for the term “client” as well); Public Citizen.

805 See AFR et al. (Feb. 2012); Public Citizen. See also Sens. Merkley & Levin (Feb. 2012) (stating that a 

banking entity’s activities that involve attempting to sell clients financial instruments that it originated, 

rather than facilitating a secondary market for client trades in previously existing financial products, should 
243

trading strategies.806 Three commenters requested more permissive definitions of these 

terms.807 According to one of these commenters, because these terms are listed in the 

disjunctive in the statute, the broadest term – a “counterparty” – should prevail.808 

v. Interdealer trading and trading for price discovery or to test market depth

With respect to interdealer trading, many commenters expressed concern that the 

proposed rule could be interpreted to restrict a market maker’s ability to engage in 

interdealer trading.809 As a general matter, commenters attributed these concerns to 

statements in proposed Appendix B810 or to the Customer-Facing Trade Ratio metric in 

proposed Appendix A.811 A number of commenters requested that the rule be modified 

 be analyzed under the underwriting exemption, not the market-making exemption; in addition, compiling 

inventory of financial instruments that the bank originated should be viewed as proprietary trading).

806 See AFR et al. (Feb. 2012).

807 See Credit Suisse (Seidel) (stating that “customer” should be explicitly defined to include any 

counterparty to whom a banking entity is providing liquidity); ISDA (Feb. 2012) (recommending that, if 

the Agencies decide to define these terms, a “counterparty” should be defined as the entity on the other side 

of a transaction, and the terms “client” and “customer” should not be interpreted to require a relationship 

beyond the isolated provision of a transaction); Japanese Bankers Ass’n. (requesting that it be clearly noted 

that interbank participants can be customers for interbank market makers).

808 See ISDA (Feb. 2012). This commenter’s primary position was that further definitions are not required 

and could create additional and unnecessary complexity. See id.

809 See, e.g., JPMC; Morgan Stanley; Goldman (Prop. Trading); Chamber (Feb. 2012); MetLife; Credit 

Suisse (Seidel); BoA; ACLI (Feb. 2012); RBC; AFR et al. (Feb. 2012); ISDA (Feb. 2012); Oliver Wyman 

(Dec. 2011); Oliver Wyman (Feb. 2012). A few commenters noted that the proposed rule would permit a 

certain amount of interdealer trading. See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012) (citing 

statements in the proposal providing that a market maker’s “customers” vary depending on the asset class 

and market in which intermediation services are provided and interpreting such statements as allowing 

interdealer market making where brokers or other dealers act as “customers” within the proposed 

construct); Goldman (Prop. Trading) (stating that interdealer trading related to hedging or exiting a 

customer position would be permitted, but expressing concern that requiring each banking entity to justify 

each of its interdealer trades as being related to one of its own customers would be burdensome and would 

reduce the effectiveness of the interdealer market). Commenters’ concerns regarding interdealer trading 

are addressed in Part IV.A.3.c.2.c.i., infra. 

810 See infra Part IV.A.3.c.8.

811 See, e.g., JPMC; SIFMA et al. (Prop. Trading) (Feb. 2012); Oliver Wyman (Feb. 2012) (recognizing 

that the proposed rule did not include specific limits on interdealer trading, but expressing concern that 

explicit or implicit limits could be established by supervisors during or after the conformance period).
244

to clearly recognize interdealer trading as a component of permitted market makingrelated activity812 and suggested ways in which this could be accomplished (e.g., through 

a definition of “customer” or “counterparty”).813 

Commenters emphasized that interdealer trading provides certain market benefits, 

including increased market liquidity;814 more efficient matching of customer order 

flow;815 greater hedging options to reduce risks;816 enhanced ability to accumulate 

inventory for current or near term customer demand, work down concentrated positions 

arising from a customer trade, or otherwise exit a position acquired from a customer;817

and general price discovery among dealers.818 Regarding the impact of interdealer 

trading on a market maker’s ability to intermediate customer needs, one commenter 

 

812 See MetLife; SIFMA et al. (Prop. Trading) (Feb. 2012); RBC; Credit Suisse (Seidel); JPMC; BoA; 

ACLI (Feb. 2012); AFR et al. (Feb. 2012); ISDA (Feb. 2012); Goldman (Prop. Trading); Oliver Wyman 

(Feb. 2012).

813 See RBC (suggesting that explicitly incorporating liquidity provision to other brokers and dealers in the 

market-making exemption would be consistent with the statute’s reference to meeting the needs of 

“counterparties,” in addition to the needs of clients and customers); AFR et al. (Feb. 2012) (recognizing 

that the ability to manage inventory through interdealer transactions should be accommodated in the rule, 

but recommending that this activity be conditioned on a market maker having an appropriate level of 

inventory after an interdealer transaction); Goldman (Prop. Trading) (representing that the Agencies could 

evaluate and monitor the amount of interdealer trading that is consistent with a particular trading unit’s 

market making-related or hedging activity through the customer-facing activity category of metrics); Oliver 

Wyman (Feb. 2012) (recommending removal or modification of any metrics or principles that would 

indicate that interdealer trading is not permitted).

814 See Prof. Duffie; MetLife; ACLI (Feb. 2012); BDA (Feb. 2012).

815 See Oliver Wyman (Dec. 2011); Oliver Wyman (Feb. 2012); MetLife; ACLI (Feb. 2012). See also

Thakor Study (stating that, when a market maker provides immediacy to a customer, it relies on being able 

to unwind its positions at opportune times by trading with other market makers, who may have knowledge 

about impending orders form their own customers that may induce them to trade with the market maker).

816 See MetLife; ACLI (Feb. 2012); Goldman (Prop. Trading); Morgan Stanley; Oliver Wyman (Dec. 

2011); Oliver Wyman (Feb. 2012).

817 See Goldman (Prop. Trading); Chamber (Feb. 2012). See also Prof. Duffie (stating that a market maker 

acquiring a position from a customer may wish to rebalance its inventory relatively quickly through the 

interdealer network, which is often more efficient than requesting immediacy from another customer or 

waiting for another customer who wants to take the opposite side of the trade).

818 See Chamber (Feb. 2012); Goldman (Prop. Trading).
245

studied the potential impact of interdealer trading limits – in combination with inventory 

limits – on trading in the U.S. corporate bond market. According to this commenter, if 

interdealer trading had been prohibited and a market maker’s inventory had been limited 

to the average daily volume of the market as a whole, 69 percent of customer trades 

would have been prevented.819 Some commenters stated that a banking entity would be 

less able or willing to provide market-making services to customers if it could not engage 

in interdealer trading.820

As noted above, a few commenters stated that market makers may use interdealer 

trading for price discovery purposes.821 Some commenters separately discussed the 

importance of this activity and requested that, when conducted in connection with 

market-making activity, trading for price discovery be considered permitted market 

making-related activity under the rule.822 Commenters indicated that price discoveryrelated trading results in certain market benefits, including enhancing the accuracy of 

prices for customers,823 increasing price efficiency, preventing market instability,824

 

819 See Oliver Wyman (Feb. 2012) (basing its finding on data from 2009). This commenter also 

represented that the natural level of interdealer volume in the U.S. corporate bond market made up 16 

percent of total trading volume in 2010. See id. 

820 See Goldman (Prop. Trading); Morgan Stanley. See also BDA (Feb. 2012) (stating that if dealers in the 

fixed-income market are not able to trade with other dealers to “cooperate with each other to provide 

adequate liquidity to the market as a whole,” an essential source of liquidity will be eliminated from the 

market and existing values of fixed income securities will decline and become volatile, harming both 

investors who currently hold such positions and issuers, who will experience increased interest costs).

821 See Chamber (Feb. 2012); Goldman (Prop. Trading). 

822 See SIFMA et al. (Prop. Trading) (Feb. 2012); Chamber (Feb. 2012); Goldman (Prop. Trading). One 

commenter provided the following example of such activity: if Security A and Security B have some price 

correlation but neither trades regularly, then a trader may execute a trade in Security A for price discovery 

purposes, using the price of Security A to make an informed bid-ask market to a customer in Security B. 

See SIFMA et al. (Prop. Trading) (Feb. 2012).

823 See Goldman (Prop. Trading); Chamber (Feb. 2012) (stating that this type of trading is necessary in 

more illiquid markets); SIFMA et al. (Prop. Trading) (Feb. 2012).

824 See Goldman (Prop. Trading).
246

improving market liquidity, and reducing overall costs for market participants.825 As a 

converse, one of these commenters stated that restrictions on such activity could result in 

market makers setting their prices too high, exposing them to significant risk and causing 

a reduction of market-making activity or widening of spreads to offset the risk.826 One 

commenter further requested that trading to test market depth likewise be permitted under 

the market-making exemption.827 This commenter represented that the Agencies would 

be able to evaluate the extent to which trading for price discovery and market depth are 

consistent with market making-related activities for a particular market through a 

combination of customer-facing activity metrics, including the Inventory Risk Turnover 

metric, and knowledge of a banking entity’s trading business developed by regulators as 

part of the supervisory process.828

vi. Inventory management

Several commenters requested that the rule provide banking entities with greater 

discretion to manage their inventories in connection with market making-related activity, 

including acquiring or disposing of positions in anticipation of customer demand.829 

Commenters represented that market makers need to be able to build, manage, and 

 

825 See Chamber (Feb. 2012).

826 See id.

827 See Goldman (Prop. Trading). This commenter represented that market makers often make trades with 

other dealers to test the depth of the markets at particular price points and to understand where supply and 

demand exist (although such trading is not conducted exclusively with other dealers). This commenter 

stated that testing the depth of the market is necessary to provide accurate prices to customers, particularly 

when customers Seeks to enter trades in amounts larger than the amounts offered by dealers who have sent 

indications to inter-dealer brokers. See id. 

828 See id.

829 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); Goldman (Prop. Trading); 

MFA; RBC. Inventory management is addressed in Part IV.A.3.c.2.c., infra.
247

maintain inventories to facilitate customer demand. These commenters further stated that 

the rule needs to provide some degree of flexibility for inventory management activities, 

as inventory needs may differ based on market conditions or the characteristics of a 

particular instrument.830 A few commenters cited legislative history in support of 

allowing banking entities to hold and manage inventory in connection with market 

making-related activities.831 Several commenters noted benefits that are associated with 

a market maker’s ability to appropriately manage its inventory, including being able to 

meet reasonably anticipated future client, customer, or counterparty demand;832

accommodating customer transactions more quickly and at favorable prices; reducing 

near term price volatility (in the case of selling a customer block position);833 helping 

maintain an orderly market and provide the best price to customers (in the case of 

accumulating long or short positions in anticipation of a large customer sale or 

purchase);834 ensuring that markets continue to have sufficient liquidity;835 fostering a 

 

830 See, e.g., MFA (stating that it is critical for banking entities to continue to be able to maintain sufficient 

levels of inventory, which is dynamic in nature and requires some degree of flexibility in application); RBC 

(requesting that the Agencies explicitly acknowledge that, depending on market conditions or the 

characteristics of a particular security, it may be appropriate or necessary for a firm to maintain inventories 

over extended periods of time in the course of market making-related activities).

831 See, e.g., RBC; NYSE Euronext; Fidelity. These commenters cited a colloquy in the Congressional 

Record between Senator Bayh and Senator Dodd, in which Senator Bayh stated: “With respect to [section 

13 of the BHC Act], the conference report states that banking entities are not prohibited from purchasing 

and disposing of securities and other instruments in connection with underwriting or market-making 

activities, provided that activity does not exceed the reasonably expected near-term demands of clients, 

customers, or counterparties. I want to clarify this language would allow banks to maintain an appropriate 

dealer inventory and residual risk positions, which are essential parts of the market-making function. 

Without that flexibility, market makers would not be able to provide liquidity to markets.” 156 Cong. Rec. 

S5906 (daily ed. July 15, 2010) (statement of Sen. Bayh).

832 See, e.g., RBC.

833 See Goldman (Prop. Trading).

834 See id.

835 See MFA.
248

two-way market; and establishing a market-making presence.836 Some commenters 

noted that market makers may need to accumulate inventory to meet customer demand 

for certain products or under certain trading scenarios, such as to create units of 

structured products (e.g., ETFs and asset-backed securities)837 and in anticipation of an 

index rebalance.838

Commenters also expressed views with respect to how much discretion a banking 

entity should have to manage its inventory under the exemption and how to best monitor 

inventory levels. For example, one commenter recommended that the rule allow market 

makers to build inventory in products where they believe customer demand will exist, 

regardless of whether the inventory can be tied to a particular customer in the near term 

or to historical trends in customer demand.839 A few commenters suggested that the 

Agencies provide banking entities with greater discretion to accumulate inventory, but 

discourage market makers from holding inventory for long periods of time by imposing 

increasingly higher capital requirements on aged inventory.840 One commenter 

 

836 See RBC.

837 See Goldman (Prop. Trading); BoA.

838 See Oliver Wyman (Feb. 2012). As this commenter explained, some mutual funds and ETFs track 

major equity indices and, when the composition of an index changes (e.g., due to the addition or removal of 

a security or to rising or falling values of listed shares), an announcement is made and all funds tracking the 

index need to rebalance their portfolios. According to the commenter, banking entities may need to step in 

to provide liquidity for rebalances of less liquid indices because trades executed on the open market would 

substantially affect share prices. The commenter estimated that if market makers are not able to provide 

direct liquidity for rebalance trades, investors tracking these indices could potentially pay incremental costs 

of $600 million to $1.8 billion every year. This commenter identified the proposed inventory metrics in 

Appendix A as potentially limiting a banking entity’s willingness or ability to facilitate index rebalance 

trades. See id. Two other commenters also discussed the index rebalancing scenario. See Prof. Duffie; 

Thakor Study. Index rebalancing is addressed in note 931, infra.

839 See Credit Suisse (Seidel).

840 See CalPERS; Vanguard. These commenters represented that placing increasing capital requirements 

on aged inventory would ease the rule’s impact on investor liquidity, allow banking entities to internalize 

the cost of continuing to hold a position at the expense of its ability to take on new positions, and 
249

represented that a trading unit’s inventory management practices could be monitored with 

the Inventory Risk Turnover metric, in conjunction with other metrics.841 

vii. Acting as an authorized participant or market maker in exchange-traded funds

With respect to ETF trading, commenters generally requested clarification that a 

banking entity can serve as an authorized participant (“AP”) to an ETF issuer or can 

engage in ETF market making under the proposed exemption.842 According to 

commenters, APs may engage in the following types of activities with respect to ETFs: 

(i) trading directly with the ETF issuer to create or redeem ETF shares, which involves 

trading in ETF shares and the underlying components;843 (ii) trading to maintain price 

 

potentially decrease the possibility of a firm realizing a loss on a position by decreasing the time such 

position is held. See id. One commenter noted that some banking entities already use this approach to 

manage risk on their market-making desks. See Vanguard. See also Capital Group (suggesting that one 

way to implement the statutory exemption would be to charge a trader or a trading desk for positions held 

on its balance sheet beyond set time periods and to increase the charge at set intervals). These comments 

are addressed in note 923, infra.

841 See Goldman (Prop. Trading) (representing that the Inventory Risk Turnover metric will allow the 

Agencies to evaluate the length of time that a trading unit tends to hold risk positions in inventory and 

whether that holding time is consistent with market making-related activities in the relevant market).

842 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); BoA; ICI (stating that an AP may trade with the ETF issuer in different capacities—in connection 

with traditional market-making activity, on behalf of customers, or for the AP’s own account); ICI Global 

(discussing non-U.S. ETFs specifically); Vanguard; SSgA (Feb. 2012). One commenter represented that an 

AP’s transactions in ETFs do not create risks associated with proprietary trading because, when an AP 

trades with an ETF issuer for its own account, the AP typically enters into an offsetting transaction in the 

underlying portfolio of securities, which cancels out investment risk and limits the AP’s exposure to the 

difference between the market price for ETF shares and the ETF’s net asset value (“NAV”). See Vanguard.

With respect to market-making activity in an ETF, several commenters noted that market makers play an 

important role in maintaining price alignment by engaging in arbitrage transactions between the ETF shares 

and the shares of the underlying components. See, e.g., JPMC; Goldman (Prop. Trading) (making similar

statement with respect to ADRs as well); SSgA (Feb. 2012); SIFMA et al. (Prop. Trading) (Feb. 2012); 

Credit Suisse (Seidel); RBC. AP and market maker activity in ETFs are addressed in Part IV.A.3.c.2.c.i., 

infra.

843 See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA; ICI (Feb. 2012) ICI Global; Vanguard; SSgA 

(Feb. 2012).
250

alignment between the ETF shares and the underlying components;844 (iii) traditional 

market-making activity;845 (iv) “seeding” a new ETF by entering into several initial 

creation transactions with an ETF issuer and holding the ETF shares, possibly for an 

extended period of time, until the ETF establishes regular trading and liquidity in the 

secondary markets;846 (v) “create to lend” transactions, where an AP enters a creation 

transaction with the ETF issuer and lends the ETF shares to an investor;847 and (vi) 

hedging.848 A few commenters noted that an AP may not engage in traditional marketmaking activity in the relevant ETF and expressed concern that the proposed rule may 

limit a banking entity’s ability to act in an AP capacity.849 One commenter estimated that 

APs that are banking entities make up between 20 percent to 100 percent of creation and 

redemption activity for individual ETFs, with an average of approximately 35 percent of 

creation and redemption activity across all ETFs attributed to banking entities. This 

commenter expressed the view that, if the rule limits banking entities’ ability to serve as 

 

844 See JPMC; Goldman (Prop. Trading); SIFMA et al. (Prop. Trading) (Feb. 2012); SSgA (Feb. 2012); ICI 

(Feb. 2012) ICI Global.

845 See ICI Global; ICI (Feb. 2012) SIFMA et al. (Prop. Trading) (Feb. 2012); BoA.

846 See BoA; ICI (Feb. 2012); ICI Global.

847 See BoA (stating that lending the ETF shares to an investor gives the investor a more efficient way to 

hedge its exposure to assets correlated with those underlying the ETF).

848 See ICI Global; ICI (Feb. 2012).

849 See, e.g., Vanguard (noting that APs may not engage in market-making activity in the ETF and 

expressing concern that if AP activities are not separately permitted, banking entities may exit or not enter 

the ETF market); SSgA (Feb. 2012) (stating that APs are under no obligation to make markets in ETF 

shares and requiring such an obligation would discourage banking entities from acting as APs); ICI (Feb. 

2012).
251

APs, then individual investors’ investments in ETFs will become more expensive due to 

higher premiums and discounts versus the ETF’s NAV.850 

A number of commenters stated that certain requirements of the proposed 

exemption may limit a banking entity’s ability to serve as AP to an ETF, including the 

proposed near term customer demand requirement,851 the proposed source of revenue 

requirement,852 and language in the proposal regarding arbitrage trading.853 With respect 

to the proposed near term customer demand requirement, a few commenters noted that 

this requirement could prevent an AP from building inventory to assemble creation 

units.854 Two other commenters expressed the view that the ETF issuer would be the 

banking entity’s “counterparty” when the banking entity trades directly with the ETF 

issuer, so this trading and inventory accumulation would meet the terms of the proposed 

requirement.855 To permit banking entities to act as APs, two commenters suggested that 

 

850 See SSgA (Feb. 2012). This commenter further stated that as of 2011, an estimated 3.5 million – or 3 

percent – of U.S. households owned ETFs and, as of September 2011, ETFs represented assets of 

approximately $951 billion. See id.

851 See BoA; Vanguard (stating that this determination may be particularly difficult in the case of a new 

ETF).

852 See BoA. This commenter noted that the proposed source of revenue requirement could be interpreted 

to prevent a banking entity acting as AP from entering into creation and redemption transactions, “Seeding” 

an ETF, engaging in “create to lend” transactions, and performing secondary market making in an ETF 

because all of these activities require an AP to build an inventory – either in ETF shares or the underlying 

components – which often result in revenue attributable to price movements. See id.

853 Commenters noted that this language would restrict an AP from engaging in price arbitrage to maintain 

efficient markets in ETFs. See Vanguard; RBC; Goldman (Prop. Trading); JPMC; SIFMA et al. (Prop. 

Trading) (Feb. 2012). See supra Part IV.A.3.c.2.a. (discussing the proposal’s proposed interpretation 

regarding arbitrage trading).

854 See BoA; Vanguard (stating that this determination may be particularly difficult in the case of a new 

ETF).

855 See ICI Global; ICI (Feb. 2012).
252

trading in the capacity of an AP should be deemed permitted market making-related 

activity, regardless of whether the AP is acting as a traditional market maker.856 

viii. Arbitrage or other activities that promote price transparency and liquidity

In response to a question in the proposal,857 a number of commenters stated that 

certain types of arbitrage activity should be permitted under the market-making 

exemption.858 For example, some commenters stated that a banking entity’s arbitrage 

activity should be considered market making to the extent the activity is driven by 

creating markets for customers tied to the price differential (e.g., “box” strategies, 

“calendar spreads,” merger arbitrage, “Cash and Carry,” or basis trading)859 or to the 

extent that demand is predicated on specific price relationships between instruments (e.g., 

ETFs, ADRs) that market makers must maintain.860 Similarly, another commenter 

suggested that arbitrage activity that aligns prices should be permitted, such as index 

arbitrage, ETF arbitrage, and event arbitrage.861 One commenter noted that many 

markets, such as futures and options markets, rely on arbitrage activities of market 

makers for liquidity purposes and to maintain convergence with underlying instruments 

 

856 See ICI (Feb. 2012) ICI Global. These commenters provided suggested rule text on this issue and 

suggested that the Agencies could require a banking entity’s compliance policies and internal controls to 

take a comprehensive approach to the entirety of an AP’s trading activity, which would facilitate easy 

monitoring of the activity to ensure compliance. See id.

857 See Joint Proposal, 76 FR at 68,873 (question 91) (inquiring whether the proposed exemption should be 

modified to permit certain arbitrage trading activities engaged in by market makers that promote liquidity 

or price transparency but do not service client, customer, or counterparty demand); CFTC Proposal, 77 FR 

at 8359.

858 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); FTN; RBC; ISDA (Feb. 2012). Arbitrage trading is further discussed in Part IV.A.3.c.2.c.i.,

infra.

859 See SIFMA et al. (Prop. Trading) (Feb. 2012).

860 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC.

861 See Credit Suisse (Seidel).
253

for cash-settled options, futures, and index-based products.862 Commenters stated that 

arbitrage trading provides certain market benefits, including enhanced price 

transparency,863 increased market efficiency,864 greater market liquidity,865 and general 

benefits to customers.866 A few commenters noted that certain types of hedging activity 

may appear to have characteristics of arbitrage trading.867 

Commenters suggested certain methods for permitting and monitoring arbitrage 

trading under the exemption. For example, one commenter suggested a framework for 

permitting certain arbitrage within the market-making exemption, with requirements such 

as: (i) common personnel with market-making activity; (ii) policies that cover the timing 

and appropriateness of arbitrage positions; (iii) time limits on arbitrage positions; and (iv) 

compensation that does not reward successful arbitrage, but instead pools any such 

revenues with market-making profits and losses.868 A few commenters represented that, 

if permitted under the rule, the Agencies would be able to monitor arbitrage activities for 

 

862 See RBC.

863 See SIFMA et al. (Prop. Trading) (Feb. 2012).

864 See Credit Suisse (Seidel); RBC.

865 See RBC.

866 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC; FTN; ISDA (Feb. 2012) (stating that arbitrage 

activities often yield positions that are ultimately put to use in serving customer demand and representing 

that the process of consistently trading makes a dealer ready and available to serve customers on a 

competitive basis).

867 See JPMC (stating that firms commonly organize their market-making activities so that risks delivered 

to client-facing desks are aggregated and transferred by means of internal transactions to a single utility 

desk (which hedges all of the risks in the aggregate), and this may optically bear some characteristics of 

arbitrage, although the commenter requested that such activity be recognized as permitted market makingrelated activity under the rule); ISDA (Feb. 2012) (stating that in some swaps markets, dealers hedge 

through multiple instruments, which can give an impression of arbitrage in a function that is risk reducing; 

for example, a dealer in a broad index equity swap may simultaneously hedge in baskets of stocks, futures, 

and ETFs). But See Sens. Merkley & Levin (Feb. 2012) (“When banks use complex hedging techniques or 

otherwise engage in trading that is suggestive of arbitrage, regulators should require them to provide 

evidence and analysis demonstrating what risk is being reduced.”).

868 See FTN.
254

patterns of impermissible proprietary trading through the use of metrics, as well as 

compliance and examination tools.869 

Other commenters stated that the exemption should not permit certain types of 

arbitrage. One commenter stated that the rule should ensure that relative value and 

complex arbitrage strategies cannot be conducted.870 Another commenter expressed the 

view that the market-making exemption should not permit any type of arbitrage 

transactions. This commenter stated that, in the event that liquidity or transparency is 

inhibited by a lack of arbitrage trading, a market maker should be able to find a customer 

who would seek to benefit from it.871

ix. Primary dealer activities

A number of commenters requested that the market-making exemption permit 

banking entities to meet their primary dealer obligations in foreign jurisdictions, 

particularly if trading in foreign sovereign debt is not separately exempted in the final 

rule.872 According to commenters, a banking entity may be obligated to perform the 

following activities in its capacity as a primary dealer: undertaking to maintain an orderly 

 

869 See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC; Goldman (Prop. Trading). One of these 

commenters stated that the customer-facing activity category of metrics, as well as other metrics, would be 

available to evaluate whether the trading unit is engaged in a directly customer-facing business and the 

extent to which its activities are consistent with the market-making exemption. See Goldman (Prop. 

Trading).

870 See Johnson & Prof. Stiglitz. See also AFR et al. (Feb. 2012) (noting that arbitrage, spread, or carry 

trades are a classic type of proprietary trade).

871 See Occupy.

872 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012) (stating that permitted activities should include 

trading necessary to meet the relevant jurisdiction’s primary dealer and other requirements); JPMC

(indicating that the exemption should cover all of a firm’s activities that are necessary or reasonably 

incidental to its acting as a primary dealer in a foreign government’s debt securities); Goldman (Prop. 

Trading); Banco de México; IIB/EBF. See infra notes 905 to 906 and accompanying text (addressing these

comments).
255

market, preventing or correcting any price dislocations,873 and bidding on each issuance 

of the relevant jurisdiction’s sovereign debt.874 Commenters expressed concern that a 

banking entity’s trading activity as primary dealer may not comply with the proposed 

near term customer demand requirement875 or the proposed source of revenue 

requirement.876 To address the first issue, one commenter stated that the final rule should 

clarify that a banking entity acting as a primary dealer of foreign sovereign debt is 

engaged in primary dealer activity in response to the near term demands of the sovereign, 

which should be considered a client, customer, or counterparty of the banking entity.877

Another commenter suggested that the Agencies permit primary dealer activities through 

commentary stating that fulfilling primary dealer obligations will not be included in 

determinations of whether the market-making exemption applies to a trading unit.878

x. New or bespoke products or customized hedging contracts

Several commenters indicated that the proposed exemption does not adequately 

address market making in new or bespoke products, including structured, customerdriven transactions, and requested that the rule be modified to clearly permit such 

 

873 See Goldman (Prop. Trading).

874 See Banco de México.

875 See JPMC; Banco de México. These commenters stated that a primary dealer is required to assume 

positions in foreign sovereign debt even when near term customer demand is unpredictable. See id.

876 See Banco de México (stating that primary dealers need to be able to profit from their positions in 

sovereign debt, including by holding significant positions in anticipation of future price movements, so that 

the primary dealer business is financially attractive); IIB/EBF (stating that primary dealers may actively 

Seek to profit from price and interest rate movements based on their debt holdings, which governments 

support as providing much-needed liquidity for securities that are otherwise purchased largely pursuant to 

buy-and-hold strategies of institutional investors and other entities Seeking safe returns and liquidity 

buffers).

877 See Goldman (Prop. Trading).

878 See SIFMA et al. (Prop. Trading) (Feb. 2012).
256

activity.879 Many of these commenters emphasized the role such transactions play in 

helping customers hedge the unique risks they face.880 Commenters stated that, as a 

result, limiting a banking entity’s ability to conduct such transactions would subject 

customers to increased risks and greater transaction costs.881 One commenter suggested 

that the Agencies explicitly state that a banking entity’s general willingness to engage in 

bespoke transactions is sufficient to make it a market maker in unique products for 

purposes of the rule.882

Other commenters stated that banking entities should be limited in their ability to 

rely on the market-making exemption to conduct transactions in bespoke or customized 

derivatives.883 For example, one commenter suggested that a banking entity be required 

to disaggregate such derivatives into liquid risk elements and illiquid risk elements, with 

liquid risk elements qualifying for the market-making exemption and illiquid risk 

elements having to be conducted on a riskless principal basis under § __.6(b)(1)(ii) of the 

proposed rule. According to this commenter, such an approach would not impact the end 

user customer.884 Another commenter stated that a banking entity making a market in 

bespoke instruments should be required both to hold itself out in accordance with § 

 

879 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); JPMC; Goldman (Prop. 

Trading); SIFMA (Asset Mgmt.) (Feb. 2012). This issue is addressed in Part IV.A.3.c.1.c.iii., supra, and 

Part IV.A.3.c.2.c.iii., infra. 

880 See Credit Suisse (Seidel); Goldman (Prop. Trading); SIFMA (Asset Mgmt.) (Feb. 2012).

881 See Goldman (Prop. Trading); SIFMA (Asset Mgmt.) (Feb. 2012).

882 See SIFMA (Asset Mgmt.) (Feb. 2012).

883 See AFR et al. (Feb. 2012); Public Citizen.

884 See AFR et al. (Feb. 2012)
257

__.4(b)(2)(ii) of the proposed rule and to demonstrate the purchase and the sale of such 

an instrument.885

c. Final near term customer demand requirement

Consistent with the statute, § __.4(b)(2)(ii) of the final rule’s 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.886 As discussed above in Part IV.A.3.c.1.c.ii., the 

trading desk’s market-maker inventory consists of positions in financial instruments in 

which the trading desk stands ready to purchase and sell consistent with the final rule.887 

The final rule requires the financial instruments to be identified in the trading desk’s 

compliance program. Thus, this requirement focuses on a trading desk’s positions in 

financial instruments for which it acts as market maker. These positions of a trading desk 

are more directly related to the demands of customers than positions in financial 

instruments used for risk management purposes, but in which the trading desk does not 

make a market. As noted above, a position or exposure that is included in a trading 

desk’s market-maker inventory will remain in its market-maker inventory for as long as 

the position or exposure is managed by the trading desk. As a result, the trading desk

must continue to account for that position or exposure, together with other positions and 

 

885 See Public Citizen.

886 The final rule includes certain refinements to the proposed standard, which would have required that the 

market making-related activities of the trading desk or other organizational unit that conducts the purchase 

or sale are, with respect to the financial instrument, designed not to exceed the reasonably expected near 

term demands of clients, customers, or counterparties. See proposed rule § __.4(b)(2)(iii).

887 See supra Part IV.A.3.c.1.c.ii.; final rule § __.4(b)(5). 
258

exposures in its market-maker inventory, in determining whether the amount, types, and 

risks of its market-maker inventory are designed not to exceed, on an ongoing basis, the 

reasonably expected near term demands of customers. 

While the near term customer demand requirement directly applies only to the 

trading desk’s market-maker inventory, this does not mean a trading desk may establish 

other positions, outside its market-maker inventory, that exceed what is needed to 

manage the risks of the trading desk’s market making-related activities and inventory. 

Instead, a trading desk must have limits on its market-maker inventory, the products, 

instruments, and exposures the trading desk may use for risk management purposes, and 

its aggregate financial exposure that are based on the factors set forth in the near term 

customer demand requirement, as well as other relevant considerations regarding the 

nature and amount of the trading desk’s market making-related activities. A banking 

entity must establish, implement, maintain, and enforce a limit structure, as well as other 

compliance program elements (e.g., those specifying the instruments a trading desk trades 

as a market maker or may use for risk management purposes and providing for specific 

risk management procedures), for each trading desk that are designed to prevent the 

trading desk from engaging in trading activity that is unrelated to making a market in a 

particular type of financial instrument or managing the risks associated with making a 

market in that type of financial instrument.888 

To clarify the application of this standard in response to comments,889 the final 

rule provides two factors for assessing whether the amount, types, and risks of the 

 

888 See infra Part IV.A.3.c.3. (discussing the compliance program requirements); final rule § __.4(b)(2)(iii).

889 See supra Part IV.A.3.c.2.b.i.
259

financial instruments in the trading desk’s market-maker inventory are designed not to 

exceed, on an ongoing basis, the reasonably expected near term demands of clients, 

customers, or counterparties. Specifically, the following must be considered under the 

revised standard: (i) the liquidity, maturity, and depth of the market for the relevant type 

of financial instrument(s),890 and (ii) demonstrable analysis of historical customer 

demand, current inventory of financial instruments, and market and other factors 

regarding the amount, types, and risks of or associated with positions in financial 

instruments in which the trading desk makes a market, including through block trades. 

Under the final rule, a banking entity must account for these considerations when 

establishing risk and inventory limits for each trading desk.891 

For purposes of this provision, “demonstrable analysis” means that the analysis 

for determining the amount, types, and risks of financial instruments a trading desk may 

manage in its market-maker inventory, in accordance with the near term demand 

requirement, must be based on factors that can be demonstrated in a way that makes the 

analysis reviewable. This may include, among other things, the normal trading records of 

the trading desk and market information that is readily available and retrievable. If the 

analysis cannot be supported by the banking entity’s books and records and available 

market data, on their own, then the other factors utilized must be identified and 

 

890 This language has been added to the final rule to respond to commenters’ concerns that the proposed 

near term demand requirement would be unworkable in less liquid markets or would otherwise restrict a 

market maker’s ability to hold and manage its inventory in less liquid markets. See supra Part 

IV.A.3.c.2.b.ii. In addition, this provision is substantially similar to one commenter’s suggested approach 

of adding the phrase “based on the characteristics of the relevant market and asset class” to the proposed 

requirement, but the Agencies have added more specificity about the relevant characteristics that should be 

taken into consideration. See Morgan Stanley. 

891 See infra Part IV.A.3.c.3.
260

documented and the analysis of those factors together with the facts gathered from the 

trading and market records must be identified in a way that makes it possible to test the 

analysis. 

Importantly, a determination of whether a trading desk’s market-maker inventory 

is appropriate under this requirement will take into account reasonably expected near 

term customer demand, including historical levels of customer demand, expectations 

based on market factors, and current demand. For example, at any particular time, a 

trading desk may acquire a position in a financial instrument in response to a customer’s 

request to sell the financial instrument or in response to reasonably expected customer 

buying interest for such instrument in the near term.892 In addition, as discussed below, 

this requirement is not intended to impede a trading desk’s ability to engage in certain 

market making-related activities that are consistent with and needed to facilitate 

permissible trading with its clients, customers, or counterparties, such as inventory 

management and interdealer trading. These activities must, however, be consistent with 

the analysis conducted under the final rule and the trading desk’s limits discussed 

below.893 Moreover, as explained below, the banking entity must also have in place 

escalation procedures to address, analyze, and document trades made in response to 

customer requests that would exceed one of a trading desk’s limits. 

 

892 As discussed further below, acquiring a position in a financial instrument in response to reasonably 

expected customer demand would not include creating a structured product for which there is no current 

customer demand and, instead, soliciting customer demand during or after its creation. See infra note 938 

and accompanying text; Sens. Merkley & Levin (Feb. 2012).

893 The formation of structured finance products and securitizations is discussed in detail in Part IV.B.2.b.

of this Supplementary Information.
261

The near term demand requirement is an ongoing requirement that applies to the 

amount, types, and risks of the financial instruments in the trading desk’s market-maker 

inventory. For instance, a trading desk may acquire exposures as a result of entering into 

market-making transactions with customers that are within the desk’s market-marker 

inventory and financial exposure limits. Even if the trading desk is appropriately 

managing the risks of its market-maker inventory, its market-maker inventory still must 

be consistent with the analysis of the reasonably expected near term demands of clients, 

customers, and counterparties and the liquidity, maturity and depth of the market for the 

relevant instruments in the inventory. Moreover, the trading desk must take action to 

ensure that its financial exposure does not exceed its financial exposure limits.894 A 

trading desk may not maintain an exposure in its market-maker inventory, irrespective of 

customer demand, simply because the exposure is hedged and the resulting financial 

exposure is below the desk’s financial exposure limit. In addition, the amount, types, and 

risks of financial instruments in a trading desk’s market-maker inventory would not be 

consistent with permitted market-making activities if, for example, the trading desk has a 

pattern or practice of retaining exposures in its market-maker inventory, while refusing to 

engage in customer transactions when there is customer demand for those exposures at 

commercially reasonable prices. 

The following is an example of the interplay between a trading desk’s marketmaker inventory and financial exposure. An airline company customer may seek to 

hedge its long-term exposure to price fluctuations in jet fuel by asking a banking entity to 

create a structured ten-year, $1 billion jet fuel swap for which there is no liquid market.

 

894 See final rule § __.4(b)(2)(iii)(B), (C).
262

A trading desk that makes a market in energy swaps may service its customer’s needs by 

executing a custom jet fuel swap with the customer and holding the swap in its marketmaker inventory, if the resulting transaction does not cause the trading desk to exceed its 

market-maker inventory limit on the applicable class of instrument, or the trading desk 

has received approval to increase the limit in accordance with the authorization and 

escalation procedures under paragraph (b)(2)(iii)(E). In keeping with the market-making 

exemption as provided in the final rule, the trading desk would be required to hedge the 

risk from this swap, either individually or as part of a set of aggregated positions, if the 

trade would result in a financial exposure that exceeds the desk’s financial exposure 

limits. The trading desk may hedge the risk of the swap, for example, by entering into 

one or more futures or swap positions that are identified as permissible hedging products, 

instruments, or exposures in the trading desk’s compliance program and that analysis, 

including correlation analysis as appropriate, indicates would demonstrably reduce or 

otherwise significantly mitigate risks associated with the financial exposure from its 

market-making activities. Alternatively, if the trading desk also acts as a market maker in 

crude oil futures, then the desk’s exposures arising from its market-making activities may 

naturally hedge the jet fuel swap (i.e., it may reduce its financial exposure levels resulting 

from such instruments). 895 The trading desk must continue to appropriately manage risks 

of its financial exposure over time in accordance with its financial exposure limits.

As discussed above, several commenters expressed concern that the near-term 

customer demand requirement is too restrictive and that it could impede a market maker’s 

 

895 This natural hedge with futures would introduce basis risk which, like other risks of the trading desk, 

must be managed within the desk’s limits.
263

ability to build or retain inventory, particularly in less liquid markets where demand is 

intermittent.896 Because customer demand in illiquid markets can be difficult to predict 

with precision, market-maker inventory may not closely track customer order flow. The 

Agencies acknowledge that market makers will face costs associated with demonstrating 

that market-maker inventory is designed not to exceed, on an ongoing basis, the 

reasonably expected near term demands of customers, as required by the statute and the 

final rule because this is an analysis that banking entities may not currently undertake. 

However, the final rule includes certain modifications to the proposed rule that are 

intended to reduce the negative impacts cited by commenters, such as limitations on 

inventory management activity and potential restrictions on market making in less liquid 

instruments, which the Agencies believe should reduce the perceived burdens of the 

proposed near term demand requirement. For example, the final rule recognizes that 

liquidity, maturity, and depth of the market vary across asset classes. The Agencies 

expect that the express recognition of these differences in the rule should avoid unduly 

impeding a market maker’s ability to build or retain inventory. More specifically, the 

Agencies recognize the relationship between market-maker inventory and customer order 

flow can vary across asset classes and that an inflexible standard for demonstrating that 

inventory does not exceed reasonably expected near term demand could provide an 

incentive to stop making markets in illiquid asset classes.

i. Definition of “client,” “customer,” and “counterparty”

 

896 See SIFMA (Asset Mgmt.) (Feb. 2012); T. Rowe Price; CIEBA; ICI (Feb. 2012) RBC.
264

In response to comments requesting further definition of the terms “client,” 

“customer,” and “counterparty” for purposes of this standard,897 the Agencies have 

defined these terms in the final rule. In particular, the final rule defines “client,” 

“customer,” and “counterparty” as, on a collective or individual basis, “market 

participants that make use of the banking entity’s market making-related services by 

obtaining such services, responding to quotations, or entering into a continuing 

relationship with respect to such services.”898 However, for purposes of the analysis 

supporting the market-maker inventory held to meet the reasonably expected near-term 

demands of clients, customer and counterparties, a client, customer, or counterparty of 

the trading desk does not include a trading desk or other organizational unit of another 

entity if that entity has $50 billion or more in total trading assets and liabilities, measured 

in accordance with § __.20(d)(1),899 unless the trading desk documents how and why 

such trading desk or other organizational unit should be treated as a customer or the 

transactions are conducted anonymously on an exchange or similar trading facility that 

permits trading on behalf of a broad range of market participants.900

 

897 See Japanese Bankers Ass’n.; Credit Suisse (Seidel); Occupy; AFR et al. (Feb. 2012); Public Citizen.

898 Final rule § __.4(b)(3).

899 See final rule § __.4(b)(3)(i). The Agencies are using a $50 billion threshold for these purposes in 

recognition that firms engaged in substantial trading activity do not typically act as customers to other 

market makers, while smaller regional firms may Seek liquidity from larger firms as part of their market 

making-related activities.

900 See final rule § __.4(b)(3)(i)(A), (B). In Appendix C of the proposed rule, a trading unit engaged in 

market making-related activities would have been required to describe how it identifies its customers for 

purposes of the Customer-Facing Trading Ratio, if applicable, including documentation explaining when, 

how, and why a broker-dealer, swap dealer, security-based swap dealer, or any other entity engaged in 

market making-related activities, or any affiliate thereof, is considered to be a customer of the trading unit. 

See Joint Proposal, 76 FR at 68,964. While the proposed approach would not have necessarily prevented 

any of these entities from being considered a customer of the trading desk, it would have required enhanced 

documentation and justification for treating any of these entities as a customer. The final rule’s exclusion 

from the definition of client, customer, and counterparty is similar to the proposed approach, but is more 
265

The Agencies believe this definition is generally consistent with the proposed 

interpretation of “customer” in the proposal. The proposal generally provided that, for 

purposes of market making on an exchange or other organized trading facility, a customer 

is any person on behalf of whom a buy or sell order has been submitted. In the context of 

the over-the-counter market, a customer was generally considered to be a market 

participant that makes use of the market maker’s intermediation services, either by 

requesting such services or entering into a continuing relationship for such services.901 

The definition of client, customer, and counterparty in the final rule recognizes that, in 

the context of market making in a financial instrument that is executed on an exchange or 

other organized trading facility, a client, customer, or counterparty would be any person 

whose buy or sell order executes against the banking entity’s quotation posted on the 

exchange or other organized trading facility.902 Under these circumstances, the person 

would be trading with the banking entity in response to the banking entity’s quotations 

and obtaining the banking entity’s market making-related services. In the context of 

market making in a financial instrument in the OTC market, a client, customer, or 

counterparty generally would be a person that makes use of the banking entity’s 

intermediation services, either by requesting such services (possibly via a request-forquote on an established trading facility) or entering into a continuing relationship with the 

banking entity with respect to such services. For purposes of determining the reasonably 

expected near-term demands of customers, a client, customer, or counterparty generally 

 narrowly focused on firms that have $50 billion or more trading assets and liabilities because, as noted 

above, the Agencies believe firms engaged in such substantial trading activity are less likely to act as 

customers to market makers than smaller regional firms. 

901 See Joint Proposal, 76 FR at 68,960; CFTC Proposal, 77 FR at 8439. 

902 See, e.g., Goldman (Prop. Trading) (explaining generally how exchange-based market makers operate).
266

would not include a trading desk or other organizational unit of another entity that has 

$50 billion or more in total trading assets except if the trading desk has a documented 

reason for treating the trading desk or other organizational unit of such entity as a 

customer or the trading desk’s transactions are executed anonymously on an exchange or 

similar trading facility that permits trading on behalf of a broad range of market 

participants. The Agencies believe that this exclusion balances commenters’ suggested 

alternatives of either defining as a client, customer, or counterparty anyone who is on the 

other side of a market maker’s trade903 or preventing any banking entity from being a 

client, customer, or counterparty.904 The Agencies believe that the first alternative is 

overly broad and would not meaningfully distinguish between permitted market makingrelated activity and impermissible proprietary trading. For example, the Agencies are 

concerned that such an approach would allow a trading desk to maintain an outsized 

inventory and to justify such inventory levels as being tangentially related to expected 

market-wide demand. On the other hand, preventing any banking entity from being a 

client, customer, or counterparty under the final rule would result in an overly narrow 

definition that would significantly impact banking entities’ ability to provide and access 

market making-related services. For example, most banks look to market makers to 

provide liquidity in connection with their investment portfolios. 

The Agencies further note that, with respect to a banking entity that acts as a 

primary dealer (or functional equivalent) for a sovereign government, the sovereign 

 

903 See ISDA (Feb. 2012). In addition, a number of commenters suggested that the rule should not limit 

broker-dealers from being customers of a market maker. See SIFMA et al. (Prop. Trading) (Feb. 2012); 

Credit Suisse (Seidel); RBC; Comm. on Capital Markets Regulation.

904 See AFR et al. (Feb. 2012); Occupy; Public Citizen.
267

government and its central bank are each a client, customer, or counterparty for purposes 

of the market-making exemption as well as the underwriting exemption.905 The Agencies 

believe this interpretation, together with the modifications in the rule that eliminate the 

requirement to distinguish between revenues from spreads and price appreciation and the 

recognition that the market-making exemption extends to market making-related 

activities appropriately captures the unique relationship between a primary dealer and the 

sovereign government. Thus, generally a banking entity may rely on the market-making 

exemption for its activities as primary dealer (or functional equivalent) to the extent those 

activities are outside of the underwriting exemption.906 

For exchange-traded funds (“ETFs”) (and related structures), Authorized 

Participants (“APs”) are generally the conduit for market participants seeking to create or 

 

905 A primary dealer is a firm that trades a sovereign government’s obligations directly with the sovereign 

(in many cases, with the sovereign’s central bank) as well as with other customers through market making. 

The sovereign government may impose conditions on a primary dealer or require that it engage in certain 

trading in the relevant government obligations (e.g., participate in auctions for the government obligation or 

maintain a liquid secondary market in the government obligations). Further, a sovereign government may 

limit the number of primary dealers that are authorized to trade with the sovereign. A number of countries 

use a primary dealer system, including Australia, Brazil, Canada, China-Hong Kong, France, Germany, 

Greece, India, Indonesia, Ireland, Italy, Japan, Mexico, Netherlands, Portugal, South Africa, South Korea, 

Spain, Turkey, the U.K., and the U.S. See, e.g., Oliver Wyman (Feb. 2012). The Agencies note that this 

standard would similarly apply to the relationship between a banking entity and a sovereign that does not 

have a formal primary dealer system, provided the sovereign’s process functions like a primary dealer 

framework. 

906 See Goldman (Prop. Trading). See also supra Part IV.A.3.c.2.b.ix. (discussing commenters’ concerns 

regarding primary dealer activity). Each suggestion regarding the treatment of primary dealer activity has 

not been incorporated into the rule. Specifically, the exemption for market making as applied to a primary 

dealer does not extend without limitation to primary dealer activities that are not conducted under the 

conditions of one of the exemptions. These interpretations would be inconsistent with Congressional intent 

for the statute, to limit permissible market- making activity through the statute’s near term demand 

requirement and, thus, does not permit trading without limitation. See SIFMA et al. (Prop. Trading) (Feb. 

2012) (stating that permitted activities should include trading necessary to meet the relevant jurisdiction’s 

primary dealer and other requirements); JPMC (indicating that the exemption should cover all of a firm’s 

activities that are necessary or reasonably incidental to its acting as a primary dealer in a foreign 

government’s debt securities); Goldman (Prop. Trading); Banco de México; IIB/EBF. Rather, recognizing 

that market making by primary dealers is a key function, the limits and other conditions of the rule are 

flexible enough to permit necessary market making-related activities.
268

redeem shares of the fund (or equivalent structure).907 For example, an AP may buy ETF 

shares from market participants who would like to redeem those shares for cash or a 

basket of instruments upon which the ETF is based. To provide this service, the AP may 

in turn redeem these shares from the ETF itself. Similarly, an AP may receive cash or 

financial instruments from a market participant seeking to purchase ETF shares, in which 

case the AP may use that cash or set of financial instruments to create shares from the 

ETF. In either case, for the purpose of the market-making exemption, such market 

participants as well as the ETF itself would be considered clients, customers, or 

counterparties of the AP.908 The inventory of ETF shares or underlying instruments held 

by the AP can therefore be evaluated under the criteria of the market-making exemption, 

such as how these holdings relate to reasonably expected near term customer demand.909 

 

907 ETF sponsors enter into relationships with one or more financial institutions that become APs for the 

ETF. Only APs are permitted to purchase and redeem shares directly from the ETF, and they can do so 

only in large aggregations or blocks that are commonly called “creation units.” In response to a question in 

the proposal, a number of commenters expressed concern that the proposed market-making exemption may 

not permit certain AP and market maker activities in ETFs and requested clarification that these activities 

would be permitted under the market-making exemption. See Joint Proposal, 76 FR at 68,873 (question 91) 

(“Do particular markets or instruments, such as the market for exchange-traded funds, raise particular 

issues that are not adequately or appropriately addressed in the proposal? If so, how could the proposal 

better address those instruments, markets or market features?”); CFTC Proposal, 77 FR at 8359 (question 

91); supra Part IV.A.3.c.2.b.vii. (discussing comments on this issue).

908 This is consistent with two commenters’ request that an ETF issuer be considered a “counterparty” of 

the banking entity when it trades directly with the ETF issuer as an AP. See ICI Global; ICI (Feb. 2012). 

Further, this approach is intended to address commenters’ concerns that the near term demand requirement 

may limit a banking entity’s ability to act as AP for an ETF. See BoA; Vanguard. The Agencies believe 

that one commenter’s concern about the impact of the proposed source of revenue requirement on AP 

activity should be addressed by the replacement of this proposed requirement with a metric-based focus on 

when a trading desk generates revenue from its trading activity. See BoA; infra Part IV.A.3.c.7.c.

(discussing the new approach to assessing a trading desk’s pattern of profit and loss). 

909 This does not imply that the AP must perfectly predict future customer demand, but rather that there is a 

demonstrable, statistical, or historical basis for the size of the inventory held, as more fully discussed 

below. Consider, for example, a fixed-income ETF with $500 million in assets. If, on a typical day, an AP 

generates requests for $10 to $20 million of creations or redemptions, then an inventory of $10 to $20 

million in bonds upon which the ETF is based (or some small multiple thereof) could be construed as 

consistent with reasonably expected near term customer demand. On the other hand, if under the same 

circumstances an AP holds $1 billion of these bonds solely in its capacity as an AP for this ETF, it would 
269

These criteria can be similarly applied to other activities of the AP, such as building 

inventory to “seed” a new ETF or engaging in ETF-loan related transactions.910 The 

Agencies recognize that banking entities currently conduct a substantial amount of AP 

creation and redemption activity in the ETF market and, thus, if the rule were to prevent 

or restrict a banking entity from acting as an AP for an ETF, then the rule would impact 

the functioning of the ETF market.911

Some firms, whether or not an AP in a given ETF, may also actively engage in 

buying and selling shares of an ETF and its underlying instruments in the market to 

maintain price continuity between the ETF and its underlying instruments, which are 

exchangeable for one another. Sometimes these firms will register as market makers on 

an exchange for a given ETF, but other times they may not register as market maker. 

Regardless of whether or not the firm is registered as a market maker on any given 

exchange, this activity not only provides liquidity for ETFs, but also, and very 

importantly, helps keep the market price of an ETF in line with the NAV of the fund. 

The market-making exemption can be used to evaluate trading that is intended to 

 be more difficult to justify this as needed for reasonably expected near term customer demand and may be 

indicative of an AP engaging in prohibited proprietary trading.

910 In ETF loan transactions (also referred to as “create-to-lend” transactions), an AP borrows the 

underlying instruments that form the creation basket of an ETF, submits the borrowed instruments to the 

ETF agent in exchange for a creation unit of ETF shares, and lends the resulting ETF shares to a customer 

that wants to borrow the ETF. At the end of the ETF loan, the borrower returns the ETF shares to the AP, 

and the AP redeems the ETF shares with the ETF agent in exchange for the underlying instruments that 

form the creation basket. The AP may return the underlying instruments to the parties from whom it 

borrowed them or may use them for another loan, as long as the AP is not obligated to return them at that 

time. For the term of the ETF loan transaction, the AP hedges against market risk arising from any 

rebalancing of the ETF, which would change the amount or type of underlying instruments the AP would 

receive in exchange for the ETF compared to the underlying instruments the AP borrowed and submitted to 

the ETF agent to create the ETF shares. See David J. Abner, The ETF Handbook, Ch. 12 (2010); Jean M. 

McLoughlin, Davis Polk & Wardwell LLP, to Division of Corporation Finance, U.S. Securities and 

Exchange Commission, dated Jan. 23, 2013, available at http://www.sec.gov/divisions/corpfin/cfnoaction/2013/davis-polk-wardwell-llp-012813-16a.pdf. 

911 See SSgA (Feb. 2012).
270

maintain price continuity between these exchangeable instruments by considering how 

the firm quotes, maintains risk and exposure limits, manages its inventory and risk, and, 

in the case of APs, exercises its ability to create and redeem shares from the fund. 

Because customers take positions in ETFs with an expectation that the price relationship 

will be maintained, such trading can be considered to be market making-related 

activity.912 

After considering comments, the Agencies continue to take the view that a trading 

desk would not qualify for the market-making exemption if it is wholly or principally 

engaged in arbitrage trading or other trading that is not in response to, or driven by, the 

demands of clients, customers, or counterparties.913 The Agencies believe this activity, 

which is not in response to or driven by customer demand, is inconsistent with the 

Congressional intent that market making-related activity be designed not to exceed the 

reasonably expected near term demands of clients, customers, or counterparties. For 

example, a trading desk would not be permitted to engage in general statistical arbitrage 

trading between instruments that have some degree of correlation but where neither 

instrument has the capability of being exchanged, converted, or exercised for or into the 

 

912 A number of commenters expressed concern that the proposed rule would limit market making or AP 

activity in ETFs because market makers and APs engage in trading to maintain a price relationship between 

ETFs and their underlying components, which promotes ETF market efficiency. See Vanguard; RBC; 

Goldman (Prop. Trading); JPMC; SIFMA et al. (Prop. Trading) (Feb. 2012); SSgA (Feb. 2012); Credit 

Suisse (Prop. Trading).

913 Some commenters suggested that a range of arbitrage trading should be permitted under the marketmaking exemption. See, e.g., Goldman (Prop. Trading); RBC; SIFMA et al. (Prop. Trading) (Feb. 2012); 

JPMC. Other commenters, however, stated that arbitrage trading should be prohibited under the final rule. 

See AFR et al. (Feb. 2012); Volcker; Occupy. In response to commenters representing that it would be 

difficult to comply with this standard because it requires a trading desk to determine the proportionality of 

its activities in response to customer demand compared to its activities that are not in response to customer 

demand, the Agencies believe that the statute requires a banking entity to distinguish between market 

making-related activities that are designed not to exceed the reasonably expected near term demands of 

customers and impermissible proprietary trading. See Goldman (Prop. Trading); RBC.
271

other instrument. A trading desk may, however, act as market maker to a customer 

engaged in a statistical arbitrage trading strategy. Furthermore as suggested by some

commenters,914 trading activity used by a market maker to maintain a price relationship 

that is expected and relied upon by clients, customers, and counterparties is permitted as 

it is related to the demands of clients, customers, or counterparties because the relevant 

instrument has the capability of being exchanged, converted, or exercised for or into 

another instrument.915

The Agencies recognize that a trading desk, in anticipating and responding to 

customer needs, may engage in interdealer trading as part of its inventory management 

activities and that interdealer trading provides certain market benefits, such as more 

efficient matching of customer order flow, greater hedging options to reduce risk, and 

enhanced ability to accumulate or exit customer-related positions.916 The final rule does 

not prohibit a trading desk from using the market-making exemption to engage in 

interdealer trading that is consistent with and related to facilitating permissible trading 

with the trading desk’s clients, customers, or counterparties.917 However, in determining 

 

914 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC.

915 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC; Credit Suisse (Seidel). For example, 

customers have an expectation of general price alignment under these circumstances, both at the time they 

decide to invest in the instrument and for the remaining time they hold the instrument. To the contrary, 

general statistical arbitrage does not maintain a price relationship between related instruments that is 

expected and relied upon by customers and, thus, is not permitted under the market-making exemption. 

Firms engage in general statistical arbitrage to profit from differences in market prices between 

instruments, assets, or price or risk elements associated with instruments or assets that are thought to be 

statistically related, but which do not have a direct relationship of being exchangeable, convertible, or 

exercisable for the other.

916 See MetLife; ACLI (Feb. 2012); Goldman (Prop. Trading); Morgan Stanley; Chamber (Feb. 2012); 

Prof. Duffie; Oliver Wyman (Dec. 2011); Oliver Wyman (Feb. 2012).

917 A number of commenters requested that the rule be modified to clearly recognize interdealer trading as 

a component of permitted market making-related activity. See MetLife; SIFMA et al. (Prop. Trading) (Feb. 

2012); RBC; Credit Suisse (Seidel); JPMC; BoA; ACLI (Feb. 2012); AFR et al. (Feb. 2012); ISDA (Feb. 
272

the reasonably expected near term demands of clients, customers, or counterparties, a 

trading desk generally may not account for the expected trading interests of a trading 

desk or other organizational unit of an entity with aggregate trading assets and liabilities 

of $50 billion or greater (except if the trading desk documents why and how a particular 

trading desk or other organizational unit at such a firm should be considered a customer 

or the trading desk or conduct market-making activity anonymously on an exchange or 

similar trading facility that permits trading on behalf of a broad range of market 

participants).918 

A trading desk may engage in interdealer trading to: establish or acquire a 

position to meet the reasonably expected near term demands of its clients, customers, or 

counterparties, including current demand; unwind or sell positions acquired from clients, 

customers, or counterparties; or engage in risk-mitigating or inventory management 

transactions.919 The Agencies believe that allowing a trading desk to continue to engage 

in customer-related interdealer trading is appropriate because it can help a trading desk 

appropriately manage its inventory and risk levels and can effectively allow clients, 

customers, or counterparties to access a larger pool of liquidity. While the Agencies 

recognize that effective intermediation of client, customer, or counterparty trading may 

 

2012); Goldman (Prop. Trading); Oliver Wyman (Feb. 2012). One of these commenters analyzed the 

potential market impact of preventing interdealer trading, combined with inventory limits. See Oliver 

Wyman (Feb. 2012). Because the final rule does not prohibit interdealer trading or limit inventory in the 

manner this commenter assumed for purposes of its analysis, the Agencies do not believe the final rule will 

have the market impact cited by this commenter.

918 See AFR et al. (Feb. 2012) (recognizing that the ability to manage inventory through interdealer 

transactions should be accommodated in the rule, but recommending that this activity be conditioned on a 

market maker having an appropriate level of inventory after an interdealer transaction).

919 Provided it is consistent with the requirements of the market-making exemption, including the near 

term customer demand requirement, a trading desk may trade for purposes of determining how to price a 

financial instrument a customer Seeks to trade with the trading desk or to determine the depth of the market 

for a financial instrument a customer Seeks to trade with the trading desk. See Goldman (Prop. Trading).
273

require a trading desk to engage in a certain amount of interdealer trading, this is an 

activity that will bear some scrutiny by the Agencies and should be monitored by banking 

entities to ensure it reflects market-making activities and not impermissible proprietary 

trading. 

ii. Impact of the liquidity, maturity, and depth of the market on the analysis

Several commenters expressed concern about the potential impact of the proposed 

near term demand requirement on market making in less liquid markets and requested 

that the Agencies recognize that near term customer demand may vary across different 

markets and asset classes.920 The Agencies understand that reasonably expected near 

term customer demand may vary based on the liquidity, maturity, and depth of the market 

for the relevant type of financial instrument(s) in which the trading desk acts as market 

maker.921 As a result, the final rule recognizes that these factors impact the analysis of 

reasonably expected near term demands of clients, customers, or counterparties and the 

amount, types, and risks of market-maker inventory needed to meet such demand.922 In 

particular, customer demand is likely to be more frequent in more liquid markets than in 

less liquid or illiquid markets. As a result, market makers in more liquid cash-based 

markets, such as liquid equity securities, should generally have higher rates of inventory 

turnover and less aged inventory than market makers in less liquid or illiquid markets.923 

 

920 See CIEBA (stating that, absent a different interpretation for illiquid instruments, market makers will 

err on the side of holding less inventory to avoid sanctions for violating the rule); Morgan Stanley; RBC; 

ICI (Feb. 2012) ISDA (Feb. 2012); Comm. on Capital Markets Regulation; Alfred Brock.

921 See supra Part IV.A.3.c.2.b.ii. (discussing comments on this issue).

922 See final rule § __.4(b)(2)(ii)(A).

923 The final rule does not impose additional capital requirements on aged inventory to discourage a trading 

desk from retaining positions in inventory, as suggested by some commenters. See CalPERS; Vanguard. 
274

Market makers in less liquid cash-based markets are more likely to hold a particular 

position for a longer period of time due to intermittent customer demand. In the 

derivatives markets, market makers carry open positions and manage various risk factors, 

such as exposure to different points on a yield curve. These exposures are analogous to 

inventory in the cash-based markets. Further, it may be more difficult to reasonably 

predict near term customer demand in less mature markets due to, among other things, a 

lack of historical experience with client, customer, or counterparty demands for the 

relevant product. Under these circumstances, the Agencies encourage banking entities to 

consider their experience with similar products or other relevant factors.924 

iii. Demonstrable analysis of certain factors

In the proposal, the Agencies stated that permitted market making includes taking 

positions in securities in anticipation of customer demand, so long as any anticipatory 

buying or selling activity is reasonable and related to clear, demonstrable trading interest 

of clients, customers, or counterparties.925 A number of commenters expressed concern

about this proposed interpretation’s impact on market makers’ inventory management 

activity and represented that it was inconsistent with the statute’s near term demand 

standard, which permits market-making activity that is “designed” not to exceed the 

 

The Agencies believe the final rule already limit a trading desk’s ability to hold inventory over an extended 

period and do not See a need at this time to include additional capital requirements in the final rule. For 

example, a trading desk must have written policies and procedures relating to its inventory and must be 

able to demonstrate, as needed, its analysis of why the levels of its market-maker inventory are necessary to 

meet, or is a result of meeting, customer demand. See final rule § __.4(b)(2)(ii), (iii)(C).

924 The Agencies agree, as suggested by one commenter, it may be appropriate for a market maker in a new 

asset class or market to look to reasonably expected future developments on the basis of the trading desk’s 

customer relationships. See Morgan Stanley. As discussed further below, the Agencies recognize that a 

trading desk could encounter similar issues if it is a new entrant in an existing market.

925 See Joint Proposal, 76 FR at 68,871; CFTC Proposal, 77 FR at 8356-8357.
275

“reasonably expected” near term demands of customers.926 In response to comments, the 

Agencies are permitting a trading desk to take positions in reasonable expectation of 

customer demand in the near term based on a demonstrable analysis that the amount, 

types, and risks of the financial instruments in the trading desk’s market-maker inventory 

are designed not to exceed, on an ongoing basis, the reasonably expected near term 

demands of customers.

The proposal also stated that a banking entity’s determination of near term 

customer demand should generally be based on the unique customer base of a specific 

market-making business line (and not merely an expectation of future price appreciation). 

Several commenters stated that it was unclear how such determinations should be made 

and expressed concern that near term customer demand cannot always be accurately 

predicted,927 particularly in markets where trades occur infrequently and customer 

demand is hard to predict928 or when a banking entity is entering a new market.929 To 

address these comments, the Agencies are providing additional information about how a 

banking entity can comply with the statute’s near term customer demand requirement, 

including a new requirement that a banking entity conduct a demonstrable assessment of 

reasonably expected near term customer demand and several examples of factors that 

may be relevant for conducting such an assessment. The Agencies believe it is important 

to require such demonstrable analysis to allow determinations of reasonably expected 

 

926 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Chamber (Feb. 2012); 

Comm. on Capital Markets Regulation. See also Morgan Stanley; SIFMA (Asset Mgmt.) (Feb. 2012).

927 See SIFMA et al. (Prop. Trading) (Feb. 2012); MetLife; Chamber (Feb. 2012); RBC; CIEBA; 

Wellington; ICI (Feb. 2012) Alfred Brock.

928 See SIFMA et al. (Prop. Trading) (Feb. 2012).

929 See CIEBA.
276

near term demand and associated inventory levels to be monitored and tested to ensure 

compliance with the statute and the final rule.

The final rule provides that, to help determine the appropriate amount, types, and 

risks of the financial instruments in the trading desk’s market-maker inventory and to 

ensure that such inventory is designed not to exceed, on an ongoing basis, the reasonably 

expected near term demands of client, customers, or counterparties, a banking entity must 

conduct demonstrable analysis of historical customer demand, current inventory of 

financial instruments, and market and other factors regarding the amount, types, and risks 

of or associated with financial instruments in which the trading desk makes a market, 

including through block trades. This analysis should not be static or fixed solely on 

current market or other factors. Instead, an appropriately conducted analysis under this 

provision will be both backward- and forward-looking by taking into account relevant 

historical trends in customer demand930 and any events that are reasonably expected to 

occur in the near term that would likely impact demand.931 Depending on the facts and 

circumstances, it may be proper for a banking entity to weigh these factors differently 

 

930 To determine an appropriate historical dataset, a banking entity should assess the relation between 

current or reasonably expected near term conditions and demand and those of prior market cycles. 

931 This analysis may, where appropriate, take into account prior and/or anticipated cyclicality to the 

demands of clients, customers, or counterparties, which may cause variations in the amounts, types, and 

risks of financial instruments needed to provide intermediation services at different points in a cycle. For 

example, the final rule recognizes that a trading desk may need to accumulate a larger-than-average amount 

of inventory in anticipation of an index rebalance. See supra note 838 (discussing a comment on this 

issue). The Agencies are aware that a trading desk engaged in block positioning activity may have a less 

consistent pattern of inventory because of the need to take on large block positions at the request of 

customers. See supra note 761 and accompanying text (discussing comments on this issue).

Because the final rule does not prevent banking entities from providing direct liquidity for rebalance trades, 

the Agencies do not believe that the final rule will cause the market impacts that one commenter predicted 

would occur were such a restriction adopted. See Oliver Wyman (Feb. 2012) (estimating that if market 

makers are not able to provide direct liquidity for rebalance trades, investors tracking these indices could 

potentially pay incremental costs of $600 million to $1.8 billion every year).
277

when conducting an analysis under this provision. For example, historical trends in 

customer demand may be less relevant when a trading desk is experiencing or expects to 

experience a change in the pattern of customer needs (e.g., requests for block 

positioning), adjustments to its business model (e.g., efforts to expand or contract its 

market shares), or changes in market conditions.932 On the other hand, absent these types 

of current or anticipated events, the amount, types, and risks of the financial instruments 

in the trading desk’s market-maker inventory should be relatively consistent with such 

trading desk’s historical profile of market-maker inventory.933 

Moreover, the demonstrable analysis required under § __.4(b)(2)(ii)(B) should 

account for, among other things, how the market factors discussed in § __.4(b)(2)(ii)(A) 

impact the amount, types, and risks of market-maker inventory the trading desk may need 

to facilitate reasonably expected near term demands of clients, customers, or 

counterparties.934 Other potential factors that could be used to assess reasonably 

expected near term customer demand and the appropriate amount, types, and risks of 

 

932 In addition, the Agencies recognize that a new entrant to a particular market or asset class may not have 

knowledge of historical customer demand in that market or asset class at the outset. See supra note 924 and 

accompanying text (discussing factors that may be relevant to new market entrants for purposes of 

determining the reasonably expected near term demands of clients, customers, or counterparties).

933 One commenter suggested an approach that would allow market makers to build inventory in products 

where they believe customer demand will exist, regardless of whether inventory can be tied to a particular 

customer in the near term or to historical trends in customer demand. See Credit Suisse (Seidel). The 

Agencies believe an approach that does not provide for any consideration of historical trends could result in 

a heightened risk of evasion. At the same time, as discussed above, the Agencies recognize that historical 

trends may not always determine the amount of inventory a trading desk may need to meet reasonably 

expected near term demand and it may under certain circumstances be appropriate to build inventory in 

anticipation of a reasonably expected near term event that would likely impact customer demand. While 

the Agencies are not requiring that market-maker inventory be tied to a particular customer, The Agencies 

are requiring that a banking entity analyze and support its expectations for near term customer demand. 

934 The Agencies recognize that a trading desk could acquire either a long or short position in reasonable 

anticipation of near term demands of clients, customers, or counterparties. In particular, if it is expected 

that customers will want to buy an instrument in the near term, it may be appropriate for the desk to acquire 

a long position in such instrument. If it is expected that customers will want to sell the instrument, 

acquiring a short position may be appropriate under certain circumstances.
278

financial instruments in the trading desk’s market-maker inventory include, among 

others: (i) recent trading volumes and customer trends; (ii) trading patterns of specific 

customers or other observable customer demand patterns; (iii) analysis of the banking 

entity’s business plan and ability to win new customer business; (iv) evaluation of 

expected demand under current market conditions compared to prior similar periods; (v) 

schedule of maturities in customers’ existing portfolios; and (vi) expected market events, 

such as an index rebalancing, and announcements. The Agencies believe that some 

banking entities already analyze these and other relevant factors as part of their overall 

risk management processes.935

With respect to the creation and distribution of complex structured products, a 

trading desk may be able to use the market-making exemption to acquire some or all of 

the risk exposures associated with the product if the trading desk has evidence of 

customer demand for each of the significant risks associated with the product.936 To have 

evidence of customer demand under these circumstances, there must be prior express 

interest from customers in the specific risk exposures of the product. Without such 

express interest, a trading desk would not have sufficient information to support the 

required demonstrable analysis (e.g., information about historical customer demand or 

other relevant factors).937 The Agencies are concerned that, absent express interest in 

 

935 See supra Part IV.A.3.c.2.b.iii. See FTN; Morgan Stanley (suggesting a standard that would require a 

position to be “reasonably consistent with observable customer demand patterns”).

936 Complex structured products can contain a combination of several different types of risks, including, 

among others, market risk, credit risk, volatility risk, and prepayment risk.

937 In contrast, a trading desk may respond to requests for customized transactions, such as custom swaps, 

provided that the trading desk is a market maker in the risk exposures underlying the swap or can hedge the 

underlying risk exposures, consistent with its financial exposure and hedging limits, and otherwise meets 

the requirements of the market-making exemption. For example, a trading desk may routinely make 

markets in underlying exposures and, thus, would meet the requirements for engaging in transactions in 
279

each significant risk associated with the product, a trading desk could evade the marketmaking exemption by structuring a deal with certain risk exposures, or amounts of risk 

exposures, for which there is no customer demand and that would be retained in the 

trading desk’s inventory, potentially for speculative purposes. Thus, a trading desk 

would not be engaged in permitted market making-related activity if, for example, it 

structured a product solely to acquire a desired exposure and not to respond to customer 

demand.938 When a trading desk acquires risk exposures in these circumstances, the 

trading desk would be expected to enter into appropriate hedging transactions or 

otherwise mitigate the risks of these exposures, consistent with its hedging policies and 

procedures and risk limits.

With regard to a trading desk that conducts its market-making activities on an 

exchange or other similar anonymous trading facility, the Agencies continue to believe 

that market-making activities are generally consistent with reasonably expected near term 

customer demand when such activities involve passively providing liquidity by 

submitting resting orders that interact with the orders of others in a non-directional or 

market-neutral trading strategy or by regularly responding to requests for quotes in 

markets where resting orders are not generally provided. This ensures that the trading 

desk has a pattern of providing, rather than taking, liquidity. However, this does not 

mean that a trading desk acting as a market maker on an exchange or other similar 

anonymous trading facility is only permitted to use these types of orders in connection 

with its market making-related activities. The Agencies recognize that it may be 

 

derivatives that reflect the same exposures. Alternatively, a trading desk might meet the requirements by 

routinely trading in the derivative and hedging in the underlying exposures. See supra Part IV.A.3.c.1.c.iii.

938 See, e.g., Sens. Merkley & Levin (Feb. 2012).
280

appropriate for a trading desk to enter market or marketable limit orders on an exchange 

or other similar anonymous trading facility, or to request quotes from other market 

participants, in connection with its market making-related activities for a variety of 

purposes including, among others, inventory management, addressing order imbalances 

on an exchange, and hedging.939 In response to comments, the Agencies are not 

requiring a banking entity to be registered as a market maker on an exchange or other 

similar anonymous trading facility, if the exchange or other similar anonymous trading 

facility registers market makers, for purposes of the final rule.940 The Agencies 

recognize, as noted by commenters, that there are a large number of exchanges and 

organized trading facilities on which market makers may need to trade to maintain 

liquidity across the markets and to provide customers with favorable prices and that 

requiring registration with each exchange or other trading facility may unnecessarily 

restrict or impose burdens on exchange market-making activities.941

 

939 The Agencies are clarifying this point in response to commenters who expressed concern that the 

proposal would prevent an exchange market maker from using market or marketable limit orders under 

these circumstances. See, e.g., NYSE Euronext; SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman 

(Prop. Trading); RBC.

940 See supra notes 774 to 779 and accompanying text (discussing commenters’ response to statements in 

the proposal requiring exchange registration as a market maker under certain circumstances). Similarly, the 

final rule does not establish a presumption of compliance with the market-making exemption based on 

registration as a market maker with an exchange, as requested by a few commenters. See supra note 777 

and accompanying text. As noted above, activity that is considered market making for purposes of this rule 

may not be considered market making for purposes of other rules, including self-regulatory organization 

rules, and vice versa. In addition, exchange requirements for registered market makers are subject to 

change without consideration of the impact on this rule. Although a banking entity is not required to be an 

exchange-registered market maker under the final rule, a banking entity must be licensed or registered to 

engage in market making-related activities in accordance with applicable law. For example, a banking 

entity would be required to be an SEC-registered broker-dealer to engage in market making-related 

activities in securities in the U.S. unless the banking entity is exempt from registration or excluded from 

regulation as a dealer under the Exchange Act. See infra Part IV.A.3.c.6.; final rule § __.4(b)(2)(vi).

941 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading) (noting that there are more 

than 12 exchanges and 40 alternative trading systems currently trading U.S. equities).
281

A banking entity is not required to conduct the demonstrable analysis under § 

__.4(b)(2)(B) of the final rule on an instrument-by-instrument basis. The Agencies 

recognize that, in certain cases, customer demand may be for a particular type of 

exposure, and a customer may be willing to trade any one of a number of instruments that 

would provide the demanded exposure. Thus, an assessment of the amount, types, and 

risks of financial instruments that the trading desk may hold in market-maker inventory 

and that would be designed not to exceed, on an ongoing basis, the reasonably expected 

near term demands of clients, customers, or counterparties does not need to be made for 

each financial instrument in which the trading desk acts as market maker. Instead, the 

amount and types of financial instruments in the trading desk’s market-maker inventory 

should be consistent with the types of financial instruments in which the desk makes a

market and the amount and types of such instruments that the desk’s customers are 

reasonably expected to be interested in trading. 

In response to commenters’ concern that banking entities may be subject to 

regulatory sanctions if reasonably expected customer demand does not materialize,942 the 

Agencies recognize that predicting the reasonably expected near term demands of clients, 

customers, or counterparties is inherently subject to changes based on market and other 

factors that are difficult to predict with certainty. Thus, there may at times be differences 

between predicted demand and actual demand from clients, customers, or counterparties. 

However, assessments of expected near term demand may not be reasonable if, in the 

aggregate and over longer periods of time, a trading desk exhibits a repeated pattern or 

practice of significant variation in the amount, types, and risks of financial instruments in 

 

942 See RBC; CIEBA; Wellington; ICI (Feb. 2012) Invesco.
282

its market-maker inventory in excess of what is needed to facilitate near term customer 

demand. 

iv. Relationship to required limits

As discussed further below, a banking entity must establish limits for each trading 

desk on the amount, types, and risks of its market-maker inventory, level of exposures to 

relevant risk factors arising from its financial exposure, and period of time a financial 

instrument may be held by a trading desk. These limits must be reasonably designed to 

ensure compliance with the market-making exemption, including the near term customer 

demand requirement, and must take into account the nature and amount of the trading 

desk’s market making-related activities. Thus, the limits should account for and 

generally be consistent with the historical near term demands of the desk’s clients, 

customers, or counterparties and the amount, types, and risks of financial instruments that 

the trading desk has historically held in market-maker inventory to meet such demands. 

In addition to the limits that a trading desk selects in managing its positions to ensure 

compliance with the market-making exemption set out in § __.4(b), the Agencies are 

requiring, for banking entities that must report metrics in Appendix A, such limits 

include, at a minimum, “Risk Factor Sensitivities” and “Value-at-Risk and Stress Valueat-Risk” metrics as limits, except to the extent any of the “Risk Factor Sensitivities” or 

“Value-at-Risk and Stress Value-at-Risk” metrics are demonstrably ineffective for 

measuring and monitoring the risks of a trading desk based on the types of positions 

traded by, and risk exposures of, that desk.943 The Agencies believe that these metrics 

 

943 See Appendix A.
283

can be useful for measuring and managing many types of positions and trading activities 

and therefore can be useful in establishing a minimum set of metrics for which limits 

should be applied.944

As this requirement applies on an ongoing basis, a trade in excess of one or more 

limits set for a trading desk should not be permitted simply because it responds to 

customer demand. Rather, a banking entity’s compliance program must include 

escalation procedures that require review and approval of any trade that would exceed 

one or more of a trading desk’s limits, demonstrable analysis that the basis for any 

temporary or permanent increase to one or more of a trading desk’s limits is consistent 

with the requirements of this near term demand requirement and with the prudent 

management of risk by the banking entity, and independent review of such demonstrable 

analysis and approval.945 The Agencies expect that a trading desk’s escalation 

procedures will generally explain the circumstances under which a trading desk’s limits 

can be increased, either temporarily or permanently, and that such increases must be 

consistent with reasonably expected near term demands of the desk’s clients, customers, 

or counterparties and the amount and type of risks to which the trading desk is authorized 

to be exposed. 

 

944 The Agencies recognize that for some types of positions or trading strategies, the use of “Risk Factor 

Sensitivities” and “Value-at-Risk and Stress Value-at-Risk” metrics may be ineffective and accordingly 

limits do not need to be set for those metrics if such ineffectiveness is demonstrated by the banking entity.

945 See final rule § __.4(b)(2)(iii); infra Part IV.A.3.c.3.c. (discussing the meaning of “independent” review 

for purposes of this requirement).
284

3. Compliance program requirement

a. Proposed compliance program requirement

To ensure that a banking entity relying on the market-making exemption had an 

appropriate framework in place to support its compliance with the exemption, § 

__.4(b)(2)(i) of the proposed rule required a banking entity to establish an internal 

compliance program, as required by subpart D of the proposal, designed to ensure 

compliance with the requirements of the market-making exemption.946

b. Comments on the proposed compliance program requirement

A few commenters supported the proposed requirement that a banking entity 

establish a compliance program under § __.20 of the proposed rule as effective.947 For 

example, one commenter stated that the requirement “keeps a strong focus on the bank’s 

own workings and allows banks to self-monitor.”948 One commenter indicated that a 

comprehensive compliance program is a “cornerstone of effective corporate governance,” 

but cautioned against placing “undue reliance” on compliance programs.949 As discussed 

further below in Parts IV.C.1. and IV.C.3., many commenters expressed concern about 

the potential burdens of the proposed rule’s compliance program requirement, as well as 

the proposed requirement regarding quantitative measurements. According to one 

 

946 See proposed rule § __.4(b)(2)(i); Joint Proposal, 76 FR at 68,870; CFTC Proposal, 77 FR at 8355.

947 See Flynn & Fusselman; Morgan Stanley. 

948 See Flynn & Fusselman.

949 See Occupy.
285

commenter, the compliance burdens associated with these requirements may dissuade a 

banking entity from attempting to comply with the market-making exemption.950

c. Final compliance program requirement

Similar to the proposed exemption, the market-making exemption adopted in the 

final rule requires that a banking entity establish and implement, maintain, and enforce an 

internal compliance program required by subpart D that is reasonably designed to ensure 

the banking entity’s compliance with the requirements of the market-making exemption, 

including reasonably designed written policies and procedures, internal controls, analysis, 

and independent testing.951 This provision further requires that the compliance program 

include particular written policies and procedures, internal controls, analysis, and 

independent testing identifying and addressing:

• The financial instruments each trading desk stands ready to purchase and sell as a 

market maker; 

• The actions the trading desk will take to demonstrably reduce or otherwise 

significantly mitigate promptly the risks of its financial exposure consistent with 

the required limits; the products, instruments, and exposures each trading desk 

may use for risk management purposes; the techniques and strategies each trading 

desk may use to manage the risks of its market making-related activities and 

inventory; and the process, strategies, and personnel responsible for ensuring that 

 

950 See ICI (Feb. 2012).

951 The independent testing standard is discussed in more detail in Part IV.C., which discusses the 

compliance program requirement in § __.20 of the final rule.
286

the actions taken by the trading desk to mitigate these risks are and continue to be 

effective; 

• Limits for each trading desk, based on the nature and amount of the trading desk’s 

market making-related activities, that address the factors prescribed by the near 

term customer demand requirement of the final rule, on: 

o The amount, types, and risks of its market-maker inventory; 

o The amount, types, and risks of the products, instruments, and exposures 

the trading desk uses for risk management purposes;

o Level of exposures to relevant risk factors arising from its financial 

exposure; and 

o Period of time a financial instrument may be held;

• Internal controls and ongoing monitoring and analysis of each trading desk’s 

compliance with its required limits; and 

• Authorization procedures, including escalation procedures that require review and 

approval of any trade that would exceed a trading desk’s limit(s), demonstrable 

analysis that the basis for any temporary or permanent increase to a trading desk’s 

limit(s) is consistent with the requirements of § __.4(b)(2)(ii) of the final rule, and 

independent review (i.e., by risk managers and compliance officers at the 

appropriate level independent of the trading desk) of such demonstrable analysis 

and approval.952

The compliance program requirement in the proposed market-making exemption 

did not include specific references to all the compliance program elements now listed in 

 

952 See final rule § __.4(b)(2)(iii).
287

the final rule. Instead, these elements were generally included in the compliance 

requirements of Appendix C of the proposed rule. The Agencies are moving certain of 

these requirements into the market-making exemption to ensure that critical components 

are made part of the compliance program for market making-related activities. Further, 

placing these requirements within the market-making exemption emphasizes the 

important role they play in overall compliance with the exemption.953 Banking entities 

should note that these compliance procedures must be established, implemented, 

maintained, and enforced for each trading desk engaged in market making-related 

activities under the final rule. Each of the requirements in paragraphs (b)(2)(iii)(A) 

through (E) must be appropriately tailored to the individual trading activities and 

strategies of each trading desk on an ongoing basis. 

As a threshold issue, the compliance program must identify the products, 

instruments, and exposures the trading desk may trade as market maker or for risk 

 

953 The Agencies note that a number of commenters requested that the Agencies place a greater emphasis 

on inventory limits and risk limits in the final exemption. See, e.g., Citigroup (suggesting that the marketmaking exemption utilize risk limits that would be set for each trading unit based on expected levels of 

customer trading—estimated by looking to historical results, target product and customer lists, and target 

market share—and an appropriate amount of required inventory to support that level of customer trading); 

Prof. Colesanti et al. (suggesting that the exemption include, among other things, a bright-line threshold of 

the amount of risk that can be retained (which cannot be in excess of the size and type required for market 

making), positions limits, and limits on holding periods); Sens. Merkley & Levin (Feb. 2012) (suggesting 

the use of specific parameters for inventory levels, along with a number of other criteria, to establish a safe 

harbor); SIFMA et al. (Prop. Trading) (Feb. 2012) (recommending the use of risk limits in combination 

with a guidance-based approach); Japanese Bankers Ass’n. (suggesting that the rule set risk allowances for 

market making-related activities based on required capital for such activities). The Agencies are not 

establishing specific limits in the final rule, as some commenters appeared to recommend, in recognition of 

the fact that appropriate limits will differ based on a number of factors, including the size of the marketmaking operation and the liquidity, depth, and maturity of the market for the particular type(s) of financial 

instruments in which the trading desk is permitted to trade. See Sens. Merkley & Levin (Feb. 2012); Prof. 

Colesanti et al. However, banking entities relying on the market-making exemption must set limits and 

demonstrate how the specific limits and limit methodologies they have chosen are reasonably designed to 

limit the amount, types, and risks of the financial instruments in a trading desk’s market-maker inventory 

consistent with the reasonably expected near term demands of the banking entity’s clients, customers, and 

counterparties, subject to the market and conditions discussed above, and to commensurately control the 

desk’s overall financial exposure.
288

management purposes.954 Identifying the relevant instruments in which a trading desk is 

permitted to trade will facilitate monitoring and oversight of compliance with the 

exemption by preventing an individual trader on a market-making desk from establishing 

positions in instruments that are unrelated to the desk’s market-making function. Further, 

this identification of instruments helps form the basis for the specific types of inventory 

and risk limits that the banking entity must establish and is relevant to considerations 

throughout the exemption regarding the liquidity, depth, and maturity of the market for 

the relevant type of financial instrument. The Agencies note that a banking entity should 

be able to demonstrate the relationship between the instruments in which a trading desk 

may act as market maker and the instruments the desk may use to manage the risk of its 

market making-related activities and inventory and why the instruments the desk may use 

to manage its risk appropriately and effectively mitigate the risk of its market makingrelated activities without generating an entirely new set of risks that outweigh the risks 

that are being hedged. 

The final rule provides that a banking entity must establish an appropriate risk 

management framework for each of its trading desks that rely on the market-making 

exemption.955 This includes not only the techniques and strategies that a trading desk 

 

954 See final rule § __.4(b)(2)(iii)(A) (requiring written policies and procedures, internal controls, analysis, 

and independent testing regarding the financial instruments each trading desk stands ready to purchase and 

sell in accordance with § __.4(b)(2)(i) of the final rule); final rule § __.4(b)(2)(iii)(B) (requiring written 

policies and procedures, internal controls, analysis, and independent testing regarding the products, 

instruments, or exposures each trading desk may use for risk management purposes).

955 This standard addresses issues raised by commenters concerning: certain language in proposed 

Appendix B regarding market making-related risk management; the market making-related hedging 

provision in § __.4(b)(3) of the proposed rule; and, to some extent, the proposed source of revenue 

requirement in § __.4(b)(2)(v) of the proposed rule. See Joint Proposal, 76 FR at 68,960; CFTC Proposal, 

77 FR at 8439-8440; proposed rule § __.4(b)(3); Joint Proposal, 76 FR at 68,873; CFTC Proposal, 77 FR at 

8358; Wellington; Credit Suisse (Seidel); Morgan Stanley; PUC Texas; CIEBA; SSgA (Feb. 2012); 

AllianceBernstein; Investure; Invesco; Japanese Bankers Ass’n.; SIFMA et al. (Prop. Trading) (Feb. 2012); 
289

may use to manage its risk exposures, but also the actions the trading desk will take to 

demonstrably reduce or otherwise significantly mitigate promptly the risks of its financial 

exposures consistent with its required limits, which are discussed in more detail below. 

While the Agencies do not expect a trading desk to hedge all of the risks that arise from 

its market making-related activities, the Agencies do expect each trading desk to take 

appropriate steps consistent with market-making activities to contain and limit risk 

exposures (such as by unwinding unneeded positions) and to follow reasonable 

procedures to monitor the trading desk’s risk exposures (i.e., its financial exposure) and 

hedge risks of its financial exposure to remain within its relevant risk limits.956 

As discussed in Part IV.A.3.c.4.c., managing the risks associated with maintaining 

a market-maker inventory that is appropriate to meet the reasonably expected near-term 

demands of customers is an important part of market making.957 The Agencies 

 FTN; RBC; NYSE Euronext; MFA. As discussed in more detail above, a number of commenters 

emphasized that market making-related activities necessarily involve a certain amount of risk-taking to 

provide “immediacy” to customers. See, e.g., Prof. Duffie; Morgan Stanley; SIFMA et al. (Prop. Trading) 

(Feb. 2012). Commenters also represented that the amount of risk a market maker needs to retain may 

differ across asset classes and markets. See, e.g., Morgan Stanley; Credit Suisse (Seidel). The Agencies 

believe that the requirement we are adopting better recognizes that appropriate risk management will tailor 

acceptable position, risk and inventory limits based on the type(s) of financial instruments in which the 

trading desk is permitted to trade and the liquidity, maturity, and depth of the market for the relevant type 

of financial instrument.

956 It may be more efficient for a banking entity to manage some risks at a higher organizational level than 

the trading desk level. As a result, a banking entity’s written policies and procedures may delegate the 

responsibility to mitigate specific risks of the trading desk’s financial exposure to an entity other than the 

trading desk, including another organizational unit of the banking entity or of an affiliate, provided that 

such organizational unit of the banking entity or of an affiliate is identified in the banking entity’s written 

policies and procedures. Under these circumstances, the other organizational unit of the banking entity or 

of an affiliate must conduct such hedging activity in accordance with the requirements of the hedging 

exemption in § __.5 of the final rule, including the documentation requirement in § __.5(c). As recognized 

in Part IV.A.4.d.4., hedging activity conducted by a different organizational unit than the unit responsible 

for the positions being hedged presents a greater risk of evasion. Further, the risks being managed by a 

higher organizational level than the trading desk may be generated by trading desks engaged in market 

making-related activity or by trading desks engaged in other permitted activities. Thus, it would be 

inappropriate for such hedging activity to be conducted in reliance on the market-making exemption.

957 See supra Part IV.A.3.c.2.c. (discussing the final near term demand requirement).
290

understand that, in the context of market-making activities, inventory management 

includes adjustment of the amount and types of market-maker inventory to meet the 

reasonably expected near term demands of customers.958 Adjustments of the size and 

types of a financial exposure are also made to reduce or mitigate the risks associated with 

financial instruments held as part of a trading desk’s market-maker inventory. A 

common strategy in market making is to establish market-maker inventory in anticipation 

of reasonably expected customer needs and then to reduce that market-maker inventory 

over time as customer demand materializes.959 If customer demand does not materialize, 

the market maker addresses the risks associated with its market-maker inventory by 

adjusting the amount or types of financial instruments in its inventory as well as taking 

steps otherwise to mitigate the risk associated with its inventory.

The Agencies recognize that, to provide effective intermediation services, a 

trading desk engaged in permitted market making-related activities retains a certain 

amount of risk arising from the positions it holds in inventory and may hedge certain 

aspects of that risk. The requirements in the final rule establish controls around a trading 

desk’s risk management activities, yet still recognize that a trading desk engaged in 

market making-related activities may retain a certain amount of risk in meeting the 

reasonably expected near term demands of clients, customers, or counterparties. As the 

Agencies noted in the proposal, where the purpose of a transaction is to hedge a market 

making-related position, it would appear to be market making-related activity of the type 

 

958 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); Goldman (Prop. Trading); 

MFA; RBC.

959 See, e.g., BoA; SIFMA et al. (Prop. Trading) (Feb. 2012); Chamber (Feb. 2012).
291

described in section 13(d)(1)(B) of the BHC Act.960 The Agencies emphasize that the 

only risk management activities that qualify for the market-making exemption – and that 

are not subject to the hedging exemption – are risk management activities conducted or 

directed by the trading desk in connection with its market making-related activities and in 

conformance with the trading desk’s risk management policies and procedures.961 A 

trading desk engaged in market making-related activities would be required to comply 

with the hedging exemption or another available exemption for any risk management or 

other activity that is not in conformance with the trading desk’s required market-making 

risk management policies and procedures.

A banking entity’s written policies and procedures, internal controls, analysis, and 

independent testing identifying and addressing the products, instruments, or exposures 

and the techniques and strategies that may be used by each trading desk to manage the 

risks of its market making-related activities and inventory must cover both how the 

trading desk may establish hedges and how such hedges are removed once the risk they 

were mitigating is unwound. With respect to establishing positions that hedge or 

otherwise mitigate the risk(s) of market making-related positions held by the trading 

 

960 See Joint Proposal, 76 FR at 68,873; CFTC Proposal, 77 FR at 8358.

961 As discussed above, if a trading desk operating under the market-making exemption directs a different 

organizational unit of the banking entity or an affiliate to establish a hedge position on the desk’s behalf, 

then the other organizational unit may rely on the market-making exemption to establish the hedge position 

as long as: (i) the other organizational unit’s hedging activity is consistent with the trading desk’s risk 

management policies and procedures (e.g., the hedge instrument, technique, and strategy are consistent 

with those identified in the trading desk’s policies and procedures); and (ii) the hedge position is attributed 

to the financial exposure of the trading desk and is included in the trading desk’s daily profit and loss. If a 

different organizational unit of the banking entity or of an affiliate establishes a hedge for the trading desk’s 

financial exposure based on its own determination, or if such position was not established in accordance 

with the trading desk’s required procedures or was included in that other organizational unit’s financial 

exposure and/or daily profit and loss, then that hedge position must be established in compliance with the 

hedging exemption in § __.5 of the rule, including the documentation requirement in § __.5(c). See supra

Part IV.A.3.c.1.c.ii.
292

desk, the written policies and procedures may consider the natural hedging and 

diversification that occurs in an aggregation of long and short positions in financial 

instruments for which the trading desk is a market maker,962 as it documents its specific 

risk-mitigating strategies that use instruments for which the desk is a market maker or 

instruments for which the desk is not a market maker. Further, the written policies and 

procedures identifying and addressing permissible hedging techniques and strategies 

must address the circumstances under which the trading desk may be permitted to engage 

in anticipatory hedging. Like the proposed rule’s hedging exemption, a trading desk may 

establish an anticipatory hedge position before it becomes exposed to a risk that it is 

highly likely to become exposed to, provided there is a sound risk management rationale 

for establishing such an anticipatory hedge position.963 For example, a trading desk may 

hedge against specific positions promised to customers, such as volume-weighted 

average price (“VWAP”) orders or large block trades, to facilitate the customer trade.964 

The amount of time that an anticipatory hedge may precede the establishment of the 

position to be hedged will depend on market factors, such as the liquidity of the hedging 

position. 

Written policies and procedures, internal controls, analysis, and independent 

testing established pursuant to the final rule identifying and addressing permissible 

 

962 For example, this may occur if a U.S. corporate bond trading desk acquires a $100 million long position 

in the corporate bonds of one issuer from clients, customers, or counterparties and separately acquires a $50 

million short position in another issuer in the same market sector in reasonable expectation of near term 

demand of clients, customers, or counterparties. Although both positions were acquired to facilitate 

customer demand, the positions may also naturally hedge each other, to some extent.

963 See Joint Proposal, 76 FR at 68,875; CFTC Proposal, 77 FR at 8361.

964 Two commenters recommended that banking entities be permitted to establish hedges prior to acquiring 

the underlying risk exposure under these circumstances. See Credit Suisse (Seidel); BoA.
293

hedging techniques and strategies should be designed to prevent a trading desk from 

over-hedging its market-maker inventory or financial exposure. Over-hedging would 

occur if, for example, a trading desk established a position in a financial instrument for 

the purported purpose of reducing a risk associated with one or more market-making 

positions when, in fact, that risk had already been mitigated to the full extent possible. 

Over-hedging results in a new risk exposure that is unrelated to market-making activities 

and, thus, is not permitted under the market-making exemption. 

A trading desk’s financial exposure generally would not be considered to be 

consistent with market making-related activities to the extent the trading desk is engaged 

in hedging activities that are inconsistent with the management of identifiable risks in its 

market-maker inventory or maintains significant hedge positions after the underlying 

risk(s) of the market-maker inventory have been unwound. A banking entity’s written 

policies and procedures, internal controls, analysis, and independent testing regarding the 

trading desk’s permissible hedging techniques and strategies must be designed to prevent 

a trading desk from engaging in over-hedging or maintaining hedge positions after they 

are no longer needed.965 Further, the compliance program must provide for the process 

and personnel responsible for ensuring that the actions taken by the trading desk to 

mitigate the risks of its market making-related activities are and continue to be effective, 

which would include monitoring for and addressing any scenarios where a trading desk 

may be engaged in over-hedging or maintaining unnecessary hedge positions or new 

significant risks have been introduced by the hedging activity. 

 

965 See final rule § __.4(b)(2)(iii)(B).
294

As a result of these limitations, the size and risks of the trading desk’s hedging 

positions are naturally constrained by the size and risks of its market-maker inventory, 

which must be designed not to exceed the reasonably expected near term demands of 

clients, customers, or counterparties, as well as by the risk limits and controls established 

under the final rule. This ultimately constrains a trading desk’s overall financial exposure 

since such position can only contain positions, risks, and exposures related to the marketmaker inventory that are designed to meet current or near term customer demand and 

positions, risks and exposures designed to mitigate the risks in accordance with the limits 

previously established for the trading desk. 

The written policies and procedures identifying and addressing a trading desk’s 

hedging techniques and strategies also must describe how and under what timeframe a 

trading desk must remove hedge positions once the underlying risk exposure is unwound. 

Similarly, the compliance program established by the banking entity to specify and 

control the trading desk’s hedging activities in accordance with the final rule must be 

designed to prevent a trading desk from purposefully or inadvertently transforming its 

positions taken to manage the risk of its market-maker inventory under the exemption 

into what would otherwise be considered prohibited proprietary trading. 

Moreover, the compliance program must provide for the process and personnel 

responsible for ensuring that the actions taken by the trading desk to mitigate the risks of 

its market making-related activities and inventory – including the instruments, 

techniques, and strategies used for risk management purposes – are and continue to be 

effective. This includes ensuring that hedges taken in the context of market makingrelated activities continue to be effective and that positions taken to manage the risks of 
295

the trading desk’s market-maker inventory are not purposefully or inadvertently 

transformed into what would otherwise be considered prohibited proprietary trading. If a 

banking entity’s monitoring procedures find that a trading desk’s risk management 

procedures are not effective, such deficiencies must be promptly escalated and remedied 

in accordance with the banking entity’s escalation procedures. A banking entity’s written 

policies and procedures must set forth the process for determining the circumstances 

under which a trading desk’s risk management strategies may be modified. In addition, 

risk management techniques and strategies developed and used by a trading desk must be 

independently tested or verified by management separate from the trading desk. 

To control and limit the amount and types of financial instruments and risks that 

a trading desk may hold in connection with its market making-related activities, a 

banking entity must establish, implement, maintain, and enforce reasonably designed 

written policies and procedures, internal controls, analysis, and independent testing 

identifying and addressing specific limits on a trading desk’s market-maker inventory, 

risk management positions, and financial exposure. In particular, the compliance 

program must establish limits for each trading desk, based on the nature and amount of its 

market making-related activities (including the factors prescribed by the near term 

customer demand requirement), on the amount, types, and risks of its market-maker 

inventory, the amount, types, and risks of the products, instruments, and exposures the 

trading desk may use for risk management purposes, the level of exposures to relevant 

risk factors arising from its financial exposure, and the period of time a financial 
296

instrument may be held.966 The limits would be set, as appropriate, and supported by an 

analysis for specific types of financial instruments, levels of risk, and duration of 

holdings, which would also be required by the compliance appendix. This approach will 

build on existing risk management infrastructure for market-making activities that subject 

traders to a variety of internal, predefined limits.967 Each of these limits is independent 

of the others, and a trading desk must maintain its aggregated market-making position 

within each of these limits, including by taking action to bring the trading desk into 

compliance with the limits as promptly as possible after the limit is exceeded.

968 For

example, if changing market conditions cause an increase in one or more risks within the 

trading desk’s financial exposure and that increased risk causes the desk to exceed one or 

more of its limits, the trading desk must take prompt action to reduce its risk exposure 

(either by hedging the risk or unwinding its existing positions) or receive approval of a 

temporary or permanent increase to its limit through the required escalation procedures. 

The Agencies recognize that trading desks’ limits will differ across asset classes 

and acknowledge that trading desks engaged in market making-related activities in less 

liquid asset classes, such as corporate bonds, certain derivatives, and securitized products, 

may require different inventory, risk exposure, and holding period limits than trading 

desks engaged in market making-related activities in more liquid financial instruments, 

such as certain listed equity securities. Moreover, the types of risk factors for which 

limits are established should not be limited solely to market risk factors. Instead, such 

 

966 See final rule § __.4(b)(2)(iii)(C).

967 See, e.g., Citigroup (Feb. 2012) (noting that its suggested approach to implementing the market-making 

exemption, which would focus on risk limits and risk architecture, would build on existing risk limits and 

risk management systems already present in institutions). 

968 See final rule § __.4(b)(2)(iv).
297

limits should also account for all risk factors that arise from the types of financial 

instruments in which the trading desk is permitted to trade. In addition, these limits 

should be sufficiently granular and focused on the particular types of financial 

instruments in which the desk may trade. For example, a trading desk that makes a 

market in derivatives would have exposures to counterparty risk, among others, and 

would need to have appropriate limits on such risk. Other types of limits that may be 

relevant for a trading desk include, among others, position limits, sector limits, and 

geographic limits. 

A banking entity must have a reasonable basis for the limits it establishes for a 

trading desk and must have a robust procedure for analyzing, establishing, and 

monitoring limits, as well as appropriate escalation procedures.969 Among other things, 

the banking entity’s compliance program must provide for: (i) written policies and 

procedures and internal controls establishing and monitoring specific limits for each 

trading desk; and (ii) analysis regarding how and why these limits are determined to be 

appropriate and consistent with the nature and amount of the desk’s market makingrelated activities, including considerations related to the near term customer demand 

requirement. In making these determinations, a banking entity should take into account 

and be consistent with the type(s) of financial instruments the desk is permitted to trade, 

the desk’s trading and risk management activities and strategies, the history and 

experience of the desk, and the historical profile of the desk’s near term customer 

demand and market and other factors that may impact the reasonably expected near term 

demands of customers. 

 

969 See final rule § __.4(b)(2)(iii)(C).
298

The limits established by a banking entity should generally reflect the amount and 

types of inventory and risk that a trading desk holds to meet the reasonably expected near 

term demands of clients, customers, or counterparties. As discussed above, while the 

trading desk’s market-maker inventory is directly limited by the reasonably expected near 

term demands of customers, the positions managed by the trading desk outside of its 

market-maker inventory are similarly constrained by the near term demand requirement 

because they must be designed to manage the risks of the market-maker inventory in 

accordance with the desk’s risk management procedures. As a result, the trading desk’s 

risk management positions and aggregate financial exposure are also limited by the 

current and reasonably expected near term demands of customers. A trading desk’s 

market-maker inventory, risk management positions, or financial exposure would not, 

however, be permissible under the market-making exemption merely because the marketmaker inventory, risk management positions, or financial exposure happens to be within 

the desk’s prescribed limits.970 

In addition, a banking entity must establish internal controls and ongoing 

monitoring and analysis of each trading desk’s compliance with its limits, including the 

frequency, nature, and extent of a trading desk exceeding its limits and patterns regarding 

the portions of the trading desk’s limits that are accounted for by the trading desk’s 

 

970 For example, if a U.S. corporate bond trading desk has a prescribed limit of $200 million net exposure 

to any single sector of related issuers, the desk’s limits may permit it to acquire a net economic exposure of 

$400 million long to issuer ABC and a net economic exposure of $300 million short to issuer XYZ, where 

ABC and XYZ are in the same sector. This is because the trading desk’s net exposure to the sector would 

only be $100 million, which is within its limits. Even though the net exposure to this sector is within the 

trading desk’s prescribed limits, the desk would still need to be able to demonstrate how its net exposure of 

$400 million long to issuer ABC and $300 million short to issuer XYZ is related to customer demand.
299

activity.971 This may include the use of management and exception reports. Moreover, 

the compliance program must set forth a process for determining the circumstances under 

which a trading desk’s limits may be modified on a temporary or permanent basis (e.g., 

due to market changes or modifications to the trading desk’s strategy).972 This process 

must cover potential scenarios when a trading desk’s limits should be raised, as well as 

potential scenarios when a trading desk’s limits should be lowered. For example, if a 

trading desk experiences reduced customer demand over a period of time, that trading 

desk’s limits should be decreased to address the factors prescribed by the near term 

demand requirement.

A banking entity’s compliance program must also include escalation procedures 

that require review and approval of any trade that would exceed one or more of a trading 

desk’s limits, demonstrable analysis that the basis for any temporary or permanent 

increase to one or more of a trading desk’s limits is consistent with the near term 

customer demand requirement, and independent review of such demonstrable analysis 

and approval of any increase to one or more of a trading desk’s limits.973 Thus, in order 

to increase a limit of a trading desk – on either a temporary or permanent basis – there 

must be an analysis of why such increase would be appropriate based on the reasonably 

 

971 See final rule § __.4(b)(2)(iii)(D).

972 For example, a banking entity may determine to permit temporary, short-term increases to a trading 

desk’s risk limits due to an increase in short-term credit spreads or in response to volatility in instruments 

in which the trading desk makes a market, provided the increased limit is consistent with the reasonably 

expected near term demands of clients, customers, or counterparties. As noted above, other potential 

circumstances that could warrant changes to a trading desk’s limits include: a change in the pattern of 

customer needs, adjustments to the market maker’s business model (e.g., new entrants or existing market 

makers trying to expand or contract their market share), or changes in market conditions. See supra note 

932 and accompanying text.

973 See final rule § __.4(b)(2)(iii)(E).
300

expected near term demands of clients, customers, or counterparties, including the factors 

identified in § __.4(b)(2)(ii) of the final rule, which must be independently reviewed. A 

banking entity also must maintain documentation and records with respect to these 

elements, consistent with the requirement of § __.20(b)(6). 

As already discussed, commenters have represented that the compliance costs 

associated with the proposed rule, including the compliance program and metrics 

requirements, may be significant and “may dissuade a banking entity from attempting to 

comply with the market making-related activities exemption.”974 The Agencies believe 

that a robust compliance program is necessary to ensure adherence to the rule and to 

prevent evasion, although, as discussed in Part IV.C.3., the Agencies are adopting a more 

tailored set of quantitative measurements to better focus on those that are most germane 

to evaluating market making-related activity. The Agencies acknowledge that the 

compliance program requirements for the market-making exemption, including 

reasonably designed written policies and procedures, internal controls, analysis, and 

independent testing, represent a new regulatory requirement for banking entities and the 

Agencies have thus been mindful that it may impose significant costs and may cause a 

banking entity to reconsider whether to conduct market making-related activities. 

Despite the potential costs of the compliance program, the Agencies believe they are 

warranted to ensure that the goals of the rule and statute will be met, such as promoting 

the safety and soundness of banking entities and the financial stability of the United 

States.

 

974 See ICI (Feb. 2012).
301

4. Market making-related hedging

a. Proposed treatment of market making-related hedging

In the proposal, certain hedging transactions related to market making were 

considered to be made in connection with a banking entity’s market making-related 

activity for purposes of the market-making exemption. The Agencies explained that 

where the purpose of a transaction is to hedge a market making-related position, it would 

appear to be market making-related activity of the type described in section 13(d)(1)(B) 

of the BHC Act.975 To qualify for the market-making exemption, a hedging transaction 

would have been required to meet certain requirements under § __.4(b)(3) of the 

proposed rule. This provision required that the purchase or sale of a financial instrument: 

(i) be conducted to reduce the specific risks to the banking entity in connection with and 

related to individual or aggregated positions, contracts, or other holdings acquired 

pursuant to the market-making exemption; and (ii) meet the criteria specified in § __.5(b) 

of the proposed hedging exemption and, where applicable, § __.5(c) of the proposal.976 

In the proposal, the Agencies noted that a market maker may often make a market in one 

type of financial instrument and hedge its activities using different financial instruments 

in which it does not make a market. The Agencies stated that this type of hedging 

transaction would meet the terms of the market-making exemption if the hedging 

transaction met the requirements of § __.4(b)(3) of the proposed rule.977 

 

975 See Joint Proposal, 76 FR at 68,873; CFTC Proposal, 77 FR at 8358.

976 See proposed rule § __.4(b)(3); Joint Proposal, 76 FR at 68,873; CFTC Proposal, 77 FR at 8358.

977 See Joint Proposal, 76 FR at 68,870 n.146; CFTC Proposal, 77 FR at 8356 n.152.
302

b. Comments on the proposed treatment of market making-related hedging

Several commenters recommended that the proposed market-making exemption 

be modified to establish a more permissive standard for market maker hedging.978 A few 

of these commenters stated that, rather than applying the standards of the risk-mitigating 

hedging exemption to market maker hedging, a market maker’s hedge position should be 

permitted as long as it is designed to mitigate the risk associated with positions acquired 

through permitted market making-related activities.979 Other commenters emphasized 

the need for flexibility to permit a market maker to choose the most effective hedge.980 

In general, these commenters expressed concern that limitations on hedging market 

making-related positions may cause a reduction in liquidity, wider spreads, or increased 

risk and trading costs for market makers.981 For example, one commenter stated that 

“[t]he ability of market makers to freely offset or hedge positions is what, in most cases, 

makes them willing to buy and sell [financial instruments] to and from customers, clients 

or counterparties,” so “[a]ny impediment to hedging market making-related positions will 

decrease the willingness of banking entities to make markets and, accordingly, reduce 

liquidity in the marketplace.”982

 

978 See, e.g., Japanese Bankers Ass’n.; SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); 

FTN; RBC; NYSE Euronext; MFA. These comments are addressed in Part IV.A.3.c.4.c., infra.

979 See SIFMA et al. (Prop. Trading) (Feb. 2012); RBC. See also FTN (stating that the principal 

requirement for such hedges should be that they reduce the risk of market making).

980 See NYSE Euronext (stating that the best hedge sometimes involves a variety of complex and dynamic 

transactions over the time in which an asset is held, which may fall outside the parameters of the 

exemption); MFA; JPMC.

981 See SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); NYSE Euronext; MFA; Japanese 

Bankers Ass’n.; RBC.

982 RBC.
303

In addition, some commenters expressed concern that certain requirements in the 

proposed hedging exemption may result in a reduction in market-making activities under 

certain circumstances.983 For example, one commenter expressed concern that the 

proposed hedging exemption would require a banking entity to identify and tag hedging 

transactions when hedges in a particular asset class take place alongside a trading desk’s 

customer flow trading and inventory management in that same asset class.984 Further, a 

few commenters represented that the proposed reasonable correlation requirement in the 

hedging exemption could impact market making by discouraging market makers from 

entering into customer transactions that do not have a direct hedge985 or making it more 

difficult for market makers to cost-effectively hedge the fixed income securities they hold 

in inventory, including hedging such inventory positions on a portfolio basis.986

One commenter, however, stated that the proposed approach is effective.987 

Another commenter indicated that it is confusing to include hedging within the marketmaking exemption and suggested that a market maker be required to rely on the hedging 

exemption under § __.5 of the proposed rule for its hedging activity.988 

As noted above in the discussion of comments on the proposed source of revenue 

requirement, a number of commenters expressed concern that the proposed rule assumed 

that there are effective, or perfect, hedges for all market making-related positions.989 

 

983 See BoA; SIFMA (Asset Mgmt.) (Feb. 2012).

984 See Goldman (Prop. Trading).

985 See BoA.

986 See SIFMA (Asset Mgmt.) (Feb. 2012).

987 See Alfred Brock.

988 See Occupy.

989 See infra notes 1068 to 1070 and accompanying text.
304

Another commenter stated that market makers should be required to hedge whenever an 

inventory imbalance arises, and the absence of a hedge in such circumstances may 

evidence prohibited proprietary trading.990

c. Treatment of market making-related hedging in the final rule

Unlike the proposed rule, the final rule does not require that market makingrelated hedging activities separately comply with the requirements found in the riskmitigating hedging exemption if conducted or directed by the same trading desk 

conducting the market-making activity. Instead, the Agencies are including requirements 

for market making-related hedging activities within the market-making exemption in 

response to comments.991 As discussed above, a trading desk’s compliance program 

must include written policies and procedures, internal controls, independent testing and 

analysis identifying and addressing the products, instruments, exposures, techniques, and 

strategies a trading desk may use to manage the risks of its market making-related 

activities, as well as the actions the trading desk will take to demonstrably reduce or 

otherwise significant mitigate the risks of its financial exposure consistent with its 

required limits.992 The Agencies believe this approach addresses commenters’ concerns 

that limitations on hedging market making-related positions may cause a reduction in 

liquidity, wider spreads, or increased risk and trading costs for market makers because it 

allows banking entities to determine how best to manage the risks of trading desks’ 

market making-related activities through reasonable policies and procedures, internal 

 

990 See Public Citizen.

991 See, e.g., Japanese Bankers Ass’n.; SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); 

FTN; RBC; NYSE Euronext; MFA.

992 See final rule § __.4(b)(2)(iii)(B); supra Part IV.A.3.c.3.c.
305

controls, independent testing, and analysis, rather than requiring compliance with the 

specific requirements of the hedging exemption.993 Further, this approach addresses 

commenters’ concerns about the impact of certain requirements of the hedging exemption 

on market making-related activities.994

The Agencies believe it is consistent with the statute’s reference to “market 

making-related” activities to permit market making-related hedging activities under this

exemption. In addition, the Agencies believe it is appropriate to require a trading desk to 

appropriately manage its risks, consistent with its risk management procedures and limits, 

because management of risk is a key factor that distinguishes permitted market makingrelated activity from impermissible proprietary trading. As noted in the proposal, while 

“a market maker attempts to eliminate some [of the risks arising from] its retained 

principal positions and risks by hedging or otherwise managing those risks [ ], a 

proprietary trader seeks to capitalize on those risks, and generally only hedges or 

manages a portion of those risks when doing so would improve the potential profitability 

of the risk it retains.”995

The Agencies recognize that some banking entities may manage the risks 

associated with market making at a different level than the individual trading desk.996

While this risk management activity is not permitted under the market-making 

 

993 See SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); NYSE Euronext; MFA; Japanese 

Bankers Ass’n.; RBC.

994 See BoA; SIFMA (Asset Mgmt.) (Feb. 2012); Goldman (Prop. Trading).

995 See Joint Proposal, 76 FR at 68,961.

996 See, e.g., letter from JPMC (stating that, to minimize risk management costs, firms commonly organize 

their market-making activities so that risks delivered to client-facing desks are aggregated and passed by 

means of internal transactions to a single utility desk and suggesting this be recognized as permitted market 

making-related behavior).
306

exemption, it may be permitted under the hedging exemption, provided the requirements 

of that exemption are met. Thus, the Agencies believe banking entities will continue to 

have options available that allow them to efficiently hedge the risks arising from their 

market-making operations. Nevertheless, the Agencies understand that this rule will 

result in additional documentation or other potential burdens for market making-related 

hedging activity that is not conducted by the trading desk responsible for the marketmaking positions being hedged.997 As discussed in Part IV.A.4.d.4., hedging conducted 

by a different organizational unit than the trading desk that is responsible for the 

underlying positions presents an increased risk of evasion, so the Agencies believe it is 

appropriate for such hedging activity to be required to comply with the hedging 

exemption, including the associated documentation requirement.

5. Compensation requirement

a. Proposed compensation requirement

Section __.4(b)(2)(vii) of the proposed market-making exemption would have 

required that the compensation arrangements of persons performing market makingrelated activities at the banking entity be designed not to reward proprietary risktaking.998 In the proposal, the Agencies noted that activities for which a banking entity 

has established a compensation incentive structure that rewards speculation in, and 

appreciation of, the market value of a financial instrument position held in inventory, 

 

997 See final rule § __.5(c).

998 See proposed rule § __.4(b)(2)(vii).
307

rather than success in providing effective and timely intermediation and liquidity services 

to customers, would be inconsistent with the proposed market-making exemption. 

The Agencies stated that under the proposed rule, a banking entity relying on the 

market-making exemption should provide compensation incentives that primarily reward 

customer revenues and effective customer service, not proprietary risk-taking. However, 

the Agencies noted that a banking entity relying on the proposed market-making 

exemption would be able to appropriately take into account revenues resulting from 

movements in the price of principal positions to the extent that such revenues reflect the 

effectiveness with which personnel have managed principal risk retained.999 

b. Comments regarding the proposed compensation requirement

Several commenters recommended certain revisions to the proposed 

compensation requirement.1000 Two commenters stated that the proposed requirement is 

effective,1001 while one commenter stated that it should be removed from the rule.1002 

Moreover, in addressing this proposed requirement, commenters provided views on: 

identifiable characteristics of compensation arrangements that incentivize prohibited 

 

999 See Joint Proposal, 76 FR at 68,872; CFTC Proposal, 77 FR at 8358.

1000 See Prof. Duffie; SIFMA et al. (Prop. Trading) (Feb. 2012); John Reed; Credit Suisse (Seidel); JPMC; 

Morgan Stanley; Better Markets (Feb. 2012); Johnson & Prof. Stiglitz; Occupy; AFR et al. (Feb. 2012); 

Public Citizen.

1001 See FTN; Alfred Brock.

1002 See Japanese Bankers Ass’n.
308

proprietary trading,1003 methods of monitoring compliance with this requirement,1004 and 

potential negative incentives or outcomes this requirement could cause.1005

With respect to suggested modifications to this requirement, a few commenters 

suggested that a market maker’s compensation should be subject to additional 

limitations.1006 For example, two commenters stated that compensation should be 

restricted to particular sources, such as fees, commissions, and spreads.1007 One 

commenter suggested that compensation should not be symmetrical between gains and 

losses and, further, that trading gains reflecting an unusually high variance in position 

values should either not be reflected in compensation and bonuses or should be less 

reflected than other gains and losses.1008 Another commenter recommended that the 

Agencies remove “designed” from the rule text and provide greater clarity about how a 

banking entity’s compensation regime must be structured.1009 Moreover, a number of 

commenters stated that compensation should be vested for a period of time, such as until 

the trader’s market making positions have been fully unwound and are no longer in the 

banking entity’s inventory.1010 As one commenter explained, such a requirement would 

 

1003 See Occupy.

1004 See Occupy; Goldman (Prop. Trading).

1005 See AllianceBernstein; Prof. Duffie; Investure; STANY; Chamber (Dec. 2011).

1006 See Better Markets (Feb. 2012); Public Citizen; AFR et al. (Feb. 2012); Occupy; John Reed; AFR et 

al. (Feb. 2012); Johnson & Prof. Stiglitz; Prof. Duffie; Sens. Merkley & Levin (Feb. 2012). These 

comments are addressed in note 1027, infra.

1007 See Better Markets (Feb. 2012); Public Citizen.

1008 See AFR et al. (Feb. 2012)

1009 See Occupy.

1010 See John Reed; AFR et al. (Feb. 2012); Johnson & Prof. Stiglitz; Prof. Duffie (“A trader’s incentives 

for risk taking can be held in check by vesting incentive-based compensation over a substantial period of 

time. Pending compensation can thus be forfeited if a trader’s negligence causes substantial losses or if his 

or her employer fails.”); Sens. Merkley & Levin (Feb. 2012).
309

discourage traders from carrying inventory and encourage them to get out of positions as 

soon as possible.1011 Some commenters also recommended that compensation be risk 

adjusted.1012

A few commenters indicated that the proposed approach may be too 

restrictive.1013 Two of these commenters stated that the compensation requirement 

should instead be set forth as guidance in Appendix B.1014 In addition, two commenters 

requested that the Agencies clarify that compensation arrangements must be designed not 

to reward prohibited proprietary risk-taking. These commenters were concerned the 

proposed approach may restrict a banking entity’s ability to provide compensation for 

permitted activities, which also involve proprietary trading.1015 

Two commenters discussed identifiable characteristics of compensation 

arrangements that clearly incentivize prohibited proprietary trading.1016 For example, one 

commenter stated that rewarding pure profit and loss, without consideration for the risk 

that was assumed to capture it, is an identifiable characteristic of an arrangement that 

incentivizes proprietary risk-taking.1017 For purposes of monitoring and ensuring 

compliance with this requirement, one commenter noted that existing Board regulations 

for systemically important banking entities require comprehensive firm-wide policies that 

 

1011 See John Reed.

1012 See Johnson & Prof. Stiglitz; John Reed; Sens. Merkley & Levin (Feb. 2012).

1013 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC; Morgan Stanley.

1014 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC.

1015 See Morgan Stanley; SIFMA et al. (Prop. Trading) (Feb. 2012). The Agencies respond to these 

comments in note 1026 and its accompanying text, infra.

1016 See Occupy; Alfred Brock.

1017 See Occupy. The Agencies respond to this comment in Part IV.A.3.c.5.c., infra.
310

determine compensation. This commenter stated that those regulations, along with 

appropriately calibrated metrics, should ensure that compensation arrangements are not 

designed to reward prohibited proprietary risk-taking.1018 For similar purposes, another 

commenter suggested that compensation incentives should be based on a metric that 

meaningfully accounts for the risk underlying profitability.1019

Certain commenters expressed concern that the proposed compensation 

requirement could incentivize market makers to act in a way that would not be beneficial 

to customers or market liquidity.1020 For example, two commenters expressed concern 

that the requirement could cause market makers to widen their spreads or charge higher 

fees because their personal compensation depends on these factors.1021 One commenter 

stated that the proposed requirement could dampen traders’ incentives and discretion and 

may make market makers less likely to accept trades involving significant increases in 

risk or profit.1022 Another commenter expressed the view that profitability-based 

compensation arrangements encourage traders to exercise due care because such 

arrangements create incentives to avoid losses.1023 Finally, one commenter stated that 

compliance with the proposed requirement may be difficult or impossible if the Agencies 

do not take into account the incentive-based compensation rulemaking.1024

 

1018 See Goldman (Prop. Trading).

1019 See Occupy. 

1020 See AllianceBernstein; Investure; Prof. Duffie; STANY. This issue is addressed in note 1027, infra.

1021 See AllianceBernstein; Investure.

1022 See Prof. Duffie.

1023 See STANY.

1024 See Chamber (Dec. 2011).
311

c. Final compensation requirement

Similar to the proposed rule, the market-making exemption requires that the 

compensation arrangements of persons performing the banking entity’s market makingrelated activities, as described in the exemption, are designed not to reward or incentivize 

prohibited proprietary trading.1025 The language of the final compensation requirement 

has been modified in response to comments expressing concern about the proposed 

language regarding “proprietary risk-taking.”1026 The Agencies note that the Agencies do 

not intend to preclude an employee of a market-making desk from being compensated for 

successful market making, which involves some risk-taking. 

The Agencies continue to hold the view that activities for which a banking entity 

has established a compensation incentive structure that rewards speculation in, and 

appreciation of, the market value of a position held in inventory, rather than use of that 

inventory to successfully provide effective and timely intermediation and liquidity 

services to customers, are inconsistent with permitted market making-related activities. 

Although a banking entity relying on the market-making exemption may appropriately 

take into account revenues resulting from movements in the price of principal positions to 

the extent that such revenues reflect the effectiveness with which personnel have 

managed retained principal risk, a banking entity relying on the market-making 

exemption should provide compensation incentives that primarily reward customer 

 

1025 See final rule § __.4(b)(2)(v).

1026 See Morgan Stanley; SIFMA et al. (Prop. Trading) (Feb. 2012). 
312

revenues and effective customer service, not prohibited proprietary trading.1027 For 

example, a compensation plan based purely on net profit and loss with no consideration 

for inventory control or risk undertaken to achieve those profits would not be consistent 

with the market-making exemption. 

6. Registration requirement

a. Proposed registration requirement

Under § __.4(b)(2)(iv) of the proposed rule, a banking entity relying on the 

market-making exemption with respect to trading in securities or certain derivatives 

would be required to be appropriately registered as a securities dealer, swap dealer, or 

security-based swap dealer, or exempt from registration or excluded from regulation as 

such type of dealer, under applicable securities or commodities laws. Further, if the 

banking entity was engaged in the business of a securities dealer, swap dealer, or 

security-based swap dealer outside the United States in a manner for which no U.S. 

registration is required, the banking entity would be required to be subject to substantive 

regulation of its dealing business in the jurisdiction in which the business is located.1028

 

1027 Because the Agencies are not limiting a market maker’s compensation to specific sources, such as fees, 

commissions, and bid-ask spreads, as recommended by a few commenters, the Agencies do not believe the 

compensation requirement in the final rule will incentivize market makers to widen their quoted spreads or 

charge higher fees and commissions, as suggested by certain other commenters. See Better Markets (Feb. 

2012); Public Citizen; AllianceBernstein; Investure. In addition, the Agencies note that an approach 

requiring revenue from fees, commissions, and bid-ask spreads to be fully distinguished from revenue from 

price appreciation can raise certain practical difficulties, as discussed in Part IV.A.3.c.7. The Agencies also 

are not requiring compensation to be vested for a period of time, as recommended by some commenters to 

reduce traders’ incentives for undue risk-taking. The Agencies believe the final rule includes sufficient 

controls around risk-taking activity without a compensation vesting requirement. See John Reed; AFR et 

al. (Feb. 2012); Johnson & Prof. Stiglitz; Prof. Duffie; Sens. Merkley & Levin (Feb. 2012).

1028 See proposed rule § __.4(b)(2)(iv); Joint Proposal, 76 FR at 68,872; CFTC Proposal, 77 FR at 8357-

8358.
313

b. Comments on the proposed registration requirement

A few commenters stated that the proposed dealer registration requirement is 

effective.1029 However, a number of commenters opposed the proposed dealer 

registration requirement in whole or in part.1030 Commenters’ primary concern with the 

requirement appeared to be its application to market making-related activities outside of 

the United States for which no U.S. registration is required.1031 For example, several 

commenters stated that many non-U.S. markets do not provide substantive regulation of 

dealers for all asset classes.1032 In addition, two commenters stated that booking entities 

may be able to rely on intra-group exemptions under local law rather than carrying dealer 

registrations, or a banking entity may execute customer trades through an international 

dealer but book the position in a non-dealer entity for capital adequacy and risk 

management purposes.1033 Several of these commenters requested, at a minimum, that 

the dealer registration requirement not apply to dealers in non-U.S. jurisdictions.1034

In addition, with respect to the provisions that would generally require a banking 

entity to be a form of SEC- or CFTC-registered dealer for market-making activities in 

securities or derivatives in the United States, a few commenters stated that these 

 

1029 See Occupy; Alfred Brock.

1030 See SIFMA et al. (Prop. Trading) (Feb. 2012) (stating that if the requirement is not removed from the 

rule, then it should only be an indicative factor of market making); Morgan Stanley; Goldman (Prop. 

Trading); ISDA (Feb. 2012).

1031 See Goldman (Prop. Trading); Morgan Stanley; RBC; SIFMA et al. (Prop. Trading) (Feb. 2012); ISDA 

(Feb. 2012); JPMC. This issue is addressed in note 1044 and its accompanying text, infra. 

1032 See Goldman (Prop. Trading); RBC; SIFMA et al. (Prop. Trading) (Feb. 2012).

1033 See JPMC; Goldman (Prop. Trading).

1034 See Goldman (Prop. Trading); RBC; SIFMA et al. (Prop. Trading) (Feb. 2012). See also Morgan 

Stanley (requesting the addition of the phrase “to the extent it is legally required to be subject to such 

regulation” to the non-U.S. dealer provisions).
314

provisions should be removed from the rule.1035 These commenters represented that 

removing these provisions would be appropriate for several reasons. For example, one 

commenter stated that dealer registration does not help distinguish between market 

making and speculative trading.1036 Another commenter indicated that effective market 

making often requires a banking entity to trade on several exchange and platforms in a 

variety of markets, including through legal entities other than SEC- or CFTC-registered 

dealer entities.1037 One commenter expressed general concern that the proposed 

requirement may result in the market-making exemption being unavailable for market 

making in exchange-traded futures and options because those markets do not have a 

corollary to dealer registration requirements in securities, swaps, and security-based 

swaps markets.1038

Some commenters expressed particular concern about the provisions that would 

generally require registration as a swap dealer or a security-based swap dealer.1039 For 

example, one commenter expressed concern that these provisions may require banking 

regulators to redundantly enforce CFTC and SEC registration requirements. Moreover, 

according to this commenter, the proposed definitions of “swap dealer” and “securitybased swap dealer” do not focus on the market making core of the swap dealing 

 

1035 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Morgan Stanley; ISDA (Feb. 

2012). Rather than remove the requirement entirely, one commenter recommended that the Agencies move 

the dealer registration requirement to proposed Appendix B, which would allow the Agencies to take into 

account the facts and circumstances of a particular trading activity. See JPMC.

1036 See SIFMA et al. (Prop. Trading) (Feb. 2012).

1037 See Goldman (Prop. Trading).

1038 See CME Group.

1039 See ISDA (Feb. 2012); SIFMA et al. (Prop. Trading) (Feb. 2012).
315

business.1040 Another commenter stated that incorporating the proposed definitions of 

“swap dealer” and “security-based swap dealer” is contrary to the Administrative 

Procedure Act.1041 

c. Final registration requirement

The final requirement of the market-making exemption provides that the banking 

entity must be licensed or registered to engage in market making-related activity in 

accordance with applicable law.1042 The Agencies have considered comments regarding 

the dealer registration requirement in the proposed rule.1043 In response to comments, the 

Agencies have narrowed the scope of the proposed requirement’s application to banking

entities engaged in market making-related activity in foreign jurisdictions.1044 Rather 

than requiring these banking entities to be subject to substantive regulation of their 

dealing business in the relevant foreign jurisdiction, the final rule only require a banking 

entity to be a registered dealer in a foreign jurisdiction to the extent required by 

applicable foreign law. The Agencies have also simplified the language of the proposed 

requirement, although the Agencies have not modified the scope of the requirement with 

respect to U.S. dealer registration requirements.

 

1040 See ISDA (Feb. 2012).

1041 See SIFMA et al. (Prop. Trading) (Feb. 2012).

1042 See final rule § __.4(b)(2)(vi).

1043 See supra Part IV.A.3.c.5.b. One commenter expressed concern that the instruments listed in § 

__.4(b)(2)(iv) of the proposed rule could be interpreted as limiting the availability of the market-making 

exemption to other instruments, such as exchange-traded futures and options. In response to this comment, 

the Agencies note that the reference to particular instruments in § __.4(b)(2)(iv) was intended to reflect that 

trading in certain types of instruments gives rise to dealer registration requirements. This provision was not 

intended to limit the availability of the market-making exemption to certain types of financial instruments. 

See CME Group. 

1044 See Goldman (Prop. Trading); RBC; SIFMA et al. (Prop. Trading) (Feb. 2012); Morgan Stanley. 
316

This provision is not intended to expand the scope of licensing or registration 

requirements under relevant U.S. or foreign law that are applicable to a banking entity 

engaged in market-making activities. Instead, this provision recognizes that compliance 

with applicable law is an essential indicator that a banking entity is engaged in marketmaking activities.1045 For example, a U.S. banking entity would be expected to be an 

SEC-registered dealer to rely on the market-making exemption for trading in securities—

other than exempted securities, security-based swaps, commercial paper, bankers 

acceptances, or commercial bills—unless the banking entity is exempt from registration 

or excluded from regulation as a dealer.1046 Similarly, a U.S. banking entity is expected 

to be a CFTC-registered swap dealer or SEC-registered security-based swap dealer to rely 

on the market-making exemption for trading in swaps or security-based swaps, 

respectively,1047 unless the banking entity is exempt from registration or excluded from 

 

1045 In response to commenters who stated that the dealer registration requirement should be removed from 

the rule because, among other things, registration as a dealer does not distinguish between permitted market 

making and impermissible proprietary trading, the Agencies recognize that acting as a registered dealer 

does not ensure that a banking entity is engaged in permitted market making-related activity. See SIFMA 

et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Morgan Stanley; ISDA (Feb. 2012). 

However, this requirement recognizes that registration as a dealer is an indicator of market making-related 

activities in the circumstances in which a person is legally obligated to be a registered dealer to act as a 

market maker.

1046 A banking entity relying on the market-making exemption for transactions in security-based swaps 

would generally be required to be a registered security-based swap dealer and would not be required to be a 

registered securities dealer. However, a banking entity may be required to be a registered securities dealer 

if it engages in market-making transactions involving security-based swaps with persons that are not 

eligible contract participants. The definition of “dealer” in section 3(a)(5) of the Exchange Act generally 

includes “any person engaged in the business of buying and selling securities (not including security-based 

swaps, other than security-based swaps with or for persons that are not eligible contract participants), for 

such person’s own account.” 15 U.S.C. 78c(a)(5).

To the extent, if any, that a banking entity relies on the market-making exemption for its trading in 

municipal securities or government securities, rather than the exemption in § __.6(a) of the final rule, this 

provision may require the banking entity to be registered or licensed as a municipal securities dealer or 

government securities dealer.

1047 As noted above, under certain circumstances, a banking entity acting as market maker in securitybased swaps may be required to be a registered securities dealer. See supra note 1046.
317

regulation as a swap dealer or security-based swap dealer.1048 In response to comments 

on whether this provision should generally require registration as a swap dealer or 

security-based swap dealer to make a market in swaps or security-based swaps,1049 the 

Agencies continue to believe that this requirement is appropriate. In general, a person 

that is engaged in making a market in swaps or security-based swaps or other activity 

causing oneself to be commonly known in the trade as a market maker in swaps or 

security-based swaps is required to be a registered swap dealer or registered securitybased swap dealer, unless exempt from registration or excluded from regulation as 

such.1050 As noted above, compliance with applicable law is an essential indicator that a 

banking entity is engaged in market-making activities. 

As noted above, the Agencies have determined that, rather than require a banking 

entity engaged in the business of a securities dealer, swap dealer, or security-based swap 

dealer outside the United States to be subject to substantive regulation of its dealing 

business in the foreign jurisdiction in which the business is located, a banking entity’s 

dealing activity outside the U.S. should only be subject to licensing or registration 

requirements under applicable foreign law (provided no U.S. registration or licensing 

requirements apply to the banking entity’s activities). As a result, this requirement will 

not impact a banking entity’s ability to engage in permitted market making-related 

 

1048 For example, a banking entity meeting the conditions of the de minimis exception in SEC Rule 3a71-2 

under the Exchange Act would not need to be a registered security-based swap dealer to act as a market 

maker in security-based swaps. See 17 CFR 240.3a71-2.

1049 See ISDA (Feb. 2012); SIFMA et al. (Prop. Trading) (Feb. 2012).

1050 See 7 U.S.C. 1a(49)(A); 15 U.S.C. 78c(a)(71)(A).
318

activities in a foreign jurisdiction that does not provide for substantive regulation of 

dealers.1051 

7. Source of revenue analysis

a. Proposed source of revenue requirement

To qualify for the market-making exemption, the proposed rule required that the 

market making-related activities of the trading desk or other organizational unit be 

designed to generate revenues primarily from fees, commissions, bid/ask spreads or other 

income not attributable to appreciation in the value of financial instrument positions it 

holds in trading accounts or the hedging of such positions.1052 This proposed requirement 

was intended to ensure that activities conducted in reliance on the market-making 

exemption demonstrate patterns of revenue generation and profitability consistent with, 

and related to, the intermediation and liquidity services a market maker provides to its 

customers, rather than changes in the market value of the positions or risks held in 

inventory.1053

b. Comments regarding the proposed source of revenue requirement

As discussed in more detail below, many commenters expressed concern about 

the proposed source of revenue requirement. These commenters raised a number of 

concerns including, among others, the proposed requirement’s potential impact on a 

 

1051 See Goldman (Prop. Trading); RBC; SIFMA et al. (Prop. Trading) (Feb. 2012); Morgan Stanley. This 

is consistent with one commenter’s suggestion that the Agencies add “to the extent it is legally required to 

be subject to such regulation” to the non-U.S. dealer provisions. See Morgan Stanley.

1052 See proposed rule § __.4(b)(2)(v).

1053 See Joint Proposal, 76 FR at 68,872; CFTC Proposal, 77 FR at 8358.
319

market maker’s inventory or on costs to customers, the difficulty of differentiating 

revenues from spreads and revenues from price appreciation in certain markets, and the 

need for market makers to be compensated for providing intermediation services.1054 

Several of these commenters requested that the proposed source of revenue requirement 

be removed from the rule or modified in certain ways. Some commenters, however, 

expressed support for the proposed requirement or requested that the Agencies place 

greater restrictions on a banking entity’s permissible sources of revenue under the 

market-making exemption.1055

i. Potential restrictions on inventory, increased costs for customers, and other 

changes to market-making services

Many commenters stated that the proposed source of revenue requirement may 

limit a market maker’s ability to hold sufficient inventory to facilitate customer 

demand.1056 Several of these commenters expressed particular concern about applying 

this requirement to less liquid markets or to facilitating large customer positions, where a 

market maker is more likely to hold inventory for a longer period of time and has 

increased risk of potential price appreciation (or depreciation).1057 Further, another 

 

1054 These concerns are addressed in Part IV.A.3.c.7.c., infra.

1055 See infra note 1103 (responding to these comments).

1056 See, e.g., NYSE Euronext; SIFMA et al. (Prop. Trading) (Feb. 2012); Morgan Stanley; Goldman 

(Prop. Trading); BoA; Citigroup (Feb. 2012); STANY; BlackRock; SIFMA (Asset Mgmt.) (Feb. 2012); 

ACLI (Feb. 2012); T. Rowe Price; PUC Texas; SSgA (Feb. 2012); ICI (Feb. 2012) Invesco; MetLife; 

MFA. 

1057 See, e.g., Morgan Stanley; BoA; BlackRock; T. Rowe Price; Goldman (Prop. Trading); NYSE 

Euronext (suggesting that principal trading by market makers in large sizes is essential in some securities, 

such as an AP’s trading in ETFs); Prof. Duffie; SSgA (Feb. 2012); CIEBA; SIFMA et al. (Prop. Trading) 

(Feb. 2012); MFA. To explain its concern, one commenter stated that bid-ask spreads are useful to capture 

the concept of market-making revenues when a market maker is intermediating on a close to real-time basis 

between balanced customer buying and selling interest for the same instrument, but such close-in-time 
320

commenter questioned how the proposed requirement would apply when unforeseen 

market pressure or disappearance of customer demand results in a market maker holding 

a particular position in inventory for longer than expected.1058 In response to this 

proposed requirement, a few commenters stated that it is important for market makers to 

be able to hold a certain amount of inventory to: provide liquidity (particularly in the face 

of order imbalances and market volatility),1059 facilitate large trades, and hedge positions 

acquired in the course of market making.1060

Several commenters expressed concern that the proposed source of revenue 

requirement may incentivize a market maker to widen its quoted spreads or otherwise 

impose higher fees to the detriment of its customers.1061 For example, some commenters 

stated that the proposed requirement could result in a market maker having to sell a 

position in its inventory within an artificially prescribed period of time and, as a result, 

the market maker would pay less to initially acquire the position from a customer.1062 

Other commenters represented that the proposed source of revenue requirement would 

compel market makers to hedge their exposure to price movements, which would likely 

increase the cost of intermediation.1063 

 intermediation does not occur in many large or illiquid assets, where demand gaps may be present for days, 

weeks, or months. See Morgan Stanley.

1058 See Capital Group.

1059 See NYSE Euronext; CIEBA (stating that if the rule discourages market makers from holding 

inventory, there will be reduced liquidity for investors and issuers).

1060 See NYSE Euronext. For a more in-depth discussion of comments regarding the benefits of permitting 

market makers to hold and manage inventory, See Part IV.A.3.c.2.b.vi., infra.

1061 See, e.g., Wellington; CIEBA; MetLife; ACLI (Feb. 2012); SSgA (Feb. 2012); PUC Texas; ICI (Feb. 

2012) BoA.

1062 See MetLife; ACLI (Feb. 2012); ICI (Feb. 2012) SSgA (Feb. 2012).

1063 See SSgA (Feb. 2012); PUC Texas.
321

Some commenters stated that the proposed source of revenue requirement may 

make a banking entity less willing to make markets in instruments that it may not be able 

to resell immediately or in the short term.1064 One commenter indicated that this concern 

may be heightened in times of market stress.1065 Further, a few commenters expressed 

the view that the proposed requirement would cause banking entities to exit the marketmaking business due to restrictions on their ability to make a profit from market-making 

activities.1066 Moreover, in one commenter’s opinion, the proposed requirement would 

effectively compel market makers to trade on an agency basis.1067

ii. Certain price appreciation-related profits are an inevitable or important 

component of market making

A number of commenters indicated that market makers will inevitably make some 

profit from price appreciation of certain inventory positions because changes in market 

values cannot be precisely predicted or hedged.1068 In particular, several commenters 

emphasized that matched or perfect hedges are generally unavailable for most types of 

 

1064 See ICI (Feb. 2012) SSgA (Feb. 2012); SIFMA (Asset Mgmt.) (Feb. 2012); BoA.

1065 See CIEBA (arguing that banking entities may be reluctant to provide liquidity when markets are 

declining and there are more sellers than buyers because it would be necessary to hold positions in 

inventory to avoid losses).

1066 See Credit Suisse (Seidel) (arguing that banking entities are likely to cease being market makers if they 

are: (i) unable to take into account the likely direction of a financial instrument, or (ii) forced to take losses 

if a financial instrument moves against them, but cannot take gains if the instrument’s price moves in their 

favor); STANY (contending that banking entities cannot afford to maintain unprofitable or marginally 

profitable operations in highly competitive markets, so this requirement would cause banking entities to 

eliminate a majority of their market-making functions).

1067 See IR&M (arguing that domestic corporate and securitized credit markets are too large and 

heterogeneous to be served appropriately by a primarily agency-based trading model).

1068 See Wellington; Credit Suisse (Seidel); Morgan Stanley; PUC Texas (contending that it is impossible 

to predict the behavior of even the most highly correlated hedge in comparison to the underlying position); 

CIEBA; SSgA (Feb. 2012); AllianceBernstein; Investure; Invesco.
322

positions.1069 According to one commenter, a provision that effectively requires a 

market-making business to hedge all of its principal positions would discourage essential 

market-making activity. The commenter explained that effective hedges may be 

unavailable in less liquid markets and hedging can be costly, especially in relation to the 

relative risk of a trade and hedge effectiveness.1070 A few commenters further indicated 

that making some profit from price appreciation is a natural part of market making or is 

necessary to compensate a market maker for its willingness to take a position, and its 

associated risk (e.g., the risk of market changes or decreased value), from a customer.1071

iii. Concerns regarding the workability of the proposed standard in certain markets or 

asset classes

Some commenters represented that it would be difficult or burdensome to identify 

revenue attributable to the bid-ask spread versus revenue arising from price appreciation, 

either as a general matter or for specific markets.1072 For example, one commenter 

expressed the opinion that the difference between the bid-ask spread and price 

appreciation is “metaphysical” in some sense,1073 while another stated that it is almost 

 

1069 See Morgan Stanley; Credit Suisse (Seidel); SSgA (Feb. 2012); PUC Texas; Wellington; 

AllianceBernstein; Investure.

1070 See Wellington. Moreover, one commenter stated that, as a general matter, market makers need to be 

compensated for bearing risk related to providing immediacy to a customer. This commenter stated that 

“[t]he greater the inventory risk faced by the market maker, the higher the expected return (compensation) 

that the market maker needs,” to compensate the market maker for bearing the risk and reward its 

specialization skills in that market (e.g., its knowledge about market conditions and early indicators that 

may imply future price movements in a particular direction). This commenter did not, however, discuss the 

source of revenue requirement in the proposed rule. See Thakor Study.

1071 See Capital Group; Prof. Duffie; Investure; SIFMA et al. (Prop. Trading) (Feb. 2012); STANY; 

SIFMA (Asset Mgmt.) (Feb. 2012); RBC; PNC.

1072 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); BoA; Citigroup (Feb. 

2012); Japanese Bankers Ass’n.; Sumitomo Trust; Morgan Stanley; Barclays; RBC; Capital Group.

1073 See SIFMA et al. (Prop. Trading) (Feb. 2012).
323

impossible to objectively identify a bid-ask spread or to capture profit and loss solely 

from a bid-ask spread in most markets.1074 Other commenters represented that it is 

particularly difficult to make this distinction when trades occur infrequently or where 

prices are not transparent, such as in the fixed-income market where no spread is 

published.1075 

Many commenters expressed particular concern about the proposed requirement’s 

application to specific markets, including: the fixed-income markets;1076 the markets for 

commodities, derivatives, securitized products, and emerging market securities;1077

equity and physical commodity derivatives markets;1078 and customized swaps used by 

 

1074 See Citigroup (Feb. 2012). See also Barclays (arguing that a bid-ask spread cannot be defined on a 

consistent basis with respect to many instruments).

1075 See Goldman (Prop. Trading); BoA; Morgan Stanley (“Observable, actionable, bid/ask spreads exist in 

only a small subset of institutional products and markets. Indicative bid/ask spreads may be observable for 

certain products, but this pricing would typically be specific to small size standard lot trades and would not 

represent a spread applicable to larger and/or more illiquid trades. End-of-day valuations for assets are 

calculated, but they are not an effective proxy for real-time bid/ask spreads because of intra-day price 

movements.”); RBC; Capital Group (arguing that bid-ask spreads in fixed-income markets are not always 

quantifiable or well defined and can fluctuate widely within a trading day because of small or odd lot 

trades, price discovery activity, a lack of availability to cover shorts, or external factors not directly related 

to the security being traded). 

1076 See Capital Group; CIEBA; SIFMA et al. (Prop. Trading) (Feb. 2012); SSgA (Feb. 2012). These 

commenters stated that the requirement may be problematic for the fixed-income markets because, for 

example, market makers must hold inventory in these markets for a longer period of time than in more 

liquid markets. See id.

1077 See SIFMA et al. (Prop. Trading) (Feb. 2012) (stating that these markets are characterized by even less 

liquidity and less frequent trading than the U.S. corporate bond market). This commenter also stated that in 

markets where trades are large and less frequent, such as the market for customized securitized products, 

appreciation in price of one position may be a predominate contributor to the overall profit and loss of the 

trading unit. See id.

1078 See BoA. According to this commenter, the distinction between capturing a spread and price 

appreciation is fundamentally flawed in some markets, like equity derivatives, because the market does not 

trade based on movements of a particular security or underlying instrument. This commenter indicated that 

expected returns are instead based on the bid-ask spread the market maker charges for implied volatility as 

reflected in options premiums and hedging of the positions. See id.
324

customers of banking entities for hedging purposes.1079 Another commenter expressed 

general concern about extremely volatile markets, where market makers often see large 

upward or downward price swings over time.1080 

Two commenters emphasized that the revenues a market maker generates from 

hedging the positions it holds in inventory are equivalent to spreads in many markets. 

These commenters explained that, under these circumstances, a market maker generates 

revenue from the difference between the customer price for the position and the banking 

entity’s price for the hedge. The commenters noted that proposed Appendix B expressly 

recognizes this in the case of derivatives and recommended that Appendix B’s guidance 

on this point apply equally to certain non-derivative positions.1081

A few commenters questioned how this requirement would work in the context of 

block trading or otherwise facilitating large trades, where a market maker may charge a 

premium or discount for taking on a large position to provide “immediacy” to its 

customer.1082 One commenter further explained that explicitly quoted bid-ask spreads are 

 

1079 See CIEBA (stating that because it would be difficult for a market maker to enter promptly into an 

offsetting swap, the market maker would not be able to generate income from the spread).

1080 See SIFMA et al. (Prop. Trading) (Feb. 2012). This commenter questioned whether proposed 

Appendix B’s reference to “unexpected market disruptions” as an explanatory fact and circumstance was 

intended to permit such market making. See id.

1081 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading). In its discussion of 

“customer revenues,” Appendix B states: “In the case of a derivative contract, these revenues reflect the 

difference between the cost of entering into the derivative contract and the cost of hedging incremental, 

residual risks arising from the contract.” Joint Proposal, 76 FR at 68,960; CFTC Proposal, 77 FR at 8440. 

See also RBC (requesting clarification on how the proposed standard would apply if a market maker took 

an offsetting position in a different instrument (e.g., a different bond) and inquiring whether, if the trader 

took the offsetting position, its revenue gain is attributable to price appreciation of the two offsetting 

positions or from the bid-ask spread in the respective bonds).

1082 See Prof. Duffie; NYSE Euronext; Capital Group; RBC; Goldman (Prop. Trading). See also Thakor 

Study (discussing market makers’ role of providing “immediacy” in general).
325

only valid for indicated trade sizes that are modest enough to have negligible market 

impact, and such spreads cannot be used for purposes of a significantly larger trade.1083 

iv. Suggested modifications to the proposed requirement

To address some or all of the concerns discussed above, many commenters 

recommended that the source of revenue requirement be modified1084 or removed from 

the rule entirely.1085 With respect to suggested changes, some commenters stated that the 

Agencies should modify the rule text,1086 use a metrics-based approach to focus on 

customer revenues,1087 or replace the proposed requirement with guidance.1088 Some 

commenters requested that the Agencies modify the focus of the requirement so that, for 

example, dealers’ market-making activities in illiquid securities can function as close to 

normal as possible1089 or market makers can take short-term positions that may ultimately 

 

1083 See CIEBA.

1084 See, e.g., JPMC; Barclays; Goldman (Prop. Trading); BoA; CFA Inst.; ICI (Feb. 2012) Flynn & 

Fusselman.

1085 See, e.g., CIEBA; SIFMA et al. (Prop. Trading) (Feb. 2012); Morgan Stanley; Goldman (Prop. 

Trading); Capital Group; RBC. In addition to the concerns discussed above, one commenter stated that the 

proposed requirement may set limits on the values of certain metrics, and it would be inappropriate to 

prejudge the appropriate results of such metrics at this time. See SIFMA et al. (Prop. Trading) (Feb. 2012).

1086 See, e.g., Barclays. This commenter provided alternative rule text stating that “market making-related 

activity is conducted by each trading unit such that its activities are reasonably designed to generate 

revenues primarily from fees, commissions, bid-ask spreads, or other income attributable to satisfying

reasonably expected customer demand.” See id.

1087 See Goldman (Prop. Trading) (suggesting that the Agencies use a metrics-based approach to focus on 

customer revenues, as measured by Spread Profit and Loss (when it is feasible to calculate) or other 

metrics, especially because a proprietary trading desk would not be expected to earn any revenues this 

way). This commenter also indicated that the “primarily” standard in the proposed rule is problematic and 

can be read to mean “more than 50%,” which is different from Appendix B’s acknowledgment that the 

proportion of customer revenues relative to total revenues will vary by asset class. See id.

1088 See BoA (recommending that the guidance state that the Agencies would consider the design and mix 

of such revenues as an indicator of potentially prohibited proprietary trading, but only for those markets for 

which revenues are quantifiable based on publicly available data, such as segments of certain highly liquid 

equity markets).

1089 See CFA Inst.
326

result in a profit or loss.1090 As discussed below, some commenters stated that the 

Agencies should modify the proposed requirement to place greater restrictions on market 

maker revenue. 

v. General support for the proposed requirement or for placing greater restrictions on 

a market maker’s sources of revenue

Some commenters expressed support for the proposed source of revenue 

requirement or stated that the requirement should be more restrictive.1091 For example, 

one of these commenters stated that a real market maker’s trading book should be fully 

hedged, so it should not generate profits in excess of fees and commissions except in 

times of rare and extraordinary market conditions.1092 According to another commenter, 

the final rule should make it clear that banking entities seeking to rely on the marketmaking exemption may not generally seek to profit from price movements in their 

inventories, although their activities may give rise to modest and relatively stable profits 

arising from their limited inventory.1093 One commenter recommended that the proposed 

requirement be interpreted to limit market making in illiquid positions because a banking 

 

1090 See ICI (Feb. 2012).

1091 See Sens. Merkley & Levin (Feb. 2012); Better Markets (Feb. 2012); FTN; Public Citizen; Occupy; 

Alfred Brock.

1092 See Better Markets (Feb. 2012). See also Public Citizen (arguing that the imperfection of a hedge 

should signal potential disqualification of the underlying position from the market-making exemption).

1093 See Sens. Merkley & Levin (Feb. 2012). This commenter further suggested that the rule identify 

certain red flags and metrics that could be used to monitor this requirement, such as: (i) failure to obtain 

relatively low ratios of revenue-to-risk, low volatility, and relatively high turnover; (ii) significant revenues 

from price appreciation relative to the value of securities being traded; (iii) volatile revenues from price 

appreciation; or (iv) revenue from price appreciation growing out of proportion to the risk undertaken with 

the security. See id.
327

entity cannot have the required revenue motivation when it enters into a position for 

which there is no readily discernible exit price.1094

Further, some commenters suggested that the Agencies remove the word 

“primarily” from the provision to limit banking entities to specified sources of 

revenue.1095 In addition, one of these commenters requested that the Agencies restrict a 

market maker’s revenue to fees and commissions and remove the allowance for revenue 

from bid-ask spreads because generating bid-ask revenues relies exclusively on changes 

in market values of positions held in inventory.1096 For enforcement purposes, a few 

commenters suggested that the Agencies require banking entities to disgorge any profit 

obtained from price appreciation.1097 

c. Final rule’s approach to assessing revenues

Unlike the proposed rule, the final rule does not include a requirement that a 

trading desk’s market making-related activity be designed to generate revenue primarily 

from fees, commissions, bid-ask spreads, or other income not attributable to appreciation 

in the value of a financial instrument or hedging.1098 The revenue requirement was one 

of the most commented upon aspects of the market-making exemption in the 

proposal.1099 

 

1094 See AFR et al. (Feb. 2012).

1095 See Occupy; Better Markets (Feb. 2012). See supra note 1103 (addressing these comments).

1096 See Occupy.

1097 See Occupy; Public Citizen.

1098 See proposed rule § __.4(b)(2)(v).

1099 See infra Part IV.A.3.c.7.b.
328

The Agencies believe that an analysis of patterns of revenue generation and 

profitability can help inform a judgment regarding whether trading activity is consistent 

with the intermediation and liquidity services that a market maker provides to its 

customers in the context of the liquidity, maturity, and depth of the relevant market, as 

opposed to prohibited proprietary trading activities. To facilitate this type of analysis, the 

Agencies have included a metrics data reporting requirement that is refined from the 

proposed metric regarding profits and losses. The Comprehensive Profit and Loss 

Attribution metric collects information regarding the daily fluctuation in the value of a 

trading desk’s positions to various sources, along with its volatility, including: (i) profit 

and loss attributable to current positions that were also held by the banking entity as of 

the end of the prior day (“existing positions); (ii) profit and loss attributable to new 

positions resulting from the current day’s trading activity (“new positions”); and (iii) 

residual profit and loss that cannot be specifically attributed to existing positions or new 

positions.1100 

This quantitative measurement has certain conceptual similarities to the proposed 

source of revenue requirement in § __.4(b)(2)(v) of the proposed rule and certain of the 

proposed quantitative measurements.1101 However, in response to comments on those 

provisions, the Agencies have determined to modify the focus from particular revenue 

sources (e.g., fees, commissions, bid-ask spreads, and price appreciation) to when the 

trading desk generates revenue from its positions. The Agencies recognize that when the 

 

1100 See Appendix A of the final rule (describing the Comprehensive Profit and Loss Attribution metric). 

This approach is generally consistent with one commenter’s suggested metrics-based approach to focus on 

customer-related revenues. See Goldman (Prop. Trading); See also Sens. Merkley & Levin (Feb. 2012)

(suggesting the use of metrics to monitor a firm’s source of revenue); proposed Appendix A.

1101 See supra Part IV.A.3.c.7. and infra Part IV.C.3.
329

trading desk is engaged in market making-related activities, the day one profit and loss 

component of the Comprehensive Profit and Loss Attribution metric may reflect 

customer-generated revenues, like fees, commissions, and spreads (including embedded 

premiums or discounts), as well as that day’s changes in market value. Thereafter, profit 

and loss associated with the position carried in the trading desk’s book may reflect 

changes in market price until the position is sold or unwound. The Agencies also 

recognize that the metric contains a residual component for profit and loss that cannot be 

specifically attributed to existing positions or new positions. 

The Agencies believe that evaluation of the Comprehensive Profit and Loss 

Attribution metric could provide valuable information regarding patterns of revenue 

generation by market-making trading desks involved in market-making activities that 

may warrant further review of the desk’s activities, while eliminating the requirement 

from the proposal that the trading desk demonstrate that its primary source of revenue, 

under all circumstances, is fees, commissions and bid/ask spreads. This modified focus 

will reduce the burden associated with the proposed source of revenue requirement and 

better account for the varying depth and liquidity of markets.1102 In addition, the 

 

1102 The Agencies understand that some commenters interpreted the proposed requirement as requiring that 

both the bid-ask spread for a financial instrument and the revenue a market maker acquired from such bidask spread through a customer trade be identifiable on a close-to-real-time basis and readily distinguishable 

from any additional revenue gained from price appreciation (both on the day of the transaction and for the 

rest of the holding period). See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); 

BoA; Citigroup (Feb. 2012); Japanese Bankers Ass’n.; Sumitomo Trust; Morgan Stanley; Barclays; RBC; 

Capital Group. We recognize that such a requirement would be unduly burdensome. In fact, the proposal 

noted that bid-ask spreads or similar spreads may not be widely disseminated on a consistent basis or 

otherwise reasonably ascertainable in certain asset classes for purposes of the proposed Spread Profit and 

Loss metric in Appendix A of the proposal. See Joint Proposal, 76 FR at 68,958-68,959; CFTC Proposal, 

77 FR at 8438. Moreover, the burden associated with the proposed requirement should be further reduced 

because we are not adopting a stand-alone requirement regarding a trading desk’s source of revenue. 

Instead, when and how a trading desk generates profit and loss from its trading activities is a factor that 

must be considered for purposes of the near term customer demand requirement. It is not a dispositive 

factor for determining compliance with the exemption. 
330

Agencies believe these modifications appropriately address commenters’ concerns about 

the proposed source of revenue requirement and reduce the potential for negative market 

impacts of the proposed requirement cited by commenters, such as incentives to widen 

spreads or disincentives to engage in market making in less liquid markets.1103 

The Agencies recognize that this analysis is only informative over time, and 

should not be determinative of an analysis of whether the amount, types, and risks of the 

financial instruments in the trading desk’s market-maker inventory are designed not to 

exceed the reasonably expected near term demands of clients, customers, or 

counterparties. The Agencies believe this quantitative measurement provides appropriate 

flexibility to obtain information on market-maker revenues, which is designed to address 

commenters’ concerns about the proposal’s source of revenue requirement (e.g., the 

burdens associated with differentiating spread revenue from price appreciation revenue) 

while also helping assess patterns of revenue generation that may be informative over 

 

Further, some commenters expressed concern that the proposed requirement suggested market makers were 

not permitted to profit from price appreciation, but rather only from observable spreads or explicit fees or 

commissions. See, e.g., Wellington, Credit Suisse (Seidel); Morgan Stanley; PUC Texas; CIEBA; SSgA 

(Feb. 2012); AllianceBernstein; Investure; Invesco. The Agencies confirm that the intent of the marketmaking exemption is not to preclude a trading desk from generating any revenue from price appreciation. 

Because this approach clarifies that a trading desk’s source of revenue is not limited to its quoted spread, 

the Agencies believe this quantitative measurement will address commenters concerns that the proposed 

source of revenue requirement could create incentives for market makers to widen their spreads, result in 

higher transaction costs, require market makers to hedge any exposure to price movements, or discourage a 

trading desk from making a market in instruments that it may not be able to sell immediately. See

Wellington; CIEBA; MetLife; ACLI (Feb. 2012); SSgA (Feb. 2012); PUC Texas; ICI (Feb. 2012) BoA; 

SIFMA (Asset Mgmt.) (Feb. 2012). The modifications to this provision are designed to better reflect when, 

on average and across many transactions, profits are gained rather than how they are gained, similar to the 

way some firms measure their profit and loss today. See, e.g., Goldman (Prop. Trading).

1103 See, e.g., Wellington; CIEBA; MetLife; ACLI (Feb. 2012); SSgA (Feb. 2012); PUC Texas; ICI (Feb. 

2012) BoA. The Agencies are not adopting an approach that limits a market maker to specified revenue 

sources (e.g., fees, commissions, and spreads), as suggested by some commenters, due to the considerations 

discussed above. See Occupy; Better Markets (Feb. 2012). In response to the proposed source of revenue 

requirement, some commenters noted that a market maker may charge a premium or discount for taking on 

a large position from a customer. See Prof. Duffie; NYSE Euronext; Capital Group; RBC; Goldman (Prop. 

Trading).
331

time about whether a market maker’s activities are designed to facilitate and provide 

customer intermediation. 

8. Appendix B of the proposed rule

a. Proposed Appendix B requirement

The proposed market-making exemption would have required that the market 

making-related activities of the trading desk or other organizational unit of the banking 

entity be consistent with the commentary in proposed Appendix B.1104 In this proposed 

Appendix, the Agencies provided overviews of permitted market making-related activity 

and prohibited proprietary trading activity.1105

The proposed Appendix also set forth various factors that the Agencies proposed 

to use to help distinguish prohibited proprietary trading from permitted market makingrelated activity. More specifically, proposed Appendix B set forth six factors that, absent 

explanatory facts and circumstances, would cause particular trading activity to be 

considered prohibited proprietary trading activity and not permitted market makingrelated activity. The proposed factors focused on: (i) retaining risk in excess of the size 

and type required to provide intermediation services to customers (“risk management 

factor”); (ii) primarily generating revenues from price movements of retained principal 

positions and risks, rather than customer revenues (“source of revenues factor”); (iii) 

generating only very small or very large amounts of revenue per unit of risk, not 

demonstrating consistent profitability, or demonstrating high earnings volatility 

 

1104 See proposed rule § __.4(b)(2)(vi).

1105 See Joint Proposal, 76 FR at 68,873, 68,960-68,961; CFTC Proposal, 77 FR at 8358, 8439-8440.
332

(“revenues relative to risk factor”); (iv) not trading through a trading system that interacts 

with orders of others or primarily with customers of the banking entity’s market-making 

desk to provide liquidity services, or retaining principal positions in excess of reasonably 

expected near term customer demands (“customer-facing activity factor”); (v) routinely 

paying rather than earning fees, commissions, or spreads (“payment of fees, 

commissions, and spreads factor”); and (vi) providing compensation incentives to 

employees that primarily reward proprietary risk-taking (“compensation incentives 

factor”).1106

b. Comments on proposed Appendix B 

Commenters expressed differing views about the accuracy of the commentary in 

proposed Appendix B and the appropriateness of including such commentary in the rule. 

For example, some commenters stated that the description of market making-related 

activity in the proposed appendix is accurate1107 or appropriately accounts for differences 

among asset classes.1108 Other commenters indicated that the appendix is too strict or 

narrow.1109 Some commenters recommended that the Agencies revise proposed 

 

1106 See Joint Proposal, 76 FR at 68,873, 68,961-68,963; CFTC Proposal, 77 FR at 8358, 8440-8442.

1107 See MetLife; ACLI (Feb. 2012).

1108 See Alfred Brock. But See, e.g., Occupy (stating that the proposed commentary only accounts for the 

most liquid and transparent markets and fails to accurately describe market making in most illiquid or OTC 

markets).

1109 See Morgan Stanley; IIF; Sumitomo Trust; ISDA (Apr. 2012); BDA (Feb. 2012) (Oct. 2012) (stating 

that proposed Appendix B places too great of a focus on derivatives trading and does not reflect how 

principal trading operations in equity and fixed income markets are structured). One of these commenters 

requested that the appendix be modified to account for certain activities conducted in connection with 

market making in swaps. This commenter indicated that a swap dealer may not regularly enjoy a dominant 

flow of customer revenues and may consistently need to make revenue from its book management. In 

addition, the commenter stated that the appendix should recognize that making a two-way market may be a 

dominant theme, but there are certain to be frequent occasions when, as a matter of market or internal 

circumstances, a market maker is unavailable to trade. See ISDA (Apr. 2012). 
333

Appendix B’s approach by, for example, placing greater focus on what market making is 

rather than what it is not,1110 providing presumptions of activity that will be treated as 

permitted market making-related activity,1111re-formulating the appendix as nonbinding 

guidance,1112 or moving certain requirements of the proposed exemption to the 

appendix.1113 One commenter suggested the Agencies remove Appendix B from the rule 

and instead use the conformance period to analyze and develop a body of supervisory 

guidance that appropriately characterizes the nature of market making-related activity.1114

A few commenters expressed concern about the appendix’s facts-andcircumstances-based approach to distinguishing between prohibited proprietary trading 

and permitted market making-related activity and stated that such an approach will make 

it more difficult or burdensome for banking entities to comply with the proposed rule1115

or will generate regulatory uncertainty.1116 As discussed below, other commenters 

opposed proposed Appendix B because of its level of granularity1117 or due to perceived 

restrictions on interdealer trading or generating revenue from retained principal positions 

 

1110 See SIFMA et al. (Prop. Trading) (Feb. 2012).

1111 See Sens. Merkley & Levin (Feb. 2012). This commenter stated that, for example, Appendix B could 

deem market making involving widely-traded stocks and bonds issued by well-established corporations, 

government securities, or highly liquid asset-backed securities as the type of plain vanilla, low risk capital 

activities that are presumptively permitted, provided the activity is within certain, specified parameters for 

inventory levels, revenue-to-risk metrics, volatility, and hedging. See id.

1112 See Morgan Stanley; Flynn & Fusselman.

1113 See JPMC. In support of such an approach, the commenter argued that sometimes proposed § __.4(b) 

and Appendix B addressed the same topic and, when this occurs, it is unclear whether compliance with 

Appendix B constitutes compliance with § __.4(b) or if additional compliance steps are required. See id.

1114 See Morgan Stanley.

1115 See NYSE Euronext; Morgan Stanley.

1116 See IAA.

1117 See Wellington; Goldman (Prop. Trading); SIFMA (Asset Mgmt.) (Feb. 2012).
334

or risks in the proposed appendix.1118 A number of commenters expressed concern about 

the complexity or prescriptiveness of the six proposed factors for distinguishing 

permitted market making-related activity from prohibited proprietary trading.1119

With respect to the level of granularity of proposed Appendix B, a number of 

commenters expressed concern that the reference to a “single significant transaction” 

indicated that the Agencies will review compliance with the proposed market-making 

exemption on a trade-by-trade basis and stated that assessing compliance at the level of 

individual transactions would be unworkable.1120 One of these commenters further stated 

that assessing compliance at this level of granularity would reduce a market maker’s 

willingness to execute a customer sell order as principal due to concern that the market 

maker may not be able to immediately resell such position. The commenter noted that 

this chilling effect would be heightened in declining markets.1121

A few commenters interpreted certain statements in proposed Appendix B as 

limiting interdealer trading and expressed concerns regarding potential limitations on this 

activity.1122 These commenters emphasized that market makers may need to trade with 

 

1118 See Morgan Stanley; Chamber (Feb. 2012); Goldman (Prop. Trading).

1119 See Japanese Bankers Ass’n.; Credit Suisse (Seidel); Chamber (Feb. 2012); ICFR; Morgan Stanley; 

Goldman (Prop. Trading); Occupy; Oliver Wyman (Feb. 2012); Oliver Wyman (Dec. 2011); Public 

Citizen; NYSE Euronext. But See Alfred Brock (stating that the proposed factors are effective).

1120 See Wellington; Goldman (Prop. Trading); SIFMA (Asset Mgmt.) (Feb. 2012). In particular, proposed 

Appendix B provided that “The particular types of trading activity described in this appendix may involve 

the aggregate trading activities of a single trading unit, a significant number or series of transactions 

occurring at one or more trading units, or a single significant transaction, among other potential scenarios.” 

Joint Proposal, 76 FR at 68,961; CFTC Proposal, 77 FR at 8441. The Agencies address commenters’ tradeby-trade concerns in Part IV.A.3.c.1.c.ii., infra.

1121 See Goldman (Prop. Trading).

1122 See Morgan Stanley; Goldman (Prop. Trading); Chamber (Feb. 2012). Specifically, commenters cited 

statements in proposed Appendix B indicating that market makers “typically only engage in transactions 

with non-customers to the extent that these transactions directly facilitate or support customer 

transactions.” On this issue, the appendix further stated that “a market maker generally only transacts with 
335

non-customers to: (i) provide liquidity to other dealers and, indirectly, their customers, or 

to otherwise allow customers to access a larger pool of liquidity;1123 (ii) conduct price 

discovery to inform the prices a market maker can offer to customers;1124 (iii) unwind or 

sell positions acquired from customers;1125 (iv) establish or acquire positions to meet 

reasonably expected near term customer demand;1126 (v) hedge;1127 and (vi) sell a 

financial instrument when there are more buyers than sellers for the instrument at that 

time.1128 Further, one of these commenters expressed the view that the proposed 

appendix’s statements are inconsistent with the statutory market-making exemption’s 

reference to “counterparties.”1129

In addition, a few commenters expressed concern about statements in proposed 

Appendix B about a market maker’s source of revenue.1130 According to one commenter, 

 non-customers to the extent necessary to hedge or otherwise manage the risks of its market making-related 

activities, including managing its risk with respect to movements of the price of retained principal positions 

and risks, to acquire positions in amounts consistent with reasonably expected near term demand of its 

customers, or to sell positions acquired from its customers.” The appendix recognized, however, that the 

“appropriate proportion of a market maker’s transactions that are with customers versus non-customers 

varies depending on the type of positions involved and the extent to which the positions are typically 

hedged in non-customer transactions.” Joint Proposal, 76 FR at 68,961; CFTC Proposal, 77 FR at 8440. 

Commenters’ concerns regarding interdealer trading are addressed in Part IV.A.3.c.2.c.i., infra.

1123 See Morgan Stanley; Goldman (Prop. Trading).

1124 See Morgan Stanley; Goldman (Prop. Trading); Chamber (Feb. 2012).

1125 See Morgan Stanley; Chamber (Feb. 2012) (stating that market makers in the corporate bond, interest 

rate derivative, and natural gas derivative markets frequently trade with other dealers to work down a 

concentrated position originating with a customer trade).

1126 See Morgan Stanley; Chamber (Feb. 2012).

1127 See Goldman (Prop. Trading).

1128 See Chamber (Feb. 2012).

1129 See Goldman (Prop. Trading).

1130 See Morgan Stanley; SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading). On this 

issue, Appendix B stated that certain types of “customer revenues” provide the primary source of a market 

maker’s profitability and, while a market maker also incurs losses or generates profits as price movements 

occur in its retained principal positions and risks, “such losses or profits are incidental to customer revenues 

and significantly limited by the banking entity’s hedging activities.” Joint Proposal, 76 FR at 68,960; CFTC 
336

the statement that profit and loss generated by inventory appreciation or depreciation 

must be “incidental” to customer revenues is inconsistent with market making-related 

activity in less liquid assets and larger transactions because market makers often must 

retain principal positions for longer periods of time in such circumstances and are unable 

to perfectly hedge these positions.1131 As discussed above with respect to the source of 

revenue requirement in § __.4(b)(v) of the proposed rule, a few commenters requested 

that Appendix B’s discussion of “customer revenues” be modified to state that revenues 

from hedging will be considered to be customer revenues in certain contexts beyond 

derivatives contracts.1132

A number of commenters discussed the six proposed factors in Appendix B that, 

absent explanatory facts and circumstances, would have caused a particular trading 

activity to be considered prohibited proprietary trading activity and not permitted market 

making-related activity.1133 With respect to the proposed factors, one commenter 

indicated that they are appropriate,1134 while another commenter stated that they are 

complex and their effectiveness is uncertain.1135 Another commenter expressed the view 

that “[w]hile each of the selected factors provides evidence of ‘proprietary trading,’ 

warrants regulatory attention, and justifies a shift in the burden of proof, some require 

 

Proposal, 77 FR at 8440. The Agencies address commenters’ concerns about proposed requirements 

regarding a market maker’s source of revenue in Part IV.A.3.c.7.c., infra. 

1131 See Morgan Stanley.

1132 See supra note 1081 and accompanying text.

1133 See supra note 1106 and accompanying text.

1134 See Alfred Brock.

1135 See Japanese Bankers Ass’n.
337

subjective judgments, are subject to gaming or data manipulation, and invite excessive 

reliance on circumstantial evidence and lawyers’ opinions.”1136 

In response to the proposed risk management factor,1137 one commenter expressed 

concern that it could prevent a market maker from warehousing positions in anticipation 

of predictable but unrealized customer demands and, further, could penalize a market 

maker that misestimated expected demand. This commenter expressed the view that such 

an outcome would be contrary to the statute and would harm market liquidity.1138 

Another commenter requested that this presumption be removed because in less liquid 

markets, such as markets for corporate bonds, equity derivatives, securitized products, 

emerging markets, foreign exchange forwards, and fund-linked products, a market maker 

needs to act as principal to facilitate client requests and, as a result, will be exposed to 

risk.1139

Two commenters expressed concern about the proposed source of revenue 

factor.1140 One commenter stated that this factor does not accurately reflect how market 

making occurs in a majority of markets and asset classes.1141 The other commenter 

expressed concern that this factor shifted the emphasis of § __.4(b)(v) of the proposed 

 

1136 Sens. Merkley & Levin (Feb. 2012).

1137 The proposed appendix stated that the Agencies would use certain quantitative measurements required 

in proposed Appendix A to help assess the extent to which a trading unit’s risks are potentially being 

retained in excess amounts, including VaR, Stress VaR, VaR Exceedance, and Risk Factor Sensitivities. 

See Joint Proposal, 76 FR at 68,961-68,962; CFTC Proposal, 77 FR at 8441. One commenter questioned 

whether, assuming such metrics are effective and the activity does not exceed the banking entity’s 

expressed risk appetite, it is necessary to place greater restrictions on risk-taking, based on the Agencies’

judgment of the level of risk necessary for bona fide market making. See ICFR.

1138 See Chamber (Feb. 2012).

1139 See Credit Suisse (Seidel).

1140 See Goldman (Prop. Trading); Morgan Stanley.

1141 See Morgan Stanley.
338

rule, which required that market making-related activities be “designed” to generate 

revenue primarily from certain sources, to the actual outcome of activities.1142

With respect to the proposed revenues relative to risk factor, one commenter 

supported this aspect of the proposal.1143 Some commenters, however, expressed concern 

about using these factors to differentiate permitted market making-related activity from 

prohibited proprietary trading.1144 These commenters stated that volatile risk-taking and 

revenue can be a natural result of principal market-making activity.1145 One commenter 

noted that customer flows are often “lumpy” due to, for example, a market maker’s 

facilitation of large trades.1146 

A few commenters indicated that the analysis in the proposed customer-facing 

activity factor may not accurately reflect how market making occurs in certain markets 

and asset classes due to potential limitations on interdealer trading.1147 According to 

another commenter, however, a banking entity’s non-customer facing trades should be 

 

1142 See Goldman (Prop. Trading). This commenter suggested that the Agencies remove any negative 

presumptions based on revenues and instead use revenue metrics, such as Spread Profit and Loss (when it 

is feasible to calculate) or other metrics for purposes of monitoring a banking entity’s trading activity. See

id.

1143 See Occupy (stating that these factors are important and will provide invaluable information about the 

nature of the banking entity’s trading activity).

1144 See Morgan Stanley; Credit Suisse (Seidel); Oliver Wyman (Feb. 2012); Oliver Wyman (Dec. 2011).

1145 See Morgan Stanley; Credit Suisse (Seidel); Oliver Wyman (Feb. 2012); Oliver Wyman (Dec. 2011). 

For example, one commenter stated that because markets and trading volumes are volatile, consistent 

profitability and low earnings volatility are outside a market maker’s control. In support of this statement, 

the commenter indicated that: (i) customer trading activity varies significantly with market conditions, 

which results in volatility in a market maker’s earnings and profitability; and (ii) a market maker will 

experience volatility associated with changes in the value of its inventory positions, and principal risk is a 

necessary feature of market making. See Morgan Stanley.

1146 See Oliver Wyman (Feb. 2012); Oliver Wyman (Dec. 2011).

1147 See Morgan Stanley; Goldman (Prop. Trading).
339

required to be matched with existing customer counterparties.1148 With respect to the 

near term customer demand component of this factor, one commenter expressed concern 

that it goes farther than the statute’s activity-based “design” test by analyzing whether a 

trading unit’s inventory has exceeded reasonably expected near term customer demand at 

any particular point in time.1149

Some commenters expressed concern about the payment of fees, commissions, 

and spreads factor. 1150 One commenter appeared to support this proposed factor.1151 

According to one commenter, this factor fails to recognize that market makers routinely 

pay a variety of fees in connection with their market making-related activity, including, 

for example, fees to access liquidity on another market to satisfy customer demand, 

transaction fees as a matter of course, and fees in connection with hedging transactions. 

This commenter also indicated that, because spreads in current, rapidly-moving markets 

are volatile, short-term measurements of profit compared to spread revenue is 

problematic, particularly for less liquid stocks.1152 Another commenter stated that this 

factor reflects a bias toward agency trading and principal market making in highly liquid, 

exchange-traded markets and does not reflect the nature of principal market making in 

most markets.1153 One commenter recommended that the rule require that a trader who 

 

1148 See Public Citizen.

1149 See Oliver Wyman (Feb. 2012).

1150 See NYSE Euronext; Morgan Stanley.

1151 See Public Citizen.

1152 See NYSE Euronext. 

1153 See Morgan Stanley.
340

pays a fee be prepared to document the chain of custody to show that the instrument is 

shortly re-sold to an interested customer.1154

Regarding the proposed compensation incentives factor, one commenter 

requested that the Agencies make clear that explanatory facts and circumstances cannot 

justify a trading unit providing compensation incentives that primarily reward proprietary 

risk-taking to employees engaged in market making. In addition, the commenter 

recommended that the Agencies delete the word “primarily” from this factor.1155

c. Determination to not adopt proposed Appendix B

To improve clarity, the final rule establishes particular criteria for the exemption 

and does not incorporate the commentary in proposed Appendix B regarding the 

identification of permitted market making-related activities. This Supplementary

Information provides guidance on the standards for compliance with the market-making 

exemption.

9. Use of quantitative measurements

Consistent with the FSOC study and the proposal, the Agencies continue to 

believe that quantitative measurements can be useful to banking entities and the Agencies 

to help assess the profile of a trading desk’s trading activity and to help identify trading 

activity that may warrant a more in-depth review.1156 The Agencies will not use 

quantitative measurements as a dispositive tool for differentiating between permitted 

 

1154 See Public Citizen.

1155 See Occupy. This commenter also stated that the commentary in Appendix B stating that a banking 

entity may give some consideration of profitable hedging activities in determining compensation would 

provide inappropriate incentives. See id.

1156 See infra Part IV.C.3.; final rule Appendix A.
341

market making-related activities and prohibited proprietary trading. Like the framework 

the Agencies have developed for the market-making exemption, the Agencies recognize 

that there may be differences in the quantitative measurements across markets and asset 

classes.

4. Section __.5: Permitted Risk-Mitigating Hedging Activities.

Section __.5 of the proposed rule implemented section 13(d)(1)(C) of the BHC 

Act, which provides an exemption from the prohibition on proprietary trading for certain 

risk-mitigating hedging activities.1157 Section 13(d)(1)(C) provides an exemption for 

risk-mitigating hedging activities in connection with and related to individual or 

aggregated positions, contracts, or other holdings of a banking entity that are designed to 

reduce the specific risks to the banking entity in connection with and related to such 

positions, contracts, or other holdings (the “hedging exemption”). Section __.5 of the 

final rule implements the hedging exemption with a number of modifications from the 

proposed rule to respond to commenters’ concerns as described more fully below.

a. Summary of Proposal’s Approach to Implementing the Hedging Exemption

The proposed rule would have required seven criteria to be met in order for a 

banking entity’s activity to qualify for the hedging exemption. First, §§ __.5(b)(1) and 

__.5(b)(2)(i) of the proposed rule generally required that the banking entity establish an 

internal compliance program that is designed to ensure the banking entity’s compliance 

with the requirements of the hedging limitations, including reasonably designed written 

 

1157 See 12 U.S.C. 1851(d)(1)(C); proposed rule § __.5.
342

policies and procedures, internal controls, and independent testing, and that a transaction 

for which the banking entity is relying on the hedging exemption be made in accordance 

with the compliance program established under § __.5(b)(1). Next, § __.5(b)(2)(ii) of the 

proposed rule required that the transaction hedge or otherwise mitigate one or more 

specific risks, including market risk, counterparty or other credit risk, currency or foreign 

exchange risk, interest rate risk, basis risk, or similar risks, arising in connection with and 

related to individual or aggregated positions, contracts, or other holdings of the banking 

entity. Moreover, § __.5(b)(2)(iii) of the proposed rule required that the transaction be 

reasonably correlated, based upon the facts and circumstances of the underlying and 

hedging positions and the risks and liquidity of those positions, to the risk or risks the 

transaction is intended to hedge or otherwise mitigate. Furthermore, § __.5(b)(2)(iv) of 

the proposed rule required that the hedging transaction not give rise, at the inception of 

the hedge, to significant exposures that are not themselves hedged in a contemporaneous 

transaction. Section __.5(b)(2)(v) of the proposed rule required that any hedge position 

established in reliance on the hedging exemption be subject to continuing review, 

monitoring and management. Finally, § __.5(b)(2)(vi) of the proposed rule required that 

the compensation arrangements of persons performing the risk-mitigating hedging 

activities be designed not to reward proprietary risk-taking. Additionally, § __.5(c) of the 

proposed rule required the banking entity to document certain hedging transactions at the 

time the hedge is established.

b. Manner of Evaluating Compliance with the Hedging Exemption
343

A number of commenters expressed concern that the final rule required 

application of the hedging exemption on a trade-by-trade basis.1158 One commenter 

argued that the text of the proposed rule seemed to require a trade-by-trade analysis 

because each “purchase or sale” or “hedge” was subject to the requirements.1159 The 

final rule modifies the proposal by generally replacing references to a “purchase or sale” 

in the § __.5(b) requirements with “risk-mitigating hedging activity.” The Agencies 

believe this approach is consistent with the statute, which refers to “risk-mitigating 

hedging activity.”1160

Section 13(d)(1)(C) of the BHC Act specifically authorizes risk-mitigating 

hedging activities in connection with and related to “individual or aggregated positions, 

contracts or other holdings.”1161 Thus, the statute does not require that exempt hedging 

be conducted on a trade-by-trade basis, and permits hedging of aggregated positions. The 

Agencies recognized this in the proposed rule, and the final rule continues to permit 

hedging activities in connection with and related to individual or aggregated positions.

The statute also requires that, to be exempt under section 13(d)(1)(C), hedging 

activities be risk-mitigating. The final rule incorporates this statutory requirement. As 

explained in more detail below, the final rule requires that, in order to qualify for the 

exemption for risk-mitigating hedging activities: the banking entity implement, maintain, 

 

1158 See Ass'n. of Institutional Investors (Feb. 2012); See also Barclays; ICI (Feb. 2012); Investure; 

MetLife; RBC; SIFMA et al. (Prop. Trading) (Feb. 2012); SIFMA (Asset Mgmt.) (Feb. 2012); Morgan 

Stanley; Fixed Income Forum/Credit Roundtable; Fidelity; FTN.

1159 See Barclays.

1160 See 12 U.S.C. 1851(d)(1)(C) (stating that “risk-mitigating hedging activities” are permitted under 

certain circumstances).

1161 See 12 U.S.C. 1851(d)(1)(C).
344

and enforce an internal compliance program, including policies and procedures that 

govern and control these hedging activities; the hedging activity be designed to reduce or 

otherwise significantly mitigate and demonstrably reduces or otherwise significantly 

mitigates specific, identifiable risks; the hedging activity not give rise to significant new 

risks that are left unhedged; the hedging activity be subject to continuing review, 

monitoring and management to address risk that might develop over time; and the 

compensation arrangements for persons performing risk-mitigating hedging activities be 

designed not to reward or incentivize prohibited proprietary trading. These requirements 

are designed to focus the exemption on hedging activities that are designed to reduce risk 

and that also demonstrably reduce risk, in accordance with the requirement under section 

13(d)(1)(C) that hedging activities be risk-mitigating to be exempt. Additionally, the 

final rule imposes a documentation requirement on certain types of hedges. 

Consistent with the other exemptions from the ban on proprietary trading for 

market-making and underwriting, the Agencies intend to evaluate whether an activity 

complies with the hedging exemption under the final rule based on the totality of 

circumstances involving the products, techniques, and strategies used by a banking entity 

as part of its hedging activity.1162 

c. Comments on the Proposed Rule and Approach to Implementing the Hedging Exemption.

Commenters expressed a variety of views on the proposal’s hedging exemption. 

A few commenters offered specific suggestions described more fully below regarding 

 

1162 See Part IV.A.4.b., infra.
345

how, in their view, the hedging exemption should be strengthened to ensure proper 

oversight of hedging activities.1163 These commenters expressed concern that the 

proposal’s exemption was too broad and argued that all proprietary trading could be 

designated as a hedge under the proposal and thereby evade the prohibition of section 

13.1164

By contrast, a number of other commenters argued that the proposal imposed 

burdensome requirements that were not required by statute, would limit the ability of 

banking entities to hedge in a prudent and cost-effective manner, and would reduce 

market liquidity.1165 These commenters argued that implementation of the requirements 

of the proposal would decrease safety and soundness of banking entities and the financial 

system by reducing cost-effective risk management options. Some commenters 

emphasized that the ability of banking entities to hedge their positions and manage risks 

taken in connection with their permissible activities is a critical element of liquid and 

efficient markets, and that the cumulative impact of the proposal would inhibit this riskmitigation by raising transaction costs and suppressing essential and beneficial hedging 

activities.1166 

 

1163 See, e.g., AFR et al. (Feb. 2012); AFR (June 2013); Better Markets (Feb. 2012); Sens. Merkley & 

Levin (Feb. 2012). 

1164 See, e.g., Occupy. 

1165 See, e.g., Australian Bankers’ Ass’n (Feb. 2012); BoA; Barclays; Credit Suisse (Seidel); Goldman 

(Prop. Trading); HSBC; ICI (Feb. 2012); Japanese Bankers Ass’n.; JPMC; Morgan Stanley; Chamber (Feb. 

2012); Wells Fargo (Prop. Trading); Rep. Bachus et al.; RBC; SIFMA et al. (Prop. Trading) (Feb. 2012); 

See also Stephen Roach.

1166 See Credit Suisse (Seidel); ICI (Feb. 2012); Wells Fargo (Prop. Trading); See also Banco de México; 

SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); BoA. 
346

A number of commenters expressed concern that the proposal’s hedging 

exemption did not permit the full breadth of transactions in which banking entities 

engage to hedge or mitigate risks, such as portfolio hedging,1167 dynamic hedging,1168

anticipatory hedging, 1169 or scenario hedging.1170 Some commenters stated that 

restrictions on a banking entity’s ability to hedge may have a chilling effect on its 

willingness to engage in other permitted activities, such as market making.1171 In 

addition, many of these commenters stated that, if a banking entity is limited in its ability 

to hedge its market-making inventory, it may be less willing or able to assume risk on 

behalf of customers or provide financial products to customers that are used for hedging 

purposes. As a result, according to these commenters, it will be more difficult for 

customers to hedge their risks and customers may be forced to retain risk.1172 

Another commenter contended that the proposal represented an inappropriate 

“one-size-fits-all” approach to hedging that did not properly take into account the way 

banking entities and especially market intermediaries operate, particularly in less-liquid 

markets.1173 Two commenters requested that the Agencies clarify that a banking entity 

may use its discretion to choose any hedging strategy that meets the requirements of the 

 

1167 See MetLife; SIFMA et al. (Prop. Trading) (Feb. 2012); Morgan Stanley; Barclays; Goldman (Prop. 

Trading); BoA; ABA; HSBC; Fixed Income Forum/Credit Roundtable; ICI (Feb. 2012); ISDA (Feb. 2012).

1168 See Goldman (Prop. Trading); BoA.

1169 See Barclays; State Street (Feb. 2012); SIFMA et al. (Prop. Trading) (Feb. 2012); Japanese Bankers 

Ass’n.; Credit Suisse (Seidel); BoA; PNC et al.; ISDA (Feb. 2012).

1170 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC; Goldman (Prop. Trading); BoA; Comm. on 

Capital Markets Regulation. Each of these types of activities is discussed further below. See infra Part 

IV.A.4.d.2.

1171 See SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); Barclays; Goldman (Prop.

Trading); BoA.

1172 See SIFMA et al. (Prop. Trading) (Feb. 2012); Goldman (Prop. Trading); Credit Suisse (Seidel).

1173 See Barclays. 
347

proposed exemption and, in particular, that a banking entity is not obligated to choose the 

“best hedge” and may use the cheapest instrument available.1174 One commenter 

suggested uncertainty about the permissibility of a situation where gains on a hedge 

position exceed losses on the underlying position. The commenter suggested that 

uncertainty may lead banking entities to not use the most cost-effective hedge, which 

would make hedging less efficient and raise costs for banking entities and customers.1175 

However, another commenter expressed concern about banking entities relying on the 

cheapest satisfactory hedge. The commenter explained that such hedges lead to more 

complicated risk profiles and require banking entities to engage in additional transactions 

to hedge the exposures resulting from the imperfect, cheapest hedge.1176

A few commenters suggested the hedging exemption be modified in favor of a 

simpler requirement that banking entities adopt risk limits and policies and procedures 

commensurate with qualitative guidance issued by the Agencies.1177 Many of these 

commenters also expressed concerns that the proposed rule’s hedging exemption would 

not allow so-called asset-liability management (“ALM”) activities.1178 Some 

commenters proposed that the risk-mitigating hedging exemption reference a set of 

 

1174 See SIFMA et al. (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel).

1175 See SIFMA et al. (Prop. Trading) (Feb. 2012).

1176 See Occupy.

1177 See BoA; Barclays; CH/ABASA; Credit Suisse (Seidel); HSBC; ICI (Feb. 2012); ISDA (Apr. 2012); 

JPMC; Morgan Stanley; PNC; SIFMA et al. (Prop. Trading) (Feb. 2012); See also Stephen Roach.

1178 A detailed discussion of ALM activities is provided in Part IV.A.1.d.2 of this Supplementary 

Information relating to the definition of trading account. As explained in that part, the final rule does not 

allow use of the hedging exemption for ALM activities that are outside of the hedging activities specifically 

permitted by the final rule. 
348

relevant descriptive factors rather than specific prescriptive requirements.1179 Other 

alternative frameworks suggested by commenters include: (i) reformulating the proposed 

requirements as supervisory guidance;1180 (ii) establishing a safe harbor,1181 presumption 

of compliance,1182 or bright line test;1183 or (iii) a principles-based approach that would 

require a banking entity to document its risk-mitigating hedging strategies for submission 

to its regulator.1184 

d. Final Rule

The final rule provides a multi-faceted approach to implementing the hedging 

exemption that seeks to ensure that hedging activity is designed to be risk-reducing in 

nature and not designed to mask prohibited proprietary trading.1185 The final rule 

includes a number of modifications in response to comments. 

This multi-faceted approach is intended to permit hedging activities that are riskmitigating and to limit potential abuse of the hedging exemption while not unduly 

constraining the important risk-management function that is served by a banking entity’s 

hedging activities. This approach is also intended to ensure that any banking entity 

relying on the hedging exemption has in place appropriate internal control processes to 

support its compliance with the terms of the exemption. While commenters proposed a 

 

1179 See BoA; JPMC; Morgan Stanley.

1180 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC; PNC et al.; ICI.

1181 See Prof. Richardson; ABA (Keating).

1182 See Barclays; BoA; ISDA (Feb. 2012).

1183 See Johnson & Prof. Stiglitz.

1184 See HSBC.

1185 See final rule § __.5.
349

number of alternative frameworks for the hedging exemption, the Agencies believe the 

final rule’s multi-faceted approach most effectively balances commenter concerns with 

statutory purpose. In response to commenter requests to reformulate the proposed rule as 

supervisory guidance,1186 including the suggestion that the Agencies simply require 

banking entities to adopt risk limits and policies and procedures commensurate with 

qualitative Agency guidance,1187 the Agencies believe that such an approach would 

provide less clarity than the adopted approach. Although a purely guidance-based

approach could provide greater flexibility, it would also provide less specificity, which 

could make it difficult for banking entity personnel and the Agencies to determine 

whether an activity complies with the rule and could lead to an increased risk of evasion 

of the statutory requirements. Further, while a bright-line or safe harbor approach to the 

hedging exemption would generally provide a high degree of certainty about whether an 

activity qualifies for the exemption, it would also provide less flexibility to recognize the 

differences in hedging activity across markets and asset classes.1188 In addition, the use 

of any bright-line approach would more likely be subject to gaming and avoidance as 

new products and types of trading activities are developed than other approaches to 

implementing the hedging exemption. Similarly, the Agencies decline to establish a 

presumption of compliance because, in light of the constant innovation of trading 

activities and the differences in hedging activity across markets and asset classes, 

 

1186 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC; PNC et al.; ICI (Feb. 2012); BoA; Morgan 

Stanley.

1187 See BoA; Barclays; CH/ABASA; Credit Suisse (Seidel); HSBC; ICI (Feb. 2012); ISDA (Apr. 2012); 

JPMC; Morgan Stanley; PNC; SIFMA et al. (Prop. Trading) (Feb. 2012); See also Stephen Roach.

1188 Some commenters requested that the Agencies establish a safe harbor. See Prof. Richardson; ABA 

(Keating). One commenter requested that the Agencies adopt a bright-line test. See Johnson & Prof. 

Stiglitz. 
350

establishing appropriate parameters for a presumption of compliance with the hedging 

exemption would potentially be less capable of recognizing these legitimate differences 

than our current approach.1189 Moreover, the Agencies decline to follow a principlesbased approach requiring a banking entity to document its hedging strategies for 

submission to its regulator.1190 The Agencies believe that evaluating each banking 

entity’s trading activity based on an individualized set of documented hedging strategies 

could be unnecessarily burdensome and result in unintended competitive impacts since 

banking entities would not be subject to one uniform rule. The Agencies believe the 

multi-faceted approach adopted in the final rule establishes a consistent framework 

applicable to all banking entities that will reduce the potential for such adverse impacts. 

Further, the Agencies believe the scope of the final hedging exemption is 

appropriate because it permits risk-mitigating hedging activities, as mandated by section 

13 of the BHC Act,1191 while requiring a robust compliance program and other internal 

controls to help ensure that only genuine risk-mitigating hedges can be used in reliance 

on the exemption.1192 In response to concerns that the proposed hedging exemption 

would reduce legitimate hedging activity and thus impact market liquidity and the 

 

1189 A few commenters requested that the Agencies establish a presumption of compliance. See Barclays; 

BoA; ISDA (Feb. 2012).

1190 One commenter suggested this principles-based approach. See HSBC.

1191 Section 13(d)(1)(C) of the BHC Act permits “risk-mitigating hedging activities in connection with and 

related to individual or aggregated positions, contracts, or other holdings of a banking entity that are 

designed to reduce the specific risks to the banking entity in connection with and related to such positions, 

contracts, or other holdings.” 12 U.S.C. 1851(d)(1)(C). 

1192 Some commenters were concerned that the proposed hedging exemption was too broad and that all 

proprietary trading could be designated as a hedge. See, e.g., Occupy.
351

banking entity’s willingness to engage in permissible customer-related activity,1193 the 

Agencies note that the requirements of the final hedging exemption are designed to 

permit banking entities to properly mitigate specific risk exposures, consistent with the 

statute. In addition, hedging related to market-making activity conducted by a marketmaking desk is subject to the requirements of the market-making exemption, which are 

designed to permit banking entities to continue providing valuable intermediation and 

liquidity services, including related risk-management activity.

1194 Thus, the final hedging 

exemption will not negatively impact the safety and soundness of banking entities or the 

financial system or have a chilling effect on a banking entity’s willingness to engage in 

other permitted activities, such as market making.1195

These limits and requirements are designed to prevent the type of activity 

conducted by banking entities in the past that involved taking large positions using novel 

strategies to attempt to profit from potential effects of general economic or market 

developments and thereby potentially offset the general effects of those events on the 

revenues or profits of the banking entity. The documentation requirements in the final 

rule support these limits by identifying activity that occurs in reliance on the riskmitigating hedging exemption at an organizational level or desk that is not responsible for 

establishing the risk or positions being hedged.

 

1193 See, e.g., Australian Bankers Ass’n. (Feb. 2012).; BoA; Barclays; Credit Suisse (Seidel); Goldman 

(Prop. Trading); HSBC; Japanese Bankers Ass’n.; JPMC; Morgan Stanley; Chamber (Feb. 2012); Wells 

Fargo (Prop. Trading); Rep. Bachus et al.; RBC; SIFMA et al. (Prop. Trading) (Feb. 2012). 

1194 See supra Part IV.A.3.c.4.

1195 Some commenters believed that restrictions on hedging would have a chilling effect on banking 

entities’ willingness to engage in market making, and may result in customers experiencing difficulty in 

hedging their risks or force customers to retain risk. See SIFMA et al. (Prop. Trading) (Feb. 2012); Credit 

Suisse (Seidel); Barclays; Goldman (Prop. Trading); BoA; IHS.
352

1. Compliance program requirement 

The first criterion of the proposed hedging exemption required a banking entity to 

establish an internal compliance program designed to ensure the banking entity’s 

compliance with the requirements of the hedging exemption and conduct its hedging 

activities in compliance with that program. While the compliance program under the 

proposal was expected to be appropriate for the size, scope, and complexity of each 

banking entity’s activities and structure, the proposal would have required each banking 

entity with significant trading activities to implement robust, detailed hedging policies 

and procedures and related internal controls and independent testing designed to prevent 

prohibited proprietary trading in the context of permitted hedging activity.1196 These 

enhanced programs for banking entities with large trading activity were expected to 

include written hedging policies at the trading unit level and clearly articulated trader 

mandates for each trader designed to ensure that hedging strategies mitigated risk and 

were not for the purpose of engaging in prohibited proprietary trading. 

Commenters, including industry groups, generally expressed support for requiring 

policies and procedures to monitor the safety and soundness, as well as appropriateness, 

of hedging activity.1197 Some of these commenters advocated that the final rule presume 

that a banking entity is in compliance with the hedging exemption if the banking entity’s 

hedging activity is done in accordance with the written policies and procedures required 

 

1196 These aspects of the compliance program requirement are described in further detail in Part IV.C. of 

this Supplementary Information.

1197 See SIFMA et al. (Prop. Trading) (Feb. 2012).
353

under its compliance program.1198 One commenter represented that the proposed 

compliance framework was burdensome and complex.1199

Other commenters expressed concerns that the hedging exemption would be too 

limiting and burdensome for community and regional banks.1200 Some commenters 

argued that foreign banking entities should not be subject to the requirements of the 

hedging exemption for transactions that do not introduce risk into the U.S. financial 

system.1201 Other commenters stated that coordinated hedging through and by affiliates 

should qualify as permitted risk-mitigating hedging activity.1202 

Some commenters urged the Agencies to adopt detailed limitations on hedging 

activities. For example, one commenter urged that all hedging trades be labeled as such 

at the inception of the trade and detailed information regarding the trader, manager, and 

supervisor authorizing the trade be kept and reviewed.1203 Another commenter suggested 

that the hedging exemption contain a requirement that the banking entity employee who 

approves a hedge affirmatively certify that the hedge conforms to the requirements of the 

rule and has not been put in place for the direct or indirect purpose or effect of generating 

 

1198 See BoA; Barclays; HSBC; JPMC; Morgan Stanley; See also Goldman (Prop. Trading); RBC; 

Barclays; ICI (Feb. 2012); ISDA (Apr. 2012); PNC; SIFMA et al. (Prop. Trading) (Feb. 2012). See the 

discussion of why the Agencies decline to take a presumption of compliance approach above.

1199 See Barclays.

1200 See ICBA; M&T Bank.

1201 See, e.g., Bank of Canada; Allen & Overy (on behalf of Canadian Banks). Additionally, foreign 

banking entities engaged in hedging activity may be able to rely on the exemption for trading activity 

conducted by foreign banking entities in lieu of the hedging exemption, provided they meet the 

requirements of the exemption for trading by foreign banking entities under § __.6(e) of the final rule. See

infra Part IV.A.8.

1202 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC.

1203 See Sens. Merkley & Levin (Feb. 2012).
354

speculative profits.1204 A few commenters requested limitations on instruments that can 

be used for hedging purposes.1205

The final rule retains the proposal’s requirement that a banking entity establish an 

internal compliance program that is designed to ensure the banking entity limits its 

hedging activities to hedging that is risk-mitigating.1206 The final rule largely retains the 

proposal’s approach to the compliance program requirement, except to the extent that, as 

requested by some commenters,1207 the final rule modifies the proposal to provide 

additional detail regarding the elements that must be included in a compliance program. 

Similar to the proposal, the final rule contemplates that the scope and detail of a 

compliance program will reflect the size, activities, and complexity of banking entities in 

order to ensure that banking entities engaged in more active trading have enhanced 

compliance programs without imposing undue burden on smaller organizations and 

entities that engage in little or no trading activity.1208 The final rule also requires, like the 

proposal, that the banking entity implement, maintain, and enforce the program.1209 

 

1204 See Better Markets (Feb. 2012). 

1205 See Sens. Merkley & Levin (Feb. 2012); Occupy; Andrea Psoras.

1206 See final rule § __.5(b)(1). The final rule retains the proposal’s requirement that the compliance 

program include, among other things, written hedging policies.

1207 See, e.g., BoA; ICI (Feb. 2012); ISDA (Feb. 2012); JPMC; Morgan Stanley; PNC; SIFMA et al. (Prop. 

Trading) (Feb. 2012).

1208 See final rule § __.20(a) (stating that “[t]he terms, scope and detail of [the] compliance program shall 

be appropriate for the types, size, scope and complexity of activities and business structure of the banking 

entity”). The Agencies believe this helps address some commenters’ concern that the hedging exemption 

would be too limiting and burdensome for community and regional banks. See ICBA; M&T Bank.

1209 Many of these policies and procedures were contained as part of the proposed rule’s compliance 

program requirements under Appendix C. They have been moved, and in some cases modified, in order to 

more clearly demonstrate how they are incorporated into the requirements of the hedging exemption.
355

In response to commenter concerns about ensuring the appropriate level of senior 

management involvement in establishing these policies,1210 the final rule requires that the 

written policies and procedures be developed and implemented by a banking entity at the 

appropriate level of organization and expressly address the banking entity’s requirements 

for escalation procedures, supervision, and governance related to hedging activities.1211 

Like the proposal, the final rule specifies that a banking entity’s compliance 

regime must include reasonably designed written policies and procedures regarding the 

positions, techniques and strategies that may be used for hedging, including 

documentation indicating what positions, contracts or other holdings a trading desk may 

use in its risk-mitigating hedging activities.1212 The focus on policies and procedures 

governing risk identification and mitigation, analysis and testing of position limits and 

hedging strategies, and internal controls and ongoing monitoring is expected to limit use 

of the hedging exception to risk-mitigating hedging. The final rule adds to the proposed 

 

1210 See Better Markets (Feb. 2012). The final rule does not require affirmative certification of each hedge, 

as suggested by this commenter, because the Agencies believe it would unnecessarily slow legitimate 

transactions. The Agencies believe the final rule’s required management framework and escalation 

procedures achieve the same objective as the commenter’s suggested approach, while imposing fewer 

burdens on legitimate risk-mitigating hedging activity.

1211 See final rule §§ __.20(b), __.5(b). This approach builds on the proposal’s requirement that senior 

management and intermediate managers be accountable for the effective implementation of the compliance 

program.

1212 This approach is generally consistent with some commenters’ suggested approach of limiting the 

instruments that can be used for hedging purposes; although the final rules provide banking entities with 

discretion to determine the types of positions, contracts, or other holdings that will mitigate specific risks of 

individual or aggregated holdings and thus may be used for risk-mitigating hedging activity. See Sens. 

Merkley & Levin (Feb. 2012); Occupy; Andrea Psoras. In response to one commenter’s request that the 

final rule require all hedges to be labeled at inception and certain detailed information be documented for 

each hedge, the Agencies note that the final rules continue to require detailed documentation for hedging 

activity that presents a heightened risk of evasion. See Sens. Merkley & Levin (Feb. 2012); final rule § 

__.5(c); infra Part IV.A.4.d.4. The Agencies believe a documentation requirement targeted at these 

scenarios balances the need to prevent evasion of the general prohibition on proprietary trading with the 

concern that documentation requirements can slow or impede legitimate risk-mitigating activity in the 

normal course. 
356

compliance program approach by requiring that the banking entity’s written policies and 

procedures include position and aging limits with respect to such positions, contracts, or 

other holdings.1213 The final rule, similar to the proposed rule, also requires that the 

compliance program contain internal controls and ongoing monitoring, management, and 

authorization procedures, including relevant escalation procedures.1214 Further, the final 

rule retains the proposed requirement that the compliance program provide for the 

conduct of analysis and independent testing designed to ensure that the positions, 

techniques, and strategies that may be used for hedging may reasonably be expected to 

demonstrably reduce or otherwise significantly mitigate the specific, identifiable risks 

being hedged.1215 

The final rule also adds that correlation analysis be undertaken as part of the 

analysis of the hedging positions, techniques, and strategies that may be used. This 

provision effectively changes the requirement in the proposed rule that the hedge must 

maintain correlation into a requirement that correlation be analyzed as part of the 

compliance program before a hedging activity is undertaken. This provision incorporates 

the concept in the proposed rule that a hedge should be correlated (negatively, when sign 

is considered) to the risk being hedged. However, the Agencies recognize that some 

effective hedging activities, such as deep out-of-the-money puts and calls, may not be 

exhibit a strong linear correlation to the risks being hedged and also that correlation over 

 

1213 See final rule § __.5(b)(1)(i). Some commenters expressed support for the use of risk limits in 

determining whether trading activity qualifies for the hedging exemption. See, e.g., Barclays; Credit Suisse 

(Seidel); ICI (Feb. 2012); Morgan Stanley.

1214 See final rule § __.5(b)(1)(ii).

1215 See final rule § __.5(b)(1)(iii). The final rule’s requirement to demonstrably reduce or otherwise 

significantly mitigate is discussed in greater detail below. 
357

a period of time between two financial positions does not necessarily mean one position 

will in fact reduce or mitigate a risk of the other. Rather, the Agencies expect the 

banking entity to undertake a correlation analysis that will, in many but not all instances, 

provide a strong indication of whether a potential hedging position, strategy, or technique 

will or will not demonstrably reduce the risk it is designed to reduce. It is important to 

recognize that the rule does not require the banking entity to prove correlation 

mathematically or by other specific methods. Rather, the nature and extent of the 

correlation analysis undertaken would be dependent on the facts and circumstances of the 

hedge and the underlying risks targeted. If correlation cannot be demonstrated, then the 

Agencies would expect that such analysis would explain why not and also how the 

proposed hedging position, technique, or strategy is designed to reduce or significantly 

mitigate risk and how that reduction or mitigation can be demonstrated without 

correlation.

Moreover, the final rule requires hedging activity conducted in reliance on the 

hedging exemption be subject to continuing review, monitoring, and management that is 

consistent with the banking entity’s written hedging policies and procedures and is 

designed to reduce or otherwise significantly mitigate, and demonstrably reduces or 

otherwise significantly mitigates, the specific, identifiable risks that develop over time 

from hedging activity and underlying positions.1216 This ongoing review should consider 

 

1216 The proposal also contained a continuing review, monitoring, and management requirement. See

proposed rule § __.5(b)(2)(v). The final rule modifies the proposed requirement, however, by removing the 

“reasonable correlation” requirement and instead requiring that the hedge demonstrably reduce or 

otherwise significantly mitigate specific identifiable risks. Correlation analysis is, however, a necessary 

component of the analysis element in the compliance program requirement of the hedging exemption in the 

final rule. See final rule § __.5(b). This change is discussed below.
358

market developments, changes in positions or the configuration of aggregated positions, 

changes in counterparty risk, and other facts and circumstances related to the risks 

associated with the underlying and hedging positions, contracts, or other holdings. 

The Agencies believe that requiring banking entities to develop and follow 

detailed compliance policies and procedures related to risk-mitigating hedging activity 

will help both banking entities and examiners understand the risks to which banking 

entities are exposed and how these risks are managed in a safe and sound manner. With 

this increased understanding, banking entities and examiners will be better able to 

evaluate whether banking entities are engaged in legitimate, risk-reducing hedging 

activity, rather than impermissible proprietary trading. While the Agencies recognize 

there are certain costs associated with this compliance program requirement,1217 we 

believe this provision is necessary to ensure compliance with the statute and the final 

rule. As discussed in Part IV.C.1., the Agencies have modified the proposed compliance 

program structure to reduce burdens on small banking entities.1218 

The Agencies note that hedging may occur across affiliates under the hedging 

exemption.1219 To ensure that hedging across trading desks or hedging done at a level of 

the organization outside of the trading desk does not result in prohibited proprietary 

trading, the final rule imposes enhanced documentation requirements on these activities, 

which are discussed more fully below. The Agencies also note that nothing in the final 

 

1217 See Barclays.

1218 See infra Part IV.C.1. Some commenters expressed concern that the compliance program requirement 

would place undue burden on regional or community banks. See ICBA; M&T Bank. 

1219 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC.
359

rule limits or restricts the ability of the appropriate supervisory agency of a banking entity 

to place limits on interaffiliate hedging in a manner consistent with their safety and 

soundness authority to the extent the agency has such authority.1220 Additionally, nothing 

in the final rule limits or modifies the applicability of CFTC regulations with respect to 

the clearing of interaffiliate swaps.

1221 

2. Hedging of specific risks and demonstrable reduction of risk

Section __.5(b)(2)(ii) of the proposed rule required that a qualifying transaction 

hedge or otherwise mitigate one or more specific risks, including market risk, 

counterparty or other credit risk, currency or foreign exchange risk, interest rate risk, 

basis risk, or similar risks, arising in connection with and related to individual or 

aggregated positions, contracts, or other holdings of a banking entity.1222 This criterion 

implemented the essential element of the hedging exemption that the transaction be riskmitigating. 

Some commenters expressed support for this provision, particularly the 

requirement that a banking entity be able to tie a hedge to a specific risk.1223 One of 

these commenters stated that a demonstrated reduction in risk should be a key indicator 

 

1220 In addition, section 608 of the Dodd-Frank Act added credit exposure arising from securities 

borrowing and lending or a derivative transaction with an affiliate to the list of covered transactions subject 

to the restrictions of section 23A of the FR Act, in each case to the extent that such transaction causes a 

bank to have credit exposure to the affiliate. See 12 U.S.C. 371c(b)(7) and (8). As a consequence, 

interaffiliate hedging activity within a banking entity may be subject to limitation or restriction under 

section 23A of the FR Act.

1221 See 17 CFR 50.52.

1222 See proposed rule § __.5(b)(2)(ii); See also Joint Proposal, 76 FR at 68,875. 

1223 See AFR (June 2013); Sens. Merkley & Levin (Feb. 2012); Public Citizen; Johnson & Prof. Stiglitz. 
360

of whether a hedge is in fact permitted.1224 However, some commenters argued that the 

list of risks eligible to be hedged under the proposed rule, which included risks arising 

from aggregated positions, could justify transactions that should be viewed as prohibited 

proprietary trading.1225 Another commenter contended that the term “basis risk” was 

undefined and could heighten the potential that this exemption would be used to evade 

the prohibition on proprietary trading.1226

Other commenters argued that requiring a banking entity to specify the particular 

risk being hedged discourages effective hedging and increases the risk at banking entities. 

These commenters contended that hedging activities must address constantly changing 

positions and market conditions.1227 Another commenter argued that this requirement 

could render a banking entity’s hedges impermissible if those hedges do not succeed in 

fully hedging or mitigating an identified risk as determined by a post hoc analysis and 

could prevent banking entities from entering into hedging transactions in anticipation of 

risks that the banking entity expects will arise (or increase).1228 Certain commenters 

requested that the hedging exemption provide a safe harbor for positions that satisfy 

FASB ASC Topic 815 (formerly FAS 133) hedging accounting standards, which 

provides that an entity recognize derivative instruments, including certain derivative 

instruments embedded in other contracts, as assets or liabilities in the statement of 

 

1224 See Sens. Merkley & Levin (Feb. 2012).

1225 See Public Citizen; See also Occupy. 

1226 See Occupy. 

1227 See, e.g., Japanese Bankers Ass’n.

1228 See Barclays. 
361

financial position and measure them at fair value.1229 Another commenter suggested that 

scenario hedges could be identifiable and subject to review by the Agencies using VaR, 

Stress VaR, and VaR Exceedance, as well as revenue metrics.1230 

The Agencies have considered these comments carefully in light of the statute. 

Section 13(d)(1)(C) of the BHC Act provides an exemption from the prohibition on 

proprietary trading only for hedging activity that is “designed to reduce the specific risks 

to the banking entity in connection with and related to” individual or aggregated 

positions, contracts, or other holdings of the banking entity.1231 Thus, while the statute 

permits hedging of individual or aggregated positions (as discussed more fully below), 

the statute requires that, to be exempt from the prohibition on proprietary trading, 

hedging transactions be designed to reduce specific risks.1232 Moreover, it requires that 

these specific risks be in connection with or related to the individual or aggregated 

positions, contracts, or other holdings of the banking entity.

The final rule implements these requirements. To ensure that exempt hedging 

activities are designed to reduce specific risks, the final rule requires that the hedging 

activity at inception of the hedging activity, including, without limitation, any 

 

1229 See ABA (Keating); Wells Fargo (Prop. Trading). Although certain accounting standards, such as 

FASB ASC Topic 815 hedge accounting standards, address circumstances in which a transaction may be 

considered a hedge of another transaction, the final rule does not refer to or expressly rely on these 

accounting standards because such standards: (i) are designed for financial statement purposes, not to 

identify proprietary trading; and (ii) change often and are likely to change in the future without 

consideration of the potential impact on section 13 of the BHC Act.

1230 See JPMC.

1231 12 U.S.C. 1851(d)(1)(C). 

1232 Some commenters expressed support for the requirement that a banking entity tie a hedge to a specific 

risk. See AFR (June 2012); Sens. Merkley & Levin (Feb. 2012); Public Citizen; Johnson & Prof. Stiglitz.
362

adjustments to the hedging activity, be designed to reduce or otherwise significantly 

mitigate and demonstrably reduces or otherwise significantly mitigates one or more 

specific, identifiable risks, including market risk, counterparty or other credit risk, 

currency or foreign exchange risk, interest rate risk, commodity price risk, basis risk, or 

similar risks, arising in connection with and related to identified individual or aggregated 

positions, contracts, or other holdings of the banking entity, based upon the facts and 

circumstances of the individual or aggregated underlying and hedging positions, 

contracts, or other holdings of the banking entity and the risks and liquidity thereof.1233 

Hedging activities and limits should be based on analysis conducted by the banking entity 

of the appropriateness of hedging instruments, strategies, techniques, and limits. As 

discussed above, this analysis must include analysis of correlation between the hedge and 

the specific identifiable risk or risks that the hedge is designed to reduce or significantly 

mitigate.1234 

This language retains the focus of the statute and the proposed rule on reducing or 

mitigating specific and identified risks.1235 As discussed more fully above, banking 

entities are required to describe in their compliance policies and procedures the types of 

strategies, techniques, and positions that may be used for hedging. 

 

1233 See final rule § __.5(b)(2)(ii).

1234 See final rule § __.5(b)(1)(iii).

1235 Some commenters represented that the proposed list of risks eligible to be hedged could justify 

transactions that should be considered proprietary trading. See Public Citizen; Occupy. One commenter 

was concerned about the proposed inclusion of “basis risk” in this list. See Occupy. As noted in the 

proposal, the Agencies believe the inclusion of a list of eligible risks, including basis risk, helps implement 

the essential element of the statutory hedging exemption – i.e., that the transaction is risk-reducing in 

connection with a specific risk. See Joint Proposal, 76 FR at 68,875. See also 12 U.S.C. 1851(d)(1)(C). 

Further, the Agencies believe the other requirements of the final hedging exemption, including 

requirements regarding internal controls and a compliance program, help to ensure that only legitimate 

hedging activity qualifies for the exemption.
363

The final rule does not prescribe the hedging strategy that a banking entity must 

employ. While one commenter urged that the final rule require each banking entity to 

adopt the “best hedge” for every transaction,1236 the Agencies believe that the complexity 

of positions, market conditions at the time of a transaction, availability of hedging 

transactions, costs of hedging, and other circumstances at the time of the transaction 

make a requirement that a banking entity always adopt the “best hedge” impractical, 

unworkable, and subjective. 

Nonetheless, the statute requires that, to be exempt under section 13(d)(1)(C), 

hedging activity must be risk-mitigating. To ensure that only risk-mitigating hedging is 

permitted under this exemption, the final rule requires that in its written policies and 

procedures the banking entity identify the instruments and positions that may be used in 

hedging, the techniques and strategies the banking entity deems appropriate for its 

hedging activities, as well as position limits and aging limits on hedging positions. These 

written policies and procedures also must specify the escalation and approval procedures 

that apply if a trader seeks to conduct hedging activities beyond the limits, position types, 

strategies, or techniques authorized for the trader’s activities.1237

As noted above, commenters were concerned that risks associated with permitted 

activities and holdings change over time, making a determination regarding the 

effectiveness of hedging activities in reducing risk dependent on the time when risk is 

 

1236 See, e.g., Occupy.

1237 A banking entity must satisfy the enhanced documentation requirements of § __.5(c) if it engages in 

hedging activity utilizing positions, contracts, or holdings that were not identified in its written policies and 

procedures.
364

measured. To address this, the final rule requires that the exempt hedging activity be 

designed to reduce or otherwise significantly mitigate, and demonstrably reduces or 

otherwise significantly mitigates, risk at the inception of the hedge. As explained more 

fully below, because risks and the effectiveness of a hedging strategy may change over 

time, the final rule also requires the banking entity to implement a program to review, 

monitor, and manage its hedging activity over the period of time the hedging activity 

occurs in a manner designed to reduce or significantly mitigate and demonstrably reduce 

or otherwise significantly mitigate new or changing risks that may develop over time 

from both the banking entity’s hedging activities and the underlying positions. Many 

commenters expressed concern that the proposed ongoing review, monitoring, and 

management requirement would limit a banking entity’s ability to engage in aggregated 

position hedging.1238 One commenter stated that because aggregated position hedging 

may result in modification of hedging exposures across a variety of underlying risks, 

even as the overall risk profile of a banking entity is reduced, it would become impossible 

to subsequently review, monitor, and manage individual hedging transactions for 

compliance.1239 The Agencies note that the final rule, like the statute, requires that the 

hedging activity relate to individual or aggregated positions, contracts or other holdings 

being hedged, and accordingly, the review, monitoring and management requirement 

would not limit the extent of permitted hedging provided for in section 13(d)(1)(C) as 

implied by some commenters. Further, the final rule recognizes that the determination of 

whether hedging activity demonstrably reduces or otherwise significantly mitigates risks 

 

1238 See SIFMA et al. (Prop. Trading) (Feb. 2012); Barclays; ICI (Feb. 2012); Morgan Stanley.

1239 See Barclays.
365

that may develop over time should be “based upon the facts and circumstances of the 

underlying and hedging positions, contracts and other holdings of the banking entity and 

the risks and liquidity thereof.”1240

A number of other commenters argued that a legitimate risk-reducing hedge may 

introduce new risks at inception.1241 A few commenters contended that a requirement 

that no new risks be associated with a hedge would be inconsistent with prudent risk 

management and greatly reduce the ability of banking entities to reduce overall risk 

through hedging.1242 A few commenters stated that the proposed requirement does not 

recognize that it is not always possible to hedge a new risk exposure arising from a hedge 

in a cost-effective manner.1243 With respect to the timing of the initial hedge and any 

additional transactions necessary to reduce significant exposures arising from it, one of 

these commenters represented that requiring contemporaneous hedges is impracticable, 

would raise transaction costs, and would make hedging uneconomic.1244 Another 

commenter stated that this requirement could have a chilling effect on risk managers’ 

willingness to engage in otherwise permitted hedging activity.1245 

 

1240 Final rule § __.5(b)(2)(iv)(B). The Agencies believe this provision addresses some commenters’

concern that the ongoing review, monitoring, and management requirement would limit hedging of 

aggregated positions, and that such ongoing review of individual hedge transactions with a variety of 

underlying risks would be impossible. See SIFMA (Prop. Trading) (Feb. 2012); Barclays; ICI (Feb. 2012); 

Morgan Stanley.

1241 See ABA (Keating); BoA; Barclays; Credit Suisse (Seidel); Goldman (Prop. Trading); SIFMA et al.

(Prop. Trading) (Feb. 2012); See also AFR et al. (Feb. 2012).

1242 See Credit Suisse (Seidel); Goldman (Prop. Trading); SIFMA et al. (Prop. Trading) (Feb. 2012).

1243 See SIFMA et al. (Prop. Trading) (Feb. 2012); Barclays.

1244 See SIFMA et al. (Prop. Trading) (Feb. 2012).

1245 See BoA.
366

Other commenters stated that a position that does not fully offset the risk of an 

underlying position is not in fact a hedge.1246 These commenters believed that the 

introduction of new risks at inception of a transaction indicated that the transaction was 

impermissible proprietary trading and not a hedge.1247 

The Agencies recognize that prudent risk-reducing hedging activities by banking 

entities are important to the efficiency of the financial system.1248 The Agencies further 

recognize that hedges are generally imperfect; consequently, hedging activities can 

introduce new and sometimes significant risks, such as credit risk, basis risk, or new 

market risk, especially when hedging illiquid positions.1249 However, the Agencies also 

recognize that hedging activities present an opportunity to engage in impermissible 

proprietary trading designed to profit from exposure to these types of risks. 

To address these competing concerns, the final rule substantially retains the 

proposed requirement that, at the inception of the hedging activity, the risk-reducing 

hedging activity does not give rise to significant new or additional risk that is not itself 

contemporaneously hedged. This approach is designed to allow banking entities to 

continue to engage in prudent risk-mitigating activities while ensuring that the hedging 

exemption is not used to engage in prohibited proprietary trading by taking on prohibited 

 

1246 See Sens. Merkley & Levin (Feb. 2012); Public Citizen; AFR (Nov. 2012).

1247 See Better Markets (Feb. 2012); AFR et al. (Feb. 2012).

1248 See FSOC study (stating that “[p]rudent risk management is at the core of both institution-specific 

safety and soundness, as well as macroprudential and financial stability”).

1249 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012).
367

short-term exposures under the guise of hedging.1250 As noted in the proposal, however, 

the Agencies recognize that exposure to new risks may result from legitimate hedging 

transactions;1251 this provision only prohibits the introduction of additional significant 

exposures through the hedging transaction unless those additional exposures are 

contemporaneously hedged.

As noted above, the final rule recognizes that whether hedging activity will 

demonstrably reduce risk must be based upon the facts and circumstances of the 

individual or aggregated underlying and hedging positions, contracts, or other holdings of 

the banking entity and the risks and liquidity thereof.1252 The Agencies believe this 

approach balances commenters’ request that the Agencies clarify that a banking entity 

may use its discretion to choose any hedging strategy that meets the requirements of the 

proposed exemption1253 with concerns that allowing banking entities to rely on the 

cheapest satisfactory hedge will lead to additional hedging transactions.1254 The 

Agencies expect that hedging strategies and techniques, as well as assessments of risk, 

 

1250 Some commenters stated that it is not always possible to hedge a new risk exposure arising from a 

hedge in a cost-effective manner, and requiring contemporaneous hedges would raise transaction costs and 

the potential for hedges to become uneconomical. See SIFMA et al. (Prop. Trading) (Feb. 2012); Barclays. 

As noted in the proposal, the Agencies believe that requiring a contemporaneous hedge of any significant 

new risk that arises at the inception of a hedge is appropriate because a transaction that creates significant 

new risk exposure that is not itself hedged at the same time would appear to be indicative of prohibited 

proprietary trading. See Joint Proposal, 76 FR at 68,876. Thus, the Agencies believe this requirement is 

necessary to prevent evasion of the general prohibition on proprietary trading. In response to commenters’ 

concerns about transaction costs and uneconomical hedging, the Agencies note that this provision only 

requires additional hedging of “significant” new or additional risk and does not apply to any risk exposure 

arising from a hedge.

1251 See Joint Proposal, 76 FR at 68,876.

1252 See final rule § __.5(b)(2)(ii).

1253 See SIFMA (Prop. Trading) (Feb. 2012); Credit Suisse (Seidel); Barclays; Goldman (Prop. Trading); 

BoA.

1254 See Occupy.
368

will vary across positions, markets, activities and banking entities, and that a “one-sizefits-all” approach would not accommodate all types of appropriate hedging activity.1255

By its terms, section 13(d)(1)(C) of the BHC Act permits a banking entity to 

engage in risk-mitigating hedging activity “in connection with and related to individual or 

aggregated positions . . . .”1256 The preamble to the proposed rule made clear that, 

consistent with the statutory reference to mitigating risks of individual or aggregated

positions, this criterion permits hedging of risks associated with aggregated positions.1257 

This approach is consistent with prudent risk-management and safe and sound banking 

practice.1258 

The proposed rule explained that, to be exempt under this provision, hedging 

activities must reduce risk with respect to “positions, contracts, or other holdings of the 

banking entity.” The proposal also required that a banking entity relying on the 

exemption be prepared to identify the specific position or risks associated with 

aggregated positions being hedged and demonstrate that the hedging transaction was riskreducing in the aggregate, as measured by appropriate risk management tools.

Some commenters were of the view that the hedging exemption applied to 

aggregated positions or portfolio hedging and was consistent with prudent riskmanagement practices. These commenters argued that permitting a banking entity to 

 

1255 See Barclays. 

1256 12 U.S.C. 1851(d)(1)(C).

1257 See Joint Proposal, 76 FR at 68,875.

1258 See, e.g., Australian Bankers’ Ass’n. (Feb. 2012); BoA; Barclays; Credit Suisse (Seidel); Goldman

(Prop. Trading); HSBC; ICI (Feb. 2012); Japanese Bankers Ass’n.; JPMC; Morgan Stanley; Wells Fargo

(Prop. Trading); Rep. Bachus et al.; RBC; SIFMA (Prop. Trading) (Feb. 2012).
369

hedge aggregate positions and risks arising from a portfolio of assets would be more 

efficient from both a procedural and business standpoint.1259 

By contrast, other commenters argued that portfolio-based hedging could be used 

to mask prohibited proprietary trading.1260 One commenter contended that the statute 

provides no basis for portfolio hedging, and another commenter similarly suggested that 

portfolio hedging should be prohibited.1261 Another commenter suggested adopting 

limits that would prevent the use of the hedging exemption to conduct proprietary activity 

at one desk as a theoretical “hedge for proprietary trading at another desk.” 1262 Among 

the limits suggested by these commenters were a requirement that a banking entity have a 

well-defined compliance program, the formation of central “risk management” groups to 

perform and monitor hedges of aggregated positions, and a requirement that the banking 

entity demonstrate the capacity to measure aggregate risk across the institution with 

precision using proven models.1263 A few commenters suggested that the presence of 

portfolio hedging should be viewed as an indicator of imperfections in hedging at the 

 

1259 See, e.g. ABA (Keating); Ass’n. of Institutional Investors (Sept. 2012); BoA; See also Barclays 

(expressing concern that the proposed rule could result in regulatory review of individual hedging trades for 

compliance on a post hoc basis); HSBC; ISDA (Apr. 2012); ICI (Feb. 2012); PNC; MetLife; RBC; SIFMA

(Prop. Trading) (Feb. 2012). 

1260 See, e.g., AFR et al. (Feb. 2012); Sens. Merkley & Levin (Feb. 2012); Occupy; Public Citizen; 

Johnson & Prof. Stiglitz.

1261 See Sens. Merkley & Levin (Feb. 2012) (commenting that the use of the term “aggregate” positions 

was intended to note that firms do not have to hedge on a trade-by-trade basis but could not hedge on a 

portfolio basis); Johnson & Prof. Stiglitz. 

1262 See AFR et al. (Feb. 2012) (citing 156 Cong. Rec. S5898 (daily ed. July 15, 2010) (statement of Sen. 

Merkley)).

1263 See, e.g., Occupy; Public Citizen.
370

desk level and be a flag used by examiners to identify and review the integrity of specific 

hedges.1264 

The final rule, like the proposed rule, implements the statutory language 

providing for risk-mitigating hedging activities related to individual or aggregated 

positions. For example, activity permitted under the hedging exemption would include 

the hedging of one or more specific risks arising from identified positions, contracts, or 

other holdings, such as the hedging of the aggregate risk of identified positions of one or 

more trading desks. Further, the final rule requires that these hedging activities be riskreducing with respect to the identified positions, contracts, or other holdings being 

hedged and that the risk reduction be demonstrable. Specifically, the final rule requires, 

among other things: that the banking entity has a robust compliance program reasonably 

designed to ensure compliance with the exemption; that each hedge is subject to 

continuing review, monitoring and management designed to demonstrably reduce or 

otherwise significantly mitigate the specific, identifiable risks that develop over time 

related to the hedging activity and the underlying positions, contracts, or other holdings 

of the banking entity; and that the banking entity meet a documentation requirement for 

hedges not established by the trading desk responsible for the underlying position or for 

hedges effected through a financial instrument, technique or strategy that is not 

specifically identified in the trading desk’s written policies and procedures. The 

Agencies believe this approach addresses concerns that a banking entity could use the 

hedging exemption to conduct proprietary activity at one desk as a theoretical hedge for 

 

1264 See Public Citizen; Occupy; AFR et al. (Feb. 2012). 
371

proprietary trading at another desk in a manner consistent with the statute.1265 Further, 

the Agencies believe the adopted exemption allows banking entities to engage in hedging 

of aggregated positions1266 while helping to ensure that such hedging activities are truly 

risk-mitigating.1267

As noted above, several commenters questioned whether the hedging exemption 

should apply to “portfolio” hedging and whether portfolio hedging may create the 

potential for abuse of the hedging exemption. The term “portfolio hedging” is not used in 

the statute. The language of section 13(d)(1)(C) of the BHC Act permits a banking entity 

to engage in risk-mitigating hedging activity “in connection with and related to individual 

or aggregated positions . . . .”1268 After consideration of the comments regarding 

portfolio hedging, and in light of the statutory language, the Agencies are of the view that 

the statutory language is clear on its face that a banking entity may engage in riskmitigating hedging in connection with aggregated positions of the banking entity. The 

permitted hedging activity, when involving more than one position, contract, or other 

holding, must be in connection with or related to aggregated positions of the banking 

entity.

 

1265 See AFR et al. (Feb. 2012) (citing 156 Cong. Rec. S5898 (daily ed. July 15, 2010) (statement of Sen. 

Merkley)).

1266 See MetLife; SIFMA et al. (Prop. Trading) (Feb. 2012); Morgan Stanley; Barclays; Goldman (Prop.

Trading); BoA; ABA (Keating); HSBC; Fixed Income Forum/Credit Roundtable; ICI (Feb. 2012); ISDA 

(Feb. 2012).

1267 The Agencies believe certain limits suggested by commenters, such as the formation of central “risk 

management” groups to monitor hedges of aggregated positions, are unnecessary given the aforementioned 

limits in the final rule. See Occupy; Public Citizen.

1268 See 12 U.S.C. 1851(d)(1)(C).
372

Moreover, hedging of aggregated positions under this exemption must be related 

to identifiable risks related to specific positions, contracts, or other holdings of the 

banking entity. Hedging activity must mitigate one or more specific risks arising from an 

identified position or aggregation of positions. The risks in this context are not intended 

to be more generalized risks that a trading desk or combination of desks, or the banking 

entity as a whole, believe exists based on non-position-specific modeling or other 

considerations. For example, the hedging activity cannot be designed to: reduce risks 

associated with the banking entity’s assets and/or liabilities generally, general market 

movements or broad economic conditions; profit in the case of a general economic 

downturn; counterbalance revenue declines generally; or otherwise arbitrage market 

imbalances unrelated to the risks resulting from the positions lawfully held by the 

banking entity.1269 Rather, the hedging exemption permits the banking entity to engage 

in trading activity designed to reduce or otherwise mitigate specific, identifiable risks 

related to identified individual or aggregated positions that the banking entity it otherwise 

lawfully permitted to have.

When undertaking a hedge to mitigate the risk of an aggregation of positions, the 

banking entity must be able to specifically identify the risk factors arising from this set of 

positions. In identifying the aggregate set of positions that is being hedged for purposes 

of § __.5(b)(2)(ii) and, where applicable, § __.5(c)(2)(i), the banking entity needs to 

identify the positions being hedged with sufficient specificity so that at any point in time, 

 

1269 The Agencies believe that it would be inconsistent with Congressional intent to permit some or all of 

these activities under the hedging exemption, regardless of whether certain metrics could be useful for 

monitoring such activity. See JPMC.
373

the specific financial instrument positions or components of financial instrument 

positions held by the banking entity that comprise the set of positions being hedged can 

be clearly identified.

The proposal would have permitted a series of hedging transactions designed to 

rebalance hedging position(s) based on changes resulting from permissible activities or 

from a change in the price or other characteristic of the individual or aggregated 

positions, contracts, or other holdings being hedged.1270 The Agencies recognized that, in 

such dynamic hedging, material changes in risk may require a corresponding 

modification to the banking entity’s current hedge positions.1271 

Some commenters questioned the risk-mitigating nature of a hedge if, at 

inception, that hedge contained component risks that must be dynamically managed 

throughout the life of the hedge. These commenters stated that hedges that do not 

continuously match the risk of underlying positions are not in fact risk-mitigating hedges 

in the first place.

1272 

On the other hand, other commenters argued that banking entities must be 

permitted to engage in dynamic hedging activity, such as in response to market 

 

1270 See proposed rule § __.5(b)(2)(ii) (requiring that the hedging transaction “hedges or otherwise 

mitigates one or more specific risks... arising in connection with and related to individual or aggregated 

positions, contracts, or other holdings of [the] banking entity”). The proposal noted that this requirement 

would include, for example, dynamic hedging. See Joint Proposal, 76 FR at 68,875.

1271 The proposal noted that this corresponding modification to the hedge should also be reasonably 

correlated to the material changes in risk that are intended to be hedged or otherwise mitigated, as required 

by § __.5(b)(2)(iii) of the proposed rule.

1272 See AFR et al. (Feb. 2012); Public Citizen; See also Better Markets (Feb. 2012), Sens. Merkley & 

Levin (Feb. 2012).
374

conditions which are unforeseeable or out of the control of the banking entity,1273 and 

expressed concern that the limitations of the proposed rule, especially the requirement 

that hedging transactions “maintain a reasonable level of correlation,” might impede truly 

risk-reducing hedging activity.1274

A number of commenters asserted that there could be confusion over the meaning 

of “reasonable correlation,” which was used in the proposal as part of explaining what 

type of activity would qualify for the hedging exemption. Some commenters urged 

requiring that there be a “high” or “strong” correlation between the hedge and the risk of 

the underlying asset.1275 

Other commenters indicated that uncertainty about the meaning of reasonable 

correlation could limit valid risk-mitigating hedging activities because the level of 

correlation between a hedge and the risk of the position or aggregated positions being 

hedged changes over time as a result of changes in market factors and conditions.1276 

Some commenters represented that the proposed provision would cause certain 

administrative burdens1277 or may result in a reduction in market-making activities in 

 

1273 See Japanese Bankers Ass’n.

1274 See, e.g., BoA; Barclays; ISDA (Apr. 2012); PNC; PNC et al.; SIFMA et al. (Prop. Trading) (Feb. 

2012).

1275 See, e.g., Occupy; Public Citizen; AFR et. al. (Feb. 2012); AFR (June 2013); Better Markets (Feb. 

2012); Sens. Merkley & Levin (Feb. 2012).

1276 See BoA; Barclays; Comm. on Capital Markets Regulation; Credit Suisse (Seidel); FTN; Goldman 

(Prop. Trading); ICI (Feb. 2012); Japanese Bankers Ass’n.; JPMC; Morgan Stanley; SIFMA et al. (Prop. 

Trading) (Feb. 2012); STANY; See also Chamber (Feb. 2012).

1277 See Japanese Bankers Ass’n.; Goldman (Prop. Trading); BoA.
375

certain asset classes.1278 A few commenters expressed concern that the reasonable 

correlation requirement could render a banking entity’s hedges impermissible if they do 

not succeed in being reasonably correlated to the relevant risk or risks based on an afterthe-fact analysis that incorporates market developments that could not have been foreseen 

at the time the hedge was placed. These commenters tended to favor a different approach 

or a type of safe harbor based on an initial determination of correlation.1279 Some 

commenters argued the focus of the hedging exemption should be on risk reduction and 

not on reasonable correlation.1280 One commenter suggested that risk management 

metrics such as VaR and risk factor sensitivities could be the focus for permitted hedging 

instead of requirements like reasonable correlation under the proposal.1281 

In consideration of commenter concerns about the proposed reasonable 

correlation requirement, the final rule modifies the proposal in the following key respects. 

First, the final rule modifies the requirement of “reasonable correlation” by providing that 

the hedge demonstrably reduce or otherwise significantly mitigate specific identifiable 

 

1278 See BoA; SIFMA (Asset Mgmt.) (Feb. 2012). As discussed above, market-maker hedging at the 

trading desk level is no longer subject to the hedging exemption and is instead subject to the requirements 

of the market-making exemption, which is designed to permit banking entities to continue providing 

legitimate market-making services, including managing the risk of market-making activity. See also supra

Part IV.A.3.c.4. of this Supplementary Information.

1279 See Barclays; Goldman (Prop. Trading); Chamber (Feb. 2012); SIFMA et al. (Prop. Trading) (Feb. 

2012); See also FTN; BoA.

1280 See, e.g., FTN; Goldman (Prop. Trading); ISDA (Apr. 2012); See also Sens. Merkley & Levin (Feb. 

2012); Occupy.

1281 See Goldman (Prop. Trading). Consistent with the FSOC study and the proposal, the Agencies 

continue to believe that quantitative measurements can be useful to banking entities and the Agencies to 

help assess the profile of a trading desk’s trading activity and to help identify trading activity that may 

warrant a more in-depth review. See infra Part IV.C.3.; final rule Appendix A. The Agencies do not intend 

to use quantitative measurements as a dispositive tool for differentiating between permitted hedging 

activities and prohibited proprietary trading. 
376

risks.1282 This change is designed to reinforce that hedging activity should be 

demonstrably risk reducing or mitigating rather than simply correlated to risk. This 

change acknowledges that hedges need not simply be correlated to underlying positions, 

and that hedging activities should be consciously designed to reduce or mitigate 

identifiable risks, not simply the result of pairing correlated positions, as some 

commenters suggested.1283 As discussed above, the Agencies do, however, recognize 

that correlation is often a critical element of demonstrating that a hedging activity reduces 

the risks it is designed to address. Accordingly, the final rule requires that banking 

entities conduct correlation analysis as part of the required compliance program in order 

to utilize the hedging exemption.1284 The Agencies believe this change better allows 

consideration of the facts and circumstances of the particular hedging activity as part of 

the correlation analysis and therefore addresses commenters’ concerns that the proposed 

reasonable correlation requirement could cause administrative burdens, impede legitimate 

hedging activity,1285 and require an after-the-fact analysis.1286

 

1282 Some commenters stated that the hedging exemption should focus on risk reduction, not reasonable 

correlation. See, e.g., FTN; Goldman (Prop. Trading); ISDA (Apr. 2012); Sens. Merkley & Levin (Feb. 

2012); Occupy. One of these commenters noted that demonstrated risk reduction should be a key 

requirement. See Sens. Merkley & Levin (Feb. 2012).

1283 See FTN; Goldman (Prop. Trading); ISDA (Apr. 2012); See also Sens. Merkley & Levin (Feb. 2012); 

Occupy.

1284 See final rule § __.5(b)(1)(iii).

1285 Some commenters expressed concern that the proposed “reasonable correlation” requirement might 

impede truly risk-reducing activity. See, e.g., BoA; Barclays; Comm. on Capital Markets Regulation; 

Credit Suisse (Seidel); FTN; Goldman (Prop. Trading); ICI (Feb. 2012); ISDA (Apr. 2012); Japanese 

Bankers Ass’n.; JPMC; Morgan Stanley; PNC; PNC et al.; SIFMA et al. (Prop. Trading) (Feb. 2012); 

STANY. Some of these commenters stated that the proposed requirement would cause administrative 

burdens. See Japanese Bankers Ass’n.; Goldman (Prop. Trading); BoA.

1286 See Barclays; Goldman (Prop. Trading); Chamber (Feb. 2012); SIFMA et al. (Prop. Trading) (Feb. 

2012; See also FTN.
377

Second, the final rule provides that the determination of whether an activity or 

strategy is risk-reducing or mitigating must, in the first instance, be made at the inception 

of the hedging activity. A trade that is not risk-reducing at its inception is not viewed as 

a hedge for purposes of the exemption in §__.5.1287

Third, the final rule requires that the banking entity conduct analysis and 

independent testing designed to ensure that the positions, techniques, and strategies used 

for hedging are reasonably designed to reduce or otherwise mitigate the risk being 

hedged. As noted above, such analysis and testing must include correlation analysis. 

Evidence of negative correlation may be a strong indicator that a given hedging position 

or strategy is risk-reducing. Moreover, positive correlation, in some instances, may be an 

indicator that a hedging position or strategy is not designed to be risk-mitigating. The

type of analysis and factors considered in the analysis should take account of the facts 

and circumstances, including type of position being hedged, market conditions, depth and 

liquidity of the market for the underlying and hedging position, and type of risk being 

hedged. 

The Agencies recognize that markets and risks are dynamic and that the risks 

from a permissible position or aggregated positions may change over time, new risks may 

emerge in the positions underlying the hedge and in the hedging position, new risks may 

emerge from the hedging strategy over time, and hedges may become less effective over 

 

1287 By contrast, the proposed requirement did not specify that the hedging activity reduce risk “at the 

inception of the hedge.” See proposed rule § __.5(b)(2)(ii).
378

time in addressing the related risk.1288 The final rule, like the proposal, continues to 

allow dynamic hedging. Additionally, the final rule requires the banking entity to engage 

in ongoing review, monitoring, and management of its positions and related hedging 

activity to reduce or otherwise significantly mitigate the risks that develop over time. 

This ongoing hedging activity must be designed to reduce or otherwise significantly 

mitigate, and must demonstrably reduce or otherwise significantly mitigate, the material 

changes in risk that develop over time from the positions, contracts, or other holdings 

intended to be hedged or otherwise mitigated in the same way, as required for the initial 

hedging activity. Moreover, the banking entity is required under the final rule to support 

its decisions regarding appropriate hedging positions, strategies and techniques for its 

ongoing hedging activity in the same manner as for its initial hedging activities. In this 

manner, the final rule permits a banking entity to engage in effective management of its 

risks throughout changing market conditions1289 while also seeking to prohibit the 

banking entity from taking large proprietary positions through action or inaction related 

to an otherwise permissible hedge.1290

As explained above, the final rule requires a banking entity relying on the hedging 

exemption to be able to demonstrate that the banking entity is exposed to the specific 

 

1288 Some commenters noted that hedging activities must address constantly changing positions and market 

conditions and expressed concern about requiring a banking entity to identify the particular risk being 

hedged. See Japanese Bankers Ass’n.; Barclays. 

1289 A few commenters expressed concern that the proposed “reasonable correlation” requirement would 

render hedges impermissible if not reasonably correlated to the relevant risk(s) based on a post hoc

analysis. See, e.g., Barclays; Goldman (Prop. Trading); Chamber (Feb. 2012); SIFMA et al. (Prop. 

Trading) (Feb. 2012).

1290 Some commenters questioned the risk-mitigating nature of a hedge if, at inception, it contained risks

that must be dynamically managed throughout the life of the hedge. See, e.g., AFR et al. (Feb. 2012); 

Public Citizen.
379

risks being hedged at the inception of the hedge and any adjustments thereto. However, 

in the proposal, the Agencies requested comment on whether the hedging exemption 

should be available in certain cases where hedging activity begins before the banking 

entity becomes exposed to the underlying risk. The Agencies proposed that the hedging 

exemption would be available in certain cases where the hedge is established “slightly” 

before the banking entity becomes exposed to the underlying risk if such anticipatory 

hedging activity: (i) was consistent with appropriate risk management practices; (ii) 

otherwise met the terms of the hedging exemption; and (iii) did not involve the potential 

for speculative profit. For example, a banking entity that was contractually obligated or 

otherwise highly likely to become exposed to a particular risk could engage in hedging 

that risk in advance of actual exposure.1291

A number of commenters argued that anticipatory hedging is a necessary and 

prudent activity and that the final rule should permit anticipatory hedging more broadly 

than did the proposed rule.1292 In particular, commenters were concerned that permitting 

hedging activity only if it occurs “slightly” before a risk is taken could limit hedging 

activities that are crucial to risk management.1293 Commenters expressed concern that 

the proposed approach would, among other things, make it difficult for banking entities 

to accommodate customer requests for transactions with specific price or size 

 

1291 See Joint Proposal, 76 FR at 68,875.

1292 See, e.g., Barclays; SIFMA et al. (Prop. Trading); Japanese Bankers Ass’n.; Credit Suisse (Seidel); 

BoA; PNC et al.; ISDA (Feb. 2012).

1293 See BoA; Credit Suisse (Seidel); ISDA (Feb. 2012); JPMC; Morgan Stanley; PNC et al.; SIFMA et al.

(Prop. Trading) (Feb. 2012).
380

executions1294 and limit dynamic hedging activities that are important to sound risk 

management.1295 In addition, a number of commenters requested that the rule permit 

banking entities to engage in scenario hedging, a form of anticipatory hedging that 

addresses potential exposures to “tail risks.”1296

Some commenters expressed concern about the proposed criterion that the 

hedging activity not involve the potential for speculative profit.1297 These commenters 

argued that the proper focus of the hedging exemption should be on the purpose of the 

transaction, and whether the hedge is correlated to the underlying risks being hedged (in 

other words, whether the hedge is effective in mitigating risk).1298 By contrast, another 

commenter urged the Agencies to adopt a specific metric to track realized profits on 

hedging activities as an indicator of prohibited arbitrage trading.1299

 

1294 See Credit Suisse (Seidel); BoA.

1295 See PNC et al.

1296 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC; Goldman (Prop. Trading); BoA; Comm. on 

Capital Market Regulation. As discussed above, hedging activity relying on this exemption cannot be 

designed to: reduce risks associated with the banking entity’s assets and/or liabilities generally, general 

market movements or broad economic conditions; profit in the case of a general economic downturn; 

counterbalance revenue declines generally; or otherwise arbitrage market imbalances unrelated to the risks 

resulting from the positions lawfully held by the banking entity.

1297 See ABA (Keating); CH/ABASA; See also Credit Suisse (Seidel); PNC; PNC et al.; SIFMA et al.

(Prop. Trading) (Feb. 2012). One commenter argued that anticipatory hedging should not be permitted 

because it represents illegal front running. See Occupy. The Agencies note that not all anticipatory 

hedging would constitute illegal front running. Any activity that is illegal under another provision of law, 

such as front running under section 10(b) of the Exchange Act, remains illegal; and section 13 of the BHC 

Act and any implementing rules thereunder do not represent a grant of authority to engage in any such 

activity. See 15 U.S.C. 78j.

1298 As discussed above, the final hedging exemption replaces the “reasonable correlation” concept with 

the requirement that hedging activity “demonstrably reduce or otherwise significantly mitigate” specific, 

identifiable risks. 

1299 See AFR et al. (Feb. 2012); See also Part IV.C.3.d., infra.
381

Like the proposal, the final rule does not prohibit anticipatory hedging. However, 

in response to commenter concerns that the proposal would limit a banking entity’s 

ability to respond to customer requests and engage in prudent risk management, the final 

rule does not retain the proposed requirement discussed above that an anticipatory hedge 

be established “slightly” before the banking entity becomes exposed to the underlying 

risk and meet certain conditions. To address commenter concerns with the statutory 

mandate, several parts of the final rule are designed to ensure that all hedging activities, 

including anticipatory hedging activities, are designed to be risk reducing and not 

impermissible proprietary trading activities. For example, the final rule retains the 

proposed requirement that a banking entity have reasonably designed policies and 

procedures indicating the positions, techniques and strategies that each trading desk may 

use for hedging. These policies and procedures should specifically address when 

anticipatory hedging is appropriate and what policies and procedures apply to 

anticipatory hedging. 

The final rule also requires that a banking entity relying on the hedging exemption 

be able to demonstrate that the hedging activity is designed to reduce or significantly 

mitigate, and does demonstrably reduce or otherwise significantly mitigate, specific, 

identifiable risks in connection with individual or aggregated positions of the banking 

entity.1300 Importantly, to use the hedging exemption, the final rule requires that the 

banking entity subject its hedging activity to continuing review, monitoring, and 

 

1300 This requirement modifies proposed rule §§ __.5(b)(2)(ii) and (iii). As discussed above, the addition 

of “demonstrably reduces or significantly mitigates” language replaces the proposed “reasonable 

correlation” requirement.
382

management that is designed to reduce or significantly mitigate specific, identifiable 

risks, and that demonstrably reduces or otherwise significantly mitigates identifiable 

risks, in connection with individual or aggregated positions of the banking entity.1301 The 

final rule also requires ongoing recalibration of the hedging activity by the banking entity 

to ensure that the hedging activity satisfies the requirements set out in § __.5(b)(2) and is 

not prohibited proprietary trading. If an anticipated risk does not materialize within a 

limited time period contemplated when the hedge is entered into, under these provisions, 

the banking entity would be required to extinguish the anticipatory hedge or otherwise 

demonstrably reduce the risk associated with that position as soon as reasonably 

practicable after it is determined that the anticipated risk will not materialize. This 

requirement focuses on the purpose of the hedge as a trade designed to reduce anticipated 

risk and not for other purposes. The Agencies will (and expect that banking entities also 

will) monitor the activities of banking entities to identify prohibited trading activity that 

is disguised as anticipatory hedging. 

As noted above, one commenter suggested the Agencies adopt a metric to monitor 

the profitability of a banking entity’s hedging activity.1302 We are not adopting such a 

metric because we do not believe it would be useful to monitor the profit and loss 

associated with hedging activity in isolation without considering the profit and loss 

 

1301 The proposed rule contained a similar provision, except that the proposed provision also required that 

the continuing review maintain a reasonable level of correlation between the hedge transaction and the risk 

being hedged. See proposed rule § __.5(b)(2)(v). As discussed above, the proposed “reasonable 

correlation” requirement was removed from that provision and instead a requirement has been added to the 

compliance program provision that correlation analysis be undertaken when analyzing hedging positions, 

techniques, and strategies before they are implemented.

1302 See AFR et al. (Feb. 2012).
383

associated with the individual or aggregated positions being hedged. For example, the 

commenter’s suggested metric would not appear to provide information about whether 

the gains arising from hedging positions offset or mitigate losses from individual or 

aggregated positions being hedged.

3. Compensation 

The proposed rule required that the compensation arrangements of persons 

performing risk-mitigating hedging activities be designed not to reward proprietary risktaking.1303 In the proposal, the Agencies stated that hedging activities for which a 

banking entity has established a compensation incentive structure that rewards 

speculation in, and appreciation of, the market value of a covered financial position, 

rather than success in reducing risk, are inconsistent with permitted risk-mitigating 

hedging activities.1304

Commenters generally supported this requirement and indicated that its inclusion 

was very important and valuable.1305 Some commenters argued that the final rule should 

limit compensation based on profits derived from hedging transactions, even if those 

hedging transactions were in fact risk-mitigating hedges, and urged that employees be 

compensated instead based on success in risk mitigation at the end of the life of the 

hedge.1306 In contrast, other commenters argued that the compensation requirement 

 

1303 See proposed rule § __.5(b)(2)(vi). 

1304 See Joint Proposal, 76 FR at 68,868.

1305 See, e.g., AFR et al. (Feb. 2012); Sens. Merkley & Levin (Feb. 2012); Public Citizen.

1306 See AFR et al.(Feb. 2012); AFR (June 2013).
384

should restrict only compensation arrangements that incentivize employees to engage in 

prohibited proprietary risk-taking.1307

After considering comments received on the compensation requirements of the 

proposed hedging exemption, the final rule substantially retains the proposed requirement 

that the compensation arrangements of persons performing risk-mitigating hedging 

activities be designed not to reward prohibited proprietary trading. The final rule is also 

modified to make clear that rewarding or incentivizing profit making from prohibited 

proprietary trading is not permitted.1308 

The Agencies recognize that compensation, especially incentive compensation, 

may be both an important motivator for employees as well as a useful indicator of the 

type of activity that an employee or trading desk is engaged in. For instance, an incentive 

compensation plan that rewards an employee engaged in activities under the hedging 

exemption based primarily on whether that employee’s positions appreciate in value 

instead of whether such positions reduce or mitigate risk would appear to be designed to 

reward prohibited proprietary trading rather than risk-reducing hedging activities.1309 

Similarly, a compensation arrangement that is designed to incentivize an employee to 

exceed the potential losses associated with the risks of the underlying position rather than 

 

1307 See Morgan Stanley. 

1308 One commenter stated that the compensation requirement should restrict only compensation 

arrangements that incentivize employees to engage in prohibited proprietary risk-taking, rather than apply 

to hedging activities. See Morgan Stanley. 

1309 Thus, the Agencies agree with one commenter who stated that compensation for hedging should not be 

based purely on profits derived from hedging. However, the final rule does not require compensation 

vesting, as suggested by this commenter, because the Agencies believe the final hedging exemption 

includes sufficient requirements to ensure that only risk-mitigating hedging is permitted under the 

exemption without a compensation vesting provision. See AFR et al. (Feb. 2012); AFR (June 2013).
385

reduce risks of underlying positions would appear to reward prohibited proprietary 

trading rather than risk-mitigating hedging activities. The banking entity should review 

its compensation arrangements in light of the guidance and rules imposed by the 

appropriate Federal supervisor for the entity regarding compensation.1310 

4. Documentation requirement

Section __.5(c) of the proposed rule would have imposed a documentation 

requirement on certain types of hedging transactions. Specifically, for any transaction 

that a banking entity conducts in reliance on the hedging exemption that involved a hedge 

established at a level of organization different than the level of organization establishing 

or responsible for the positions, contracts, or other holdings the risks of which the 

hedging transaction is designed to reduce, the banking entity was required, at a minimum, 

to document: the risk-mitigating purpose of the transaction; the risks of the individual or 

aggregated positions, contracts, or other holdings of a banking entity that the transaction 

is designed to reduce; and the level of organization that is establishing the hedge.1311 

Such documentation was required to be established at the time the hedging transaction is 

effected. The Agencies expressed concern in the proposal that hedging transactions 

established at a different level of organization than the positions being hedged may 

present or reflect heightened potential for prohibited proprietary trading, either at the 

trading desk level or at the level instituting the hedging transaction. In other words, the 

 

1310 See 12 U.S.C. 5641.

1311 For example, as explained under the proposal, a hedge would be established at a different level of 

organization of the banking entity if multiple market-making desks were exposed to similar risks and, to 

hedge such risks, a hedge was established at the direction of a supervisor or risk manager responsible for 

more than one desk rather than at each of the market-making desks that established the initial positions, 

contracts, or other holdings. See Joint Proposal, 76 FR at 68,876 n.161.
386

further removed hedging activities are from the specific positions, contracts, or other 

holdings the banking entity intends to hedge, the greater the danger that such activity is 

not limited to hedging specific risks of individual or aggregated positions, contracts, or 

other holdings of the banking entity, as required by the rule.

Some commenters argued that the final rule should require comprehensive 

documentation for all activity conducted pursuant to the hedging exemption, regardless of 

where it occurs in an organization.1312 One of these commenters stated that such 

documentation can be easily and quickly produced by traders and noted that traders 

already record execution details of every trade.1313 Several commenters argued that the 

rule should impose a requirement that banks label all hedges at their inception and 

provide information regarding the specific risk being offset, the expected duration of the 

hedge, how it will be monitored, how it will be wound down, and the names of the trader, 

manager, and supervisor approving the hedge.1314

Some commenters requested that the documentation requirement be applied at a 

higher level of organization,1315 and some commenters noted that policies and procedures 

alone would be sufficient to address hedging activity, wherever conducted within the 

organization.1316 Two commenters indicated that making the documentation requirement 

narrower is necessary to avoid impacts or delays in daily trading operations that could 

 

1312 See AFR (June 2013); Occupy.

1313 See Occupy.

1314 See Sens. Merkley & Levin (Feb. 2012); Occupy; AFR (June 2013).

1315 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC; Barclays; See also Japanese Bankers Ass’n.

1316 See JPMC; SIFMA et al. (Prop. Trading) (Feb. 2012).
387

lead to a banking entity being exposed to greater risks.1317 A number of commenters 

stated that any enhanced documentation requirement would be burdensome and costly, 

and would impede rapid and effective risk mitigation, whether done at a trading desk or 

elsewhere in the banking entity.1318 

At least one commenter also argued that a banking entity should be permitted to 

consolidate some or all of its hedging activity into a trading desk that is not responsible 

for the underlying positions without triggering a requirement that all hedges undertaken 

by a trading desk be documented solely because the hedges are not undertaken by the 

trading desk that originated the underlying position.1319 

The final rule substantially retains the proposed requirement for enhanced 

documentation for hedging activity conducted under the hedging exemption if the 

hedging is not conducted by the specific trading desk establishing or responsible for the 

underlying positions, contracts, or other holdings, the risks of which the hedging activity 

is designed to reduce. The final rule clarifies that a banking entity must prepare enhanced 

documentation if a trading desk establishes a hedging position and is not the trading desk 

that established the underlying positions, contracts, or other holdings. The final rule also 

requires enhanced documentation for hedges established to hedge aggregated positions 

across two or more desks. This change in the final rule clarifies that the level of the 

organization at which the trading desk exists is important for determining whether the 

 

1317 See JPMC; Barclays. 

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

1319 See JPMC. 
388

trading desk established or is responsible for the underlying positions, contracts, or other 

holdings. The final rule recognizes that a trading desk may be responsible for hedging 

aggregated positions of that desk and other desks, business units, or affiliates. In that 

case, the trading desk putting on the hedge is at least one step removed from some of the 

positions being hedged. Accordingly, the final rule provides that the documentation 

requirements in § __.5 apply if a trading desk is hedging aggregated positions that 

include positions from more than one trading desk. 

The final rule adds to the proposal by requiring enhanced documentation for 

hedges established by the specific trading desk establishing or directly responsible for the 

underlying positions, contracts, or other holdings, the risks of which the purchases or 

sales are designed to reduce, if the hedge is effected through a financial instrument, 

technique, or strategy that is not specifically identified in the trading desk’s written 

policies and procedures as a product, instrument, exposure, technique, or strategy that the 

trading desk may use for hedging.1320 The Agencies note that this documentation 

requirement does not apply to hedging activity conducted by a trading desk in connection 

with the market 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 

 

1320 One commenter suggested that the rule require documentation when a banking entity needs to engage 

in new types of hedging transactions that are not covered by its hedging policies, although this 

commenter’s suggested approach would only apply when a hedge is conducted two levels above the level 

at which the risk arose. See SIFMA et al. (Prop. Trading) (Feb. 2012). The Agencies agree that 

documentation is needed when a trading desk is acting outside of its hedging policies and procedures. 

However, the final rule does not limit this documentation requirement to circumstances when the hedge is 

conducted two organizational levels above the trading desk. Such an approach would be less effective than 

the adopted approach at addressing evasion concerns.
389

the hedging activity is conducted in accordance with the compliance program for that 

trading desk.

The Agencies continue to believe that, for the reasons stated in the proposal, it is 

appropriate to retain documentation of hedging transactions conducted by those other 

than the traders responsible for the underlying position in order to permit evaluation of 

the activity. In order to reduce the burden of the documentation requirement while still 

giving effect to the rule’s purpose, the final rule requires limited documentation for 

hedging activity that is subject to a documentation requirement, consisting of: (1) the 

specific, identifiable risk(s) of the identified positions, contracts, or other holdings that 

the purchase or sale is designed to reduce; (2) the specific risk-mitigating strategy that the 

purchase or sale is designed to fulfill; and (3) the trading desk or other business unit that 

is establishing and responsible for the hedge transaction. As in the proposal, this 

documentation must be established contemporaneously with the hedging transaction. 

Documentation would be contemporaneous if it is completed reasonably promptly after a 

trade is executed. The banking entity is required to retain records for no less than 5 years 

(or such longer period as may be required under other law) in a form that allows the 

banking entity to promptly produce such records to the Agency on request.1321 While the 

Agencies recognize this documentation requirement may result in certain costs, the 

Agencies believe this requirement is necessary to prevent evasion of the statute and final 

rule. 

 

1321 See final rule § __5(c)(3).
390

5. Section __.6(a)-(b): Permitted Trading in Certain Government and Municipal 

Obligations

Section __.6 of the proposed rule permitted a banking entity to engage in trading 

activities that were authorized by section 13(d)(1) of the BHC Act,1322 including trading 

in certain government obligations, trading on behalf of customers, trading by insurance 

companies, and trading outside of the United States by certain foreign banking 

entities.1323 Section __.6 of the final rule generally incorporates these same statutory 

exemptions. However, the final rule has been modified in some ways in response to 

comments received on the proposal.

a. Permitted Trading in U.S. Government Obligations

Section 13(d)(1)(A) permits trading in various U.S. government, U.S. agency and 

municipal securities.1324 Section __.6(a) of the proposed rule, which implemented 

section 13(d)(1)(A) of the BHC Act, permitted the purchase or sale of a financial 

instrument that is an obligation of the United States or any agency thereof or an 

obligation, participation, or other instrument of or issued by the Government National 

Mortgage Association, the Federal National Mortgage Association, the Federal Home 

Loan Mortgage Corporation, a Federal Home Loan Bank, the Federal Agricultural 

Mortgage Corporation or a Farm Credit System institution chartered under and subject to 

 

1322 See proposed rule § __.6. 

1323 See 12 U.S.C. 1851(d)(1)(A), (C), (F), and (H).

1324 12 U.S.C. 1851(d)(1)(A). 
391

the provisions of the Farm Credit Act of 1971 (12 U.S.C. 2001 et seq.).1325 The proposal 

did not contain an exemption for trading in derivatives referencing exempt U.S. 

government and agency securities, but requested comment on whether the final rule 

should contain an exemption for proprietary trading in options or other derivatives 

referencing an exempt government obligation.1326 

Commenters were generally supportive of the manner in which the proposal 

implemented the exemption for permitted trading in U.S. government and U.S. agency 

obligations.1327 Many commenters argued that the exemption for permissible proprietary 

trading in government obligations should be expanded, however, to include trading in 

derivatives on government obligations.1328 These commenters asserted that failure to 

provide an exemption would adversely impact liquidity in the underlying government 

obligations themselves and increase borrowing costs to governments.1329 Several 

commenters asserted that U.S. government and agency obligations and derivatives on 

those instruments are substitutes and pose the same investment risks and 

 

1325 The Agencies proposed that United States “agencies” for this purpose would include those agencies 

described in section 201.108(b) of the Board’s Regulation A. See 12 CFR 201.108(b). The Agencies also 

noted that the terms of the exemption would encompass the purchase or sale of enumerated government 

obligations on a forward basis (e.g., in a to-be-announced market). In addition, this would include passthrough or participation certificates that are issued and guaranteed by a government-sponsored entity (e.g.,

the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation) in 

connection with its securitization activities. 

1326 See Joint Proposal, 76 FR at 68,878. 

1327 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Sens. Merkley & Levin (Feb. 2012).

1328 See BoA; CalPERS; Credit Suisse (Seidel); CME Group; Fixed Income Forum/Credit Roundtable; 

FIA; JPMC; Morgan Stanley; PNC; SIFMA et al. (Prop. Trading) (Feb. 2012); Wells Fargo (Prop. 

Trading). 

1329 See BoA; FIA; HSBC; JPMC; Morgan Stanley; Wells Fargo (Prop. Trading). 
392

opportunities.1330 According to some commenters, the significant connections between 

these markets and the interchangeable nature of these instruments significantly contribute 

to price discovery, in particular, in the cash market for U.S. Treasury obligations.1331 

Commenters also argued that trading in Treasury futures and options improves liquidity 

in Treasury securities markets by providing an outlet to relieve any supply and demand 

imbalances in spot obligations. Many commenters argued that the authority to engage in 

trading in derivatives on U.S. government, agency, and municipal obligations is inherent 

in the statutory exceptions granted by section 13(d)(1)(A) to trade in the underlying 

obligation.1332 To the extent there is any doubt about the scope of those exemptions, 

commenters urged the Agencies to use the exemptive authority under section 13(d)(1)(J) 

if necessary to permit proprietary trading in derivatives on government obligations.1333 

Two commenters opposed providing an exemption for proprietary trading in derivatives 

on exempt government obligations.1334

The final rule has not been modified to permit a banking entity to engage in 

proprietary trading of derivatives on U.S. government and agency obligations.

The Agencies note that the cash market for exempt government obligations is 

already one of the most liquid markets in the world, and the final rule will permit banking 

entities to participate fully in these cash markets. In addition, the final rule permits 

 

1330 See Barclays; Credit Suisse (Seidel); Fixed Income Forum/Credit Roundtable; FIA. 

1331 See Barclays; CME Group; Fixed Income Forum/Credit Roundtable; See also UBS. 

1332 See CME Group; See also Morgan Stanley; PNC; SIFMA et al. (Prop. Trading) (Feb. 2012); Wells 

Fargo (Prop. Trading).

1333 See Barclays; CME Group; JPMC.

1334 See Occupy; Alfred Brock.
393

banking entities to make a market in U.S. government securities and in derivatives on 

those securities. Moreover, the final rule allows banking entities to continue to use U.S. 

government obligations and derivatives on those obligations in risk-mitigating hedging 

activities permitted by the rule. Further, proprietary trading in derivatives on such 

obligations will continue by entities other than banking entities.

Proprietary trading of derivatives on U.S. government obligations is not necessary 

to promote and protect the safety and soundness of a banking entity or the financial 

stability of the United States. Commenters offered no compelling reasons why 

derivatives on exempt government obligations pose little or no risk to the financial 

system as compared to derivatives on other financial products for which proprietary 

trading is generally prohibited and did not indicate how proprietary trading in derivatives 

of U.S. government and agency obligations by banking entities would promote the safety 

and soundness of those entities or the financial stability of the United States. For these

reasons, the Agencies have not determined to provide an exemption for proprietary 

trading in derivatives on exempt government obligations.

The Agencies believe banking entities will continue to provide significant support 

and liquidity to the U.S. government and agency security markets through permitted 

trading in the cash exempt government obligations markets, making markets in 

government obligation derivatives and through derivatives trading for hedging purposes. 

The final rule adopts the same approach as the proposed rule for the exemption for 

permitted trading in U.S. government and U.S. agency obligations. In response to 

commenters, the Agencies are clarifying how banking entities would be permitted to use 

Treasury derivatives on Treasury securities when relying on the exemptions for market-
394

making related activities and risk-mitigating hedging activities. The Agencies agree with 

commenters that some Treasury derivatives are close economic substitutes for Treasury 

securities and provide many of the same economic exposures.1335 The Agencies also 

understand that the markets for Treasury securities and Treasury futures are fully 

integrated, and that trading in these derivative instruments is essential to ensuring the 

continued smooth functioning of market-making related activities in Treasury securities. 

Treasury derivatives are frequently used by market makers to hedge their market-making 

related positions across many different types of fixed-income securities. Under the final 

rule, market makers will generally be able to continue their practice of using Treasury 

futures to hedge their activities as block positioners off exchanges. Additionally, when 

engaging in permitted market-making related or risk-mitigating hedging activities in 

accordance with the requirements in §§___.4(b) or ___.(5), the final rule permits banking 

entities to acquire a short or long position in Treasury futures through manual trading or 

automated processes. For example, a banking entity would be permitted to use Treasury 

futures to hedge the duration risk (i.e., the measure of a bond’s price sensitivity to interest 

rates movements) associated with the banking entity’s market-making in Treasury 

securities or other fixed-income products, provided that the banking entity complies with

the market-making requirements in § __.4(b). In their market making, banking entities 

also frequently trade Treasury futures (and acquire a corresponding long or short 

position) in reasonable anticipation of the near-term demands of their clients, customers, 

and counterparties. For example, banking entities may acquire a long or short position in 

Treasury futures to hedge anticipated market risk when they reasonably expect clients, 

 

1335 See infra note 1330.
395

customers, or counterparties will seek to establish long or short positions in on- or offthe-run Treasury securities. Similarly, banking entities could acquire a long or short 

position in the “Treasury basis” to hedge the anticipated basis risk associated with 

making markets for clients, customers, or counterparties that are reasonably expected to 

engage in basis trading of the price spread between Treasury futures and Treasury 

securities. A banking entity can also use Treasury futures (or other derivatives on exempt 

government obligations) to hedge other risks such as the aggregated interest rate risk for 

specifically identified loans as well as other financial instruments such as asset-backed 

securities, corporate bonds, and interest rate swaps. Therefore, depending on the relevant 

facts and circumstances, banking entities would be permitted to acquire a very large long 

or short position in Treasury derivatives provided that they comply with the requirements 

in §§___.4(b) or ___.(5). The Agencies also understand that banking entities that have 

been designated as “primary dealers” by the Federal Reserve Bank of New York are 

required to underwrite issuances of Treasury securities. This necessitates the banking 

entities to frequently establish very large short positions in Treasury futures to order to 

hedge the duration risk associated with potentially owning a large volume of Treasury 

securities. As described below,1336 the Agencies note that, with respect to a banking 

entity that acts as a primary dealer for Treasury securities, the U.S. government will be 

considered a client, customer, or counterparty of the banking entity for purposes of the 

market-making exemption.1337 We believe this interpretation appropriately captures the 

unique relationship between a primary dealer and the government. Moreover, this 

 

1336 See infra Part IV.A.3.c.2.c.i.

1337 See supra note 905 (explaining the functions of primary dealers). 
396

interpretation clarifies that a banking entity may rely on the market-making exemption 

for its activities as primary dealer to the extent those activities are outside the scope of the 

underwriting exemption.1338 

The final rule also includes an exemption for obligations of or guaranteed by the 

United States or an agency of the United States. An obligation guaranteed by the U.S. or 

an agency of the U.S. is, in effect, an obligation of the U.S. or that agency.

The final rule also includes an exemption for an obligation of the FDIC, or any 

entity formed by or on behalf of the FDIC for the purpose of facilitating the disposal of 

assets acquired or held by the FDIC in its corporate capacity or as conservator or receiver 

under the Federal Deposit Insurance Act (“FDI Act”) or Title II of the Dodd-Frank 

Act.1339 These FDIC receivership and conservatorship operations are authorized under 

the FDI Act and Title II of the Dodd-Frank Act and are designed to lower the FDIC’s 

resolution costs. The Agencies believe that an exemption for these types of obligations 

would promote and protect the safety and soundness of banking entities and the financial 

stability of the United States because they facilitate the FDIC’s ability to conduct 

receivership and conservatorship operations in an orderly manner, thereby limiting risks 

to the financial system generally that might otherwise occur if the FDIC was restricted in 

its ability to conduct these operations. 

b. Permitted Trading in Foreign Government Obligations

 

1338 See supra Part IV.A.3.c.2.b.ix. (discussing commenters’ concerns regarding primary dealer activity, as 

well as one commenter’s request for such an interpretation).

1339 See final rule § __.6(a)(4).
397

The proposed rule did not contain an exemption for trading in obligations of 

foreign sovereign entities. As part of the proposal, however, the Agencies specifically 

requested comment on whether proprietary trading in the obligations of foreign 

governments would promote and protect the safety and soundness of banking entities and 

the financial stability of the United States under section 13(d)(1)(J) of the BHC Act.1340 

The treatment of proprietary trading in foreign sovereign obligations prompted a 

significant number of comments. Many commenters, including foreign governments, 

foreign and domestic banking entities, and various trade groups, argued that the final rule 

should permit trading in foreign sovereign debt, including obligations issued by political 

subdivisions of foreign governments.1341 Representatives from foreign governments such 

as Canada, Germany, Luxembourg, Japan, Australia, and Mexico specifically requested 

an exemption for trading in obligations of their governments and argued that an 

exemption was necessary and appropriate to maintain and promote financial stability in 

their markets.1342 Some commenters also requested an exemption for trading in 

 

1340 See Joint Proposal, 76 FR at 68,878. 

1341 See, e.g., Allen & Overy (Gov’t Obligations); Allen & Overy (Canadian Banks); BoA; Australian 

Bankers Ass’n. (Feb. 2012); AFMA; Banco de México; Bank of Canada; Ass’n of German Banks;

BAROC; Barclays; BEC (citing the National Institute of Banking and Finance); British Bankers’ Ass’n.; 

BaFin/Deutsche Bundesbank; Chamber (Feb. 2012); Mexican Banking Comm’n.; French Treasury et al.; 

EFAMA; ECOFIN; EBF; French Banking Fed’n.; FSA (Apr. 2012); FIA; Goldman (Prop. Trading); 

HSBC; Hong Kong Inv. Funds Association; IIB/EBF; ICFR; ICSA; IRSG; Japanese Bankers Ass’n.; 

Ass’n. of Banks in Malaysia; OSFI; British Columbia; Québec; Sumitomo Trust; TMA Hong Kong; UBS; 

Union Asset. 

1342 See, e.g., Allen & Overy (Gov’t Obligations); Bank of Canada; British Columbia; Ontario; IIAC; 

Quebec; IRSG; IIB/EBF; Mitsubishi; Gov’t of Japan/Bank of Japan; Australian Bankers Ass’n (Feb. 2012); 

AFMA; Banco de México; Ass’n. of German Banks; ALFI; Embassy of Switzerland. 
398

obligations of multinational central banks, such as Eurobonds issued or guaranteed by the 

European Central Bank.1343

Many commenters argued that the same rationale for the statutory exemption for 

proprietary trading in U.S. government obligations supported exempting proprietary 

trading in foreign sovereign debt and related obligations.1344 Commenters contended that 

lack of an express exemption for trading in foreign sovereign obligations could critically 

impact the functioning of money market operations of foreign central banks and limit the 

ability of foreign sovereign governments to conduct monetary policy or finance their 

operations.1345 These commenters also contended that an exemption for proprietary 

trading in foreign sovereign debt would promote and protect the safety and soundness 

and the financial stability of the United States by avoiding the possible negative effects of 

a contraction of government bond market liquidity.1346 

Commenters also contended that in some foreign markets, local regulations or 

market practice require U.S. banking entities operating in those jurisdictions to hold, 

trade or support government issuance of local sovereign securities. They also indicated 

 

1343 See Ass’n. of German Banks; Goldman (Prop. Trading); IIB/EBF; ICFR; FIA; Mitsubishi; Sumitomo

Trust; Allen & Overy (Gov’t Obligations). 

1344 See Allen & Overy (Gov’t. Obligations); Banco de México; Barclays; BaFIN/Deutsche Bundesbank; 

EFAMA; Union Asset; TMA Hong Kong; ICI (Feb. 2012) (arguing that such an exemption would be 

consistent with Congressional intent to limit the extra-territorial application of U.S. law).

1345 See Banco de México; Barclays; BoA; Gov’t of Japan/Bank of Japan; IIAC; OSFI. 

1346 See, e.g., Allen & Overy (Gov’t. Obligations); AFMA; Banco de México; Ass’n. of German Banks; 

Barclays; Mexican Banking Comm’n.; EFAMA; EBF; French Banking Fed’n.; Goldman (Prop. Trading); 

HSBC; IIB/EBF; HSBC; ICSA; T. Rowe Price; UBS; Union Asset; IRSG; EBF; Mitsubishi (citing 

Japanese Bankers Ass’n. and IIB); Wells Fargo (Prop. Trading); ICI Global. 
399

that these instruments are traded in the United States or on U.S. markets.1347 In addition, 

a number of commenters contended that U.S. and foreign banking entities often perform 

functions for foreign governments similar to those provided in the United States by U.S. 

primary dealers and alleged that restricting these trading activities would have a 

significant negative impact on the ability of foreign governments to implement their 

monetary policy and on liquidity for such securities in many foreign markets.1348 A few 

commenters further argued that banking entities use foreign sovereign debt, particularly 

debt of their home country and of the country in which they are operating, to manage 

their risk by posting sovereign securities as collateral in foreign jurisdictions, to manage 

international rate and foreign exchange risk (particularly in local operations), and for 

liquidity and asset-liability management purposes in different countries.1349 Similarly, 

commenters expressed concern that the lack of an exemption for trading in foreign 

government obligations could adversely interact with other banking regulations, such as 

liquidity requirements under the Basel III capital rules that encourage financial 

institutions to hold large concentrations of sovereign bonds to match foreign currency 

 

1347 See Allen & Overy (Gov’t. Obligations) (contending that “even if not primary dealers, banking entities 

or their branches or agencies acting in certain foreign jurisdictions, such as Singapore and India, are still 

required to hold or transact in local sovereign debt under local law”); BoA; Barclays; Citigroup; SIFMA et 

al. (Prop. Trading) (Feb. 2012).

1348 See Allen & Overy (Gov’t. Obligations); Australian Bankers Ass’n. (Feb. 2012); BoA; Banco de 

México; Barclays; Citigroup; Goldman (Prop. Trading); IIB/EBF; See also JPMC (suggesting that, at a 

minimum, the Agencies should make clear that all of a firm's activities that are necessary or reasonably 

incidental to its acting as a primary dealer in a foreign government's debt securities are protected by the 

market-making-related permitted activity); SIFMA et al. (Prop. Trading) (Feb. 2012). As discussed in 

Parts IV.A.2.c.2.c. and IV.A.2.c.2.b.ix of this Supplementary Information, the Agencies believe primary 

dealing activities would generally qualify under the scope of the market-making or underwriting 

exemption.

1349 See Citigroup; SIFMA et al. (Prop. Trading) (Feb. 2012).
400

denominated obligations.1350 Commenters also expressed particular concern that the 

limitations and obligations of section 13 of the BHC Act would likely be problematic and 

unduly burdensome if banking entities were able to trade in foreign sovereign obligations 

only under the market making or other proposed exemptions from the proprietary trading 

prohibition.1351 One commenter expressed the view that lack of an exemption for 

proprietary trading in foreign government obligations together with the proposed 

exemption for trading that occurs solely outside the U.S. may cause foreign banks to 

close their U.S. branches to avoid being subject to section 13 of the BHC Act and any 

final rule thereunder.1352

According to some commenters, providing an exemption only for proprietary 

trading in U.S. government obligations, without a similar exemption for foreign 

government obligations, would be discriminatory and inconsistent with longstanding 

principles of national treatment and with U.S. treaty obligations, such as obligations 

under the World Trade Organization framework or bilateral trade agreements.1353 In 

addition, several commenters argued that not exempting proprietary trading of foreign 

sovereign debt may encourage foreign regulators to enact similar regulations to the 

detriment of U.S. financial institutions operating abroad.1354 However, another 

 

1350 See Allen & Overy (Gov’t. Obligations); BoA. 

1351 See Barclays; IIAC; UBS; Ass’n. of Banks in Malaysia; IIB/EBF.

1352 See Comm. on Capital Markets Regulation.

1353 See Allen & Overy (Gov’t. Obligations); Banco de México; IIB/EBF; Ass’n. of Banks in Malaysia.

1354 See Sumitomo Trust; SIFMA et al. (Prop. Trading) (Feb. 2012); Allen & Overy (Govt. Obligations); 

BoA; ICI Global; RBC; ICFR; ICI (Feb. 2012); Bank of Canada; Cadwalader (on behalf of Singapore 

Banks); Ass'n. of Banks in Malaysia; Cadwalader (on behalf of Thai Banks); Chamber (Feb. 2012);

BAROC. See also IIB/EBF.
401

commenter disagreed that the failure to exempt trading in foreign government obligations 

would violate trade agreements or that the proposal discriminated in any way against 

foreign banking entities’ ability to compete with U.S. banking entities in the U.S.1355

Based on these concerns, some commenters suggested that the Agencies exempt 

proprietary trading by foreign banking entities in obligations of their home or host 

country.1356 Other commenters suggested allowing trading in foreign government 

obligations that meet some condition on quality (e.g., OECD-member country 

obligations, government bonds eligible as collateral for Federal Reserve advances, 

sovereign bonds issued by G-20 countries, or other highly liquid or rated instruments).1357 

One commenter indicated that in their view, provided appropriate risk-management 

procedures are followed, investing in non-U.S. government securities is as low risk as 

investing in U.S. government securities despite current price volatility in certain types of 

sovereign debt.1358 Some commenters also suggested the final rule give deference to 

home country regulation and permit foreign banking entities to engage in proprietary 

trading in any government obligation to the extent that such trading is permitted by the 

entity’s primary regulator.1359

 

1355 See Sens. Merkley &Levin (Feb. 2012).

1356 See Cadwalader (on behalf of Thai Banks); IIB/EBF; Ass’n. of Banks in Malaysia; UBS; See also

BAROC. 

1357 See BoA; Cadwalader (on behalf of Singapore Banks); IIB/EBF; Norinchukin; OSFI; Cadwalader (on 

behalf of Thai Banks); Ass’n. of Banks in Malaysia; UBS; See also BAROC; ICFR; Japanese Bankers 

Ass’n.; JPMC; Québec. 

1358 See, e.g., Allen & Overy (Gov’t Obligations).

1359 See Allen & Overy (Gov’t. Obligations); HSBC. 
402

By contrast, other commenters argued that proprietary trading in foreign 

sovereign obligations represents a risky activity and that there is no effective way to draw 

the line between safe and unsafe foreign debt.1360 Two of these commenters pointed to 

several publicly reported instances where proprietary trading in foreign sovereign 

obligations resulted in significant losses to certain firms. These commenters argued that 

restricting proprietary trading in foreign sovereign debt would not cause reduced liquidity 

in government bond markets since banking entities would still be permitted to make a 

market in and underwrite foreign government obligations.1361 A few commenters 

suggested that, if the final rule exempted proprietary trading in foreign sovereign debt, 

foreign governments should commit to pay for any damage to the U.S. financial system 

related to proprietary trading in their obligations pursuant to such exemption.1362

The Agencies carefully considered all the comments related to proprietary trading 

in foreign sovereign debt in light of the language, purpose and standards for exempting 

activity contained in section 13 of the BHC Act. Under section 13(d)(1)(J), the Agencies 

may grant an exemption from the prohibitions of the section for any activity that the 

Agencies determine would promote and protect the safety and soundness of the banking 

entity and the financial stability of the United States. 

The Agencies note as an initial matter that section 13 permits banking entities –

both inside the United States and outside the United States – to make markets in and to 

 

1360 See Better Markets (Feb. 2012); Occupy; Prof. Johnson; Sens. Merkley & Levin (Feb. 2012).

1361 See Prof. Johnson; Better Markets (Feb. 2012). 

1362 See Better Markets (Feb. 2012); See also Prof. Johnson.
403

underwrite all types of securities, including all types of foreign sovereign debt. The final 

rule implements the statutory market-making and underwriting exemptions, and thus, the 

key role of banking entities in facilitating trading and liquidity in foreign government 

debt through market-making and underwriting is maintained. This includes underwriting 

and marketmaking as a primary dealer in foreign sovereign obligations. Banking entities 

may also hold foreign sovereign debt in their long-term investment book. In addition, the 

final rule does not prevent foreign banking entities from engaging in proprietary trading 

outside of the United States in any type of sovereign debt.1363 Moreover, the Agencies 

continue to believe that positions, including positions in foreign government obligations, 

acquired or taken for the bona fide purpose of liquidity management and in accordance 

with a documented liquidity management plan that is consistent with the relevant 

Agency’s supervisory requirements, guidance and expectations regarding liquidity 

management are not covered by the prohibitions in section 13.1364 The final rule 

continues to incorporate this view.1365 

The issue raised by commenters, therefore, is the extent to which proprietary 

trading in foreign sovereign obligations by U.S. banking entities anywhere in the world 

and by foreign banking entities in the United States is consistent with promoting and 

protecting the safety and soundness of the banking entity and the financial stability of the 

United States. Taking into account the information provided by commenters, the 

Agencies’ understanding of market operations, and the purpose and language of section 

 

1363 See final rule § __.6(e). 

1364 See Joint Proposal, 76 FR at 68,862. 

1365 See final rule § __.3(d)(3). 
404

13, the Agencies have determined to grant a limited exemption to the prohibition on 

proprietary trading for trading in foreign sovereign obligations under certain 

circumstances. 

This exemption, which is contained in § __.6(b) of the final rule, permits the U.S. 

operations of foreign banking entities to engage in proprietary trading in the United 

States in the foreign sovereign debt of the foreign sovereign under whose laws the 

banking entity – or the banking entity that controls it – is organized (hereinafter, the 

“home country”), and any multinational central bank of which the foreign sovereign is a 

member so long as the purchase or sale as principal is not made by an insured depository 

institution.1366 Similar to the exemption for proprietary trading in U.S. government 

obligations, the permitted trading activity in the U.S. by the eligible U.S. operations of a 

foreign banking entity would extend to obligations of political subdivisions of the foreign 

banking entity’s home country.1367 

Permitting the eligible U.S. operations of a foreign banking entity to engage in 

proprietary trading in the United States in the foreign sovereign obligations of the foreign 

 

1366 See final rule § __.6(b). Some commenters requested an exemption for trading in obligations of 

multinational central banks. See Ass’n. of German Banks; Goldman (Prop. Trading); IIB/EBF; ICFR; FIA; 

Mitsubishi; Sumitomo Trust; Allen & Overy (Gov’t. Obligations). In the case of a foreign banking entity 

that is owned or controlled by a second foreign banking entity domiciled in a country other than the home 

country of the first foreign banking entity, the final rule would permit the eligible U.S. operations of the 

first foreign banking entity to engage in proprietary trading only in the sovereign debt of the first foreign 

banking entity’s home country, and would permit the U.S. operations of the second foreign banking entity

to engage in proprietary trading only in the sovereign debt of the home country of the second foreign 

banking entity. As noted earlier, other provisions of the final rule make clear that the rule does not restrict 

the proprietary trading outside of the United States of either foreign banking organization in debt of any 

foreign sovereign. 

1367 See Part IV.A.5.c., infra. Many commenters requested an exemption for trading in foreign sovereign 

debt, including obligations issued by political subdivisions of foreign governments. See, e.g., Allen & 

Overy (Gov’t. Obligations); BoA; Australian Bankers Ass’n. (Feb. 2012); Banco de México; Bank of 

Canada; Ass’n. of German Banks; BAROC; Barclays.
405

entity’s home country allows these U.S. operations of foreign banking entities to continue 

to support the smooth functioning of markets in foreign sovereign obligations in the same 

manner as U.S. banking entities are permitted to support the smooth functioning of 

markets in U.S. government and agency obligations.1368 At the same time, the risk of 

these trading activities is largely determined by the foreign sovereign that charters the 

foreign bank. By not permitting proprietary trading in foreign sovereign debt in insured 

depository institutions (other than in accordance with the limitations in other 

exemptions), the exemption limits the direct risks of these activities to insured depository 

institutions in keeping with the statute.1369 Thus, the Agencies have determined that this 

limited exemption for proprietary trading in foreign sovereign obligations promotes and 

protects the safety and soundness of banking entities and also promotes and protects the 

financial stability of the United States. 

The Agencies have also determined to permit a foreign bank or foreign brokerdealer regulated as a securities dealer and controlled by a U.S. banking entity to engage 

in proprietary trading in the obligations of the foreign sovereign under whose laws the 

foreign entity is organized (hereinafter, the “home country”), including obligations of an 

 

1368 As part of this exemption, for example, the U.S. operations of a European bank would be able to trade 

in obligations issued by the European Central Bank. Many commenters represented that the same rationale 

for exempting trading in U.S. government obligations supports exempting trading in foreign sovereign 

debt. See, e.g., Allen & Overy (Gov’t. Obligations); Banco de México; Barclays; EFAMA; ICI (Feb. 

2012). 

1369 The Agencies believe this approach appropriately balances commenter concerns that proprietary 

trading in foreign sovereign obligations represents a risky activity and the interest in preserving the ability 

of U.S. operations of foreign banking entities to continue to support the smooth functioning of markets in 

foreign sovereign obligations in the same manner as U.S. banking entities are permitted to support the 

smooth functioning of markets in U.S. government and agency obligations. See Better Markets (Feb. 

2012); Occupy; Prof. Johnson; Sens. Merkley & Levin (Feb. 2012).
406

agency or political subdivision of that foreign sovereign.1370 This limited exemption is 

necessary to allow U.S. banking organizations to continue to own and acquire foreign 

banking organizations and broker-dealers without requiring those foreign banking 

organizations and broker-dealers to discontinue proprietary trading in the sovereign debt 

of the foreign banking entity’s home country.1371 The Agencies have determined that this 

limited exemption will promote the safety and soundness of banking entities and the 

financial stability of the United States by allowing U.S. banking entities to continue to be 

affiliated with and operate foreign banking entities and benefit from international 

diversification and participation in global financial markets.

1372 However, the Agencies 

intend to monitor activity of banking entities under this exemption to ensure that U.S. 

banking entities are not seeking to evade the restrictions of section 13 by using an 

affiliated foreign bank or broker-dealer to engage in proprietary trading in foreign 

sovereign debt on behalf of or for the benefit of other parts of the U.S. banking entity. 

Apart from this limited exemption, the Agencies have not extended this 

exemption to proprietary trading in foreign sovereign debt by U.S. banking entities for 

several reasons. First, section 13 was primarily concerned with the risks posed to the 

 

1370 See final rule § __.6(c). Many commenters requested an exemption for trading in foreign sovereign 

debt, and some commenters suggested exempting proprietary trading by foreign banking entities in 

obligations of their home country. See, e.g., Allen & Overy (Gov’t. Obligations); BoA; FSA (Apr. 2012); 

Cadwalader (on behalf of Thai Banks); IIB/EBF; Ass’n. of Banks in Malaysia; UBS.

1371 Commenters argued that in some foreign markets, U.S. banks operating in those jurisdictions are 

required by local regulation or market practice to trade in local sovereign securities. See, e.g., Allen & 

Overy (Gov’t. Obligations); AFMA; Ass’n. of German Banks; Barclays; EBF; Goldman (Prop. Trading); 

UBS.

1372 Some commenters represented that the limitations and obligations of section 13 would be problematic 

and unduly burdensome on banking entities because they would only be able to trade in foreign sovereign 

obligations under existing exemptions, such as the market-making exemption. See Barclays; IIAC; UBS; 

Ass’n. of Banks in Malaysia; IIB/EBF. 
407

U.S. financial system by proprietary trading activities. This risk is most directly 

transmitted by U.S. banking entities, and while commenters alleged that prohibiting U.S. 

banking entities from engaging in proprietary trading in debt of foreign sovereigns would 

harm liquidity in those markets, the evidence provided by commenters did not 

sufficiently indicate that permitting U.S. banking entities to engage in proprietary trading 

(as opposed to market-making or underwriting) in debt of foreign sovereigns contributed 

in any significant degree to the liquidity of markets in foreign sovereign instruments.1373 

Thus, expanding the exemption to permit U.S. banking entities to engage in proprietary 

trading in debt of foreign sovereigns would likely increase the risks to these entities and 

the U.S. financial system without a significant concomitant and offsetting benefit. As 

explained above, these U.S. entities are permitted by the final rule to continue to engage 

fully in market-making in and underwriting of debt of foreign sovereigns anywhere in the 

world. The only restriction placed on these entities is on the otherwise impermissible 

proprietary trading in these instruments for the purpose of selling in the near term or 

otherwise with the intent to resell in order to profit from short-term price movements. 

The Agencies recognize that, depending on the extent to which banking entities 

subject to the rule have contributed to the liquidity of trading markets for foreign 

sovereign debt, the lack of an exemption for proprietary trading in foreign sovereign debt 

could result in certain negative impacts on the markets for such debt. In general, the 

Agencies believe these concerns should be mitigated somewhat by the refined 

 

1373 See, e.g., BoA; Citigroup; Goldman (Prop. Trading); IIB/EBF; Allen & Overy (Gov’t. Obligations); 

Australian Bankers Ass’n. (Feb. 2012).; Banco de México; Barclays. The Agencies recognize some 

commenters’ representation that restricting trading in foreign sovereign debt would not necessarily cause 

reduced liquidity in government bond markets because banking entities would still be able to make a 

market in and underwrite foreign government obligations. See Prof. Johnson; Better Markets (Feb. 2012).
408

exemptions for market making, underwriting and permitted trading activity of foreign 

banking entities; however, those exemptions do not address certain of the collateral, 

capital, and other operational issues identified by commenters.1374 Foreign sovereign 

debt of home and host countries generally serves these purposes. Due to the relationships 

among global financial markets, permitting trading that supports these essential functions 

promotes the financial stability and the safety and soundness of banking entities.1375 In 

contrast, a broad exemption for proprietary trading in all foreign sovereign debt without 

the limitations contained in the underwriting, market making and hedging exemptions 

could lead to more complicated risk profiles and significant unhedged risk exposures that 

section 13 of the BHC Act is designed to address. Thus, the Agencies believe use of 

 

1374 Representatives from foreign governments stated that an exemption allowing trading in obligations of 

their governments is necessary to maintain financial stability in their markets. See, e.g., Allen & Overy 

(Gov’t. Obligations); Bank of Canada; IRSG; IIB/EBF; Gov’t of Japan/Bank of Japan; Australian Bankers 

Ass’n. (Feb. 2012); Banco de México; Ass’n. of German Banks; ALFI. Commenters argued that 

exempting trading in foreign sovereign debt would avoid the possible negative impacts of a contraction of 

government bond market liquidity. See, e.g., BoA; Citigroup; Goldman (Feb. 2012); IIB/EBF. 

Additionally, commenters suggested that failing to provide an exemption for this activity would impact 

money market operations of foreign central banks and limit the ability of foreign sovereign governments to 

conduct monetary policy or finance their operations. See, e.g., Barclays; BoA; Gov’t of Japan/Bank of 

Japan; OSFI. A number of commenters also argued that, since U.S. and foreign banking entities often 

perform functions for foreign governments similar to those provided in the U.S. by U.S. primary dealers, 

the lack of an exemption would have a significant, negative impact on the ability of foreign governments to 

implement monetary policy and on liquidity in many foreign markets. See, e.g., Allen & Overy (Gov’t. 

Obligations); Australian Bankers Ass’n. (Feb. 2012); BoA; Banco de México; Barclays; Citigroup (Feb. 

2012); Goldman (Prop. Trading); IIB/EBF. Some commenters argued that banking entities and their 

customers use foreign sovereign debt to manage their risk by posting collateral in foreign jurisdictions and 

to manage international rate and foreign exchange risk. See Citigroup (Feb. 2012); SIFMA et al. (Prop. 

Trading) (Feb. 2012).

1375 The Agencies generally concur with commenters’ concerns that because the lack of an exemption 

could result in negative consequences – such as harming liquidity in foreign sovereign debt markets, 

making it more difficult and more costly for foreign governments to fund themselves, or subjecting banking 

entities to increased concentration risk – systemic risk could increase or there could be spillover effects that 

would harm global markets, including U.S. markets. See IIF; EBF; ICI Global; HSBC; Barclays; ICI (Feb. 

2012); IIB/EBF; Union Asset. Additionally, in consideration of one commenter’s statements, the Agencies 

believe that failing to provide this exemption may cause foreign banks to close their U.S. branches, which 

could harm U.S. markets. See Comm. on Capital Markets Regulation.
409

section 13(d)(1)(J) exemptive authority to permit proprietary trading in foreign 

government obligations in certain limited circumstances is appropriate.

The Agencies decline to follow commenters’ suggested alternative of allowing 

trading in foreign government obligations if the obligations meet a particular condition on 

quality, such as obligations of OECD member countries.1376 The Agencies do not believe 

such an approach responds to the statutory purpose of limiting risks posed to the U.S. 

financial system by proprietary trading activities as directly as our current approach, 

which is structured to limit the exposure of banking entities, including insured depository 

institutions, to the risks of foreign sovereign debt. Additionally, the Agencies decline to 

permit proprietary trading in any obligation permitted under the laws of the foreign 

banking entity’s home country,1377 because such an approach could result in unintended 

competitive impacts since banking entities would not be subject to one uniform standard 

inside the United States. Further, unlike some commenters, the Agencies do not believe 

it is appropriate to require foreign governments to commit to paying for any damage to 

the U.S. financial system resulting from the foreign sovereign debt exemption.1378

The proposal also did not contain an exemption for trading in derivatives on 

foreign government obligations. Many commenters who recommended providing an 

exemption for proprietary trading in foreign government obligations also requested that 

 

1376 See, e.g., BoA; Cadwalader (on behalf of Singapore Banks).; IIB/EBF; OSFI; UBS; BAROC; Japanese 

Bankers Ass’n.; JPMC.

1377 Some commenters suggested permitting non-U.S. banking entities to trade in any government 

obligation to the extent that such trading is permitted by the entity’s primary regulator. See Allen & Overy 

(Gov’t. Obligations); HSBC.

1378 See Better Markets (Feb. 2012); See also Prof. Johnson.
410

the exemption be extended to derivatives on foreign government obligations.1379 Two of 

these commenters urged that trading in derivatives on foreign sovereign obligations 

should be exempt for the same reason that trading in derivatives on U.S. government 

obligations is exempt because such trading supports liquidity and price stability in the 

market for the underlying government obligations.1380 One commenter recommended 

that the Agencies use the authority in section 13(d)(1)(J) to grant an exemption for 

proprietary trading in derivatives on foreign government obligations.1381 

The final rule has not been modified in § __.6(b) to permit a banking entity to 

engage in proprietary trading in derivatives on foreign government obligations. As noted 

above, the Agencies have determined not to permit proprietary trading in derivatives on 

U.S. exempt government obligations under section 13(d) and, for the same reasons, have 

determined not to extend the permitted activities to include proprietary trading in 

derivatives on foreign government obligations.

c. Permitted Trading in Municipal Securities

Section __.6(a) of the proposed rule implemented an exemption to the prohibition 

against proprietary trading under section 13(d)(1)(A) of the BHC Act, which permits 

trading in certain governmental obligations. This exemption permits the purchase or sale 

of obligations issued by any State or any political subdivision thereof (the “municipal 

securities trading exemption”). The proposed rule included both general obligation bonds 

 

1379 See Barclays; Credit Suisse (Seidel); IIB/EBF; Japanese Bankers Ass’n.; Norinchukin; RBC; 

Sumitomo Trust; UBS. 

1380 See Barclays; FIA.

1381 See Barclays.
411

and limited obligation bonds, such as revenue bonds, within the scope of this municipal 

securities trading exemption. The proposed rule, however, did not extend to obligations 

of “agencies” of States or political subdivisions thereof.1382

Many commenters, including industry participants, trade groups, and Federal and 

state governmental representatives, argued that the municipal securities trading 

exemption should be interpreted to permit banking entities to engage in proprietary 

trading in a broader range of municipal securities, including the following: obligations 

issued directly by States and political subdivisions thereof; obligations issued by 

agencies, constituted authorities, and similar governmental entities acting as 

instrumentalities on behalf of States and political subdivisions thereof; and obligations 

issued by such governmental entities that are treated as political subdivisions under 

various more expansive definitions of political subdivisions under Federal and state 

laws.1383 These commenters argued that States and municipalities often issue obligations 

through agencies and instrumentalities and that these obligations generally have the same 

level of risk as direct obligations of States and political subdivisions.1384 Commenters 

asserted that permitting trading in a broader group of municipal securities would be 

consistent with the terms and purposes of section 13 and would not adversely affect the 

 

1382 See Joint Proposal, 76 FR at 68,878 n.165. 

1383 See, e.g., ABA (Keating); Ashurst; Ass’n. of Institutional Investors (Feb. 2012); BoA; BDA (Feb. 

2012); Capital Group; Chamber (Feb. 2012); Citigroup (Jan. 2012); CHFA; Eaton Vance; Fidelity; Fixed 

Income Forum/Credit Roundtable; HSBC; MEFA; Nuveen Asset Mgmt.; Sens. Merkley & Levin (Feb. 

2012); Am. Pub. Power et al.; MSRB; Fidelity; State of New York; STANY; SIFMA (Municipal 

Securities) (Feb. 2012); State Street (Feb. 2012); North Carolina; T. Rowe Price; Sumitomo Trust; UBS; 

Washington State Treasurer; Wells Fargo (Prop. Trading).

1384 See, e.g., CHFA; Sens. Merkley & Levin (Feb. 2012); Am. Pub. Power et al.; North Carolina;

Washington State Treasurer; See also NABL; Ashurst; BDA (Feb. 2012); Chamber (Feb. 2012); Eaton 

Vance; Fidelity; MEFA; MSRB; Am. Pub. Power et al.; Nuveen Asset Mgmt.; PNC; SIFMA (Municipal 

Securities) (Feb. 2012); UBS.
412

safety and soundness of banking entities involved in these transactions or create 

additional risk to the financial stability of the United States.1385 

Commenters expressed concerns that the proposed rule would result in a 

bifurcation of the municipal securities market that would achieve no meaningful benefits 

to the safety and soundness of banking entities, create administrative burdens for 

determining whether or not a municipal security qualifies for the exemption, result in 

inconsistent applications across different States, increase costs, and decrease liquidity in 

the diverse municipal securities market.1386 Commenters also argued that the market for 

securities issued by agencies and instrumentalities of States and political subdivisions 

thereof would be especially disrupted, and would affect about 40 percent of the municipal 

securities market.1387

Commenters recommended that the final rule provide a broad exemption to the 

prohibition on proprietary trading for municipal securities, based on the definition of 

“municipal securities” used in section 3(a)(29) of the Exchange Act,1388 which is 

 

1385 See Ashurst; Citigroup (Jan. 2012); Eaton Vance; Am. Pub. Power et al.; SIFMA (Municipal 

Securities) (Feb. 2012); North Carolina; T. Rowe Price; Wells Fargo (Prop. Trading); See also Capital 

Group (arguing that municipal securities are not generally used as a profit making strategy and thus, 

including all municipal securities in the exemption by itself should not adversely affect the safety and 

soundness of banking entities); PNC (arguing that the safe and sound nature of trading in State and 

municipal agency obligations was “a fact recognized by Congress in 1999 when it authorized well 

capitalized national banks to underwrite and deal in, without limit, general obligation, limited obligation 

and revenue bonds issued by or on behalf of any State, or any public agency or authority of any State or 

political subdivision of a State”); Sens. Merkley & Levin (Feb. 2012).

1386 See, e.g., MSRB; City of New York; Am. Pub. Power et al.; Wells Fargo; State of New York; 

Washington State Treasurer; ABA (Keating); Capital Group; North Carolina; Eaton Vance; Port Authority; 

Connecticut; Citigroup (Jan. 2012); Ashurst; Nuveen Asset Mgmt.; SIFMA (Municipal Securities) (Feb. 

2012). 

1387 See, e.g., MSRB (stating that, based on data from Thomson Reuters, 41.4 percent of the municipal 

securities issued in FY 2011 were issued by agencies and authorities).

1388 See 15 U.S.C. 78c(a)(29).
413

understood by market participants and by Congress, and has a well-settled meaning and 

an established body of law. 1389 Other commenters contended that adopting the same 

definition of municipal securities as used in the Federal securities laws would reduce 

regulatory burden, remove uncertainty, and lead to consistent treatment of these securities 

under the banking and securities laws.1390 According to some commenters, the terms 

“agency” and “political subdivision” are used differently under some State laws, and 

some State laws identify certain agencies as political subdivisions or define political 

subdivision to include agencies.1391 Commenters also noted that a number of Federal 

statutes and regulations define the term “political subdivision” to include municipal 

agencies and instrumentalities.1392 Commenters suggested that the Agencies interpret the

term “political subdivision” in section 13 more broadly than in the proposal to include a 

wider range of State and municipal governmental obligations issued by agencies and 

instrumentalities or, alternatively, that the Agencies use the exemptive authority in 

 

1389 See ABA (Keating); Ashurst; BoA; Capital Group; Chamber (Feb. 2012); Comm. on Capital Markets 

Regulation; Citigroup (Jan. 2012); Eaton Vance; Fidelity; MEFA; MTA-NY; MSRB; Am. Pub. Power et 

al.; NABL; NCSL; State of New York; Nuveen Asset Mgmt.; Port Authority; PNC; SIFMA (Municipal 

Securities) (Feb. 2012); North Carolina; T. Rowe Price; UBS; Washington State Treasurer; Wells Fargo 

(Prop. Trading). 

1390 See Ashurst; Citigroup (Jan. 2012) (noting that the National Bank Act explicitly lists State agencies 

and authorities as examples of political subdivisions); MSRB.

1391 See, e.g., Citigroup (Jan. 2012).

1392 See, e.g., MSRB; Citigroup (Jan. 2012). In addition to the Federal securities laws, the National Bank 

Act explicitly includes agencies and authorities as examples of political subdivisions. See 12 U.S.C. 

24(seventh) (permitting investments in securities “issued by or on behalf of any State or political 

subdivision of a State, including any municipal corporate instrumentality of 1 or more States, or any public 

agency or authority of any State or political subdivision of a State . . . .”). In addition, a number of banking 

regulations also include agencies as examples of political subdivisions or define political subdivision to 

include municipal agencies, authorities, districts, municipal corporations and similar entities. See, e.g., 12 

CFR 1.2; 12 CFR 160.30; 12 CFR 161.38; 12 CFR 330.15. Further, for purposes of the tax-exempt bond 

provisions in the Internal Revenue Code, Treasury regulations treat obligations issued by or “on behalf of” 

States or political subdivisions by “constituted authorities” as obligations of such States or political 

subdivisions, and the Treasury regulations define the term “political subdivision” to mean “any division of 

any State or local governmental unit which is a municipal corporation or which has been delegated the right 

to exercise part of the sovereign power of the unit. . . .” See 26 CFR 1.103-1(b). 
414

section 13(d)(1)(J) if necessary to permit proprietary trading of a broader array of State 

and municipal obligations.1393 

On the other hand, one commenter contended that bonds issued by agencies and 

instrumentalities of States or municipalities pose risks to the banking system because the 

commenter believed the market for these bonds has not been properly regulated or 

controlled.1394 A few commenters also recommended tightening the proposed municipal 

securities trading exemption to exclude conduit obligations that benefit private businesses 

and private organizations.1395 One commenter suggested that the proposed municipal 

securities trading exemption should not apply to tax-exempt municipal bonds that benefit 

private businesses (referred to as “private activity bonds” in the Internal Revenue 

Code1396) and that allow private businesses to finance private projects at lower interest 

rates as a result of the exemption from Federal income taxation for the interest received 

by investors.1397

 

1393 See ABA (Keating); Ashurst; Ass’n. of Institutional Investors (Feb. 2012); Citigroup (Jan. 2012); 

Comm. on Capital Markets Regulation; Sens. Merkley & Levin (Feb. 2012); MSRB; Wells Fargo (Prop. 

Trading); SIFMA et al. (Prop. Trading) (Feb. 2012).

1394 See Occupy.

1395 See AFR et al. (Feb. 2012); Occupy.

1396 See 26 U.S.C. 141. In general, the rules applicable to the issuance of tax-exempt private activity bonds 

under the Internal Revenue Code of 1986, as amended (the “Code”) are more restrictive than those 

applicable to traditional governmental bonds issued by States or political subdivisions thereof. Section 146 

of the Code imposes an annual State bond volume cap on most tax-exempt private activity bonds that is 

tied to measures of State populations. Sections 141-150 of the Code impose other additional restrictions on 

tax-exempt private activity bonds, including, among others, eligible project and use restrictions, bond 

maturity restrictions, land and existing property financing restrictions, an advance refunding prohibition, 

and a public approval requirement.

1397 See AFR et al. (Feb. 2012). 
415

The final rule includes the statutory exemption for proprietary trading of 

obligations of any State or political subdivision thereof.1398 In response to the public 

comments and for the reasons discussed below, this exemption uses the definition of the 

term “municipal security” modeled after the definition of “municipal securities” under 

section 3(a)(29) of the Exchange Act,1399 but with simplifications.1400 The final rule 

defines the term “municipal security” to mean “a security which is a direct obligation of 

or issued by, or an obligation guaranteed as to principal or interest by, a State or any 

political subdivision thereof, or any agency or instrumentality of a State or any political 

subdivision thereof, or any municipal corporate instrumentality of one or more States or 

political subdivisions thereof.”

 

1398 See final rule § __.6(a)(3).

1399 Many commenters requested that the final rule use the definition of “municipal securities” used in the 

federal securities laws because, among other reasons, the industry is familiar with that definition and such 

an approach would promote consistent treatment of these securities under banking and securities laws. See, 

e.g., ABA (Keating); Ashurst; BoA; Comm. on Capital Markets Regulation; Citigroup (Jan. 2012); NCSL; 

Port Authority; SIFMA (Municipal Securities) (Feb. 2012); MSRB. Section 3(a)(29) of the Exchange Act 

defines the term “municipal securities” to mean “securities which are direct obligations of, or obligations 

guaranteed as to principal or interest by, a State or any political subdivision thereof, or any agency or 

instrumentality of a State or any political subdivision thereof, or any municipal corporate instrumentality of 

one or more States, or any security which is an industrial development bond (as defined in section 

103(c)(2) of Title 26) the interest on which is excludable from gross income under section 103(a)(1) of 

Title 26 if, by reason of the application of paragraph (4) or (6) of section 103(c) of Title 26 (determined as 

if paragraphs (4)(A), (5), and (7) were not included in such section 103(c)), paragraph (1) of such section 

103(c) does not apply to such security.” See 15 U.S.C. 78c(a)(29). 

1400 The definition of municipal securities in section 3(a)(29) of the Exchange Act has outdated tax 

references to the prior law under the former Internal Revenue Code of 1954, including particularly 

references to certain provisions involving the concept of “industrial development bonds.” The successor 

current Internal Revenue Code of 1986, as amended, replaces the prior definition of “industrial 

development bonds” with a revised, more restrictive successor definition of “private activity bonds” and 

related definitions of “exempt facility bonds” and “small issue bonds.” In recognition of the numerous tax 

law changes since the last statutory revision of section 3(a)(29) of the Exchange Act in 1970 and the 

potential attendant confusion, the Agencies determined to use a simpler, streamlined, independent 

definition of municipal securities for purposes of the municipal securities trading exception. This revised 

definition is intended to encompass, among others, any securities that are covered by the definition of the 

term “municipal securities” under section 3(a)(29) of the Exchange Act.
416

The final rule modifies the proposal to permit proprietary trading in obligations 

issued by agencies and instrumentalities acting on behalf of States and municipalities 

(e.g., port authority bonds and bonds issued by municipal agencies or corporations).1401 

As noted by commenters, many States and municipalities rely on securities issued by 

agencies and instrumentalities to fund essential activities, including utility systems, 

infrastructure projects, affordable housing, hospitals, universities, and other nonprofit 

institutions.1402 Both obligations issued directly by States and political subdivisions 

thereof and obligations issued by an agency or instrumentality of such a State or local 

governmental entity are ultimately obligations of the State or local governmental entity 

on whose behalf they act. Moreover, exempting obligations issued by State and 

municipal agencies and instrumentalities in the same manner as the direct obligations of 

States and municipalities lessens potential inconsistent treatment of government 

obligations across States and municipalities that use different funding methods for 

government projects.1403

 

1401 Many commenters requested that the municipal securities trading exemption be interpreted to include a

broader range of State and municipal obligations issued by agencies and instrumentalities. See, e.g., ABA 

(Keating); Ashurst; BoA; BDA (Feb. 2012); Fixed Income Forum/Credit Roundtable; Sens. Merkley & 

Levin (Feb. 2012); SIFMA (Municipal Securities) (Feb. 2012); Citigroup (Jan. 2012); Comm. on Capital 

Markets Regulation. 

1402 See, e.g., Citigroup (Jan. 2012); Ashurst; SIFMA et al. (Prop. Trading) (Feb. 2012); SIFMA 

(Municipal Securities) (Feb. 2012); Chamber (Dec. 2011); BlackRock; Fixed Income Forum/Credit 

Roundtable.

1403 Commenters represented that the proposed rule would result in inconsistent applications of the 

exemption across States and political subdivisions. The Agencies also recognize, as noted by commenters, 

that the proposed rule would likely have resulted in a bifurcation of the municipal securities market and 

associated administrative burdens and disruptions. See, e.g., MSRB; Am. Pub. Power et al.; Port 

Authority; Citigroup (Jan. 2012); SIFMA et al. (Prop. Trading) (Feb. 2012); SIFMA (Municipal Securities) 

(Feb. 2012).
417

The Agencies believe that interpreting the language of section 13(d)(1)(A) of the 

BHC Act to provide an exemption to the prohibition on proprietary trading for 

obligations issued by States and municipal agencies and instrumentalities as described 

above is consistent with the terms and purposes of section 13 of the BHC Act.1404 The 

Agencies recognize that state and political subdivision agency obligations generally 

present the same level of risk as direct obligations of States and political subdivisions.1405 

Moreover, the Agencies recognize that other federal laws and regulations define the term 

“political subdivision” to include municipal agencies and instrumentalities.1406 The 

Agencies decline to exclude from this exemption conduit obligations that benefit private 

entities, as suggested by some commenters.1407

The proposal did not exempt proprietary trading of derivatives on obligations of 

States and political subdivisions. The proposal solicited comment on whether exempting 

proprietary trading in options or other derivatives referencing an obligation of a State or 

 

1404 Commenters asserted that permitting trading in a broader group of municipal securities would be 

consistent with the terms and purposes of section 13. See, e.g., Ashurst; Citigroup (Jan. 2012); Eaton 

Vance; Am. Pub. Power et al.; SIFMA (Municipal Securities) (Feb. 2012).

1405 Commenters argued that obligations issued by agencies and instrumentalities generally have the same 

level of risk as direct obligations of States and political subdivisions. See, e.g., CHFA; Sens. Merkley &

Levin (Feb. 2012); Am. Pub. Power et al.; North Carolina. In response to one commenter’s concern that 

the markets for bonds issued by agencies and instrumentalities are not properly regulated, the Agencies 

note that all types of municipal securities, as defined under the securities laws to include, among others, 

State direct obligation bonds and agency or instrumentality bonds, are generally subject to the same 

regulations under the securities laws. Thus, the Agencies do not believe that obligations of agencies and 

instrumentalities are subject to less effective regulation than obligations of States and political subdivisions. 

See Occupy.

1406 Commenters noted that a number of federal statutes and regulations define “political subdivision” to 

include municipal agencies and instrumentalities. See, e.g., MSRB; Citigroup (Jan. 2012).

1407 See AFR et al. (Feb. 2012); Occupy. The Agencies do not believe it is appropriate to exclude conduit 

obligations, which are tax-exempt municipal bonds, from this exemption because such obligations are used 

to finance important projects related to, for example, multi-family housing, healthcare (hospitals and 

nursing homes), colleges and universities, power and energy companies and resource recovery facilities. 

See U.S. Securities & Exchange Comm’n., Report on the Municipal Securities Market 7 (2012), available 

at http://www.sec.gov/news/studies/2012/munireport073112.pdf.
418

political subdivision thereof was consistent with the terms and purpose of the statute.1408 

The Agencies did not receive persuasive information on this topic and, for the same 

reasons discussed above related to derivatives on U.S. government securities, the 

Agencies have determined not to provide an exemption for proprietary trading in 

municipal securities, beyond the underwriting, market-making, hedging and other 

exemptions provided generally in the rule. The Agencies note that banking entities may 

trade derivatives on municipal securities under any other available exemption to the 

prohibition on proprietary trading, providing the requirements of the relevant exemption 

are met. 

d. Determination to Not Exempt Proprietary Trading in Multilateral Development Bank 

Obligations

The proposal did not exempt proprietary trading in obligations of multilateral 

banks or derivatives on multilateral development bank obligations but requested 

comment on this issue.1409 A number of commenters argued that the final rule should 

include an exemption for obligations of multilateral development banks.1410 

 

1408 See Joint Proposal, 76 FR at 68,878.

1409 See id.

1410 Commenters argued that including obligations of multilateral developments banks in a foreign 

sovereign debt exemption is necessary to avoid endangering international cooperation in financial 

regulation and potential retaliatory prohibitions against U.S. government obligations. See Ass’n. of 

German Banks; Sumitomo; SIFMA et al. (Prop. Trading) (Feb. 2012). Additionally, some commenters 

represented that an exemption for obligations of international and multilateral development banks is 

appropriate for many of the same reasons provided for exempting U.S. government obligations and foreign 

sovereign debt generally. See Ass’n. of German Banks; Barclays; Goldman (Prop. Trading); IIB/EBF; 

ICFR; ICI Global; FIA; Sumitomo Trust; Allen & Overy (Gov’t. Obligations); SIFMA et al. (Prop. 

Trading) (Feb. 2012). 
419

The Agencies have not included an exemption to permit banking entities to 

engage in proprietary trading in obligations of multilateral development banks at this 

time. The Agencies do not believe that providing an exemption for trading obligations of 

multilateral development banks will help enhance the markets for these obligations and 

therefore promote and protect the safety and soundness of banking entities and U.S. 

financial stability. 

6. Section __.6(c): Permitted Trading on Behalf of Customers

Section 13(d)(1)(D) of the BHC Act provides an exemption from the prohibition 

on proprietary trading for the purchase, sale, acquisition, or disposition of financial 

instruments on behalf of customers.1411 The statute does not define when a transaction or 

activity is conducted “on behalf of customers.” 

a. Proposed Exemption for Trading on Behalf of Customers

Section __.6(b) of the proposed rule implemented the exemption for trading on 

behalf of customers by exempting three types of trading activity. Section __.6(b)(i) of

the proposed rule provided that a purchase or sale of a financial instrument occurred on 

behalf of customers if the transaction (i) was conducted by a banking entity acting as 

investment adviser, commodity trading advisor, trustee, or in a similar fiduciary capacity 

for the account of that customer, and (ii) involved solely financial instruments for which 

the banking entity’s customer, and not the banking entity or any affiliate of the banking 

entity, was the beneficial owner. This exemption was intended to permit trading activity 

that a banking entity conducts in the context of providing investment advisory, trust, or 

 

1411 12 U.S.C. 1851(d)(1)(D). 
420

fiduciary services to customers provided that the banking entity structures the activity so 

that the customer, and not the banking entity, benefits from any gains and suffers any 

losses on the traded positions. 

Section __.6(b)(ii) of the proposed rule exempted the purchase or sale of a 

covered financial position if the banking entity was acting as riskless principal.1412 Under 

the proposed rule, a banking entity qualified as a riskless principal if the banking entity, 

after having received an order to purchase or sell a covered financial position from a 

customer, purchased or sold the covered financial position for its own account to offset a 

contemporaneous sale to or purchase from the customer.1413

Section __.6(b)(iii) of the proposed rule permitted trading by a banking entity that 

was an insurance company for the separate account of insurance policyholders. Under 

the proposed rule, only a banking entity that is an insurance company directly engaged in 

the business of insurance and subject to regulation by a State insurance regulator or 

foreign insurance regulator was eligible for this prong of the exemption for trading on 

behalf of customers. Additionally, the purchase or sale of the covered financial position 

was exempt only if it was solely for a separate account established by the insurance 

company in connection with one or more insurance policies issued by that insurance 

company under which all profits and losses arising from the purchase or sale of the 

financial instrument were allocated to the separate account and inured to the benefit or 

detriment of the owners of the insurance policies supported by the separate account, and 

 

1412 See Joint Proposal, 76 FR at 68,879.

1413 This language generally mirrors that used in the Board’s Regulation Y, OCC interpretive letters, and 

the SEC’s Rule 3a5-1 under the Exchange Act. See 12 CFR 225.28(b)(7)(ii); 17 CFR 240.3a5-1(b); OCC 

Interpretive Letter 626 (July 7, 1993).
421

not the banking entity. These types of transactions are customer-driven and do not 

expose the banking entity to gains or losses on the value of separate account assets even 

though the banking entity is treated as the owner of those assets for certain purposes.

b. Comments on the Proposed Rule

Several commenters contended that the Agencies construed the statutory 

exemption too narrowly by limiting permissible proprietary trading on behalf of 

customers to only three categories of transactions.1414 Some of these commenters argued 

the exemption in the proposal was not consistent with the statutory language or 

Congressional intent to permit all transactions that are “on behalf of customers.”1415 One 

of these commenters expressed concern that the proposed exemption for trading on behalf 

of customers may be construed to permit only customer-driven transactions involving 

securities and not other financial instruments such as foreign exchange forwards and 

other derivatives.1416

Several commenters urged the Agencies to expand the exemption for trading on 

behalf of customers to permit other categories of customer-driven transactions in which 

the banking entity may be acting as principal but that serve legitimate customer needs 

including capital formation. For example, one commenter urged the Agencies to permit 

customer-driven transactions in which the banking entity has no ready counterparty but 

that are undertaken at the instruction or request of a customer or client or in anticipation 

 

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

Wells Fargo (Prop. Trading).

1415 See, e.g., Am. Express; SIMFA et al. (Prop. Trading) (Feb. 2012).

1416 See Am. Express. 
422

of such an instruction or request, such as facilitating customer liquidity needs or block 

positioning transactions.1417 Other commenters urged the Agencies to exempt 

transactions where the banking entity acts as principal to accommodate a customer and 

substantially and promptly hedges the risks of the transaction.1418 Commenters argued 

that these kinds of transactions are similar in purpose and level of risk to riskless 

principal transactions.1419 Commenters also argued that these transactions could be 

viewed as market-making related activities, but indicated that the potential uncertainty 

and costs of making that determination would discourage banking entities from taking 

principal risks to accommodate customer needs.1420 Commenters also requested that the 

Agencies expressly permit transactions on behalf of customers to create structured 

products, as well as for client funding needs, customer clearing, and prime brokerage, if 

these transactions are included within the trading account.1421

In contrast, some commenters supported the proposed approach for implementing 

the exemption for trading on behalf of customers or urged narrowing the exemption.1422 

One commenter expressed general support for the requirement that all profits (or losses) 

from the transaction flow to the customer and not the banking entity providing the service 

for a transaction to be exempt.1423 One commenter contended that the statute did not 

 

1417 See RBC. The Agencies note that acting as a block positioner is expressly contemplated and included 

as part of the exemption for market making-related activities under the final rule.

1418 See BoA; SIMFA et al. (Prop. Trading) (Feb. 2012). 

1419 See SIMFA et al. (Prop. Trading) (Feb. 2012). 

1420 See SIMFA et al. (Prop. Trading) (Feb. 2012).

1421 See SIMFA et al. (Prop. Trading) (Feb. 2012).

1422 See, e.g., Alfred Brock; ICBA; Occupy.

1423 See ICBA.
423

permit transactions on behalf of customers to be performed by an investment adviser.1424 

Another commenter argued that the final rule should permit a banking entity to engage in 

a riskless principal transaction only where the banking entity has already arranged for 

another customer to be on the other side of the transaction.1425 Other commenters urged 

the Agencies to ensure that both parties to the transaction agree beforehand to the time 

and price of any relevant trade to ensure that the banking entity solely stands in the 

middle of the transaction and in fact passes on all gains (or losses) from the transaction to 

the customers.1426 Commenters also urged the Agencies to define other key terms used in 

the exemption. For instance, some commenters requested that the final rule define which 

entities may qualify as a “customer” for purposes of the exemption.1427

Some commenters urged the Agencies to provide uniform guidance on how the 

Agencies will interpret the riskless principal exemption.1428 One commenter urged the 

Agencies to clarify how the riskless principal exemption would be implemented with 

respect to transactions in derivatives, including a hedged derivative transaction executed 

at the request of a customer.1429

 

1424 See Occupy.

1425 See Public Citizen. 

1426 See Occupy; Alfred Brock.

1427 See Occupy; Public Citizen. Conversely, other commenters supported the approach taken in the 

proposed rule without requesting such a definition. See Alfred Brock.

1428 See, e.g., Am. Express; SIMFA et al. (Prop. Trading) (Feb. 2012). 

1429 See Am. Express. 
424

Several commenters generally expressed support for the exemption for trading for 

the separate account of insurance policyholders under the proposed rule.1430 One 

commenter requested that the final rule more clearly articulate who may qualify as a 

permissible owner of an insurance policy to whom the profits and losses arising from the 

purchase or sale of a financial instrument allocated to the separate account may inure.1431 

Several commenters argued that certain types of separate account activities, 

including the allocation of seed money by an insurance company to a separate account or 

the offering of certain non-variable separate account contracts by the insurance company, 

would not appear to be permitted under the proposal.1432 Commenters also expressed 

concern that these separate account activities might not satisfy the proposed requirement 

that all profits and losses arising from the purchase or sale of the financial position inure 

to the benefit or detriment of the owners of the insurance policies supported by the 

separate account, and not the insurance company.1433 In addition, commenters argued 

that under the proposed rule, these activities would appear to fall outside of the 

exemption for activities in the general account of an insurance company because the 

proposed rule defined a general account as excluding a separate account.1434 

Commenters urged the Agencies to more closely align the exemptions for trading by an 

 

1430 See ACLI; Chris Barnard; NAMIC; Fin. Services Roundtable (Feb. 3, 2012).

1431 See Chris Barnard.

1432 See ACLI; Sutherland (on behalf of Comm. of Annuity Insurers); Fin. Services Roundtable (Feb. 3, 

2012); NAMIC.

1433 See ACLI; Sutherland (on behalf of Comm. of Annuity Insurers); Fin. Services Roundtable (Feb. 3, 

2012); NAMIC.

1434 See ACLI; Sutherland (on behalf of Comm. of Annuity Insurers); Fin. Services Roundtable (Feb. 3, 

2012); NAMIC.
425

insurance company for the general account and separate account.1435 According to these 

commenters, this change would permit insurance companies to continue to engage in the 

business of insurance by offering the full suite of insurance products to their 

customers.1436

c. Final Exemption for Trading on Behalf of Customers

The Agencies have carefully considered the comments and are adopting the 

exemption for trading on behalf of customers with several modifications. The Agencies 

believe that the final rule implements the exemption in section 13(d)(1)(D) in a manner 

consistent with the legislative intent to allow banking entities to use their own funds to 

purchase or sell financial instruments when acting on behalf of their customers.1437 At 

the same time, the limited activities permitted under the final rule limit the potential for 

abuse.1438

The final rule slightly modifies the proposed rule by providing that a banking 

entity is not prohibited from trading on behalf of customers when that activity is 

conducted by the banking entity as trustee or in a similar fiduciary capacity for a 

customer and so long as the transaction is conducted for the account of, or on behalf of 

 

1435 See ACLI; Sutherland (on behalf of Comm. of Annuity Insurers); Fin. Services Roundtable (Feb. 3, 

2012); NAMIC.

1436 See ACLI; Sutherland (on behalf of Comm. of Annuity Insurers); Fin. Services Roundtable (Feb. 3, 

2012); NAMIC.

1437 See 156 Cong. Rec. S5896 (daily ed. July 15, 2010) (statement of Sen. Merkley) (arguing that “this 

permitted activity is intended to allow financial firms to use firm funds to purchase assets on behalf of their 

clients, rather than on behalf of themselves.”). 

1438 Some commenters urged narrowing the exemption. See, e.g., Alfred Brock; ICBA; Occupy. The 

Agencies believe the final rule is appropriately narrow to limit potential abuse.
426

the customer and the banking entity does not have or retain a beneficial ownership of the 

financial instruments. The final rule removes the proposal’s express exemption for 

investment advisers. After further consideration, the Agencies do not believe an express 

reference to investment advisers is necessary because investment advisers generally act in 

a fiduciary capacity on behalf of clients in a manner that is separately covered by other 

exclusions and exemptions in the final rule. Additionally, the final rule deletes the 

proposal’s express exemption for commodity trading advisors because the legal 

relationship between a commodity trading advisor and its client depends on the facts and 

circumstances of each relationship. Therefore, the Agencies determined that it was 

appropriate to limit the discussion to fiduciary obligations generally and to omit any 

specific discussion of commodity trading advisors. In order to ensure that a banking 

entity utilizes this exemption to engage only in transactions for customers and not to 

conduct its own trading activity, the final rule (consistent with the proposed rule) requires 

that the purchase or sale of financial instruments be conducted for the account of the 

customer and that it involve solely financial instruments of which the customer, and not 

the banking entity, is beneficial owner.1439 The final rule, like the proposed rule, permits 

transactions in any financial instrument, including derivatives such as foreign exchange 

forwards, so long as those transactions are on behalf of customers.1440

 

1439 See final rule § __.6(c)(1)(ii) – (iii). See also proposed rule § __.6(b)(2)(i)(B) – (C).

1440 Some commenters expressed concern that the proposed exemption for trading on behalf of customers 

may be construed to not permit transactions in foreign exchange forwards and other derivatives. See Am.

Express; SIFMA et al. (Prop. Trading) (Feb. 2012). 
427

While some commenters requested that the final rule define “customer” for 

purposes of this exemption,1441 the Agencies believe the requirements of this exemption 

address commenters’ underlying concerns about what constitutes a “customer.” 

Specifically, the Agencies believe that requiring a transaction relying on this exemption 

to be conducted in a fiduciary capacity for a customer, to be conducted for the account of 

the customer, and to involve solely financial instruments of which the customer is 

beneficial owner address the underlying concerns that a transaction could qualify for this 

exemption if done on behalf of an indirect customer or on behalf of a customer not served 

by the banking entity.

The final rule also provides that a banking entity may act as riskless principal in a 

transaction in which the banking entity, after receiving an order to purchase (or sell) a 

financial instrument from a customer, purchases (or sells) the financial instrument for its 

own account to offset the contemporaneous sale of the financial instrument to (purchase 

from) the customer.1442 Any transaction conducted pursuant to the exemption for riskless 

principal activity must be customer-driven and may not expose the banking entity to 

gains (or losses) on the value of the traded instruments as principal.1443 Importantly, the 

final rule does not permit a banking entity to purchase (or sell) a financial instrument 

without first having a customer order to buy (sell) the instrument. While some 

commenters requested that the Agencies modify the final rule to permit activity without a 

 

1441 See Occupy; Public Citizen.

1442 See final rule § __.6(c)(2).

1443 Some commenters urged the Agencies to ensure that the banking entity passes on all gains (or losses) 

from the transaction to the customers. See Occupy; Public Citizen.
428

customer order,1444 the Agencies are concerned that broadening the exemption in this 

manner would enable banking entities to evade the requirements of section 13 and engage 

in prohibited proprietary trading under the guise of trading on behalf of customers.

Several commenters requested that the final rule explain how a banking entity 

may determine when it is acting as riskless principal.1445 The Agencies note that riskless 

principal transactions typically are undertaken as an alternative method of executing 

orders by customers to buy or sell financial instruments on an agency basis. Acting as 

riskless principal does not include acting as underwriter or market maker in the particular 

financial instrument and is generally understood to be equivalent to agency or brokerage 

transactions in which all of the risks associated with ownership of financial instruments 

are borne by customers. The Agencies have generally equivalent standards for 

determining when a banking entity acts as riskless principal and require that the banking 

entity, after receiving an order to buy (or sell) a financial instrument from a customer, 

buys (or sells) the instrument for its own account to offset a contemporaneous sale to (or 

purchase from) the customer.1446 The Agencies intend to determine whether a banking 

entity acts as riskless principal in accordance with and subject to the requirements of 

these standards.

Some commenters requested that the final rule permit a greater variety of 

transactions to be conducted on behalf of customers. Many of these transactions, such as 

 

1444 See RBC; SIFMA et al. (Prop. Trading) (Feb. 2012). .

1445 See, e.g., Am. Express; SIFMA et al. (Prop. Trading) (Feb. 2012). .

1446 See, e.g., 12 CFR 225.28(b)(7)(ii); 17 CFR 240.3a5-1(b); OCC Interpretive Letter 626 (July 7, 1993). 

One commenter stated that a banking entity should only be allowed to engage in a riskless principal 

transaction where the banking entity has already arranged for another customer to be on the other side of 

the transaction. See Public Citizen. The Agencies believe that the contemporaneous requirement in the 

final rule addresses this comment.
429

transactions that facilitate customer liquidity needs or block positioning transactions1447

or transactions in which the banking entity acts as principal to accommodate a customer 

and substantially and promptly hedges the risks of the transaction,1448 may be permissible 

under the market-making exemption. To the extent these transactions are conducted by a 

market maker, the Agencies believe that the restrictions and limits required in connection 

with market making-related activities are important for limiting the risks to the banking 

entity from these transactions.1449 While some commenters requested that clearing and 

settlement activities and prime brokerage activities be viewed as permitted proprietary 

trading on behalf of customers,1450 these transactions are not considered proprietary 

trading as an initial matter under the final rule.1451

Finally, the Agencies have decided to move the exemption for trading activity 

conducted by an insurance company for a separate account into the provision exempting 

trading activity in an insurance company’s general account in order to better align the two 

exemptions.1452 As discussed below in Part IV.A.7., the final rule provides exemptions 

 

1447 One commenter requested an exemption for transactions at the instruction or request of a customer or 

client or in anticipation of such an instruction or request, such as facilitating customer liquidity needs or 

block positioning transactions. See RBC.

1448 Some commenters requested an exemption for these types of transactions. See BoA; SIFMA et al.

(Prop. Trading) (Feb. 2012).

1449 Some commenters stated that the potential uncertainty and costs of determining whether an activity 

qualifies for the market-making exemption would discourage banking entities from taking principal risks to 

accommodate customer needs. See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012). The Agencies believe 

that adjustments made to the market-making exemption in the final rule help address this concern. 

Specifically, the final market-making exemption better accounts for the varying characteristics of marketmaking across markets and assets classes.

1450 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012).

1451 See final rule § __.3(d)(4)-(6). See also infra Part IV.A.1.d.3-4.

1452 Some commenters requested that the Agencies more closely align the exemptions for trading by an 

insurance company for the general account and separate account. See ACLI; Sutherland (on behalf of 

Comm. of Annuity Insurers); Fin. Services Roundtable (Feb. 3, 2012); NAMIC.
430

for trading activity conducted by an insurance company that is a banking entity either in 

the general account or in a separate account of customers in § __.6(d). As explained 

below, the statute specifically exempts trading activity that is conducted by a regulated 

insurance company engaged in the business of insurance for the general account of the 

company if conducted in accordance with applicable state law and if not prohibited by the 

appropriate Federal banking agencies.1453 Unlike activity for the general account of an 

insurance company, investments made by regulated insurance companies in separate 

accounts in accordance with applicable state law are made on behalf of and for the 

benefit of customers of the insurance company.1454 Also unlike general accounts (which 

are supported by all of the assets of the insurance company), a separate account is 

supported only by the assets in that account and does not have call on the other assets of 

the company. The customer benefits (or loses) based solely on the performance of the 

assets in the separate account. These arrangements are the equivalent for insurance 

companies of fiduciary accounts at banks. For these reasons, the final rule recognizes 

that separate accounts at regulated insurance companies maintained in accordance with 

 

1453 See 12 U.S.C. 1851(d)(1)(F).

1454 One commenter requested clarification on who may qualify as a permissible owner of an insurance 

policy to whom the profits and losses arising from the purchase or sale of a financial instrument allocated 

to the separate account may inure. See Chris Barnard. The Agencies note that the proposed requirement 

that all profits and losses arising from the purchase or sale of a financial instrument inure to the benefit or 

detriment of the “owners of the insurance policies supported by the separate account” has been removed. 

See proposed rule § __.6(b)(2)(iii)(C). Instead, the final rule requires that the income, gains, and losses 

from assets allocated to a separate account be credited to or charged against the account without regard to 

other income, gains or losses of the insurance company. See final rule § __.2(z) (definition of “separate 

account”). Thus, the final rule no longer references “owners of the insurance policies supported by the 

separate account.” The Agencies note, however, that the final rule requires exempted separate account 

transactions to be “conducted in compliance with, and subject to, the insurance company investment laws, 

regulations, and written guidance of the State or jurisdiction in which such insurance company is 

domiciled.” See final rule § __.6(d)(3).
431

applicable state insurance laws are exempt from the prohibitions in section 13 as 

acquisitions on behalf of customers.

7. Section __.6(d): Permitted Trading by a Regulated Insurance Company

Section 13(d)(1)(F) permits a banking entity that is a regulated insurance 

company acting for its general account, or an affiliate of an insurance company acting for 

the insurance company’s general account, to purchase or sell a financial instrument 

subject to certain conditions (the “general account exemption”).1455 Section 13(d)(1)(D) 

permits a banking entity to purchase or sell a financial instrument on behalf of customers.

1456 In the proposed rule, the Agencies viewed Section 13(d)(1)(D) as permitting an 

insurance company to purchase or sell a financial instrument for certain separate accounts 

(the “separate account exemption”). The proposal implemented both these exemptions 

with respect to activities of insurance companies, in each case subject to the restrictions 

discussed below.1457

Section __.6(c) of the proposed rule implemented the general account exemption 

by generally restating the statutory requirements of the exemption that:

• The insurance company directly engage in the business of insurance and 

be subject to regulation by a State insurance regulator or foreign insurance regulator;

 

1455 See 12 U.S.C. 1851(d)(1)(F).

1456 See 12 U.S.C. 1851(d)(1)(D).

1457 See proposed rule §§ __.6(b)(2)(iii), __.6(c). 
432

• The insurance company or its affiliate purchase or sell the financial 

instrument solely for the general account of the insurance company; 

• The purchase or sale be conducted in compliance with, and subject to, the 

insurance company investment laws, regulations, and written guidance of the State or 

jurisdiction in which such insurance company is domiciled; and 

• The appropriate Federal banking agencies, after consultation with the 

Council and the relevant insurance commissioners of the States, must not have jointly 

determined, after notice and comment, that a particular law, regulation, or written 

guidance described above is insufficient to protect the safety and soundness of the 

banking entity or of the financial stability of the United States.

The proposed rule defined the term “general account” to include all of the assets 

of the insurance company that are not legally segregated and allocated to separate 

accounts under applicable State law.

1458

As noted above in Part IV.A.6.a., §__.6(b)(iii) of the proposed rule provided an 

exemption for a banking entity that is an insurance company when it acted through a 

separate account for the benefit of insurance policyholders. The proposed rule defined a 

“separate account” as an account established or maintained by a regulated insurance 

company subject to regulation by a State insurance regulator or foreign insurance 

regulator under which income, gains, and losses, whether or not realized, from assets 

allocated to such account, are, in accordance with the applicable contract, credited to or 

 

1458 See proposed rule § __.3(c)(6).
433

charged against such account without regard to other income, gains, or losses of the 

insurance company.1459

To limit the potential for abuse of the separate account exemption, the proposed 

rule included requirements designed to ensure that the separate account trading activity is 

subject to appropriate regulation and supervision under insurance laws and not structured 

so as to allow gains or losses from trading activity to inure to the benefit or detriment of 

the banking entity.1460 In particular, the proposed rule provided that a purchase or sale of 

a financial instrument qualified for the separate account exemption only if:

• The banking entity is an insurance company directly engaged in the 

business of insurance and subject to regulation by a State insurance regulator or foreign 

insurance regulator;1461

• The banking entity purchases or sells the financial instrument solely for a 

separate account established by the insurance company in connection with one or more 

insurance policies issued by that insurance company;

• All profits and losses arising from the purchase or sale of the financial 

instrument are allocated to the separate account and inure to the benefit or detriment of 

 

1459 See proposed rule § __.2(z).

1460 The Agencies noted in the proposal they would not consider profits to inure to the benefit of the 

banking entity if the banking entity were solely to receive payment, out of separate account profits, of fees 

unrelated to the investment performance of the separate account.

1461 The proposed rule provided definitions of the terms “State insurance regulator” and “foreign insurance 

regulator.” See proposed rule §§ __.3(c)(4), (13).
434

the owners of the insurance policies supported by the separate account, and not the 

banking entity; and

• The purchase or sale is conducted in compliance with, and subject to, the 

insurance company investment and other laws, regulations, and written guidance of the 

State or jurisdiction in which such insurance company is domiciled.

The proposal explained that the proposed separate account exception represented 

transactions on behalf of customers because the insurance-related transactions are 

generally customer-driven and do not expose the banking entity to gains or losses on the 

value of separate account assets, even though the banking entity may be treated as the 

owner of those assets for certain purposes.

Commenters generally supported the general account exemption and the separate 

account exemption for regulated insurance companies as consistent with both the statute 

and Congressional intent to accommodate the business of insurance.1462 For instance, 

commenters argued that the statute was designed to appropriately accommodate the 

business of insurance, subject to regulation in accordance with relevant insurance 

company investment laws, in recognition that insurance company investment activities 

are already subject to comprehensive regulation and oversight.1463

 

1462 See, e.g., Alfred Brock; Chris Barnard; Fin. Services Roundtable (Feb. 3, 2012); Sutherland (on behalf 

of Comm. of Annuity Insurers); TIAA-CREF; NAMIC. 

1463 See, e.g., ACLI (Jan. 2012); Fin. Services Roundtable (Feb. 3, 2012); Country Fin. et al.; Sutherland 

(on behalf of Comm. of Annuity Insurers). 
435

A few commenters expressed concerns about the definition of “general account” 

and “separate account.”1464 One commenter argued the definition of general account was 

unclear.1465 A few commenters expressed concern that the proposed definition of 

separate account inappropriately excluded some separate accounts, such as certain 

insurance company investment activities such as guaranteed investment contracts, which 

would also not fall within the proposed definition of general account.1466 Several 

commenters argued that the final rule should be modified so that all insurance company 

investment activity permitted under applicable insurance laws would qualify for either 

the general account exemption or the separate account exemption.1467

Some commenters argued that the prohibition in the proposed definition of 

separate account against any profits or losses from activity in the account inuring to the 

benefit (or detriment) of the insurance company would exclude some activity permitted 

by insurance regulation in separate accounts.1468 For example, commenters contended 

that an insurer may allocate its own funds to a separate account as “seed money” and the 

profits and losses on those funds inure to the benefit or detriment of the insurance 

company.1469

 

1464 See, e.g., Fin. Services Roundtable (Feb. 3, 2012); ACLI (Jan. 2012); Sutherland (on behalf of Comm. 

of Annuity Insurers). 

1465 See Sutherland (on behalf of Comm. of Annuity Insurers). 

1466 See ACLI (Jan. 2012); NAMIC.

1467 See Fin. Services Roundtable (Feb. 3, 2012); ACLI (Jan. 2012); NAMIC; See also Nationwide. 

1468 See Fin. Services Roundtable (Feb. 3, 2012); ACLI (Jan. 2012); NAMIC; Sutherland (on behalf of 

Comm. of Annuity Insurers); See also Nationwide.

1469 See Fin. Services Roundtable (Feb. 3, 2012); ACLI (Jan. 2012).
436

Some commenters expressed specific concerns about the scope or requirements 

of the proposal. For instance, one commenter argued that the final rule should provide 

that a trade is exempt if the trade is made by an affiliate of the insurance company in 

accordance with state insurance law.1470 Another commenter urged that the Agencies 

consult with the foreign insurance supervisor of an insurance company regulated outside 

of the United States before finding that an insurance activity conducted by the foreign 

insurance company was inconsistent with the safety and soundness or financial 

stability.1471

One commenter suggested that insurance company affiliates of banking entities 

should expressly be made subject to data collection and reporting requirements to prevent 

possible evasion of the restrictions of section 13 and the final rule using their insurance 

affiliates.1472 By contrast, other commenters argued that the reporting and recordkeeping 

and compliance requirements of the rule should not apply to permitted insurance 

company investment activities.1473 These commenters argued that insurance companies 

are already subject to comprehensive regulation of the kinds and amounts of investments 

they can make under insurance laws and regulations and that additional recordkeeping 

obligations would impose unnecessary compliance burdens on these entities without 

producing significant offsetting benefits.

 

1470 See USAA. 

1471 See HSBC Life. 

1472 See Sens. Merkley & Levin (Feb. 2012). 

1473 See ACLI (Jan. 2012); Fin. Services Roundtable (Feb. 3, 2012); Mutual of Omaha; NAMIC. 
437

After considering the comments received and the language and purpose of the 

statute, the final rule has been modified to better account for the language of the statute 

and more appropriately accommodate the business of insurance. 

As explained in the proposal, section 13(d)(1)(F) of the BHC Act specifically and 

broadly exempts the purchase, sale, acquisition or disposition of securities and other 

instruments by a regulated insurance company engaged in the business of insurance for 

the general account of the company (and by an affiliate solely for the general account of 

the regulated insurance company). Section 13(d)(1)(D) of the statute also specifically 

exempts the same activity when done on behalf of customers. As explained in the 

proposal, separate accounts managed and maintained by insurance companies as part of 

the business of insurance are generally customer-driven and do not expose the banking 

entity to gains or losses on the value of assets held in the separate account, even though 

the banking entity may be treated as the owner of the assets for certain purposes. Unlike 

the general account of the insurance company, separate accounts are managed on behalf 

of specific customers, much as a bank would manage a trust or fiduciary account. 

For these reasons, the final rule retains both the general account exemption and 

the separate account exemption. The final rule removes any gap between the definition 

of general account and the definition of separate account by defining the general account 

to be all of the assets of an insurance company except those allocated to one or more 

separate accounts.1474

 

1474 See final rule §§ __.2(p), (bb). Some commenters expressed concerns about the proposed definitions 

of “general account” and “separate account,” including that the proposed definition of “separate account” 

excluded some legitimate separate account activities that do not fall within the proposed general account 

definition. See, e.g., ACLI (Jan. 2012); NAMIC; Sutherland (on behalf of Comm. of Annuity Insurers). 

See also proposed rule §§ __.2(z), __.3(c)(5).
438

The final rule also combines the general account exemption and the separate account 

exemption into a single section. This makes clear that both exemptions are available 

only: 

• If the insurance company or its affiliate purchases or sells the financial 

instruments solely for the general account of the insurance company or a separate 

account of the insurance company;

• The purchases or sales of financial instruments are conducted in 

compliance with, and subject to, the insurance company investment laws, regulations, 

and written guidance of the State or jurisdiction in which such insurance company is 

domiciled; and

• The appropriate Federal banking agencies, after consultation with the 

Financial Stability Oversight Council and the relevant insurance commissioners of the 

States and relevant foreign jurisdictions, as appropriate, have not jointly determined, after 

notice and comment, that a particular law, regulation, or written guidance regarding 

insurance is insufficient to protect the safety and soundness of the banking entity, or the 

financial stability of the United States.1475

 

1475 The Federal banking agencies have not at this time determined, as part of the final rule, that the 

insurance company investment laws, regulations, and written guidance of any particular State or 

jurisdiction are insufficient to protect the safety and soundness of the banking entity, or of the financial 

stability of the United States. The Federal banking agencies expect to monitor, in conjunction with the 

FSOC, the insurance company investment laws, regulations, and written guidance of States or jurisdictions 

to which exempt transactions are subject and make such determinations in the future, where appropriate. 

The Agencies believe the final approach addresses one commenter’s request that the Agencies consult with 

the foreign insurance supervisor of an insurance company regulated outside of the United States before 

finding that an insurance activity conducted by the foreign company was inconsistent with the safety and 

soundness or financial stability. See HSBC Life.
439

Like section 13(d)(1)(F) of the BHC Act, the final rule permits an affiliate of an 

insurance company to purchase and sell financial instruments in reliance on the general 

account exemption, so long as that activity is for the general account of the insurance 

company. Similarly, the final rule implements section 13(d)(1)(D) and permits an 

affiliate of an insurance company to purchase and sell financial instruments for a separate 

account of the insurance company, so long as the separate account is established and 

maintained at the insurance company.

Importantly, the final rule applies only to covered trading activity in a general or 

separate account of a licensed insurance company engaged in the business of insurance 

under the supervision of a State or foreign insurance regulator. As in the statute, an 

affiliate of an insurance company may not rely on this exemption for activity in any 

account of the affiliate (unless it, too, meets the definition of an insurance company). An 

affiliate may rely on the exemption to the limited extent that the affiliate is acting solely 

for the account of the insurance company.1476

As noted above, one commenter requested that the final rule impose special data 

and reporting obligations on insurance companies. Other commenters argued that 

insurance companies are already subject to comprehensive regulation under insurance 

laws and regulations and that additional recordkeeping obligations would impose 

unnecessary compliance burdens on these entities without producing significant 

 

1476 Although one commenter requested that the final rule exempt a trade as long as the trade is made by an 

affiliate of the insurance company in accordance with state insurance law, the Agencies believe the final 

approach properly implements the statute. See USAA.
440

offsetting benefits. In accordance with the statute,1477 the Agencies expect insurance 

companies to have appropriate compliance programs in place for any activity subject to 

section 13 of the BHC Act. 

The final rule contains a number of other related definitions that are intended to 

help make clear the limitations of the insurance company exemption, including 

definitions of foreign insurance regulator and State insurance regulator.

8. Section __.6(e): Permitted Trading Activities of a Foreign Banking Entity 

Section 13(d)(1)(H) of the BHC Act1478 permits certain foreign banking entities to 

engage in proprietary trading that occurs solely outside of the United States (the “foreign 

trading exemption”).

1479 The statute does not define when a foreign banking entity’s 

trading occurs solely outside of the United States.

The proposed rule defined both the type of foreign banking entity that is eligible 

for the exemption and activity that constitutes trading solely outside of the United States. 

The proposed rule effectively precluded a foreign banking entity from engaging in 

proprietary trading through a transaction that had any connection with the United States, 

including: trading with any party located in the United States; allowing U.S. personnel of 

 

1477 See 12 U.S.C. 1851(e)(1) (requiring that the Agencies issue regulations regarding “internal controls 

and recordkeeping, in order to insure compliance with this section”).

1478 Section 13(d)(1)(H) of the BHC Act provides an exemption to the prohibition on proprietary trading 

for trading conducted by a foreign banking entity pursuant to paragraph (9) or (13) of section 4(c) of the 

BHC Act, if the trading occurs solely outside of the United States, and the banking entity is not directly or 

indirectly controlled by a banking entity that is organized under the laws of the United States or of one or 

more States. See 12 U.S.C. 1851(d)(1)(H).

1479 This section’s discussion of the concept “solely outside of the United States” is provided solely for 

purposes of the rule’s implementation of section 13(d)(1)(H) of the BHC Act, and does not affect a banking 

entity’s obligation to comply with additional or different requirements under applicable securities, banking, 

or other laws.
441

the foreign banking entity to be involved in the purchase or sale; or executing any 

transaction in the United States (on an exchange or otherwise).1480

In general, commenters emphasized the importance of and supported an 

exemption for foreign trading activities of foreign banking entities. However, a number 

of commenters expressed concerns that the proposed foreign trading exemption was too 

narrow and would not be effective in permitting foreign banking entities to engage in 

foreign trading activities.1481 For instance, many commenters stated that the proposal’s 

prohibition on trading activities that have any connection to the U.S. was not consistent 

with the purpose of section 13 of the BHC Act where the risk of the trading activity is 

taken or held outside of the United States and does not implicate the U.S. safety net.1482 

These commenters argued that, since one of the principal purposes of section 13 of the 

BHC Act is to limit the risk posed by prohibited proprietary trading to the federal safety 

net, the safety and soundness of U.S. banking entities, and the financial stability of the 

United States, the exemption for foreign trading activity should similarly focus on 

whether the trading activity involves principal risk being taken or held by the foreign 

banking entity inside the United States.1483 

Many commenters argued that the proposal’s transaction-based approach to 

implementing the foreign trading exemption would harm U.S. markets and U.S. market 

 

1480 See proposed rule § __.6(d).

1481 See, e.g., IIB/EBF; ICI Global; ICI (Feb. 2012); Wells Fargo (Prop. Trading); BoA.

1482 See IIB/EBF; Ass’n. of Banks in Malaysia; EBF; Credit Suisse (Seidel); Cadwalader (on behalf of Thai

Banks).

1483 See BaFin/Deutsche Bundesbank; ICSA; IIB/EBF; Allen & Overy (on behalf of Canadian Banks);

Credit Suisse (Seidel); George Osbourne.
442

participants. For example, some commenters argued that the proposed exemption would 

cause foreign banks to exit U.S. markets or shrink their U.S.-based operations, thereby 

resulting in less liquidity and greater fragmentation in markets without producing any 

significant offsetting benefit.1484 Commenters also asserted that the proposal would 

impose significant compliance costs on the foreign operations of foreign banking entities 

and would lead to foreign firms refusing to trade with U.S. counterparties, including the 

foreign operations of U.S. entities, to avoid compliance costs associated with relying on 

another exemption under the proposed rule.1485 Additionally, commenters argued that the 

proposal represented an improper extraterritorial application of U.S. law that could be 

found to violate international treaty obligations of the United States, such as those under 

the North American Free Trade Agreement, and might result in retaliation by foreign 

countries in their treatment of U.S. banking entities abroad.1486

a. Foreign Banking Entities Eligible for the Exemption

The statutory language of section 13(d)(1)(H) provides that, in order to be eligible 

for the foreign trading exemption, the banking entity must not be directly or indirectly 

controlled by a banking entity that is organized under the laws of the United States or of 

one or more States. The proposed rule limited the scope of the exemption to banking 

 

1484 See ICE; ICI Global; BoA; Citigroup (Feb. 2012); British Bankers’ Ass’n.; IIB/EBF.

1485 See BaFin/Deutsche Bundesbank; Norinchukin; IIF; Allen & Overy (on behalf of Canadian Banks);

ICFR; BoA; Citigroup (Feb. 2012). As discussed below in Part IV.C. of this Supplementary

Information, other parts of the final rule address commenters’ concerns regarding the compliance burden 

on foreign banking entities.

1486 See Norinchukin; Cadwalader (on behalf of Thai Banks); Barclays; EBF; Commissioner Barnier; 

Ass’n. of German Banks; Société Générale; Chamber (Dec. 2012).
443

entities that are organized under foreign law and, as applicable, controlled only by 

entities organized under foreign law. 

Commenters generally supported this aspect of the proposal.1487 However, some 

commenters requested that the final rule be modified to allow U.S. banking entities’ 

affiliates or branches that are physically located outside of the United States (“foreign 

operations of U.S. banking entities”) to engage in proprietary trading outside of the 

United States pursuant to this exemption.1488 These commenters argued that, unless 

foreign operations of U.S. banking entities are provided similar authority to engage in 

proprietary trading outside of the United States, foreign operations of U.S. banking 

entities would be at a competitive disadvantage abroad with respect to foreign banking 

entities. One commenter also asserted that, unless foreign operations of U.S. banking 

entities were able to effectively access foreign markets, they could be shut out of those 

markets and would be unable to effectively manage their risks in a safe and sound 

manner.1489

As noted above, section 13(d)(1)(H) of the BHC Act specifically provides that its 

exemption is available only to a banking entity that is not “directly or indirectly” 

controlled by a banking entity that is organized under the laws of the United States or of 

 

1487 See Sens. Merkley & Levin (Feb. 2012) (arguing that the final rule’s foreign trading exemption should 

not exempt foreign affiliates of U.S. banking entities when they engage in trading activity abroad); See also

Occupy; Alfred Brock.

1488 See Citigroup (Feb. 2012); Sen. Carper; IIF; ABA (Keating); Wells Fargo (Prop. Trading); Abbot 

Labs. et al. (Feb. 14, 2012).

1489 See Citigroup (Feb. 2012).
444

one or more States.1490 Because of this express statutory threshold requirement, a foreign 

subsidiary controlled, directly or indirectly, by a banking entity organized under the laws 

of the United States or one of its States, and a foreign branch office of a banking entity 

organized under the laws of the United States or one of the States, may not take 

advantage of this exemption.

Like the proposal, the final rule incorporates the statutory requirement that the 

banking entity conduct its trading activities pursuant to sections 4(c)(9) or 4(c)(13) of the 

BHC Act.1491 The final rule retains the tests in the proposed rule for determining when a 

banking entity would meet that requirement. The final rule provides qualifying criteria 

for both a banking entity that is a qualifying foreign banking organization under the 

Board’s Regulation K and a banking entity that is not a foreign banking organization for 

purposes of Regulation K.1492 

Section 4(c)(9) of the BHC Act applies to any company organized under the laws 

of a foreign country the greater part of whose business is conducted outside the United 

States, if the Board by regulation or order determines that, under the circumstances and 

subject to the conditions set forth in the regulation or order, the exemption would not be 

substantially at variance with the purposes of the BHC Act and would be in the public 

 

1490 See 12 U.S.C. 1851(d)(1)(H).

1491 See final rule § __.6(e)(1)(ii).

1492 Section __.6(e)(2) addresses only when a transaction will be considered to have been conducted 

pursuant to section 4(c)(9) of the BHC Act. Although the statute also references section 4(c)(13) of the 

BHC Act, the Board has to date applied the general authority contained in that section solely to the foreign 

activities of U.S. banking organizations which, by the express terms of section 13(d)(1)(H) of the BHC Act, 

are unable to rely on the foreign trading exemption.
445

interest.1493 The Board has implemented section 4(c)(9) as part of subpart B of the 

Board’s Regulation K,1494 which specifies a number of conditions and requirements that a 

foreign banking organization must meet in order to act pursuant to that authority.1495 The 

qualifying conditions and requirements include, for example, that the foreign banking 

organization demonstrate that more than half of its worldwide business is banking and 

that more than half of its banking business is outside the United States.1496 Under the 

final rule a banking entity that is a qualifying foreign banking organization for purposes 

of the Board’s Regulation K, other than a foreign bank as defined in section 1(b)(7) of the 

International Banking Act of 1978 that is organized under the laws of any 

commonwealth, territory, or possession of the United States, will qualify for the 

exemption for proprietary trading activity of a foreign banking entity.

1497

 

1493 See 12 U.S.C. 1843(c)(9).

1494 See 12 CFR 211.20 et seq.

1495 Commenters noted that the Board’s Regulation K contains a number of limitations that may not be 

appropriate to include as part of the requirements of the foreign trading exemption. See Allen & Overy (on 

behalf of Foreign Bank Group); HSBC Life. Accordingly, the final rule does not retain the proposal’s 

requirement that the activity be conducted in compliance with subpart B of the Board’s Regulation K (12 

CFR 211.20 through 211.30). However, the exemption in section 13(d)(1)(H) of the BHC Act and the final 

rule operates as an exemption and is not a separate grant of authority to engage in an otherwise 

impermissible activity. To the extent a banking entity is a foreign banking organization, it remains subject 

to the Board’s Regulation K and must, as a separate matter, comply with any and all applicable rules and 

requirements of that regulation.

1496 See 12 CFR 211.23(a), (c), and (e). The proposed rule referenced only the qualifying test under 

section 211.23(a) of the Board’s Regulation K; however, because there are two other methods by which a 

foreign banking organization may meet the requirements to be considered a qualified foreign banking 

organization, the final rule incorporates a reference to those provisions as well.

1497 This modification to the definition of foreign banking organization is necessary because, under the 

International Banking Act and the Board’s Regulation K, depository institutions that are located in, or 

organized under the laws of a commonwealth, territory, or possession of the United States, are foreign 

banking organizations. However, for purposes of the Federal securities laws and certain banking statutes, 

such as section 2(c)(1) of the BHC Act and section 3 of the FDI Act, these same entities are defined to be 

and treated as domestic entities. For instance, these entities act as domestic broker-dealers under U.S. 

securities laws and their deposits are insured by the FDIC. Because one of the purposes of section 13 is to 

protect insured depository institutions and the U.S. financial system from the perceived risks of proprietary 
446

Section 13 of the BHC Act also applies to foreign companies that control a U.S. 

insured depository institution but that are not currently subject to the BHC Act generally 

or to the Board’s Regulation K – for example, because the foreign company controls a 

savings association or an FDIC-insured industrial loan company. Accordingly, the final

rule also provides that a foreign banking entity that is not a foreign banking organization 

would be considered to be conducting activities “pursuant to section 4(c)(9)” for purposes 

of this exemption1498 if the entity, on a fully-consolidated basis, meets at least two of 

three requirements that evaluate the extent to which the foreign banking entity’s business 

is conducted outside the United States, as measured by assets, revenues, and income.1499 

This test largely mirrors the qualifying foreign banking organization test that is made 

applicable under section 4(c)(9) of the BHC Act and section 211.23(a), (c), or (e) of the 

Board’s Regulation K, except that the test does not require the foreign entity to 

demonstrate that more than half of its banking business is outside the United States.1500 

This difference reflects the fact that foreign entities subject to section 13 of the BHC Act, 

but not the BHC Act generally, are likely to be, in many cases, predominantly 

commercial firms. A requirement that such firms also demonstrate that more than half of 

 

trading and covered fund activities, the Agencies believe that these entities should be considered to be 

located within the United States for purposes of section 13. The final rule includes within the definition of 

State a commonwealth, territory or possession of the United States, the District of Columbia, the 

Commonwealth of Puerto Rico, the Commonwealth of the Northern Mariana Islands, American Samoa, 

Guam, or the United States Virgin Islands.

1498 This clarification would be applicable solely in the context of section 13(d)(1) of the BHC Act. The 

application of section 4(c)(9) to foreign companies in other contexts is likely to involve different legal and 

policy issues and may therefore merit different approaches.

1499 See final rule § __.6(e)(2)(ii)(B). For purposes of determining whether, on a fully consolidated basis, it 

meets the requirements under § __.6(e)(2)(ii)(B), a foreign banking entity that is not a foreign banking 

organization should base its calculation on the consolidated global assets, revenues, and income of the toptier affiliate within the foreign banking entity’s structure.

1500 See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a), (c), and (e); final rule § __.6(e)(2)(ii)(B).
447

their banking business is outside the United States would likely make the exemption 

unavailable to such firms and subject their global activities to the prohibition on 

proprietary trading.

b. Permitted Trading Activities of a Foreign Banking Entity

As noted above, the proposed rule laid out a transaction-based approach to 

implementing the foreign trading exemption and provided that a transaction would be 

considered to qualify for the exemption only if (i) the transaction was conducted by a 

banking entity not organized under the laws of the United States or of one or more States;

(ii) no party to the transaction was a resident of the United States; (iii) no personnel of the 

banking entity that was directly involved in the transaction was physically located in the 

United States; and (iv) the transaction was executed wholly outside the United States.1501 

Many commenters objected to the proposed exemption, arguing that it was 

unworkable and would have unintended consequences. For example, commenters argued 

that prohibiting a foreign banking entity from conducting a proprietary trade with a 

resident of the United States, including a subsidiary or branch of a U.S. banking entity, 

wherever located, would likely cause foreign banking entities to be unwilling to enter into 

permitted trading transactions with foreign subsidiaries or branches of U.S. firms.1502 In 

addition, some commenters represented that it would be difficult to determine and track 

whether a party is a resident of the United States or that this requirement would require 

non-U.S. banking entities to inefficiently bifurcate their activities into U.S.-facing and 

 

1501 See proposed rule § __.6(d).

1502 See BoA; Citigroup (Feb. 2012); British Bankers’ Ass’n.; Credit Suisse (Seidel); George Osbourne; IIB/EBF.
448

non-U.S.-facing trading desks.1503 For example, one commenter noted that trading on 

many exchanges and platforms is anonymous (i.e., each party to the trade is unaware of 

the identity of the other party to the trade), so a foreign banking entity would likely have 

to avoid U.S. trading platforms and exchanges entirely to avoid transactions with any 

resident of the United States.1504 Further, commenters stated that the proposed rule could 

deter foreign banking entities from conducting business with U.S. parties outside of the 

United States, which could also incentivize foreign market centers to limit participation 

by U.S. parties on their markets.1505 

Commenters also expressed concern about the requirement that transactions be 

executed wholly outside of the United States in order to qualify for the proposed foreign 

trading exemption. Commenters represented that foreign banking entities currently use 

U.S. trading platforms to trade in certain products (such as U.S.-listed securities or a 

variety of derivatives contracts), to take advantage of robust U.S. infrastructure, and for 

time zone reasons.1506 Commenters indicated that the proposed requirement could harm 

the competitiveness of U.S. trading platforms and the liquidity available on such 

facilities.1507 Some commenters stated that this requirement would effectively result in 

 

1503 See Cadwalader (on behalf of Singapore Banks); Ass’n. of Banks in Malaysia; Cadwalader (on behalf 

of Thai Banks); IIF; ICE; Banco de México; ICFR; Australian Bankers Ass’n. (Feb. 2012); BAROC.

1504 See ICE.

1505 See, e.g., RBC.

1506 See, e.g., IIF; ICE; Société Générale; Mexican Banking Comm’n.; Australian Bankers Ass’n. (Feb. 

2012); Banco de México; OSFI. In addition, a few commenters argued that Canadian and Mexican 

financial firms frequently use U.S. infrastructure to conduct their trading activities in Canada or Mexico. 

See, e.g., OSFI; Banco de México; Mexican Banking Comm’n.

1507 See, e.g., ICE; Société Générale (arguing that the requirement would impair capital raising efforts of 

many U.S. companies); Australian Bankers Ass’n. (Feb. 2012); Canadian Minister of Fin.; Ass’n. of 

German Banks.
449

most foreign banking entities moving their trading operations and personnel outside of 

the United States and executing transactions on exchanges outside of the United 

States.1508 These commenters stated that the relocation of these activities would reduce 

trading activity in the United States that supports the financial stability and efficiency of 

U.S. markets. Moreover, these commenters argued that, if foreign banking entities 

relocate their personnel from the United States to overseas, this would diminish U.S. jobs 

with no concomitant benefit. They also contended that the proposal was at cross 

purposes with other parts of the Dodd-Frank Act and would hinder growth of market 

infrastructure being developed under the requirements of Title VII of that Act, including 

use of swap execution facilities and security-based swap execution facilities to enhance 

transparency in the swaps markets and use of central clearinghouses to reduce 

counterparty risk for the parties to a swap transaction.1509 For example, one commenter 

represented that the proposed exemption could make it difficult for non-U.S. swap 

entities to comply with potential mandatory execution requirements under Title VII of the 

Dodd-Frank Act and could cause market fragmentation across borders through the 

creation of parallel execution facilities outside of the United States, which would result in 

less transparency and greater systemic risk.1510 In addition, another commenter stated 

that the proposed requirement would force issuers to dually list their securities to permit 

trading on non-U.S. exchanges and, further, clearing and settlement systems would have 

to be set up outside of the United States, which would create inefficiencies, operational 

 

1508 See IIB/EBF.

1509 See Bank of Canada; Banco de México; Allen & Overy (on behalf of Canadian Banks). 

1510 See Allen & Overy (on behalf of Candian Banks).
450

risks, and potentially systemic risk by adding needless complexity to the financial 

system.1511 

Instead of the proposal’s transaction-based approach to implementing the foreign 

trading exemption, many commenters suggested the final rule adopt a risk-based 

approach.1512 These commenters noted that a risk-based approach would prohibit or 

significantly limit the amount of financial risk from such activities that could be 

transferred to the United States by the foreign trading activity of foreign banking 

entities.1513 Commenters also noted that foreign trading activities of most foreign 

banking entities are already subject to activities limitations, capital requirements, and 

other prudential requirements of their home-country supervisor(s).1514 

The Agencies have carefully considered these comments and have determined to 

modify the approach in the final rule. The Agencies believe that the revisions mitigate 

the potential adverse impacts of the proposed approach while still remaining faithful to 

the overall purpose of section 13(d)(1)(H). Also, the Agencies believe that section 

13(d)(1)(J) of the BHC Act, which authorizes the Agencies to provide an exemption from 

the prohibition on proprietary trading for any activity the Agencies determine by rule 

“would promote and protect the safety and soundness of the banking entity and the 

financial stability of the United States,”1515 supports allowing foreign banking entities to 

 

1511 See IIF.

1512 See BaFin/Deutsche Bundesbank; ICSA; IIB/EBF; Allen & Overy (on behalf of Canadian Banks);

Credit Suisse (Seidel); George Osbourne.

1513 See IIB/EBF.

1514 See IIB/EBF.

1515 See 12 U.S.C. 1851(d)(1)(J). 
451

use U.S. infrastructure and trade with certain U.S. counterparties in certain 

circumstances, which will promote and protect the safety and soundness of banking 

entities and U.S. financial stability.

Overall, the comments illustrated that both the mechanical steps of the specified 

transactions to purchase or sell various instruments (e.g., execution, clearing), and the 

identity of the entity for whose trading account the specified trading is conducted are 

important.1516 Consistent with the comments described above, the Agencies believe that 

the application of section 13(d)(1)(H) and their exemptive authority under section 

13(d)(1)(J) should focus on both how the transaction occurs and which entity will bear 

the risk of those transactions. Although the statute does not define expressly what it 

means to act “as a principal” (acting as principal ordinarily means acting for one’s own 

account), the combination of references to engaging as principal and to a trading account 

focuses on an entity’s incurring risks of profit and loss through taking ownership of 

securities and other instruments. Thus, the final rule provides an exemption for trading 

activities of foreign banking entities that addresses both the location of the facilities that 

effect the acquisition, holding, and disposition of such positions, and the location of the 

banking entity that incurs such risks through acquisition, holding, and disposition of such 

positions. 

The Agencies believe this approach is consistent with one of the principal 

purposes of section 13, which is to limit risks that proprietary trading poses to the U.S. 

 
452

financial system.1517 Further, the purpose of section 13(d)(1)(H) is to limit the 

extraterritorial application of section 13 as it applies to foreign banking entities.1518 

In addition, prohibiting foreign banking entities from using U.S. infrastructure or 

trading with all U.S. counterparties could cause certain trading activities to move 

offshore, with corresponding negative impacts on U.S. market participants, including 

U.S. banking entities. For example, movement of trading activities offshore, particularly 

in U.S. financial instruments, could result in bifurcated markets for these instruments that 

are less efficient and less liquid and could reduce transparency for oversight of trading in 

these instruments. In addition, reducing access to foreign counterparties for U.S.

instruments could concentrate risks in the United States and to its financial system. 

Moreover, the statute provides separate exemptions for U.S. banking entities to engage in 

underwriting and market making-related activities, subject to certain requirements, and 

there is no evidence that limiting the range of potential customers for these entities would 

further the purposes of the statute. In fact, it is possible that limiting the customer bases 

of U.S. banking entities, as well as other U.S. firms that are not banking entities, could 

reduce their ability to effectively manage their inventories and risks and could also result 

in concentration risk. 

 

1517 See, e.g., 12 U.S.C. 1851(b)(1) (directing the FSOC to study and make recommendations on 

implementing section 13 so as to, among other things, protect taxpayers and consumers and enhance 

financial stability by minimizing the risk that insured depository institutions and the affiliates of insured 

depository institutions will engage in unsafe and unsound activities).

1518 See, e.g., 156 Cong. Rec. S5897 (daily ed. July 15, 2010) (statement of Sen. Merkley) (stating that the 

foreign trading exemption “recognize[s] rules of international comity by permitting foreign banks, 

regulated and backed by foreign taxpayers, in the course of operating outside of the United States to engage 

in activities permitted under relevant foreign law.”).
453

These potential effects of the approach taken in the proposal appear to be 

inconsistent with the statute’s goals, including the promotion and protection of the safety 

and soundness of banking entities and U.S. financial stability. To the contrary, the 

exemptive approach taken in the final rule appears to be more consistent with the goals of 

the statute and would promote and protect the safety and soundness of banking entities 

and U.S. financial stability by limiting the risks of foreign banking entities’ proprietary 

trading activities to the U.S. financial system, while also allowing U.S. markets to 

continue to operate efficiently in conjunction with foreign markets (rather than creating 

incentives to establish barriers between U.S. and foreign markets).1519

Thus, in response to commenter concerns, the final rule has been modified to 

better reflect the text and achieve the overall purposes of the statute (by ensuring that the 

principal risks of proprietary trading by foreign banking entities allowed under the 

foreign trading exemption remain solely outside of the United States) while mitigating

potentially adverse effects on competition.

1520 In order to ensure these risks remain 

largely outside of the United States, and to limit potential risk that could flow to the U.S. 

financial system through trades by foreign banking entities with or through U.S. entities, 

the final rule includes several conditions on the availability of the exemption. 

Specifically, in addition to limiting the exemption to foreign banking entities, the final 

 

1519 12 U.S.C. 1851(d)(1)(J).

1520 The proposed rule also contained a definition of “resident of the United States” that was designed to 

capture the scope of U.S. counterparties that, if involved in the transaction, would preclude that transaction 

from being considered to have occurred solely outside the United States. The final rule addresses this point 

by including a definition, for purposes of §__.6(e) only, of the term “U.S. entity.” 
454

rule provides that the exemption for the proprietary trading activity of a foreign banking 

entity is available only if:

(i) The banking entity engaging as principal in the purchase or sale 

(including any personnel of the banking entity or its affiliate that arrange, 

negotiate or execute such purchase or sale) is not located in the United 

States or organized under the laws of the United States or of any State; 1521

(ii) The banking entity (including relevant personnel) that makes the decision 

to purchase or sell as principal is not located in the United States or 

organized under the laws of the United States or of any State;

(iii) The purchase or sale, including any transaction arising from riskmitigating hedging related to the instruments purchased or sold, is not 

accounted for as principal directly or on a consolidated basis by any 

branch or affiliate that is located in the United States or organized under 

the laws of the United States or of any State; 

(iv) No financing for the banking entity’s purchase or sale is provided, 

directly or indirectly, by any branch or affiliate that is located in the 

United States or organized under the laws of the United States or of any 

State;1522

 

1521 Personnel that arrange, negotiate, or execute a purchase or sale conducted under the exemption for 

trading activity of a foreign banking entity must be located outside of the United States. Thus, for example, 

personnel in the United States cannot solicit or sell to or arrange for trades conducted under this exemption. 

Personnel in the United States also cannot serve as decision makers in transactions conducted under this 

exemption. Personnel that engage in back-office functions, such as clearing and settlement of trades, 

would not be considered to arrange, negotiate, or execute a purchase or sale for purposes of this provision.

1522 This provision is not intended to restrict the ability of a U.S. branch or affiliate of a foreign banking 

entity to provide funds collected in the United States to its foreign parent for general purposes.
455

(v) The purchase or sale is not conducted with or through any U.S. entity,1523

other than:

(A) A purchase or sale with the foreign operations of a U.S. entity, if no 

personnel of such U.S. entity that are located in the United States are 

involved in the arrangement, negotiation or execution of such purchase or 

sale.

The Agencies believe it is appropriate to exercise their exemptive authority under 

section 13(d)(1)(J) to also allow, under clause (vi) of the final rule, the following types of 

purchases or sales conducted with a U.S. entity:

(B) A purchase or sale with an unaffiliated market intermediary acting as 

principal,1524 provided the purchase or sale is promptly cleared and settled 

through a clearing agency or derivatives clearing organization acting as a 

central counterparty; or

(C) A purchase or sale through an unaffiliated market intermediary, provided 

the purchase or sale is conducted anonymously (i.e. each party to the 

purchase or sale is unaware of the identity of the other party(ies) to the 

purchase or sale) on an exchange or similar trading facility and promptly 

cleared and settled through a clearing agency or derivatives clearing 

organization acting as a central counterparty.

The requirements are designed to ensure that any foreign banking entity engaging 

in trading activity under this exemption does so in a manner that ensures the risk, 

decision-making, arrangement, negotiation, execution and financing of the activity 

 

1523 “U.S. entity” is defined for purposes of this provision as any entity that is, or is controlled by, or is 

acting on behalf of, or at the direction of, any other entity that is, located in the United States or organized 

under the laws of the United States or of any State. See final rule § __.6(e)(4).

1524 This provision would generally allow market intermediaries to engage in market-making, underwriting 

or similar market intermediation functions. 
456

resides solely outside the United States and limits the risk to the U.S. financial system 

from trades by foreign banking entities with or through U.S. entities. 

The final rule specifically recognizes that, for purposes of the exemption for 

trading activity of a foreign banking entity, a U.S. branch, agency, or subsidiary of a 

foreign bank, or any subsidiary thereof, is located in the United States; however, a 

foreign bank that operates or controls that branch, agency, or subsidiary is not considered 

to be located in the United States solely by virtue of operation of the U.S. branch, agency, 

or subsidiary.1525 This provision helps give effect to the statutory language limiting the 

foreign trading exemption to activities of foreign banking entities that occur solely 

outside of the United States by clarifying that the U.S. operations of foreign banking 

entities may not conduct proprietary trading based on this exemption.

The Agencies have considered whether the concerns raised by commenters that 

the foreign operations of U.S. banking entities would be disadvantaged in competing 

outside the United States warrant an exemption under section 13(d)(1)(J) of the BHC Act 

that extends to foreign operations of U.S. banking entities. The competitiveness of U.S. 

banking entities outside the United States often improves the potential for the operations 

of U.S. firms outside the United States to succeed and be profitable, and thereby, often 

improves the safety and soundness of the entity and financial stability in the United 

States. 

However, Congress has determined to generally prohibit U.S. banking entities 

(including foreign branches and subsidiaries thereof) from engaging in proprietary 

 

1525 See final rule § __.6(e)(5).
457

trading because of the perceived risks of those activities to banking entities and the U.S. 

economy.1526 Allowing U.S. banking entities to conduct, through branches or 

subsidiaries that are physically located outside the United States, the same proprietary 

trading activities those U.S. firms are expressly prohibited from conducting directly 

through their operations located within the United States would subject U.S. banking 

entities and the U.S. economy to the very risks section 13 is designed to avoid. The risks 

of proprietary trading would continue to be borne by the U.S. banking entity whether the 

activity is conducted by the U.S. banking entity through units physically located inside or 

outside of the United States. Moreover, the robust trading markets that exist overseas 

could allow U.S. banking entities to shift their prohibited proprietary trading activities to 

branches or subsidiaries that are physically located outside the United States under such 

an exemption, without achieving a meaningful elimination of risk. Accordingly, the 

Agencies have not exercised their authority under section 13(d)(1)(J) at this time to allow 

U.S. banking entities to conduct otherwise prohibited proprietary trading activities 

through operations located outside the United States. As a consequence, and consistent 

with the statutory language and purpose of section 13(d)(1)(H) of the BHC Act, the final 

rule provides that the exemption is available only if the banking entity is not organized

under, or directly or indirectly controlled by a banking entity that is organized under, the 

laws of the United States or of one or more States.

1527

 

1526 See, e.g., 156 Cong. Rec. S5897 (daily ed. July 15, 2010) (statement of Sen. Merkley) (“However, 

these subparagraphs are not intended to permit a U.S. banking entity to avoid the restrictions on proprietary 

trading simply by setting up an offshore subsidiary or reincorporating offshore, and regulators should 

enforce them accordingly.”).

1527 See final rule § __.6(e)(1)(i).
458

As discussed above, many commenters requested that the final rule permit a 

foreign banking entity to engage in proprietary trading transactions with a greater variety 

of counterparties, including counterparties that are located in or organized and 

incorporated under the laws of the United States or of one or more States.1528 These 

commenters also requested that the final rule not require that any purchase or sale under 

the exemption be executed wholly outside of the United States.

As described above and in response to commenters’ concerns, the final rule 

provides that a foreign banking entity generally may engage in trading activity under the 

exemption with U.S. entities, provided the transaction is with the foreign operations of an 

unaffiliated U.S. firm (whether or not the U.S. firm is a banking entity subject to section 

13 of the BHC Act) and does not involve any personnel of the U.S. entity that are in the 

United States and involved in the arrangement, negotiation, or execution of the 

transaction. The Agencies have also exercised their exemptive authority under section 

13(d)(1)(J) to allow foreign banking entities to engage in a transaction that is either 

through an unaffiliated market intermediary and executed anonymously on an exchange 

or similar trading facility (regardless of whether the ultimate counterparty is a U.S. entity 

or not) or is executed with a U.S. entity that is an unaffiliated market intermediary acting 

as principal, provided in either case that the transaction is promptly cleared and settled 

through a clearing agency or derivatives clearing organization acting as a central 

counterparty. 

 

1528 A number of commenters also requested that the foreign trading exemption permit proprietary trading 

of foreign sovereign debt or similar obligations of foreign governments. As discussed in Part IV.A.5.b. of 

this Supplementary Information, the final rule addresses banking entities’ ability to engage in transaction 

in these types of instruments in § __.6(b).
459

For purposes of the final rule, market intermediary is defined as an unaffiliated 

entity, acting as an intermediary, that is: (i) a broker or dealer registered with the SEC 

under section 15 of the Exchange Act or exempt from registration or excluded from 

regulation as such; (ii) a swap dealer registered with the CFTC under section 4s of the 

Commodity Exchange Act or exempt from registration or excluded from regulation as 

such; (iii) a security-based swap dealer registered with the SEC under section 15F of the 

Exchange Act or exempt from registration or excluded from regulation as such; or (iv) a

futures commission merchant registered with the CFTC under section 4f of the 

Commodity Exchange Act or exempt from registration or excluded from regulation as 

such.1529

These provisions of the final rule, viewed as a whole, prevent the exemption for 

trading of foreign banking entities from weakening U.S. trading markets and U.S. firms 

that are either not subject to the provisions of section 13 or that conduct activities in 

compliance with other parts of section 13. For instance, the final rule permits a foreign 

banking entity to trade under the exemption with the foreign operations of a U.S. firm, so 

long as the purchase or sale does not involve any personnel of the U.S. firm who are 

located in the United States and involved in arranging, negotiating or executing the 

trade.1530 Transactions that occur outside of the United States between foreign operations 

of U.S. entities and foreign banking entities improve access to and functioning of liquid 

markets without raising the concerns for increased risk to banking entities in the U.S. that 

 

1529 See final rule § __.6(e)(5). For example, under this definition, a bank that is exempt from registration 

as a swap dealer under the de minimis exception to swap dealer registration requirements could be a market 

intermediary for transactions in swaps. See 17 CFR 1.3(ggg)(4).

1530 See final rule § __.6(e)(3)(v)(A).
460

motivated enactment of section 13 of the BHC Act. The final rule permits a foreign 

banking entity to engage in transactions with the foreign operations of both U.S. nonbanking and U.S. banking entities. Among other things, this approach will ensure that 

the foreign operations of U.S. banking entities continue to be able to access foreign 

markets.1531 The language of the exemption expressly requires that trading with the 

foreign operations of a U.S. entity may not involve the use of personnel of the U.S. entity 

who are located in the United States for purposes of arranging, negotiating, or executing 

transactions. 

Under the final rule, the exemption in no way exempts the U.S. or foreign 

operations of the U.S. banking entities from having to comply with the restrictions and 

limitations of section 13. Thus, the U.S. and foreign operations of a U.S. banking entity 

that is engaged in permissible market making-related activities or other permitted 

activities may engage in those transactions with a foreign banking entity that is engaged 

in proprietary trading in accordance with the exemption under § __.6(e) of the final rule. 

Importantly, the final rule does not impose a duty on the foreign banking entity or the 

U.S. banking entity to ensure that its counterparty is conducting its activity in 

conformance with section 13 of the BHC Act and the final rule. Rather, that burden is at 

all times on each party subject to section 13 to ensure that it is conducting its activities in 

accordance with section 13 and this implementing rule. 

 

1531 The Agencies believe that this provision should address commenters’ concerns that the proposed rule 

could cause foreign banking entities to avoid conducting business with U.S. firms outside the United States 

or could incentivize foreign market places to restrict access to U.S. firms. See, e.g., RBC.
461

The final rule also permits, pursuant to section 13(d)(1)(J), a foreign banking 

entity to trade through an unaffiliated market intermediary if the trade is conducted 

anonymously on an exchange or similar trading facility and is promptly cleared and 

settled through a clearing agency or derivatives clearing organization.1532 Allowing 

foreign banking entities to generally conduct anonymous proprietary trades on U.S. 

exchanges and similar anonymous trading facilities allows these exchanges and facilities 

– which are generally not subject to section 13 and do not take the risks section 13 is 

designed to address – to serve the widest possible range of counterparties. This prevents 

the potential adverse impacts from possible reductions in competitiveness of or liquidity 

available on these regulated exchanges and facilities, which could also harm other U.S. 

market participants who trade on these exchanges and facilities. In addition, the 

Agencies recognize that anonymous trading on exchanges and similar anonymous trading 

facilities promotes transparency and that prohibiting foreign banking entities from trading 

on U.S. exchanges and similar anonymous trading facilities under this exemption would 

likely reduce transparency for trading in U.S. financial instruments. All of these 

considerations support the Agencies’ exercise of their exemptive authority under section 

13(d)(1)(J) to allow such trading by foreign banking entities.

The final rule requires that foreign banking entities trade through an unaffiliated 

market intermediary to access a U.S. exchange or trading facility in recognition that 

 

1532 Under the final rule, “anonymous” means that each party to a purchase or sale is unaware of the 

identity of the other party(ies) to the purchase or sale. See final rule § __.3(e)(1). 
462

existing laws and regulations generally require this structure.1533 For purposes of this 

exemption, an exchange would include, unless the context otherwise requires, any 

designated contract market, swap execution facility, or foreign board of trade registered 

with the CFTC, and any exchange or security-based swap execution facility, as such 

terms are defined under the Exchange Act.1534 

This provision of the final rule requires that foreign banking entities trade 

anonymously and that the trade be centrally cleared and settled. The Agencies 

understand that in these circumstances, the foreign banking entity would not have any 

prior information regarding its counterparty to the trade. Requiring that the trade be 

executed anonymously preserves the benefits of allowing U.S. entities to participate in 

such trades, while reducing the potential for evasion of section 13 that could occur if 

foreign banking entities directly arranged purchases and sales with U.S. entities.1535 The 

final rule specifies that a trade is anonymous if each party to the purchase or sale is 

unaware of the identity of the other party(ies) to the purchase or sale. That is, it is lack of 

knowledge of the identity of the counteryparty(ies) to the trade that is relevant. The final 

rule does not prohibit foreign banking entities from accessing a trading facility through 

an unaffiliated U.S. market intermediary (which the foreign banking entity would 

 

1533 See, e.g., 15 U.S.C. 78f(c)(1) (providing that a national securities exchange shall deny membership to 

(A) any person, other than a natural person, which is not a registered broker or dealer or (B) any natural 

person who is not, or is not associated with, a registered broker or dealer).

1534 See final rule § __.3(e)(6) (defining the term “exchange”). The rule refers to an “exchange or similar 

trading facility.” A similar trading facility for these purposes may include, for example, an alternative 

trading system.

1535 In addition, allowing a foreign banking entity to trade directly with a U.S. end user customer under the 

foreign trading exemption could give the foreign banking entity a competitive advantage over U.S. banking 

entities with respect to trading in the United States.
463

necessarily know), so long as the foreign banking entity is not aware of the identity of the 

counterparty to the transaction.

Similarly, also pursuant to section 13(d)(1)(J), the final rule allows a foreign 

banking entity to trade with an unaffiliated market intermediary acting in a principal 

capacity and effecting a market intermediation function, in a transaction that is not 

conducted on an exchange or similar anonymous trading facility, as long as the trade is 

promptly cleared and settled through a clearing agency or derivatives clearing 

organization. This provision recognizes that not all financial instruments are traded on an 

exchange or similar anonymous trading facility and, thus, allows foreign banking entities 

to trade and contribute to market liquidity in all types of U.S. financial instruments 

without requiring separate market infrastructure to be developed outside the U.S. for such 

trading activity, which could result in inefficiencies and reduce U.S. market liquidity. 

Market intermediaries can serve the same general purpose as exchanges or similar trading 

facilities in intermediating between buyers and sellers, particularly in asset classes that do 

not generally trade on these exchanges or facilities, although this intermediation function 

may not be as immediate in the case of market intermediaries. 

In either case (i.e., for either an anonymous trade or a trade with an unaffiliated 

market intermediary), if the U.S. counterparty to the transaction is a banking entity 

subject to section 13 and these rules, it must comply with an exemption to the prohibition 

on proprietary trading, such as the market-making exemption or the exemption for 

riskless principal transactions. Allowing foreign banking entities to trade with 

unaffiliated U.S. market intermediaries, including banking entities engaged in permitted 

market making-related activities, expands the range of potential buyers and sellers for 
464

which the U.S. entities can trade and may result in more efficient and timely matching of 

trades, reducing inventory risks to the U.S. market intermediary. At the same time, this 

exemption does not permit a U.S. market intermediary that is subject to section 13 of the 

BHC Act to conduct trading activities other than in compliance with the provisions of 

section 13. Thus, the Agencies believe it is appropriate to allow foreign banking entities 

to conduct such trading under the exemption in section 13(d)(1)(J).

To reduce risks to U.S. entities and the potential for evasion, the provisions 

allowing trading with U.S. entities include two additional protections. First, the final rule 

does not allow a foreign banking entity to trade through an affiliated U.S. entity under the 

exemption out of concern that it could increase the risk of evasion.1536 Second, a foreign 

banking entity’s trades conducted through an unaffiliated market intermediary on an 

exchange or conducted directly with an unaffiliated market intermediary must be 

promptly cleared and settled through a clearing agency or derivatives clearing 

organization acting as central counterparty. Consistent with the goals of section 13 to 

reduce risk to banking entities and the U.S. financial system, this requirement is designed 

to reduce risk to U.S. entities arising from foreign banking entities’ proprietary trading 

activity, particularly counterparty risk, and preclude foreign banking entities from relying 

on the exemption for trading that creates exposure of U.S. counterparties pursuant to 

 

1536 In addition, allowing a foreign banking entity to trade through or with a U.S. affiliate under the 

exemption for trading activity of a foreign banking entity could give the foreign banking entity a 

competitive advantage over U.S. banking entities that are subject to limitations on their trading activities. 

Thus, the Agencies are not permitting a foreign banking entity to trade through a U.S. affiliate as agent, as 

requested by some commenters. See, e.g., IIB/EBF. However, the Agencies recognize that, with respect to 

trading anonymously, there is no way to know the identity of the counterparty to the trade. Thus, a foreign 

banking entity would not be in violation of this rule if it traded through an unaffiliated market intermediary 

on an exchange, in accordance with the exemption for trading activity of a foreign banking entity, and the 

counterparty to its trade happened to be an affiliated entity. 
465

bilateral, uncleared transactions, which poses heightened counterparty credit risks.1537 

This condition is also consistent with the systemic risk benefits of central clearing and 

may incentivize the use of central clearing for trading by foreign banking entities and 

foreign affiliates of U.S. banking entities. The Agencies believe this approach is 

consistent with and reinforces the goals of the central clearing framework of Title VIII of 

the Dodd-Frank Act. 

The final rule does not allow a foreign banking entity to trade with a broader 

range of U.S. entities under the exemption because the Agencies are concerned such an 

approach may result in adverse competitive impacts between U.S. banking entities and 

foreign banking entities with respect to their trading in the United States, which could 

harm the safety and soundness of banking entities and U.S. financial stability. For 

example, such an approach could allow foreign banking entities to act as market makers 

for U.S. customers under the exemption in § __.6(e) of the final rule so long as the 

foreign banking entity held the risk of its market-making trades outside the United States. 

In turn, this could give foreign banking entities a competitive advantage over U.S. 

banking entities with respect to U.S. market-making activities because foreign banking 

entities could trade directly with U.S. non-banking entities without incurring the 

additional costs, or being subject to the limitations, associated with the market-making or 

other exemptions under the rule. This competitive disparity in turn could create a 

significant potential for regulatory arbitrage. The Agencies do not believe this result was 

 

1537 As discussed above, centralized clearing redistributes counterparty risk among members of a clearing 

agency or derivatives clearing organization through mutualization of losses, reducing the likelihood of 

sequential counterparty failure and contagion. See supra note 266 and accompanying text.
466

intended by the statute. Instead, the final rule seeks to alleviate the concern that an overly 

broad approach to the exemption (e.g., permitting trading with all U.S. counterparties) 

may result in competitive impacts and increased risks to the U.S. financial system, while 

mitigating the concern that an overly narrow approach to the exemption (e.g., prohibiting 

trading with any U.S. counterparty) may cause market bifurcations, reduce the efficiency 

and liquidity of markets, and harm U.S. market participants. 

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

Section __.8 of the proposed rule implemented section 13(d)(2) of the BHC 

Act,1538 which provides that a banking entity may not engage in certain exempt activities 

(e.g., permitted market making-related activities, risk-mitigating hedging, etc.) if the 

activity would involve or result in a material conflict of interest between the banking 

entity and its clients, customers, or counterparties; result, directly or indirectly, in a 

material exposure by the banking entity to a high-risk asset or a high-risk trading 

strategy; or pose a threat to the safety and soundness of the banking entity or U.S. 

financial stability.1539 The Agencies sought comment on proposed definitions of the 

terms “material conflict of interest,” “high-risk asset,” and “high-risk trading strategy” 

for these purposes.

With respect to general comments regarding the proposed rule, commenters 

generally agreed on the need to limit banking entities’ proprietary trading activities so as 

 

1538 Section __.8 of the proposed rule regarding limitations on permitted trading activities is consistent with 

§ __.17 of the proposed rule regarding other limitations on permitted covered funds activities. 

Accordingly, the discussion regarding proposed rule §__.8 and final rule §__.7 in this part also pertain to 

§__.17 of the proposed rule and § __.16 of the final rule. See also Part IV.B.6., infra.

1539 See 12 U.S.C. 1851(d)(2).
467

to avoid material conflicts of interest and material exposures to high-risk trading 

strategies and high-risk assets.1540 One commenter expressed support for the Agencies’ 

proposed approach, stating that the proposed rule was clear and structured in such a 

manner so that it should remain effective even as financial markets evolve and 

change.1541 As discussed in greater detail below, most commenters suggested 

amendments, clarification, or alternative approaches. For example, some commenters 

expressed concern regarding the application of the prudential backstops to the activities 

of foreign banking entities.1542 The Agencies did not receive any comments on the 

prohibition against transactions or activities that pose a threat to the safety or soundness 

of the banking entity or the financial stability of the United States.

As explained in detail below, the Agencies have carefully reviewed comments on 

the proposed rule’s implementation of the prudential backstops under section 13(d)(2) of 

the BHC Act, including commenters’ suggestions for expanding, contracting, or revising 

the proposed rule. After carefully considering these comments, the Agencies continue to 

believe the expansive scope of section 13 of the BHC Act supports a similarly inclusive 

approach focusing on the facts and circumstances of each potential conflict or high-risk 

activity. Therefore, and in consideration of all issues discussed below, the Agencies are 

adopting the final rule substantially as proposed.1543 The Agencies intend to develop 

additional guidance regarding best practices for addressing potential material conflicts of 

 

1540 See, e.g., Sens. Merkley & Levin (Feb. 2012); Public Citizen; Paul Volcker. 

1541 See Alfred Brock.

1542 See IIB/EBF; Ass’n. of German Banks. 

1543 The Agencies note that proposed Appendix C, which required banking entities to describe how they 

comply with these provisions, will be adopted as Appendix B with similar requirements regarding 

compliance with the limitations on permitted activities.
468

interest, high-risk assets and trading strategies and practices that pose significant risks to 

safety and soundness and to the U.S. financial system as the Agencies and banking 

entities gain experience with implementation of the requirements and limitations in 

section 13 of the BHC Act and this rule, which are all generally designed to limit risky 

behavior in trading and investment activities.

a. Scope of “Material Conflict of Interest”

1. Proposed rule

Section __.8(b) of the proposed rule defined the scope of material conflicts of 

interest which, if arising in connection with a permitted trading activity, were prohibited 

under the proposal.1544 As noted in the proposal, conflicts of interest may arise in a 

variety of circumstances related to permitted trading activities. For example, a banking 

entity may acquire substantial amounts of nonpublic information about the financial 

condition of a particular company or issuer through its lending, underwriting, investment 

advisory or other activities which, if improperly transmitted to and used in trading 

operations, would permit the banking entity to use such information to its customers’, 

clients’ or counterparties’ disadvantage. Similarly, a banking entity may conduct a 

transaction that places the banking entity’s own interests ahead of its obligations to its 

customers, clients or counterparties, or it may seek to gain by treating one customer 

involved in a transaction more favorably than another customer involved in that 

transaction. Concerns regarding conflicts of interest are likely to be elevated when a 

transaction is complex, highly structured or opaque, involves illiquid or hard-to-value 

 

1544 Section __.17(b) of the proposed rule defined the scope of material conflicts of interest which, if 

arising in connection with permitted covered fund activities, are prohibited.
469

instruments or assets, requires the coordination of multiple internal groups (such as 

multiple trading desks or affiliated entities), or involves a significant asymmetry of 

information or transactional data among participants.1545 In all cases, the existence of a 

material conflict of interest depends on the specific facts and circumstances.1546

To address these types of material conflicts of interest, § __.8(b) of the proposed 

rule specified that a material conflict of interest between a banking entity and its clients, 

customers, or counterparties exists if the banking entity engages in any transaction, class 

of transactions, or activity that would involve or result in the banking entity’s interests 

being materially adverse to the interests of its client, customer, or counterparty with 

respect to such transaction, class of transactions, or activity, unless the banking entity has 

appropriately addressed and mitigated the conflict of interest, and subject to specific 

requirements provided in the proposal, through either (i) timely and effective disclosure, 

or (ii) information barriers.1547 Unless the conflict of interest is addressed and mitigated 

in one of the two ways specified in the proposal, the related transaction, class of 

transactions or activity would be prohibited under the proposed rule, notwithstanding the 

fact that it may be otherwise permitted under §§ __.4 through __.6 of the proposed rule.

1548

 

1545 See, e.g., U.S. Senate Permanent Subcommittee on Investigations, WALL STREET AND THE FINANCIAL 

CRISIS: ANATOMY OF A FINANCIAL COLLAPSE (Apr. 13, 2011), available at

http://hsgac.senate.gov/public/_files/Financial_Crisis/FinancialCrisisReport.pdf.

1546 See Joint Proposal, 76 FR at 68,893.

1547 See proposed rule § __.8(b)(1). 

1548 See Joint Proposal, 76 FR at 68,893.
470

However, the Agencies determined that while these conflicts may be material for 

purposes of the proposed rule, the mere fact that the buyer and seller are on opposite 

sides of a transaction and have differing economic interests would not be deemed a 

“material” conflict of interest with respect to transactions related to bona fide

underwriting, market making, risk-mitigating hedging or other permitted activities, 

assuming the activities are conducted in a manner that is consistent with the proposed 

rule and securities, derivatives, and banking laws and regulations. 

Section __.8(b)(1) of the proposed rule described the two requirements that must 

be met in cases where a banking entity addresses and mitigates a material conflict of 

interest through timely and effective disclosure. First, § __.8(b)(1)(A)(i) of the proposed 

rule required that the banking entity, prior to effecting the specific transaction or class or 

type of transactions, or engaging in the specific activity, for which a conflict may arise, 

make clear, timely and effective disclosure of the conflict or potential conflict of interest, 

together with any other necessary information. This would also require such disclosure 

to be provided in reasonable detail and in a manner sufficient to permit a reasonable 

client, customer, or counterparty to meaningfully understand the conflict of interest.1549 

Disclosure that is only general or generic, rather than specific to the individual, class, or 

type of transaction or activity, or that omits details or other information that would be 

necessary to a reasonable client’s, customer’s, or counterparty’s understanding of the 

conflict of interest, would not meet this standard. Second, § __.8(b)(1)(ii) of the 

proposed rule required that the disclosure be made explicitly and effectively, and in a 

 

1549 See id.
471

manner that provides the client, customer, or counterparty the opportunity to negate, or 

substantially mitigate, any materially adverse effect on the client, customer, or 

counterparty that was created or would be created by the conflict or potential conflict.1550 

The Agencies noted that, in order to provide the requisite opportunity for the 

client, customer or counterparty to negate or substantially mitigate the disadvantage 

created by the conflict, the disclosure would need to be provided sufficiently close in 

time to the client’s, customer’s, or counterparty’s decision to engage in the transaction or 

activity to give the client, customer, or counterparty an opportunity to meaningfully 

evaluate and, if necessary, take steps that would negate or substantially mitigate the 

conflict. Disclosure provided far in advance of a particular transaction, such that the 

client, customer, or counterparty is unlikely to take that disclosure into account when 

evaluating the transaction, would not suffice. Conversely, disclosure provided without a 

sufficient period of time for the client, customer, or counterparty to evaluate and act on 

the information it receives, or disclosure provided after the fact, would also not suffice 

under the proposal. The Agencies note that the proposed definition would not prevent or 

require disclosure with respect to transactions or activities that align the interests of the 

banking entity with its clients, customers, or counterparties or that otherwise do not 

involve “material” conflicts of interest as discussed above.

The proposed disclosure standard reflected the fact that some types of conflicts 

may be appropriately resolved through the disclosure of clear and meaningful 

information to the client, customer, or counterparty that provides such party with an 

 

1550 See proposed rule § __.8(b)(1)(B).
472

informed opportunity to consider and negate or substantially mitigate the conflict. 

However, in the case of a conflict in which a client, customer, or counterparty does not 

have sufficient information and opportunity to negate or mitigate the materially adverse 

effect on the client, customer, or counterparty created by the conflict, the existence of that 

conflict of interest would prevent the banking entity from availing itself of any exemption 

(e.g., the underwriting or market-making exemptions) with respect to the relevant 

transaction, class of transactions, or activity. The Agencies note that the proposed 

disclosure provisions were provided solely for purposes of the proposed rule’s definition 

of material conflict of interest, and did not affect a banking entity’s obligation to comply 

with additional or different disclosure or other requirements with respect to a conflict 

under applicable securities, banking, or other laws (e.g., section 27B of the Securities

Act, which governs conflicts of interest relating to certain securitizations; section 206 of 

the Investment Advisers Act of 1940, which governs conflicts of interest between 

investment advisers and their clients; or 12 CFR 9.12, which applies to conflicts of 

interest in the context of a national bank’s fiduciary activities).

Section __.8(b)(2) of the proposed rule described the requirements that must be 

met in cases where a banking entity uses information barriers that are reasonably 

designed to prevent a material conflict of interest from having a materially adverse effect 

on a client, customer or counterparty. Information barriers can be used to restrict the 

dissemination of information within a complex organization and to prevent material 

conflicts by limiting knowledge and coordination of specific business activities among 

units of the entity. Examples of information barriers include, but are not limited to, 

restrictions on information sharing, limits on types of trading, and greater separation 
473

between various functions of the firm. Information barriers may also require that banking 

entity units or affiliates have no common officers or employees. Such information 

barriers have been recognized in Federal securities laws and rules as a means to address 

or mitigate potential conflicts of interest or other inappropriate activities.1551

In order to address and mitigate a conflict of interest through the use of the 

information barriers pursuant to § __.8(b)(2) of the proposed rule, a banking entity would 

be required to establish, maintain, and enforce information barriers that are memorialized 

in written policies and procedures, including physical separation of personnel, functions, 

or limitations on types of activity, that are reasonably designed, taking into consideration 

the nature of the banking entity’s business, to prevent the conflict of interest from 

involving or resulting in a materially adverse effect on a client, customer, or counterparty. 

Importantly, the proposed rule also provided that, notwithstanding a banking entity’s 

establishment of such information barriers if the banking entity knows or should 

reasonably know that a material conflict of interest arising out of a specific transaction, 

class or type of transactions, or activity may involve or result in a materially adverse 

 

1551 See, e.g., 15 U.S.C. 78c(a)(4)(B)(i)(I) – (IV) (finding that disclosure and physical separation of 

personnel and activities addresses the potential that consumers might be misled by the broker-dealer 

activities of banks). 15 U.S.C. 80b-6(3) (“It shall be unlawful for any investment adviser, by use of the 

mails or any means or instrumentality of interstate commerce, directly or indirectly . . . acting as principal 

for his own account, knowingly to sell any security to or purchase any security from a client, or acting as 

broker for a person other than such client, knowingly to effect any sale or purchase of any security for the 

account of such client, without disclosing to such client in writing before the completion of such transaction 

the capacity in which he is acting and obtaining the consent of the client to such transaction.”). See also

Form ADV, the form used by investment advisers to register with the Securities and Exchange Commission 

and state securities authorities, and, in particular, Form ADV Part 2: Uniform Requirements for the 

Investment Adviser Brochure and Brochure Supplements. A registered investment adviser generally must 

deliver the Form ADV brochure, which contains disclosure about conflicts of interest, to its prospective and 

existing clients. See 17 CFR 275.204-3; Amendments to Form ADV, Investment Advisers Act Release No. 

3060 (July 28, 2010), 75 FR 49234 (Aug. 12, 2010) (“We are adopting a requirement that investment 

advisers registered with us provide prospective and existing clients with a narrative brochure written in 

plain English . . . We believe these amendments will greatly improve the ability of clients and prospective 

clients to evaluate firms offering advisory services and the firms' personnel, and to understand relevant 

conflicts of interest that the firms and their personnel face and their potential effect on the firms' services.”).
474

effect on a client, customer, or counterparty, the banking entity may not rely on those 

information barriers to address and mitigate any conflict of interest. In such cases, the 

transaction or activity would be prohibited, unless the banking entity otherwise complied 

with the requirements of proposed § __.8(b)(1).1552 This aspect of the proposal was 

intended to make clear that, in specific cases in which a banking entity has established an 

information barrier but knows or should reasonably know that it has failed or will fail to 

prevent a conflict of interest arising from a specific transactions or activity that 

disadvantages a client, customer, or counterparty, the information barrier is insufficient to 

address that conflict and the transaction would be prohibited, unless the banking entity is 

otherwise able to address and mitigate the conflict through timely and effective disclosure 

under the proposal.1553 

The proposed definition of material conflict of interest did not address instances 

in which a banking entity has made a material misrepresentation to its client, customer, or 

counterparty in connection with a transaction, class of transactions, or activity, as such 

transactions or activity appears to involve fraud rather than a conflict of interest. This is 

because such misrepresentations are generally illegal under a variety of Federal and State 

regulatory schemes (e.g., the Federal securities laws).1554 In addition, the Agencies noted 

that any activity involving a material misrepresentation to, or other fraudulent conduct 

with respect to, a client, customer, or counterparty would not be permitted under the 

proposed rule in the first instance. 

 

1552 See proposed rule § __.8(b)(2).

1553 See Joint Proposal, 76 FR at 68,894.

1554 See 12 U.S.C. 1851(g)(3).
475

2. Comments on the proposed limitation on material conflicts of interest

Commenters expressed a variety of views regarding the treatment of material 

conflicts of interest under the proposal, including the manner in which conflicts may be 

mitigated or eliminated. One commenter believed that the proposed material conflict of 

interest provisions would be effective.1555 Another commenter stated that conflicts of 

interest were unavoidable but that the final rule should ensure that institutional investors 

have confidence that the banking entities they are dealing with are not operating at a 

conflict with investors’ goals.1556 

Other commenters expressed differing views on whether the proposed rule’s 

provisions for addressing conflicts of interest through disclosure or information barriers 

were appropriate. A few commenters stated there is no statutory basis for allowing 

conflicts of interest in connection with exempted activities even if banking entities 

provide disclosure or establish information barriers, and the rule should prohibit banking 

entities from engaging in permitted activities if material conflicts of interest exist.1557 

One commenter believed the definition did not appear to address issues of customer 

favoritism, in which a bank is financially incentivized to treat one customer more 

favorably than another (typically less sophisticated) customer.1558 Some commenters 

believed that the proposed definition of material conflict of interest was too vague or 

narrow and suggested it should be strengthened by either expanding the types of 

 

1555 See Alfred Brock.

1556 See Paul Volcker.

1557 See Public Citizen; Sens. Merkley & Levin; Occupy; AFR et al. (Feb. 2012). 

1558 See Public Citizen.
476

transactions that may result in a material conflict of interest or by imposing additional 

limitations or restrictions on transactions.1559 For instance, one commenter suggested the 

final rule consider depositors of a banking entity to be “customers” for the purpose of this 

provision, impose a fiduciary duty on any banking entity conducting an exempt activity 

pursuant to section 13(d)(1) of the BHC Act, and impose size restrictions on any banking 

entity engaging in proprietary trading under an exemption. This commenter also stated 

that a banking entity inherently has a material conflict of interest with its customer when 

it takes the opposite side of a transaction and, therefore, that the final rule should require 

a banking entity to disgorge all principal gains from transactions conducted pursuant to 

any exemption under section 13(d)(1) of the BHC Act, including market-making, trading 

in U.S. government obligations, insurance company activities and other exempt 

activities.1560 In addition, a few commenters stated that, if disclosure or information 

barriers were permitted to mitigates conflicts under the final rule, clients of the banking 

entity must be required to acknowledge in writing that they understand the potential 

conflicts of interest present in order for any disclosure to be effective in mitigating a 

conflict of interest.1561 

Some commenters believed that the Agencies should consider issuing additional 

guidance regarding the definition of material conflicts of interest, high-risk assets, and 

high-risk trading strategies.1562 One commenter stated that the final rule should limit the 

 

1559 See, e.g., Occupy; AFR et al. (Feb. 2012); Sens. Merkley & Levin (Feb. 2012).

1560 See Occupy.

1561 See, e.g., Lynda Aiman-Smith; AFR et al. (Feb. 2012); Sens. Merkley & Levin (Feb. 2012). 

1562 See Rep. Blumenauer et al.; Sens. Merkley & Levin (Feb. 2012).
477

extraterritorial impact of section 13 by only applying the restrictions of section 13(d)(2) 

of the BHC Act to the U.S. operations or activities of foreign banking entities and that the 

regulation of safety and soundness of the foreign operations and activities of foreign 

banking entities should be left to the home country regulator or supervisor of a foreign 

banking entity.1563

Some commenters provided general suggestions on enhancing compliance with 

the prohibition on material conflicts of interest. A common suggestion among industry 

participants was to implement the prohibition on material conflicts of interest under these 

rules in a manner consistent with the implementation of section 621 of Dodd-Frank.1564 

One commenter suggested that trading in government obligations should not be subject to 

the material conflict of interest provision because government obligations are broadly 

traded and do not present the types of conflicts addressed by the proposed rule.1565 In 

contrast, one commenter stated banking entities should be required to receive pre-trade 

clearance from the Federal Reserve for trading in certain government obligations like 

municipal bonds and mortgage-backed securities, due to their role in the 2008 financial 

crisis. 1566 

a. Disclosure

Some commenters expressed concern about potential difficulties associated with 

the proposed disclosure provision and provided suggestions to address these difficulties. 

 

1563 See IIB/EBF; EBF.

1564 See ASF (Conflicts) (Feb. 2012); SIFMA et al. (Prop. Trading) (Feb. 2012); SIFMA (Securitization) 

(Feb. 2012); LSTA (Feb. 2012); Sens. Merkley & Levin (Feb. 2012).

1565 See BDA (Feb. 2012).

1566 See Occupy.
478

For example, a few commenters noted the difficulty in determining what constitutes 

effective disclosure,1567 especially in relation to the volume of disclosure or the impact of 

information asymmetry in illiquid markets.1568 One commenter stated that unless the rule 

requires full disclosure of a banking entity’s trading strategy and the rationale behind it, 

allowing disclosure will permit the banking entity to protect itself without adequately 

mitigating the harm of the conflict. This commenter also noted the practical difficulties 

associated with disclosing anticipated future conflicts and conflicts in the context of 

block trading. 1569 Another commenter stated market participants understand inherent 

conflicts of interest and believed disclosure in such situations would be burdensome and 

unnecessary.1570 One commenter stated that the rule should require a banking entity to 

negate, not just permit the client, customer, or counterparty to substantially mitigate, the 

materially adverse effect of the conflict.1571

A few commenters disagreed with the disclosure provision, noting that Congress 

specifically considered and rejected disclosure as a mitigation method for purposes of 

section 621 of the Dodd-Frank Act and that this indicates the Agencies should not permit 

a material conflict of interest to be mitigated through disclosure for purposes of section 

13 of the BHC Act.1572 

 

1567 See Occupy; ISDA (Apr. 2012); Better Markets (Feb. 2012); SIFMA et al. (Prop. Trading) (Feb. 

2012); ICFR.

1568 See Occupy.

1569 See Public Citizen; See also AFR et al. (Feb. 2012).

1570 See SIFMA et al. (Prop. Trading) (Feb. 2012)

1571 See Occupy.

1572 See, e.g, Occupy.
479

Commenters were in disagreement as to the extent and timing of disclosure that 

should be required under the rule. Some commenters stated the disclosure provisions 

would slow trading, and suggested the rule require only one-time disclosure at the 

inception of the business relationship1573 or periodic disclosures to address ongoing 

conflicts.1574 One of these commenters noted that extensive trade-by-trade disclosure 

requirements create the risk of unintended breaches of confidentiality.1575 Other

commenters requested the Agencies provide additional guidance, such as when 

transaction-specific disclosure is necessary,1576 whether disclosure should be written,1577

and what constitutes “reasonable detail.”1578 

In addition, some commenters provided suggestions on whether parties should be 

required to acknowledge receipt of disclosures1579 or affirmatively consent to the 

conflict.1580 One commenter proposed allowing a majority of a committee of 

independent board members to approve consent to waivers of conflicts of interest.1581 

One commenter believed disclosure and consent by a sophisticated investor ought to be 

sufficient to serve as a waiver to most types of conflict of interest.1582 In contrast, 

 

1573 See ISDA (Apr. 2012); Arnold & Porter.

1574 See SIFMA et al. (Prop. Trading) (Feb. 2012); ISDA (Apr. 2012).

1575 See ISDA (Apr. 2012).

1576 See SIFMA et al. (Prop. Trading) (Feb. 2012);

1577 See Sens. Merkley & Levin (Feb. 2012); ICFR (questioning the effectiveness of enforcement 

mechanisms if oral disclosure permitted under the rule); Occupy.

1578 See ICFR.

1579 See, e.g., Arnold & Porter; Sens. Merkley & Levin (Feb. 2012); Better Markets (Feb. 2012); Public 

Citizen; AFR et al. (Feb. 2012); Lynda Aiman-Smith.

1580 See Public Citizen; Sens. Merkley & Levin (Feb. 2012); Better Markets (Feb. 2012).

1581 See Arnold & Porter.

1582 See Arnold & Porter.
480

another commenter asserted general disclosure or waivers of conflicts should never be 

allowed, and the Agencies should not provide any additional guidance as to the extent, 

timing, frequency, or scope of disclosure appropriate in any given situation.1583 

Similarly, one commenter asserted the Agencies should not provide guidance on what 

issues can be addressed by disclosure, as such guidance would be “dangerously 

prescriptive and would introduce moral hazards.”1584

b. Information barriers

A few commenters addressed the information barriers provision of the proposed 

rule. One commenter expressed support for the proposed approach,1585 while three 

commenters stated this provision was ineffective.1586 A few commenters opposed the 

information barriers provision because they believed information barriers would make 

conflict mitigation more difficult1587 or would effectively mandate that no single officer 

be aware of a banking entity’s collective operations.1588 

A few commenters also requested the Agencies provide guidance regarding the 

use of information barriers. One commenter requested the Agencies specify the type and 

nature of information barriers and where they are practical to implement.1589 Another 

commenter believed that the Agencies should view information barriers favorably. This 

 

1583 See Alfred Brock (stating there is no such thing as a “sophisticated party”). 

1584 See ICFR.

1585 See Alfred Brock.

1586 See Better Markets (Feb. 2012); Occupy; Public Citizen.

1587 See Occupy.

1588 See Public Citizen (contending that this would undermine the Dodd-Frank Act’s requirement to 

promote sound management, ensure financial stability, and reduce systemic risk).

1589 See AFR et al. (Feb. 2012).
481

commenter stated that information barriers should be permitted for addressing conflicts 

of interest unless the banking entity knows, or should reasonably know, that the 

information barrier would not be effective in restricting the spread of information that 

could lead to the conflict.1590 To provide greater clarity, another commenter 

recommended the Agencies provide guidance on certain elements that may be used to 

determine the reasonableness of information barriers, such as memorialization of 

procedures and documentation of actions taken pursuant to such procedures.1591 

3. Final rule

After considering carefully comments received on the proposal as well as the 

purpose and language of section 13 of the BHC Act, the Agencies have adopted the final 

rule largely as proposed. Under the final rule, a banking entity that engages in any 

transaction, class of transactions, or activity that would involve or result in the banking 

entity’s interests being materially adverse to the interests of its client, customer, or 

counterparty with respect to the transaction, class of transactions, or activity, must 

address and mitigate the conflict of interest, where possible, through either timely and 

effective disclosure or informational barriers.1592 This requirement is in addition to, and 

does not supplant, any limitations or prohibitions contained in other laws. For example, a 

 

1590 See SIFMA et al. (Prop. Trading) (Feb. 2012).

1591 See ISDA (Apr. 2012) (arguing that its suggested guidance was derived from prior SEC and selfregulatory organization guidance on information barriers).

1592 The Agencies note that the definition of material conflict of interest and the disclosure provisions 

related to that definition apply solely for purposes of the rule’s definition of material conflict of interest, 

and does not affect the scope of that term in other contexts or a banking entity’s obligation to comply with 

additional or different requirements with respect to a conflict under applicable securities, banking, or other 

laws (e.g., section 27B of the Securities Act, which governs conflicts of interest relating to certain 

securitizations; section 206 of the Investment Advisers Act of 1940, which applies to conflicts of interest 

between investment advisers and their clients; or 12 CFR 9.12, which applies to conflicts of interest in the 

context of a national bank’s fiduciary activities).
482

material misrepresentation by a banking entity to its client, customer, or counterparty in 

connection with market-making activities may involve fraud and is generally illegal 

under a variety of Federal and State regulatory schemes (e.g., the Federal securities 

laws)1593 as well as being prohibited under section 13 of the BHC Act. 

The Agencies believe that certain of commenters’ suggested modifications to the 

proposed rule are outside the scope of the Agencies’ statutory authority. For example, 

the Agencies do not believe section 13 of the BHC Act provides statutory authority to 

directly impose limits on the size of banking entities1594 or to implement specific 

fiduciary standards on banking entities.1595 In addition, the Agencies do not believe it is 

appropriate to expand the definition of “customer” to include individuals and entities that 

solely make use of the bank’s traditional banking services because section 13 is focused 

on the trading activities and investment in which banking entities may be involved.1596 

The final rule recognizes that a banking entity may address or substantially 

mitigate a potential conflict of interest by making adequate disclosures or creating and 

enforcing informational barriers. Some commenters argued that the legislative history of 

the Dodd-Frank Act suggests that disclosure or informational barriers are not adequate to 

address a material conflict of interest. 1597 However, section 13 of the BHC Act directs 

the Agencies to define “material conflict of interest” and gives the Agencies discretion to 

determine how to define this term for purposes of the rule. Under the final rule, a 

 

1593 See 12 U.S.C. 1851(g)(3).

1594 See Occupy.

1595 See Occupy. 

1596 See Occupy.

1597 See Public Citizen; Sens. Merkley & Levin (Feb. 2012); Occupy; AFR et al. (Feb. 2012). 
483

material conflict of interest exists when the banking entity engages in transactions or 

activities that cause its interests to be materially adverse to the interests of its client, 

customer, or counterparty. At the same time, the final rule provides banking entities the 

opportunity to take certain actions to address the conflict, such that the conflict does not 

have a materially adverse effect on that client, customer, or counterparty. Under the final 

rule, a banking entity may address a conflict by establishing, maintaining, and enforcing 

information barriers reasonably designed to avoid a conflict’s materially adverse effect, 

or by disclosing the conflict in a manner that allows the client, customer, or counterparty 

to substantially mitigate or negate any materially adverse effect created by the conflict of 

interest. The Agencies believe that, to the extent the materially adverse effect of a 

conflict has been substantially mitigated, negated, or avoided, it is appropriate to allow 

the transaction, class of transaction, or activity under the final rule. Continuing to view 

the conflict as a material conflict of interest under these circumstances would not appear 

to benefit the banking entity’s client, customer, or counterparty. The disclosure standard 

under the final rule requires clear and meaningful information be provided to the client, 

customer, or counterparty in a manner that provides such party the opportunity to negate 

or substantially mitigate, any materially adverse effects on such party created by the 

conflict.

Some commenters suggested that obtaining consent to or waiver of disclosed 

conflicts should be sufficient to comply with the rule.1598 The Agencies do not believe 

that consent or waivers alone are sufficient to address material conflicts of interest, and 

continue to believe that any banking entity using disclosure to address a conflict of 

 

1598 See, e.g., Arnold & Porter.
484

interest should be required to provide any client, customer, or counterparty with whom 

the banking entity has a conflict with the opportunity to negate or substantially mitigate 

the materially adverse effect of the conflict on the client, customer, or counterparty. The 

Agencies believe this approach, which applies equally to all types of clients, customers, 

or counterparties, will reduce the potential for unintended or differing impacts on certain 

types of clients, customers, or counterparties. In response to one commenter’s suggestion 

that the final rules require full negation of the materially adverse effect on the client, 

customer, or counterparty, the Agencies continue to believe it is appropriate to allow a 

transaction or activity to continue if the client, customer, or counterparty is provided an 

opportunity to substantially mitigate the materially adverse effect.1599 The Agencies are 

concerned that requiring the conflict’s impact to be fully negated under all circumstances 

could prevent a banking entity from providing a service to a particular customer despite 

that customer’s knowledge of the conflict and ability to substantially reduce the effect of 

the conflict on that customer.

With regards to commenters’ statements that information barriers and disclosure 

will not work to address the harm caused by conflicts, the Agencies emphasize that under 

the final rule, like the proposed rule, a banking entity may use disclosure or information 

barriers to address a conflict only in those instances where the disclosure provides the 

client, customer, or counterparty with the opportunity to negate or substantially mitigate 

any materially adverse effect of the conflict on that entity or the information barriers are 

reasonably designed to prevent the conflict of interest from involving or resulting in a 

materially adverse effect on a client, customer, or counterparty. If the banking entity is 

 

1599 See Occupy.
485

unable to effectively use disclosure or information barriers in a way that meets the rule’s 

requirements, then the banking entity is prohibited from engaging in the conflicted 

transaction, class of transaction, or activity. Additionally, the Agencies note that the 

material conflict of interest provisions in the final rule do not preempt any duties owed to 

parties outside the transaction, including any duty of confidentiality.1600

In response to commenters’ statements that the volume of information included in 

a disclosure or the manner in which the disclosure is presented may make it difficult for a 

customer to identify and understand the relevant information regarding the conflict,1601

the Agencies note that the final rule requires disclosure of the conflict or potential 

conflict be clear, timely, and effective and that the disclosure includes any other 

necessary information. Disclosure is also required to be provided in reasonable detail and 

in a manner sufficient to permit a reasonable client, customer, or counterparty to 

meaningfully understand the conflict of interest.1602 Thus, disclosure that is only general 

or generic, that omits details or other information that would be necessary to a reasonable 

client’s, customer’s, or counterparty’s understanding of the conflict of interest, or that is 

hidden in a large volume of needless information would not meet this standard. The 

Agencies believe these provisions of the final rule are designed to ensure that customers 

receive sufficient information about the conflict of interest so that they are well informed 

 

1600 See ISDA (Apr. 2012).

1601 See Better Markets (Feb. 2012) (suggesting that a disclosure regime can facilitate abuse by enabling 

market participants to point to obscure and meaningless disclosure as a shield against liability); Occupy 

(arguing that a large volume of disclosed information can be difficult to understand or can serve to hide 

relevant information).

1602 See final rule § __.7(b)(1)(i) and final rule § __.16(b)(1)(i).
486

and, as required by the rule, able to negate or substantially mitigate any materially 

adverse effect of the conflict.

In addition to requiring that customers are provided with detailed information 

about the conflict, the final rule, like the proposal, requires that disclosure is made prior 

to effecting the specific transaction or class or type of transactions, or engaging in the 

specific activity, for which a conflict may arise and is otherwise timely. As a result, 

under § __.7(b)(2)(i), disclosure must be provided sufficiently close in time to the 

client’s, customer’s, or counterparty’s decision to engage in the transaction or activity to 

give the client, customer, or counterparty an opportunity to meaningfully evaluate and 

take steps that would negate or substantially mitigate the conflict. This approach is 

similar to the approach permitted by a variety of consumer protection statutes and 

regulations for addressing potential conflicts of interest in consumer transactions.1603 

Some commenters requested that the final rule permit a conflict to be negated or 

substantially mitigated through generic or periodic disclosures, such as at the beginning 

of a trading relationship or on an annual basis. Other commenters stated that some 

 

1603 See, e.g., 15 U.S.C. 78c(a)(4)(B)(i)(I) – (IV) (finding that disclosure and physical separation of 

personnel and activities addresses the potential that consumers might be misled by the broker-dealer 

activities of banks); 15 U.S.C. 80b-6(3) (“It shall be unlawful for any investment adviser, by use of the 

mails or any means or instrumentality of interstate commerce, directly or indirectly . . . acting as principal 

for his own account, knowingly to sell any security to or purchase any security from a client, or acting as 

broker for a person other than such client, knowingly to effect any sale or purchase of any security for the 

account of such client, without disclosing to such client in writing before the completion of such transaction 

the capacity in which he is acting and obtaining the consent of the client to such transaction.”). See also

Form ADV, the form used by investment advisers to register with the Securities and Exchange Commission 

and state securities authorities, and, in particular, Form ADV Part 2: Uniform Requirements for the 

Investment Adviser Brochure and Brochure Supplements. A registered investment adviser generally must 

deliver the Form ADV brochure, which contains disclosure about conflicts of interest, to its prospective and 

existing clients. See 17 CFR 275.204-3; Amendments to Form ADV, Investment Advisers Act Release No. 

3060 (July 28, 2010), 75 FR 49234 (Aug. 12, 2010) (“We are adopting a requirement that investment 

advisers registered with us provide prospective and existing clients with a narrative brochure written in 

plain English . . . We believe these amendments will greatly improve the ability of clients and prospective 

clients to evaluate firms offering advisory services and the firms' personnel, and to understand relevant 

conflicts of interest that the firms and their personnel face and their potential effect on the firms' services.”).
487

conflicts, such as anticipated future conflicts or those that arise in the context of block 

trading, may require the banking entity to provide disclosure in advance of the actual 

conflict in order to allow the client, customer, or counterparty the opportunity to mitigate 

the materially adverse effect.1604 The Agencies emphasize, however, that disclosure 

provided far in advance of a particular transaction, such that the client, customer, or 

counterparty is unlikely to take that disclosure into account when evaluating the 

transaction, would not suffice. At the same time, disclosure provided without a sufficient 

period of time for the client, customer, or counterparty to evaluate and act on the 

information it receives, or disclosure provided after the fact, would also not be 

permissible disclosure under the final rules. The Agencies believe that, in considering 

the effectiveness of disclosures, the type, timing and frequency of disclosures depends 

significantly on the customer relationship, the type of transaction, and the matter that 

creates the potential conflict. Therefore, while written disclosures may be appropriate in 

certain circumstances, the Agencies are not requiring banking entities to provide written 

disclosure,1605 or obtain documentation showing that disclosure was received,1606 because 

the Agencies believe it is more important that disclosure is timely than documented. For 

example, if disclosure were required to be in writing, this might slow a banking entity’s 

ability to provide the disclosure to the relevant customer, which could impede the 

customer’s ability to consider the disclosed information and take steps to negate or 

substantially mitigate the conflict’s effect on the customer. The Agencies further note 

 

1604 See Public Citizen; See also AFR et al. (Feb. 2012).

1605 See Sens. Merkley & Levin (Feb. 2012); ICFR; Occupy; Alfred Brock.

1606 See, e.g., Arnold & Porter; Sens. Merkley & Levin (Feb. 2012); Better Markets (Feb. 2012); Public 

Citizen; AFR et al. (Feb. 2012); Lynda Aiman-Smith.
488

that the final rule does not prevent or require disclosure with respect to transactions or 

activities that align the interests of the banking entity with its clients, customers, or 

counterparties.

As noted above, one commenter expressed concern about the burdens of 

disclosing inherent conflicts and stated such disclosure is unnecessary because market 

participants understand inherent conflicts of interest.1607 As noted in the proposal, certain 

inherent conflicts, such as the mere fact that the buyer and seller are on opposite sides of 

a transaction and have differing economic interests, would not be deemed a “material” 

conflict of interest with respect to permitted activities.1608 

The Agencies continue to believe that information barriers can be an effective 

means of addressing conflicts of interest that may arise through, for example, the spread 

of information among trading desks engaged in different trading activities that may result 

in potentially inappropriate informational advantage. The Agencies are not adopting one 

commenter’s suggestion that the final rule specify the particular types of scenarios where 

information barriers may be effective1609 because, as discussed below, the Agencies

believe banking entities are better positioned to determine when information barriers may 

be effective given their trading activities and business structure.1610 In response to one 

 

1607 See SIFMA et al. (Prop. Trading) (Feb. 2012); but See Occupy.

1608 See Joint Proposal, 76 FR at 68,893. Thus, the Agencies are not adopting one commenter’s suggestion 

that the final rule consider all transactions by a banking entity to involve a material conflict of interest 

because the banking entity is necessarily on the opposite side of a transaction with its client, customer, or 

counterparty. See Occupy.

1609 See SIFMA et al. (Prop. Trading) (Feb. 2012).

1610 The Agencies note examples of information barriers that may address or substantially mitigate a 

material conflict of interest include restrictions on information sharing, limits on types of trading, 

prohibitions on common officers or employees between functions. Such information barriers have been 

recognized in Federal securities laws as a means to address or mitigate potential conflicts of interest or 

other inappropriate activities. See, e.g., 17 U.S.C. 78o(g).
489

commenter’s concern that information barriers may result in the banking entity’s 

management not being aware of the firm’s collective operations,1611 the Agencies note 

that information barriers do not require this result. Rather, information barriers would be 

established between relevant personnel or functions while other personnel, including 

senior managers, internal auditors, and compliance personnel, would have access to each 

group separated by the barrier.

The final rule continues to recognize that a banking entity may address or 

substantially mitigate a conflict of interest through use of information barriers. In order 

to address and mitigate a conflict of interest through the use of the information barriers, a 

banking entity is required to establish, maintain, and enforce information barriers that are 

memorialized in written policies and procedures, including physical separation of 

personnel, functions, or limitations on types of activity, that are reasonably designed, 

taking into consideration the nature of the banking entity’s business, to prevent the 

conflict of interest from involving or resulting in a materially adverse effect on a client, 

customer or counterparty.1612 Importantly, the final rule also provides that, 

 

1611 See Public Citizen.

1612 The Agencies note that a banking entity subject to Appendix B of the final rule must implement a 

compliance program that includes, among other things, policies and procedures that explain how the 

banking entity monitors and prohibits conflicts of interest with clients, customers, and counterparties. As 

part of maintaining and enforcing information barriers, a banking entity should have processes to review, 

test, and modify information barriers on a continuing basis. In addition, banking entities should have 

ongoing monitoring to maintain and to enforce information barriers, for example by identifying whether 

such barriers have not prevented unauthorized information sharing and addressing instances in which the 

barriers were not effective. This may require both remediating any identified breach as well as updating 

the information barriers to prevent further breaches, as necessary. Periodic assessment of the effectiveness 

of information barriers and periodic review of the written policies and procedures are also important to the 

maintenance and enforcement of effective information barriers and reasonably designed policies and 

procedures. Such assessments can be done either (i) internally by a qualified employee or (ii) externally by 

a qualified independent party. See Part IV.C.2.e., infra.
490

notwithstanding a banking entity’s establishment of such information barriers, if the 

banking entity knows or should reasonably know that a material conflict of interest 

arising out of a specific transaction, class or type of transactions, or activity may involve 

or result in a materially adverse effect on a client, customer, or counterparty, the banking 

entity may not rely on those information barriers to address and mitigate any conflict of 

interest. In such cases, the transaction or activity would be prohibited, unless the banking 

entity otherwise complied with the requirements of § __.7(b)(2)(i).1613

While some commenters requested that the final rule include additional 

limitations as part of implementing the material conflict of interest provisions in section 

13(d)(2), the Agencies do not believe additional restrictions are appropriate at this time. 

Concerns regarding conflicts of interest are likely to be elevated when a transaction is 

complex, highly structured or opaque, involves illiquid or hard-to-value instruments or 

assets, requires the coordination of multiple internal groups (such as multiple trading 

desks or affiliated entities), or involves a significant asymmetry of information or 

transactional data among participants.1614 In all cases, the question of whether a material 

conflict of interest exists will depend on an evaluation of the specific facts and 

circumstances. For example, certain simple transactions may implicate conflicts of 

interest that cannot be mitigated by disclosure or restricted by information barriers. On 

 

1613 If a conflict occurs to the detriment of a client, customer, or counterparty despite an information 

barrier, the Agencies would also expect the banking entity to review the effectiveness of its information 

barrier and make adjustments, as necessary, to avoid future occurrences, or review whether such 

information barrier is appropriate for that type of conflict.

1614 See, e.g., U.S. Senate Permanent Subcommittee on Investigations, WALL STREET AND THE FINANCIAL 

CRISIS: ANATOMY OF A FINANCIAL COLLAPSE (Apr. 13, 2011), available at

http://hsgac.senate.gov/public/_files/Financial_Crisis/FinancialCrisisReport.pdf.
491

the other hand, certain highly structured and complex transactions may involve conflicts 

of interest that can be mitigated by disclosure or restricted by information barriers. 

The Agencies believe that conflicts of interest must be determined and addressed 

in accordance with the specific facts and circumstances presented. One commenter 

suggested that the proposed rule be modified so that a banking entity could conclusively 

rely on information barriers unless it knows or has reason to know that policies, 

procedures, and controls establishing barriers would not be effective in restricting the 

spread of information.1615 By focusing on whether a banking entity knows or has reason 

to know that its policies and procedures would not be effective, rather than on what the 

banking entity knows or should reasonably know about a conflict of interest that may 

involve or result in a material adverse effect on a client, customer, or counterparty, the 

commenter’s suggestion has the potential to allow a banking entity to engage in 

transactions that involve a material conflict of interest. Therefore, the Agencies have 

determined not to adopt the commenter’s suggested approach. Similarly, the Agencies 

are rejecting some commenters’ suggestions that the final rule prescribe the method, 

scope, or specific content of disclosures.1616 The Agencies believe that specific guidance 

on disclosure may provide an incentive for banking entities to consider the form of 

disclosure provided, rather than whether disclosure can address the substance of the 

conflict as determined by the specific facts and circumstances at hand. Moreover, the 

Agencies believe banking entities are in the best position to identify and evaluate the 

 

1615 See SIFMA et al. (Prop. Trading) (Feb. 2012).

1616 See Occupy; ISDA (Apr. 2012); Better Markets (Feb. 2012); SIFMA et al. (Prop. Trading) (Feb. 

2012); ICFR; Alfred Brock; Public Citizen; AFR et al. (Feb. 2012); Arnold & Porter; Sens. Merkley & 

Levin (Feb. 2012).
492

conflicts present in their business as well as the most effective method of disclosing such 

conflicts. Banking entities must tailor their compliance programs to identify, monitor, 

and evaluate potential conflicts based on their business structure and specific activities 

and customer relationships.1617

Finally, some commenters requested that the final rule specifically address the 

conflict of interest provisions related to asset-backed securitizations contained in section 

621 of the Dodd-Frank Act. As explained below in Part IV.B.1., some securitizations are 

subject to the final rule, and others such as securitizations of loans are not subject to 

section 13 of the BHC Act. For any securitization that meets the definition of covered 

fund under the final rule, relationships with and transactions by a banking entity 

involving those securitizations remain subject to the requirements of section 13, including 

the requirements of section 13(d)(2). In addition, the banking entity would be subject to 

the limitations contained in section 621 of the Dodd-Frank Act and any rules regarding 

conflicts of interest relating to securitizations implemented under that section. The final 

rule in no way limits the application of section 621 of that Act with respect to an assetbacked security that is subject to that section.

b. Definition of “High-Risk Asset” and “High-Risk Trading Strategy”

 

1617 For a full discussion of the final rule’s compliance requirements, including a discussion of the specific 

compliance requirements applicable to different banking entities, See Part IV.C. of this Supplementary

Information, infra. 
493

1. Proposed rule

Section __.8(c) of the proposed rule defined “high-risk asset” and “high-risk 

trading strategy” for purposes of the proposed limitations on permitted trading activities. 

Proposed § __.8(c)(1) defined a “high-risk asset” as an asset or group of assets that 

would, if held by the banking entity, significantly increase the likelihood that the banking 

entity would incur a substantial financial loss or would fail. Proposed § __.8(c)(2) 

defined a “high-risk trading strategy” as a trading strategy that would, if engaged in by 

the banking entity, significantly increase the likelihood that the banking entity would 

incur a substantial financial loss or would fail.1618 

2. Comments on proposed limitations on high-risk assets and trading strategies 

With respect to the prohibition on transactions or activities that expose banking 

entities to high-risk assets or high-risk trading strategies, one commenter stated the 

provisions were effective,1619 while other commenters stated the proposed rule was too 

vague1620 and implied that banking entities may be required to exit positions in periods of 

market stress, further reducing liquidity.1621 A few commenters suggested the Agencies 

identify and prohibit certain types of high-risk assets or high-risk trading strategies under 

 

1618 See Joint Proposal, 76 FR at 68,894. The Agencies noted that a banking entity subject to proposed 

Appendix C must implement a compliance program that includes, among other things, policies and 

procedures that explain how the banking entity monitors and prohibits exposure to high-risk assets and 

high-risk trading strategies, and identifies a variety of assets and strategies (e.g., assets or strategies with 

significant embedded leverage). See Joint Proposal, 76 FR at 68,894 n.215.

1619 See Alfred Brock.

1620 See AFR et al. (Feb. 2012); Japanese Bankers Ass’n.; Investure; AllianceBernstein; Comm. on Capital 

Markets Regulation.

1621 See Obaid Syed.
494

the rule.1622 In contrast, one commenter asserted the Agencies should not specify certain 

classes of assets or trading strategies as “high risk.”1623 A few commenters requested 

greater clarity on the proposed definitions and suggested the Agencies provide additional 

guidance.1624 One of these commenters suggested the Agencies simplify compliance by 

establishing safe harbors, setting pre-determined risk limits within risk-based approaches, 

or allowing individual banking entities to set practical risk-based standards that the 

Agencies can review.1625 

One commenter suggested integrating the ban on high-risk activities throughout 

the rule and stated that, given the evolving nature of financial markets, regulators should 

have the flexibility to update criteria for identifying high-risk assets or high-risk trading

strategies.1626 This commenter stated the definition of high-risk trading strategies was 

appropriately broad and flexible, but suggested improving the rule by encompassing 

trading strategies that are so complex the risk or value thereof cannot be reliably and 

objectively determined.1627 The commenter also suggested that the quantitative 

measurements collected under proposed Appendix A could be utilized to help inform 

whether a high-risk asset or trading strategy exists.1628 

One commenter stated that in large concentrations, all assets can be high risk. 

This commenter suggested evaluating transactions on a case-by-case basis and believed 

 

1622 See Sens. Merkley & Levin (Feb. 2012); Johnson & Prof. Stiglitz; Occupy.

1623 See Alfred Brock.

1624 See Japanese Bankers Ass’n.; Sens. Merkley & Levin (Feb. 2012); Occupy; Public Citizen.

1625 See Japanese Bankers Ass’n.

1626 See Sens. Merkley & Levin (Feb. 2012).

1627 See Sens. Merkley & Levin (Feb. 2012).

1628 See Sens. Merkley & Levin (Feb. 2012).
495

all activity exempted under section 13(d)(1) of the BHC Act should be viewed as “highrisk” absent prior regulatory approval. This commenter further suggested that high-risk 

assets or trading strategies be defined to include any asset or trading strategy that would 

have forced a banking entity to exit the market during the 2008 financial crisis, and that 

leverage, rehypothecation, concentration limits, and high frequency trading should be 

viewed as indicia of high-risk trading strategies. Finally, this commenter suggested the 

Agencies require banking entity CEOs to certify that their institution’s activities do not 

result in a material exposure to high-risk assets or high-risk trading strategies.1629 

3. Final rule

After considering carefully the comments received, the Agencies have modified 

the final rule to provide that a high-risk asset means an asset or group of assets that 

would, if held by a banking entity, significantly increase the likelihood that the banking 

entity would incur a substantial financial loss or would pose a threat to the financial 

stability of the United States. Similarly, the final rule defines high-risk trading strategy to 

include any strategy that would, if engaged in by a banking entity, significantly increase 

the likelihood that the banking entity would incur a substantial financial loss or would 

pose a threat to the financial stability of the United States.

Importantly, under the final rule, banking entities that engage in activities 

pursuant to an exemption must have a reasonably designed compliance program in place 

to monitor and understand whether it is exposed to high-risk assets or trading strategies. 

For instance, any banking entity engaged in activity pursuant to the market-making 

 

1629 See Occupy.
496

exemption in § __.4(b) must, as part of its compliance program, have reasonably 

designed written policies and procedures, internal controls, analysis and independent 

testing regarding the limits for each trading desk, including limits on the level of 

exposures to relevant risk factors that the trading desk may incur. These policies and 

procedure and any activity conducted pursuant to the final rule will be evaluated by the 

Agencies, as appropriate, as part of ensuring the safety and soundness of banking entities 

and monitoring for exposures to high-risk activities or assets.

While some commenters stated that the definition of high risk asset or trading 

strategy should be more clearly defined, the Agencies believe that it is appropriate to 

include a broad definition of these terms that accounts for different facts and 

circumstances that may impact whether a particular asset or trading strategy is high-risk 

with respect to a banking entity. As stated by commenters, this framework is effective 

and flexible enough to be utilized by the Agencies in a variety of contexts. For instance, 

a trading strategy or asset may be high-risk to one banking entity but not another, or may 

be high-risk to a banking entity under some market conditions but not others. As part of 

evaluating whether a banking entity is exposed to a high-risk asset or trading strategy, the 

Agencies expect that a variety of factors will be considered, such as the presence of 

excess leverage, rehypothecation or excessively high concentration of assets, or unsafe 

and unsound trading strategies.

We believe an approach limiting this provision’s applicability to certain permitted 

activities or creating a safe harbor for certain assets or trading strategies would be 

inconsistent with the statutory language, which prohibits any permitted activity that 

involves or results in a material exposure to a high-risk asset or high-risk trading 
497

strategy.1630 In addition, the Agencies decline to identify any particular assets or trading 

strategies as per se high-risk because a determination of the specific risk posed to a 

banking entity depends on the facts and circumstances.1631 Certain facts and 

circumstances may include, but are not limited to, the amount of capital at risk in a 

transaction, whether or not the transaction can be hedged, the amount of leverage present 

in the transaction, and the general financial condition of the banking entity engaging in 

the transaction. In response to one commenter’s recommendation that the Agencies 

adopt a CEO certification requirement specific to the high-risk provisions,1632 the 

Agencies believe such a requirement is unnecessary in light of the required management 

framework in the compliance program provision of § __.20 of the final rule, as well as 

the CEO certification requirement included in the final rule.1633 

c. Limitations on Permitted Activities that Pose a Threat to Safety and Soundness of the 

Banking Entity or the Financial Stability of the United States

Finally, as the Agencies did not receive any comments on the proposed rule’s 

limitations on permitted activities that pose a threat to the safety and soundness of the 

banking entity or to the financial stability of the United States and the proposed approach 

mirrored the statutory language, the Agencies have determined no changes to final rule 

are necessary.

B. Subpart C – Covered Fund Activities and Investments

 

1630 See BDA (Feb. 2012); Japanese Bankers Ass’n.

1631 See Occupy.

1632 See Occupy.

1633 See § __.20 and Appendix B of the final rule, also discussed in Part IV.C., infra. 
498

As noted above and except as otherwise permitted, section 13(a)(1)(B) of the 

BHC Act generally prohibits a banking entity from acquiring or retaining any ownership 

in, or acting as sponsor to, a covered fund.1634 Section 13(d) of the BHC Act contains 

certain exemptions to this prohibition. Subpart C of the final rule implements these and 

other provisions of section 13 related to covered funds. Additionally, subpart C contains 

a discussion of the internal controls, reporting and recordkeeping requirements applicable 

to covered fund activities and investments, and incorporates by reference the minimum 

compliance standards for banking entities contained in subpart D of the final rule, as well 

as Appendix B, to the extent applicable.

1. Section __.10: Prohibition on Acquisition or Retention of Ownership Interests in, 

and Certain Relationships with, a Covered Fund

Section __.10 of the final rule defines the scope of the prohibition on the 

acquisition and retention of ownership interests in, and certain relationships with, a 

covered fund. It also defines a number of key terms, including the definition of covered 

fund. 

The term “covered fund” specifies the types of entities to which the prohibition 

contained in § __.10(a) applies, unless the activity is specifically permitted under an 

available exemption contained in subpart C of the final rule.1635 The final rule modifies 

the proposed definition of covered fund in a number of key aspects. The Agencies have 

defined the term “covered fund” with reference to sections 3(c)(1) and 3(c)(7) of the 

Investment Company Act of 1940 (“Investment Company Act”) with some additions and 

 

1634 See 12 U.S.C. 1851(a)(1)(B).

1635 See final rule §§ __.10(b)-(c). The term banking entity is defined in final rule § __.2(c).
499

subject to a number of exclusions, several of which have been modified from permitted 

activity exemptions included in the proposal. 

The Agencies have tailored the final definition to include entities of the type that 

the Agencies believe Congress intended to capture in its definition of private equity fund 

and hedge fund in section 13(h)(2) of the BHC Act by reference to section 3(c)(1) and 

3(c)(7) of the Investment Company Act. Thus, the final definition focuses on the types of 

entities formed for the purpose of investing in securities or derivatives for resale or 

otherwise trading in securities or derivatives, and that are offered and sold in offerings 

that do not involve a public offering, but typically involve offerings to institutional 

investors and high-net worth individuals (rather than to retail investors). These types of 

funds are not subject to all of the securities law protections applicable with respect to 

funds that are registered with the SEC as investment companies, and the Agencies 

therefore believe that these types of entities may be more likely to engage in risky 

investment strategies. At the same time, the Agencies have tailored the definition to 

exclude entities that have more general corporate purposes and do not present the same 

risks for banking entities as those associated with the funds described above, as well as 

certain other entities as further discussed below. 

The final rule also contains a revised version of the proposal’s treatment of certain 

foreign funds as covered funds, which has been modified from the proposal and tailored 

to include only the types of foreign funds that the Agencies believe are intended to be the 

focus of the statute, such as certain foreign funds that are established by U.S. banking 

entities and not otherwise subject to the Investment Company Act. 
500

The Agencies have not included all commodity pools within the definition of 

covered fund as proposed. Instead, and as discussed in more detail below, the Agencies 

have included only commodity pools for which the commodity pool operator has claimed 

exempt pool status under section 4.7 of the CFTC’s regulations or that could qualify as 

exempt pools and which have not been publicly offered1636 to persons who are not 

qualified eligible persons under section 4.7 of the CFTC’s regulations.1637 Qualified 

eligible persons are typically institutional investors, banking entities and high net worth 

individuals (rather than retail investors). This more tailored approach, together with the 

various exclusions from the covered fund definition in the final rule, is designed to 

include as covered funds those commodity pools that are similar to funds that rely on 

section 3(c)(1) or 3(c)(7) while not also including as covered funds entities, like 

commercial end-users or registered investment companies, whose activities do not 

implicate the concerns that section 13 was designed to address.

Finally, other related terms, including “ownership interest,” “resident of the 

United States,” “sponsor,” and “trustee,” are also defined in § __.10(d) of the final 

rule.1638 As explained below, these terms are largely defined in the same manner as in 

the proposal although with certain changes, including changes to help clarify the scope of 

these definitions as requested by commenters. Some of these terms and related 

provisions also have been reorganized to improve clarity. As explained in more detail 

below, the Agencies received a number of comments relating to some of the terms 

 

1636 See infra note 1721 and accompanying text regarding the meaning of the term “offer” as used in the 

final rule’s inclusion of certain commodity pools as covered funds. 

1637 See final rule § __.10(b)(1)(ii).

1638 See final rule § __.10(d)(6), (8), (9), and (10).
501

defined in § __.10. Some comments directly relate to the scope of the proposed rule and 

the economic effects associated with the prohibitions on covered funds activities and 

investments, some of which commenters argued did not further the purposes of section 

13.1639 The Agencies have carefully considered these and other comments when defining 

the key terms used in the statute and in providing certain exclusions to the definition of 

the term covered fund. The Agencies also have sought to provide guidance below, where 

appropriate, on how these key terms would operate in order to better enable banking 

entities to understand their obligations under section 13 and the final rule. 

a. Prohibition Regarding Covered Fund Activities and Investments

Section __.10(a) of the final rule implements section 13(a)(1)(B) of the BHC Act 

and prohibits a banking entity from, directly or indirectly, acquiring or retaining as 

principal an equity, partnership, or other ownership interest in, or acting as sponsor to, a 

covered fund, unless otherwise permitted under subpart C of the final rule.1640 This 

provision of the rule reflects the statutory prohibition. 

The general prohibition in § __.10(a) of the proposed rule applied solely to the 

acquisition or retention of an ownership interest in, or acting as sponsor to, a covered 

fund, “as principal.”1641 Commenters generally supported this approach, arguing that 

applying the prohibition related to covered fund activities and investments by a banking 

entity only to instances where the banking entity acts as principal is consistent with the 

 

1639 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); BoA; Goldman (Covered Funds); Rep. Himes; 

SVB; Scale.

1640 See final rule § __.10(a).

1641 See proposed rule § __.10(a); See also Joint Proposal, 76 FR at 68,896. 
502

statutory focus on principal activity.1642 The final rule takes this approach as discussed 

below. 

The proposed rule and preamble accompanying it described potential exemptions 

from the definition of ownership interest for a variety of interests, including interests

related to employee benefit plans, interests held in the ordinary course of collecting a 

debt previously contracted, positions as trustee, or interests acquired as agent, broker or 

custodian. Commenters provided information on each of these types of ownership 

interests, and generally supported excluding each of these from the section’s prohibition 

on acquiring or retaining an ownership interest in a covered fund. 

A significant number of commenters focused on employee benefit plans. 

Commenters generally argued that the prohibition in section 13(a) of the BHC Act did 

not encompass interests held on behalf of employees through an employee benefit plan. 

While the proposed rule did not explicitly cover certain “qualified plans” under the 

Internal Revenue Code, a number of commenters argued that the prohibition should not 

cover activity or investments related to other types of employee benefit plans that are not 

a “qualified plan” under the Internal Revenue Code.1643 A significant number of 

commenters urged exclusion of interests in and relationships with foreign employee 

benefit plans.1644 Commenters argued that the risks of investments made through 

employee benefit plans are borne by the employee beneficiaries of these plans, and any 

decision to cover employee benefit plans or investments made by these plans under the 

 

1642 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA et al. (Mar. 2012).

1643 See Credit Suisse (Williams); Arnold & Porter; UBS; Hong Kong Inv. Funds Ass'n.

1644 See, e.g., Credit Suisse (Williams); Arnold & Porter; UBS; NAB; Hong Kong Inv. Funds Ass'n; 

Australian Bankers Ass'n. (Feb. 2012). 
503

prohibitions in section 13 of the BHC Act would eliminate or severely restrict the 

availability of employee programs that are widely offered, regulated and endorsed under 

a system of Federal, state and foreign laws.1645 

Commenters also supported the exemption under the proposed rule for holdings in 

satisfaction of a debt previously contracted in good faith.1646 This provision of the 

proposal recognized that banking entities may acquire an ownership interest in or 

relationship with a covered fund as a result of a counterparty’s failure to repay a bona 

fide debt and without an intent to engage in those activities as principal.1647

Several commenters urged revision to the proposal to add a specific exclusion for 

investments held by a banking entity in the capacity of trustee (including as trustee for a 

charitable trust).1648 These commenters argued that failing to recognize and exempt these 

types of activities in the final rule would prevent banking entities that act as trustees from 

effectively meeting their trust and fiduciary obligations and from providing these services 

to customers. Commenters also argued that the exemption for trust activities should not 

be dependent on the duration of the trust because the law governing the duration of trusts 

is changing and varies across jurisdictions.1649

As with the proposed rule, the prohibition in § __.10(a) of the final rule applies 

only to the acquisition or retention of an ownership interest in, or sponsorship of, a 

covered fund as principal. The Agencies continue to believe section 13 of the BHC Act 

 

1645 See, e.g., Arnold & Porter. 

1646 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); LSTA (Feb. 2012). 

1647 See proposed rule § __.14(b). 

1648 See, e.g., ABA (Keating).

1649 See, e.g., ABA (Keating); Arnold & Porter; NAB. 
504

was designed to address the risks attendant to principal activity and not those that are 

borne by customers of the banking entity or for which the banking entity lacks design or 

intent to take a proprietary interest as principal. 

In order to address commenter concerns regarding the types of activity that are 

subject to the prohibition, the Agencies have modified and reorganized the final rule to 

make the scope of acting “as principal” clear and more consistent with the proprietary 

trading restrictions under the final rule.1650 The final rule provides that the prohibition 

does not include acquiring or retaining an ownership interest in a covered fund by a 

banking entity: (1) acting solely as agent, broker, or custodian, so long as the activity is 

conducted for the account of, or on behalf of, a customer, and the banking entity and its 

affiliates do not have or retain beneficial ownership of the ownership interest1651; (2) 

through a deferred compensation, stock-bonus, profit-sharing, or pension plan of the 

banking entity (or an affiliate thereof) that is established and administered in accordance 

with the law of the United States or a foreign sovereign, if the ownership interest is held 

or controlled directly or indirectly by a banking entity as trustee for the benefit of people 

who are or were employees of the banking entity (or an affiliate thereof)1652; (3) in the 

ordinary course of collecting a debt previously contracted in good faith, provided that the 

 

1650 See final rule § __.3(d)(7)-(9).

1651 A banking entity acting as agent, broker, or custodian is not acting “as principal” under the final rule so 

long as the activity is conducted for the account of, or on behalf of, a customer and the banking entity does 

not have or retain beneficial ownership of such ownership interest, as noted above. This provision is 

consistent with the final rule’s treatment of banking entities acting on behalf of customers as trustee or in a 

fiduciary capacity.

1652 The Agencies note that this provision does not permit joint investments between the banking entity and 

its employees. Rather, this provision is intended to enable banking entities to maintain deferred 

compensation and other similar plans formed for the benefit of employees. The Agencies recognize that, 

since it is possible an employee may forfeit its interest in such a plan, the banking entity may have a 

residual or reversionary interest in the assets referenced under the plan. However, other than such residual 

or reversionary interests, a banking entity may not rely on this provision to invest in a covered fund.
505

banking entity divests the ownership interest as soon as practicable, and in no event may 

the banking entity retain such instrument for longer than such period permitted by the 

appropriate agency; or (4) on behalf of customers as trustee or in a similar fiduciary 

capacity for a customer that is not a covered fund, so long as the activity is conducted for 

the account of, or on behalf of, the customer, and the banking entity and its affiliates do 

not have or retain beneficial ownership of such ownership interest.1653 

Because these activities do not involve the banking entity engaging in an activity 

intended or designed to take ownership interests in a covered fund as principal, they do 

not appear to be the types of activities that section 13 of the BHC Act was designed to 

address. However, the Agencies note that in order to prevent a banking entity from 

evading the requirements of section 13 and the final rule, the exclusions for these 

activities do not permit a banking entity to engage in establishing, organizing and 

offering, or acting as sponsor to a covered fund in a manner other than as permitted 

elsewhere in the final rule. The Agencies intend to monitor these activities and 

investments for efforts to evade the restrictions in section 13 of the BHC Act and the final 

rule on banking entities’ investments in and relationships with covered funds. 

b. “Covered Fund” Definition

Section 13(h)(2) of the BHC Act defines hedge fund and private equity fund to 

mean an issuer that would be an investment company, but for section 3(c)(1) or 3(c)(7) of 

the Investment Company Act, or “such similar funds” as the Agencies determine by 

 

1653 See final rule § __.10(a)(2). For instance, as part of engaging in its traditional trust company functions, 

a bank or savings association typically may act through an entity that is excluded from the definition of 

investment company under section 3(c)(3) or 3(c)(11). This would be included within the scope of acting 

on behalf of customers as trustee or in a similar fiduciary capacity, provided that it meets the applicable 

requirements of the exclusion under the final rule.
506

rule.1654 Given that the statute defines “hedge fund” and “private equity fund” without 

differentiation, the proposed rule and the final rule combine the terms into the definition 

of a “covered fund.” Sections 3(c)(1) and 3(c)(7) of the Investment Company Act are 

exclusions commonly relied on by a wide variety of entities that would otherwise be 

covered by the broad definition of “investment company” contained in that Act.1655 The 

proposal included as a covered fund any entity that would be an investment company but 

for the exclusion from that definition contained in section 3(c)(1) or 3(c)(7) of the 

Investment Company Act, any foreign entity that would also be an investment company 

but for those same exclusions were the foreign entity to be organized or offered in the 

United States, and a commodity pool as defined in section 1a(10) of the Commodity 

Exchange Act.1656 The preamble to the proposal recognized that this definition was 

broad and specifically requested comment on whether and how the definition of covered 

fund should be modified for purposes of the final rule. 

Commenters contended that the definition of covered fund should not focus 

exclusively on whether an entity relies on section 3(c)(1) or 3(c)(7) of the Investment 

Company Act. Commenters argued that sections 3(c)(1) and 3(c)(7) of the Investment 

Company Act are exclusions commonly relied on by a wide variety of entities that would 

otherwise be covered by the broad definition of “investment company” contained in that 

 

1654 See 12 U.S.C. 1851(h)(2).

1655 12 U.S.C. 1851(h)(2). Sections 3(c)(1) and 3(c)(7) of the Investment Company Act, in relevant part, 

provide two exclusions from the definition of “investment company” for: (1) any issuer whose outstanding 

securities are beneficially owned by not more than one hundred persons and which is not making and does 

not presently propose to make a public offering of its securities (other than short-term paper); or (2) any 

issuer, the outstanding securities of which are owned exclusively by persons who, at the time of acquisition

of such securities, are qualified purchasers, and which is not making and does not at that time propose to 

make a public offering of such securities. See 15 U.S.C. 80a-3(c)(1) and (c)(7). 

1656 See proposed rule § __.10(b)(1). 
507

Act. Under the Investment Company Act, any entity that holds investment securities 

(i.e., generally all securities other than U.S. government securities) representing at least 

40 percent of the entity’s total assets would be an investment company.1657 According to 

commenters, this definition and the accompanying exclusions are part of a securities law 

and regulatory framework designed for purposes different than the prudential purpose 

that underlies section 13 of the BHC Act.1658

A number of comments received on the proposal argued that the proposed 

definition of covered fund was overly broad and would lead to anomalous results 

inconsistent with the words, structure, and purpose of section 13.1659 For instance, many 

commenters asserted that the proposed rule’s definition of covered fund would cause a 

number of commonly used corporate entities that are not traditionally thought of as hedge 

funds or private equity funds, such as wholly-owned subsidiaries, joint ventures, and 

acquisition vehicles, to be subject to the covered fund restrictions of section 13. These 

commenters argued that this interpretation of section 13 would cause a disruption to the 

operations of banking entities and their closely related affiliates that does not relate to the 

intent of section 13 and therefore cause an unnecessary burden on banking entities. 

Commenters argued that the words, structure and purpose of section 13 allow the 

 

1657 15 U.S.C. 80a-3(a)(1)(A) & (C). The definition of securities is very broad under the Investment 

Company Act and has been interpreted to include instruments such as loans, that would not be regarded as 

securities under the Securities Act of 1933 and the Securities Exchange Act of 1934. In addition, the 

determination of what constitutes an “investment security” under the Investment Company Act requires 

complex analysis and consideration of a broad set of facts and circumstances. 

1658 See, e.g., NVCA.

1659 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); BlackRock; AHIC; Sen. Carper et al.; Rep. 

Garrett et al.
508

Agencies to adopt a more tailored definition of covered fund that focuses on vehicles 

used for investment purposes that were the target of section 13’s restrictions.

In particular, commenters requested that the final rule exclude at least the 

following from the definition of covered fund: U.S. registered investment companies 

(including mutual funds); the foreign equivalent of U.S. registered investment companies; 

business development companies; wholly-owned subsidiaries; joint ventures; acquisition 

vehicles; financial market utilities; foreign pension or retirement funds; insurance 

company separate accounts; loan securitizations, including asset-backed commercial 

paper conduits; cash management vehicles or cash collateral pools; credit funds; real 

estate investment trusts; various securitization vehicles; tender option bond programs; 

and venture capital funds.1660 Commenters requested some of these exclusions in order 

to mitigate the impact of the proposal’s inclusion of commodity pools as part of the 

definition of covered fund.1661

Some commenters argued that the proposal failed to distinguish between different 

types of investment funds.1662 These commenters expressed the view that the statute 

provides the Agencies with the discretion to distinguish between investment funds 

generally and a subset of funds -- hedge funds and private equity funds -- that may 

 

1660 See ABA (Keating); ABA (Abernathy); SIFMA et al. (Covered Funds) (Feb. 2012); Allen & Overy 

(on behalf of Foreign Bank Group); Allen & Overy (on behalf of Canadian Banks); Deutsche Bank 

(Repackaging Transactions); ICI (Feb. 2012); Putnam; JPMC; GE (Feb. 2012); Chamber (Feb. 2012); Rep. 

Himes; BOK; Ass'n. of Institutional Investors (Feb. 2012); Wells Fargo (Covered Funds); BoA; NAIB et 

al.; PNC; SunTrust; Nationwide; STANY; BNY Mellon et al.; RMA; Goldman (Covered Funds); Japanese 

Bankers Ass'n; IRSG; ISDA (Feb. 2012); IIB/EBF; Citigroup (Jan. 2012); SSgA (Feb. 2012); State Street 

(Feb. 2012); Eaton Vance; Fidelity; SBIA; River Cities; Ashurst; Sen. Hagan; Sen. Bennet. 

1661 As discussed below, the Agencies have modified the final rule to include only certain commodity pools 

within the definition of covered fund.

1662 See NVCA; See also SIFMA et al. (Covered Funds) (Feb. 2012); ABA (Keating).
509

engage in particularly risky trading and investment activities. For example, several 

commenters argued that the proposed rule’s restrictions on covered fund investments 

should not cover venture capital funds that provide investment capital to new 

businesses.1663 Others argued for an exclusion for securitization vehicles such as 

securitizations that are backed, in whole or in part, by assets that are not loans, including 

corporate debt repackagings,1664 CLOs,1665 ABCP conduits,1666 insurance-linked 

securities,1667 and synthetic securitizations backed by derivatives.1668

As a potential solution to some of these concerns, a number of commenters 

argued that the Agencies should define covered fund by reference to characteristics that 

are designed to distinguish hedge funds and private equity funds from other types of 

entities that rely on section 3(c)(1) or 3(c)(7) of the Investment Company Act.1669 

Commenters believed this approach would help exclude some of the corporate vehicles 

and funds mentioned above that they did not believe were intended by Congress to be 

 

1663 See, e.g., ABA (Keating); ABA (Abernathy); Canaan (Young); Canaan (Ahrens); Canaan (Kamra); 

Growth Managers; River Cities; SVB; EVCA. 

1664 See AFME et al.; Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); Cleary 

Gottlieb; Deutsche Bank (Repackaging Transactions); SIFMA (Securitization) (Feb. 2012).

1665 See SIFMA (Securitization) (Feb. 2012); Allen & Overy (on behalf of Foreign Bank Group); ASF 

(Feb. 2012); Cleary Gottlieb; Credit Suisse (Williams); JPMC; LSTA (Feb. 2012).

1666 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); Credit Suisse (Williams); 

Eaton Vance; Fidelity; GE (Feb. 2012); GE (Aug. 2012); ICI (Feb. 2012); IIB/EBF; JPMC; PNC; RBC;

SIFMA (Securitization) (Feb. 2012); AFME et al.

1667 See AFME et al.; SIFMA (Securitization) (Feb. 2012).

1668 See AFME et al.; ASF (Feb. 2012); Cleary Gottlieb; Credit Suisse (Williams); SIFMA (Securitization) 

(Feb. 2012); ABA (Keating).

1669 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); BlackRock; Credit Suisse (Williams); SSgA 

(Feb. 2012); State Street (Feb. 2012); Deutsche Bank (Repackaging Transactions); Allen & Overy (on 

behalf of Foreign Bank Group).
510

included as hedge funds and private equity funds and therefore reduce costs that, in the 

commenters’ view, did not further the purposes of section 13.

1670

These commenters proposed a number of different potential types of 

characteristics for defining hedge fund and private equity fund. Some commenters 

focused on certain structural or investment characteristics found in traditional private 

equity funds and hedge funds, such as investor redemption rights, performance 

compensation fees, leverage and the use of short-selling.1671 Another commenter argued 

that the characteristics used to define a covered fund should focus on the types of 

speculative behavior that the statute was intended to address, citing characteristics such 

as volatility of asset performance and high leverage.1672 

In contrast to the majority of the commenters, one commenter urged that 

characteristics be used to expand the proposed definition to include any issuer that 

exhibits characteristics of proprietary trading that the statute prohibits to be done by a 

banking entity.1673 According to this commenter, any fund engaging in more than 

minimal proprietary trading should be a covered fund and subject to the requirements of 

section 13.

 

1670 See SIFMA et al. (Covered Funds) (Feb. 2012); AFME et al.; Allen & Overy (on behalf of Foreign 

Bank Group); ASF (Feb. 2012); Ashurst; Barclays; BDA (Feb. 2012); Credit Suisse (Williams); 

Commercial Real Estate Fin. Council; Fidelity; ICI (Feb. 2012); ISDA (Feb. 2012); JPMC; Nuveen Asset 

Mgmt.; PNC; RBC; SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA (Municipal Securities) (Feb. 

2012); SSgA (Feb. 2012); State Street (Feb. 2012); Vanguard; Wells Fargo (Covered Funds).

1671 See Ass'n. of Institutional Investors (Feb. 2012); Barclays; JPMC; SIFMA et al. (Covered Funds) (Feb. 

2012); See also FSOC study at 62-63 (suggesting a characteristics-based approach considering 

compensation structure; trading/investment strategy; use of leverage; investor composition); ABA 

(Keating); BNY Mellon et al.; Northern Trust, SSgA (Feb. 2012); State Street (Feb. 2012); Deutsche Bank 

(Repackaging Transactions); T. Rowe Price; RMA (suggesting use of characteristics derived from the 

SEC’s Form PF for registration of investment advisers of private funds).

1672 See RBC (citing FSOC study).

1673 See Occupy.
511

However, not all commenters supported a characteristics-based definition. One 

commenter opposed a characteristics-based definition, suggesting that the final rule rely 

only on the statutory reference to the Investment Company Act, and arguing that using 

characteristics to define a covered fund (e.g., leverage) could create opportunities for 

circumvention of the rule.1674 Commenters that generally supported the proposed 

definition argued that its broad scope prevented circumvention.1675

One commenter argued in favor of broadening the definition of covered fund to 

include entities that rely on an exclusion from the definition of investment company other 

than those contained in section 3(c)(1) and 3(c)(7), such as section 3(c)(2) (which 

provides an exclusion for underwriters and brokers) or 3(c)(6) (which provides an 

exclusion for entities engaged in a business other than investing in securities).1676 By 

contrast, other commenters argued that an entity should not be considered a covered fund 

if the entity relies on an exclusion or exemption contained in the Investment Company 

Act other than an exclusion contained in section 3(c)(1) or 3(c)(7) under that Act, such as 

the exclusion contained in section 3(c)(3) for bank collective investment funds.1677 

The Agencies have carefully considered all of the comments related to the 

definition of covered fund. While the Agencies believe that the proposal reflected a 

reasonable interpretation of the statutory provision, on further review and in light of the 

 

1674 See AFR et al. (Feb. 2012).

1675 See Sens. Merkley & Levin (Feb. 2012); AFR et al. (Feb. 2012); Alfred Brock.

1676 See Occupy (also arguing in favor of including entities that rely on rule 3a-1 (which provides an 

exemption for issuers that hold less than 45% of their assets in securities excluding government securities) 

or 3a-6 (which provides an exemption for foreign banks and insurance companies) to avoid being regulated 

as investment companies under the Investment Company Act).

1677 See, e.g., ABA (Keating). 
512

comments the Agencies have determined to adopt a different approach. The Agencies 

have revised the final rule to address many of the concerns raised by commenters 

regarding the scope of the original proposal in a manner the Agencies believe is a better 

reading of the statutory provision because it is both consistent with the language, purpose 

and structure of section 13 and avoids unintended consequences of the less precise 

definitional approach of the proposal. 

In the final rule, the Agencies have joined the definitions of “hedge fund” and 

“private equity fund” into a single definition “covered fund” (as in the statute) and have 

defined this term as any issuer that would be an investment company as defined in the 

Investment Company Act but for section 3(c)(1) or 3(c)(7) of that Act with a number of 

express exclusions and additions (explained below) as determined by the Agencies. 

Thus, for example, an entity that invests in securities and relies on any exclusion or 

exemption from the definition of “investment company” under the Investment Company 

Act other than the exclusion contained in section 3(c)(1) or 3(c)(7) of that Act would not 

be considered a covered fund so long as it satisfies the conditions of another Investment 

Company Act exclusion or exemption.1678 Such an entity would not be an investment 

company but for section 3(c)(1) or 3(c)(7), and the Agencies have modified the final rule 

to explicitly exclude such an entity.1679

 

1678 For instance, bank common trust and collective funds that qualify for the exclusion from the definition 

of investment company pursuant to section 3(c)(3) or 3(c)(11) of the Investment Company Act are not 

covered funds. See 15 U.S.C. 78a-3(c)(3) and (c)(11). These funds are subject to supervision and 

regulation by a Federal banking agency, thus helping to distinguish them from traditional hedge funds and 

private equity funds which are generally not themselves subject to such supervision or regulation.

1679 See final rule § __.10(c)(12).
513

The Agencies believe this definition is consistent with the words, structure, 

purpose and legislative history of section 13 of the BHC Act. As noted above, section 

13(h)(2) provides that:

the terms “hedge fund” and “private equity fund” mean an issuer that 

would be an investment company as defined in the [Investment 

Company Act] (15 U.S.C. 80a-1 et seq.), but for section 3(c)(1) or 

3(c)(7) of that Act, or such similar funds as the [Agencies] may, by rule, 

as provided in subsection (b)(2), determine.1680

The statutory provision contains two parts: a first part that refers to any issuer that is “an 

investment company, as defined in the Investment Company Act, but for section 3(c)(1) 

and 3(c)(7) of the Act”; and a second part that covers “such similar funds as the 

[Agencies] may, by rule . . . determine.” The proposed rule offered a reading of this 

provision as a simple concurrent definition with two self-contained, supplementary parts. 

Under this approach, all entities covered by part one of the definition would be included 

in the definitions of “hedge fund” and “private equity fund,” and the role of the Agencies 

under the second part was limited to considering whether and how to augment the scope 

of the primary statutory definition.

As noted above, commenters argued that this interpretation led to unintended 

consequences that were not consistent with other provisions of section 13 or the purposes 

of section 13, and that other interpretations of the definition of covered fund were 

consistent with both the words and the purpose of the statute. Also as explained above, 

 

1680 See 12 U.S.C. 1851(h)(2) (emphasis added).
514

commenters offered multiple alternative interpretations of the definition of, the scope of 

the prohibition on ownership interests in, and relationships with, a covered fund. 1681

The Agencies believe that the language of section 13(h)(2) can best be interpreted 

to provide two alternative definitions of the entities to be covered by the statutory terms 

“hedge fund” and “private equity fund.” Under this reading, the first part of section 

13(h)(2) contains a base definition that references the noted exclusions under the 

Investment Company Act (the “default definition”), while the second part grants the 

Agencies the authority to adopt an alternate definition that is triggered by agency action 

(the “tailored definition”). Thus, if the Agencies do not act by rule, the definition is set 

by reference to the Investment Company Act and the relevant exclusions alone; if the 

Agencies act by rule, the definitions are set by the Agencies under that rule. As noted 

above, the Agencies have determined to exercise the authority under the second part of 

the statute to define “hedge fund” and “private equity fund” in the final rule. 

Relying on the Agencies’ authority to adopt an alternative, tailored definition of 

“hedge fund” and “private equity fund,” the final rule references funds that are similar to 

the funds in the base alternative provided in the first alternative definition – that is, an 

issuer that would be an investment company under the Investment Company Act but for 

section 3(c)(1) or 3(c)(7) of that Act. The additions and exclusions from that definition 

represent further determinations by the Agencies regarding the scope of that definition 

 

1681 In addition to the readings described above, one commenter argued that the section could be read to 

provide that both the reference to issuers covered by section 3(c)(1) or 3(c)(7) of the Investment Company 

Act in the first part of section 13(h)(2) and the reference to similar funds in the second part of the section 

should be read as qualified by the clause “as the Agencies may by rule... determine.” Under this reading, 

Congress granted the Agencies authority to determine by rule whether an entity described by the first part 

would be covered and whether an issuer would be deemed to be a similar fund under the second part. See

SIFMA et al. (Covered Funds) (Feb. 2012). 
515

that were made in the course of a rulemaking conducted in accordance with section 

13(b)(2) of the BHC Act. 

The Agencies believe that this reading of the statutory provision is consistent with 

the purpose of section 13. That purpose appears to be to limit the involvement of 

banking entities in 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.

1682 Further, the Agencies believe that the provision permits them to tailor the 

scope of the definition to funds that engage in the investment activities contemplated by 

section 13 (as opposed, for example, to vehicles that merely serve to facilitate corporate 

structures); doing so allows the Agencies to avoid the unintended results, some of which 

commenters identified, that might follow from a definition that is inappropriately 

imprecise.1683 

The Agencies also note that nothing in the structure or history of the Dodd-Frank 

Act suggests that the definition of hedge fund and private equity fund was intended to 

necessitate a fundamental restructuring of banking entities by disallowing investments in 

 

1682 See 156 Cong. Reg. S.5894-5895 (daily ed. July 15, 2010) (statement of Sen. Merkley).

1683 The Agencies believe that the choice of the tailored definition is supported by the legislative history 

that suggests that Congress may have foreSeen that its base definition could lead to unintended results and 

might be overly broad, too narrow, or otherwise off the mark. Part two of the statutory definition was not 

originally included in the bill reported by the Senate Committee on April 30, 2010. While the addition of 

part two did not receive specific comment, Rep. Frank, a co-sponsor and principal architect of the DoddFrank Act, noted that the default definition “could technically apply to lots of corporate structures, and not 

just the hedge funds and private equity funds” and confirmed that “[w]e do not want these overdone.” See

156 Cong. Rec. H5226 (daily ed. June 30, 2010) (statement of Reps. Himes and Frank) (noting intent that 

subsidiaries or joint ventures not be included within the definition of covered fund); 156 Cong. Rec. S5904-

05 (daily ed. July 15, 2010) (statement of Sens. Boxer and Dodd) (noting broad definition of hedge fund 

and private equity fund and recommending that the Agencies take steps to ensure definition is reasonably 

tailored).
516

common corporate vehicles such as intermediate holding companies, joint operating 

companies, acquisition vehicles and similar entities that do not engage in the types of 

investment activities contemplated by section 13. Moreover, other provisions of the 

Dodd-Frank Act and existing banking laws and regulations would be undermined or 

vitiated by a reading that restricts investments in these types of corporate vehicles and 

structures.1684 

Based on the interpretive and policy considerations raised by commenters, the 

language of section 13(h)(2), and the language, structure, and purpose of the Dodd-Frank 

Act, the Agencies have adopted a tailored definition of covered fund in the final rule that 

covers issuers of the type that would be investment companies but for section 3(c)(1) or 

3(c)(7) of the Investment Company Act with exclusions for certain specific types of 

issuers in order to focus the covered fund definition on vehicles used for the investment 

purposes that were the target of section 13. The definition of covered fund under the 

final rule also includes certain funds organized and offered outside of the United States in 

order to address foreign fund structures and certain commodity pools that might 

otherwise allow circumvention of the restrictions of section 13. The Agencies also 

 

1684 For example, the Dodd-Frank Act requires banking entities to serve as a source of financial strength to 

their insured depository institutions and requires certain banking entities to form intermediate holding 

companies to separate their financial and non-financial activities. See Sections 167, 616(d) & 626 of the 

Dodd-Frank Act. These provisions would be severely undermined if the prohibitions on investments and 

activities contained in section 13 were applied to ownership of intermediate holding companies. For 

instance, a bank holding company would not be able to serve as a source of strength to an intermediate 

holding company (or any subsidiary thereof) that is a covered fund due to the transaction restrictions 

contained in section 13(f). See 12 U.S.C. 1851(f). As another example, the Agencies have made certain 

modifications to the final rule to make clear that it will not affect the resolution authority of the Federal 

Deposit Insurance Corporation, including by excluding from the covered fund definition issuers formed by 

or on behalf of the Corporation for the purpose of facilitating the disposal of assets acquired in the 

Corporation’s capacity as conservator or receiver. See § __.10(c)(13).
517

expect to exercise the statutory anti-evasion authority provided in section 13(e) of the 

BHC Act and other prudential authorities in order to address instances of evasion.1685

As discussed above, an alternative approach to defining a covered fund would be 

to reference fund characteristics. Commenters arguing for a characteristics-based 

approach stated that it would more precisely tailor the final rule to the intent of section 13 

and limit the potential for undue burden on banking entities. A characteristics-based 

definition, however, could be less effective than the approach taken in the final rule as a 

means to prohibit banking entities, either directly or indirectly, from engaging in the 

covered fund activities limited or proscribed by section 13. A characteristics-based 

approach also could require more analysis by banking entities to apply those 

characteristics to every potential covered fund on a case-by-case basis, and create greater 

opportunity for evasion. As discussed below, the Agencies have sought to address some 

of the concerns raised by commenters suggesting a characteristics-based approach by 

tailoring the definition of covered fund to provide exclusions for certain entities that rely 

on section 3(c)(1) or 3(c)(7) of the Investment Company Act and otherwise would be 

treated as covered funds. 

Some commenters discussed the potential cost to banking entities to analyze the 

covered fund status of certain entities if the Agencies were to define the term covered 

fund by reference to sections 3(c)(1) and 3(c)(7), arguing that this analysis would be 

 

1685 As discussed in Part IV.C.1 of this Supplementary Information regarding the compliance program 

requirements of the final rule, the Agencies will consider information maintained and provided by banking 

entities under the compliance program mandate to help monitor potential evasions of the prohibitions and 

restrictions of section 13. Additionally and consistent with the statute, the final rule permits the Agencies 

to jointly determine to include within the definition of covered fund any fund excluded from that definition. 

The Agencies expect that this authority may be used to help address situations of evasion.
518

costly.1686 A characteristics-based approach could mitigate the costs associated with an 

investment company analysis but, depending on the characteristics, could result in 

additional compliance costs in some cases to the extent banking entities would be 

required to implement policies and procedures to prevent potential covered funds from 

having characteristics that would bring them within the covered fund definition. 

Furthermore, banking entities may currently rely on section 3(c)(1) and 3(c)(7) of the 

Investment Company Act to avoid registering various entities under the Investment 

Company Act, and the costs to analyze the status of these entities under a statutory-based 

definition of covered fund are generally already included as part of the fund formation 

process and the costs of determining covered fund status may thus be mitigated, 

especially given the exclusions provided in the final rule. 

The entities excluded from the definition of covered fund are described in detail 

in section (c) below.

1. Foreign covered funds

In order to prevent evasion of the prohibition and purposes of section 13, the 

proposal included within the definition of covered fund any issuer organized or offered 

outside of the United States (“foreign covered fund”) that would be a covered fund were 

it organized or offered in the United States.1687 

Commenters expressed concern that the proposed treatment of foreign covered 

funds was overly broad, exceeded the Agencies’ statutory authority, was not consistent 

 

1686 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012).

1687 See proposed rule § __.10(b)(1)(iii). 
519

with principles of national treatment, and violated international treaties.1688 Commenters 

expressed concern about the difficulties of applying Investment Company Act concepts 

to foreign funds that are structured to comply with regulatory schemes under local laws 

outside the United States. They also argued that it would be burdensome and costly to 

require foreign banking entities to interpret and apply U.S. securities laws to foreign 

structures that are designed primarily to be offered and sold outside the United States.1689 

Commenters also contended that foreign mutual fund equivalents, such as retail 

Undertakings for Collective Investments in Transferable Securities (“UCITS”),1690 would 

be treated as covered funds under the proposal even though they generally are similar to 

U.S. registered investment companies, which are not covered funds, meaning that under 

the proposal the scope of foreign funds captured was broader than the scope of domestic 

funds.1691 These commenters argued that a foreign fund organized and offered outside of 

 

1688 See SIFMA et al. (Covered Funds) (Feb. 2012); BNY Mellon et al.; BlackRock; ABA (Keating); 

AFTI; AFG; ICI Global; Ass'n. of Institutional Investors (Feb. 2012); ICI (Feb. 2012); SSgA (Feb. 2012); 

State Street (Feb. 2012); JPMC; BoA; Goldman (Covered Funds); Bank of Montreal et al. (Jan. 2012); 

AGC; Cadwalader (on behalf of Thai Banks); ALFI; BVI; EBF; British Bankers Ass'n.; French ACP; 

AFME et al.; F&C; IIF; ICSA; IMA; EFAMA; UKRCBC; AIMA; AFMA; Australian Bankers Ass'n. (Feb. 

2012); Allen & Overy (on behalf of Foreign Bank Group); IFIC; Allen & Overy (on behalf of Canadian 

Banks); RBC; French Treasury et al.; Hong Kong Inv. Funds Ass'n.; TCW; Govt. of Japan/Bank of Japan. 

1689 See JPMC; See also Cadwalader (on behalf of Thai Banks); Cadwalader (on behalf of Singapore 

Banks); Ass'n. of Banks in Malaysia; Govt. of Japan/Bank of Japan.

1690 UCITS are public limited companies that, under a series of directives issued by the EU Commission, 

coordinate distribution and management of unit trusts or collective investment schemes in financial 

instruments on a cross-border basis throughout the European Union on the basis of the authorization of a 

single member state. 

1691 See Allen & Overy (on behalf of Foreign Bank Group); ABA (Keating); AFG; AFTI; BoA; French 

Banking Fed'n.; SIFMA et al. (Covered Funds) (Feb. 2012); See also BNY Mellon et al.; BlackRock; ICI 

Global; Ass'n. of Institutional Investors (Feb. 2012); ICI (Feb. 2012); SSgA (Feb. 2012); State Street (Feb. 

2012); JPMC; BoA; Goldman (Covered Funds); Bank of Montreal et al. (Jan. 2012); AGC; Cadwalader (on 

behalf of Thai Banks); ALFI; BVI; EBF; British Bankers Ass'n.; French ACP; AFME et al.; F&C; IIF; 

ICSA; IMA; EFAMA; UKRCBC; AIMA; AFMA; Australian Bankers Ass'n. (Feb. 2012); Allen & Overy 

(on behalf of Foreign Bank Group); IFIC; Allen & Overy (on behalf of Canadian Banks); RBC; French 

Treasury et al.; Hong Kong Inv. Funds Ass'n.; HSBC Life; ICSA Ass'n. of Banks in Malaysia (arguing that 

foreign banking organization would have to determine how a fund would be regulated under U.S. law 

before making investments in funds in their home markets).
520

the United States should not be treated as a covered fund simply because the foreign fund 

may (or could) rely on the exclusion under section 3(c)(1) or 3(c)(7) of the Investment 

Company Act were it to be offered in the United States.1692

Some commenters argued that the proposal did not clearly identify which foreign 

funds would be covered, thereby creating uncertainty about the scope of funds to which 

section 13 would apply.1693 Several commenters argued that the proposal’s foreign 

covered fund definition could be read to include a foreign fund, even if its securities were 

never offered and sold to U.S. persons, because the fund could theoretically be offered in 

the United States in reliance on section 3(c)(1) or 3(c)(7).1694 Commenters argued that 

the definition of foreign covered fund should be tailored.1695 Some commenters argued 

that foreign funds that are not made available for sale in the U.S. or actively marketed to 

U.S. investors should be specifically excluded from the definition of covered fund.1696 

Several other commenters supported narrowing the definition of foreign covered fund to 

those foreign funds with characteristics similar to domestic hedge funds or private equity 

funds.1697

 

1692 See Allen & Overy (on behalf of Foreign Bank Group); ABA (Keating); SSgA (Feb. 2012); BoA; 

Goldman (Covered Funds). 

1693 See Australian Bankers Ass'n. (Feb. 2012); BlackRock.

1694 See BlackRock; SIFMA et al. (Covered Funds) (Feb. 2012); JPMC; ABA (Keating); IIB/EBF. These 

commenters argued that the proposed definition of a covered fund could result in virtually every foreign 

fund being considered a covered fund, regardless of whether the fund is similar to a hedge fund or private 

equity fund.

1695 See, e.g., AGC; Ass'n. of Institutional Investors (Feb. 2012); ABA (Keating); Goldman (Covered 

Funds); BoA; GE (Feb. 2012); Japanese Bankers Ass'n.; EBF.

1696 See Australian Bankers Ass'n. (Feb. 2012); AFG; BNY Mellon et al.; BlackRock; Goldman (Covered 

Funds); IIB/EBF. 

1697 See SIFMA et al. (Covered Funds) (Feb. 2012); JPMC; Goldman (Covered Funds); Credit Suisse 

(Williams); ABA (Keating); IIB/EBF; Barclays; BoA; GE (Feb. 2012) (discussing the uncertainty with 
521

After considering the comments in light of the statutory provisions and purpose of 

section 13, the Agencies have modified the final rule to more effectively tailor the scope 

of foreign funds that would be covered funds under the rule and better implement the 

language and purpose of section 13. As noted above, section 13 of the BHC Act applies 

to the global operations of U.S. banking entities, and one of the purposes of section 13 is 

to reduce the risk to the U.S. financial system of activities with and investments in 

covered funds. The Agencies proposed to include foreign funds within the definition of 

covered fund in order to more effectively accomplish the purpose of section 13. In 

particular, the Agencies were concerned that a definition of covered fund that did not 

include foreign funds would allow U.S. banking entities to be exposed to risks and 

engage in covered fund activities outside the United States that are specifically prohibited 

in the United States. This result would undermine section 13 and pose risks to U.S. 

banking entities and the stability of the U.S. financial system that section 13 was 

designed to prevent. 

At the same time, section 13 includes other provisions that explicitly limit its 

extra-territorial application to the activities of foreign banks outside the United States. 

As explained below, section 13 specifically exempts certain activities in covered funds 

conducted by foreign banking entities solely outside of the United States. 

Based on these considerations and the information provided by commenters, the 

Agencies have revised the definition of covered fund in the final rule to include certain 

foreign funds under certain circumstances. The final rule provides that a foreign fund is 

 

respect to foreign-based loan and securitization programs and whether they would be deemed covered 

funds).
522

included within the definition of covered fund only for any banking entity that is, or is 

controlled directly or indirectly by a banking entity that is, located in or organized or 

established under the laws of the United States or of any State. Under this definition a 

foreign fund becomes a covered fund only with respect to the U.S. banking entity (or 

foreign affiliate of a U.S. banking entity) that acts as a sponsor to the foreign fund or has 

an ownership interest in the foreign fund. Under the rule, a foreign fund is any entity 

that: (i) is organized or established outside the United States and the ownership interests 

of which are offered and sold solely outside the United States; (ii) is, or holds itself out as 

being, an entity or arrangement that raises money from investors primarily for the 

purpose of investing in securities for resale or other disposition or otherwise trading in 

securities; and (iii) has as its sponsor the U.S. banking entity (or an affiliate thereof) or 

has issued an ownership interest that is owned directly or indirectly by the U.S. banking 

entity (or an affiliate thereof).1698 A foreign fund therefore may be a covered fund with 

respect to the U.S. banking entity that sponsors the fund, but not be a covered fund with 

respect to a foreign bank that invests in the fund solely outside the United States.

This approach is designed to include within the definition of covered fund only 

foreign entities that would pose risks to U.S. banking entities of the type section 13 was 

designed to address. The Agencies note that any foreign fund, including a foreign fund 

sponsored or owned by a foreign banking entity, that is offered or sold in the United 

States in reliance on the exclusions in section 3(c)(1) or 3(c)(7) of the Investment 

Company Act would be included in the definition of covered fund under § __.10(b)(1)(i) 

of the final rule unless it meets the requirements of an exclusion from that definition as 

 

1698 See final rule §__.10(b)(1)(iii). 
523

discussed below.1699 Thus, the rule is designed to provide parity -- and no competitive 

advantages or disadvantages -- between U.S. and non-U.S. funds sold within the United 

States. 

To further ensure that this approach to foreign funds is consistent with the scope 

of coverage applied within the United States, the final rule excludes from the definition 

of covered fund any foreign issuer that, were it subject to U.S. securities laws, would be 

able to rely on an exclusion or exemption from the definition of investment company 

other than the exclusions contained in section 3(c)(1) or 3(c)(7) of the Investment 

Company Act.1700 

As explained below, the final rule also contains an exclusion for foreign public 

funds.1701 This is designed to prevent the extension of the definition of covered fund 

from including foreign funds that are similar to U.S. registered investment companies, 

which are by statute not covered by section 13. 

2. Commodity pools

Under the proposal, the Agencies proposed to use their authority to expand the 

definition of covered fund to include a commodity pool as defined in section 1a(10) of 

the Commodity Exchange Act.1702 A commodity pool is defined in the Commodity 

Exchange Act to mean any investment trust, syndicate, or similar form of enterprise 

 

1699 See also Goodwin, Procter & Hoar LLP, SEC Staff No-Action Letter (Feb. 28, 1997); Touche 

Remnant & Co., SEC Staff No-Action Letter (Aug. 27, 1984).

1700 See final rule §__.10(b)(2). Because any issuer that offers its securities under the U.S. securities laws 

that may rely on an exclusion or exemption from the definition of investment company other than the 

exclusions contained in section 3(c)(1) or 3(c)(7) of the Investment Company Act would not be a covered 

fund, this exclusion is designed to provide equivalent treatment for foreign covered funds.

1701 See §__.10(c)(1).

1702 See proposal rule §__.10(b)(1)(ii).
524

operated for the purpose of trading in commodity interests.1703 The Agencies proposed to 

include commodity pools in the definition of covered fund because some commodity 

pools are managed and structured in a manner similar to a covered fund. 

Some commenters objected to this expansion of the definition of covered fund as 

beyond the scope of section 13. Commenters argued that covering commodity pools 

would extend section 13 of the BHC Act to any entity that engages in a single 

commodity, futures or swap transaction, including entities that share few, if any, of the 

characteristics or risk associated with private equity funds or hedge funds.1704 For 

example, some commenters argued that many non-bank businesses that are not 

investment companies but that hedge risks using commodity interests would be treated as 

covered funds if all commodity pools were covered.1705 In addition, registered mutual 

funds, pension funds, and many investment companies that rely on exclusions or 

exceptions other than section 3(c)(1) or 3(c)(7) of the Investment Company Act would be 

covered as commodity pools. Commenters argued that the CFTC has ample authority to 

regulate the activities of commodity pools and commodity pool operators, and nothing in 

section 13 indicates that Congress intended section 13 to govern commodity pool 

 

1703 Commodity interests include: (i) commodity for future delivery, security futures product, or swap; (ii)

agreement, contract, or transaction described in section 2(c)(2)(C)(i) or 2(c)(2)(D)(i) of the Commodity 

Exchange Act; (iii) commodity option authorized under section 4c of the Commodity Exchange Act; or (iv) 

leveraged transaction authorized under section 23 of the Commodity Exchange Act. See Joint Proposal, 76 

FR at 68,897 n.224 and accompanying text.

1704 See, e.g., ABA (Keating) (citing See, e.g., CFTC Interpretative Letter No. 86-22, Comm. Fut. L. Rep. 

(CCH) ¶ 23,280 (Sept. 19, 1986)); SIFMA et al. (Covered Funds) (Feb. 2012); ICI (Feb. 2012); 

BlackRock; Goldman (Covered Funds); Wells Fargo (Covered Funds); BoA; EFAMA; TCW; ISDA (Feb. 

2012); Arnold & Porter; BNY Mellon et al.; SSgA (Feb. 2012); State Street (Feb. 2012); Credit Suisse 

(Williams); RMA; IIB/EBF. 

1705 See Goldman (Covered Funds); TCW; IIB/EBF.
525

activities or investments in commodity pools.1706 Commenters also argued that 

expanding the definition of covered fund to include commodity pools would have the 

unintended consequence of limiting all covered transactions between a banking entity 

sponsor or investor in a commodity pool and the commodity pool itself.1707 If a 

commercial end user is a commodity pool for example, this restriction could limit access 

to credit for that entity. 

Commenters that opposed the proposal’s inclusion of commodity pools generally 

asserted that, if commodity pools were nonetheless included as covered funds under the 

final rule, the definition of commodity pool should be modified so that it would include 

only those pools that engage “primarily” or “principally” in commodities trading and

exhibit characteristics similar to those of conventional hedge funds and private equity 

funds.1708 Other commenters urged the Agencies to incorporate the exemptions from the 

commodity pool operator registration requirements under the Commodity Exchange Act 

(such as rule 4.13(a)(4)).1709 

Some commenters supported including commodity pools within the definition of 

covered fund,1710 with some suggesting that this approach would be consistent with the 

goals of the statute.1711 One commenter asserted that including commodity pools would 

be necessary to prevent banking entities from indirectly engaging in prohibited 

 

1706 See, e.g. ̧ SIFMA et al. (Covered Funds) (Feb. 2012); ICI (Feb. 2012); BlackRock. 

1707 See, e.g., BoA.

1708 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); Goldman (Covered Funds); BlackRock; Wells 

Fargo (Covered Funds); BNY Mellon, et al.; SSgA (Feb. 2012); State Street (Feb. 2012); Credit Suisse 

(Williams); ABA (Keating); FIA; IIB/EBF; BoA.

1709 See Credit Suisse (Williams).

1710 See AFR et al. (Feb. 2012); Alfred Brock; Occupy; Sens. Merkley & Levin (Feb. 2012). 

1711 See Sens. Merkley & Levin (Feb. 2012); Occupy; AFR et al. (Feb. 2012); Alfred Brock.
526

proprietary trading through commodity pools.1712 Another commenter asserted that the 

inclusion of commodity pools was advisable because the CFTC has in the past viewed 

many commodity pools as similar to hedge funds.1713

After carefully considering these comments, the Agencies have determined not to 

include all commodity pools as covered funds as proposed. Instead, and taking into 

account commenters’ concerns, the Agencies have taken a more tailored approach that is 

designed to more accurately identify those commodity pools that are similar to issuers 

that would be investment companies as defined the Investment Company Act of 1940 but 

for section 3(c)(1) or 3(c)(7) of that Act, consistent with section 13(h)(2) of the BHC Act. 

Under the final rule, as a threshold matter, a collective investment vehicle must 

determine whether it is a “commodity pool” as that term is defined in section 1a(10) of 

the Commodity Exchange Act.1714 The Agencies note that collective investment vehicles 

need to make this determination for purposes of complying with the Commodity 

Exchange Act regardless of whether commodity pools are covered funds. Under section 

1a(10), a commodity pool is “any investment trust, syndicate, or similar form of 

enterprise operated for the purpose of trading commodity interests.”1715 If a collective 

investment vehicle meets that definition, the commodity pool would be considered a 

 

1712 See Sens. Merkley & Levin (Feb. 2012).

1713 See Occupy.

1714 See 7 U.S.C. 1a(10). 

1715 Id. The CFTC and its divisions have provided interpretative guidance with respect to the meaning of 

the definition of commodity pool. See, e.g., 46 FR 26004, 26005 (May 8, 1981) (adopting the CFTC’s 

regulatory definition of commodity pool in 17 CFR 4.10(d), which is substantively identical to the 

definition in section 1a(10) of the Commodity Exchange Act); 77 FR 11252, 11258 (Feb. 24, 2012) 

(explaining the need for swaps to be included in the de minimis exclusion and exemption in 17 CFR 4.5 

and 4.13); CFTC Staff Letter 12-13 (Oct. 11, 2012) (providing interpretative guidance to equity real estate 

investment trusts); and CFTC Staff Letters Nos. 12-14 (Oct. 11, 2012) and 12-45 (Dec. 7, 2012) (providing 

interpretative relief that certain securitization vehicles are not commodity pools).
527

covered fund provided it meets one of two alternative tests and does not also qualify for 

an exclusion from the covered fund definition (e.g., the exclusion for registered 

investment companies). 

First, a commodity pool will be a covered fund if it is an “exempt pool” under 

section 4.7(a)(1)(iii) of the CFTC’s regulations,1716 meaning that it is a commodity pool 

for which a registered commodity pool operator has elected to claim the exemption 

provided by section 4.7 of the CFTC’s regulations. The Agencies believe that such 

commodity pools are appropriately considered covered funds because, like funds that rely 

on section 3(c)(1) or 3(c)(7), these commodity pools sell their participation units in 

restricted offerings that are not registered under the Securities Act of 1933 and are 

offered only to investors who meet certain heightened qualification standards, as 

discussed above.1717 The Agencies therefore have determined that they properly are 

considered “such similar funds” as specified in section 13(h)(2) of the BHC Act. 

Alternatively, a commodity pool for which exempt pool status under section 4.7 

of the CFTC’s regulations has not been elected may also be a covered fund if the pool 

features certain elements that make the pool substantively similar to exempt pools under 

section 4.7. The Agencies are including the alternative definition of commodity pools 

that are covered funds because, if the Agencies had included only pools for which exempt 

pool status had been elected, covered fund status for pools in which banking entities are 

 

1716 17 CFR 4.7(a)(1)(iii).

1717 Although section 3(c)(1) itself does not limit the types of investors who may invest in a fund relying on 

that exclusion, section 3(c)(1) provides that the fund may not conduct a public offering. A fund relying on 

section 3(c)(1) therefore must offer and sell its interests in offerings that are not registered under the 

Securities Act of 1933, which offerings generally are limited to persons who meet certain qualification 

standards. 
528

invested could easily be avoided merely by not electing exempt pool status under section 

4.7. The following is a description of the elements of a pool that would cause a pool that 

is not an exempt pool under section 4.7 to be a covered fund. 

The first element is that a commodity pool operator for the pool is registered 

pursuant to the Commodity Exchange Act in connection with the operation of that 

commodity pool. This element is present for all pools that are exempt pools under 

section 4.7 because exempt pool status can only be elected by registered commodity pool 

operators. This element excludes from the definition of covered fund an entity that is a 

commodity pool, but for which the pool operator has been either exempted from 

registration as a commodity pool operator or excluded from the definition of commodity 

pool operator under the CFTC’s regulations or pursuant to a no-action letter issued by 

CFTC staff.1718

The second element under the alternative definition is that substantially all of the 

commodity pool’s participation units are owned only by qualified eligible persons under 

section 4.7(a)(2) and (a)(3).1719 This element is consistent with the requirement under 

section 4.7 that exempt pool status can only be claimed if the participation units in the 

pool are only offered or sold to qualified eligible persons.1720 Moreover, the inclusion of 

 

1718 See, e.g., CFTC regulations 3.10(c) and 4.13 and CFTC Staff Letters Nos. 12-37 (Nov. 29, 2012) (relief 

from registration for operators of certain types of family office pools), 12-40 (Dec. 4, 2012) (relief from 

registration for operators of business development companies that meet certain conditions) and 12-44 (Dec. 

7, 2012) (relief from registration for operators of mortgage real estate investment trusts that meet certain 

conditions). See also supra note 1715.

1719 17 CFR 4.7(a)(2) and (a)(3).

1720 Although section 4.7 requires that all participation units be owned by qualified eligible persons, this 

element of the final rule has been modified to include pools for which “substantially all” participation units 

are owned by qualified eligible persons to prevent avoidance of covered fund status by distributing a small 

number of participation units to persons who are not qualified eligible persons.
529

this element aligns the elements of the alternative test with features that define funds that 

rely on sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940. 

The assessment as to whether the commodity pool in question satisfies this 

condition must be made at the time that the banking entity is required to make the 

following determinations: whether it can obtain new participation units in the commodity 

pool, whether it can retain previously purchased participation units in the commodity 

pool, and whether it can act as the commodity pool’s sponsor. The Agencies believe this 

to be appropriate because it would require the banking entity to consider current 

information regarding the commodity pool and its participants rather than assess the 

composition of the pool’s participants over time even though its investments in or 

relationships with the pool do not change, which could be difficult depending upon the 

length of time that the pool has been in operation and the records available at the time of 

determination.

Finally, the third element under the alternative definition is that the commodity 

pool participation units have not been publicly offered to persons other than qualified 

eligible persons. Consistent with CFTC regulations addressing the meaning of “offer” in 

the context of the CFTC’s regulations, the term “offer” as used in § __.10(b)(1)(ii)(B) 

“has the same meaning as in contract law, such that, if accepted the terms of the offer 

would form a binding contract.”1721 This aspect of the alternative definition is intended 

to limit the ability for commodity pools to avoid classification as covered funds through 

 

1721 See 77 FR 9734, 9741 (Feb. 17, 2012) (describing the meaning of the term “offer” in the context of the 

business conduct standards for swap dealers and major swap participants with counterparties adopted by 

the CFTC). The term “offered” as used in this section of the final rule is not intended to denote an “offer” 

for purposes of the Securities Act of 1933.
530

an offer, either in the past or currently ongoing, to non-qualified eligible persons “in 

name only” where there is no actual offer to non-qualified eligible persons.

Accordingly, unless the pool operator can show that the pool’s participation units 

have been actively and publicly offered to non-affiliated parties that are not qualified 

eligible persons whereby such non-qualified eligible persons could in fact purchase a 

participation unit in the commodity pool, a pool that features the other elements listed in 

the alternative definition would be a covered fund. Such a showing will not turn solely 

on whether the commodity pool has filed a registration statement to offer its participation 

units under the Securities Act of 1933 or whether the commodity pool operator has 

prepared a disclosure document consistent with the provisions of section 4.24 of the 

CFTC’s regulations.1722 Rather, the pool operator would need to show that a reasonably 

active effort, based on the facts and circumstances, has been undertaken by brokers and 

other sales personnel to publicly offer the pool’s participation units to non-affiliated 

parties that are not qualified eligible persons. 

In taking this more tailored approach to commodity pools that will be covered 

funds, the Agencies are more closely aligning the types of commodity pools that will be 

covered funds under the final rule with section 13’s definition of a hedge fund and private 

equity fund by reference to section 3(c)(1) or section 3(c)(7), and addressing concerns of 

commenters that the proposal was overly broad and would lead to outcomes inconsistent 

with the words, structure, and purpose of section 13.1723 The Agencies believe that the 

types of commodity pools described above generally are similar to funds that rely on 

 

1722 17 CFR 4.24 (2013).

1723 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); BlackRock; AHIC; Sen. Carper et al.; Rep. 

Garrett et al.
531

section 3(c)(1) and 3(c)(7) in that, like funds that rely on section 3(c)(1) or 3(c)(7), these 

commodity pools may be owned only by investors who meet certain heightened 

qualification standards, as discussed above.1724 Further, the Agencies believe that the 

final rule’s identification of the elements of a commodity pool that is a covered fund are 

clearly established and readily ascertainable such that once it is determined whether an 

entity is a commodity pool, an assessment that is already necessary to comply with the 

Commodity Exchange Act, then the further determination of whether an entity that is a 

commodity pool is also a covered fund can be made based on readily ascertainable 

information.

In adopting this approach, the Agencies also are utilizing the current regulatory 

structure promulgated by the CFTC under the CEA. As the CFTC regulates commodity 

pools, commodity pool operators, and commodity trading advisors that advise commodity 

pools, the Agencies believe that it is beneficial to utilize an already established set of 

rules, regulations, and guidance. The Agencies considered alternative approaches 

provided by the commenters, but have adopted the approach taken in the final rule for the 

reasons discussed above and because the Agencies believe that the final rule, by 

incorporating concepts with which commodity pools and their operators are familiar, 

more clearly delineates the commodity pools that are covered funds.1725 

 

1724 Funds relying on section 3(c)(7) must be owned exclusively by qualified purchasers, as defined in the 

Investment Company Act. The Agencies note in this regard that section 4.7 of the CFTC’s regulations use 

substantially the same definition of a qualified purchaser in defining the term qualified eligible person.

1725 Operators of commodity pools currently must consider whether they are required to register with the 

CFTC as commodity pool operators, and whether the pools have the characteristics that would make it 

possible for the operator to claim an exemption under section 4.7. These concepts thus should be familiar 

to commodity pools and their operators, and including these concepts in the final rule should allow banking 

entities more easily to determine if a particular commodity pools is a covered fund than if the Agencies 

were to develop new concepts solely for purposes of the final rule.
532

The Agencies believe that the final rule’s tailored approach to commodity pools 

includes in the definition of covered fund commodity pools that are similar to funds that 

rely on section 3(c)(1) and 3(c)(7). The Agencies also note in this regard that a 

commodity pool that would be a covered fund even under this tailored approach will not 

be a covered fund if the pool also qualifies for an exclusion from the covered fund 

definition, including the exclusion for registered investments companies. Accordingly, 

this approach excludes from covered funds entities like commercial end users and 

registered investment companies, whose activities do not implicate the concerns section 

13 was designed to address. Rather, the final rule limits the commodity pools that will be 

included as covered funds to those that are similar to other covered funds except that they 

are not generally subject to the Investment Company Act of 1940 due to the instruments 

in which they invest. For all of these reasons, the Agencies believe that the final rule’s 

approach to commodity pools addresses both the Agencies’ concerns about the potential 

for evasion and commenters’ concerns about the breadth of the proposed rule, and 

provides that the commodity pools captured as covered funds are “such similar funds,” 

consistent with section 13(h)(2) of the BHC Act. 

The Agencies acknowledge that as a result of including certain commodity pools 

in the definition of covered fund, the prohibitions under section 13(f) and §__.14 may 

result in certain structural changes in the industry. The Agencies note that these changes 

(e.g., bank-affiliated FCMs may not be able to lend money in certain clearing transactions 

to affiliated commodity pools that are covered funds) may result in certain changes in the 

way related entities do business with each other. However, the Agencies believe that 

because the industry is competitive with a significant number of alternative non-affiliate 
533

competitors, the changes would not result in a less competitive landscape for investors in 

commodity pools.

3. Entities regulated under the Investment Company Act

The proposed rule did not specifically include registered investment companies 

(including mutual funds) or business development companies within the definition of 

covered fund.1726 As explained above, the statute references funds that rely on section 

3(c)(1) or 3(c)(7) of the Investment Company Act. Registered investment companies and 

business development companies do not rely on either section 3(c)(1) or 3(c)(7) of the 

Investment Company Act and are instead registered or regulated in accordance with the 

Investment Company Act. 

Many commenters argued that registered investment companies and business 

development companies would be treated as covered funds under the proposed definition 

if commodity pools are treated as covered funds.1727 A few commenters argued that the 

final rule should specifically provide that all SEC-registered funds are excluded from the 

definition of covered fund (and the definition of banking entity) to avoid any uncertainty 

about whether section 13 applies to these types of funds.1728 

Commenters also requested that the final rule exclude from the definition of 

covered fund entities formed to establish registered investment companies during the 

 

1726 See proposed rule § __.10(b)(1). 

1727 See, e.g., Arnold & Porter; BoA; Goldman (Covered Funds); ICI (Feb. 2012); Putnam; TCW; 

Vanguard. According to these commenters, a registered investment company may use security or 

commodity futures, swaps, or other commodity interests in various ways to manage its investment portfolio 

and be swept into the broad definition of “commodity pool” contained in the Commodity Exchange Act. 

1728 See Arnold & Porter; Goldman (Covered Funds); See also SIFMA et al. (Covered Funds) (Feb. 2012); 

SIFMA et al. (Mar. 2012); ABA (Keating); BoA; ICI (Feb. 2012); JPMC; (requesting clarification that 

registered investment companies are not banking entities); TCW. 
534

seeding period. These commenters contended that, during the early stages of forming 

and seeding a registered investment company, an entity relying on section 3(c)(1) or 

(3)(c)(7) may be created to facilitate the development of a track record for the registered 

investment company so that it may be marketed to unaffiliated investors.1729 

The Agencies did not intend to include registered investment companies and 

business development companies as covered funds under the proposal. Section 13’s 

definition of private equity fund and hedge fund by reference to section 3(c)(1) and 

3(c)(7) of the Investment Company Act appears to reflect Congress’ concerns about 

banking entities’ exposure to and relationships with investment funds that explicitly are 

excluded from SEC regulation as investment companies. The Agencies do not believe it 

would be appropriate to treat as a covered fund registered investment companies and 

business development companies, which are regulated by the SEC as investment 

companies. The Agencies believe that the proposed rule’s inclusion of commodity pools 

would have resulted in some registered investment companies and business development 

companies being covered funds, a result the Agencies did not intend. The Agencies, in 

addition to narrowing the commodity pools that will be included as covered funds as 

discussed above, have also modified the final rule to exclude SEC-registered investment 

companies and business development companies from the definition of covered fund.1730

The Agencies also recognize that an entity that becomes a registered investment 

company or business development company might, during its seeding period, rely on 

section 3(c)(1) or 3(c)(7). The Agencies have determined to exclude these seeding 

 

1729 See ICI (Feb. 2012); TCW.

1730 See final rule § __.10(c)(12).
535

vehicles from the covered fund definition for the same reasons the Agencies determined 

to exclude entities that are operating as registered investment companies or business 

development companies as discussed in more detail below in Part IV.B.1.c.12 of this 

Supplementary Information. 

The Agencies also understand that registered investment companies may establish 

and hold subsidiary entities that rely on section 3(c)(1) or 3(c)(7) in order to trade in 

various financial instruments for the registered investment company parent. If a 

registered investment company were itself a banking entity, section 13 and the final rule 

would prohibit the registered investment company from sponsoring or investing in such 

an investment subsidiary. But a registered investment company would only itself be a 

banking entity if it is an affiliate of an insured depository institution. As explained in the 

proposal, a registered investment company, such as a mutual fund or exchange traded 

fund, or an entity that has made an effective election to be regulated as a business 

development company, would not be an affiliate of a banking entity for purposes of 

section 13 of that Act solely by virtue of being advised, or organized, sponsored and 

managed by a banking entity in accordance with the BHC Act (including section 13) and 

the Board’s Regulation Y.1731 

Under the BHC Act, an entity (including a registered investment company) would 

generally be considered an affiliate of a banking entity, and therefore a banking entity 

itself, if it controls, is controlled by, or is under common control with an insured 

depository institution.1732 Pursuant to the BHC Act, a company controls another 

 

1731 See Joint Proposal, 76 FR at 68,856.

1732 See final rule § __.2(a) (defining “affiliate” for purposes of the final rule). 
536

company if: (i) the company directly or indirectly or acting through one or more other 

persons owns, controls, or has power to vote 25 per cent or more of any class of voting 

securities of the company; (ii) the company controls in any manner the election of a 

majority of the directors of trustees of the other company; or (iii) the Board determines, 

after notice and opportunity for hearing, that the company directly or indirectly exercises 

a controlling influence over the management or policies of the company.1733 

The Board’s regulations and orders have long recognized that a bank holding 

company may organize, sponsor, and manage a mutual fund such as a registered 

investment company, including by serving as investment adviser to registered investment 

company, without controlling the registered investment company for purposes of the 

BHC Act.1734 For example, the Board has permitted a bank holding company to own up 

to 5 percent of the voting shares of a registered investment company for which the bank 

holding company provides investment advisory, administrative, and other services, and 

has a number of director and officer interlocks, without finding that the bank holding 

company controls the fund.1735 The Board has also permitted a bank holding company to 

own less than 25 percent of the voting shares of a registered investment company and 

provide similar services without finding that the bank holding company controls the fund, 

 

1733 See 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e). 

1734 See, e.g., 12 CFR 211.10(a)(11); 225.28(b)(6)(i); 225.86(b)(3); Unicredito, 86 FED. RES. BULL. 825 

(2000); Societe Generale, 84 FED. RES. BULL. 680 (1998); Commerzbank AG, 83 FED. RES. BULL. 678 

(1997); The Governor and Company of the Bank of Ireland, 82 FED. RES. BULL. 1129 (1996); Mellon Bank 

Corp., 79 FED. RES. BULL. 626 (1993); Bayerische Vereinsbank AG, 73 FED. RES. BULL. 155 (1987). 

1735 See, e.g., Societe Generale, 84 FED. RES. BULL. 680 (1998) (finding that a bank holding company does 

not control a mutual fund for which it holds up to 5 percent of the voting shares and also provides 

investment advisory, administrative and other services, has directors or employees who comprise less than 

25 percent of the board of directors of the fund (including the chairman of the board), and has three senior 

officer interlocks and a number of junior officer interlocks).
537

so long as the fund limits its investments to those permissible for the holding company to 

make itself.1736

The BHC Act, as amended by the Gramm-Leach-Bliley Act, and the Board’s 

Regulation Y authorize a bank holding company that qualifies as a financial holding 

company to engage in a broader set of activities, and to have a broader range of 

relationships or investments with entities, than bank holding companies.1737 For instance, 

a financial holding company may engage in, or acquire shares of any company engaged 

in, any activity that is financial in nature or incidental to such financial activity, including 

any activity that a bank holding company is permitted to engage in or acquire by 

regulation or order.1738 In light of the foregoing, for purposes of section 13 of the BHC 

Act a financial holding company may own more than 5 percent (and less than 25 percent) 

of the voting shares of a registered investment company for which the holding company 

provides investment advisory, administrative, and other services and has a number of 

director and officer interlocks, without controlling the fund for purposes of the BHC 

Act.1739 

 

1736 See letter dated June 24, 1999, to H. Rodgin Cohen, Esq., Sullivan & Cromwell (First Union Corp.), 

from Jennifer J. Johnson, Secretary of the Board of Governors of the Federal Reserve System (finding that 

a bank holding company does not control a mutual fund for which it provides investment advisory and 

other services and that complies with the limitations of section 4(c)(7) of the BHC Act (12 U.S.C. 

1843(c)(7)), so long as (i) the bank holding company reduces its interest in the fund to less than 25 percent

of the fund’s voting shares after a six-month period, and (ii) a majority of the fund’s directors are 

independent of the bank holding company and the bank holding company cannot select a majority of the 

board) (“First Union Letter”); H.R. Rep. No. 106-434 at 153 (1999) (Conf. Rep.) (noting that the Act 

permits a financial holding company to sponsor and distribute all types of mutual funds and investment 

companies); See also 12 U.S.C. 1843(k)(1), (6).

1737 See, e.g., H.R. Rep. No. 106-434 at 153 (1999) (Conf. Rep.) (noting that the Act permits a financial 

holding company to sponsor and distribute all types of mutual funds and investment companies).

1738 See 12 U.S.C. 1843(k)(1); 12 CFR 225.86.

1739 See First Union Letter (June 24, 1999); See also 12 CFR 225.86(b)(3) (authorizing a financial holding 

company to organize, sponsor, and manage a mutual fund so long as (i) the fund does not exercise 
538

So long as a bank holding company or financial holding company complies with 

these limitations, it would not, absent other facts and circumstances, control a registered 

investment company and the registered investment company for purposes of section 13

(and any subsidiary thereof) would not itself be a banking entity subject to the restrictions 

of section 13 of the BHC Act and any final implementing rules (unless the registered 

investment company itself otherwise controls an insured depository institution). Also 

consistent with the Board’s precedent regarding bank holding company control of and 

relationships with funds, a seeding vehicle that will become a registered investment 

company or SEC-regulated business development company would not itself be viewed as 

violating the requirements of section 13 during the seeding period so long as the banking 

entity that establishes the seeding vehicle operates the vehicle pursuant to a written plan, 

developed in accordance with the banking entity’s compliance program, that reflects the 

banking entity’s determination that the vehicle will become a registered investment 

company or SEC-regulated business development company within the time period 

provided by section 13(d)(4) and §__.12 for seeding a covered fund.1740

c. Entities Excluded from Definition of Covered Fund

As noted above, the final rule excludes a number of entities from the definition of 

covered fund.1741 As discussed in more detail below, these exclusions more effectively 

tailor the definition of covered fund to those types of entities that section 13 was designed 

 

managerial control over the entities in which the fund invests, and (ii) the financial holding company 

reduces its ownership in the fund, if any, to less than 25 percent of the equity of the fund within one year of 

sponsoring the fund or such additional period as the Board permits).

1740 See final rule §§ __.10(c)(12) and __.20(e). Under the final rule, these Seeding vehicles also must 

comply with the limitations on leverage under the Investment Company Act that apply to registered 

investment companies and SEC-regulated business development companies. See final rule § __.10(c)(12).

1741 See final rule §__.10(c). 
539

to focus on. The exclusions thus are designed to provide certainty, mitigate compliance 

costs and other burdens, and address the potential over-breadth of the covered fund 

definition and related requirements without such exclusions by permitting banking 

entities to invest in and have other relationships with entities that do not relate to the 

statutory purpose of section 13. These exclusions, described in more detail below, take 

account of information provided by many commenters regarding entities that would 

likely be included within the proposed definition of a covered fund, but that are not 

traditionally thought of as hedge funds or private equity funds.1742 Finally, the Agencies 

note that providing exclusions from the covered fund definition, rather than providing 

permitted activity exemptions as proposed in some cases, aligns the final rule with the 

statute in applying the restrictions imposed by section 13(f) on transactions with covered 

funds only to transactions with issuers that are defined as covered funds and thus raise the 

concerns section 13 was designed to address. 

The Agencies recognize, however, that the final rule’s definition of covered fund 

does not include certain pooled investment vehicles. For example, the definition of 

covered fund excludes business development companies, entities that rely on section 

3(c)(5)(C), 3(c)(3), or 3(c)(11) of the Investment Company Act, and certain foreign 

public funds that are subject to home-country regulation. The Agencies expect that the 

types of pooled investment vehicles sponsored by the financial services industry will 

continue to evolve, including in response to the final rule, and the Agencies will be 

 

1742 See 156 Cong. Rec. H5226 (daily ed. June 30, 2010) (statement of Reps. Himes and Frank) (noting 

intent that subsidiaries or joint ventures not be included within the definition of covered fund); 156 Cong. 

Rec. S5904-05 (daily ed. July 15, 2010) (statement of Sens. Boxer and Dodd) (noting broad definition of 

hedge fund and private equity fund and recommending that the Agencies take steps to ensure definition is 

reasonably tailored); See also FSOC study at 61 – 63.
540

monitoring this evolution to determine whether excluding these and other types of entities 

remains appropriate. The Agencies will also monitor use of the exclusions for attempts 

to evade the requirements of section 13 and intend to use their authority where 

appropriate to prevent evasions of the rule.

1. Foreign public funds

As discussed above, under the proposal a covered fund was defined to include the 

foreign equivalent of any covered fund in order to address the potential for 

circumvention. Many commenters argued that the proposed definition could capture nonU.S. public retail funds, such as UCITS.1743 These commenters contended that non-U.S. 

public retail funds should be excluded from the definition of covered fund because they 

are regulated in their home jurisdiction; commenters noted that similar funds registered in 

the United States, such as mutual funds, are not covered funds.1744

Some commenters were concerned that the proposed definition could 

inadvertently capture exchange-traded funds trading in foreign jurisdictions,1745 separate 

accounts set up to fund foreign pension plans,1746 non-U.S. issuers of asset-backed 

 

1743 As discussed above, the proposed rule generally included in the covered fund definition a foreign fund 

that, were it organized or offered under the laws of the United States or offered to U.S. residents, would 

meet the definition of a domestic covered fund (i.e., would need to rely section 3(c)(1) or 3(c)(7) of the 

Investment Company Act). Many commenters argued that this definition is too broad and could include as 

covered funds various types of foreign funds, like UCITS, that commenters argued should not be included. 

See, e.g., JPMC; BlackRock.

1744 See SIFMA et al. (Covered Funds) (Feb. 2012); Hong Kong Inv. Funds Ass'n.; UBS; ICI Global;

BlackRock; TCW; State Street (Feb. 2012); SSgA (Feb. 2012); IAA; JPMC; Goldman (Covered Funds); 

BoA; Credit Suisse (Williams); BNY Mellon, et al.; Union Asset; EFAMA; BVI; IRSG, SEB; IIB/EBF; 

GE (Feb. 2012) (commenting on the overbreadth of the definition because of the effect on foreign issuers 

of asset-backed securities); Allen & Overy (on behalf of Foreign Bank Group).

1745 See BlackRock; Vanguard. 

1746 See BlackRock.
541

securities,1747 and non-U.S. regulated funds specifically designed for institutional 

investors.1748 Commenters also provided several potential effects of capturing foreign 

public funds under the covered fund definition: U.S. banking entities would incur 

unnecessary and substantial costs to rebrand and restructure their non-U.S. regulated 

funds,1749 banking entities could be eliminated from the potential pool of counterparties, 

thereby affecting pricing and efficiency,1750 U.S. banking entities may exit the UCITS 

market and lose competitiveness,1751 the growth of mutual fund formation in foreign 

countries could be limited,1752 and market liquidity in foreign jurisdictions could be 

impaired.1753

Some commenters supported excluding any foreign public fund that is organized 

or formed under non-U.S. law, authorized for public sale in the jurisdiction in which it is 

organized or formed, and regulated as a public investment company in that 

jurisdiction.1754 In light of the proposal’s broad definition of covered fund, some 

commenters recommended explicitly excluding non-U.S. regulated funds based on 

 

1747 See ASF (Feb. 2012).

1748 See Union Asset; EFAMA; BVI. 

1749 See Goldman (Covered Funds).

1750 See AFMA.

1751 See BoA.

1752 See BVI.

1753 See Goldman (Covered Funds).

1753 See AFMA.

1753 See BoA.

1754 See ICI Global; ICI (Feb. 2012); SSgA (Feb. 2012); BNY Mellon et al.
542

characteristics to distinguish the foreign funds that should be treated as covered funds.1755 

Several commenters recommended excluding non-U.S. funds based upon whether the 

funds are subject to a regulatory framework comparable to that which is imposed on 

SEC-registered funds;1756 one commenter specifically identified European UCITS, 

Canadian mutual funds, Australian unit trusts, and Japanese investment trusts as 

examples of regulated funds to be excluded.1757 

To address these concerns, the final rule generally excludes from the definition of 

covered fund any issuer that is organized or established outside of the United States and 

the ownership interests of which are authorized to be offered and sold to retail investors 

in the issuer’s home jurisdiction and are sold predominantly through one or more public 

offerings outside of the United States.1758 Foreign funds that meet these requirements 

will not be covered funds, except that an additional condition applies to U.S. banking 

entities1759 with respect to the foreign public funds they sponsor. The foreign public fund 

exclusion is only available to a U.S. banking entity with respect to a foreign fund 

sponsored by the U.S. banking entity if, in addition to the requirements discussed above, 

the fund’s ownership interests are sold predominantly to persons other than the 

 

1755 See UBS; ICI Global; ICI (Feb. 2012); Allen & Overy (on behalf of Foreign Bank Group); T. Rowe 

Price; HSBC Life; Union Asset; EFAMA; BVI; EBF; Hong Kong Inv. Funds Ass'n.; IMA; Ass'n. of 

Institutional Investors (Feb. 2012); Katten (on behalf of Int'l Clients); Credit Suisse (Williams).

1756 See T. Rowe Price; Credit Suisse (Williams); SSgA (Feb. 2012); BNY Mellon et al.

1757 See T. Rowe Price.

1758 See final rule §__.10(c)(1). 

1759 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 final rule § __.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”). 
543

sponsoring banking entity, affiliates of the issuer and the sponsoring banking entity, and 

employees and directors of such entities.

For purposes of this exclusion, the Agencies note that the reference to retail 

investors, while not defined, should be construed to refer to members of the general 

public who do not possess the level of sophistication and investment experience typically 

found among institutional investors, professional investors or high net worth investors 

who may be permitted to invest in complex investments or private placements in various 

jurisdictions. Retail investors would therefore be expected to be entitled to the full 

protection of securities laws in the home jurisdiction of the fund, and the Agencies would 

expect a fund authorized to sell ownership interests to such retail investors to be of a type 

that is more similar to a U.S. registered investment company rather than to a U.S. covered 

fund. 

In order to help maintain this distinction and to avoid circumstances that could 

result in an evasion of section 13 and the final rule, the ownership interests of the fund 

must be sold predominantly in one or more public offerings outside of the United States 

to qualify for the exclusion. Given this restriction, a U.S. banking entity therefore could 

not rely on this exclusion to set up a foreign public fund for the purpose of selling a 

significant amount of ownership interests in the fund through one or more offerings 

conducted on an unregistered basis (whether in a foreign jurisdiction or in the United 

States). The Agencies generally expect that an offering is made predominantly outside of 

the United States if 85 percent or more of the fund’s interests are sold to investors that are 

not residents of the United States. 
544

The requirements that a foreign public fund both be authorized for sale to retail 

investors and sold predominantly in public offerings outside of the United States are 

based in part on the Agencies’ view that foreign funds that meet these requirements 

generally will be sufficiently similar to U.S. registered investment companies such that it 

is appropriate to exclude these foreign funds from the covered fund definition. A foreign 

fund authorized for sale to retail investors that is also publicly offered may, for example, 

provide greater information than funds that are sold through private offerings like funds 

that rely on section 3(c)(1) or 3(c)(7). Such foreign funds also may be subject to various 

restrictions, as deemed appropriate by foreign regulators in light of local conditions and 

practices, that exceed those applicable to privately offered funds. Foreign regulators may 

apply these or other enhanced restrictions or other requirements to funds that are offered 

on a broad basis to the general public for the protection of investors in those jurisdictions.

A foreign fund that purports to publicly offer its shares but in fact offers them on 

a more limited basis, however, may be less likely to resemble a registered investment 

company in these and other respects. In order to limit the foreign public fund exclusion 

to funds that publicly offer their shares on a sufficiently broad basis, the final rule defines 

the term “public offering” for purposes of this exclusion to mean a “distribution” (as 

defined in § __.4(a)(3) of subpart B) of securities in any jurisdiction outside the United 

States to investors, including retail investors, provided that (i) the distribution complies 

with all applicable requirements in the jurisdiction in which such distribution is being 

made; (ii) the distribution does not restrict availability to investors having a minimum 

level of net worth or net investment assets; and (iii) the issuer has filed or submitted, with 
545

the appropriate regulatory authority in such jurisdiction, offering disclosure documents 

that are publicly available.1760

Under the final rule, therefore, a foreign fund’s distribution would not be a public 

offering for purposes of the foreign public fund exclusion if the distribution imposes 

investor restrictions based on a required minimum level of net worth or net investment 

assets. This would not be affected by any suitability requirements that may be imposed 

under applicable local law. In addition, the final rule requires that, in connection with a 

public offering by a foreign public fund, the offering disclosure documents must be 

“publicly available.” This requirement will provide assurance regarding the transparency 

for such an offering and will generally be satisfied where the documents are made 

accessible to all persons in such jurisdiction. Disclosure documents may be made 

publicly available in a variety of means, such as through a public filing with a regulatory 

agency or through a website that provides broad accessibility to persons in such 

jurisdiction.

In addition and as discussed above, the final rule also places an additional 

condition on a U.S. banking entity’s ability to rely on the foreign public fund exclusion 

with respect to the foreign public funds it sponsors. For a U.S. banking entity to rely on 

the foreign public fund exclusion with respect to a foreign public fund it sponsors, the 

ownership interests in the fund must be sold predominantly to persons other than the 

sponsoring U.S. banking entity and certain persons connected to that banking entity. 

Consistent with the Agencies’ view concerning whether a foreign public fund has been 

sold predominantly outside of the United States, the Agencies generally expect that a 

 

1760 See final rule § __.10(c)(1)(iii).
546

foreign public fund will satisfy this additional condition if 85 percent or more of the 

fund’s interests are sold to persons other than the sponsoring U.S. banking entity and 

certain persons connected to that banking entity. 

This additional condition reflects the Agencies’ view that the foreign public fund 

exclusion is designed to treat foreign public funds consistently with similar U.S. funds 

and to limit the extraterritorial application of section 13 of the BHC Act, including by 

permitting U.S. banking entities and their foreign affiliates to carry on traditional asset 

management businesses outside of the United States. The exclusion is not intended to 

permit a U.S. banking entity to establish a foreign fund for the purpose of investing in the 

fund as a means of avoiding the restrictions imposed by section 13. Permitting a U.S. 

banking entity to invest in a foreign public fund under this exclusion only when that fund 

is sold predominantly to persons other than the sponsoring U.S. banking entity and 

certain persons connected to that banking entity permits U.S. banking entities to continue 

their asset management businesses outside of the United States while also limiting the 

opportunity for evasion of section 13 as discussed below. 

This additional condition only applies to U.S. banking entities with respect to the 

foreign public funds they sponsor because the Agencies believe that a foreign public fund 

sponsored by a U.S. banking entity may present heightened risks of evasion. Absent the 

additional condition, a U.S. banking entity could establish a foreign public fund for the 

purpose of itself investing substantially in that fund and, through the fund, making 

investments that the banking entity could not make directly under section 13. The 

Agencies believe it is less likely that a U.S. banking entity effectively could evade section 

13 by investing in third-party foreign public funds that the banking entity does not 
547

sponsor. In those cases it is less likely that the U.S. banking entity would be able to 

control the investments of the fund, and the fund thus likely would be a less effective 

means for the banking entity to engage in proprietary trading through the fund. The 

Agencies therefore have declined to apply this additional condition with respect to any

foreign public fund in which a U.S. banking entity invests but does not act as sponsor. 

The Agencies note that the foreign public fund exclusion is not intended to permit 

a banking entity to sponsor a foreign fund for the purpose of selling ownership interests 

to any banking entity (affiliated or unaffiliated) that is, or is controlled directly or 

indirectly by a banking entity that is, located in or organized under the laws of the United 

States or of any State (or to a limited group of such banking entities). The Agencies 

intend to monitor banking entities’ investments in foreign public funds to ensure that 

banking entities do not use the exclusion for foreign public funds in a manner that 

functions as an evasion of section 13 in this or any other way. The Agencies expect that 

one area of focus for such monitoring would be significant investments in a foreign 

public fund, including a fund that is unaffiliated with any banking entity located in or 

organized under the laws of the United States or of any State, where such investments 

represent a substantial percentage of the ownership interests in such fund. 

In order to conduct this monitoring more effectively, the Agencies also are 

adopting certain documentation requirements concerning U.S. banking entities’ 

investments in foreign public funds, as discussed in more detail below in Part IV.C.1 of 

this Supplementary Information. Under the final rule, a U.S. banking entity with more 

than $10 billion in total consolidated assets will be required to document its investments 

in foreign public funds, broken out by each foreign public fund and each foreign 
548

jurisdiction in which any foreign public fund is organized, if the U.S. banking entity and 

its affiliates’ ownership interests in foreign public funds exceed $50 million at the end of 

two or more consecutive calendar quarters. This requirement thus is tailored to apply 

only to U.S. banking entities above a certain size that also have substantial investments in 

foreign public funds.1761 The Agencies believe this approach appropriately balances the 

Agencies’ evasion concerns and the burdens that documentation requirements impose. 

For all of the reasons discussed above, the Agencies believe that the final rule’s 

approach to foreign public funds is consistent with the final rule’s exclusion of registered 

or otherwise exempt (without reliance on the exemptions in section 3(c)(1) or 3(c)(7)) 

funds in the United States. It also limits the extraterritorial application of section 13 of 

the BHC Act and reduces the potential economic and other burdens commenters argued 

would result for banking entities. The Agencies believe that this exclusion represents an 

appropriate balancing of considerations that should not significantly increase the risks to 

the U.S. financial system that section 13 was designed to limit.

2. Wholly-owned subsidiaries

Under the proposed rule, a banking entity would have been permitted to invest in 

or sponsor a wholly-owned subsidiary that relies on the exclusion contained in section 

3(c)(1) or 3(c)(7) of the Investment Company Act to avoid being an investment company 

under that Act if the subsidiary was carried on the balance sheet of its parent and was 

engaged principally in performing bona fide liquidity management activities.1762 

 

1761 See final rule § __.20(e). 

1762 See proposed rule § __.14(a)(2)(iv); Joint Proposal, 76 FR at 68,913. 
549

Commenters argued that, instead of providing a permitted activity exemption for 

banking entities to invest in or sponsor certain wholly-owned subsidiaries as proposed, all 

wholly-owned subsidiaries should be excluded from the definition of covered fund under 

the final rule because wholly-owned subsidiaries are typically used for organizational 

convenience and generally do not have the characteristics, risks, or purpose of a hedge 

fund or private equity fund, which involves unaffiliated investors owning interests in the 

structure for the purpose of sharing in the profits and losses from investment 

activities.1763 Commenters explained that publicly traded companies often establish 

wholly-owned intermediate companies for the purpose of holding securities of operating 

entities or other corporate vehicles necessary to the business of the entity. Because these 

intermediate companies invest entirely (or substantially) in the securities of other entities,

these intermediate companies may be investment companies for purposes of the 

Investment Company Act but for the exclusion provided by section 3(c)(1) or 3(c)(7) of 

the Investment Company Act.1764 

Commenters contended that requiring banking entities to divest their interests in 

wholly-owned subsidiaries and cease certain intercompany transactions would have a 

material adverse effect on the safety, soundness, efficiency and stability of the U.S. and 

global financial systems, which could in turn have a material adverse effect on the wider 

economy in terms of reduced credit, increased unemployment and reduced output.1765 

Commenters also argued that an exclusion for wholly-owned subsidiaries is necessary in 

 

1763 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012), JPMC; Goldman (Covered Funds), NAIB et al.; 

GE (Feb. 2012); BoA; Chamber (Feb. 2012); Wells Fargo (Covered Funds); ABA (Keating); Ass'n. of

Institutional Investors (Feb. 2012); Credit Suisse (Williams); Rep. Himes; BOK. 

1764 See 15 U.S.C. 80a-3(a)(1)(A) & (C). 

1765 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012).
550

order to avoid a conflict with other important requirements in the Dodd-Frank Act. For 

example, commenters alleged that including wholly-owned subsidiaries within the 

definition of covered fund for purposes of section 13 would create a conflict with the 

requirement that a banking entity that is a bank holding company serve as a source of 

strength to its subsidiaries because the prohibition in section 13(f) on transactions 

between a banking entity and covered funds owned or sponsored by the banking entity 

would effectively prohibit the banking entity from providing financial resources to 

wholly-owned intermediate holding companies and their subsidiaries.1766 Other 

commenters argued that banking entities would bear extensive compliance costs and 

operational burdens and likely would be restricted from structuring themselves 

effectively.1767

Commenters proposed several alternatives to address these concerns. For 

instance, commenters recommended that the final rule exclude all wholly-owned 

subsidiaries from the definition of covered fund.1768 Commenters also urged that the 

final rule include ownership interests held by employees of a banking entity with any 

ownership interests held directly by the banking entity for purposes of qualifying for any 

exclusion granted by the rule for wholly-owned subsidiaries.1769 Another commenter 

 

1766 See SIFMA et al. (Covered Funds) (Feb. 2012); BoA; Rep. Himes.

1767 See, e.g., Goldman (Covered Funds); BoA.

1768 See Rep. Himes; Fin. Services Roundtable (June 14, 2011); SIFMA et al. (Covered Funds) (Feb. 

2012); BOK; Chamber (Feb. 2012); ABA (Keating); GE (Feb. 2012); Wells Fargo (Covered Funds); 

Goldman (Covered Funds); Ass'n. of Institutional Investors (Feb. 2012); BoA; NAIB et al.

1769 See Wells Fargo (Covered Funds); Credit Suisse (Williams). 
551

recommended the exclusion of subsidiaries, wholly owned or not, that engage in bona

fide liquidity management.1770

In light of these comments and consistent with the purposes of section 13 and the 

terms of the Dodd-Frank Act as discussed in more detail above, the Agencies have 

revised the final rule to exclude wholly-owned subsidiaries from the definition of covered 

fund, including those not engaged in liquidity management.1771 A wholly-owned 

subsidiary, as defined in the final rule, is an entity, all of the outstanding ownership 

interests of which are owned directly or indirectly by the banking entity (or an affiliate 

thereof), except that (i) up to five percent of the entity’s ownership interests may be 

owned by directors, employees, and certain former directors and employees of the 

banking entity (or an affiliate thereof); and (ii) within the five percent ownership interests 

described in clause (i), up to 0.5 percent of the entity’s outstanding ownership interests 

may be held by a third party if the ownership interest is held by the third party for the 

purpose of establishing corporate separateness or addressing bankruptcy, insolvency, or 

similar concerns.1772

Although the final rule includes ownership interests held by certain former 

directors and employees for purposes of qualifying for the exclusion, the exclusion 

requires that an interest held by a former (or current) director or employee must actually 

be held by that person (or by the banking entity) and must have been acquired while 

 

1770 See Credit Suisse (Williams).

1771 Although not a condition of the exclusion, banking entities may use wholly-owned subsidiaries to 

engage in bona fide liquidity management. As discussed below, however, a wholly-owned subsidiary is 

itself a banking entity, and thus is subject to all of the requirements that apply to banking entities, including 

the requirements applicable to a banking entity’s liquidity management activities under § __.3(d)(3).

1772 See final rule § __ .10(c)(2). 
552

employed by or in the service of the banking entity. For example, if a former employee 

subsequently transfers his/her interest to a third party (other than to immediate family 

members of the employee or through intestacy of the employee), then the ownership 

interest would no longer be held by the banking entity or persons whose ownership 

interests may be aggregated with interests held by the banking entity for purposes of the 

exclusion for wholly-owned subsidiaries under the final rule. 

The final rule also permits up to 0.5 percent of the ownership interest of a whollyowned subsidiary to be held by a third party if the interest is held by the third party for 

the purpose of establishing corporate separateness or addressing bankruptcy, insolvency, 

or similar concerns, and the ownership interest is included when calculating the five 

percent cap on employee and director ownership. The Agencies understand that it is 

often important, or in certain circumstances required, under the laws of various 

jurisdictions for a parent company to establish corporate separation of a subsidiary 

through the issuance of a small amount of ownership interest to a third party. 

The Agencies believe that permitting limited employee and director ownership of 

a vehicle and accommodating the foreign law requirements discussed above is consistent 

with a vehicle’s treatment as a wholly-owned subsidiary. Under the final rule, the 

banking entity (or an affiliate thereof) will control the vehicle because it must, as 

principal, own at least 95% of the vehicle.1773 These conditions are designed to exclude 

from the covered fund definition vehicles that are formed for corporate and 

 

1773 Cf. Section 2(a)(43) of the Investment Company Act (defining a “wholly-owned subsidiary” of a 

person to mean “a company 95 per centum or more of the outstanding voting securities of which are owned 

by such person, or by a company which, within the meaning of this paragraph, is a wholly-owned 

subsidiary of such person”).
553

organizational convenience, as discussed above, and that thus do not engage in the 

investment activities prohibited by section 13. The exclusion also should reduce the 

disruption to the operations of banking entities that commenters asserted would result 

from the proposed rule.1774 

Importantly, the Agencies note that a wholly-owned subsidiary of a banking 

entity—although excluded from the definition of covered fund—still would itself be a 

banking entity, and therefore remain subject to the prohibitions and other provisions of 

section 13 of the BHC Act and the final rule.1775 Accordingly, a wholly-owned 

subsidiary of a banking entity would remain subject to the restrictions of section 13 and 

the final rule (including the ban on proprietary trading) and may not engage in activity in 

violation of the prohibitions of section 13 and the final rule. 

3. Joint ventures

The proposed rule would have permitted a banking entity to invest in or manage a 

joint venture between the banking entity and any other person, provided that the joint 

venture was an operating company and did not engage in any activity or any investment 

not permitted under the proposed rule. As noted in the proposal, many joint ventures rely 

 

1774 The Agencies also note that depositors for asset-backed securities offerings are important to the 

process of securitization. See, e.g., ASF (July 2012) (noting that a depositor, as used in a securitization 

structure, is an entity that generally acts only as a conduit to transfer the loans from the originating bank to 

the issuing entity for the purpose of facilitating a securitization transaction and engages in no discretionary 

investment or securities issuance activities). See also, Rule 191 under the Securities Act of 1933 (17 CFR 

230.191) (depositor as issuer for registered asset-backed securities offerings). Commenters raised a 

question about the treatment of depositors under the Investment Company Act, and therefore, whether they 

would technically fall within the definition of covered fund. See ASF (July 2012); GE (Aug. 2012). For 

purposes of the covered fund prohibitions, the Agencies note that depositors may fall within the whollyowned subsidiary exclusion from the covered fund definition. 

1775 See 12 U.S.C. 1851(h)(1) (defining banking entity to include any affiliate or subsidiary of a banking 

entity). 
554

on the exclusion contained in section 3(c)(1) or 3(c)(7) of the Investment Company 

Act.1776 Joint ventures are a common form of business, especially for firms seeking to 

enter new lines of business or new markets, or seeking to share complementary business 

expertise.

Commenters supported this aspect of the proposal and argued that joint ventures 

do not share the same characteristics as a hedge fund or private equity fund. However, 

they expressed concern that joint ventures were defined too narrowly under the proposal 

because the exclusion was limited to joint ventures that were operating companies. 1777 

Some commenters criticized the lack of guidance regarding the meaning of operating 

company.1778 One commenter proposed defining operating company as any company 

engaged in activities that are permissible for a financial holding company under sections 

3 or 4 of the BHC Act, other than a company engaged exclusively in investing in 

securities of other companies for resale or other disposition.1779

Another commenter argued that joint ventures are often used to share risk from 

non-performing loans, credit card receivables, consumer loans, commercial real estate 

loans or automobile loans.1780 According to this commenter, these joint ventures, while 

not generally viewed as operating companies, promote safety and soundness by allowing 

 

1776 See Joint Proposal, 76 FR at 68,913.

1777 See, , e.g., ABA (Keating); Chamber (Feb. 2012); SIFMA et al. (Covered Funds) (Feb. 2012); GE 

(Aug. 2012); Goldman (Covered Funds); NAIB et al.; Rep Himes; Sen. Bennet; See also 156 Cong Rec.

H5226 (daily ed. June 30, 2010) (statement of Rep. Himes).

1778 See, e.g., ABA (Keating); NAIB et al.; GE (Aug. 2012); Chamber (Feb. 2012); SIFMA et al.

(Covered Funds) (Feb. 2012); Wells Fargo (Covered Funds); Credit Suisse (Williams); Goldman (Covered 

Funds).

1779 See SIFMA et al. (Covered Funds) (Feb. 2012).

1780 See Goldman (Covered Funds).
555

a banking entity to limit the size of its exposure to permissible investments or to more 

efficiently transfer the risk of existing assets to a small number of partners. Commenters 

stated that banking entities often employ similar types of non-operating company joint 

ventures to engage in merchant banking activities or other permissible banking activities, 

and that the final rule should not prevent a banking entity from sharing the risk of a 

portfolio company investment with third parties.1781 A number of commenters argued 

that treating joint ventures as covered funds would create the same inconsistencies with 

other provisions and principles embodied in the Dodd-Frank Act noted for wholly-owned 

subsidiaries, were they to be treated as covered funds.1782 Several commenters argued 

that the proposed exemption, as drafted, was unworkable because it did not appear to 

provide an exception to the intercompany limitations on transactions under section 13(f), 

which prohibits transactions between a banking entity and a related covered fund.1783

Commenters proposed several alternatives to address these issues. Several 

commenters recommended that the final rule eliminate the operating company condition 

under the proposed exemption.1784 Other commenters recommended excluding joint 

ventures that have an unspecified but limited number of partners (such as five or fewer 

joint venture partners).1785 One commenter recommended excluding all “controlled joint 

 

1781 See ABA (Keating); SIFMA et al. (Covered Funds) (Feb. 2012). 

1782 See SIFMA et al. (Covered Funds) (Feb. 2012); Goldman (Covered Funds); ABA (Keating); Chamber 

(Feb. 2012).

1783 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); Goldman (Covered Funds); ABA (Keating); GE 

(Feb. 2012); Chamber (Feb. 2012).

1784 See SIFMA et al. (Covered Funds) (Feb. 2012); ABA (Keating); Credit Suisse (Williams).

1785 See SIFMA et al. (Covered Funds) (Feb. 2012); Credit Suisse (Williams); GE (Feb. 2012).
556

ventures” but did not provide an explanation of how to define that term.1786 Another 

commenter suggested defining a joint venture in one of the following ways: (1) any 

company with a limited number of co-venturers that is managed pursuant to a 

shareholders’ agreement, as opposed to managed by a general partner;1787 or (2) a joint 

venture in which: (a) there are a limited number of unaffiliated partners; (b) the parties 

operate the venture on a joint basis or in proportion to their relative ownership, including 

pursuant to a shareholders’ agreement; (c) material decisions are made by one party (for 

example, a general partner); and (d) the joint venture does not engage in any activity or 

investment not permitted under section 13, other than activities or investments incidental 

to its permissible business.1788

In response to commenter concerns, the final rule excludes joint ventures from the 

definition of covered fund with some modifications from the proposal to more clearly 

identify entities that are excluded. Under the final rule, a joint venture is excluded from 

the definition of covered fund if the joint venture is between the banking entity or any of 

its affiliates and no more than 10 unaffiliated co-venturers, is in the business of engaging 

in activities that are permissible for the banking entity other than investing in securities 

for resale or other disposition, and is not, and does not hold itself out as being, an entity 

or arrangement that raises money from investors primarily for the purpose of investing in 

securities for resale or other disposition or otherwise trading in securities.1789 Banking 

 

1786 See Goldman (Covered Funds).

1787 See ABA (Keating); Credit Suisse (Williams); SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA et 

al. (Mar. 2012); See also GE (Feb. 2012); NAIB et al.

1788 See Goldman (Covered Funds).

1789 See final rule § __ .10(c)(3). 
557

entities, therefore, will continue to be able to share the risk and cost of financing their 

banking activities through these types of entities which, as noted by commenters as 

discussed above, may allow banking entities to more efficiently manage the risk of their 

operations.

The Agencies have specified a limit on the number of joint venture partners at the 

request of many commenters that suggested such a limit be added (though typically 

without suggesting the specific number of partners). The Agencies believe that a limit of 

10 partners allows flexibility in structuring larger business ventures without involving 

such a large number of partners as to suggest the venture is in reality a hedge fund or 

private equity fund established for investment purposes. The Agencies will monitor joint 

ventures – and other excluded entities – to ensure that they are not used by banking 

entities to evade the provisions of section 13. 

The final rule’s requirement that a joint venture not be an entity or arrangement 

that raises money from investors primarily for the purpose of investing in securities for 

resale or other disposition or otherwise trading in securities prevents a banking entity 

from relying on this exclusion to evade section 13 of the BHC Act by owning or 

sponsoring what is or will become a covered fund. Consistent with this restriction and to 

prevent evasion of section 13, a banking entity may not use a joint venture to engage in 

merchant banking activities because that involves acquiring or retaining shares, assets, or 

ownership interests for the purpose of ultimate resale or disposition of the investment.1790

As with wholly-owned subsidiaries, if a banking entity owns 25 percent or more 

of the voting securities of the joint venture or otherwise controls an entity that qualifies 

 

1790 See 12 U.S.C. 1843(k)(4)(H).
558

for the joint venture exclusion, the joint venture would then itself be a banking entity and 

would remain subject to the restrictions of section 13 and the final rule (including the ban 

on proprietary trading). 

The Agencies note that the statute defines banking entity to include not only 

insured depository institutions and bank holding companies, but also their affiliates. In 

the context of a company that owns an insured depository institution but is not a bank 

holding company or savings and loan holding company, the insured depository 

institution’s affiliates may engage in commercial activities impermissible for banks and 

bank holding companies. However, section 13 of the BHC Act and the final rule do not 

authorize a banking entity to engage in otherwise impermissible activities. Because of 

this, the scope of activities in which a joint venture may engage under the final rule will 

depend on the status and identity of its co-venturers. For instance, a joint venture 

between a bank holding company and unaffiliated companies may not engage in 

commercial activities impermissible for a bank holding company. 

4. Acquisition vehicles

Similar to wholly-owned subsidiaries and joint ventures, the proposed rule would 

have permitted a banking entity to invest in or sponsor an acquisition vehicle provided 

that the sole purpose and effect of the acquisition vehicle was to effectuate a transaction 

involving the acquisition or merger of an entity with or into the banking entity or one of 

its affiliates. As noted in the proposal, banking entities often form corporate vehicles for 

the purpose of accomplishing a corporate merger or asset acquisition.1791 Because of the 

 

1791 Cf. Joint Proposal, 76 FR at 68,897.
559

way they are structured, acquisition vehicles may rely on section 3(c)(1) or 3(c)(7) of the 

Investment Company Act.1792

Commenters supported the exclusion of acquisition vehicles from the restrictions 

governing covered funds, and argued that acquisition vehicles do not share the same 

characteristics as a hedge fund or private equity fund.1793 However, similar to concerns 

articulated above with respect to wholly-owned subsidiaries and joint ventures, 

commenters argued that the proposed rule, as drafted, left uncertain how other provisions 

of section 13 would apply to these vehicles.1794

In light of the comments, the final rule has been modified to exclude acquisition 

vehicles from the definition of covered fund, rather than provide a permitted activity 

exemption for banking entities to invest in or sponsor the vehicles, so long as the vehicle 

is formed solely for the purpose of engaging in a bona fide merger or acquisition 

transaction and the vehicle exists only for such period as necessary to effectuate the 

transaction.1795 The final rule thus reflects modifications from the exemption for 

acquisition vehicles in the proposal, which was available for acquisition vehicles where 

the sole purpose and effect of the entity was to effectuate a transaction involving the 

acquisition or merger of one entity with or into the banking entity.1796 The Agencies 

 

1792 See Joint Proposal, 76 FR at 68,913; SIFMA et al. (Covered Funds) (Feb. 2012). 

1793 See, e.g., JPMC; SIFMA et al. (Covered Funds) (Feb. 2012); GE (Feb. 2012); Sen. Bennet; Sen. 

Carper et al.

1794 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); JPMC; GE (Feb. 2012). 

1795 See final rule § __.10(c)(4).

1796 The proposed rule contained an exemption for investments in acquisition vehicles, provided that the 

“the sole purpose and effect of such entity is to effectuate a transaction involving the acquisition or merger 

of one entity with or into the covered banking entity or one of its affiliates.” See proposed rule § 

__.14(a)(2)(ii). The final rule excludes an acquisition vehicle, which is defined as an issuer that is 
560

modified the conditions in the final rule, as discussed above, to more clearly reflect the 

limited activities in which an excluded acquisition vehicle may engage and to exclude 

acquisition vehicles from the definition of covered fund, rather than only permit banking 

entities to invest in or sponsor them pursuant to an exemption. 

The Agencies also note that an acquisition vehicle that survives a transaction 

would likely be excluded from the definition of covered fund under the separate 

exclusion for either joint ventures or wholly-owned subsidiaries described above. An 

acquisition vehicle that is controlled by a banking entity would be a banking entity itself 

and would be subject to the restrictions of section 13 and the final rule that apply to a 

banking entity. 

5. Foreign pension or retirement funds

Under the proposed rule, a foreign pension plan that relied on section 3(c)(1) or 

3(c)(7) of the Investment Company Act to avoid being an investment company (or that 

was a commodity pool), would have been a covered fund. Commenters argued that 

including pension funds within the definition of covered fund would produce many 

unexpected results for pension plans as well as plan participants.1797

Commenters generally argued that foreign pension or retirement funds are 

established by a foreign company or foreign sovereign for the purpose of providing a 

 

“[f]ormed solely for the purpose of engaging in a bona fide merger or acquisition transaction” and that 

“exists only for such period as necessary to effectuate the transaction.” See final rule § __.10(c)(4).

1797 As explained above, commenters also argued that a foreign pension plan should not be considered a 

banking entity if the plan is sponsored by a banking entity or is established for the benefit of employees of 

the banking entity. If deemed a banking entity, the pension plan could become subject to the limits on 

section 13 on investing in covered funds. See Allen & Overy (on behalf of Canadian Banks); Arnold & 

Porter; Credit Suisse (Williams). The final rule addresses these comments with the exclusions described 

above.
561

specific group of foreign persons with income during retirement or when they reach a 

certain age or meet certain predetermined criteria and are typically eligible for 

preferential tax treatment, and are not formed for the same purposes as hedge funds or 

private equity funds.1798 Commenters argued that the definition of covered fund should 

not include certain foreign pension or retirement funds, including managed investment 

arrangements and wrap platforms, such as so-called “superannuation funds,” that are 

managed by foreign banks as part of providing retirement or pension schemes to foreign 

citizens pursuant to foreign law and are generally not available for sale to U.S. citizens. 

Commenters asserted that many foreign banking entities act as sponsor to and organize 

and offer foreign pension funds abroad as part of a foreign sovereign program to provide 

retirement, pension, or similar benefits to its citizens or workforce.1799 These 

commenters contended that a foreign pension plan might itself rely on the exclusion in 

section 3(c)(1) or 3(c)(7) in order to avoid being an investment company if it is offered to 

citizens of the foreign sovereign present in the United States.1800 

Several commenters argued that foreign pension and retirement plans should be 

excluded from the definition of covered fund on the same basis as U.S. pension and 

retirement funds that are ERISA-qualified funds that rely on the exclusion from the 

definition of investment company provided under section 3(c)(11) of the Investment 

Company Act.1801 Commenters alleged that without an exclusion for foreign pension or 

 

1798 See, e.g., Allen & Overy (on behalf of Canadian Banks).

1799 See Allen & Overy (on behalf of Canadian Banks); Arnold & Porter; UBS; Hong Kong Inv. Funds 

Ass'n.

1800 See Allen & Overy (on behalf of Canadian Banks); Arnold & Porter; UBS; Hong Kong Inv. Funds 

Ass'n.; Credit Suisse (Williams).

1801 See Arnold & Porter; UBS; Hong Kong Inv. Funds Ass'n.; Credit Suisse (Williams).
562

retirement funds, section 13 of the BHC Act would have an extra-territorial effect on 

pension or retirement benefits abroad that would be severe and beyond what was 

contemplated by section 13 of the BHC Act. 

In light of comments received on the proposal, the final rule excludes from the 

definition of covered fund a plan, fund, or program providing pension, retirement, or 

similar benefits that is: (i) organized and administered outside of the United States; (ii) a 

broad-based plan for employees or citizens that is subject to regulation as a pension, 

retirement, or similar plan under the laws of the jurisdiction in which the plan, fund, or 

program is organized and administered; and (iii) established for the benefit of citizens or 

residents of one or more foreign sovereign or any political subdivision thereof.1802 This 

is similar to the treatment provided to U.S. pension funds by virtue of the exclusion from 

the definition of investment company under the Investment Company Act for certain 

broad-based employee benefit plans provided by section 3(c)(11) of that Act. The 

exclusion from the covered fund definition for foreign plans would be available for bona

fide plans established for the benefit of employees or citizens outside the U.S. even if 

some of the beneficiaries of the fund reside in the U.S. or subsequently become U.S. 

residents. 

The Agencies believe this exclusion is appropriate in order to facilitate parallel 

treatment of domestic and foreign pension and retirement funds to the extent possible and 

 

1802 See final rule §__.10(c)(5).
563

to assist in ensuring that section 13 of the BHC Act does not apply to foreign pension, 

retirement, or similar benefits programs.1803

6. Insurance company separate accounts 

Under the proposed rule, insurance company separate accounts would have been 

covered funds to the extent that the separate accounts relied on section 3(c)(1) or 3(c)(7). 

Such reliance would generally occur in circumstances where policies funded by the 

separate account are distributed in an unregistered securities offering solely to qualified 

purchasers or on a limited basis to accredited investors. While the proposed rule did not 

generally exclude insurance company separate accounts from the definition of covered 

fund, the proposed rule did provide a limited exemption for investing in or acting as 

sponsor to separate accounts that were used for the purpose of allowing a banking entity 

to purchase bank owned life insurance (“BOLI”), subject to certain restrictions.1804

Various state or foreign laws allow regulated insurance companies to create 

separate accounts that are generally not separate legal entities but represent a segregated 

pool of assets on the balance sheet of the insurance company that support a specific 

policy claim on the insurance company. These accounts have assets and obligations that 

are separate from the general account of the insurance company. Insurance companies 

often utilize these separate accounts to allow policyholders of variable annuity and 

variable life insurance to allocate premium amounts for the purpose of engaging in 

 

1803 Additionally and as discussed above, the prohibitions of section 13 and the final rule do not apply to an 

ownership interest that is acquired or retained by a banking entity through a deferred compensation, stockbonus, profit-sharing, or pension plan of the banking entity that is established and administered in 

accordance with the law of the United States or a foreign sovereign, if the ownership interest is held or 

controlled directly or indirectly by a banking entity as trustee for the benefit of persons who are or were 

employees of the banking entity.

1804 See proposed rule § __.14(a)(1).
564

various investment strategies that are tailored to the requirements of the individual 

policyholder. The policyholder, and not the insurance company, primarily benefits from 

the results of investments in the separate account. These separate accounts are generally 

investment companies for purposes of the Investment Company Act, unless an exclusion 

from that definition is applicable,1805 and, as noted above, may rely on the exclusion 

contained in section 3(c)(1) or 3(c)(7) of the Investment Company Act.

While most commenters supported the proposal’s recognition that interests in 

BOLI separate accounts should be permitted, commenters generally argued that the final 

rule should also provide a broader exclusion from the definition of covered fund for all 

insurance company separate accounts. Commenters argued that covering separate 

accounts could lead to unintended consequences and was inconsistent with the statutory 

recognition that the business of insurance should continue to be accommodated.1806 

These commenters argued that covering separate accounts within the definition of 

covered fund would disrupt a substantial portion of customer-driven insurance or 

retirement planning activity and pose a burden on insurance companies and holders of 

insurance policies funded by separate accounts, a result commenters alleged Congress did 

not intend.1807

In response to commenter concerns and in order to more appropriately 

accommodate the business of insurance in a regulated insurance company, the final rule 

 

1805 See In re The Prudential Ins. Co. of Am., 41 S.E.C. 335, 345 (1963), aff'd, The Prudential Ins. Co. of

Am. v. SEC, 326 F.2d 383 (3d Cir.), cert. denied, 377 U.S. 953 (1964).

1806 See ACLI (Jan. 2012); Nationwide; Sutherland (on behalf of Comm. of Annuity Insurers); See also

STANY. 

1807 See ACLI (Jan. 2012); Nationwide; Sutherland (on behalf of Comm. of Annuity Insurers); See also

STANY. 
565

excludes an insurance company separate account from the definition of covered fund 

under certain circumstances. To prevent this exclusion from being used to evade the 

restrictions on investments and sponsorship of covered funds by a banking entity, the 

final rule provides that no banking entity other than the insurance company that 

establishes the separate account may participate in the account’s profits and losses.1808 In 

this manner, the final rule appropriately accommodates the business of insurance by 

permitting an insurance company that is a banking entity to continue to provide its 

customers with a variety of insurance products through separate account structures in 

accordance with applicable insurance laws while protecting against the use of separate

accounts as a means by which banking entities might take a proprietary or beneficial 

interest in an account that engages in prohibited proprietary trading and thereby evade the 

requirements of section 13 of the BHC Act. The exclusion of insurance company

separate accounts from the definition of covered fund therefore is designed to reduce the 

potential burden of the final rule on insurance companies and holders of insurance 

policies funded by separate accounts while also continuing to prohibit banking entities 

from taking ownership interests in, and sponsoring or having certain relationships with, 

entities that engage in investment and trading activities prohibited by section 13. 

7. Bank owned life insurance separate accounts

As explained above, bank owned life insurance (“BOLI”) is generally offered 

through a separate account held by an insurance company. In recognition of the fact that 

banking entities have for many years invested in life insurance policies that covered key 

 

1808 See final rule § __.10(c)(6).
566

employees, in accordance with supervisory policies established by the Federal banking 

agencies, the proposal contained a provision that would permit banking entities to invest 

in and sponsor BOLI separate accounts.1809 

Many commenters supported the exemption in the proposal for BOLI separate 

accounts, arguing that permitting this kind of activity was appropriate and consistent with 

safety and soundness as well as financial stability.1810 Conversely, one commenter 

objected to the proposed rule’s exemption for investments in BOLI separate accounts, 

contending that such an exemption did not promote and protect the safety and soundness 

of banking entities or the financial stability of the United States.1811

After considering comments received on the proposal, the final rule excludes 

BOLI separate accounts from the definition of covered fund but maintains the substance 

of the conditions from the proposal designed to ensure that BOLI investments are not 

conducted in a manner that raises the concerns that section 13 of the BHC Act was 

designed to address. In particular, in order for a separate account to qualify for the BOLI 

exclusion from the definition of covered fund, the final rule requires that the separate 

account be used solely for the purpose of allowing one or more banking entities (which 

by definition includes their affiliates) to purchase a life insurance policy for which such 

banking entity(ies) is a beneficiary.1812 Additionally, if the banking entity is relying on 

this exclusion, the banking entity that purchases the insurance policy (i) must not control 

 

1809 See proposed rule § __.14(a)(1).

1810 See ACLI (Jan. 2012); Mass. Mutual; Jones of Northwestern; AALU; BBVA; BoA; Chris Barnard; 

Clark Consulting (Feb. 7, 2012); Clark Consulting (Feb. 13, 2012); Gagnon of GW Financial.

1811 See Occupy.

1812 See final rule § __ .10(c)(7).
567

the investment decisions regarding the underlying assets or holdings of the separate 

account,1813 and (ii) must participate in the profits and losses of the separate account in 

compliance with applicable supervisory guidance regarding BOLI.1814 

When made in the normal course, investments by banking entities in BOLI 

separate accounts do not involve the types of speculative risks section 13 of the BHC Act 

was designed to address. Rather, these accounts permit the banking entity to effectively 

hedge and cover costs of providing benefits to employees through insurance policies 

related to key employees. Moreover, applying the prohibitions of section 13 to 

investments in these accounts would eliminate an investment that helps banking entities 

to efficiently reduce their costs of providing employee benefits, and therefore potentially 

introduce a burden to banking entities that would not further the statutory purpose of 

section 13. The Agencies expect this exclusion to be used by banking entities in a 

manner consistent with safety and soundness. 

8. Exclusion for loan securitizations and definition of loan

a. Definition of loan

The proposal defined the term “loan” for purposes of the restrictions on 

proprietary trading and the covered funds provisions and, as discussed in more detail 

below, provided an exemption for loan securitizations in two separate sections of the 

proposed rule. As proposed, loan was defined as “any loan, lease, extension of credit, or 

 

1813 This requirement is not intended to preclude a banking entity from purchasing a life insurance policy 

from an affiliated insurance company.

1814 See, e.g., Bank Owned Life Insurance, Interagency Statement on the Purchase and Risk Management 

of Life Insurance (Dec. 7, 2004).
568

secured or unsecured receivable.”1815 The definition of loan in the proposed rule was 

expansive, and included a broad array of loans and similar credit transactions, but did not 

include any asset-backed security issued in connection with a loan securitization or 

otherwise backed by loans.

Some commenters requested that the Agencies narrow the proposed definition of 

“loan.”1816 One of these commenters was concerned that the proposed definition could 

apply to any banking activity and argued that the definition of loan for purposes of the 

final rule should not include securities.1817 Another commenter, citing a statement made 

by Senator Merkley, asserted that Congress did not intend the rule of construction for the 

sale and securitization of loans in section 13(g)(2) to include “loans that become financial 

instruments traded to capture the change in their market value.”1818

Other commenters requested that the Agencies expand the proposed definition of 

“loan” to capture many traditional extensions of credit that the proposal would otherwise 

exclude.1819 Examples of traditional credit extensions that commenters requested be 

 

1815 See proposed rule § __.2(q).

1816 See AFR et al. (Feb. 2012); Occupy; Public Citizen. 

1817 See Public Citizen. This commenter argued that the loan definition should be limited to the plain 

meaning of the term “loan” and noted that a loan is not a security. Id.

1818 See Occupy (citing 156 Cong. Rec. S5895 (daily ed. July 15, 2010)).

1819 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); Credit Suisse (Williams); 

GE (Feb. 2012); Goldman (Covered Funds); ICI (Feb. 2012); Japanese Bankers Ass’n.; JPMC; LSTA (Feb. 

2012); RBC; SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA (Securitization) (Feb. 2012). One 

individual commenter supported the proposed definition of loan. See Alfred Brock. For example, one 

commenter requested that definition of “loan” be revised to include “(i) any loan, lease (including any 

lease residual), extension [of] credit, or secured or unsecured receivables, (ii) any note, bond or security 

collateralized and payable from pools of loans, leases (including Lease residuals), extensions of credit or 

secured or unsecured receivables, and (iii) any contractual rights arising from, or security interests or liens, 

assets, property guarantees, insurance policies, letters of credit, or supporting obligations underlying or 

relating to any of the foregoing.” See RBC. Another commenter requested that the definition of “loan” be 

revised to include “any type of credit extension (including bonds, other [banking entity-eligible] debt 

securities, asset-backed securities [as defined in their letter], variable funding notes and securities lending 
569

specifically included within the definition of “loan” included loan participations,1820

variable funding notes or certificates,1821 note purchase facilities,1822 certain forms of 

revolving credit lines,1823 corporate bonds,1824 municipal securities,1825 securities lending 

agreements and reverse repurchase agreements,1826 auto lease securitizations,1827 and any 

other type of credit extension that banking entities traditionally have been permitted to 

issue under their lending authority.1828

The definition of “loan” in the final rule applies both in the context of the 

proprietary trading restrictions as well as in determining the scope of the exclusion of 

loan securitizations and asset-backed commercial paper conduits from the definition of 

covered fund. The final rule modifies the proposed definition and defines “loan” as “any 

 

agreements, repurchase agreements, reverse repurchase agreements and other similar extensions of credit) 

that a banking entity could hold or deal in.” See SIFMA (Securitization) (Feb. 2012).

1820 See JPMC.

1821 See ASF (Feb. 2012); Credit Suisse (Williams); JPMC (arguing that such notes operate in economic 

substance as loans); SIFMA (Securitization) (Feb. 2012).

1822 See ASF (Feb. 2012). This commenter asserted that a note purchase facility is negotiated by the assetbacked commercial paper conduit and allows the asset-backed commercial paper conduit to purchase assetbacked securities issued by an intermediate special purpose vehicle and backed by loans or asset-backed 

securities backed by loans. Id.

1823 See ASF (Feb. 2012).

1824 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); Credit Suisse (Williams); 

JPMC.

1825 See ASF (Feb. 2012). This commenter argued that certain municipal securities may be ABS, including 

revenue bonds that involve the issuance of senior and subordinate bonds. Id.

1826 See Credit Suisse (Williams); SIFMA (Securitization) (Feb. 2012).

1827 See SIFMA (Securitization) (Feb. 2012). This commenter contended that because securitization 

transactions have been viewed by the Agencies and courts as ‘legally transparent' (i.e., as simply another 

way for banking entities to buy and sell the loans or other assets underlying such securities), auto lease 

securitizations supported by a beneficial interest in a titling trust should be treated as securitizations of the 

underlying auto leases and should fall within the loan securitization exemption. This commenter also 

argued that if the definition of “loan” is not expanded to include securities, then banking entities could not 

act as sponsors for auto lease securitizations (including resecuritizations) supported by a beneficial interest 

in a titling trust.

1828 See Credit Suisse (Williams); Goldman (Covered Funds); SIFMA et al. (Covered Funds) (Feb. 2012); 

SIFMA (Securitization) (Feb. 2012).
570

loan, lease, extension of credit, or secured or unsecured receivable that is not a security or 

derivative.”1829 The definition of loan in the final rule specifically excludes loans that are 

securities or derivatives because trading in these instruments is expressly included in the 

statute’s definition of proprietary trading.1830 In addition, the Agencies believe these 

instruments, if not excluded from the definition of loan, could be used to circumvent the 

restrictions on proprietary trading. 

The definition of loan in the final rule excludes loans that are securities or 

derivatives, including securities or derivatives of or based on such instruments. The 

definition of “loan” does not specify the type, nature or structure of loans included within 

the definition, other than by excluding securities and derivatives. In addition, the 

definition of loan does not limit the scope of parties that may be lenders or borrowers for 

purposes of the definition. The Agencies note that the parties’ characterization of an 

instrument as a loan is not dispositive of its treatment under the federal securities laws or 

federal laws applicable to derivatives. The determination of whether a loan is a security 

or a derivative for purposes of the loan definition is based on the federal securities laws 

and the Commodity Exchange Act. Whether a loan is a “note” or “evidence of 

indebtedness” and therefore a security under the federal securities laws will depend on 

the particular facts and circumstances, including the economic terms of the loan.1831 For 

example, loans that are structured to provide payments or returns based on, or tied to, the 

 

1829 See final rule § __.2(s). 

1830 12 U.S.C. 1851(h)(4).

1831 See 15 U.S.C. 77b(a)(1) and 15 U.S.C. 78c(a)(10); Reves v. Ernst & Young, 494 U.S. 56 (1990) ; Trust 

Company of Louisiana v. N.N.P. Inc., 104 F.3d 1478 (5th Cir. 1997); Pollack v. Laidlaw Holdings, 27 F.3d 

808 (2d Cir. 1994); but See Marine Bank v. Weaver, 455 U.S. 551 (1982) ; Banco Espanol de Credito v. 

Security Pacific National Bank, 973 F.2d 51 (2d Cir. 1992); Bass v. Janney Montgomery Scott, Inc., 210 

F.3d 577 (6th Cir. 2000); Piaubert v. Sefrioui, 2000 WL 194140 (9th Cir. 2000).
571

performance of an asset, index or commodity or provide synthetic exposure to the credit 

of an underlying borrower or an underlying security or index may be securities or 

derivatives depending on their terms and the circumstances of their creation, use, and 

distribution.1832 Regardless of whether a party characterizes the instrument as a loan, 

these kinds of instruments, which may be called “structured loans,” must be evaluated 

based on the standards associated with evaluating derivatives and securities in order to 

prevent evasion of the restrictions on proprietary trading and ownership interests in 

covered funds. 

b. Loan securitizations

An exemption for loan securitizations was contained in two separate sections of 

the proposed rule. The first, in section __.13(a), was proposed as part of “other permitted 

covered fund activities and investments.” The second, in § __.14(d), was proposed as 

part of “covered fund activities determined to be permissible.” These proposed 

provisions would have acted in concert to permit a banking entity to acquire and retain an 

ownership interest in, or act as sponsor to, a loan securitization regardless of the 

relationship that the banking entity had with the securitization. The Agencies have 

evaluated all comments received on securitizations. These sections of the proposed rule 

were intended to implement the rule of construction contained in section 13(g)(2) of the 

BHC Act which provides that nothing in section 13 of the BHC Act shall be construed to 

limit or restrict the ability of a banking entity or nonbank financial company supervised 

 

1832 Id.
572

by the Board to sell or securitize loans in a manner that is otherwise permitted by law.1833 

The language of the proposed exemption for loan securitizations would have permitted a 

banking entity to acquire and retain an ownership interest in a covered fund that is an 

issuer of asset-backed securities, the assets or holdings of which were solely comprised 

of: (i) loans (as defined); (ii) rights or assets directly arising from those loans supporting 

the asset-backed securities; and (iii) interest rate or foreign exchange derivatives that (A) 

materially relate to the terms of such loans or rights or assets and (B) are used for 

hedging purposes with respect to the securitization structure.1834 The proposed rule in § 

__.13(d) was further augmented by the proposed rule in § __.14(a)(2) so that a banking 

entity would be permitted to purchase loan securitizations and engage in the sale and 

securitization of loans. This was accomplished through the authorization in proposed 

section __.14(a)(2) of a banking entity’s acquisition or retention of an ownership interest 

in such securitization vehicles that the banking entity did not organize and offer, or for 

which it did not act as sponsor, provided that the assets or holdings of such vehicles were 

solely comprised of the instruments or obligations identified in the proposed exemption.

The proposed rules would have allowed a banking entity to engage in the sale and 

securitization of loans by acquiring and retaining an ownership interest in certain 

securitization vehicles (which could be a covered fund for purposes of the proposed 

rules) that the banking entity organized and offered, or acted as sponsor to, without being 

subject to the ownership and sponsor limitations contained in the proposed rule.1835 As 

 

1833 See 12 U.S.C. 1851(g)(2).

1834 See proposed rule § __.13(d); Joint Proposal, 76 FR at 68,912. 

1835 Id.
573

noted in the proposing release, the Agencies recognized that by defining “covered fund” 

broadly, and, in particular, by reference to sections 3(c)(1) and 3(c)(7) of the Investment 

Company Act, securitization vehicles may be affected by the restrictions and 

requirements of the proposed rule. The Agencies attempted to mitigate the potential 

adverse impact on the securitization market by excluding loan securitizations from the 

restrictions on sponsoring or acquiring and retaining ownership interests in covered 

funds, consistent with the rule of construction contained in section 13(g)(2) of the BHC 

Act.1836 As a result, under the proposal, loan securitizations would not be limited or 

restricted because banking entities would be able to find investors or buyers for their 

loans or loan securitizations. The proposing release included several requests for 

comment on the proposed loan securitization exemption and the application of the 

covered fund prohibitions to securitizations.

Some commenters supported a narrow exemption for loan securitizations and in 

some cases suggested that the proposed exemption could be narrowed even further. For 

example, one commenter argued that the definition of “loan” for purposes of the 

exemption could include any extension of credit and any banking activity.1837 Also, in 

response to the proposing release,1838 some commenters suggested that any exemption for 

 

1836 See Joint Proposal, 76 FR at 68,931.

1837 See, e.g., Public Citizen. This commenter argued that any exemption should prevent evasion, should 

ensure that each exempted securitization reduces risk and should be designed to only serve client needs. A

different commenter recommended a safe harbor available only to a particular pre-specified, transparent 

and standardized securitization structure, where Agencies would need to justify why the specified structure 

protects against the systemic risks associated with securitization. See AFR (Nov. 2012).

1838 See Request for Comment No. 231 in the Proposing Release (noting that many issuers of asset-backed 

securities have features and structures that resemble some of the features of hedge funds and private equity 

funds (e.g., CDOs are managed by an investment adviser that has the discretion to choose investments, 

including investments in securities) and requesting comment on how to prevent hedge funds or private 
574

securitizations should seek to prevent evasion of the covered fund prohibitions by issuers 

with “hedge-fund or private equity fund-like characteristics” or issuers with “hidden 

proprietary trading operations.”1839

On the other hand, many commenters believed that the proposed exemption from 

the covered fund prohibitions for loan securitizations should be expanded to cover 

securitizations generally and not just loan securitizations. These commenters provided 

various arguments for their request to exempt all securitizations from the covered fund 

prohibitions, including that the regulation of securitizations was addressed in other areas 

of the Dodd-Frank Act,1840 that securitization is essentially a lending activity, 1841 and 

that securitizations have “long been recognized as permissible activities for banking 

entities.”1842 

Commenters recommending a broader exclusion for securitizations also provided 

a wide variety of specific suggestions or concerns. Some commenters suggested that 

permissible assets for a loan securitization include assets other than loans acquired in the 

course of collecting a debt previously contracted, restructuring a loan, during a loan work 

out or during the disposition of a loan or other similar situation.1843 Commenters noted 

 equity funds from structuring around an exemption for asset-backed securities from the covered fund 

prohibitions).

1839 See, e.g., AFR et al. (Feb. 2012); Occupy; Public Citizen. But See Credit Suisse (Williams) (arguing it 

would be difficult to use the typical structure and operation of securitizations to avoid the prohibition on 

proprietary trading because the structures are not set up to engage in the kind of proprietary trading about 

which Congress was concerned). 

1840 See AFME et al.; Ass’n. of German Banks; Cleary Glottlieb; Credit Suisse (Williams); GE (Feb. 

2012); IIB/EBF; RBC; SIFMA (Securitization) (Feb. 2012). 

1841 See, e.g., Credit Suisse (Williams).

1842 See Credit Suisse (Williams); JPMC. These commenters cited the sponsoring of asset-backed 

commercial paper conduits as an example of permissible bank securitization activity.

1843 See Allen & Overy (on behalf of Foreign Bank Group); Credit Suisse (Williams); JPMC.
575

that, for example, rules 2a-7 and 3a-7 under the Investment Company Act define eligible 

assets for a securitization as not only including financial assets but also “any rights or 

other assets designed to assure the servicing or timely distribution of proceeds to security 

holders.”1844 Commenters requested that various additional rights or assets be added to 

the list of permissible assets held by a loan securitization such as cash and cash 

accounts,1845 cash equivalents,1846 and various other high quality short term investments, 

liquidity agreements or credit enhancements, certain beneficial interests in titling trusts 

used in lease securitizations or lease residuals.1847 One commenter suggested that a loan 

securitization be permitted to include “any contractual rights arising from or supporting 

obligations underlying or relating to the loans.”1848

Others requested that loan securitizations also be permitted to hold repurchase 

agreements or unlimited amounts of various forms of securities, including municipal 

securities, asset-backed securities, credit-linked notes, trust certificates and “equity like-

 

1844 See GE (Feb. 2012); GE (Aug. 2012); ICI (Feb. 2012).

1845 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); Cleary Gottlieb; Credit 

Suisse (Williams) (including cash that did not arise directly from the underlying loans); JPMC; LSTA (Feb. 

2012); LSTA (July 2012); RBC; SIFMA (Securitization) (Feb. 2012).

1846 See Cleary Gottlieb; Credit Suisse (Williams).

1847 See JPMC (requesting high quality, highly liquid investments, including Treasury securities and highly 

rated commercial paper); LSTA (Feb. 2012); LSTA (July 2012) (requesting short-term highly liquid 

investments such as obligations backed by the full faith and credit of the United States, deposits insured by 

the Federal Deposit Insurance Corporation, various obligations of U.S. financial institutions and 

investments in money market funds); ASF (Feb. 2012); Commercial Real Estate Fin. Council; RBC 

(requesting short-term, high quality investments); Allen & Overy (on behalf of Foreign Bank Group)

(requesting short-term eligible investments); Credit Suisse (Williams) (requesting government guaranteed 

securities, money market funds and other highly credit-worthy and liquid investments); Cleary Gottlieb

(requesting money-market interests; SIFMA (Securitization) (Feb. 2012) (requesting associated 

investments which are customarily employed in securitization transactions). One commenter further noted 

that such investments are required by securitization documents. See Commercial Real Estate Fin. Council.

1848 RBC. This commenter argued that the loan securitization exemptions as proposed would not permit 

“traditional securitizations and securitizations with the characteristics of traditional securitizations” and 

“would effectively eliminate a substantial portion of the very securitization activities carried on by banks

that the [loan securitization exemptions] are designed to preserve.” 
576

rights.”1849 Some commenters requested that loan securitizations be permitted to hold a 

limited amount of certain rights such as securities.1850 Commenters also had suggestions 

about the types of derivatives that an exempted securitization vehicle be permitted to 

hold.1851 For example, one industry association requested that the loan securitization 

exemption include securitizations where up to 10 percent of the assets are held in the 

form of synthetic risk exposure that references “loans that could otherwise be held 

directly” under the proposal in order to achieve risk diversification. 1852 This commenter 

stated its belief that the rule of construction requires that synthetic exposures be permitted 

because they are used in certain types of loan securitizations. 

In addition to requests that specific types of underlying assets be permitted under 

the loan securitization exemption, the Agencies also received comments about specific 

types of asset classes or structures. Some commenters suggested certain asset classes or 

structures should be an excluded securitization from the covered fund prohibitions 

including insurance-linked securities, collateralized loan obligations, tender option bonds, 

asset-backed commercial paper conduits (ABCP conduits), resecuritizations of asset-

 

1849 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); Credit Suisse (Williams); 

GE (Feb. 2012); JPMC; RBC; SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA (Securitization) (Feb. 

2012).

1850 See, e.g., ASF (Feb. 2012); Cleary Gottlieb; LSTA (Feb. 2012). LSTA (Feb. 2012) specifically 

requested that entities issuing collateralized loan obligations that are primarily backed by loans or loan 

participations also be permitted to hold a limited amount of corporate credit obligations. This commenter 

provided recommendations about such limitations—if the amount of such corporate credit obligations 

exceeded 10 percent, a CLO would not be able to purchase any assets other than senior, secured syndicated 

loans and temporary investments (as defined in the letter). If the amount of such assets exceeded 30

percent, the entity should not be able to purchase any assets other than loans. 

1851 See AFME et al.; Allen & Overy (on behalf of Foreign Bank Group); Credit Suisse (Williams); 

Japanese Bankers Ass’n.; LSTA (Feb. 2012); SIFMA (Securitization) (Feb. 2012). 

1852 See ASF (Feb. 2012). Permissible synthetic exposure would include “credit default swaps, total return 

swaps or other agreements referencing corporate loans or corporate bonds pursuant to which the issuer is 

the seller of credit protection or otherwise ‘long’ the credit exposure of the reference corporate loan or 

bond, and receives a yield derived from the yield on the reference corporate loan or bond.”
577

backed securities, and corporate debt re-packagings.1853 In some cases, commenters 

believed that the Agencies should use their authority under section 13(d)(1)(J) of the 

BHC Act to exempt these types of vehicles. Some commenters identified other vehicles 

such as credit funds and issuers of covered bonds that they believed should be excluded 

from the covered fund prohibitions.1854 On the other hand, the Agencies also received 

comment letters that argued that certain securitizations should not be exempted from the 

covered fund prohibitions, including resecuritizations, CDO-squared, and CDO-cubed 

securitizations because of concern about their complexity and lack of reliable 

performance data or ability to value those securities.1855 

Because a loan securitization could still be a covered fund, several commenters 

expressed concern that the proposed loan securitization exemption, as drafted, did not 

exempt loan securitizations from the prohibitions of section 13(f) of the BHC Act. As a 

result, one commenter noted that the proposed loan securitization exemptions would not 

have their intended result of excluding loan securitizations from the BHC Act restrictions 

applicable to covered funds.1856 

 

1853 See AFME et al.; ASF (July 2012); GE (Aug. 2012); Capital Group; Goldman (Covered Funds); LSTA

(Feb. 2012); SIFMA et al. (Covered Funds) (Feb. 2012).

1854 See Goldman (Covered Funds) (requesting exclusion for credit funds). AFME et al. (requesting 

exclusion for covered bonds); FSA (Apr. 2012) (requesting exclusion for covered bonds); UKRCBC

(requesting exclusion for covered bonds).

1855 See Sens. Merkley & Levin (Feb. 2012). These commenters argued that there should be increased 

capital charges in line with the complexity of a securitization and using the “high risk asset limitations on 

permitted activities to bar any securitization by a bank from using complex structures, re-securitization 

techniques, synthetic features, or other elements that may increase risk or make a risk analysis less 

reliable.”

1856 See AFME et al.; SIFMA (May 2012) (arguing that because of the narrowness of the proposed 

exemption and because it would not exempt securitizations from prohibitions on covered transactions 

imposed by section 13(f), the rule as proposed “will effectively prevent banking entities from sponsoring 

and owning a large variety of asset-backed securities, in contravention of the rule of construction.”)
578

Certain securitization transactions may involve the issuance of an intermediate 

asset-backed security that supports the asset-backed securities that are issued to investors, 

such as in auto lease securitizations and ABCP conduits. Commenters suggested that the 

Agencies should look through intermediate securitizations to the assets that support the 

intermediate asset-backed security to determine if those assets would satisfy the 

definition of “loan” for purposes of the loan securitization exemption. If those assets are 

loans, these commenters suggested that the entire securitization transaction should be 

deemed a loan securitization, even if the assets supporting the asset-backed securities 

issued to investors are not loans.1857 However, some commenters argued that each step in 

a multi-step securitization should be viewed separately to ensure compliance with the 

specific restrictions in the proposal because otherwise a multi-step securitization could 

include impermissible assets.1858 Some commenters also raised question about whether 

depositors would fall within the definition of “investment company” under the 

Investment Company Act and, therefore, may fall within the proposed definition of 

covered fund.1859 

After considering carefully the comments received on sections of the proposed 

rule, the Agencies have determined to adopt a single section in the final provision relating 

 

1857 See AFME et al.; ASF (Feb. 2012); SIFMA (Securitization) (Feb. 2012).

1858 See Occupy; Public Citizen. Occupy contended that the structured security issued in a multi-step 

securitization can hide underlying risks under layers of structured complexity. See Occupy. Public Citizen 

argued that prohibiting such activity would ensure that securitizations do not become proprietary trading 

vehicles for banking entities that are effectively off-balance sheet. See Public Citizen. See infra Part 

IV.B.1.c.8.b.iv. of this Supplementary Information.

1859 A depositor, as used in a securitization structure, is an entity that generally acts only as a conduit to 

transfer the loans from the originating bank to the issuing entity for the purpose of facilitating a 

securitization transaction and engages in no discretionary investment or securities issuance activities. See

ASF (July 2012); GE (Aug. 2012). For purposes of this rule, the Agencies believe the wholly owned 

subsidiary exclusion is available for depositors. See supra note 1774.
579

to loan securitizations that would exclude loan securitizations that meet certain criteria 

contained in the rule from the definition of covered fund. The rule, as adopted, takes into 

account comments received on each of the conditions specified in the two loan 

securitization sections of the proposed provisions and has adopted those conditions with 

some clarifying changes from the proposed language. In addition, in response to 

comments, as discussed more fully below, the Agencies are adopting additional 

exclusions from the definition of covered fund for certain types of vehicles if they are 

backed by the same types of assets as the assets that are permitted to be held in the loan 

securitization exclusion. These additional exclusions are tailored to vehicles that are very 

similar to loan securitizations but have particular structural issues, which are described in 

more detail below. 

In light of the comments received on the proposal, the final rule was revised to 

exclude from the definition of covered fund an issuing entity of asset-backed securities, 

as defined in Section 3(a)(79) of the Exchange Act,1860 if the underlying assets or 

holdings are comprised solely of: (A) loans, (B) any rights or other assets (i) designed to 

assure the servicing or timely distribution of proceeds to security holders or (ii) related or 

incidental to purchasing or otherwise acquiring, and holding the loans, (C) certain interest 

rate or foreign exchange derivatives, and (D) certain special units of beneficial interests 

and collateral certificates (together, “loan securitizations”).1861 In addition, as discussed 

 

1860 15 U.S.C. 78c(a)(79). This definition was added by Section 941 of the Dodd-Frank Act. 

1861 See final rule § __.10(c)(8). Consistent with the proposal, certain securitizations, regardless of asset 

composition, would not be considered covered funds because the securitization issuer is deemed not to be 

an investment company under Investment Company Act exclusions other than section 3(c)(1) or 3(c)(7) of 

the Investment Company Act. For example, this would include issuers that meet the requirements of 

section 3(c)(5) or rule 3a-7 of the Investment Company Act, and the asset-backed securities of such issuers 

may be offered in transactions registered under the Securities Act.
580

below, the Agencies are adopting specific exclusions for certain vehicles that issue short 

term asset-backed securities and for pools of assets that are part of covered bond 

transactions which pools also meet the conditions delineated above.1862 

Although commenters argued that various types of assets should be included 

within the definition of loan or otherwise permitted to be held under the loan 

securitization exclusion, the loan securitization exclusion in the final rule has not been 

expanded to be a broad exclusion for all securitization vehicles. Although one 

commenter suggested that any securitization is essentially a lending activity,1863 the 

Agencies believe such an expansion of the exclusion would not be consistent with the 

rule of construction in section 13(g)(2) of the BHC Act, which specifically refers to the 

“sale and securitization of loans.” The Agencies believe that a broad definition of loan 

and therefore a broad exemption for transactions that are structured as securitizations of 

pooled financial assets could undermine the restrictions Congress intended to impose on 

banking entities’ covered fund activities, which could enable market participants to use 

securitization structures to engage in activities that otherwise are constrained for covered 

funds. The Agencies believe the purpose underlying section 13 is not to expand the 

scope of assets in an excluded loan securitization beyond loans as defined in the final rule 

and the other assets that the Agencies are specifically permitting in a loan securitization. 

While not expanding the permitted assets under the loan securitization exclusion, 

the Agencies have made modifications in response to commenters to ensure that the 

 

1862 As discussed below, the Agencies are adopting an exclusion from the definition of covered funds for 

the pools of assets that are involved in the covered bond financings. Although the cover pools must satisfy 

the same criteria as the excluded loan securitizations, a separate exclusion is needed because the securities 

involved in the covered bond issuance are not asset-backed securities.

1863 See, e.g., Credit Suisse (Williams).
581

provisions of the final rule appropriately accommodate the need, in administering a loan 

securitization transaction on an ongoing basis, to hold various assets other than the loans 

that support the asset-backed securities. Moreover, the Agencies do not believe that the 

assets permitted under the loan securitization need to be narrowed further to prevent 

evasion and hidden proprietary trading as requested by certain commenters because the 

Agencies believe that the potential for evasion has been adequately addressed through 

modifications to the definition of loan and more specific limitations on the types of 

securities and derivatives permitted in an excluded loan securitization. The Agencies 

have revised the scope of the loan securitization exclusion to accommodate existing 

market practice for securitizations as discussed by commenters while limiting the 

availability of the exclusion for these particular types of securitization transactions to 

issuers of asset-backed securities supported by loans.

The Agencies are not adopting specific exclusions for other securitization vehicles 

identified by commenters, including insurance-linked securities, collateralized loan 

obligations, and corporate debt re-packagings.1864 The Agencies believe that providing 

such exclusions would not be consistent with the rule of construction in section 

13(g)(2)of the BHC Act, which specifically refers to the “sale and securitization of 

loans.” These other types of securitization vehicles referenced by commenters are used 

to securitize exposures to instruments which are not included in the definition of loan as 

adopted by the final rule. Moreover, the Agencies note in response to commenters that 

resecuritizations of asset-backed securities and CDO-squared and CDO-cubed 

 

1864 Commenters’ concerns regarding credit funds are discussed below in Part IV.B.1.d.6. of this 

Supplementary Information.
582

securitizations could be used as a means of evading the prohibition on the investment in 

the ownership interests of covered funds.

As with the proposed rules, the Agencies are excluding certain loan 

securitizations from the definition of covered fund and therefore the prohibitions 

applicable to banking entities’ involvement in covered funds in order to implement 

Congressional intent expressed in the rule of construction in section 13(g)(2) of the BHC 

Act.1865 The Agencies believe that, as reflected in the rule of construction, the continued 

ability of banking entities to participate in loan securitizations is important to enable 

banks of all sizes to be able to continue to provide financing to loan borrowers at 

competitive prices. Loan securitizations provide an important avenue for banking entities 

to obtain investor financing for existing loans, which allows such banks greater capacity 

to continuously provide financing and lending to their customers. The Agencies also 

believe that loan securitizations that meet the conditions of the rule as adopted do not 

raise the same types of concerns as other types of securitization vehicles that could be 

used to circumvent the restrictions on proprietary trading and prohibitions in section 13(f) 

of the BHC Act.

Under the rule as adopted, loan securitizations that meet the conditions of the rule 

as adopted are excluded from the definition of covered fund and, consequently, banking 

entities are not restricted as to their ownership of such entities or their ongoing 

relationships with such entities by the final rule. As the Agencies stated in the proposal, 

permitting banking entities to acquire or retain an ownership interest in these loan 

 

1865 As discussed below, the Agencies are excluding those loan securitizations that hold only loans (and 

certain other assets identified in the final rule), consistent with the rule of construction in section 13(g)(2) 

of the BHC Act.
583

securitizations will allow for a deeper and richer pool of potential participants and a more 

liquid market for the sale of such securitizations, which in turn should result in the 

continued availability of funding to individuals and small businesses, as well as provide 

an efficient allocation of capital and sharing of risk. The Agencies believe that excluding 

these loan securitizations from the definition of covered fund is consistent with the terms 

and the purpose of section 13 of the BHC Act, including the rule of construction 

regarding loan securitizations.1866

i. Loans

The first condition of the loan securitization exclusion from the definition of 

covered fund is that the underlying assets or holdings are comprised of loans. In the 

proposal, “loan” was a defined term for purposes of the restrictions on proprietary trading 

and the covered funds provisions. As proposed, a loan was defined as a loan, lease, 

extension of credit, or secured or unsecured receivable.1867 The definition of loan in the 

proposed rule was expansive, and included a broad array of loans and similar credit 

transactions, but did not include any asset-backed security that is issued in connection 

with a loan securitization or otherwise backed by loans.

As discussed above under “Definition of Loan,” the Agencies received comments 

regarding the loan definition in the securitization context. In particular, one commenter, 

citing a statement made by Senator Merkley, argued that Congress did not intend the loan 

 

1866 The Agencies note that the loan securitization and other securitization exclusions apply only to the

definition of covered fund, and therefore the covered fund-related provisions of the rule, and not to its 

prohibition on proprietary trading. The Agencies recognize that trading in loans is not subject to the 

proprietary trading restrictions.

1867 See proposed rule § __.2(q).
584

securitization exemption to include “loans that become financial instruments traded to 

capture the change in their market value.”1868

The Agencies, after considering carefully the comments received, have adopted a 

definition of loan that is revised from the proposed definition. The final rule defines 

“loan” as “any loan, lease, extension of credit, or secured or unsecured receivable that is 

not a security or derivative.”1869 The definition of loan in the final rule specifically 

excludes loans that are securities or derivatives because trading in these instruments is 

expressly included in the statute’s definition of proprietary trading.1870 In addition, the 

Agencies believe these instruments, if not excluded from the definition of loan, could be 

used to circumvent the restrictions on proprietary trading. Further, for purposes of the 

loan securitization exclusion, the loan securitization must own the loan directly; a 

synthetic exposure to a loan, such as through holding a derivative, such as a credit default 

swap, will not satisfy the conditions for the loan securitization exclusion.1871 As such, a 

securitization that owns a tranche of another loan securitization is not itself a loan 

securitization, even if the ownership of such tranche by a banking entity would otherwise 

be permissible under the final rule.

As discussed above under “Definition of Loan,” the definition of loan in the final 

rule has not been expanded as requested by some commenters but has been clarified in 

some respects in response to comments. The final rule explicitly excludes securities or 

 

1868 See Occupy (citing 156 Cong. Rec. S5895 (daily ed. July 15, 2010)).

1869 See § __.2(r). 

1870 12 U.S.C. 1851(h)(4). 

1871 Under the final provision, the issuing entity for the SUBIs and collateral certificate may rely on the 

loan securitization exclusion because of the separate provisions allowing such a holding.
585

derivatives.1872 In addition, the definition of loan has not been modified to include 

repurchase agreements or reverse repurchase agreements regardless of the character of 

the underlying asset. The Agencies are concerned that parties, under the guise of a 

“loan” might instead create instruments that provide the same exposures to securities and 

derivatives that otherwise are prohibited by section 13 and might attempt to use the loan 

securitization exclusion to acquire ownership interests in covered funds holding those 

types of instruments, counter to the terms and the purpose of section 13 of the BHC Act. 

As the Agencies have noted previously, the rules relating to covered funds and to 

proprietary trading are not intended to interfere with traditional lending practices or with 

securitizations of loans generated as a result of such activities. Although the Agencies 

have revised the definition of loan in response to commenters’ concerns as discussed 

above, the Agencies are not adopting a separate definition of loan for securitization 

transactions as requested by commenters. The Agencies believe that the definition of 

loan adopted in the final rule appropriately encompasses the financial instruments that 

result from lending money to customers.

ii. Contractual rights or assets 

Under the proposed loan securitization definition, a covered fund that is an issuer 

of asset-backed securities would have been permitted to hold contractual rights or assets 

 

1872 The determination of whether an instrument falls outside the definition of loan because it is a security 

or a derivative is based on the federal securities laws and the Commodity Exchange Act. Whether a loan, 

lease, extension of credit, or secured or unsecured receivable is a note or evidence of indebtedness that is 

defined as a security under the federal securities laws will depend on the particular facts and circumstances, 

including the economic terms of the transaction. See supra note 1831and accompanying text.
586

directly arising from those loans supporting the asset-backed securities.1873 The proposal 

did not identify or describe such contractual rights or assets.

Commenters requested that the Agencies expand the list of contractual rights and 

assets that an issuer of asset-backed securities would be permitted to hold under the 

proposed loan securitization exemption.1874 Examples of the additional rights and assets 

requested by commenters include cash and cash accounts;1875 cash equivalents;1876

liquidity agreements, including asset purchase agreements, program support facilities and 

support commitments;1877 credit enhancements:1878 asset-backed securities;1879 municipal 

 

1873 See proposed rule § __.13(d).

1874 See Allen & Overy (on behalf of Foreign Bank Group); AFME et al.; ASF (Feb. 2012); Cleary 

Gottlieb; Credit Suisse (Williams); Commercial Real Estate Fin. Council; GE (Feb. 2012); GE (Aug. 

2012); ICI (Feb. 2012); Japanese Bankers Ass’n.; JPMC; LSTA (Feb. 2012); LSTA (July 2012); RBC; 

SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA (Securitization) (Feb. 2012); Vanguard.

1875 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); Cleary Gottlieb; Credit 

Suisse (Williams).

1876 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); Cleary Gottlieb; Credit 

Suisse (Williams); Commercial Real Estate Fin. Council; JPMC; LSTA (Feb. 2012); LSTA (July 2012); 

RBC; SIFMA (Securitization) (Feb. 2012). Commenters requested inclusion of the following examples of 

cash equivalents: government guaranteed securities, money market funds, and “other highly credit-worthy 

and liquid investments” (Credit Suisse (Williams)); and high quality, highly liquid investments, including 

Treasury securities and highly rated commercial paper (JPMC). In addition, LSTA (Feb. 2012) requested 

inclusion of the following: (i) short-term highly liquid investments; (ii) direct obligations of, and 

obligations fully guaranteed as to full and timely payment by, the United States (or by any agency thereof 

to the extent such obligations are backed by the full faith and credit of the United States); (iii) demand 

deposits, time deposits or certificates of deposit that are fully insured by the Federal Deposit Insurance 

Corporation; (iv) corporate, non-extendable commercial paper; (v) notes that are payable on demand or 

bankers’ acceptances issued by regulated U.S. financial institutions; (vi) investments in money market 

funds or other regulated investment companies; time deposits having maturities of not more than 90 days; 

(vii) repurchase obligations with respect to direct obligations and guaranteed obligations of the U.S. entered 

into with a regulated U.S. financial institution; and (viii) other investments with a maturity one year or less, 

with the requirement that each of the investments listed have, at the time of the securitization’s investment 

or contractual commitment to invest therein, a rating of the highest required investment category.

1877 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); GE (Feb. 2012); JPMC; 

RBC; SIFMA (Securitization) (Feb. 2012).

1878 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); GE (Feb. 2012); JPMC; 

RBC; SIFMA (Securitization) (Feb. 2012). For example, SIFMA (Securitization) (Feb. 2012) requested 

inclusion of third party credit enhancements such as guarantees and letters of credit. Commenters 

requested inclusion of the following examples of credit enhancements: (i) external credit support of 

borrower obligations under such loans, including a credit support facilities, third party or parent guarantee, 
587

securities;1880 repurchase agreements;1881 credit-linked notes;1882 trust certificates;1883

lease residuals;1884 debt securities;1885 and derivatives.1886 As an alternative, commenters 

requested that an issuer of asset-backed securities be permitted to hold under the 

 

insurance policy, letter of credit or other contractual commitment to make payments or perform other 

obligations of the borrower under the loans (ASF (Feb. 2012)); and (ii) property guarantees, insurance 

policies, letters of credit, or supporting obligations underlying or relating to any of the loans (RBC).

1879 See Allen & Overy (on behalf of Foreign Bank Group); AFME et al.; ASF (Feb. 2012); Credit Suisse 

(Williams); GE (Feb. 2012); GE (Aug. 2012); ICI (Feb. 2012); JPMC; RBC; SIFMA et al. (Covered 

Funds) (Feb. 2012); SIFMA (Securitization) (Feb. 2012). Commenters requested inclusion of the 

following examples of asset-backed securities: (i) SUBI certificates (beneficial interests in titling trusts 

typically used in lease securitizations) (AFME et al.; ASF (Feb. 2012); GE (Aug. 2012); SIFMA 

(Securitization) (Feb. 2012)); (ii) ownership interests and bonds issued by CLOs (JPMC); a broad array of 

receivables that support asset-backed commercial paper (ICI (Feb. 2012)); certain notes, certificates or 

other instruments backed by loans or financial assets that are negotiated by the purchasing asset-backed 

commercial paper conduit (ASF (Feb. 2012); GE (Feb. 2012)); municipal securities that are technically 

ABS, including revenue bonds that involve the issuance of senior and subordinate bonds (ASF (Feb. 

2012)); ownership interests in credit funds (as defined in their letter) (SIFMA et al. (Covered Funds) (Feb. 

2012)); any note, bond or security collateralized and payable from pools of loans, leases (including lease 

residuals), extensions of credit or secured or unsecured receivables (RBC); asset-backed securities issued 

by intermediate vehicles in a securitization collateralized predominantly by loans and financial assets, and 

other similar instruments (Credit Suisse (Williams)); and asset-backed securities backed by loans or 

receivables that are originated by or owned by the sponsor of such securitization or which are issued by an 

entity that is organized under the direction of the same sponsor as the issuer of the covered fund (ASF (Feb. 

2012)).

1880 See ICI (Feb. 2012); Vanguard.

1881 See Credit Suisse (Williams); SIFMA (Securitization) (Feb. 2012).

1882 See Allen & Overy (on behalf of Foreign Bank Group).

1883 See Credit Suisse (Williams).

1884 See ASF (Feb. 2012); GE (Feb. 2012); GE (Aug. 2012); RBC.

1885 See GE (Aug. 2012).

1886 See Allen & Overy (on behalf of Foreign Bank Group); Credit Suisse (Williams); Japanese Bankers 

Ass’n.; LSTA (Feb. 2012); SIFMA (Securitization) (Feb. 2012). Commenters requested inclusion of the 

following examples of derivatives: (i) credit derivatives (without explanation) as a means of diversifying 

the portfolio (Japanese Bankers Association); (ii) synthetic securities that reference corporate credits or 

other debt (Credit Suisse (Covered Fund)); (iii) credit instruments or other obligations that the banking 

entity could originate or invest or deal in directly, including tranched or untranched credit linked notes 

exposed to the credit risk of such reference assets through a credit default swap or other credit derivative 

entered into by the related ABS Issuer (SIFMA (Securitization) (Feb. 2012)); (iv) any derivatives structured 

as part of the securitization of loans (without explanation) (Allen & Overy (on behalf of Foreign Bank

Group)); (v) hedge agreements (Credit Suisse (Williams)); and (vi) any derivative, including a credit 

default swap, as and to the extent a banking entity could use such derivative in managing its own 

investment portfolio (SIFMA (Securitization) (Feb. 2012)).
588

proposed loan securitization exemption certain of such additional rights and/or assets up 

to a threshold, such as a specified percentage of the assets of such covered fund.1887

In response to comments, the final rule modifies the loan securitization exclusion 

from the proposal to identify the types of contractual rights or assets directly arising from 

those loans supporting the asset-backed securities that a loan securitization relying on 

such exclusion may hold. Under the final rule, a loan securitization which is eligible for 

the loan securitization exclusion may hold contractual rights or assets (i) designed to 

assure the servicing or timely distribution of proceeds to security holders or (ii) related or 

incidental to purchasing or otherwise acquiring, and holding the loans (“servicing 

assets”).1888 The servicing assets are permissible in an excluded loan securitization 

transaction only to the extent that they arise from the structure of the loan securitization 

or from the loans supporting a loan securitization. If such servicing assets are sold and 

securitized in a separate transaction, they will not qualify as permissible holdings for the 

loan securitization exclusion.1889 

In adopting this approach, the Agencies considered commenters’ concerns and 

determined to revise the condition to be more consistent with the definition and treatment 

of servicing assets in other asset-backed securitization regulations, such as the exemption 

 

1887 See ASF (Feb. 2012); Cleary Gottlieb; Credit Suisse (Williams); GE (Feb. 2012); GE (Aug. 2012); 

LSTA (Feb. 2012); LSTA (July 2012).

1888 See final rule § __.10(c)(8)(i)(B). The use of the term “servicing assets” is not meant to imply that 

servicing assets are limited to those contractual rights or assets related to the servicer and the performance 

of the servicer’s obligations. 

1889 For example, under the final rule, mortgage insurance policies supporting the mortgages in a loan 

securitization are servicing assets permissible for purposes of § __.10(c)(8)(i)(B). However, a separate 

securitization of the payments on those mortgage insurance policies would not qualify for the loan 

securitization exclusion.
589

from the definition of “investment company” under rule 3a-7 promulgated under the 

Investment Company Act.1890 

Although the Agencies have revised the proposal in response to commenters’ 

concerns, the final rule does not permit a loan securitization to hold as servicing assets a 

number of instruments specifically requested by commenters whether in their entirety or 

as a percentage of the pool. Under the final rule, servicing assets do not include 

securities or derivatives other than as specified in the rule. 

Under the final rule, a loan securitization which is eligible for the loan 

securitization exclusion may hold securities if those securities fall into one of three 

categories.1891 First, such loan securitizations may hold securities that are cash 

equivalents. For purposes of the exclusion for loan securitizations, the Agencies interpret 

“cash equivalents” to mean high quality, highly liquid short term investments whose 

maturity corresponds to the securitization’s expected or potential need for funds and 

whose currency corresponds to either the underlying loans or the asset-backed securities. 

1892 Depending on the specific funding needs of a particular securitization, “cash 

equivalents” might include deposits insured by the Federal Deposit Insurance 

Corporation, certificates of deposit issued by a regulated U.S. financial institution, 

obligations backed by the full faith and credit of the United States, investments in 

 

1890 The Agencies believe that for purposes of the final rule, in the context of securitization, such related or 

incidental assets in a loan securitization should support or further, and therefore, be secondary to the loans 

held by the securitization vehicle.

1891 See final rule § __.10(c)(8)(iii).

1892 If either the loans supporting the loan securitization or the asset-backed securities issued by the loan 

securitization are denominated in a foreign currency, for purposes of the exclusion a loan securitization 

would be permitted to hold foreign currency, cash equivalents denominated in foreign currency and foreign 

exchange derivatives that comply with § __.10(c)(8)(iv). 
590

registered money market funds, and commercial paper.1893 Second, such loan 

securitizations may hold securities received in lieu of debts previously contracted with 

respect to the loans supporting the asset-backed securities. Finally, such loan 

securitizations may hold securities that qualify as SUBIs or collateral certificates subject 

to the provisions set forth in the rule for such intermediate asset-backed securities. 

The Agencies have specifically limited the types of securities held as eligible 

assets in a loan securitization that may be excluded from the definition of covered fund 

under the final rule, even in limited amounts, in order to assure that the types of securities 

are cash equivalents or otherwise related to the loan securitization and to prevent the 

possible misuse of the loan securitization exclusion to circumvent the restrictions on 

proprietary trading, investments in covered funds and prohibitions in section 13(f) of the 

BHC Act.1894 The Agencies believe that types of securities other than those specifically 

included in the final rule could be misused in such manner, because without limitations 

on the types of securities in which an excluded loan securitization may invest, a banking 

entity could structure an excluded loan securitization with provisions to engage in 

activities that are outside the scope of the definition of loan as adopted and also to engage 

in impermissible proprietary trading. Further, the Agencies do not believe that the use of 

thresholds with respect to such other types of securities as an alternative is appropriate 

because similarly, such a securitization would then involve a securitization of non-loan 

 

1893 Servicing assets should not introduce significant additional risks to the transaction, including foreign 

currency risk or maturity risk. For instance, funds on deposit in an account that is swept on a monthly basis 

should not be invested in securities that mature in 90 days.

1894 Commenters expressed concerns about the use of securitization vehicles for evasion. See, e.g., AFR et 

al. (Feb. 2012); Occupy; Public Citizen. 
591

assets, outside the scope of what the Agencies believe the rule of construction was 

intended to cover. By placing restrictions on the securities permitted to be held by an 

excluded loan securitization, the potential for evasion is reduced. Loan securitizations 

are intended, as contemplated by the rule of construction, to permit banks to continue to 

engage in securitizations of loans. Including all types of securities within the scope of 

permitted assets in an excluded loan securitization would expand the exclusion beyond 

the scope of the definition of loan in the final rule that is intended to implement the rule 

of construction.

iii. Derivatives

Under the proposed loan securitization definition, an exempted loan securitization 

would be permitted to hold interest rate or foreign exchange derivatives that materially 

relate to the terms of any loans supporting the asset-backed securities and any contractual 

rights or assets directly arising from such loans so long as such derivatives are used for 

hedging purposes with respect to the securitization structure.1895 The Agencies indicated 

in the proposing release that the proposed loan securitization definition would not allow 

an exempted loan securitization to use credit default swaps.1896

Commenters criticized the proposed limitations on the use of derivatives included 

in the proposed loan securitization definition.1897 In particular, one commenter indicated 

 

1895 See Joint Proposal, 76 FR at 68,912.

1896 Id.

1897 See AFME et al.; Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012) (requesting that 

an excluded loan securitization be permitted to hold up to 10% of its assets in the form of synthetic risk 

exposure to loans); Credit Suisse (Williams); Japanese Bankers Ass’n.; LSTA (Feb. 2012) (for CLOs); 

SIFMA (Securitization) (Feb. 2012).
592

that the use of credit derivatives such as credit default swaps is important in loan 

securitizations to provide diversification of assets.1898 Another commenter noted the use 

of such instruments to manage risks with respect to corporate loan and debt books by 

accessing capital from a broad group of capital markets investors and facilitates making 

markets.1899 In contrast, two commenters generally supported the limitations on the use 

of derivatives under the proposed loan securitization definition and indicated that 

excluding credit default swaps from the loan securitization definition was appropriate.1900

With respect to the use of derivatives, the Agencies are adopting the loan 

securitization exclusion substantially as proposed with certain modifications to reflect a 

restructuring of this provision in order to more closely align the permissible uses of 

derivatives under the loan securitization exclusion with the loans, the asset-backed 

securities, or the contractual rights and other assets that a loan securitization relying on 

the loan securitization exclusion may hold. As adopted, for a loan securitization to be 

eligible for the loan securitization exclusion, the loan securitization may hold only 

interest rate or foreign exchange derivatives that meet the following requirements: (i) the 

written terms of the derivatives directly relate to either the loans or the asset-backed 

 

1898 See Japanese Bankers Ass’n. This commenter indicated that credit derivatives are important in 

securitizations to provide diversification when the desired mix of assets cannot be achieved.

1899 See ASF (Feb. 2012). This commenter argued that for some loan securitizations, investors may Seek a 

broader pool of credit exposures than the bank has available or can obtain to securitize in order to achieve 

risk diversification.

1900 See AFR et al. (Feb. 2012); Public Citizen. One of these commenters stated that the credit default 

exclusion was appropriate because “synthetic securitizations and resecuritizations were a key contributor to 

financial contagion during the crisis.” See AFR et al. (Feb. 2012). Another commenter argued that the 

loan securitization definition should not permit the use of derivatives. See Occupy. This commenter 

argued that covered funds should only be permitted to engage in hedging activity in accordance with the 

proposed exemption for hedging activity. This commenter also argued that the inclusion of derivatives in 

the loan securitization definition exceeded the Agencies’ statutory authority. Id. Two senators indicated 

that “complex securitizations” including those with “synthetic features” and “embedded derivatives” should 

not be allowed to rely on the exclusion for loan securitizations. See Sens. Merkley & Levin (Feb. 2012).
593

securities that such loan securitization may hold under the other provisions of the loan 

securitization exclusion; and (ii) the derivatives reduce interest rate and/or foreign 

exchange risk with respect to risks related to either such loans, the asset-backed securities 

or the contractual rights or other assets that a loan securitization may hold.1901

The first requirement that the written terms of the derivatives “directly relate” to 

either the loans or the asset-based securities themselves is intended to quantitatively and 

qualitatively limit the use of derivatives permitted under the loan securitization 

exclusion.1902 The Agencies would expect that neither the total notional amount of 

directly related interest rate derivatives nor the total notional amount of directly related 

foreign exchange derivatives would exceed the greater of either the outstanding principal 

balance of the loans supporting the asset-backed securities or the outstanding principal 

balance of the asset-backed securities.1903 Moreover, under the loan securitization 

exclusion, the type of derivatives must be related to the types of risks associated with the 

underlying assets and may not be derivatives designed to supplement income based on 

general economic scenarios, income management or unrelated risks.

The second requirement that derivatives reduce the interest rate and/or foreign 

exchange risks related to either such loans, contractual rights or other assets, or such 

asset-backed securities is intended to permit the use of derivatives to hedge interest rate 

 

1901 See final rule § __.10(c)(8)(iv).

1902 Under the final rule, the Agencies expect that a loan securitization relying on the loan securitization 

exclusion would not have a significant amount of interest rate and foreign exchange derivatives with 

respect to risks arising from contractual rights or other assets.

1903 For example, a $100 million securitization cannot be hedged using an interest rate hedge with a 

notional amount of $200 million.
594

and/or foreign exchange risks that result from a mismatch between the loans and the 

asset-backed securities.1904

The Agencies believe that the statutory rule of construction should be 

implemented in a manner that does not limit or restrict the sale and securitization of 

loans. The Agencies further believe that the sale and securitization of credit exposures 

other than “loans” as defined in the rule, such as through securities or derivatives, could 

be abused. The derivatives that may be held in a loan securitization for purposes of the 

exclusion may not be used for speculative purposes. Consistent with the proposal, the 

loan securitization exclusion does not permit a loan securitization relying on such 

exclusion to hold credit default swaps or other types of derivatives whether or not they 

are related either to the underlying loans or the asset-backed securities.1905 Under the 

final rule, a synthetic securitization in which the asset-backed securities are supported by 

cash flow from derivatives, such as credit default swaps and total return swaps, would not 

be permitted to rely on the loan securitization exclusion because such derivatives are 

excluded from the final rule’s definition of loan specifically, as a derivative. Similarly, a 

loan securitization that relies on the loan securitization exclusion would not be permitted 

to hold a credit default swap or total return swap that references a loan that is held by the 

loan securitization. Under the final rule as adopted, an excluded loan securitization 

 

1904 The derivatives permitted in a securitization that may rely on the loan securitization exclusion would 

permit a securitization to hedge the risk resulting from differences between the income received by the 

issuing entity and the amounts due under the terms of the asset-backed securities. For example, fixed rate 

loans could support floating rate asset-backed securities; loans with an interest rate determined by reference 

to the Prime Rate could support asset-backed securities with an interest rate determined by reference to 

LIBOR; or Euro-denominated loans could support U.S. Dollar-denominated asset-backed securities.

1905 Loan securitizations excluded from the covered fund definition may only hold certain directly related 

derivatives as specified in § __.11(c)(8)(iv) and as discussed in this Part.
595

would not be able to hold derivatives that would relate to risks to counterparties or issuers 

of the underlying assets referenced by these derivatives because the operation of 

derivatives, such as these, that expand potential exposures beyond the loans and other 

assets, would not in the Agencies’ view be consistent with the limited exclusion 

contained in the rule of construction under section 13(g)(2) of the BHC Act, and could be 

used to circumvent the restrictions on proprietary trading and prohibitions in section 13(f) 

of the BHC Act. The Agencies believe that the use of derivatives by an issuing entity for 

asset-backed securities that is excluded from the definition of covered fund under the 

loan securitization exclusion should be narrowly tailored to hedging activities that reduce 

the interest rate and/or foreign exchange risks directly related to the asset-backed 

securities or the loans supporting the asset-backed securities because the use of 

derivatives for purposes other than reducing interest rate risk and foreign exchange risks 

would introduce credit risk without necessarily relating to or involving a reduction of 

interest rate risk or foreign exchange risk. 

On the other hand, while the Agencies are not expanding the types of permitted 

derivatives to be held in a loan securitization, the Agencies in the final rule are not 

restricting the use of all derivatives under the loan securitization exclusion as requested 

by certain commenters. The Agencies believe that a loan securitization that is excluded 

from the definition of covered fund should be allowed to engage in activities that reduce 

interest rate and foreign exchange risk because the hedging of such risks is consistent 

with the prudent risk management of interest rate and currency risk in a loan portfolio 

while at the same time avoiding the potential for additional risk arising from other types 
596

of derivatives.1906 The Agencies do not believe that the exemption for hedging activity 

applicable to market making and underwriting under the final rule is the appropriate 

measure for permitted derivatives in a loan securitization that would be excluded from 

definition of covered fund1907 because the hedging exemptions for market making and 

underwriting are not tailored to the hedging requirements of a securitization 

transaction.1908 The Agencies also do not believe that they lack the statutory authority to 

permit a loan securitization relying on the loan securitization exclusion to use derivatives, 

as suggested by one commenter,1909 because the Agencies believe that the permitted 

derivatives relate directly to loans that are permitted and have limited the quality and 

quantity of derivatives that an excluded loan securitization is permitted to hold directly to 

the reduction of risks that result from the loans and the loan securitization. 

While loan securitizations that include non-loan assets are not excluded from the 

definition of covered fund, banking entities are not prohibited from owning interests or 

sponsoring these covered funds under the final rule. Under the final rule, these 

securitizations would be covered funds, and banking entities engaged with these covered 

funds would be subject to the limitations on ownership interests and relationships with 

these covered funds imposed by section 13 of the BHC Act. 

iv. SUBIs and collateral certificates

 

1906 See AFR et al. (Feb. 2012); Occupy; Public Citizen.

1907 See Occupy. This commenter argued that covered funds should only be permitted to engage in 

hedging activity in accordance with the proposed exemption for hedging activity. 

1908 For example, a banking entity may hold an ownership interest in a covered fund in order to hedge 

employee compensation risks. Because securitizations do not have employees, such a hedging exemption 

would not be applicable to a securitization structure. 

1909 See Occupy. 
597

Commenters also argued that, under the proposed exemption for loan 

securitizations, securitizations that are backed by certain intermediate asset-backed 

securities would not satisfy the conditions for the exemption and therefore would be 

subject to the covered fund prohibitions.1910 For example, commenters noted that, in a 

securitization of leases with respect to equipment where a titling trust is used to hold 

ownership of the equipment, a titling trust will typically own the equipment and the right 

to payment on the leases, and then will issue a security or other instrument, often referred 

to as a special unit of beneficial interest (SUBI), that represents an ownership interest in 

the titling trust to the securitization issuer.1911 As another example, certain securitizations 

frequently use a master trust structure allowing the trust to issue more than one series of 

asset-backed security collectively backed by a common revolving pool of assets. In such 

a structure, a master trust may hold assets (such as loans) and issue a collateral certificate 

supported by those assets to an issuing trust that issues asset-backed securities to 

investors. The assets held by the master trust are typically a pool of revolving accounts 

that may be paid in full each month (e.g., credit card receivables) or a revolving pool of 

short-term loans that are replaced with new loans as they mature (e.g., floor plan 

loans).1912 One commenter opposed the inclusion of securitizations backed by 

intermediate asset-backed securities, arguing that each step should be viewed separately 

 

1910 See AFME et al.; Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); Credit Suisse 

(Williams); GE (Aug. 2012); PNC; RBC; SIFMA (Securitization) (Feb. 2012).

1911 See SIFMA (Securitization) (Feb. 2012).

1912 See, e.g., ASF (Feb. 2012). UK RMBS master trusts also use a master trust structure. See AFME et 

al.; ASF (Feb. 2012); SIFMA (Securitization) (Feb. 2012).
598

to ensure compliance to prevent the inclusion of impermissible assets such as prohibited 

derivatives.1913 

In response to comments, the Agencies are modifying the proposal to provide that 

a securitization backed by certain intermediate asset-backed securities will qualify for the 

loan securitization exclusion. The Agencies recognize that securitization structures that 

use these types of intermediate asset-backed securities are essentially loan securitization 

transactions, because the intermediate asset-backed securities in the asset pool are created 

solely for the purpose of facilitating a securitization1914 and once created, are issued 

directly into a securitization vehicle rather than to any third party investor. 

Under the final rule, a loan securitization that is excluded from the definition of 

covered fund may include SUBIs or collateral certificates, provided that four conditions 

are met.1915 First, the special purpose vehicle issuing the SUBI or collateral certificate 

itself must meet the conditions of the loan securitization exclusion, as adopted in the final 

rule.1916 Under this provision, for example, the special purpose vehicle, in addition to the 

issuing entity, may hold an interest rate or foreign exchange derivative or other assets 

only if the derivative or asset is permitted to be held in accordance with the requirements 

for derivatives in respect of the loan securitization exclusion. Second, the SUBI or 

collateral certificate must be used for the sole purpose of transferring economic risks and 

 

1913 See Occupy.

1914 The use of SUBIs, for example, allows the sponsor to avoid administrative expenses in retitling the 

physical property underlying the leases. 

1915 See final rule § __.10(c)(8)(v).

1916 The provision will allow for the existing practice of a master trust to hold a collateral certificate issued 

by a legacy master trust.
599

benefits of the loans (and other permissible assets)1917 to the issuing entity for the 

securitization and may not directly or indirectly transfer any interest in any other 

economic or financial exposures. Third, the SUBI or collateral certificate must be 

created solely to satisfy legal requirements or otherwise facilitate the structuring of the 

loan securitization. Fourth, the special purpose vehicle issuing the SUBI or collateral 

certificate and the issuing entity for the excluded loan securitization transaction must be 

established under the direction of the same entity that initiated the loan securitization 

transaction. The Agencies believe that the fourth condition will ensure that the 

resecuritizations of asset-backed securities purchased in the secondary market, which the 

Agencies do not believe would constitute a loan securitization, will not be able to use 

these special provisions tailored only for transactions utilizing SUBIs and collateral 

certificates in order to fall within the loan securitization exclusion. 

The Agencies believe that these conditions provide that only securitizations 

backed by SUBIs and collateral certificates involving loans—and not other types of 

securities or other types of assets—will be able to use the loan securitization exclusion. 

These conditions are intended to assure that for purposes of the loan securitization 

exclusion that only SUBI and collateral certificates that essentially represent the 

underlying loans are included consistent with the terms and the purpose of section 13 of 

the BHC Act, while also not adversely affecting securitization of “loans” as defined in 

 

1917 This would include a collateral certificate issued by a legacy master trust that meets the requirements 

of the loan securitization exclusion.
600

the final rule.1918 The Agencies believe that the limitation of the types of asset-backed 

securities permitted in an excluded loan securitization (only SUBIs and collateral 

certificates) and the restrictions placed on those SUBIs and collateral certificates that are 

permitted in an excluded loan securitization will avoid loan securitizations that contain 

other types of assets from being excluded from the definition of covered fund. 

v. Impermissible assets

As discussed above, commenters on the loan securitization proposals argued that 

various types of assets should be included within the definition of loan or otherwise 

permitted to be held by the loan securitization that would be entitled to rely on the 

proposed exemptions.

After considering comments, the Agencies have determined to retain the narrower 

scope of the permitted assets in a loan securitization that is eligible for the loan 

securitization exclusion. The Agencies have revised the language regarding loan 

securitizations from the proposal to specify certain types of assets or holdings that a loan 

securitization would not be able to hold if it were eligible to rely on the exclusion from 

the definition of covered fund for loan securitizations.1919 The Agencies recognize that 

securitization structures vary significantly and, accordingly, the loan securitization 

exclusion as adopted in the final rule accommodates a wider range of securitization 

practices. The Agencies believe that these limitations provide that only securitizations

backed by loans—and not securities, derivatives or other types of assets—will be able to 

 

1918 See, e.g., rule 190 under the Securities Act. See also, e.g., ASF (Feb. 2012) (noting that certain rules 

under the Securities Act and staff interpretations have carved out SUBIs and collateral certificates from 

certain disclosure and other requirements). 

1919 See final rule § __.10(c)(8)(ii).
601

use the loan securitization exclusion consistent with the terms and the purpose of section 

13 of the BHC Act.1920 The Agencies believe that the limitation of the types of assets 

permitted in an excluded loan securitization will avoid loan securitizations that contain 

other types of assets from being excluded from the definition of covered fund. 

Under the final rule, in order to be excluded from the definition of covered fund, a 

loan securitization may not hold (i) a security, including an asset-backed security, or an 

interest in an equity or debt security (unless specifically permitted, such as with respect to 

a SUBI or collateral certificate as described above), (ii) a derivative other than an interest 

rate or foreign exchange derivative that meets the requirements described above,1921 or 

(iii) a commodity forward contract.1922 The Agencies have determined that a loan 

securitization relying on the loan securitization exclusion may not include a commodity 

forward contract because a commodity forward contract is not a loan.1923

9. Asset-backed commercial paper conduits

Under the proposed rule, certain securitization vehicles, including ABCP 

conduits, would not have been covered by the loan securitization exclusion and, 

therefore, would have been deemed to be a covered fund.1924 ABCP is a type of liability 

that is typically issued by a special purpose vehicle (commonly referred to as a “conduit”) 

 

1920 The Agencies discuss earlier in this Part the permissible assets an excluded loan securitization may 

hold and the Agencies’ belief that excluding loan securitizations as defined in the final rule is consistent 

with the terms and the purpose of section 13 of the BHC Act, including the rule of construction in section 

13(g)(2). See, e.g., supra note 1866 and accompanying and following text. 

1921 See final rule § __.10(c)(8)(iv); See also 7 U.S.C. 27(a)-(b).

1922 See the discussion above in Part IV.B.1.c.8 of this Supplementary Information.

1923 For a discussion of commodity forward contracts, See Further Definition of “Swap,” “Security-Based 

Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement 

Recordkeeping, 77 FR 48208 (Aug. 13, 2012) (Release Nos. 33-9338 and 34-67453, July 18, 2012).

1924 See proposed rule § __.13(d).
602

sponsored by a financial institution or other entity. The short term asset-backed securities 

issued by the conduit are supported by a managed pool of assets, which may change over 

the life of the entity. Depending on the type of ABCP conduit, the securitized assets 

ultimately supporting the short term asset-backed securities may consist of a wide range 

of assets including automobile loans, commercial loans, trade receivables, credit card 

receivables, student loans, and other loans in addition to asset-backed securities 

supported by such assets. The term of ABCP typically is short, and the liabilities are 

“rolled” (i.e., replaced or refinanced) at regular intervals. Thus, ABCP conduits 

generally fund longer-term assets with shorter-term liabilities.1925 In this regard, in the 

proposing release, the Agencies requested comment on the proposed rule’s definition of 

“covered fund” with respect to asset-backed securities and/or securitization vehicles1926

and received numerous comments requesting a variety of exemptions for ABCP 

conduits.1927

A number of commenters requested that the final rule exclude ABCP conduits 

from the definition of covered fund1928 or that the Agencies use their authority under 

section 13(d)(1)(J) of the BHC Act1929 to similar effect.1930 One commenter argued that 

 

1925 Structured investment vehicles (“SIVs”) and securities arbitrage ABCP programs both purchase 

securities (rather than receivables and loans). SIVs typically lack liquidity facilities covering all of these 

liabilities issued by the SIV, while securities arbitrage ABCP programs typically have such liquidity 

coverage, though the terms are more limited than those of the ABCP conduits eligible for the exclusion 

pursuant to the final rule.

1926 See Joint Proposal, 76 FR at 68,899.

1927 See, e.g., ASF (Feb. 2012); BoA; Capital Group; Eaton Vance; Fidelity; ICI (Feb. 2012); Japanese 

Bankers Ass’n.; PNC; RBC.

1928 See, e.g., ICI (Feb. 2012); PNC et al.; SIFMA (May 2012).

1929 See 12 U.S.C. 1851(d)(1)(J).

1930 See ICI (Feb. 2012).
603

ABCP conduits do not have the characteristics of a private equity fund or hedge fund,1931

even though they typically rely on the exemptions set forth in section 3(c)(1) or 3(c)(7) of 

the Investment Company Act. Another commenter argued that the proposed rule’s 

definition of covered fund would negatively impact asset-backed securitizations 

(including ABCP conduits), and suggested that the Agencies define covered funds, in 

part, as those that both (i) rely on section 3(c)(1) or 3(c)(7) of the Investment Company 

Act and (ii) have the traditional characteristics of private equity funds or hedge funds.1932 

Another commenter stated that the rule of construction set forth in section 13(g)(2) of the 

BHC Act1933 is a clear indication that section 13 of the BHC Act was not intended to 

apply to securitization vehicles such as ABCP conduits.1934 Another commenter stated 

that the lending that occurs through ABCP conduits is the type of activity that Congress 

and the Executive Branch have urged banks to expand in order to support economic 

growth and job creation,1935 while another commenter stated that ABCP conduits provide 

low cost, reliable financing for registered investment companies, which poses little risk to 

the safety and soundness of banks because federal law requires registered investment 

companies to maintain prescribed asset coverage in connection with borrowings.1936

Two commenters contended that, while certain issuers of asset-backed securities 

may rely on section 3(c)(5) of the Investment Company Act or rule 3a-7 thereunder, and, 

 

1931 See PNC.

1932 See Barclays.

1933 See 12 U.S.C. 1851(g)(2).

1934 See ICI (Feb. 2012).

1935 See Credit Suisse (Williams).

1936 See Eaton Vance.
604

therefore, not be brought under the proposed rule’s definition of covered fund, ABCP 

conduits typically cannot rely on this section or rule either because to do so would be too 

restrictive (in the case of section 3(c)(5)) or because they cannot meet the rule’s 

requirements.1937 

One commenter, employing ABCP conduits as an example, stated that failing to 

exempt securitization vehicles from the covered fund prohibitions would preclude 

banking entities from engaging in activities that have long been recognized as permissible 

activities for banking entities and that are vital to the normal functioning of the 

securitization markets, and will have a significant and negative impact on the 

securitization markets and on the ability of banking entities and other companies to 

provide credit to their customers.1938 This commenter further stated that ABCP conduits 

are an efficient and attractive way for banking entities to lend their own credit-worthiness 

to expand the pool of possible lenders willing to finance key economic activity while 

maintaining a low cost of funding for consumers, and because of the liquidity support 

provided by the sponsoring banking entity, the sponsoring banking entity to the ABCP 

conduit has full exposure to the assets acquired by or securing the amounts lent by the 

ABCP conduit and the banking entity subjects those assets and the obligors to the same 

analysis as it would engage in if the bank were lending directly against those assets.1939 

Another commenter stated that the provision of credit to companies to finance receivables 

through ABCP conduits is an area of traditional banking activity that should be 

 

1937 See RBC; ASF (Feb. 2012).

1938 See Credit Suisse (Williams).

1939 Id.
605

distinguished from the type of high-risk, conflict-ridden financial activities that Congress 

sought to restrict under section 13 of the BHC Act.1940

To this end, commenters proposed several means to exclude ABCP conduits from 

the proposed rule’s restrictions and requirements, including an expansion of the loan 

securitization exemption to treat two-step securitization transactions as a single loan 

securitization,1941 a separate exclusion for ABCP conduits,1942 an expansion of the 

definition of loan,1943 or as part of a broad exclusion for all issuers of asset-backed 

securities.1944 In order to allow ABCP conduits to qualify as loan securitizations, 

commenters suggested that the loan securitization exclusion should permit a limited 

amount of securities purchased in the secondary market.1945 Commenters also proposed 

 

1940 See ICI (Feb. 2012). This commenter emphasized the importance of the ABCP conduit market to 

money market funds, noting that as of November 2011, taxable money market funds held $126 billion of 

the $348.1 billion of securities issued by ABCP conduits outstanding, which represented approximately 

5.4% of taxable money market funds’ total assets. Another commenter noted that approximately $66.7 

billion of automobile loans and leases, $52.1 billion of student loans, $22.3 billion of credit card charges, 

$49.4 billion of loans to commercial borrowers and $50.7 billion of trade receivables were financed by the 

U.S. ABCP conduit market as of October 31, 2011, and that the total outstanding amount of securities sold 

by ABCP conduits in the U.S. market was $344.5 billion as of January 18, 2012. See ASF (Feb. 2012).

1941 See AFME et al.; Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); PNC; SIFMA 

(Securitization) (Feb. 2012). 

1942 See ASF (Feb. 2012); Capital Group (alleging that ABCP does not pose the risks that the rule is meant 

to combat); GE (Feb. 2012). One commenter proposed an exemption for ABCP conduits that included a 

requirement of 100% liquidity support from a regulated, affiliated entity, and such liquidity support may be 

conditional or unconditional. See RBC.

1943 See Credit Suisse (Williams) (alleging that ABCP conduits acquire ownership of loans indirectly 

through the purchase of variable funding notes, trust certificates, asset-backed securities, repurchase 

agreements and other instruments that may be considered securities, all of which economically are 

consistent with providing funding or extensions of credit to customers); ICI (Feb. 2012) (requesting that the 

definition of loan include the broad array of receivables that back ABCP).

1944 See AFME et al.; SIFMA (Securitization) (Feb. 2012).

1945 See ASF (Feb. 2012) (requesting that ABCP conduits be permitted to own asset-backed securities 

purchased on the secondary market only if the aggregate principal amount of such securities does not 

exceed 5% of the aggregate principal or face amount of all assets held by the ABCP conduit in order to 

diversify their asset base and avoid the negative consequences of divestiture of such assets); RBC 

(requesting that loan securitizations be permitted to hold cash equivalents and assets, other than loans, 
606

changes to the permissible assets such as allowing a loan securitization to hold liquidity 

and support commitments, asset-backed securities and certain financial assets in addition 

to loans that by their terms convert to cash within a finite period of time.1946 Another 

commenter argued that the loan securitization exemption should allow banking entities to 

sponsor, control, and invest in ABCP conduits that facilitate the securitization of 

customer loans and receivables.1947 In contrast, one commenter supported the restriction 

of the loan securitization exemption to the plain meaning of what constitutes a loan and 

advocated that the Agencies not include ABCP conduits under the exemption.1948 

In addition to the effect the proposed rule’s definition of covered fund would have 

on ABCP conduits, commenters also noted that section 13(f) of the BHC Act1949 would 

prohibit certain transactions between a banking entity sponsor and a covered fund 

securitization.1950 Two commenters requested a specific exemption from § __.16 of the 

proposed rule for ABCP conduits based on the interpretation that the proposed rule 

subjects covered funds exempted under the loan securitization exemption or other 

exemptions to § __.16.1951 Commenters argued that without liquidity and credit support, 

 

which, by their terms, convert to cash within a finite period of time so long as such assets comprise no 

more than 10% of their total assets based on book value).

1946 See ASF (Feb. 2012) (arguing that the loans, receivables, leases, or other assets purchased by the 

ABCP conduit might have fit the definition of loan in the proposed rules but for the proposal’s express 

assertion that the definition of loan does not include any asset-backed security that is issued in connection 

with a loan securitization or otherwise backed by loans). See Joint Proposal, 76 FR at 68,865; GE (Feb. 

2012); RBC.

1947 See PNC.

1948 See Public Citizen.

1949 See 12 U.S.C. 1851(f); See also § __.16 of the proposed rule.

1950 See, e.g., Allen & Overy (on behalf of Foreign Bank Group); Credit Suisse (Williams); Fidelity; 

IIB/EBF; JPMC; PNC; RBC; SIFMA (Securitization) (Feb. 2012).

1951 See ICI (Feb. 2012); Fidelity.
607

ABCP conduits are not viable,1952 cannot effectively operate,1953 could not function,1954

or would not be marketable.1955 One commenter argued that prohibiting a banking entity 

from providing liquidity facilities to ABCP conduits is tantamount to requiring the 

banking entity to wind down the operation of such ABCP conduits.1956

In response to the comments received and in light of the rule of construction 

contained in section 13(g)(2) of the BHC Act, the Agencies have determined in the final 

rule to exclude from the definition of covered fund an ABCP conduit that is a “qualifying 

asset-backed commercial paper conduit” as defined in the final rule is excluded from the 

definition of covered fund.1957 

Under the final rule, a qualifying asset-backed commercial paper conduit is an 

ABCP conduit that holds only (i) loans or other assets that would be permissible in a loan 

securitization1958 and (ii) asset-backed securities that are supported solely by assets 

permissible for a loan securitization and are acquired by the conduit as part of an initial 

issuance directly from the issuer or directly from an underwriter engaged in the 

 

1952 See JPMC.

1953 See ASF (Mar. 2012).

1954 See Allen & Overy (on behalf of Foreign Bank Group).

1955 See ASF (Feb. 2012); Fidelity.

1956 See ASF (Mar. 2012).

1957 See final rule § __.10(c)(9)(i). The rule of construction contained in section 13(g)(2) of the BHC Act

provides that nothing in section 13 of the BHC Act shall be construed to limit or restrict the ability of a 

banking entity or nonbank financial company supervised by the Board to sell or securitize loans in a 

manner that is otherwise permitted by law. As noted above and explained below, a qualifying asset-backed 

commercial paper conduit under the final rule is an ABCP conduit that holds only (i) loans or other assets 

that would be permissible in a loan securitization and (ii) asset-backed securities that are supported solely 

by assets permissible for a loan securitization and are acquired by the conduit as part of an initial issuance 

directly from the issuer or directly from an underwriter engaged in the distribution of the securities.

1958 See final rule § __.10(c)(8).
608

distribution of the securities.1959 In addition, a qualifying asset-backed commercial paper 

conduit must issue only asset-backed securities, comprising of a residual and securities 

with a term of 397 days or less and in addition, a “regulated liquidity provider,” as 

defined in the final rule, must provide a legally binding commitment to provide full and 

unconditional liquidity coverage with respect to all the outstanding short term assetbacked securities issued by the qualifying asset-backed commercial paper conduit in the 

event that funds are required to redeem the maturing securities.1960

Under the final rule, a regulated liquidity provider is (i) a depository institution as 

defined in section 3 of the Federal Deposit Insurance Act;1961 (ii) a bank holding 

company or a subsidiary thereof;1962 (iii) a savings and loan holding company,1963

provided all or substantially all of the holding company’s activities are permissible for a 

financial holding company,1964 or a subsidiary thereof; (iv) a foreign bank whose home 

country supervisor as defined in section 211.21 of the Federal Reserve Board’s 

Regulation K1965 has adopted capital standards consistent with the Capital Accord of the 

Basel Committee on Banking Supervision, as amended, and that is subject to such 

standards, or a subsidiary thereof or (v) a sovereign nation.1966 In order for a sovereign 

nation to qualify as a regulated liquidity provider, the liquidity provided must be 

 

1959 See final rule § __.10(c)(9)(i)(B).

1960 See final rule § __.10(c)(9)(ii) and (iii).

1961 See 12 U.S.C. 1813.

1962 See 12 U.S.C. 1841.

1963 See 12 U.S.C. 1467a.

1964 See 12 U.S. C. 1843(k).

1965 See 12 CFR 211.21.

1966 See final rule § __.10(c)(9)(iii).
609

unconditionally guaranteed by the sovereign, which would include its departments and 

ministries, including the central bank. 

In this regard, under the final rule, the exclusion from the definition of covered 

fund in respect of ABCP conduits is only available to an issuer of short-term asset-backed 

securities supported by loans and certain asset-backed securities supported by loans that 

were issued or initially sold to the ABCP conduit, and the short term asset-backed 

securities issued by the ABCP conduit are supported by a liquidity facility that provides 

100 percent liquidity coverage from a regulated liquidity provider. The exclusion, 

therefore, is not available to ABCP conduits that lack 100 percent liquidity coverage. 

The liquidity coverage may be provided in the form of a lending facility, an asset 

purchase agreement, a repurchase agreement, or similar arrangement and 100 percent 

liquidity coverage means that, in the event the qualifying asset-backed commercial paper 

conduit is unable for any reason to repay maturing asset-backed securities issued by the 

issuing entity, the total amount for which the regulated liquidity provider may be

obligated is equal to 100 percent of the amount of asset-backed securities outstanding 

plus accrued and unpaid interest. In addition, amounts due pursuant to the required 

liquidity coverage may not be subject to the credit performance of the asset-backed

securities held by the qualifying asset-backed commercial paper conduit or reduced by 

the amount of credit support provided to the qualifying asset-backed commercial paper 

conduit. Under the final rule, liquidity coverage that only funds an amount determined 

by reference to the amount of performing loans, receivables, or asset-backed securities 

will not be permitted to satisfy the liquidity requirement for a qualifying asset-backed 

commercial paper conduit. 
610

As discussed above, the final rule defines a qualifying asset-backed commercial 

paper conduit as having certain elements. First, a qualifying asset-backed commercial 

paper conduit must issue only a residual interest and short-term asset-backed securities. 

This requirement distinguishes ABCP conduits from covered funds that issue partnership 

interests and mitigates the potential that a qualifying ABCP conduit would be used for 

evasion of the covered fund prohibitions. The Agencies chose a maximum term of 397 

days for these securities because this time frame corresponds to the maximum maturity of 

securities allowed to be purchased by money market funds under Rule 2a-7 of the 

Investment Company Act.

Second, the asset-backed securities issued by the ABCP conduit must be 

supported only by loans and certain asset-backed securities that meet the requirements of 

the loan securitization exclusion. By placing restrictions on the assets permitted to be 

held by an excluded loan securitization, the potential for evasion of the covered fund 

prohibitions is reduced. The exclusion for qualifying ABCP conduits is intended, as 

contemplated by the rule of construction in section 13(g)(2) of the BHC Act, to permit 

banks to continue to engage in securitizations of loans. Including all types of securities 

and other assets within the scope of permitted assets in a qualifying ABCP conduit, as 

with loan securitizations, would expand the exclusion beyond the scope of the definition 

of loan in the final rule that is intended to implement the rule of construction. 

Third, the asset-backed securities supporting a qualifying asset-backed 

commercial paper conduit must be purchased as part of the initial issuance of such assetbacked securities. Asset-backed securities purchased by an ABCP conduit in the 

secondary market will not be permitted because such a purchase would not be part of an 
611

initial issuance and the banking entity that established and manages the ABCP conduit 

would not have participated in the negotiation of the terms of such asset-backed 

securities. Without a more direct connection between the banking entity and the ABCP 

conduit, the purchase of such asset-backed securities in the secondary market would 

resemble investments in securities. 

Fourth, under the final rule, the ABCP conduit exclusion will not be available to 

ABCP conduits that lack 100 percent liquidity coverage. The Agencies believe that the 

100 percent liquidity coverage requirement distinguishes the conduits eligible for the 

exemption, which sometimes hold and securitize a customer’s loans through an

intervening special-purpose vehicle instead of holding the loans directly, and are 

supported by a 100 percent liquidity guarantee, from other types of conduits with partial 

liquidity guarantees (such as structured investment vehicles) that have sometimes been 

operated by banking entities for the purpose of financing portfolios of securities acquired 

or retained as part of their activities in the securities markets. 

The Agencies recognize that ABCP conduits that do not satisfy the elements of 

the ABCP conduit exclusion may be covered funds and therefore would be subject to 

section 13(f) of the BHC Act.1967 As a result of section 13(f) of the BHC Act, which 

prohibits certain transactions between banking entities and a covered fund securitization 

that the banking entity sponsors or for which it provides investment management 

services, the banking entity would be prohibited from providing liquidity support for the 

ABCP conduit. 

 

1967 See 12 U.S.C. 1851(f); See also § __.16 of the proposed rule.
612

Similarly, while some commenters requested that the loan securitization exclusion 

permit the holding of a limited amount of securities purchased in the secondary market, 

the final rule does not provide for this in the context of ABCP conduits. The Agencies 

believe that the limitations on the types of securities that a qualifying asset-backed 

commercial paper conduit may invest in are needed to avoid the possibility that a banking 

entity could use a qualifying asset-backed commercial paper conduit to securitize nonloan assets or to engage in proprietary trading of such securities prohibited under the final 

rule. Thus this limitation reduces the potential for evasion of the covered fund provisions 

of section 13 of the BHC Act. In developing the exclusion from the definition of covered 

fund for qualifying asset-backed commercial paper conduits in the final rule, the 

Agencies considered the factors set forth in sections 13(g)(2) and 13(h)(2) of the BHC 

Act. The final rule includes conditions designed to ensure that an ABCP conduit 

established and managed by a banking entity serves as a means of facilitating that 

banking entity’s loan securitization activity rather than financing that banking entity’s 

capital market investments. The final rule distinguishes between qualifying asset-backed 

commercial paper conduits and other ABCP conduits in order to adhere to the tenets of 

section 13 of the BHC Act while accommodating the market practices discussed by the 

commenters by facilitating reasonable access to credit by consumers and businesses 

through the issuance of ABCP backed by consumer and business receivables. As 

discussed above, the Agencies understand that some existing ABCP conduits may need to 

be restructured to conform to the requirements of the ABCP conduit exclusion. 

To the extent that the definition of covered fund, the loan securitization exclusion 

and the ABCP conduit exclusion do not eliminate the applicability of the final rule 
613

provisions to certain covered funds, there may be adverse effects on the provision of 

capital to customers,1968 to securitization markets,1969 and to the creation of new 

securitization products to meet investor demands that Congress may not have 

contemplated. 1970 However, financial institutions that are not banking entities and 

therefore are not subject to the restrictions on ownership can continue to engage in 

activities relating to securitization, including those securitizations that fall under the 

definition of covered fund. Furthermore, new securitizations may be structured so as to 

qualify for the loan securitization exclusion or other exclusions under the final rule. For 

these reasons, the impact on securitizations that are not excluded under the final rule may 

be mitigated. 

The Agencies believe that the final rule excludes from the definition of covered 

fund typical structures used in the most common loan securitizations representing a 

significant majority of the current securitization market, such as residential mortgages, 

commercial mortgages, student loans, credit card receivables, auto loans, auto leases and 

equipment leases. Additionally, the Agencies believe that esoteric asset classes 

supported by loans may also be able to rely on the loan securitization exclusion, such as 

time share loans, container leases and servicer advances. 

 

1968 See, e.g., ASF (Feb. 2012).

1969 See Credit Suisse (Williams) (employing ABCP conduits as an example); ASF (Feb. 2012) (describing 

the constriction of the market for asset-backed securities if banking entities are restricted from owning debt 

classes of new asset backed securities).

1970 See RBC; ASF (Feb. 2012).
614

10. Covered bonds

Several commenters called for covered bond structures to be excluded from the 

definition of covered fund.1971 They indicated that the proposed rule may interfere with 

and restrict non-U.S. banks’ ability to establish or issue covered bonds. As described by 

several commenters, covered bonds are full recourse debt instruments typically issued by 

a non-U.S. entity that are fully secured or “covered” by a pool of high-quality collateral 

(e.g., residential or commercial mortgage loans or public sector loans).1972 Certain of 

these covered bond structures utilize a special purpose vehicle (“SPV”) that holds a 

collateral pool. As such, under the proposed rule, an SPV could be a covered fund that 

relies on the exclusion in section 3(c)(1) or 3(c)(7) of the Investment Company Act. 

According to one commenter, the majority of covered bonds are issued under 

specific legislative frameworks which define permitted characteristics for covered bond 

issuances, including the kinds and quality of collateral that may be included in cover 

pools, the specific legal framework for issuance of covered bonds, and the procedures for 

resolution in the event that the issuer becomes insolvent.1973 Some commenters 

expressed concern about the possibility that certain covered bond structures could fall 

within the definition of covered fund, as proposed. In particular, commenters expressed 

concern about covered bond structures in the United Kingdom that also would be relevant 

 

1971 See Allen & Overy (on behalf of Foreign Bank Group); UKRCBC; FSA (Apr. 2012); ASF (Feb. 

2012).

1972 See AFME et al.; Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); FSA (Apr. 

2012); UKRCBC.

1973 See UKRCBC. For example, a commenter indicated that in the European Union, Article 52(4) of the 

EU UCITS Directive sets out the defining characteristics of covered bonds, and this directive is 

implemented by specific legislative frameworks.
615

in principle with respect to covered bond structures used in other European Union (“EU”) 

jurisdictions (e.g., the Netherlands and Italy) and certain non-EU jurisdictions (e.g., 

Canada, Australia, and New Zealand).1974 Another commenter indicated that covered 

bonds issued by certain French entities that hold a revolving pool of loans may be 

impacted by the proposed rule.1975

Certain commenters argued that in order to achieve the intended economic effect 

of providing recourse to both the bank issuing covered bonds and to the collateral pool, 

the issuing bank may enter into a number of agreements with the SPV that holds the 

collateral. This includes transactions where the bank takes on credit exposure to the SPV 

(e.g., through derivatives and securities lending, provision of loans, and/or investments in 

securities of the SPV).1976 The issuing bank typically also provides asset and liability

management services to the SPV and may also repurchase certain assets from the 

SPV.1977 Commenters also contended that under certain legislative frameworks, the SPV 

issues the covered bonds and holds the collateral, and a sponsoring bank lends money to 

the SPV.1978 According to commenters, the broad definition of covered fund in the 

proposed rule could capture an SPV that holds the collateral, so transactions between an 

SPV and the issuing bank or sponsor bank may be prohibited.1979 These commenters 

 

1974 See UKRCBC; FSA (Apr. 2012). One commenter argued that there are two main models used for 

covered bond structures in Europe—the integrated model (where the collateral pool continues to be owned 

directly by the bank issuer and is segregated by special legislation) and the structured model (where the 

pool is transferred to a special purpose vehicle and is segregated by operation of legal principles). See

UKRCBC.

1975 See Allen & Overy (on behalf of Foreign Bank Group).

1976 See FSA (Apr. 2012). 

1977 See UKRCBC. 

1978 See Allen & Overy (on behalf of Foreign Bank Group).

1979 See Allen & Overy (on behalf of Foreign Bank Group); UKRCBC; FSA (Apr. 2012).
616

argued that including covered bond structures in the definition of covered fund is 

inconsistent with the legislative intent of the rule, would have a negative and 

disproportionate effect on foreign banks, markets and economies and would give rise to 

potential conflicts with such foreign legislative frameworks.1980

According to certain commenters, SPVs whose sole function is as part of an 

offering of covered bonds should be excluded from the definition of covered fund in the 

final rule. These commenters provided that the proposed rule was not clear on whether 

these SPVs, which effectively function as collateral devices for the covered bond, would 

be excluded from the definition of covered fund.1981 One commenter indicated that the 

key concern was primarily due to the wide definition of covered fund in the proposed 

rule.1982 Other commenters indicated that the final rule should not apply to covered bond 

transactions because they are not traditionally recognized or regulated as asset-backed 

securities transactions, and they are not the type of transactions that the rule was intended 

to address.1983

As a result of comments received on covered bond vehicles, the final rule 

specifically excludes from the definition of covered fund certain entities that own or hold 

a dynamic or fixed pool of assets that covers the payment obligations of covered bonds. 

In order to qualify for the exclusion, the assets or holdings in the cover pool must satisfy 

the conditions in the loan securitization exclusion, except for the requirement that the 

 

1980 See Allen & Overy (on behalf of Foreign Bank Group); UKRCBC; FSA (Apr. 2012); ASF (Feb. 

2012); AFME et al. For a discussion of possible economic effects, See FSA (Feb. 2012); UKRCBC; Allen 

& Overy (on behalf of Foreign Bank Group).

1981 See ASF (Feb. 2012); AFME et al.; UKRCBC. 

1982 See UKRCBC.

1983 See, e.g., AFME et al.
617

securities they issue are asset-backed securities (the “permitted cover pool”).1984 The 

Agencies believe this approach is consistent with the rule of construction contained in 

section 13(g)(2) of the BHC Act. The rule of construction in section 13(g)(2) of the BHC 

Act specifically refers to the “sale and securitization of loans” and the Agencies would 

not want a banking entity to use an excluded cover pool to engage in proprietary trading 

of such securities prohibited under the final rule. The Agencies believe this restriction 

reduces the potential for evasion of the final rule.

By placing restrictions on the assets permitted to be held by a cover pool, the 

potential for evasion of the covered fund prohibitions is reduced. The exclusion for cover 

pools is intended, as contemplated by the rule of construction in section 13(g)(2) of the 

BHC Act, to permit banking entities to continue to engage in lending activities and the 

financing those lending activities. Including all types of securities and other assets within

the scope of permitted assets in a cover pools would expand the exclusion beyond the 

scope of the definition of loan in the final rule that is intended to implement the rule of 

construction. Additionally, because the exclusion for cover pools is only available to 

foreign banking organizations, allowing such cover pools to hold securities would 

provide unequal treatment of covered bonds as compared to a loan securitization 

sponsored by a U.S. banking entity. 

Under the definition of covered bond in the final rule, the debt obligation may be 

issued directly by a foreign banking organization or by an entity that owns a permitted 

cover pool. In both cases, the payment obligations of the debt obligation must be fully 

 

1984 See final rule § __.10(c)(10).
618

and unconditionally guaranteed. If the debt obligation is issued by a foreign banking 

organization, such debt obligation will be a “covered bond” under the final rule if the 

payment obligations are fully and unconditionally guaranteed by an entity that owns a 

permitted cover pool.1985 If the debt obligation is issued by an entity that owns a 

permitted cover pool, such debt obligation will be a “covered bond” under the final rule if 

(i) the payment obligations are fully and unconditionally guaranteed by a foreign banking 

organization and (ii) the issuer of the debt obligation is a wholly-owned subsidiary (as 

defined) by such foreign banking organization.1986 Thus, under the final rule, a covered 

bond structure in which an entity holds the cover pool and issues securities that are fully 

and unconditionally guaranteed by a foreign banking organization may also be able to 

rely on the loan securitization exclusion if it meets all of the requirements of that 

exclusion.

The Agencies recognize that many covered bond programs may involve foreign 

covered bond programs (and their related cover pools) that are permitted by their 

respective laws to own residential mortgage-backed securities and other non-loan assets. 

As a result, the exclusion for covered bonds in the final rule may not be available to many 

of the existing cover pools that support outstanding covered bonds. The Agencies 

recognize that this approach may not exclude all foreign covered bond programs. 

Although certain commenters argued that including covered bond structures in the 

 

1985 See final rule § __.10(c)(10)(ii)(A).

1986 See final rule § __.10(c)(10)(ii)(B). As discussed above in the section describing the wholly-owned 

subsidiary exclusion from the definition of covered fund, the Agencies are permitting 0.5 of a whollyowned subsidiary to be owned by an unaffiliated party for the purpose of establishing corporate

separateness or addressing bankruptcy, insolvency, or similar concerns. 
619

definition of covered fund is inconsistent with the legislative intent of the rule,1987 the 

Agencies believe that the exclusion for qualifying covered bonds, including the 

limitations on the types of securities that a loan securitization can hold, is consistent with 

the rule of construction contained in section 13(g)(2) of the BHC Act and appropriate for 

the reasons discussed directly above and under “Definition of Loan.” The Agencies also 

recognize that commenters argued that including covered bonds as covered funds could 

have a negative and disproportionate effect on foreign banks, markets and economies and 

would give rise to potential conflicts with such foreign legislative frameworks.1988 The 

Agencies note that, although they do not know the composition of the cover pools, the

Agencies believe that foreign banking organizations should be able to look at the 

composition of their cover pools to evaluate how to meet the requirements of the 

exclusion—and thus to avoid or mitigate the adverse effects commenters asserted would 

occur—as they determine appropriate.

11. Certain permissible public welfare and similar funds

Section 13(d)(1)(E) of the BHC Act permits a banking entity to make and retain: 

(i) investments in one or more small business investment companies (“SBICs”), as 

defined in section 103(3) of the Small Business Investment Act of 1958 (SBA) (15 

U.S.C. § 662)1989; (ii) investments that are designed primarily to promote the public 

 

1987 See supra note 1980 and accompanying text. 

1988 Id.

1989 The Agencies note that section 13(d)(1)(E) of the BHC Act incorrectly provides that the term “small 

business investment company” is defined in section 102 of the SBA, while the definition is in fact 

contained in section 103(3) of the SBA as codified at 15 U.S.C. 662. The statute includes the correct 

citation to 15 U.S.C. 662. The Agencies are correcting this technical error in the final rule by updating the 

reference to section 102 to section 103(3). 
620

welfare, of the type permitted under paragraph (11) of section 5136 of the Revised 

Statutes of the United States (12 U.S.C. § 24); and (iii) investments that are qualified 

rehabilitation expenditures with respect to a qualified rehabilitated building or certified 

historic structure, as such terms are defined in section 47 of the Internal Revenue Code of 

1986 or a similar State historic tax credit program.1990 The proposed rule permitted 

banking entities to invest in and act as sponsor1991 to these entities, but did not explicitly 

exclude them from the definition of covered fund.1992

Commenters generally supported the proposed exemption for investments in and 

sponsorship of funds designed to promote the public welfare, SBICs, and other tax credit 

funds given the valuable funding and assistance these investments provide in facilitating 

community and economic priorities and the role these investments play in the ability of 

banking entities, especially community and regional banks, to achieve their financial and 

Community Reinvestment Act (“CRA”) goals. However, commenters raised some issues 

with respect to the proposed exemption and sought clarification on its application to 

specific investments.1993 Of primary concern to commenters was the impact of the 

prohibition in section 13(f) of the BHC Act on the ability of a banking entity sponsoring a 

tax credit fund or its affiliate to guarantee certain obligations of the fund in order to 

 

1990 See 12 U.S.C. 1851(d)(1)(E). 

1991 The proposal implemented a proposed determination by the Agencies under 13(d)(1)(J) “that a 

banking entity may not only invest in such entities as provided under section 13(d)(1)(E) of the BHC Act, 

but also may sponsor an entity described in that paragraph and that such activity, since it generally would 

facilitate investment in small businesses and support the public welfare, would promote and protect the 

safety and soundness of banking entities and the financial stability of the United States.” Joint Proposal, 76 

FR at 68,908 n.292.

1992 See proposed rule § __.13(a).

1993 See Novogradac (LIHTC); Novogradac (NMTC); Novogradac (RETC); PNC; Raymond James; 

SIFMA et al. (Covered Funds) (Feb. 2012); SBIA.
621

provide assurance to investors that the investment has been properly structured to enable 

the investor to receive the tax benefits on which the investment are sold.1994 Some 

commenters noted that failure to address this issue in the final rule would damage a large 

segment of this market and therefore urged the Agencies to exempt these investments 

from the application of section 13(f) or, in the alternative, from the definition of covered 

fund.1995

In addition, commenters requested clarification that specific types of public 

welfare, SBIC, and other tax credit investments would be eligible for the exemption, 

including Low Income Housing Tax Credits, Renewable Energy Tax Credits, New 

Markets Tax Credits, and Rural Business Investment Companies.1996 One commenter 

requested that applicants for an SBIC license that have received permission from the 

Small Business Administration to file a formal SBIC license application be viewed the 

same as an SBIC.1997 Other commenters sought coverage of investments in non-SBIC 

funds that provide capital to small and middle-market companies,1998 investments in any 

state administered tax credit program,1999 and investments outside the United States that 

are of the type permitted under paragraph (11) of section 5136 of the Revised Statutes of 

the United States (12 U.S.C. § 24).2000 

 

1994 See AHIC; Novogradac (LIHTC); Novogradac (NMTC); Novogradac (RETC); SBIA; Union Bank; 

U.S. Bancorp.

1995 See ABA (Keating); Lone Star; Novogradac (LIHTC); Novogradac (NMTC); Novogradac (RETC); 

SVB; U.S. Bancorp.

1996 See NCHSA; SBIA; Novogradac (LIHTC); Novogradac (NMTC); Novogradac (RETC).

1997 See SBIA; See also SEC Rule 3c-2.

1998 See ABA (Keating); PNC.

1999 See USAA.

2000 See JPMC; SIFMA et al. (Covered Funds) (Feb. 2012).
622

In light of the comments received, the final rule excludes from the definition of 

covered fund an issuer that is an SBIC (or that has received from the Small Business 

Administration notice to proceed to qualify for a license as an SBIC, which notice or 

license has not been revoked) or the business of which is to make investments that are: (i) 

designed primarily to promote the public welfare, of the type permitted under paragraph 

(11) of section 5136 of the Revised Statutes of the United States (12 U.S.C. § 24), 

including the welfare of low- and moderate-income communities or families (such as 

providing housing, services, or jobs); or (ii) qualified rehabilitation expenditures with 

respect to a qualified rehabilitated building or certified historic structure, as such terms 

are defined in section 47 of the Internal Revenue Code of 1986 or a similar State historic 

tax credit program.2001 

By excluding SBICs and other public interest funds from the definition of covered 

fund—rather than provide a permitted activity exemption as proposed—the Agencies 

addressed commenters’ concerns regarding the burdens imposed by section 13(f). The 

Agencies believe that excluding these investments from the definition of covered fund 

addresses the issues many commenters raised with respect to the application of section 

13(f) of the BHC Act, and gives effect to the statutory exemption of these investments in 

a way that appropriately facilitates national community and economic development 

objectives. The Agencies believe that permitting a banking entity to sponsor and invest 

 

2001 See final rule § __.10(c)(11). This provision would cover any issuer that engages in the business of 

making tax credit investments (e.g., Low Income Housing Tax Credit, New Markets Tax Credit, 

Renewable Energy Tax Credit, Rural Business Investment Company) that are either designed to promote 

the public welfare of the type permitted under 12 U.S.C. 24(Eleventh) or are qualified rehabilitation 

expenditures with respect to a qualified rehabilitated building or certified historic structure, as provided for 

under § __.10(c)(11).
623

in these types of public interest entities will result in banking entities being able to 

provide valuable expertise and services to these entities and to provide funding and 

assistance to small businesses and low- and moderate-income communities. The 

Agencies believe that providing the exclusion will also allow banking entities to continue 

to provide capital to community-improving projects and in some instances promote 

capital formation.

12. Registered investment companies and excluded entities

The proposed rule did not specifically include registered investment companies 

(including mutual funds) or business development companies within the definition of 

covered fund.2002 As explained above, the statute references funds that rely on section 

3(c)(1) or 3(c)(7) of the Investment Company Act. Registered investment companies and 

business development companies do not rely on either section 3(c)(1) or 3(c)(7) of the 

Investment Company Act and are instead registered or regulated in accordance with the 

Investment Company Act. 

Many commenters argued that registered investment companies and business 

development companies would be treated as covered funds under the proposed definition 

if commodity pools are treated as covered funds.2003 A few commenters argued that the 

final rule should specifically provide that all SEC-registered funds are excluded from the 

 

2002 See proposed rule § __.10(b)(1). 

2003 See, e.g., Arnold & Porter; BoA; Goldman (Covered Funds); ICI (Feb. 2012); Putnam; TCW; 

Vanguard. According to these commenters, a registered investment company may use security or 

commodity futures, swaps, or other commodity interests in various ways to manage its investment portfolio 

and be swept into the broad definition of “commodity pool” contained in the Commodity Exchange Act. 
624

definition of covered fund (and the definition of banking entity) to avoid any uncertainty 

about whether section 13 applies to these types of funds.2004 

Commenters also requested that the final rule exclude from the definition of 

covered fund entities formed to establish registered investment companies during the 

seeding period. These commenters contended that, during the early stages of forming 

and seeding a registered investment company, an entity relying on section 3(c)(1) or 

(3)(c)(7) may be created to facilitate the development of a track record for the registered 

investment company so that it may be marketed to unaffiliated investors.2005 

Section 13’s definition of private equity fund and hedge fund by reference to 

section 3(c)(1) and 3(c)(7) of the Investment Company Act appears to reflect Congress’ 

concerns about banking entities’ exposure to and relationships with investment funds that 

explicitly are excluded from SEC regulation as investment companies. The Agencies do 

not believe it would be appropriate to treat as a covered fund registered investment 

companies and business development companies, which are regulated by the SEC as 

investment companies. The Agencies believe that the proposed rule’s inclusion of 

commodity pools would have resulted in some registered investment companies and 

business development companies being covered funds, a result the Agencies did not 

intend. The Agencies, in addition to narrowing the commodity pools that will be 

included as covered funds as discussed above, have also modified the final rule to 

 

2004 See Arnold & Porter; Goldman (Covered Funds); See also SIFMA et al. (Covered Funds) (Feb. 2012); 

SIFMA et al. (Mar. 2012); ABA (Keating); BoA; ICI (Feb. 2012); JPMC (requesting clarification that 

registered investment companies are not banking entities); TCW.

2005 See ICI (Feb. 2012); TCW.
625

exclude SEC-registered investment companies and business development companies 

from the definition of covered fund.2006

The Agencies also recognize that an entity that becomes a registered investment 

company or business development company might, during its seeding period, rely on 

section 3(c)(1) or 3(c)(7). The Agencies have determined to exclude these seeding 

vehicles from the covered fund definition for the same reasons the Agencies determined 

to exclude entities that are operating as registered investment companies or business 

development companies as discussed above. 

In order to prevent banking entities from purporting to use this exclusion for 

vehicles that the banking entity does not reasonably expect to become a registered 

investment company or business development company, the exclusion is available only 

with respect to a vehicle that the banking entity operates (i) pursuant to a written plan, 

developed in accordance with the banking entity’s compliance program, that reflects the 

banking entity’s determination that the vehicle will become a registered investment 

company or business development company within the time period provided by the final 

rule for seeding a covered fund; (ii) consistently with the leverage requirements under the 

Investment Company Act of 1940 that are applicable to registered investment companies 

and SEC-regulated business development companies.2007 A banking entity that seeds a 

covered fund for any purpose other than to register it as an investment company or 

establish a business development company must comply with the requirements of section 

13(d)(1)(G) of the BHC Act and § __.11 of the final rule as described above. The 

 

2006 See final rule § __.10(c)(12).

2007 See final rule §§ __.10(c)(12)(i); 10(c)(12)(iii); __.20(e). 
626

Agencies will monitor this seeding activity for attempts to use this exclusion to evade the 

requirements governing the ownership of and relationships with covered funds under 

section 13 of the BHC Act and the final rule.2008 

13. Other excluded entities

Section 13(h)(2) permits the Agencies to include similar funds within the 

definition of covered fund, but the proposal did not contain a process for excluding from 

the definition of covered fund other entities that do not engage in the investment activities 

contemplated by section 13. Many commenters argued that the breadth of entities that 

may be required to rely on the exclusions in section 3(c)(1) or 3(c)(7) of the Investment 

Company Act could result in additional unidentified entities becoming subject to the 

definition of covered fund.2009 In order to ensure that the final rule effectively addresses 

the full scope of entities that may inadvertently be included within the definition of 

covered fund, a number of commenters urged that the final rule include a mechanism to 

exclude other entities from the term “covered fund” by rule or order if the Agencies 

determine such an exclusion is appropriate.2010 

As evidenced by the extensive comments discussed above identifying the many 

types of corporate structures and other vehicles (not just investment funds) that rely on 

sections 3(c)(1) and 3(c)(7) but do not engage in investment activities of the type 

 

2008 The Agencies also note that banking entities with more than $10 billion in total consolidated assets as 

reported on December 31 of the previous two calendar years must maintain records that include, among 

other things, documentation of the exclusions or exemptions other than sections 3(c)(1) and 3(c)(7) of the 

Investment Company Act of 1940 relied on by each fund sponsored by the banking entity in determining 

that such fund is not a covered fund. See final rule § __.20(e). 

2009 See also FSOC study.

2010 See SIFMA et al. (Covered Funds) (Feb. 2012); Credit Suisse (Williams); GE (Feb. 2012). 
627

contemplated by section 13, the scope of an overly broad definition of covered fund may 

impose significant burdens on banking entities that are in conflict with the purposes of 

section 13 of the BHC Act. In response to commenters’ concerns and to address the 

potential that the final rule’s definition of covered fund might encompass entities that do 

not engage in the investment activities contemplated by section 13, the final rule includes 

a provision that provides that the Agencies may jointly determine to exclude an issuer 

from the definition of covered fund if the exclusion is consistent with the purposes of 

section 13 of the BHC Act.2011 

As noted above, the statute permits the Agencies to act by rule to modify the 

definition of covered fund. After issuing the proposed rule and receiving comment on it, 

the final rule provides that the Agencies may act jointly to provide an exclusion.2012 The 

Agencies are working to establish a process within which to evaluate requests for 

exclusions and expect to provide additional guidance on this matter as the Agencies gain 

experience with the final rule.2013 As a result, the definition of covered fund would 

remain unified and consistent. The final rule also provides that a determination by the 

Agencies to exclude an entity from the definition of covered fund will be promptly made 

public in order to ensure that both banking entities and the public may understand what 

entities are and are not included within the definition of covered fund. 

d. Entities Not Specifically Excluded from the Definition of Covered Fund

 

2011 See final rule § __.10(c)(14).

2012 As discussed above, the Agencies also may determine jointly that an entity excluded from the definition 

of covered fund under § __.10(c) is in fact a covered fund, and consequently banking entities’ investments 

in and transactions with such fund would be subject to limitations and/or divestiture. The Agencies intend 

to utilize this authority to monitor for and address, as appropriate, instances of evasion. See, e.g., 12 U.S.C. 

1851(e)(2).

2013 A joint determination specified under § __.10(c)(14) may take a variety of forms.
628

In addition to the entities identified above which are excluded from the definition 

of covered fund under the final rule, commenters argued that a number of other entities 

such as financial market utilities, venture capital funds, credit funds, cash management 

vehicles or cash collateral pools may also be an investment company but for the 

exclusion contained in section 3(c)(1) or 3(c)(7) of the Investment Company Act and 

requested that these entities expressly be excluded from the final rule’s definition of 

covered fund. The Agencies have considered carefully the comments received on each of 

these entities but, for the reasons explained below, have declined to provide a separate 

exclusion for them from the definition of covered fund at this time. As discussed below, 

some of these entities are not covered funds for various reasons or may, with relatively 

little cost, conform to the terms of an exclusion or exemption from the definition of 

covered fund. As noted above, to the extent that one of these entities qualifies for one or 

more of the other exclusions from the definition of covered fund, that entity would not be 

a covered fund under the final rule. Any entity that would be a covered fund would still 

be able to rely on the conformance period in order to come into compliance with the 

requirements of section 13 and the final rule.

A number of commenters requested that certain existing covered funds be either 

excluded from the definition of covered fund or grandfathered and not be subject to the 

limitations of section 13 of the BHC Act.2014 The Agencies note, however, that section 

13 specifically addresses a banking entity’s preexisting investments in covered funds by 

providing a conformance period, which banking entities may use to bring their activities 

 

2014 See, e.g., PNC; SVB; SIFMA (Securitization) (Feb. 2012); AFME et al.; BoA. See also, e.g., Credit 

Suisse (Williams).
629

and investments into compliance with the requirements of section 13 and the final rule.

To the extent that section 13 could be interpreted to permit the Agencies to take a 

different approach, despite addressing banking entities’ preexisting covered fund 

investments directly, the Agencies believe it would be inconsistent with the purposes of 

section 13 to permit banking entities to continue to hold ownership interests in covered 

funds beyond the conformance period provided by the statute. Section 13’s prohibition 

on banking entities’ investments in and relationships with covered funds and the 

requirement that banking entities divest or conform these investments appear to reflect 

the statutory purpose that banking entities be limited in their ability to continue to be 

exposed to these investments outside of the statutorily-provided conformance period. 

The Agencies believe that permitting banking entities to hold ownership interests 

indefinitely beyond the conformance period provided by the statute appears inconsistent 

with this purpose.

1. Financial market utilities

Several commenters contended that financial market utilities (“FMUs”) could be 

covered funds because they might rely on section 3(c)(1) or 3(c)(7) for an exclusion from 

the definition of investment company under the Investment Company Act and may not 

qualify for an alternative exemption.2015 These commenters argued that banking entities 

have long been investors in domestic and foreign FMUs, such as securities clearing 

agencies, derivatives clearing organizations, securities exchanges, derivatives boards of 

trade and alternative trading systems. These commenters expressed concern that, unless 

 

2015 See SIFMA et al. (Covered Funds) (Feb. 2012); Credit Suisse (Williams). 
630

FMUs are expressly excluded from the definition of covered fund, banking entities could 

be prohibited from entering into any new covered transactions with related FMUs and 

would be required to divest their investments in FMUs, thereby disrupting the operations 

of those FMUs and financial markets generally. 

After carefully considering commenters’ concerns, the Agencies believe that 

FMUs are not investment vehicles of the type section 13 of the BHC Act was designed to 

address, but rather entities that generally engage in other activities, including acting as 

central counterparties that reduce counterparty risk in clearing and settlement activities. 

Congress recognized, in the Payment, Clearing, and Settlement Supervision Act of 2010 

(title VIII of the Dodd–Frank Act),2016 that properly designed, operated, and supervised 

financial market utilities as defined in that Act mitigate systemic risk and promote 

financial stability.2017

However, the Agencies have not provided an exclusion from the covered fund 

definition for FMUs because these kinds of entities do not generally appear to rely on 

section 3(c)(1) or 3(c)(7) of the Investment Company Act, and therefore do not appear to 

need an exclusion. For example, section 3(b)(1) of the Investment Company Act 

excludes from the definition of investment company -- and thus from the definition of a 

covered fund -- entities primarily engaged in a business other than that of an investment 

company.2018 If an FMU is primarily engaged in a business other than those that would 

make it an investment company, for example, if the FMU is primarily engaged in 

 

2016 12 USC 5461 et seq.

2017 See id.

2018 Section 3(b)(1) of the Investment Company Act excludes from the definition of investment company 

“[a]ny issuer primarily engaged, directly or through a wholly-owned subsidiary or subsidiaries, in a 

business or businesses other than that of investing, reinvesting, owning, holding, or trading in securities.”
631

transferring, clearing, or settling payments, securities, or other financial transactions 

among or between financial institutions,2019 the FMU could rely on the exclusion to the 

definition of investment company provided by section 3(b)(1) and would not need to rely 

on section 3(c)(1) or 3(c)(7) and, as such, would not be a covered fund. 

2. Cash collateral pools

Some commenters expressed concern that cash collateral pools, which are part of 

securities lending programs, could be included in the definition of covered fund.2020 

According to these commenters, banking entities, including bank custodians acting as 

lending agent for customer’s securities lending activities, typically manage these pools as 

fiduciaries for their customers.2021 These commenters argued that collateral pools are 

part of a banks’ traditional custody and advisory services and have been an integral part 

of any lending agent’s role (whether custodial or non-custodial) for years.2022

Cash collateral pools are typically formed when, as part of a securities lending 

program, a customer of a bank authorizes the bank to take securities from the customer’s 

account and lend them in the open market. The agent bank then lends those securities 

and receives collateral in return from the borrower; a securities lending customer of a 

bank typically elects to have cash collateral provided by a borrower pooled by the agent 

bank with other cash collateral provided to other clients.2023 These investment pools may 

exist in the form of trusts, partnerships, limited liability companies, or separate accounts 

 

2019 See 12 U.S.C. 1562(6); 12 CFR Part 234.

2020 See RMA; State Street (Feb. 2012); See also BNY Mellon et al.

2021 See RMA; State Street (Feb. 2012). 

2022 See RMA; BNY Mellon et al. (citing Comptroller’s Handbook: Custody Services (Jan. 2002)).

2023 See RMA. 
632

maintained by more than one party and these structures may rely on sections 3(c)(1) and 

3(c)(7) of the Investment Company Act to avoid being an investment company.2024 

While their ownership interest may be nominal in amount, the agent banks may hold a 

general partnership, limited liability company membership or trustee interest in the cash 

collateral pool.

2025 As part of these arrangements, custodian banks routinely offer 

borrower default indemnifications to the securities lender in a securities lending 

transactions. 

Commenters raised concerns that these indemnification agreements could be 

considered a covered transaction prohibited by section 13(f) of the BHC Act.2026 Since 

some cash collateral pools are established outside of the United States, commenters 

requested that the final rule permit banking entities to have interests in and relationships 

with both U.S. and non-U.S. cash collateral pools.2027 These commenters suggested that 

cash collateral pools be excluded from the definition of covered fund or, in the 

alternative, that the Agencies make clear that cash collateral pools managed by agent 

banks qualify for the exemption in § __.11 of the proposed rule for organizing and 

offering a covered fund and that the prime brokerage exemption from the restrictions of 

 

2024 See RMA. 

2025 See RMA. 

2026 See State Street; RMA. Commenters also argued that as part of offering pooled cash collateral 

management, agent banks have traditionally provided short-term extensions of credit and contractual 

income and settlement services to lending clients and cash collateral pools to facilitate trade settlement and 

related cash collateral investment activities. See RMA. One commenter further argued that if banks are 

required to “outsource” cash collateral pools and/or the related short-term credit services provided to the 

pools, “participation in securities lending programs would only be cost effective for the largest lending 

clients” and, as a result, “many small and intermediate securities lending clients would be denied the 

incremental revenue securities lending can provide”; “securities lending programs could lose significant

diversification in lending clients, lendable assets, borrowers and agent banks”; and, as a result of lost 

revenues, “the actual costs of [] custodial or other services provided to clients that no longer participate in 

lending would increase.” Id.

2027 See RMA. 
633

section 13(f) would permit the indemnification and income or settlement services agent 

banks typically provide to the pools.2028 These commenters also suggested that the 

Agencies use their authority under section 13(d)(1)(J) to provide an exemption for 

banking entities to continue to have interests in and provide services to these types of 

pools.2029 

After carefully considering comments received, the final rule does not provide a 

specific exclusion from the definition of covered fund for cash collateral pools. The 

Agencies have determined to provide specific exclusions for entities that do not function 

as investment funds, consistent with the intent of section 13’s restrictions, or in response 

to other unique considerations (e.g., to provide consistent treatment for certain foreign 

and domestic pension plans). These considerations do not support a separate exclusion 

for cash collateral pools.

The Agencies note, however, that some cash collateral pools may not be covered 

funds because they rely on an exclusion from the definition of investment company other 

than those contained in section 3(c)(1) or 3(c)(7) of the Investment Company Act.2030 

Banking entities may determine to register cash collateral pools with the SEC as 

investment companies or to operate them as separate accounts to exclude the pools from 

the covered fund definition or, if the pools remain covered funds, to organize and offer 

them in compliance with the requirements of § __.11 of the final rule. 

 

2028 See RMA. 

2029 See RMA.

2030 For instance, the Agencies understand that a banking entity may set up a cash collateral pool in 

reliance on the exclusion contained in section 3(c)(3) of the Investment Company Act, or may be able to 

structure these pools as SEC-registered money market funds operated in accordance with rule 2a-7 under 

the Investment Company Act.
634

In response to comments received on the proposal, the Agencies note that the 

provision of a borrower default indemnification by a banking entity to a lending client in 

connection with securities lending transactions involving a covered fund is not a covered 

transaction subject to 13(f) or a guarantee of the performance or obligations of a covered 

fund prohibited under § __.11 of the final rule. Those restrictions apply to transactions 

with the covered fund or guarantees of the covered fund’s performance. Borrower 

default indemnifications are provided to the bank’s securities lending customer, not to the 

cash collateral pool. 

3. Pass-through REITS

Some banking entities may issue real estate investment trust (“REIT”) preferred 

securities to the public directly from a subsidiary that qualifies for the exclusion in 

section 3(c)(5) or section 3(c)(6) of the Investment Company Act. These entities would 

not be considered a “covered fund” because they may rely on an exclusion from the 

definition of an investment company other than the exclusion in section 3(c)(1) or 3(c)(7) 

of the Investment Company Act.2031 However, in order to meet the demands of 

customers and avoid undesirable tax consequences, some banking entities structure their 

REIT offerings by using a passive, pass-through statutory trust between the banking 

entity and the REIT to issue REIT preferred securities to the public.2032 Because the 

pass-through trust holds the preferred securities of the underlying REIT (which would 

itself not be a covered fund), as well as provides administrative and ministerial functions 

for the REIT (including passing through dividends from the underlying REIT), the pass-

 

2031 See PNC. 

2032 See PNC. 
635

through trust may not itself rely on the exclusion contained in section 3(c)(5) or 3(c)(6) 

and, thus, typically relies on section 3(c)(1) or 3(c)(7).2033 

Some commenters urged the Agencies to provide an exclusion for pass-through 

REITS from the definition of covered fund.2034 These commenters argued that because 

the pass-through trust exists as a corporate convenience as part of issuing REIT preferred 

securities to the banking entity and its customers, it is not the type of entity that the 

covered fund prohibition in section 13 of the BHC Act was intended to address. These 

commenters also argued that pass-through REITs enable banking entities to offer 

preferable tax treatment to holders of the REIT preferred securities and that if passthrough REITs were included as covered funds, because of the limitations on covered 

transactions contained in section 13(f), the minority interests in the preferred securities 

issued by the REIT would no longer be able to be included in a banking entity’s tier 1 

capital, thereby negatively impacting the safety and soundness of the banking entity.2035

The Agencies are not providing a specific exclusion from the definition of 

covered fund for pass-through REITs because the Agencies are concerned that such an 

exclusion could enable banking entities to structure non-loan securitization transactions 

using a pass-through entity in a manner inconsistent with the final rule’s treatment of 

similar vehicles that invest in securities. Furthermore, banking entities have alternative 

 

2033 See ABA (Keating); PNC. 

2034 See ABA (Keating); PNC. 

2035 See PNC; ABA (Keating). These commenters argued that most REIT preferred securities contain a 

conditional exchange provision that allows the primary regulator to direct that the preferred securities be 

automatically exchanged for preferred shares of the bank or parent BHC upon occurrence of a conditional 

exchange event. Because this arrangement involves the purchase of securities issued by an affiliate or the 

purchase of assets, it would be prohibited under section 13(f) of the BHC Act if the pass-through REIT 

were a covered fund. 
636

manners in which they may issue or hold REIT preferred securities, including through

REITs directly, which do not raise the same concerns about evasion.2036 

4. Municipal securities tender option bond transactions 

The Agencies received a number of comments addressing how the final rule 

should treat municipal securities tender option bond vehicles. A number of commenters 

argued that issuers of municipal securities tender option bonds would fall under the 

definition of covered fund in the proposed rule because these issuers typically rely on the 

exclusion contained in section 3(c)(1) or 3(c)(7) of the Investment Company Act.2037 

According to commenters, a typical tender option bond transaction consists of the deposit 

of a single issue of highly-rated, 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 

 

2036 The Agencies recognize that banking entities may have relied on pass-through REIT structures to issue 

preferred securities in the past and prohibiting such transactions may pose inefficiencies. Furthermore, it 

may not be possible to unwind or conform past issuances without significant effort by the banking entity 

and negotiation with the holders of the preferred securities. As noted above, in these circumstances, section 

13 provides a conformance period which banking entities may take advantage of in order to bring their 

activities and investments into compliance with the requirements of section 13 and the final rule.

2037 See, e.g., Ashurst; SIFMA (Municipal Securities) (Feb. 2012); Citigroup (Jan. 2012); Cadwalader 

(Municipal Securities); Vanguard; ICI (Feb. 2012); ASF (Feb. 2012); Fidelity; Wells Fargo (Covered 

Funds). Commenters also noted that tender option bond programs as currently structured may not meet the 

requirements of section 3(a)(5) of the Investment Company Act or rule 3a-7 thereunder, or any other 

exclusion or exemption under the Investment Company Act. See Ashurst; RBC; ASF (Feb. 2012).
637

is held by a longer-term investor (in many cases the banking entity sponsoring the trust, 

or an insurance company, mutual fund, or hedge fund). According to commenters, the 

residual investors take all of the market and structural risk related to the tender option 

bonds structure, with the investors in floaters taking only limited, well-defined 

insolvency and default risks associated with the underlying municipal bonds generally 

equivalent to the risks associated with investing in the municipal bonds directly. 

According to commenters, the structure of tender option bond transactions is governed by 

certain provisions of the Internal Revenue Code in order to preserve the tax-exempt 

treatment of the underlying municipal securities.

Many commenters requested a specific exclusion for municipal tender option 

bond vehicles from the definition of a covered fund.2038 These commenters argued that, 

without an exclusion from the definition of covered fund, banking entities would be 

prohibited from owning or sponsoring tender option bonds and from providing credit 

enhancement, liquidity support, remarketing, and other services required in connection 

with a tender option bond program.2039 Commenters argued that tender option bond 

vehicles should be excluded because section 13(d)(1)(A) of the BHC Act already allows 

banking entities to own and dispose of municipal securities directly,2040 tender option 

bonds are economically similar to repurchase agreements, which are expressly excluded 

 

2038 See, e.g., ASF (Feb. 2012); BDA (Feb. 2012); Eaton Vance; Fidelity; ICI (Feb. 2012); RBC; SIFMA 

(Municipal Securities) (Feb. 2012); SIFMA (May 2012); State Street (Feb. 2012); Vanguard.

2039 See Ashurst; ASF (Feb. 2012). 

2040 See ASF (Feb. 2012); SIFMA (Municipal Securities) (Feb. 13, 2012); Citigroup (Jan. 2012). See also

Cadwalader (Municipal Securities) (alleging that the legislative history of section 13 of the BHC Act 

suggests that the exemption relating to municipal securities should not be construed to apply only to the 

section of the rule pertaining to the proprietary trading prohibitions); BDA (Feb. 2012) (arguing that any 

fund or trust the assets of which are entirely invested in any of the obligations that are excluded from the 

proprietary trading prohibitions should also be excluded from the definition of covered fund).
638

from the proprietary trading restrictions of the proposed rule, and, because they are safe 

and low risk are similar to the types of transactions that the proposed rule would have 

exempted.2041 Commenters also argued that tender option bonds are different from other 

covered funds that rely on the exclusion contained in section 3(c)(1) or 3(c)(7) of the 

Investment Company Act2042 and play an important role in the municipal bond 

markets.2043 Commenters requested that the Agencies use their authority under section 

13(d)(1)(J) of the BHC Act to exclude tender option bonds because they argued that 

tender option bonds promote the safety and soundness of banking entities and the 

financial stability of the United States by providing for a deeper, richer pool of potential 

investors, a larger and more liquid market for municipal securities that results in lower 

borrowing costs for municipalities and other issuers of municipal securities, and greater 

efficiency and risk diversification.2044 Commenters also suggested a number of other 

ways to exclude tender option bonds, including defining ownership interest to exclude 

any interest in a tender option bond transaction;2045 defining banking entity to exclude 

tender option bond issuers;2046 expanding the loan securitization exclusion to include 

tender option bond issuers;2047 and revising the definition of sponsor to exclude sponsors 

 

2041 See, e.g., Ashurst; Cadwalader (Municipal Securities); Eaton Vance; Nuveen Asset Mgmt.; SIFMA 

(Municipal Securities) (Feb. 13, 2012); State Street (Feb. 2012); Vanguard; Wells Fargo (Covered Funds); 

Citigroup (Jan. 2012). 

2042 See, e.g., ASF (Feb. 2012); State Street (Feb. 2012); Citigroup (Jan. 2012); Vanguard; Wells Fargo 

(Covered Funds); Cadwalader (Municipal Securities); Ashurst.

2043 See Cadwalader (Municipal Securities); ICI (Feb. 2012); Ashurst; ASF (Feb. 2012). 

2044 See Cadwalader (Municipal Securities).

2045 See RBC.

2046 See ICI (Feb. 2012).

2047 See ASF (Feb. 2012).
639

of tender option bond vehicles.2048 One commenter urged the Commission to consider 

amending the exemption under rule 3a-7 under the Investment Company Act or providing 

formal guidance regarding the status of tender option bond programs.2049 In addition, 

some commenters requested an exclusion for tender option bond transactions from the 

provisions of section 13(f) of the BHC Act.2050

After carefully considering the comments received, the final rule does not provide 

a specific exclusion from the definition of covered fund or from the prohibitions and 

requirements of the final rule for tender option bond vehicles.2051 The Agencies have 

determined to provide specific exclusions for entities that they believe fall within the rule 

of construction contained in section 13(g)(2) of the BHC Act, which expressly relates to 

the sale and securitization of loans,2052 do not function as investment funds, consistent 

with the intent of section 13’s restrictions, or in response to other unique considerations. 

The Agencies do not believe that these considerations support a separate exclusion for 

tender option bond vehicles, which have municipal securities as underlying assets and not 

loans. 

The Agencies recognize commenters’ concerns about the treatment of tender 

option bonds under the final rule, as discussed above. However, as there is no 

corresponding rule of construction in section 13 of the BHC Act for financial instruments 

 

2048 See RBC.

2049 See Ashurst.

2050 See, e.g., RBC; ASF (Mar. 2012); ASF (Feb. 2012).

2051 The Agencies received a variety of requests requesting specific treatment of tender option bond 

transactions. See, e.g., supra notes 2045-2050. As discussed above, the Agencies believe that, in light of 

the comments received, tender option bond vehicles do not fall within the rule of construction contained in 

section 13(g)(2) of the BHC Act and, as a result, the final rule does not provide such treatment.

2052 See 12 U.S.C. 1851(g)(2).
640

other than loans, the Agencies do not believe that the resecuritization of municipal debt 

instruments should be treated differently than the resecuritization of other debt 

instruments.2053 Notwithstanding the statutory treatment of municipal securities for 

purposes of the proprietary trading restrictions, the Agencies also do not believe that 

tender option bond vehicles fall within the rule of construction contained in section 

13(g)(2) of the BHC Act, because, in light of commenters’ descriptions of these vehicles, 

tender option bond vehicles are more in the nature of other types of bond repackaging 

securitizations and other non-excluded securitization vehicles.2054 The final rule, 

however, does not prevent a banking entity from owning or otherwise participating in a 

tender option bond vehicle; it requires that these activities be conducted in the same 

manner as with other covered funds. 

In this regard, under the final rule, a banking entity would need to evaluate 

whether a tender option bond vehicle is a covered fund as defined in the final rule. If a 

tender option bond vehicle is a covered fund and an exclusion from that definition is not 

available, then banking entities sponsoring such a vehicle will be subject to the 

 

2053 For these same reasons, and based on the definitions of sponsor and banking entity in section 13, the 

Agencies have not modified those definitions in the final rule to exclude sponsors of tender options bonds 

and tender bond issuers, respectively, as some commenters requested. See supra notes 2046 and 2048 and 

accompanying text. 

2054 Commenters also argued that to the extent tender option bond programs are not excluded from the 

definition of covered fund, the definition of ownership interest should exclude any interest in a tender 

option bond program (See RBC) or that where a third party owns the residual, the banking entity should not 

be treated as having an ownership interest, even when it owns a small interest for tax purposes or becomes 

the owner through liquidity or remarketing agreements (See Cadwalader (Municipal Securities)). The 

definition of ownership interest in the final rule focuses on the attributes of the interest, as discussed below, 

and not the particular type of covered fund involved. The Agencies are not providing separate definitions 

of or exclusions from the ownership interest definition based on the type of vehicle or financing involved. 

See infra note 2098 and preceding and following text. Banking entities will need to evaluate whether the 

interests they may acquire are ownership interests as defined under the final rule. 
641

prohibitions in § __.14 of the final rule and the provisions of section 13(f) of the BHC 

Act.2055 

As tender option bond vehicles are considered issuers of asset-backed securities 

subject to the risk retention requirements of section 15G of the Exchange Act, banking 

entities may look to the provisions of the final rule governing the limits applicable to 

banking entities’ interests in and relationships with those funds. Under the final rule, as 

in the statute, a banking entity that conducts the activities described in section 13(f) of the 

BHC Act is subject to the restrictions on transactions with a tender option bond vehicle, 

including guaranteeing or insuring the performance of the tender option bond vehicle, 

contained in section 13(f) of the BHC Act. As a result, a banking entity is not permitted 

to provide credit enhancement, liquidity support, and other similar services if it serves in 

a capacity covered by section 13(f) with the tender option bond program.2056 An 

unaffiliated third party may provide such services if it does not have a relationship with 

the tender option bond vehicle that triggers application of section 13(f). The extent to 

which the final rule causes a disruption to the securitization of, and market for, municipal 

tender option bonds may also affect the economic burden and effects on the municipal 

bond market and its participants, including money market mutual funds2057 and issuers of 

municipal securities. The Agencies recognize that a potential economic burden may be 

an increase in financing costs to municipalities as a result of a decrease in demand for the 

 

2055 See 12 U.S.C. 1851(f).

2056 As discussed above, while commenters requested treatment of municipal tender option bond vehicles 

that would cause section 13(f) of the BHC Act not to apply to them, the final rule does not exclude these 

vehicles from the definition of covered fund or the prohibitions relating to covered funds. As a result, 

section 13(f) of the BHC Act will apply to a banking entity that is sponsoring a tender option bond vehicle.

2057 See ASF (Feb. 2012); Nuveen Asset Mgmt.
642

types of municipal securities customarily included in municipal tender option bond 

vehicles2058 and therefore potential effects on the depth and liquidity of the market for 

certain types of municipal securities.2059

5. Venture capital funds

Some private equity funds that make investments in early-stage start-up 

companies or other companies with significant growth potential (“venture capital funds”) 

would be investment companies but for the exclusion contained in section 3(c)(1) or 

3(c)(7) of the Investment Company Act. Venture capital funds would therefore qualify as 

a covered fund under the proposal. The proposal specifically requested comment on 

whether venture capital funds should be excluded from the definition of “covered fund.”

Some commenters argued that venture capital funds should be treated differently 

than other covered funds and excluded from the definition. These commenters argued 

that, unlike conventional hedge funds and private equity funds, venture capital funds do 

not possess high leverage and do not engage in risky trading activities of the type section 

13 of the BHC Act was designed to address.2060 These commenters contended that 

investments and relationships by banking entities in venture capital funds would be 

consistent with safety and soundness; provide important funding and expertise and other 

services to start-up companies; and provide positive benefits to employment, GDP, 

growth, and innovation.2061 These commenters argued that restricting banking entities’ 

 

2058 See Ashurst.

2059 See Eaton Vance.

2060 See SVB; NVCA; Rep. Eshoo; Sen. Boxer; Rep. Goodlatte; Rep. Schweikert; Rep. Speier; Rep. 

Honda; Rep. Lofgren; Rep. Peters et. al. 

2061 See, e.g., NVCA; SVB; Scale.
643

ability to invest in or sponsor venture capital funds would have a negative impact on 

companies and the U.S. economy generally.2062 Some commenters asserted that bank 

investments in venture capital funds are important to the success of venture capital,2063

with some citing a consulting firm’s data indicating that approximately 7 percent of all 

venture capital is provided by banks.2064 One commenter argued, therefore, that 

“preventing banks from investing in venture thus could depress U.S. GDP by roughly 

1.5% (or $215 billion annually) and eliminate nearly 1% of all U.S. private sector 

employment over the long term,” and the funding gap that would result if banks could not 

invest in venture capital funds would not be met by other market participants if bank 

investments in venture capital were restricted.2065 Several commenters recommended 

that venture capital funds be excluded if they: (i) do not fundamentally engage in 

proprietary trading; (ii) do not use leverage to increase investment returns; and (iii) 

typically invest in high-growth start-up companies as compared to more mature publicly 

traded companies.2066 

Conversely, one commenter alleged that there was no credible way to exclude 

venture capital funds without providing a means to circumvent the requirements of 

 

2062 See, e.g., SVB; Scale; Sen. Boxer; SIFMA et al. (Covered Funds) (Feb. 2012) (citing a colloquy 

between Sen. Dodd and Sen. Boxer supporting an exemption for venture capital funds (156 Cong. Rec. 

H5226 (daily ed., June 30, 2010)).

2063 See River Cities; Scale. See also Sofinnova; Canaan (Young); Canaan (Ahrens); Canaan (Kamra); 

Mohr Davidow; ATV; BlueRun; Westly; Charles River; Flybridge; SVB.

2064 See, e.g., SVB.

2065 See SVB.

2066 See, e.g., SVB (arguing that the definition of “venture capital fund” in section 203(l)-1 of the 

Investment Advisers Act and the SEC’s Form PF reporting requirements for investment advisers to private 

funds would be instructive for defining an exclusion for venture capital funds for purposes of section 13 of 

the BHC Act).
644

section 13 and the final rule.2067 Another commenter argued that venture capital funds do 

in fact engage in risky activities and that, instead of making investments in venture 

capital funds, banking entities may directly extend credit to start-up companies in a safe 

and sound manner.2068

The final rule does not provide an exclusion for venture capital funds. The 

Agencies believe that the statutory language of section 13 does not support providing an 

exclusion for venture capital funds from the definition of covered fund. Congress 

explicitly recognized and treated venture capital funds as a subset of private equity funds 

in various parts of the Dodd-Frank Act and accorded distinct treatment for venture capital 

fund advisers by exempting them from registration requirements under the Investment 

Advisers Act.2069 This indicates that Congress knew how to distinguish venture capital 

funds from other types of private equity funds when it desired to do so.2070 No such 

distinction appears in section 13 of the BHC Act. Because Congress chose to distinguish 

between private equity and venture capital in one part of the Dodd-Frank Act, but chose 

not to do so for purposes of section 13, the Agencies believe it is appropriate to follow 

this Congressional determination.

 

2067 See Occupy.

2068 See Sens. Merkley & Levin (Feb. 2012).

2069 See S. Rep. No. 111-176, at 71-3 (2010) (“S. Rep. No. 111-176”); H. Rep. No. 111-517, at 866 (2010) 

(“H. Rep. No. 111-517”). H. Rep. No. 111-517 contains the conference report accompanying the version 

of H.R. 4173 that was debated in conference. See S. Rep. No. 111-176, at 74 (“The Committee believes 

that venture capital funds, a subset of private investment funds specializing in long-term equity investment 

in small or start-up businesses, do not present the same risks as the large private funds whose advisers are 

required to register with the SEC under this title.”). Compare Restoring American Financial Stability Act 

of 2010, S. 3217, 111th Cong. § 408 (2010) (as passed by the Senate) with The Wall Street Reform and 

Consumer Protection Act of 2009, H.R. 4173, 111th Cong. (2009) (as passed by the House) (“H.R. 4173”) 

and Dodd-Frank Act (2010).

2070 But See Rep. Honda.
645

In addition to the language of the statute, it appears to the Agencies that the 

activities and risk profiles for banking entities regarding sponsorship of, and investment 

in, venture capital funds and private equity funds are not readily distinguishable. Many 

key structural and operational characteristics of venture capital funds are substantially 

similar to those of hedge funds and private equity funds, thereby making it difficult to 

define venture capital funds in a manner that would not provide banking entities with an 

opportunity to evade the restrictions of section 13 of the BHC Act. 

For instance, in addition to relying on the same exemptions under the Securities 

Act,2071 venture capital funds, private equity funds and hedge funds all rely on the 

exclusion in section 3(c)(1) or 3(c)(7) from the definition of investment company under 

the Investment Company Act. Moreover, like private equity funds, venture capital funds 

pool funds from multiple investors and invest those funds in interests of portfolio 

companies for the purpose of profiting from the resale of those interests. Indeed, funds 

that are called “venture capital funds” may invest in the very same entities and to the 

same extent as do funds that call themselves private equity funds. Venture capital funds, 

like private equity funds, also typically charge incentive compensation to fund investors 

based on the price appreciation achieved on the investments held by the fund and provide 

a return of principal plus gains at specific times during the limited life of the fund. Not 

including venture capital funds in the definition of covered fund, therefore, could allow 

banking entities, either directly or indirectly, to engage in the type of activities section 13 

was designed to address. 

 

2071 These funds all typically offer their shares on an unregistered basis in reliance on section 4(a)(2) of the 

Securities Act of 1933 or Regulation D thereunder. 
646

While the final rule does not provide a separate exclusion for venture capital 

funds from the definition of covered fund, the Agencies recognize that certain venture 

capital investments by banking entities provide capital and funding to nascent or earlystage companies and small businesses and also may provide these companies expertise 

and other services.2072 Other provisions of the final rule or the statute may facilitate, or at 

least not impede, other forms of investing that may provide the same or similar benefits. 

For example, in addition to permitting a banking entity to organize and offer a covered 

fund in section 13(d)(1)(G), section 13 of the BHC Act does not prohibit a banking 

entity, to the extent otherwise permitted under applicable law, from making a venture 

capital-style investment in a company or business so long as that investment is not 

through or in a covered fund, such as through a direct investment made pursuant to 

merchant banking authority2073 or through business development companies which are 

not covered funds and, like venture capital funds, often invest in small, early-stage 

companies.2074 

Thus, to the extent that banking entities are required to reduce their investments in 

venture capital funds, certain of these investments may be redirected to the types of 

 

2072 As noted above, some commenters quantified the importance of banking entities to the provision of 

venture capital by providing information indicating that approximately 7 percent of all venture capital is 

provided by banks. See, e.g., SVB (citing The Venture Capital Industry: A Preqin Special Report,

published by Preqin, Ltd. (Oct. 2010)). The 7% estimate commenters identified includes information on 

investors based in North America, Europe, and Asia; thus, although potentially indicative of the extent of 

venture capital investing by banking entities in venture capital funds, the estimate does not specifically 

address the proportion of investment by banking entities in venture capital funds that are covered funds, as 

those terms are defined in the final rule.

2073 See 12 U.S.C. 1843(k)(4)(H); 12 CFR 225.170 et seq.

2074 See 15 U.S.C. 80a-54. Companies that have elected to be treated as a business development company 

are subject to limits under the Investment Company Act, including: (i) limits on how much debt the 

business development company may incur; (ii) prohibitions on certain affiliated transactions; (iii) 

regulation and examination by the SEC; and (iv) registration and filing requirements.
647

entities in which venture capital funds invest through alternative means. To the extent 

that banking entities may reduce their investments in venture capital funds that are 

covered funds, the potential funding gap for venture capital funds may also be offset, in 

whole or in part, by investments from firms that are not banking entities and thus not 

subject to section 13’s restrictions. 

6. Credit funds

Several commenters requested that the final rule explicitly exclude from the 

definition of covered fund entities that are generally formed as partnerships with thirdparty capital and invest in loans or make loans or otherwise extend the type of credit that 

banks are authorized to undertake on their own balance sheet (“credit funds”).2075 Two 

commenters contended that the language of section 13(g)(2) indicates that Congress did 

not intend section 13 of the BHC Act to limit a banking entity’s ability to extend 

credit.2076 They argued that lending is a fundamental banking activity, whether 

accomplished through direct loans or through a fund structure. These commenters argued 

that credit funds functioned like syndicated loans that enable borrowers to secure credit 

during periods of market distress and reduce the concentration of risk for both individual 

banking entities and the banking system as a whole.

Commenters suggested different approaches for excluding credit funds from the 

definition of covered fund. One commenter recommended excluding an entity that would 

 

2075 See, e.g., Goldman (Covered Funds); ABA (Keating); Credit Suisse (Williams); Comm. on Capital 

Markets Regulation; Chamber (Feb. 2012).

2076 See ABA (Keating); Goldman (Covered Funds).
648

otherwise be a covered fund if more than 50 percent of its assets consist of loans.2077 

Another commenter proposed defining a credit fund as an entity that met a number of 

criteria designed to ensure the entity only held loans or otherwise engaged in prudent 

lending activity.2078 Another commenter requested that the Agencies use their authority 

under section 13(d)(1)(J) to permit a banking entity to sponsor, invest in, or enter into 

covered transactions with related credit funds that are covered funds.2079

The Agencies, however, are unable effectively to distinguish credit funds from 

other types of private equity funds or hedge funds in a manner that would give effect to 

the language and purpose of section 13 and not raise concerns about banking entities 

being able to evade the requirements of section 13. Moreover, the Agencies also believe 

that the final rule largely addresses commenters’ concerns in other ways because some 

credit funds may be able to rely on another exclusion from the definition of covered fund 

in the final rule such as the exclusion for joint ventures or the exclusion, discussed above, 

for loan securitizations. To the extent that a credit fund may rely on another exclusion 

from the definition of covered fund, it would not be a covered fund under section 13 of 

the BHC Act. 

7. Employee securities companies

Several commenters argued that employee securities companies (“ESCs”) should 

be explicitly excluded from the definition of covered fund.2080 One commenter alleged 

 

2077 See Credit Suisse (Williams). 

2078 See Goldman (Covered Funds).

2079 See SIFMA et al. (Covered Funds) (Feb. 2012); See also. ABA (Keating); Chamber (Feb. 2012).

2080 See, e.g., ABA (Keating), Credit Suisse (Williams), Arnold & Porter (as it relates to commodity pools). 

Section 2(a)(13) of the Investment Company Act generally defines an ESC as “any investment company or 
649

that, though many ESCs could qualify for the exemption in section 6(b) of the Investment 

Company Act, they often opt to rely on section 3(c)(1) or 3(c)(7) instead due to the fact 

that the section 6(b) exemption is available only upon application to the SEC.2081 

According to this commenter, the limitations contained in section 13 on employee 

investments and intercompany transactions with covered funds would severely limit the 

ability of a banking entity to design competitive employee compensation 

arrangements.2082 This commenter also argued that an exclusion should be provided for 

any investment vehicle that satisfies the definition of an ESC under section 2(a)(13) of 

the Investment Company Act.

After considering carefully the comments received on the proposed rule, the final 

rule does not provide a specific exclusion for ESCs because the Agencies believe that 

these vehicles may avoid being a covered fund by either complying with the conditions of 

another exclusion from the definition of covered fund or seeking and receiving an 

exemption available under section 6(b) of the Investment Company Act. As such, the 

Agencies believe a banking entity has a reasonable alternative to design competitive 

employee compensation arrangements. The Agencies recognize that preparing an 

application under section 6(b) of the Investment Company Act or modifying an ESC’s 

activities to meet the terms of another exclusion from the covered fund definition is not 

without costs, but have determined to provide specific exclusions for entities that do not 

 

similar issuer all of the outstanding securities of which (other than short-term paper) are beneficially 

owned” by employees and certain related persons (e.g., employees’ immediate family members). 

2081 Section 6(b) of the Investment Company Act provides, in part, that “[u]pon application by any 

employees' security company, the Commission shall by order exempt such company from the provisions of 

this title and of the rules and regulations hereunder, if and to the extent that such exemption is consistent 

with the protection of investors.”

2082 See Credit Suisse (Williams).
650

function as investment funds, consistent with the purpose of section 13, or in response to 

other unique considerations (e.g., to provide consistent treatment for certain foreign and 

domestic pension plans). These considerations do not support a separate exclusion for 

ESCs.

The Agencies also note that non-qualified plans are not exempt from the 

Investment Company Act under 3(c)(11) and thus would be covered funds if they are 

operating in reliance on section 3(c)(1) or 3(c)(7) of the Investment Company Act. Some 

of these non-qualified plans may be formed as employees’ securities companies, 

however, and could qualify for an exemption under section 6(b) of the Investment 

Company Act for employees’ securities companies as discussed above. 

e. Definition of “Ownership Interest”

The proposed rule defined “ownership interest” in a covered fund to mean any 

equity, partnership, or other similar interest (including, without limitation, a share, equity 

security, warrant, option, general partnership interest, limited partnership interest, 

membership interest, trust certificate, or other similar instrument) in a covered fund, 

whether voting or nonvoting, as well as any derivative of such an interest.2083 This 

definition focused on the attributes of the interest and whether it provided a banking 

entity with economic exposure to the profits and losses of the covered fund, rather than 

its form. The proposal thus would also have included a debt security or other interest in a 

covered fund as an ownership interest if it exhibited substantially the same characteristics 

as an equity or other ownership interest (e.g., provides the holder with voting rights, the 

 

2083 See proposed rule § __.10(b)(3). 
651

right or ability to share in the covered fund’s profits or losses, or the ability, directly or 

pursuant to a contract or synthetic interest, to earn a return based on the performance of 

the fund’s underlying holdings or investments).2084 As described further below, the 

proposed rule excluded carried interest (termed “restricted profit interest” in the final 

rule) from the definition of ownership interest.

Many commenters argued that the proposed definition of ownership interest was 

too broad and urged excluding one or more types of interests from the definition. A 

number of commenters raised concerns regarding the difficulty of applying the ownership 

interest definition to securitization structures and questioned whether the definition of 

ownership interest might apply to a debt security issued by, or a debt interest in, a 

covered fund that has some characteristics similar to an equity or other ownership 

interest.2085 One commenter argued that the ownership interest definition should not 

include debt instruments with equity features unless the Agencies determine with respect 

to a particular debt instrument, after appropriate notice and opportunity for hearing, that 

the equity features are so pervasive that the debt instrument is the functional equivalent of 

an equity interest or partnership interest and was structured to evade the prohibitions and 

 

2084 See Joint Proposal, 76 FR at 68,897.

2085 See AFME et al.; AFR et al. (Feb. 2012); ASF (Feb. 2012); BoA; Cadwalader (Municipal Securities); 

Credit Suisse (Williams); Deutsche Bank (Repackaging Transactions); Occupy; RBC; SIFMA et al.

(Covered Funds) (Feb. 2012); SIFMA (Securitization) (Feb. 2012); TCW. For example, securitization 

structures generally provide that either the most senior or the most junior tranche notes have controlling 

voting rights. One commenter argued that under the proposed ownership interest definition, a banking 

entity could be deemed to have an ownership interest in an entity it does not own or sponsor simply due to 

its obtaining voting rights. See ASF (Feb. 2012). As a further example, one commenter alleged that 

securitization structures generally are not viewed as providing economic exposure to the profits and losses 

of the issuer in the same manner as equity interests in hedge funds and private equity funds. This 

commenter argued that the ownership interest definition should include only those interests that permit the 

banking entity to share without limit in the profits and losses or that earn a return that is based on the 

performance of the underlying assets. See SIFMA (Securitization) (Feb. 2012).
652

restrictions in the proposal.2086 Several commenters argued that the Agencies should 

explicitly exclude certain debt instruments with equity features from the ownership 

interest definition.2087 Finally, certain commenters argued that, because the application 

of the ownership interest definition to securitization structures was problematic, 

alternative regulatory treatment was appropriate.2088

One commenter expressed concern over the proposal’s inclusion of “derivatives” 

of ownership interests in the definition of ownership interest and recommended certain 

derivative interests of ownership interests in hedge funds and private equity funds not be 

included within the definition of ownership interest.2089 This commenter also 

 

2086 See SIFMA et al. (Covered Funds) (Feb. 2012).

2087 See AFME et al.; ASF (Feb. 2012); BoA; Cadwalader (Municipal Securities); RBC; SIFMA 

(Securitization) (Feb. 2012). These commenters argued that the ownership interest definition should not 

include tender option bond programs and other debt asset-backed securities. Two of these commenters 

argued that debt asset-backed securities should not be viewed as ownership interests because: (i) they are 

not typically viewed as having economic exposure to profits and losses of an ABS Issuer; (ii) they have a 

limited life, periodic fixed or fluctuating cumulative payments, and are senior to equity of the issuer should 

the issuer fail; (iii) they do not have perpetual life with broad voting rights, appreciation in the market value 

of the issuer and non-cumulative dividends, and subordination to the claims of debt holders if the issuer 

fails; and (iv) their limited voting rights (such as the rights to replace a servicer or manager) and such rights 

are protective in nature and similar to voting rights that accompany securities traditionally classified by the 

Agencies as debt securities (including securities formally structured as equity). See AFME et al.; SIFMA 

(Securitization) (Feb. 2012). One of these commenters argued that the ownership interest definition should 

be limited to those interests that share in the profits or losses of the relevant entity on an unlimited basis or 

that otherwise earn a return that is specifically based upon the performance of the underlying assets because 

the senior tranche in an asset-based securities transaction often has substantial voting rights and banking 

entities should not be penalized for requiring or otherwise obtaining voting rights that protect their 

interests. This commenter also expressed the view that banking entities should not be restricted from 

owning debt classes of new asset-backed securities because “doing so would substantially constrict the 

market for asset-backed securities.” See ASF (Feb. 2012).

2088 See AFR et al. (Feb. 2012); Credit Suisse (Williams); Occupy. One of these commenters argued that 

any general statement about what instruments would be considered an “ownership interest” for purposes of 

securitization structures would be problematic and easy to evade because transaction documents underlying 

securitization structures are not standardized. This commenter suggested as an alternative using a safe 

harbor for standardized, pre-specified securitization structures. See AFR et al. (Feb. 2012). Another of 

these commenters argued that “it is difficult to characterize holders of ABS securities in most securitization 

structures as having ‘ownership interests’ in any common understanding of the term” and the concept of 

ownership interest is a “poor fit for the securitization market, underscoring the benefits of excluding 

securitization issuers from the definition of covered fund entirely.” See Credit Suisse (Williams).

2089 See Credit Suisse (Williams).
653

recommended that the Agencies expressly exclude from the definition of ownership 

interest lending arrangements with a covered fund that contain protective covenants 

linking the interest rate on the loan to the profits of the borrowing fund.2090 

As discussed in detail below, the Agencies are adopting the definition of 

“ownership interest” largely as proposed but clarifying the scope of that definition, 

including with respect to the inclusion of interests that are linked to profits and losses of a 

covered fund and the exclusion for a restricted profit interest in a covered fund.2091 The 

definition is centered on equity interests, partnership interests, membership interests, trust 

certificates, and similar interests, and would not generally cover typical extensions of 

credit the terms of which provide for payment of stated principal and interest calculated 

at a fixed rate or at a floating rate based on an index or interbank rate. However, as under 

the proposal, to the extent that a debt security or other interest in a covered fund exhibits 

specified characteristics that are similar to those of equity or other ownership interests 

(e.g., provides the holder with the ability to participate in the election or removal of a 

party with investment discretion, the right or ability to share in the covered fund’s profits 

or losses, or the ability, directly or pursuant to a contract or synthetic interest, to earn a 

return based on the performance of the fund’s underlying holdings or investments), the 

instrument would be an ownership interest under the final rule. 

 

2090 See Credit Suisse (Williams) (arguing that such arrangements are a fundamental part of a bank’s 

lending activities).

2091 See final rule § __.10(d)(6 ). The concept of a restricted profit share was referred to as “carried 

interest” in the proposed rule, a term that is often used as a generic reference to performance-based 

allocations or compensation. The Agencies have instead used the term “restricted profit interest” in the 

final rule to avoid any confusion that could result from using a term that is also used in other contexts. The 

final rule focuses only on whether a profit interest is excluded from the definition of ownership interest 

under section 13, and the final rule does not address in any way the treatment of such profit interests under 

other laws, including under Federal income tax law. 
654

In response to commenters and in order to provide clarity about the types of 

interests that would be considered within the scope of ownership interest, the Agencies 

have revised the definition of “ownership interest” to define the term more clearly. The 

Agencies are not explicitly excluding or including debt securities, instruments or interests 

with equity features as requested by some commenters, but are instead identifying certain 

specific characteristics that would cause a particular interest, regardless of the name or 

legal form of that interest, to be included within the definition of ownership interest. The 

Agencies believe that this elaboration on the characteristics of an ownership interest will 

enable parties, including securitization structures, to more easily analyze whether their 

interest is an ownership interest, regardless of the type of legal entity or the name of the 

particular interest. 

As adopted, the final rule provides that an ownership interest would be any 

interest in or security issued by a covered fund that exhibits any of the following features 

or characteristics on a current, future, or contingent basis:2092

• has the right to participate in the selection or removal of a general partner, 

managing member, member of the board of directors or trustees, investment 

manager, investment adviser, or commodity trading advisor of the covered fund. 

For purposes of the rule, this would not include the rights of a creditor to exercise 

remedies upon the occurrence of an event of default or similar rights arising due 

to an acceleration event;

 

2092 Each of these factors are designed to clarify the interests identified in the proposed definition of 

ownership interest as noted above. 
655

• has the right under the terms of the interest to receive a share of the income, gains 

or profits of the covered fund. This would apply regardless of whether the right is 

pro rata with other owners or holders of interests;2093

• has the right to receive the underlying assets of the covered fund, after all other 

interests have been redeemed and/or paid in full (commonly known as the 

“residual” in securitizations). For purposes of the rule, this would not include the 

rights of a creditor to exercise remedies upon the occurrence of an event of default 

or similar rights arising due to an acceleration event; 

• has the right to receive all or a portion of excess spread (the positive difference, if 

any, between the aggregate interest payments received from the underlying assets 

of the covered fund and the aggregate interest paid to the holders of other 

outstanding interests);2094

• provides that the amounts payable by the covered fund with respect to the interest 

could, under the terms of the interest, be reduced based on losses arising from the 

underlying assets of the covered fund, such as allocation of losses, write-downs or 

charge-offs of the outstanding principal balance, or reductions in the amount of 

interest due and payable on the interest;2095

 

2093 This characteristic exists for both multi-class and single-class covered funds. In the context of an 

entity that issues shares, this right could cover, for example, common shares, as well as preferred shares the 

dividend payments of which are determined by reference to the performance of the covered fund.

2094 The reference to “all or a portion of excess spread” is meant to include within the definition of 

ownership interest the right to receive any excess spread which remains after the excess spread is used to 

pay expenses, maintain credit enhancement such as overcollateralization or is otherwise reduced.

2095 This characteristic does not refer to any reduction in the stated claim to principal or interest of a holder 

of an interest that occurs either as a result of a bona fide subsequent renegotiation of the terms of an interest 

or as a result of a bankruptcy, insolvency, or similar proceeding. 
656

• receives income on a pass-through basis from the covered fund, or has a rate of 

return that is determined by reference to the performance of the underlying assets 

of the covered fund.2096 This provision would not include an interest that is 

entitled to receive dividend amounts calculated at a fixed or at a floating rate 

based on an index or interbank rate such as LIBOR; or 

• any synthetic right to have, receive or be allocated any of the rights above. This 

provision would not permit banking entities to obtain synthetic or derivative 

exposure to any of the characteristics identified above in order to avoid being 

considered to have an ownership interest in the covered fund.

This definition of “ownership interest” is intended to address commenters’ 

concerns regarding the applicability of the ownership interest definition to different types 

of interests. The Agencies believe defining “ownership interest” in this way will allow 

existing as well as potential holders of interests in covered funds, including 

securitizations, to effectively determine whether they have an ownership interest. As an 

example, this definition would include preferred stock, as well as a lending arrangement 

with a covered fund in which the interest or other payments are calculated by reference to 

the profits of the fund. As a contrasting example, the Agencies believe that a loan that 

provides for a step-up in interest rate margin when a covered fund has fallen below or 

breached a NAV trigger or other negotiated covenant would not generally be an 

ownership interest. Banking entities will be expected to evaluate the specific terms of 

their interests to determine whether any of the specified characteristics exist. In this 

 

2096 This provision is not intended to encompass derivative transactions entered into in connection with 

typical prime brokerage activities of banking entities. However, the activities of banking entities are 

subject to the anti-evasion provisions.
657

manner, the Agencies believe that the definition of ownership interest in the final rule is 

clearer than under the proposal and thus should be less burdensome for banking entities 

in their determination of whether certain rights would cause an interest to be an 

ownership interest for purposes of compliance with the rule.

As indicated above, many commenters on securitizations under the proposed rule 

made arguments regarding the difficulty of applying the proposal’s definition of 

ownership interest to securitization structures, contending that the definition should not 

include debt instruments with equity features, or that the final rule should provide a safe 

harbor under which the use of a standardized, pre-specified securitization structure would 

not give rise to an ownership interest.2097 The Agencies are not adopting a separate 

definition of ownership interest for securitization transactions, providing for differing 

treatment of financial instruments, or providing a safe harbor as requested by some 

commenters. The revised definition of ownership interest will apply regardless of the 

type of legal entity or the name or legal form of the particular interest. The determination 

of whether an interest is an ownership interest under the final rule will depend on the 

features and characteristics of the particular interest, including the rights the particular 

interest provides its holder, including not only voting rights but also the right to receive a 

share of the income, gains, or profits of a covered fund, the right to receive a residual, the 

right to receive excess spread, and any synthetic or derivative that would provide similar 

rights. While some commenters argued that securities issued in asset-backed securities 

transactions and by tender option bond issuers should not be viewed as ownership 

interests due to the nature of the securities issued or the possible lack of exposure to 

 

2097 See supra note 2085.
658

profits and losses,2098 the Agencies do not believe that the type of covered fund involved 

or the type of security issued is an appropriate basis for determining whether there is an 

ownership interest for purposes of the restrictions contained in section 13(a)(1)(B) of the 

BHC Act. The Agencies believe that making distinctions in the definition of ownership 

interest based on the type of entity or the type of security, in which many of the same 

rights exist as for other types of ownership interests, would not be consistent with the 

statutory restrictions on ownership. Similarly, while some commenters argued that 

including a safe harbor for standardized securitization structures would be more effective 

in identifying an ownership interest in securitizations, the Agencies believe that the type 

of interest and the rights associated with the interest are more appropriate to determine 

whether an interest is an ownership interest and is necessary to avoid potential evasion of 

the ownership restrictions contained in section 13 of the BHC Act. 

The Agencies understand that the definition of ownership interest in the final rule 

may include interests in a covered fund that might not be considered an ownership 

interest or equity interest in other contexts. For instance, it may include loans with an 

interest rate determined by reference to the performance of a covered fund or senior debt 

interests issued in a securitization. While the definition of ownership interest may affect 

the ability of a banking entity to hold such interests, whether existing or in the future, the 

Agencies believe that the definition of ownership interest as adopted in the final rule is 

more effective in preventing possible evasion of section 13 by capturing interests that 

may be characterized as debt but confer benefits of ownership, including voting rights 

and/or the ability to participate in profits or losses of the covered fund.

 

2098 See supra note 2087.
659

The definition of ownership interest in the final rule, like the proposed rule, 

includes derivatives of the interests described above. Derivatives of ownership interests 

provide holders with economic exposure to the profits and losses of the covered fund or 

an ability to earn a return based on the performance of the fund’s underlying holdings or 

investments in a manner substantially similar to an ownership interest. The Agencies 

believe the final rule’s approach appropriately addresses the statutory purpose to limit a 

banking entity’s economic exposure to covered funds, irrespective of the legal form, 

name, or issuer of that ownership interest.

As noted above, the proposed definition of ownership interest did not include 

carried interest (termed “restricted profit interest” in the final rule). The proposal 

recognized that many banking entities that serve as investment adviser or provide other 

services to a covered fund are routinely compensated for services they provide to the fund 

through receipt of carried interest. As a result, the proposed rule provided that an 

ownership interest with respect to a covered fund did not include an interest held by a 

banking entity (or an affiliate, subsidiary or employee thereof) in a covered fund for 

which the banking entity (or an affiliate, subsidiary or employee thereof) served as 

investment manager, investment adviser, or commodity trading advisor, so long as certain 

enumerated conditions were met.2099

The enumerated conditions contained in the proposal were designed to narrow the 

scope of the exclusion of carried interest from the definition of “ownership interest” so as 

to distinguish between an investor’s economic risks and a service provider’s 

performance-based compensation. This was designed to limit the ability of a banking 

 

2099 See proposed rule § __.10(b)(3)(ii). 
660

entity to structure carried interest in a manner that would evade section 13’s restriction on 

the amount of ownership interests a banking entity may have as an investment in a 

covered fund.

Commenters disagreed over whether the definition of ownership interest should 

exclude carried interest. For instance, some commenters did not support excluding 

carried interest from the definition of ownership interest, arguing that such an exclusion 

was too permissive and inconsistent with the statute because, for instance, carried interest 

derives its value in part by tracking gains on price movements of investments by the 

fund.2100 One commenter argued that, despite the fact that carried interest is typically 

provided as compensation for services provided to a fund, carried interest is a form of 

investment and therefore should be included as an ownership interest.2101 Another 

commenter argued that permitting banking entities to hold an unrestricted amount of 

carried interest could create an indirect and undesirable link between prohibited 

proprietary trading and covered fund activities.2102 These commenters also argued that 

treating carried interest as compensation for providing services would be inconsistent 

with the manner in which carried interest is treated for tax purposes.2103

Other commenters, however, supported excluding carried interest from the 

definition of an ownership interest and argued the exclusion was consistent with the 

words and purpose of section 13.2104 One commenter argued that carried interest is 

 

2100 See, e.g., Occupy; AFR et al. (Feb. 2012).

2101 See Public Citizens; See also Occupy.

2102 See AFR et al. (Feb. 2012).

2103 See Occupy; Public Citizens; AFR et al. (Feb. 2012).

2104 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); TCW; Credit Suisse (Williams); SVB.
661

readily distinguished from an investment in a covered fund because carried interest 

normally does not expose a banking entity to a covered fund’s losses (other than in 

limited instances such as when a “clawback” provision is triggered).2105 Another 

commenter argued that permitting a banking entity to receive carried interest without 

being subject to the requirements of section 13 regarding ownership interests better aligns 

the interest of the investment manager with that of the fund and its investors.2106 Another 

commenter supported expanding the definition of carried interest to include an interest 

received by a banking entity in return for qualifying services (e.g., lending, placement, 

distribution, or equity financing) provided to the investment manager of the fund, but not 

directly provided to the fund itself.2107

The proposal established four criteria that must be met in order for carried interest 

to be excluded from the definition of ownership interest. First, the proposal required that 

carried interest have the sole purpose and effect of permitting the banking entity or an 

employee thereof to share in the covered fund’s profits as performance compensation for 

services provided to the fund. While most commenters did not object to this criterion, 

one commenter argued that the wording of this approach would appear to prohibit an 

employee of the banking entity from retaining a carried interest after the employee has 

changed employment.2108 This commenter argued that the determination of the carried 

interest’s purpose should be made only at the time the interest is granted, thereby 

enabling an employee to retain the carried interest if and when the employee no longer 

 

2105 See Credit Suisse (Williams).

2106 See TCW.

2107 See Credit Suisse (Williams).

2108 See TCW. 
662

provides investment management, investment advisory, or similar services to the fund or 

is no longer employed at the banking entity. 

Second, the proposal required that carried interest, once allocated, be distributed 

to the banking entity promptly after it is earned or, if not so distributed, not share in the 

subsequent profits and losses of the covered fund. One commenter urged the Agencies to 

allow the “reserve” portion of carried interest that for tax purposes is allocated to the 

investment manager or investment adviser, but invested alongside the fund and not 

formally allocated or distributed by the fund, also to qualify for the exclusion as carried 

interest.2109 This commenter also suggested that this criterion should not affect the

common European structure in which allocated carried interest may share in the 

subsequent losses, but not the profits, of the fund. 

Third, under the proposal a banking entity (including its affiliates or employees) 

was not permitted to provide funds to the covered fund in connection with receiving a 

carried interest. The proposal specifically requested comment on whether the exemption 

for carried interest, including this requirement, was consistent with the current tax 

treatment and requirements of carried interest arrangements.2110 Commenters urged the 

Agencies to relax or amend this criterion so that banking entities, including their affiliates 

and employees, whether directly or indirectly through a fund vehicle, would be permitted 

to make minimal capital contributions to the fund (typically less than 1 percent) in 

connection with the receipt of carried interest to the extent that such contributions 

 

2109 See Credit Suisse (Williams). 

2110 Joint Proposal, 76 FR at 68,899. 
663

provide the basis for treating the interest as carried interest for tax purposes.2111 

However, these commenters supported the proposal’s requirement that any amount 

contributed by a banking entity in connection with receiving a carried interest should be 

aggregated with the banking entity’s ownership interests for purposes of the 3 percent 

investment limits. 

Fourth, the proposal provided that carried interest may not be transferable by the 

banking entity (or the affiliate, subsidiary or employee thereof) except to another affiliate 

or subsidiary of the banking entity. Commenters generally urged removing the 

proposal’s limitations on transferability and argued, among other things, that this 

criterion could prevent a banking entity (or its affiliate or employee) from transferring the 

carried interest in connection with selling or otherwise transferring the provision of 

advisory or other services that gave rise to the carried interest.2112 Similarly, one 

commenter argued that the final rule should not require carried interest to be recharacterized as an ownership interest if it is transferred among employees, family

members of employees or to estate planning vehicles upon an employee’s death.2113 

After considering carefully comments received on the proposal, the Agencies 

have determined to retain in the final rule the exclusion from the definition of “ownership 

interest” for a restricted profit interest (termed “carried interest” in the proposed rule2114) 

largely as provided in the proposed rule. The final rule, like the proposal, recognizes that 

banking entities that serve as investment adviser or provide other services to a covered 

 

2111 See TCW; SIFMA (Covered Funds) (Feb. 2012); Credit Suisse (Williams). 

2112 See ASF (Feb. 2012); See also Credit Suisse (Williams); SVB. 

2113 See TCW.

2114 See supra note 2091 and accompanying text. 
664

fund are routinely compensated for such services through receipt of a restricted profit 

interest. The final rule, also like the proposal, generally excludes restricted profit interest 

from the definition of ownership interest subject to conditions designed to distinguish 

restricted profit interest, which serves as a form of compensation, from an investment in 

the fund prohibited (or limited) by section 13. As explained in detail below, the 

definition of restricted profit interest in the final rule has been modified from the proposal 

in several aspects to respond to commenters’ concerns and to more effectively capture the 

types of compensation that is often granted in exchange for services provided to a fund. 

However, like the proposal, the final rule continues to contain a number of requirements 

designed to ensure that restricted profit interest functions as compensation for providing 

certain services to a covered fund and does not permit a banking entity to evade the 

investment limitations or other requirements of section 13. 

Under the final rule, restricted profit interest is defined to include an interest held 

by an entity (or employee or former employee thereof) that serves as investment 

manager, investment adviser, commodity trading advisor, or other service provider so 

long as: 

(i) the sole purpose and effect of the interest is to allow the entity (or an 

employee or former employee thereof) to share in the profits of the covered 

fund as performance compensation for the investment management, 

investment advisory, commodity trading advisory, or other services provided 

to the covered fund by the entity (or employee or former employee thereof), 

provided that the entity (or employee or former employee thereof) may be 

obligated under the terms of such interest to return profits previously received;

(ii) all such profit, once allocated, is distributed to the entity (or employee or 

former employee thereof) promptly after being earned or, if not so distributed, 

is retained by the covered fund for the sole purpose of establishing a reserve 

amount to satisfy contractual obligations with respect to subsequent losses of 

the covered fund and such undistributed profit of the entity (or employee or 
665

former employee thereof) does not share in subsequent investment gains of 

the covered fund;

(iii)any amounts invested in the covered fund, including any amounts paid by the 

entity (or employee or former employee thereof) in connection with obtaining 

the restricted profit interest, are within the investment limitations of § __.12; 

and

(iv)the interest is not transferable by the entity (or employee or former employee 

thereof) except to an affiliate thereof (or an employee of the banking entity or 

affiliate), to immediate family members, or through the intestacy of the 

employee or former employee, or in connection with a sale of the business 

that gave rise to the restricted profit interest by the entity (or employee or 

former employee thereof) to an unaffiliated party that provides investment 

management, investment advisory, commodity trading advisory, or other 

services to the fund.2115

The final rule, like the proposal, permits any entity (or the affiliate or employee thereof) 

to receive or hold restricted profit interest if the entity (or the affiliate or employee 

thereof) serves as investment manager, investment adviser, commodity trading advisor, 

or other service provider to the covered fund. For example, an entity that provides 

services to the covered fund in a capacity as sub-adviser or placement agent would be 

eligible to receive or hold restricted profit interest. 

As requested by commenters, the first condition in the final rule, in contrast to the 

proposal, permits an employee or former employee to retain a restricted profit interest 

after a change in employment status so long as the restricted profit interest was originally 

received as compensation for qualifying services provided to the covered fund. 

Also in response to issues raised by commenters, the second condition in the final 

rule has been modified to permit so-called “clawback” features whereby restricted profit 

interest that has been provided to an investment manager, investment adviser, commodity 

 

2115 See final rule § __.10(d)(6)(ii).
666

trading advisor, or similar service provider may be taken back if certain subsequent 

events occur, such as if the fund fails to achieve a specified preferred rate of return or if 

liabilities or subsequent losses are incurred by the fund. Under these circumstances, the 

Agencies believe it is appropriate to allow the allocated but undistributed profits to be 

clawed back from the service provider’s performance compensation, and the final rule 

has been amended to allow this practice. The final rule makes clear, however, that the 

undistributed profits may only be held in the fund in connection with such a clawback 

arrangement. Undistributed profits that remain in the covered fund after they have been 

allocated without connection to such an arrangement would be deemed to be an 

investment in the fund and would be an ownership interest under the final rule. 

Importantly, the final rule also retains the limitation in the proposal that undistributed 

profit may not share in subsequent investment gains of the covered fund. This limitation 

(together with the limited circumstances under which the undistributed profit may be 

retained in the fund) appears necessary in order to distinguish restricted profit interest, 

which functions as performance compensation and is not intended to be a form of 

investment, from an ownership interest, which is designed to be an investment. The 

Agencies believe that this approach achieves an appropriate balance between 

accommodating receipt of restricted profit interest, including such amounts held in 

“reserve,”2116 and limiting the ability of a banking entity to evade the investment 

limitations of section 13. The Agencies expect to review restricted profit interests to 

 

2116 The Agencies believe that this addresses a commenter’s concern regarding the “reserve” portion of 

carried interest discussed above; however such amounts may not share in subsequent investment gains of 

the covered fund for the reasons also discussed above.
667

ensure banking entities do not use the exclusion for restricted profit interest in a manner 

that functions as an evasion of section 13.

As noted above, the Agencies understand that entities that provide investment 

management, investment advisory, commodity trading advisory or other services to a 

covered fund may, in connection with receiving restricted profit interest, be required to 

hold a small amount of ownership interests in a fund to provide the basis for desired tax 

treatment of restricted profit interest. Accordingly, the third condition of the final rule 

allows an entity that provides qualifying services to a fund to contribute funds to, and 

have an ownership interest in, the fund in connection with receiving restricted profit 

interest. As under the proposal, the amount of the contribution must be counted toward 

the investment limits under section 13(d)(4) and § __.12 of the final rule. This would 

include attribution to the banking entity of sums invested by employees in connection 

with obtaining a restricted profit interest. Thus, the final rule permits a banking entity 

that provides investment management, investment advisory, or commodity trading 

advisory services to have both an ownership interest in, and receive restricted profit 

interest from, the covered fund, so long as the aggregate of the sums invested in all 

ownership interests acquired or retained by the banking entity (including a general 

partnership interest), either in connection with receiving the restricted profit interest or as 

an investment, are within the investment limitations in section 13(d)(4) and § __.12 of the 

final rule. The Agencies believe this more appropriately implements the requirements of 

section 13 of the BHC Act by permitting banking entities to continue to provide 

customer-driven investment management services through organizing and offering 

covered funds, while also abiding by the investment limitations of section 13.
668

In response to comments, the fourth condition of the final rule permits the transfer 

of a restricted profit interest in connection with a sale to an unaffiliated party that 

provides investment management, investment advisory, commodity trading advisory, or 

other services to the fund. In response to comments, the final rule also permits the 

transfer of a restricted profit interest to immediate family members of the banking 

entity’s employees or former employees that provide investment management, 

investment advisory, commodity trading advisory, or other services to the covered fund, 

or in connection with the death of such employee. Also in response to comments, the 

final rule permits the transfer of a restricted profit interest to an affiliate or employee that 

provides investment management, investment advisory, commodity trading advisory, or 

other services to the covered fund. However, the final rule, like the proposed rule, would 

treat a restricted profit interest as an ownership interest if the restricted profit interest is 

otherwise transferable. This remaining restriction recognizes that a freely transferable 

restricted profit interest has the same economic benefits as an ownership interest and is 

essential to differentiating a restricted profit interest from an ownership interest. 

f. Definition of “Resident of the United States”

Section 13(d)(1)(I) of the BHC Act provides that a foreign banking entity may 

acquire or retain an ownership interest in or act as sponsor to a covered fund, but only if 

that activity is conducted according to the requirements of the statute, including that no 

ownership interest in the covered fund is offered for sale or sold to a “resident of the 

United States.” The statute does not define this term. 

Under the proposed rule, the term “resident of the United States” was used in the 

context of the exemptions for covered trading and covered fund activities. As proposed, 
669

the definition of resident of the United States was similar, but not identical, to the SEC’s 

definition of U.S. person in Regulation S, which governs offerings of securities outside of 

the United States.2117 The Agencies proposed this approach in order to promote 

consistency and understanding among market participants that have experience with the 

concept from the SEC’s Regulation S.

Some commenters supported the proposed definition of resident of the United 

States.2118 One commenter suggested that the proposed rule defined resident of the 

United States too broadly and inappropriately precluded investments in U.S. funds by 

foreign banking entities.2119

Other commenters generally argued that the final rule should adopt the definition 

of “U.S. person” under the SEC’s Regulation S without the modifications in the proposed 

rule.2120 According to many commenters, market participants are familiar with and rely 

upon the body of law interpreting U.S. Person under Regulation S.2121 They argued that, 

to the extent that the definitions of “resident of the United States” under section 13 and 

“U.S. person” under Regulation S differ, this would create unnecessary uncertainty and 

increase compliance burdens associated with monitoring multiple definitions.2122 Other 

commenters urged the Agencies not to depart from the treatment of international parties 

 

2117 See proposed rule § __.2(t); 17 CFR 230.901 – 230.905.

2118 See, e.g., Occupy.

2119 See Sens. Merkley & Levin (Feb. 2012) (citing 156 Cong. Rec. S5897 (daily ed. July 15, 2010) 

(statement of Sen. Merkley)).

2120 See, e.g., Union Asset; EFAMA; BVI; AFME et al.; IIB/EBF; Credit Suisse (Williams); Hong Kong 

Inv. Funds Ass’n.; PEGCC; UBS; Allen & Overy (on behalf of Canadian Banks); Allen & Overy (on 

behalf of Foreign Bank Group); AFG.

2121 See PEGCC; Allen & Overy (on behalf of Canadian Banks); Allen & Overy (on behalf of Foreign 

Bank Group); ICI (Feb. 2012); Credit Suisse (Williams).

2122 See IIB/EBF; Credit Suisse (Williams); ICI (Feb. 2012); ICI Global; PEGCC.
670

and organizations (e.g., the International Monetary Fund and the World Bank) under the 

SEC’s Regulation S.2123

Many commenters contended that, because the definition of resident of the United 

States in the proposal was generally broader than the definition of U.S. person under 

Regulation S, many additional types of persons, entities and investors would be deemed 

residents of the United States for purposes of the foreign activity exemptions. 

Commenters argued that this would limit the potential for foreign banking entities to 

effectively use those statutorily provided exemptions. A few commenters noted that 

using a definition in the foreign fund exemption that differs from the definition in 

Regulation S loses the advantage of using a term that is already understood by market 

participants and that avoids confusion and limits compliance costs.2124

Other commenters suggested that defining resident of the United States as 

proposed presented problems for investment funds managed by U.S. investment advisers, 

even those without U.S. investors.2125 Some commenters argued that, under the proposed 

definition, a foreign fund managed by a U.S. investment adviser or sub-adviser that is not 

otherwise subject to section 13 might be deemed a resident of the United States, thereby 

disqualifying the fund from relying on the foreign funds exemption, a result inconsistent 

with the purpose of section 13 and the statutory exemption in section 13(d)(1)(I).2126

 

2123 See IIB/EBF; ICI Global; Credit Suisse (Williams).

2124 See Allen & Overy (on behalf of Foreign Bank Group); IIB/EBF; PEGCC; Union Asset. 

2125 See, e.g., MFA; TCW.

2126 See AFG; BVI. See also MFA; TCW. Similarly, these commenters argued that although treated as a 

non-U.S. person under Regulation S, a non-U.S. fund organized as a trust in accordance with local law with

a limited number of U.S. investors would have been a resident of the United States. Under the proposal, 

this foreign fund could not invest in another foreign covered fund Seeking to rely on the exemption for 

covered fund activities or investments that occur solely outside of the United States.
671

Commenters also argued that the proposed definition raised issues for 

compensation plans of international organizations that are subject to section 13 of the 

BHC Act. Several commenters argued that U.S. employees of a foreign banking entity 

should not be considered residents of the United States if they invest in a non-U.S. 

covered fund pursuant to a bona fide employee investment, retirement or compensation 

program.2127 The Agencies have carefully considered the comments received on the 

definition of resident of the United States, and have determined to modify the final rule as 

discussed below. The term “resident of the United States” is not defined in the statute 

and is used by the statute to clarify when foreign activity or investment of a foreign 

banking entity qualifies for the foreign funds exemption in section 13(d)(1)(I). The 

purpose of this exemption is to enable foreign banking entities to continue to engage in 

foreign funds activities and investments that do not have a sufficient nexus to the United 

States so as to present risk to U.S. investors or the U.S. financial system.2128 The purpose 

of Regulation S is to provide a safe harbor from the registration provisions under the 

Securities Act for offerings that take place outside of the United States.2129

The Agencies believe that, because the covered funds provisions of the final rule 

involve sponsoring covered funds and offering and selling securities issued by funds (as 

compared to counterparty transactional relationships), the securities law framework 

reflected in Regulation S would most effectively achieve the purpose of the foreign funds 

exemption. As noted by commenters and discussed above, market participants are 

 

2127 See IIB/EBF; Credit Suisse (Williams); UBS; JPMC.

2128 See 156 Cong. Reg. S.5894-5895 (daily ed. July 15, 2010) (statement of Sen. Merkley).

2129 Offers and Sales, Securities Act Release No. 6863 (Apr. 24, 1990), 55 FR 18,306 (May 2, 1990).
672

familiar with and rely upon the body of law interpreting U.S. Person under Regulation S, 

and differing definitions under section 13 and Regulation S could create uncertainty and 

increase compliance burdens associated with monitoring multiple definitions. The 

Agencies therefore have defined the term “resident of the United States” in the final rule 

to mean a “U.S. person” as defined in Regulation S.2130 

In addition, as explained in detail below in Part IV.B.4.b.3. of this 

Supplementary Information, the final rule provides that an ownership interest is offered 

for sale or sold to a resident of the United States if it is sold in an offering that “targets” 

residents of the United States.2131 As explained in more detail in that section, this 

approach is consistent with Regulation S. 

g. Definition of “Sponsor”

Section 13(h)(5) of the BHC Act defines “sponsor” to mean: (i) serving as a 

general partner, managing member, or trustee of a covered fund; (ii) in any manner 

selecting or controlling (or to have employees, officers, or directors, or agents who 

constitute) a majority of the directors, trustees, or management of a covered fund; or (iii) 

sharing with a covered fund, for corporate, marketing, promotional, or other purposes, the 

same name or a variation of the same name.2132 Sponsor is a key definition because it 

defines, in part, the scope of activities to which the prohibition in section 13(a)(1) 

applies.2133

 

2130 See final rule § __.10(d)(8). 

2131 See infra Part IV.B.4.b.3.

2132 See 12 U.S.C. 1851(h)(5). 

2133 See 12 U.S.C. 1851(a)(1). 
673

Under the proposal, the term sponsor would have been defined largely as in the 

statute.2134 Nearly all commenters who addressed the definition of sponsor argued that 

the definition was too broad and suggested various ways to narrow or limit the 

definition.2135 Commenters generally expressed concerns that a sponsor to a covered 

fund became subject to the restrictions of section 13(f), limiting the relationships of the 

banking entity with the covered fund. Commenters argued this would prevent banking 

entities from providing many customary services to covered funds.2136 

The proposal excluded from the definition of “trustee” as used in the term sponsor 

a trustee that does not exercise investment discretion with respect to a covered fund, 

including a directed trustee, as that term is used in section 403(a)(1) of the Employee’s 

Retirement Income Security Act (“ERISA”) (29 U.S.C. 1103(a)(1)).2137 On the other 

hand, the proposal provided that any banking entity that directs a directed trustee, or that 

possesses authority and discretion to manage and control the assets of a covered fund for 

which a directed trustee serves as trustee, would be considered a trustee of the covered 

fund. 

Commenters generally supported the exception for directed trustees in the 

proposed rule but argued that the exception was too narrow because it only referred to 

directed trustees under section 403(a)(1) of the ERISA and did not include other similar 

 

2134 See proposed rule __.10(b)(5). 

2135 A number of comments received regarding the definition of sponsor relate to securitization structures 

and are addressed below. There also were a few comments urging that insurance companies not be 

considered to sponsor their separate accounts. See Sutherland (on behalf of Comm. of Annuity Insurers); 

Nationwide. The Agencies believe these concerns should be addressed by the exclusion of separate 

accounts from the definition of covered fund, as discussed in Part IV.B.1.c.6. of this Supplementary

Information. 

2136 See, e.g., ASF (Feb. 2012); BNY Mellon et al.; Credit Suisse (Williams).

2137 See proposed rule § __.10(b)(6); See also 29 U.S.C. 1103(a)(1). 
674

custodial or administrative arrangements that may not meet those requirements or be 

subject to ERISA.2138 These commenters argued that banking entities that serve as 

trustees or custodians of covered funds may provide a limited range of ministerial 

services or exercise limited fiduciary duties that, while not subject to ERISA or beyond 

those permitted for a directed trustee under ERISA, nevertheless do not involve the 

exercise of investment discretion or control over the operations of the covered fund in the 

same manner as a general partner or managing member. Some of these commenters 

advocated defining “directed trustee” more expansively to include any situation in which 

a banking entity serves solely in a directed, fiduciary, or administrative role where a 

third-party and not the banking entity exercises investment discretion. 

In particular, some commenters also argued that a trustee should not be viewed as 

having investment discretion, and therefore should not be treated as a sponsor, if it 

possesses only the authority to terminate an investment adviser to a covered fund and to 

appoint another unaffiliated investment adviser in order to fulfill a demonstrable legal or 

contractual obligation of the trustee, or the formal but unexercised power to make 

investment decisions for a covered fund in circumstances where one or more unaffiliated 

investment advisers have been appointed to manage fund assets. Some commenters 

argued in favor of excluding trustees serving under non-U.S. trust arrangements pursuant 

to which they may have legal or contractual authority to, but in fact do not, exercise 

investment discretion (i.e., the entity has the formal authority to appoint an investment 

 

2138 See, e.g., Arnold & Porter; Ass’n. of Global Custodians; BNY Mellon et al.; SIFMA et al. (Covered 

Funds) (Feb. 2012); State Street (Feb. 2012); See also Fin. Services Roundtable (June 14, 2011) 

(recommending the definition of directed trustee under the Board’s Regulation R be used, which defines 

directed trustee to mean “a trustee that does not exercise investment discretion with respect to the 

account”). 
675

adviser to a trust but does so only in extraordinary circumstances such as appointing a 

successor investment adviser).2139 

A few commenters requested confirmation that a banking entity acting as a 

custodian should not be considered a sponsor of a covered fund.2140 One commenter 

argued that traditional client trust accounts for which a bank serves as discretionary 

trustee should not, by implication, themselves become “covered funds” that are 

“sponsored” by the bank.2141 

One commenter argued that any person performing similar functions to a directed 

trustee (such as a fund management company established under Irish law), regardless of 

its formal title or position, also should be excluded if the person does not exercise 

investment discretion.2142 Some commenters argued more generally for an exclusion 

from the definition of trustee (and therefore from the definition of sponsor) for entities 

that act as service providers (such as custodians, trustees, or administrators) to non-U.S. 

regulated funds, arguing that European laws already impose significant obligations on 

entities serving in these roles.2143

Under both section 13 of the BHC Act and the proposal, the definition of sponsor 

also included the ability to select or control (or to have employees, officers, directors, or 

 

2139 See BNY Mellon et al. (providing proposed rule text or suggesting in the alternative clarification 

regarding the phrase “exercise investment discretion” in the final rule preamble); Ass’n. of Global 

Custodians; ICI Global; State Street (Feb. 2012).

2140 See Ass’n. of Global Custodians; SIFMA et al. (Covered Funds) (Feb. 2012); ABA (Keating); AFG; 

AFTI; BNY Mellon et al.; EFAMA; IMA; State Street (Feb. 2012). 

2141 See Arnold & Porter. To the extent that a client trust account would not be an investment company but 

for the exclusion contained in section 3(c)(1) or 3(c)(7) of the Investment Company Act, such as the 

exclusion for common trust funds under section 3(c)(3) of that Act, it would not be a covered fund 

regardless of whether a banking entity acts as trustee.

2142 See BNY Mellon et al.

2143 See EFAMA; F&C; IRSG; Union Asset.
676

agents who constitute) a majority of the directors, trustees or management of a covered 

fund. Some commenters argued that an entity should not be treated as a sponsor of a 

covered fund when it selects a majority of the initial directors, trustees or management of 

a covered fund that are independent of the banking entity, so long as the banking entity 

may not remove or replace the directors, trustees, or management and directors are 

subsequently either chosen by others or self-perpetuating.2144 One of these commenters 

argued similarly that a banking entity should not be deemed to sponsor a covered fund if 

it selects an independent general partner, managing member or trustee of a new fund, so 

long as the general partner, managing member or trustee may not be terminated and 

replaced by the banking entity.2145 Commenters argued that initial selection of these 

parties was inherently part of, and necessary to allow, the formation of a covered fund 

and would not provide a banking entity with ongoing control over the fund to a degree 

that the banking entity should be considered to be a sponsor.

The statute and proposed rule also defined the term sponsor to include an entity 

that shares, for corporate, marketing, promotional, or other purposes, the same name or a 

variation of the same name, with a covered fund. One commenter argued in favor of a 

narrower interpretation of this statutory provision.2146 This commenter argued that a 

covered fund should be permitted to share the name of the asset manager that advises the 

 

2144 See SIFMA et al. (Covered Funds) (Feb. 2012) (recommending the Agencies adopt independence 

guidelines similar to the FDIC’s guidelines for determining whether audit committee members of insured 

depository institutions are “independent” of management); Credit Suisse (Williams).

2145 See Credit Suisse (Williams) (arguing that such an approach would be consistent with the existing BHC 

Act concept of control with respect to funds).

2146 A number of comments were also received regarding the restriction on name sharing that is one of the 

requirements of section 13(d)(1)(G) and § __.11 of the proposed rule. These comments are discussed in 

Part IV.B.2.a.5. of this Supplementary Information. 
677

fund without the asset manager becoming a sponsor so long as the asset manager does not 

share the same name as an affiliated insured depository institution or the ultimate parent 

of an affiliated insured depository institution.2147 Another commenter argued that the

proposal would put U.S. banking entities at a competitive disadvantage relative to nonbanking entities and foreign banks.2148 These commenters argued that the costs of 

rebranding covered funds or an asset manager would far outweigh any potential benefit in

terms of reducing the risk that a banking entity may be pressured to “bail out” a covered 

fund with a name similar to its investment manager.2149 One commenter also requested 

clarification that the name sharing prohibition does not apply in the context of offering 

documents that carry the names of the manager, sponsor, distributor, as well as the name 

of the fund itself.2150 This commenter also advocated that, because of the costs 

associated with changing a fund name, the Agencies give specific guidance regarding 

how similar a name may be so as not to be a “variation of the same name” for purposes of 

the definition of sponsor and the activities permitted under section 13(d)(1)(G) and § 

__.11 of the rule.

The Agencies have carefully considered comments received in light of the terms 

of the statute. Section 13(h)(5) of the BHC Act specifically defines the term “sponsor” 

for purposes of section 13. The Agencies recognize that the broad definition of sponsor 

in the statute will result in some of the effects commenters identified, as discussed above. 

 

2147 See Credit Suisse (Williams); See also ABA (Keating); BlackRock; Goldman (Covered Funds); 

SIFMA et al. (Covered Funds) (Feb. 2012); TCW (proposing similarly to limit the name-sharing restriction 

to the insured depository institution in context of section 13(d)(1)(G)).

2148 See Goldman (Covered Funds).

2149 See Credit Suisse (Williams); See also Goldman (Covered Funds).

2150 See Credit Suisse (Williams).
678

The final rule generally retains the definition of “sponsor” in the statute and the 

proposed rule, although with certain modifications and clarifications to respond to 

comments received regarding the exclusion for “directed trustees.” As in the proposed 

rule, the definition of sponsor in the final rule covers an entity that (i) serves as general 

partner, managing member, or trustee of a covered fund, or that serves as a commodity 

pool operator of a covered fund as defined in § __.10(b)(1)(ii) of the final rule, (ii) in any 

manner selects or controls (or has employees, officers, or directors, or agents who 

constitute) a majority of the directors, trustees, or management of a covered fund, or (iii) 

shares with a covered fund, for corporate, marketing, promotional, or other purposes, the 

same name or a variation of the same name.2151 

While commenters urged the Agencies to provide an exemption from the 

definition of sponsor for a banking entity that selects the initial directors, trustees, or 

management of a fund,2152 the final rule has not been modified in this manner because the 

initial selection of the directors, trustees or management of a fund is an action 

characteristic of a sponsor and is essential to the creation of a covered fund. The 

Agencies note, however, that the statute and the final rule allow banking entities to 

sponsor covered funds, including selecting the initial board of directors, trustees and 

management, so long as the banking entity observes certain requirements and conforms 

any initial investment in the covered fund to the limits in the statute and regulation during 

 

2151 See final rule § __.10(d)(9). Some commenters asserted that custodians and service providers should 

not treated as sponsors under the final rule. The Agencies note, however, that a banking entity is not a 

sponsor under the final rule unless it serves in one or more of the capacities specified in the definition; 

controls or makes up the fund’s board of directors or management as described in the final rule; or shares 

the same name or a variation of the same name with the fund as described in the final rule. See, e.g., supra

note 2151 and accompanying text. See also infra note 2155. 

2152 See supra note 2144 and accompanying text. 
679

the relevant conformance period as discussed in Part IV.B.3.b. of this Supplementary 

Information.

2153 Moreover, a banking entity that does not continue to select or control a 

majority of the board of directors would not be considered to be a sponsor under this part 

of the definition once that role or control terminates. In the case of a covered fund that 

will have a self-perpetuating board of directors or a board selected by the fund’s 

shareholders, this would not be considered to have occurred until the board has held its 

first re-selection of directors or first shareholder vote on directors without selection or 

control by the banking entity.

As explained below, the Agencies believe that, in context, the term trustee in the 

definition of the term sponsor refers to a trustee with investment discretion. Consistent 

with this view, commenters urged the Agencies to exclude from the definition of sponsor 

certain trustees and parties commenters asserted acted in a similar capacity, as discussed 

above.2154 The final rule therefore has been modified to exclude from the definition of 

trustee: (i) a trustee that does not exercise investment discretion with respect to a covered 

fund, including a trustee that is subject to the direction of an unaffiliated named fiduciary 

who is not a trustee pursuant to section 403(a)(1) of the Employee’s Retirement Income 

Security Act (29 U.S.C. 1103(a)(1)); or (ii) a trustee that is subject to fiduciary standards 

imposed under foreign law that are substantially equivalent to those described in 

paragraph (i).2155 Under the final rule, a trustee would be excluded if the trustee does not 

 

2153 Similarly, a banking entity may share the same name or a variation of the same name with a covered 

fund so long as the banking entity does not organize and offer the covered fund in accordance with section 

13(d)(1)(G) and § __.11.

2154 See, e.g., supra notes 2138-2139 and accompanying text. See also supra note 2151.

2155 See final rule § __.10(d)(10). With respect to the concept of a “directed trustee” under foreign law, 

commenters generally requested changes only if non-U.S. mutual fund equivalents were not excluded from 
680

have any investment discretion, but is required to ensure that the underlying assets are 

appropriately segregated for the benefit of the trust. Similarly, a trustee would be 

excluded if the trustee has no investment discretion but is authorized to replace an 

investment adviser with an unaffiliated party when the investment adviser resigns. With 

respect to an issuing entity of asset-backed securities and as explained below, a directed 

trustee excluded from the definition of sponsor would include a person that conducts their 

actions solely in accordance with directions prepared by an unaffiliated party.

The Agencies believe that this exclusion is appropriate because the relevant prong 

of the definition of sponsor (i.e., serving as general partner, managing member, or 

trustee) specifies entities that have the ongoing ability to exercise control over a fund; 

directed trustees excluded from definition of sponsor in the final rule do not appear to 

have this ability and thus do not appear to be the type of entity that this prong of the 

definition of sponsor was intended to capture. If a trustee were itself to assume the role 

of investment adviser, or have the ability to exercise investment discretion with respect to 

the covered fund, the trustee would not qualify for this exclusion. The final rule does not 

include within the definition of sponsor custodians or administrators of covered funds 

unless they otherwise meet the definitional qualifications set forth in section 13 and the 

final rule.

The definition of sponsor will continue to cover entities that share the same name 

or variation of the same name of a covered fund for corporate, marketing, promotional, or 

other purposes, consistent with the definition of sponsor in section 13(h)(5). The 

 

the definition of covered fund. As discussed above, the final rule explicitly excludes foreign public funds 

from the definition of covered fund, which should address these commenters concerns. See final rule § 

__.10(c)(1).
681

Agencies recognize that some commenters urged the Agencies to modify this aspect of 

the definition of sponsor, and that the name-sharing prohibition included in the definition 

of sponsor (and in the conditions for the organize and offer exemption) will require some 

banking entities to rebrand their covered funds, which may prove expensive and will limit 

the extent to which banking entities may continue to benefit from brand equity they have 

developed.2156 The costs a banking entity would incur to rebrand its covered funds would 

depend on the cost to rebrand the banking entity’s current funds, as well as the banking 

entity’s ability to attract new investor capital to its current and future covered funds. The 

total burden per banking entity, therefore, would depend on the brand equity as well as 

the number of covered funds that share a similar name.2157 One commenter argued that, 

as a result, banking entities subject to section 13 may be at a competitive disadvantage to 

other firms that are not subject to these or similar restrictions.2158 The Agencies believe 

that the final rule addresses some commenters’ concerns to an extent by adopting a more 

tailored definition of covered, including a focused definition of foreign funds that will be 

covered funds and an exclusion for foreign public funds.2159 In addition, to the extent 

that a banking entity would otherwise come under pressure for reputational reasons to 

directly or indirectly assist a covered fund under distress that bears the banking entity’s 

name, the name-sharing prohibition could reduce the risk to the banking entity this 

assistance could pose. 

 

2156 See supra notes 2146-2150 and accompanying text.

2157 See infra note 2159. 

2158 See supra note 2148 and accompanying text.

2159 For example, one commenter argued that it would need to rebrand approximately 500 established 

funds under the rule proposal if the final rule was not modified to exclude established and regulated funds 

in foreign jurisdictions. See Goldman (Covered Funds). 
682

B. Definition of sponsor with respect to securitizations. 

Commenters on the definition of sponsor in the context of securitization vehicles 

generally argued that the proposed definition of sponsor was too broad and requested

clarification that various roles that banking entities might serve within a securitization 

structure would be excluded from the definition of sponsor, including servicers;2160

backup servicers and master servicers;2161 collateral agents and administrators;2162

custodians;2163 indenture trustees;2164 underwriters, distributors, placement agents;2165

arrangers, structuring agents;2166 originators, depositors, securitizers;2167 “sponsors” 

under the SEC’s Regulation AB;2168 administrative agents;2169 and securities 

administrators and remarketing agents.2170 Commenters argued that these parties should 

not be included in the definition of sponsor because such parties have clearly defined and 

 

2160 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); Credit Suisse (Williams); 

SIFMA (Securitization) (Feb. 2012); Wells Fargo (Covered Funds). One of these commenters argued that 

servicers will not have the right to control the decision-making and operational functions of the issuer. See

SIFMA (Securitization) (Feb. 2012). Another commenter stated that servicers do not have the authority to 

select assets or make investment decisions on behalf of investors. See PNC. 

2161 See ASF (Feb. 2012).

2162 Id.

2163 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012).

2164 Id.

2165 See Cleary Gottlieb; Credit Suisse (Williams); SIFMA (Securitization) (Feb. 2012); Wells Fargo 

(Covered Funds). One of these commentators argued that placement agents and underwriters will not have 

the right to control the decision-making and operational functions of the issuer. See SIFMA 

(Securitization) (Feb. 2012).

2166 See Cleary Gottlieb (“party that structures the asset-backed securities”); SIFMA (Securitization) (Feb. 

2012).

2167 See Credit Suisse (Williams); Wells Fargo (Covered Funds). 

2168 See SIFMA (Securitization) (Feb. 2012) (arguing that Regulation AB sponsors will not have the right 

to control the decision-making and operational functions of the issuer after they deposit the assets). 

2169 See Credit Suisse (Williams).

2170 See ASF (Feb. 2012); Wells Fargo (Covered Funds).
683

extremely limited authority and discretion,2171 do not have the right to control the 

decision-making and operational functions of the issuer,2172 and would not have “control” 

under BHC Act control precedent.2173 Conversely, one commentator supported defining 

sponsor under the proposed rule to include the Regulation AB sponsor, the servicer and 

the investment manager.2174 Commenters also made arguments regarding the potential 

detrimental effects to securitization and credit markets if banking entities are prohibited 

from acting as sponsors of securitizations. 2175

Commenters disagreed as to whether or not a sponsor under the final rule should 

include a party with any investment discretion, some investment discretion or complete 

investment discretion. Some commenters argued that certain parties should not be 

considered a sponsor because they were not an investment advisor or did not have 

investment discretion.2176 Other commenters argued that an entity should not be 

considered a sponsor even though it has limited investment discretion,2177 while others 

 

2171 See Allen & Overy (on behalf of Foreign Bank Group).

2172 See SIFMA (Securitization) (Feb. 2012).

2173 See Credit Suisse (Williams). 

2174 See Occupy.

2175 See ASF (Feb. 2012); Credit Suisse (Williams). 

2176 See ASF (Feb. 2012) (arguing that service providers, including trustees, custodians, collateral agents, 

servicers, master servicers, backup servicers, securities administrators, remarketing agents and collateral 

administrators, should not be considered the sponsor or investment manager of a fund under section 13 of 

the BHC Act because they have roles that are principally ministerial in nature and do not generally involve 

investment discretion or management and control activities); PNC (arguing that a banking entity should not 

be deemed a sponsor simply by serving as underwriter, distributor, placement agent, originator, depositor, 

investment adviser, servicer, administrative agent, securitizer or similar role because these parties do not 

have the authority to select assets or make investment decisions on behalf of investors).

2177 See Allen & Overy (on behalf of Foreign Bank Group); ASF (Feb. 2012); SIFMA (Securitization) 

(Feb. 2012). One commenter argued that the limited discretion that a servicer, trustee or custodian may 

have to either invest funds within certain parameters, liquidate assets following a default on the asset or the 

securitization default, or mitigate losses subject to a servicing standard, should not be considered a sponsor 

because these entities do not exercise the level of management and control exercised by the general partner 

or managing member of a hedge fund or private equity fund. Another commenter argued that to the extent 
684

argued that investment advisers and parties with investment discretion should not be 

included in the definition of sponsor.2178

After considering comments received and the language and purpose of section 13, 

the Agencies have determined not to adopt a separate definition of sponsor for issuers of 

covered funds that are issuers of an asset-backed security. As described above and 

consistent with the statute, the definition of sponsor only includes parties that: (i) serve as 

a general partner, managing member, or trustee (other than a directed trustee) of a 

covered fund; (ii) have the right to select or control a majority of the directors, trustees, or 

management of a covered fund; or (iii) share with a covered fund, for corporate, 

marketing, promotional, or other purposes, the same name or a variation of the same 

name. If the parties that commenters described do not serve in those capacities for a 

covered fund, do not have those rights with respect to a covered fund or do not share a 

name with a covered fund, such parties would not be a sponsor for purposes of the final 

 

that any of these parties exercises discretion, such discretion (A) involves decisions made after another 

party defaults (e.g., post-event of default collateral sale), (B) prescribed by the transaction documents (e.g.,

choosing among a limited number of eligible investments) and (C) governed by standards of care (e.g., the 

servicing standards). See ASF (Feb. 2012). Another commenter requested clarification that the exclusion 

of trustees that do not exercise investment discretion would also cover trustees that (A) direct investment of 

amounts in accordance with the applicable transaction documents, (B) act as servicer pending the 

appointment of a successor or (C) liquidate collateral. See SIFMA (Securitization) (Feb. 2012). One 

commenter argued that the definition of sponsor should not include an investment manager unless the 

investment manager (A) serves in one of the capacities designated in the definition of sponsor and can be 

replaced at the discretion of one or more entities serving in such capacity or with or without cause by the 

security holders or (B) has the “discretion to acquire or dispose of assets in the securitization for the 

primary purpose of recognizing gains or decreasing losses resulting from market value changes.” Id. 

2178 See Credit Suisse (Williams); SIFMA (Securitization) (Feb. 2012); TCW (arguing that the investment 

manager is typically unaffiliated with the general partner or equivalent of such fund, does not control the 

board of directors, is not responsible for the operations or books and records of the fund and generally does 

not perform any other significant function for the fund, such as acting as transfer agent). 
685

rule, and, therefore, they would not be subject to the restrictions applicable to the sponsor 

of a covered fund, including the restrictions contained in section 13(f).2179 

Additionally, the Agencies believe that the exclusion of loan securitizations from 

the definition of covered fund under the final rule addresses many of the commenters’ 

concerns about the sponsor definition because this exclusion limits the types of 

securitizations that are covered funds and subject to the final rule. Similarly, the 

exclusion of certain ABCP conduits from the definition of covered fund will mean that 

the restrictions under section 13(f) will not apply to qualifying asset-backed commercial 

paper conduits. 

As with any other covered fund under the final rule, the term sponsor would 

include a trustee that has the right to exercise any investment discretion for the 

securitization. For issuers of asset-backed securities, this would generally not include a 

trustee that executes decision-making, including investment of funds prior to the 

occurrence of an event of default, solely according to the provisions of a written contract 

or at the written direction of an unaffiliated party. In addition, under the rule as adopted a 

trustee with investment discretion may avoid characterization as a sponsor if it 

irrevocably delegates all of its investment discretion to another unaffiliated party with 

respect to the covered fund. The Agencies believe that these considerations regarding 

 

2179 As discussed above, commenters argued that that various roles that banking entities might serve within 

a securitization structure should be excluded from the definition of sponsor. See supra notes 2160-2170

and accompanying text.
686

when a trustee is a sponsor responds to commenters’ concerns regarding the roles of 

trustees in securitizations.2180

2. Section __.11: Activities Permitted in Connection with Organizing and Offering 

a Covered Fund

Section 13(d)(1)(G) of the BHC Act permits a banking entity to make investments 

in and sponsor covered funds within certain limits in connection with organizing and 

offering the covered fund.2181 Section __.11 of the final rule implements this statutory 

exemption, and includes several changes from the proposed rule in response to concerns 

raised by commenters as described in detail below.2182

a. Scope of Exemption 

Section __.11 of the proposed rule described the conditions that must be met in 

order to qualify for the exemption provided by section 13(d)(1)(G) for covered fund 

activities conducted in connection with organizing and offering a covered fund.2183 

These conditions generally mirrored section 13(d)(1)(G) of the statute, and included: (i) 

the banking entity must provide bona fide trust, fiduciary, investment advisory, or 

commodity trading advisory services;2184 (ii) the covered fund must be organized and 

 

2180 The Agencies also note that, while the entities commenters identified may not fall into the definition of 

sponsor, the ability of a banking entity to acquire and retain an interest in a securitization that is a covered 

fund will depend on whether it conducts its activity in a manner permitted under one of the exemptions 

contained in section 13(d)(1) of the BHC Act, such as the exemption for organizing and offering a covered 

fund. 

2181 156 Cong. Rec. S5889 (daily ed. July 15, 2010) (statement of Sen. Hagan) (arguing that section 13 

permits a banking entity to engage in a certain level of traditional asset management business).

2182 See final rule § __.11; proposed rule § __.11. 

2183 See proposed rule §§ __.11(a) – (h). 

2184 While section 13(d)(1)(G) of the BHC Act does not explicitly mention “commodity trading advisory 

services,” the Agencies proposed to treat commodity trading advisory services in the same way as 
687

offered only in connection with the provision of bona fide trust, fiduciary, investment 

advisory, or commodity trading advisory services and only to persons that are customers 

of such services of the banking entity; (iii) the banking entity may not acquire or retain an 

ownership interest in the covered fund except in accordance with the limitations on 

amounts and value of those interests as permitted under subpart C of the proposed rule; 

(iv) the banking entity must comply with the restrictions governing relationships with 

covered funds under § __.16 of the proposed rule; (v) the banking entity may not, directly 

or indirectly, guarantee, assume, or otherwise insure the obligations or performance of 

the covered fund or of any covered fund in which such covered fund invests; (vi) the 

covered fund, for corporate, marketing, promotional, or other purposes, may not share the 

same name or a variation of the same name with the banking entity (or an affiliate or 

subsidiary thereof), and may not use the word “bank” in its name; (vii) no director or 

employee of the banking entity may take or retain an ownership interest in the covered 

fund, except for any director or employee of the banking entity who is directly engaged in 

providing investment advisory or other services to the covered fund; (viii) the banking 

entity must clearly and conspicuously disclose, in writing, to any prospective and actual 

investor in the covered fund (such as through disclosure in the covered fund’s offering 

documents) the enumerated disclosures contained in § __.11(h) of the proposed rule; and 

(ix) the banking entity must comply with any additional rules of the appropriate Agency 

 

investment advisory services because the proposed rule would have included commodity pools within the 

definition of “covered fund.” One commenter argued that a covered banking entity should not be permitted 

to qualify for the exemption in section 13(d)(1)(G) based on providing commodity trading advisory 

services. See Occupy. The Agencies believe that commodity trading advisors provide services to 

commodity pools that are similar to the services an investment adviser provides to a hedge fund or private 

equity fund. Because certain commodity pools are included within the definition of covered fund, banking 

entities may organize and offer these commodity pools as a means of providing these services to customers. 
688

or Agencies, designed to ensure that losses in such covered fund are borne solely by 

investors in the covered fund and not by the banking entity.

2185 

Commenters raised concern that the proposed rule could be read to extend the 

prohibition on covered fund activities beyond the scope intended by the statute.2186 

Because the proposed exemption was applicable to banking entities engaged in 

“organizing and offering” a covered fund, commenters were concerned that the proposed 

rule might be interpreted to prohibit a banking entity from engaging in activities that are 

part of organizing and offering a covered fund but that are not prohibited under the 

covered fund prohibition. In this regard, commenters contended that the activity of 

“organizing and offering” a covered fund would include serving as investment adviser, 

distributor, broker, and other activities not prohibited by section 13 of the BHC Act and 

not involving the acquisition or retention of an ownership interest in or sponsorship of a 

covered fund as those terms are defined in section 13.2187 

The Agencies have modified the final rule to address this concern, which reflects 

a reading of the proposal not intended by the Agencies. Section 13(d)(1)(G) of the BHC 

Act by its terms provides an exemption from section 13(a) of the BHC Act, which 

prohibits a banking entity from acquiring or retaining an equity, partnership or other 

ownership interest in or sponsoring a covered fund. To the extent that an activity is not 

prohibited by section 13(a), no exemption to that statutory prohibition is needed to 

 

2185 See proposed rule §§ __.11(a) – (h). 

2186 See, e.g., Arnold & Porter. 

2187 See Arnold & Porter; F&C. 
689

conduct that activity. However, it is common for prohibited and non-prohibited activities 

to be conducted together in connection with offering and organizing a covered fund. For 

example, an entity that provides investment advisory services to a covered fund (an 

activity not itself prohibited by section 13(a)(1)(B) of the BHC Act) often acquires an 

ownership interest in a covered fund and/or appoints a majority of management of the 

covered fund (which is included in the definition of sponsor under the statute), both of 

which are covered by the statutory prohibition in section 13(a)(1)(B). In that case, the 

banking entity may engage in the prohibited activity as part of organizing and offering a 

covered fund only if the prohibited activity is conducted in accordance with the 

requirements in the exemption in section 13(d)(1)(G) or some other exemption. 

The final rule reflects this view in that it permits a banking entity to invest in or 

sponsor a covered fund in connection with organizing and offering the fund, which may 

involve activities that are not prohibited by section 13. Under the final rule, a banking 

entity that serves as an investment adviser to a covered fund (including a sub-adviser), for 

example, may permissibly invest in the covered fund to the extent the banking entity 

complies with the requirements of section 13(d)(1)(G) of the Act. An entity that serves 

only as investment adviser, without making any investment or conducting any activity 

covered by the prohibition in section 13(a), would not be covered by the prohibition in 

section 13(a) and thus would not need to rely on section 13(d)(1)(G) and § __.11 of the 

final rule to conduct that investment advisory activity.

As described in more detail below, a number of commenters expressed concern 

about applying the requirements of section 13(d)(1)(G) and the final rule outside of the 

United States, including with respect to foreign public funds organized and offered by 
690

foreign banking entities, particularly in situations where requirements in foreign 

jurisdictions may conflict with the requirements of section 13 of the BHC Act and 

implementing regulations.2188 The Agencies believe that many of the concerns raised 

with respect to applying section 13(d)(1)(G) and the proposed rule outside the United 

States have been addressed through the revised definition of covered fund described 

above and revisions to the exemption provided for activities conducted solely outside the 

United States. In particular, the revised definition of covered fund makes clear that a 

foreign fund offered outside the United States is only a covered fund under specified 

circumstances with respect to a banking entity that is, or is controlled directly or 

indirectly by a banking entity that is, located in or organized or established under the laws 

of the United States or of any State.

2189 Furthermore, foreign public funds are excluded 

from the definition of covered fund in the final rule.2190 Consequently, a foreign banking 

entity may invest in or organize and offer a variety of funds outside of the United States 

without becoming subject to the requirements of section 13(d)(1)(G) and § __.11 of the 

final rule, such as the name-sharing restriction or limitations on director and employee 

investments.

1. Fiduciary services

In order to qualify for the exemption for activities related to organizing and 

offering a covered fund, section 13(d)(1)(G) generally requires that a banking entity 

provide bona fide trust, fiduciary, investment advisory, or commodity trading advisory 

 

2188 See, e.g., EFAMA; ICI Global; JPMC. 

2189 See final rule § __.10(b)(1)(iii). 

2190 See final rule § __.10(c)(1). 
691

services, that the covered fund be organized and offered in connection with providing

these services, and that the banking entity providing those services offer the covered fund 

only to persons that are customers of those services of the banking entity.2191 These 

requirements were largely mirrored in the proposed rule. Requiring a customer 

relationship in connection with organizing and offering a covered fund helps to ensure 

that a banking entity is engaging in the covered fund activity for others and not on the 

banking entity’s own behalf.2192

As noted in the proposal, section 13(d)(1)(G)(ii) of the BHC Act does not 

explicitly require that the customer relationship be pre-existing. Accordingly, the 

Agencies explained in the proposal that the customer relationship may be established 

through or in connection with the banking entity’s organization and offering of a covered 

fund, so long as that fund is a manifestation of the provision by the banking entity of 

bona fide trust, fiduciary, investment advisory, or commodity trading advisory services to 

the customer. This application of the customer requirement is consistent with the manner 

in which these services are provided by banking entities. The proposed rule also required 

that a banking entity relying on the authority contained in § __.11 adopt a credible plan 

or similar documentation outlining how the banking entity intended to provide advisory 

or similar services to its customers through organizing and offering such fund. 

Several commenters indicated support for this customer requirement and, in 

particular, the Agencies’ view that the customer relationship need not be a preexisting 

 

2191 See 12 U.S.C. 1851(d)(1)(G)(i); proposed rule § __.11(a). 

2192 See 156 Cong. Rec. at S5897 (daily ed. July 15, 2010) (statement of Sen. Merkley).
692

one.2193 A few commenters contended that the statute required that a banking entity have 

a pre-existing customer relationship, and may not solicit investors outside of its existing 

asset management customers.2194 One of these commenters argued that this would place 

banking entities at a competitive disadvantage compared to investment advisers that are 

not banking entities (and thus not subject to the requirements of section 13 and the final 

rule), but argued that this is a necessary result of section 13.2195

The final rule adopts the language largely as proposed, and the Agencies continue 

to believe that the customer relationship required under section 13(d)(1)(G) and the final 

rule may be established through or in connection with the banking entity’s organization 

and offering of a covered fund, so long as that fund is a manifestation of the provision by 

the banking entity of bona fide trust, fiduciary, investment advisory, or commodity 

trading advisory services to the customer.2196 The final rule requires that a covered fund 

be organized and offered pursuant to a written plan or similar documentation outlining 

how the banking entity (or an affiliate thereof) intends to provide advisory or similar 

services to its customers through organizing and offering the fund. As part of this 

requirement, the plan must be credible and indicate that the banking entity has conducted 

reasonable analysis to show that the fund is organized and offered for the purpose of 

providing bona fide trust, fiduciary, investment advisory, or commodity trading advisory 

 

2193 See Ass’n of Institutional Investors (Feb. 2012); SIFMA et al. (Covered Funds) (Feb. 2012); JPMC. 

2194 See Sens. Merkley & Levin (Feb. 2012); AFR et al. (Feb. 2012); Occupy; Public Citizen.

2195 See Sens. Merkley & Levin.

2196 See final rule §__.11(a)(1)-(2). See Part IV.B.2.b. below for a discussion of these requirements in the 

context of a banking entity that organizes and offers a covered fund that is an issuing entity of asset-backed 

securities. 
693

services to customers of the banking entity (or an affiliate thereof) and not to evade the 

restrictions of section 13 of the BHC Act.

The language of the final rule also adopts the statutory requirements (and 

modifications related to commodity pools as discussed above) that the banking entity 

provide bona fide trust, fiduciary, investment advisory, or commodity trading advisory 

services, and that the covered fund be organized and offered only in connection with the 

provision of those services. Banking entities provide a wide range of customer-oriented 

services which may qualify as bona fide trust, fiduciary, investment advisory, or 

commodity trading advisory services.2197 Historically, banking entities have used 

covered funds as a method of providing these services to customers in a manner that is 

both cost efficient for the customer and allows customers to benefit from access to advice 

and services that might not otherwise be available to them. These benefits apply to longestablished customers as well as individuals or entities that have no pre-existing 

relationship with the banking entity but choose to obtain the benefit of trust, fiduciary, 

investment advisory, or commodity trading advisory services through participation in the 

covered fund. Covered funds also allow customers to gauge the historical record of the 

banking entity in providing these services by reviewing the funds’ past performance.

The statute does not require that a covered fund be offered only to pre-existing 

customers of the banking entity, and the Agencies believe that imposing such a 

requirement would not improve the quality of the trust, fiduciary, investment advisory, or 

 

2197 See, e.g., 12 U.S.C. 1843(c)(4), (c)(8), (K), 12 CFR 225.28(b)(5) and (6), 12 CFR 225.86, 12 CFR 

225.125 (with respect to a bank holding company); 12 U.S.C. 24(Seventh), 92a, 12 CFR Part 9 (with 

respect to a national bank); 12 U.S.C. Part 362 (with respect to a state non-member bank).
694

commodity trading advisory service, enhance the safety and soundness of the banking 

entity, or reduce the risks to the customers or the banking entity. In each case, the 

banking entity provides trust, fiduciary or advisory services to a covered fund for the 

benefit of the banking entity’s customers, and the statute recognizes that organizing and 

offering a covered fund is a legitimate method for providing that service. In addition, the 

banking entity must abide by all the statutory and prudential requirements imposed by 

section 13 and the entity’s supervisors on the provision of those services. The Agencies 

do not believe that a pre-existing customer relationship requirement would be meaningful 

because it could easily be satisfied by a prospective customer seeking to invest in a 

covered fund by first establishing an account with a banking entity or purchasing another 

product (e.g., a brokerage account or shares of a mutual fund). 

2. Compliance with investment limitations

Section 13(d)(1)(G)(iii) of the BHC Act limits the ability of a banking entity that 

organizes and offers a covered fund to acquire or retain an ownership interest in that 

covered fund as an investment.2198 Both the proposed rule and the final rule implement 

this provision by requiring that a banking entity limit its investments in a covered fund 

that the banking entity organizes and offers as provided in § __.12.2199 Comments 

received on investment limitations in the proposed rule, and modifications made to the 

final rule implementing these limitations, are described in Part IV.B.3. below. 

 

2198 See 12 U.S.C. 1851(d)(1)(G)(iii).

2199 See proposed rule and final rule § __.12.
695

3. Compliance with section 13(f) of the BHC Act

Section __.11(d) of the proposed rule required that the banking entity comply 

with the limitations on relationships with covered funds imposed by section 13(f) of the 

BHC Act.2200 The final rule adopts this requirement and provides that the banking entity

(and its affiliates) must comply with the requirements of § __.14. Section 13(f) of the 

BHC Act prohibits certain transactions or relationships that would be covered by section 

23A of the Federal Reserve Act, and provides that any permitted transaction is subject to 

section 23B of the Federal Reserve Act, in each instance as if such banking entity were a 

member bank and such covered fund were an affiliate thereof.

2201 These limitations 

apply in several contexts, and are contained in § __.14 of the final rule, discussed in 

detail below in Part IV.B.5.

4. No guarantees or insurance of fund performance

Section __.11(e) of the proposed rule prohibited a banking entity that organizes 

and offers a covered fund from, directly or indirectly, guaranteeing, assuming or 

otherwise insuring the obligations or performance of the covered fund or any covered 

fund in which such covered fund invests.2202 This prong implemented section 

 

2200 12 U.S.C. 1851(d)(1)(G)(iv); proposed rule § __.11(d). 

2201 See Part IV.B.5. below. The comments received on section 13(f) and § __.16 of the proposed rule are 

described below. 

2202 12 U.S.C. 1851(d)(1)(G)(v); proposed rule § __.11(e). 
696

13(d)(1)(G)(iv) of the BHC Act and was intended to prevent a banking entity from 

engaging in bailouts of a covered fund in which the banking entity has an interest.2203

There were only a few comments received on this aspect of the proposal. One 

commenter supported the restriction on guarantees as effective and consistent with the 

statute.2204

One commenter argued that the final rule should not prohibit borrower default 

indemnification services (i.e., the guarantee of collateral sufficiency upon a securities 

borrower’s default) provided to lending clients by agent banks in connection with 

securities lending transactions involving a covered fund.2205 This commenter argued that 

borrower default indemnification services guarantee only the deficit between the mark to 

market value of cash collateral received and the amount of any borrower default, and are 

therefore different from and more limited than the type of general investment 

performance or obligation guarantee that section 13 was designed to prevent.

The Agencies believe that the statute does not permit either full or partial 

guarantees of the obligations of a covered fund that the banking entity organizes and 

offers. Accordingly, the final rule, like the proposed rule, continues to mirror the 

statutory restriction on direct or indirect guarantees of the obligations or performance of a 

covered fund by a banking entity in connection with reliance on the exemption provided 

in section 13(d)(1)(G) of the BHC Act. However, in response to comments received on 

 

2203 See 156 Cong. Rec. S5897 (daily ed. July 15, 2010) (statement of Sen. Merkley).

2204 See Occupy.

2205 See RMA. 
697

the proposal, the Agencies note that the provision of a borrower default indemnification 

by a banking entity to a lending client in connection with securities lending transactions 

involving a covered fund is not prohibited. This type of indemnification is not a 

guarantee of the performance or obligations of a covered fund because it represents a 

guarantee to the customer or borrower of the obligation of the counterparty to perform 

and not a guarantee of the performance or underlying obligations of the covered fund. 

The requirement of the final rule that a banking entity and its affiliates not guarantee the 

obligations or performance of a covered fund that it organizes and offers therefore does 

not prohibit a banking entity from providing borrower default indemnifications to 

customers.

5. Limitation on name sharing with a covered fund

Section __.11(f) of the proposed rule prohibited the covered fund from sharing the 

same name or a variation of the same name with the banking entity that relies on the 

exemption in section 13(d)(1)(G) of the BHC Act.2206 The proposed rule also prohibited 

the covered fund from using the word “bank” in its name.2207

The name-sharing restriction was one of the most commented upon aspects of § 

__.11. A number of commenters on this section expressed the view that the namesharing restriction in section 13(d)(1)(G)(vi) of the BHC Act and the proposed rule was 

too strict. In particular, a number of commenters argued that the name-sharing restriction 

 

2206 12 U.S.C. 1851(d)(1)(G)(vi); proposed rule § __.11(f).

2207 Similar restrictions on a fund sharing the same name, or variation of the same name, with an insured 

depository institution or company that controls an insured depository institution or having the word “bank” 

in its name, have been used previously in order to prevent customer confusion regarding the relationship 

between such companies and a fund. See, e.g., Bank of Ireland, 82 FED. RES. BULL. 1129 (1996).
698

should allow an asset manager to share its name with a sponsored covered fund so long as 

the covered fund does not share the name of the insured depository institution or its 

affiliated holding company or use the word “bank.”2208 

 Commenters argued that the name-sharing restriction as proposed would impose 

significant business and branding burdens on the industry without providing incremental 

benefit to the public.2209 These commenters argued that it would be unduly burdensome 

and costly for funds currently affiliated with banking entities or managers that are 

themselves banking entities to change the name of their affiliated funds and that many of 

these funds have developed a reputation in the marketplace based on the current name of 

the fund and/or fund manager. Some of these commenters argued that the name-sharing 

restriction would place asset managers and funds affiliated with banking entities at a 

competitive disadvantage to other asset managers and funds.2210 

A few commenters argued that the rationale for the name-sharing restriction (i.e., 

to discourage bailing out funds) was already addressed under other restrictions of section 

13(d)(1)(G) and the proposed rule that prohibit a banking entity from, directly or 

indirectly, guaranteeing, assuming or otherwise insuring the obligations or performance 

of the covered fund or of any covered fund in which such covered fund invested and that 

require disclosure that investments in the covered fund are not insured by the Federal 

 

2208 See ABA (Keating); Ass’n of Institutional Investors (Feb. 2012); Blackrock; EFAMA; SIFMA et al.

(Covered Funds) (Feb. 2012); TCW; Katten (on behalf of Int’l Clients); Union Asset. 

2209 See, e.g., ABA (Keating); Ass’n of Institutional Investors (Feb. 2012); Blackrock; See also SVB; 

Katten (on behalf of Int’l Clients); SIFMA et al. (Covered Funds) (Feb. 2012); UBS. 

2210 See Ass’n of Institutional Investors (Feb. 2012); Katten (on behalf of Int’l Clients); SIFMA et al.

(Covered Funds) (Feb. 2012).
699

Deposit Insurance Corporation.2211 These commenters questioned the necessity for the 

name-sharing restriction when a prohibition on bailing out funds is already in place and 

where there is disclosure that investors bear the risk of loss in the fund. Some of these 

commenters contended it was unlikely that investors in a covered fund with an SECregistered investment adviser that has a name unrelated to the name of an insured 

depository institution would be misled to believe that the fund would be backed in any 

way by a related insured depository institution or the Federal Deposit Insurance 

Corporation.2212 One of these commenters argued that the name-sharing restriction 

should not apply to organizations where insured depository institutions represent a de

minimis component of the organization’s operations.2213 

Other commenters recommended that the name-sharing restriction not be applied 

to covered funds that rely on the exemption for covered fund activities and investments 

that occur solely outside of the United States.2214 A few commenters expressed concern 

that the name-sharing restriction could be incompatible with regulatory requirements in 

certain foreign jurisdictions that a covered fund’s name must indicate the fund’s 

connection with the fund sponsor.2215 One commenter argued that it is common practice 

in Germany to disclose the designation of the sponsoring investment manager in the fund 

 

2211 See Ass’n of Institutional Investors (Feb. 2012); SIFMA et al. (Covered Funds) (Feb. 2012); T. Rowe 

Price; TCW.

2212 See TCW; Union Asset. 

2213 See T. Rowe Price.

2214 See, e.g., UBS. 

2215 See Credit Suisse (Williams); EFAMA; JPMC; Katten (on behalf of Int’l Clients); Union Asset; IAA; 

ICI Global; UBS; SIFMA et al. (Covered Funds) (Feb. 2012) (citing Directive 2004/39/EC of the 

European Parliament and Council). 
700

name in order to provide transparency to investors, while a few commenters contended 

that European jurisdictions, including the U.K., require an authorized fund to have a 

name representative of the authorized investment manager to avoid misleading fund 

investors.2216 Commenters also argued that the name-sharing restriction was inconsistent 

with the laws of Ireland and Hong Kong.2217 Certain commenters argued that the impact 

of the name-sharing restriction would be particularly unfair to non-U.S. retail funds like 

European UCITS if such funds are not allowed to use the name of the bank while U.S. 

mutual funds would not be subject to the same restriction.2218 

By contrast, some commenters supported the name-sharing restriction. For 

example, one commenter indicated that the use of the word “bank” or a shared name in 

the fund’s name was already strongly discouraged by prior guidance.2219 Another 

commenter supported the name-sharing restriction but argued it did not go far enough 

because it did not apply to funds that a banking entity was permissibly allowed to sponsor 

and invest in under other provisions of section 13.2220 According to this commenter, 

covered funds permitted under other exemptions should not be allowed to share the same 

name with the banking entity.2221 

 

2216 See BVI; EFAMA; JPMC; UBS; Union Asset; ICI Global; IAA.

2217 See UBS; Union Asset; ICI Global.

2218 See, e.g., AFG; ICI Global; JPMC. 

2219 See Arnold &Porter (citing SEC Division of Investment Management, Letter to Registrants (May 13, 

1993); Memorandum to SEC Chairman Breeden from Division of Investment Management (May 6, 1993); 

FDIC, Board, OCC, OTS, Interagency Statement on Retail Sales of Non-Deposit Investment Products (Feb. 

14, 1994)).

2220 See Occupy the SEC at 165. 

2221 See id. 
701

After carefully considering comments and the express terms of the statute, the 

final rule includes the name-sharing restriction as proposed.2222 The name-sharing 

restriction is imposed by the statute and prohibits a banking entity from sharing the same 

name or variation of the same name with a covered fund. The statute also defines the 

scope of the prohibition by defining the term “banking entity” to generally include any 

affiliate or subsidiary of an insured depository institution or any company that controls an 

insured depository institution.2223 

However, the Agencies believe that many of the concerns raised by commenters 

with respect to this provision should be addressed through the revised definition of 

covered fund in the final rule, and modifications to the exemption for covered fund 

activities and investments that occur solely outside of the United States.2224 For example, 

as discussed in greater detail above in Part IV.B.1.c.1., foreign public funds sold outside 

the United States are excluded from the definition of covered fund.2225 In addition, 

pursuant to the definition of covered fund in the final rule, a foreign fund only becomes a 

covered fund with respect to a U.S. banking entity (including a foreign affiliate of that 

U.S. banking entity) that acts as sponsor to, or has an ownership interest in, the fund. 

Moreover, numerous funds operate successfully with names that differ from the name of 

the fund sponsor or adviser.

 

2222 See final rule § __.11(f).

2223 See 12 U.S.C. 1851(d)(1)(G)(vi) & (h)(1). 

2224 For example, one commenter alleged that it would need to rebrand approximately 500 established 

funds if the final rule was not modified to exclude established and regulated funds in foreign jurisdictions. 

See Goldman (Covered Funds).

2225 See final rule §§ __.10(b) (1)(ii) & (c)(1). 
702

The Agencies recognize, however, that the statutory name-sharing restriction may 

affect some entities that will be covered funds and that cannot rely on another permitted 

activity exemption under section 13(d)(1) and the final rule. The name-sharing 

restriction may result in certain costs and other economic burdens for banking entities 

that advise these funds, as discussed in greater detail in Part IV.B.1.g. above.2226 

However, as the Agencies also note above, to the extent that the restriction results in a 

banking entity not otherwise coming under pressure for reputational reasons to directly or 

indirectly assist a covered fund under distress that shares the banking entity’s name, the 

name-sharing prohibition could reduce the risk to the banking entity that this assistance 

might pose. The Agencies also expect that the conformance period, both for compliance 

with section 13 of the BHC Act generally and for funds that are illiquid funds, should be 

sufficient to allow covered funds to take the steps necessary to comply with the namesharing restriction in the statute and final rule. 

6. Limitation on ownership by directors and employees

Section __.11(g) of the proposed rule implemented section 13(d)(1)(G)(vii) of the 

BHC Act. That statutory provision prohibits any director or employee of the banking 

entity from acquiring or retaining an ownership interest in the covered fund, except for 

any director or employee of the banking entity who is directly engaged in providing 

investment advisory or other services to the covered fund.2227 This allows an individual 

employed by a banking entity, who also acts as fund manager or adviser (for example), to 

 

2226 See Part IV.B.1.g.

2227 See 12 U.S.C. 1851(d)(1)(G)(vii); proposed rule § __.11(g). 
703

acquire or retain an ownership interest in a covered fund that aligns the manager or 

adviser’s incentives with those of the banking entity’s customers.2228 

 One commenter argued that only employees or directors who provide investment 

advisory services should be allowed to make an investment in the fund and that the rule 

should not allow employees or directors who provide other, unspecified services to invest 

in a fund.2229 This commenter argued that the proposed rule would allow non-adviser 

banking entity employees who have no need to maintain “skin in the game” to earn profit 

on the fund’s performance. According to another commenter, fiduciary clients of 

banking organizations often are less interested in whether the fund manager or other 

service providers have money in the fund than whether the client’s own account manager, 

and those individuals above him/her who are responsible for investment decisions, have 

allocated his or her own assets in the same way and into the same general asset classes 

and funds as the client’s fiduciary account is being allocated.2230 

The more prevalent view among commenters was that the proposed rule should be 

revised and expanded to permit investments in a sponsored fund by a broader group of 

banking entity directors, officers, and employees, directly or indirectly through employee 

benefit programs or trust and fiduciary accounts, regardless of whether the individual 

provides services to the covered fund.2231 Some commenters argued that narrowly 

limiting permissible director and employee investments could put asset managers 

 

2228 See 156 Cong. Rec. S5897 (daily ed. July 15, 2010) (statement of Sen. Merkley).

2229 See Occupy. 

2230 See Arnold & Porter.

2231 See Arnold & Porter; BOK, Credit Suisse (Williams); Fin. Services Roundtable (Jun. 14, 2011); 

PEGCC; T. Rowe Price. 
704

affiliated with an insured depository institution at a competitive disadvantage relative to 

managers that are not affiliated with an insured depository institution,2232 as well as make 

it more difficult for banking entities to offer their U.S. and non-U.S. employees similar 

choices in retirement plans.2233

Two commenters urged that the supervisors of a fund’s portfolio managers or 

investment advisers should be permitted to invest.2234 These commenters also argued 

that individuals who provide support services to the fund, including administrative, 

oversight and risk management, legal compliance, regulatory, product structuring, deal 

sourcing and origination, deal evaluation and diligence, investor relations, sales and 

marketing, tax, accounting, valuation and other operational support services, should be 

permitted to invest in the fund. These commenters also requested confirmation that any 

director, including an individual serving on the board or investment committee of a fund 

or its manager, should be permitted to invest.2235 Another commenter argued that 

employees and directors should be permitted to make their own individual investment 

decisions independently without regard to whether they provide services to the covered 

fund.2236 One commenter contended that a grandfathering approach is necessary to 

address situations where a pre-existing covered fund already has investments from 

 

2232 See Credit Suisse (Williams).

2233 See T. Rowe Price.

2234 See Credit Suisse (Williams); Fin. Services Roundtable (Jun. 14, 2011).

2235 See Credit Suisse (Williams); Fin. Services Roundtable (Jun. 14, 2011).

2236 See BOK (citing proposed rule at §__.17); Arnold & Porter.
705

directors and employees who do not directly provide services to the fund because the 

fund may be unable to force those individuals out of the fund.2237 

A number of commenters argued that, if defined too narrowly, this restriction may 

conflict with the laws of other jurisdictions that require advisers and/or their directors and 

employees to invest in the funds they manage.2238 For example, several commenters 

argued that this requirement will directly conflict with the European Alternative 

Investment Fund Managers Directive.2239 Two commenters contended that certain 

jurisdictions, including the Netherlands, require directors and other personnel of fund 

managers to hold fund units or shares of funds managed by the fund manager as part of 

their pensions.2240 

The final rule retains the requirement limiting the ownership of a covered fund by 

directors and employees of a banking entity (or an affiliate thereof) relying on the 

exemption in section 13(d)(1)(G) of the BHC Act.2241 This limitation is imposed by 

statute on banking entities that rely on this exemption. If a director or employee does not 

provide services to the fund, they may not invest in that fund. As in the statute, the final 

rule allows employees who provide services to the fund other than investment advisory 

services to invest in the fund. Under the final rule, directors or employees who provide 

investment advice or investment management services to the fund may invest in that 

 

2237 See SVB. 

2238 See EFAMA; BVI; IAA; ICI Global; JPMC; Union Asset.

2239 See Annex II para. 1(m). Directive 2011/61/EU of the European Parliament and the Council of 8 June 

2011 on Alternative Investment Fund Managers.

2240 See EFAMA; Union Asset. 

2241 See final rule § __.11(g).
706

fund. Similarly, directors or employees who provide services that enable the provision of 

investment advice or investment management, such as oversight and risk management, 

deal origination, due diligence, administrative or other support services, may also invest 

in the fund. In response to comments, the final rule has been modified to make clear that 

a former director or employee may retain an interest in a covered fund if the director or 

employee acquired the interest while serving as a director or employee of the banking 

entity and providing investment advisory or other services to the covered fund.

The Agencies believe that many of the concerns raised by commenters regarding 

the effects of this limitation on foreign funds are addressed through the scope of foreign 

funds that will be covered funds, and revisions to the exemption provided for covered 

fund activities and investments that occur solely outside of the United States. Moreover, 

the final rule excludes foreign public funds and broad-based foreign pension funds from 

the definition of covered fund and they are thus not subject to the restrictions of section 

13 or the final rule.2242

Section 13 clearly contemplates investments by certain employees and directors 

of the banking entity.2243 However, the Agencies continue to believe that certain director 

or employee investments in a covered fund may provide an opportunity for a banking 

entity to evade the limitations regarding the amount or value of ownership interests a 

banking entity may acquire or retain in a covered fund or funds contained in section 

13(d)(4) of the BHC Act and the final rule. In order to address this concern, the final rule 

attributes an ownership interest in a covered fund acquired or retained by a director or 

 

2242 See final rule §§ __.10(c)(1) and __.10(c)(5).

2243 See 12 U.S.C. 1851(d)(1)(G)(vii).
707

employee to a banking entity for purposes of the investment limits in section 13(d)(4) 

under certain circumstances. This attribution is discussed in detail below in Part IV.B.3.f. 

7. Disclosure requirements

Section __.11(h) of the proposed rule required that, in connection with organizing 

and offering a covered fund, the banking entity clearly and conspicuously disclose, in 

writing, to prospective and actual investors in the covered fund that any losses in the 

covered fund will be borne solely by investors in the covered fund and not by the banking 

entity and its affiliates or subsidiaries; and that the banking entity’s and its affiliates’ or 

subsidiaries’ losses in the covered fund will be limited to losses attributable to the 

ownership interests in the covered fund held by the banking entity and its affiliates or 

subsidiaries in their capacity as investors in the covered fund. In addition, the proposed 

rule required that a banking entity disclose, in writing: (i) that each investor should read 

the fund offering documents before investing in the covered fund; (ii) that the ownership 

interests in the covered fund are not insured by the FDIC, and are not deposits, 

obligations of, or endorsed or guaranteed in any way, by any banking entity (unless that 

happens to be the case); and (iii) the role of the banking entity and its affiliates, 

subsidiaries, and employees in sponsoring or providing any services to the covered fund. 

The proposed rule also required banking entities to comply with any additional rules of 

the appropriate Agency designed to ensure that losses in any covered fund are borne 

solely by the investors in the covered fund and not by the banking entity.2244 In 

proposing the rule, the Agencies indicated that a banking entity may satisfy these 

 

2244 12 U.S.C. 1851(d)(1)(G)(viii); proposed rule § __.11(h). 
708

disclosure requirements by making the required disclosures in the covered fund’s offering 

documents.2245

A few commenters supported the disclosure requirement as effective and 

consistent with the statute.2246 One commenter stated that the disclosures required in 

section 13(d)(1)(G)(viii) of the Act and the proposed rule are consistent with disclosures 

in the banking agencies’ February 1994 “Interagency Statement on Retail Sales of Nondeposit Investment Products” and other FINRA and SEC guidance.2247 One commenter 

suggested that the rule include a requirement that the disclosures be issued in plain 

English.2248 

Another commenter argued that the Agencies should revise the disclosure 

requirements under the proposal so that offering materials of non-U.S. funds provided to 

non-U.S. investors outside the United States need not include the specified disclosures 

nor refer to the FDIC or other specific U.S. agencies.2249 This commenter argued that a 

non-U.S. person investing in a non-U.S. fund offered or sponsored by a non-U.S. banking 

entity has no expectation that the fund or its interests would be insured by the FDIC. The 

Agencies believe this concern is addressed through the revised definition of covered 

fund, which generally provides that a foreign fund offered outside of the United States 

 

2245 To the extent that any additional rules are issued to ensure that losses in a covered fund are borne 

solely by the investors in the covered fund and not by the banking entity, a banking entity would be 

required to comply with those as well in order to satisfy the requirements of section 13(d)(1)(G)(viii) of the 

BHC Act.

2246 See, e.g., Occupy. 

2247 See Arnold& Porter. 

2248 See Occupy. 

2249 See Katten (on behalf of Int’l Clients). 
709

will only be a covered fund with respect to a U.S. banking entity (including a foreign 

affiliate of the U.S. banking entity) that acts as sponsor to, or invests in, the fund.2250 

The final rule adopts the proposed disclosure requirements substantially as 

proposed. As explained above, these disclosures are largely required by the statute.2251 

The proposed requirement to disclose that ownership interests in a covered fund are not 

insured by the FDIC, and are not deposits, obligations of, or endorsed or guaranteed in 

any way, by any banking entity (unless that happens to be the case) is not expressly 

required by the statute. However, section 13(d)(1)(G)(iii) permits the Agencies to impose 

additional rules designed to ensure that losses in a covered fund are borne solely by 

investors in the fund and not by a banking entity. The Agencies believe that requiring a 

banking entity to make this disclosure as part of organizing and offering a covered fund 

furthers this purpose by removing the potential for misperception that a covered fund 

sponsored by a banking entity (which by definition must be affiliated with a depository 

institution insured by the FDIC) is guaranteed by that insured institution or the FDIC. 

Moreover, as noted above, this disclosure is already commonly provided by banking 

entities.

b. Organizing and Offering an Issuing Entity of Asset-Backed Securities

To the extent that an issuing entity of asset-backed securities is a covered fund, 

the investment limitations contained in section 13(d)(4) of the BHC Act also would limit 

the ability of a banking entity to acquire or retain an investment in that issuer. Section 

941 of the Dodd-Frank Act added a new section 15G of the Exchange Act (15 U.S.C. 

 

2250 See final rule § __.10(b)(1)(iii). 

2251 See 12 U.S.C. 1851(d)(1)(G)(viii).
710

78o-11) which requires a banking entity to retain and maintain a certain minimum 

interest in certain asset-backed securities.2252 In order to give effect to this separate 

requirement under the Dodd-Frank Act, § __.14(a)(2) of the proposed rule permitted a 

banking entity that is a “securitizer” or “originator” under the provisions of that Act to 

acquire or retain an ownership interest in an issuer of asset-backed securities, in an 

amount (or value of economic interest) required to comply with the minimum 

requirements of section 15G of the Exchange Act and any implementing regulations 

issued thereunder.2253 The proposal also permitted a banking entity to act as sponsor to 

the securitization. 

Commenters expressed a variety of views on the treatment of interests in 

securitizations held under risk retention pursuant to the proposed rule. Some commenters 

argued that the proposal was effective as written and represented a reasonable way to 

reconcile the two sections of the Dodd-Frank Act consistent with the risk-reducing 

objective of section 13 of the BHC Act.2254 Other commenters also supported the 

proposal’s recognition that banking entities may be required to hold a certain amount of 

risk in a securitization that would also be a covered fund, but argued that the proposed 

exemption was too narrow.2255 

 

2252 The relevant agencies issued a proposed rule to implement the requirements of section 15G of the 

Exchange Act, as required under section 941 of the Dodd-Frank Act. See Credit Risk Retention, 76 FR 

24,090 (Apr. 29, 2011). Those agencies recently issued a re-proposal of the risk-retention requirements. 

See Credit Risk Retention, 78 FR 57,928 (Sept. 20, 2013).

2253 See proposed rule § __.14(a)(2)(iii).

2254 See Sens. Merkley & Levin (Feb. 2012); Alfred Brock.

2255 See, e.g., AFME et al.; SIFMA (Securitization) (Feb. 2012); JPMC; BoA.
711

After carefully considering the comments received on the proposal, as well as the 

language and purpose of section 13 of the BHC Act, the final rule provides an exemption 

that permits a banking entity to organize and offer a covered fund that is an issuing entity 

of asset-backed securities.2256 The Agencies have determined to provide this exemption 

in order to address the unique circumstances and ownership structures presented by 

securitizations.2257 Under the final rule, a banking entity may permissibly organize and 

offer a covered fund that is an issuing entity of asset-backed securities so long as the 

banking entity (and its affiliates) comply with all of the requirements of § __.11(a)(3) 

through (a)(8).2258 As discussed above, the requirements of § __.11(a)(3) through 

__.11(a)(8) are that: (i) the banking entity and its affiliates do not acquire or retain an 

ownership interest in the covered fund except as permitted under § __.12 of the final 

rule;2259 (ii) the banking entity and its affiliates comply with the requirements of § __.14 

of the final rule; (iii) the banking entity and its affiliates do not, directly or indirectly, 

guarantee, assume, or otherwise insure the obligations or performance of the covered 

fund or of any covered fund in which such covered fund invests; (iv) the covered fund, 

for corporate, marketing, promotional, or other purposes, does not share the same name 

or variation of the same name with the banking entity (or an affiliate thereof) and does 

 

2256 See final rule § __.11(b).

2257 As used in this Supplementary Information, the term “securitization” means a transaction or series of 

transactions that result in the issuance of asset-backed securities.

2258 See final rule § __.11(b) (providing the requirements for a banking entity that is organizing and 

offering a covered fund that is an issuing entity of asset-backed securities by reference to the requirements 

of § __.11(a), as discussed above). 

2259 As explained in detail below in Part IV.B.3. addressing the limitations on investments in covered funds 

by a banking entity, the final rule permits a banking entity to acquire and retain ownership interests in a 

covered fund in order to comply with section 15G of the Exchange Act (15 U.S.C.78o-11) in an amount 

that does not exceed the amount required to comply with the banking entity’s chosen method of compliance 

under section 15G and the implementing regulations issued thereunder.
712

not use the word “bank” in its name; (v) no director or employee of the banking entity (or 

an affiliate thereof) takes or retains an ownership interest in the covered fund except 

under the limited circumstances noted in the final rule; and (vi) the banking entity 

complies with the disclosure requirements regarding covered funds in the final rule.

The Agencies believe that the requirements of the exemption for organizing and 

offering a covered fund that is an issuing entity of asset-backed securities, which are in 

most aspects consistent with the exemption for organizing and offering a covered fund in 

section 13(d)(1)(G), provide limitations on a banking entity’s securitization activities 

involving covered funds that are consistent with the limitations imposed with respect to 

organizing and offering a covered fund that is not an issuing entity of asset-backed 

securities. For instance, a banking entity may not share the same name as a covered fund 

that is an issuing entity of asset-backed securities and is prohibited from guaranteeing or 

otherwise “bailing out” a covered fund that is an issuing entity of asset-backed securities, 

including being required to comply with section 13(f) of the BHC Act regarding covered 

transactions with the covered fund. Furthermore, like a banking entity’s investment in 

any covered fund, the final rule limits the ability of a banking entity to invest in a covered 

fund that is an issuing entity of asset-backed securities unless it meets the requirements of 

§ __.12.

Unlike many other covered funds, the Agencies understand that banking entities 

might not act in a fiduciary capacity when they organize and offer a covered fund that is a 

securitization vehicle. For instance, as part of organizing and offering a securitization 

vehicle, one or more parties may typically organize and initiate the securitization by 

selling or transferring assets, either directly or indirectly, to an issuing entity of asset-
713

backed securities. An entity that provides these services typically does so as a service to 

provide investors and the entity’s customers with the ability to invest in the assets in a 

manner and to a degree that they may otherwise be unable to do. In order to identify 

certain activities that would be included as organizing and offering a securitization, the 

final rule provides that organizing and offering an issuing entity of asset-backed 

securities means acting as the securitizer, as that term is used in section 15G(a)(3) of the 

Exchange Act, for the issuer, or acquiring or retaining an ownership interest in the issuer 

in compliance with the implementing regulations issued under section 15G of that Act. 

The final rule reflects, as discussed above, that one or more parties that organize 

and offer an issuing entity of asset-backed securities may not provide any of the services 

identified in § __.11(a)(1). In this case the banking entity is not required to comply with 

§ __.11(a)(1) or (a)(2). Section __.11(b) of the final rule is designed to address situations 

where, as discussed above, a banking entity does not act in a fiduciary capacity when it 

organizes and offers a covered fund that is a securitization vehicle. With respect to any 

securitization vehicle that retains a collateral manager for investment advice regarding 

the assets of the securitization vehicle, such a collateral manager would be required to 

comply with all of the provisions of § __.11(a) to acquire and retain an ownership interest 

in such securitization vehicle. 

The final rule therefore both identifies certain activities that would be included as 

organizing and offering a securitization and modifies the requirements of § __.11 to 

reflect differences between securitizations and other types of covered funds, as discussed

above. The Agencies believe, therefore, that the final rule appropriately addresses the 

type of activity that is usually associated with organizing and offering a securitization and 
714

also comports with the manner in which Congress chose to define the type of parties 

engaged in activities that merit special attention related to issuing entities of asset-backed 

securities in another part of the Dodd-Frank Act. 

The Agencies have determined to provide this exemption by using their authority 

in section 13(d)(1)(J) of the BHC Act and believe that this exemption promotes and 

protects the safety and soundness of banking entities and the financial stability of the 

United States. Many companies and other entities utilize securitization transactions to 

efficiently manage, allocate and distribute risks throughout the markets in a manner 

consistent with meeting the demands of their investors. Companies also utilize 

securitizations in order to help provide liquidity to certain asset classes or portions of the 

market that, absent this liquidity, may experience decreased liquidity and increased costs 

of funding. For instance, if banking entities were not permitted to organize and offer a 

securitization, the Agencies believe this would result in increased costs of funding or 

credit for many businesses of all sizes that are engaged in activities that section 13 of the 

BHC Act was not designed to address. Additionally, this exemption enables banking 

entities to acquire and retain ownership interests in a covered fund to comply with section 

15G of the Exchange Act, which requires certain parties to a securitization transaction to 

retain a minimum amount of risk in a securitization, a requirement not applicable to 

covered funds that are not securitizations. The Agencies therefore have determined that 

this exemption will promote and protect the safety and soundness of banking entities and 

the financial stability of the United States by facilitating the benefits securitizations can 

provide as discussed above, and also by enabling banking entities to comply with section 

15G of the Exchange Act. 
715

The Agencies believe it would not be consistent with the safety and soundness of 

banking entities or the financial stability of the United States to prevent banking entities 

from acquiring or retaining ownership interests in securitizations as part of the permitted 

activity of organizing and offering securitizations or from meeting any applicable 

requirements related to securitizations, including those imposed under section 15G of the 

Exchange Act. The Agencies note that the exemption for organizing and offering a 

securitization does not relieve banking entities of any requirements that they may be 

subject to with respect to their investments in or relationships with a securitization, such 

as any applicable requirements regarding conflicts of interest relating to certain 

securitizations under section 27B of the Securities Act of 1933. 

c. Underwriting and Market Making for a Covered Fund

Section 13(d)(1)(B) permits a banking entity to purchase and sell securities and 

other instruments described in 13(h)(4) in connection with certain underwriting or market 

making-related activities.2260 The proposal did not discuss how this exemption applied in 

the context of underwriting or market making of ownership interests in covered funds.

Commenters argued that the scope of the permitted activities under sections 

13(d)(1)(B), (D) and (F), which respectively set out permitted activities of underwriting 

and market making-related activities, activities on behalf of customers, and activities by a 

regulated insurance company, apply to all of the activities prohibited under section 13(a), 

whether those activities would involve proprietary trading or ownership of or acting as a 

 

2260 See 12 U.S.C. 1851(d)(1)(B).
716

sponsor to covered funds.2261 Commenters argued that the statutory exemption for 

underwriting and market making-related activities is applicable to both proprietary 

trading and covered fund activities, and recommended that the final rule allow banking 

entities to hold ownership interests and other securities of covered funds for the purpose 

of underwriting and engaging in market making-related activities.2262 Commenters noted 

that many structured finance vehicles rely on sections 3(c)(1) and 3(c)(7) of the 

Investment Company Act, and argued that, without a market making exemption for 

securities of covered funds, banking entities would be unable to engage in customerdriven underwriting and market making activity with respect to securities issued by 

entities such as collateralized loan obligation issuers and non-U.S. exchange-traded 

funds.2263

After careful review of the comments in light of the statutory provisions, the final 

rule has been modified to provide a covered fund specific provision for underwriting and 

market making-related activities of ownership interests in covered funds. These 

underwriting and market making activities are within the scope of permitted activities 

under the final rule so long as:

• The banking entity conducts the activities in accordance with the requirements of 

§ __.4(a) or § __.4(b), respectively; 

 

2261 See Cleary Gottlieb et al.; JPMC; Credit Suisse (Williams).

2262 See BoA; Cleary Gottlieb; Credit Suisse (Williams); SIFMA et al. (Covered Funds) (Feb. 2012); See

also Deutsche Bank (Fund-Linked Products); SIFMA (Securitization) (Feb. 2012). Other commenters 

argued that application of Section 13(f) of the BHC Act would prohibit the underwriting and market 

making by a banking entity of the securities of a covered fund that such banking entity sponsors, organizes 

and offers or provides investment management advice or services because Section 13(f) of the BHC Act 

prohibits the purchase of securities by a banking entity from such a covered fund. See, e.g., ASF (Feb. 

2012); Cleary Gottlieb; Credit Suisse (Williams); SIFMA (Securitization) (Feb. 2012); FSA (Feb. 2012).

2263 See JPMC; Cleary Gottlieb.
717

• With respect to any banking entity (or an affiliate thereof) that: acts as a sponsor, 

investment adviser or commodity trading advisor to a particular covered fund or 

otherwise acquires and retains an ownership interest in such covered fund in 

reliance on § __.11(a); acquires and retains an ownership interest in such covered 

fund and is either a securitizer, as that term is used in section 15G(a)(3) of the 

Exchange Act, or is acquiring and retaining an ownership interest in such covered 

fund in compliance with section 15G of that Act and the implementing regulations 

issued thereunder each as permitted by § __.11(b); or, directly or indirectly, 

guarantees, assumes, or otherwise insures the obligations or performance of the 

covered fund or of any covered fund in which such fund invests, then in each such 

case any ownership interests acquired or retained by the banking entity and its 

affiliates in connection with underwriting and market making related activities for 

that particular covered fund are included in the calculation of ownership interests 

permitted to be held by the banking entity and its affiliates under the limitations of 

§ __.12(a)(2)(ii) and § __.12(d); and

• With respect to any banking entity, the aggregate value of all ownership interests 

of the banking entity and its affiliates in all covered funds acquired and retained 

under § __.11, including all covered funds in which the banking entity holds an 

ownership interest in connection with underwriting and market making related 

activities under § __.11(c), are included in the calculation of all ownership 

interests under § __.12(a)(2)(iii) and § __.12(d).2264

The Agencies believe that providing a separate provision relating to permitted 

underwriting and market making-related activities for ownership interests in covered 

funds is supported by section 13(d)(1)(B) of the BHC Act.2265 The exemption for 

underwriting and market making-related activities under section 13(d)(1)(B), by its terms, 

is a statutorily permitted activity and exemption from the prohibitions in section 13(a), 

whether on proprietary trading or on covered fund activities. Applying the statutory 

exemption in this manner accommodates the capital raising activities of covered funds 

 

2264 See final rule §_.11(c). 

2265 A discussion of the implementation of section 13(d)(1)(D) and (F) with regard to the final rule’s 

limitations on covered fund investments and activities is provided in the section that relates to permitted 

covered fund interests and activities by a regulated insurance company and §__.13(c) of the final rule. 
718

and other issuers in accordance with the underwriting and market making provisions 

under the statute. 

The final rule provides that a banking entity must include any ownership interests 

that it acquires or retains in connection with underwriting and market making-related 

activities for a particular covered fund for purposes of the per-fund limitation under § 

__.12(a)(2)(ii) if the banking entity: (i) acts as a sponsor, investment adviser or 

commodity trading advisor to the covered fund; (ii) otherwise acquires and retains an 

ownership interest in the covered fund as permitted under § __.11(a); (iii) acquires and 

retains an ownership interest in the covered fund and is either a securitizer, as that term is 

used in section 15G(a)(3) of the Exchange Act, or is acquiring and retaining an 

ownership interest in the covered fund in compliance with section 15G of that Act and 

the implementing regulations issued thereunder each as permitted by § __.11(b); or (iv) 

directly or indirectly guarantees, assumes, or otherwise insures the obligations or 

performance of the covered fund or of any covered fund in which such fund invests. This 

is designed to prevent any unintended expansion of ownership of covered funds by 

banking entities that are subject to the per fund limitations under § __.12.

These banking entities will have a limited ability to engage in underwriting or 

market making-related activities for a covered fund for which the banking entity’s 

investments are subject to the per-fund limitations in § __.12 as discussed above. Such a 

banking entity will have more flexibility to underwrite and make a market in the 

ownership interests of such a covered fund in connection with organizing and offering the 

covered fund during the fund’s seeding period, since during the seeding period a banking 
719

entity may own in excess of three percent of the covered fund, subject to the other 

requirements in § __.12. 

The final rule also provides that all banking entities that engage in underwriting 

and market-making related activities in covered funds are required to include the 

aggregate value of all ownership interests of the banking entity in all covered funds 

acquired and retained under 

§ __.11, including in connection with underwriting and market making-related activities 

under 

§ __.11(c), in the calculation of the aggregate covered fund ownership interest limitations 

under § __.12(a)(2)(iii) (and make the associated deduction from tier one capital for 

purposes of calculating compliance with applicable regulatory capital requirements).2266 

Some commenters asked that the Agencies permit banking entities to engage in 

market making and underwriting in non-sponsored covered fund interests.2267 The final 

rule permits a banking entity that does not hold an ownership interest in the covered fund 

in reliance on 

§§ __.11(a) or __.11(b) of the final rule, is not a sponsor of the covered fund, is not an 

investment adviser or commodity trading advisor to the covered fund, and does not, 

directly or indirectly, guarantee, assume, or otherwise insure the obligations or 

performance of the covered fund or of any covered fund in which such fund invests to 

rely on the market-making and underwriting exemption in § __.11(c) provided that the 

banking entity meets all of the requirements of that exemption. These conditions include 

 

2266 See final rule § __.11(c)(3). 

2267 See Cleary Gottlieb; Credit Suisse (Williams).
720

the aggregate funds limitation and the capital deduction contained in § __.12 after 

including all ownership interest held by the banking entity and its affiliates under § __.11, 

including ownership interests acquired or retained under the exemption for underwriting 

and market making-related activities in § __.11(c). In accordance with section 13(d)(1) 

of the BHC Act, the Agencies have determined that these restrictions on reliance on the 

market-making and underwriting exemption provided by section 13(d)(1)(B) are 

appropriate to address the purposes of section 13 of the BHC Act, which is aimed at 

assuring that banking entities do not bail-out a covered fund and maintain sufficient 

capital against the risks of ownership of covered funds. The Agencies note, however, 

that the guarantee restriction is not intended to prevent a banking entity from entering 

into arrangements with a covered fund that are not entered into for the purpose of 

guaranteeing the obligations or performance of the covered fund. For example, this 

restriction is not intended to prohibit a banking entity from entering into or providing 

liquidity facilities or letters of credit for covered funds; however, it would apply to 

arrangements such as a put of the ownership interest in the covered fund to the banking 

entity. The determination of whether an arrangement would fall within this guarantee 

restriction would depend on the facts and circumstances.

The Agencies emphasize that any banking entity that engages in underwriting or 

market making-related activities in covered funds must comply with all of the conditions 

applicable to such activity as set forth in section §§ __.4(a) and __.4(b).2268 Thus, 

holdings of a single covered fund would be subject to limitations on risk as well as length 

 

2268 See final rule § __.11(c)(1).
721

of holding period, among other applicable limitations and requirements. These 

requirements are designed specifically to address a banking entity’s underwriting and 

market making-related activities and to prohibit holding exposures in excess of 

reasonably expected near term demand of clients, customers and counterparties. 

3. Section __.12: Permitted Investment in a Covered Fund

a. Proposed Rule

Section __.12 of the proposed rule implemented section 13(d)(4) of the BHC Act 

and described the limited circumstances under which a banking entity may acquire or 

retain an ownership interest in a covered fund that the banking entity (which includes its 

subsidiaries and affiliates) organizes and offers.2269 Section 13(d)(4)(A) of the BHC Act 

permits a banking entity to acquire and retain an ownership interest in a covered fund that 

the banking entity organizes and offers for the purpose of: (i) establishing the fund and 

providing the fund with sufficient initial equity for investment to permit the fund to 

attract unaffiliated investors; or (ii) making a de minimis investment in the fund, subject 

to several limitations. Section 13(d)(4)(B) of the BHC Act requires that investments by a 

banking entity in a covered fund must, not later than one year after the date of 

establishment of the fund, be reduced to an amount that is not more than three percent of 

the total outstanding ownership interests of the fund. Consistent with the statute, § 

.__12 of the proposal provided that, after expiration of the seeding period, a banking 

entity’s investment in a single covered fund may not represent more than three percent of 

the total outstanding ownership interests in the covered fund (the “per-fund 

 

2269 12 U.S.C. 1851(d)(4); proposed rule § __.12.
722

limitation”).2270 In addition, as provided in the statute, the proposal provided that the 

total amount invested by a banking entity in all covered funds may not exceed three 

percent of the tier 1 capital of the banking entity (the “aggregate funds limitation”).2271 

b. Duration of Seeding Period for New Covered Funds 

Commenters argued that it is essential to serving their customers efficiently that a 

banking entity be permitted to acquire and retain an ownership interest in a covered fund 

that it organizes and offers as a de minimis investment or for the purpose of establishing 

the fund. A number of commenters contended that a banking entity typically invests a 

limited amount of its own capital in a fund (“seed capital”) as part of organizing the fund 

to produce investment performance as a record of the fund’s investment strategy (“track 

record”).2272 Once a track record for the fund is established, the banking entity markets 

the fund to unaffiliated investors. 

Commenters argued that the one-year seeding period provided in the proposed 

rule would be too short to establish a track record for many types of covered funds. 

Commenters argued that the duration of the track record investors typically demand 

before investing in a new fund depends on a number of factors (e.g., the type of fund, 

investment strategy, and potential investors). According to commenters, an inability to 

demonstrate a track record over multiple years may reduce the allocation of capital by 

 

2270 See proposed rule §§ __.12(a)(1)(i); _.12(a)(2)(i)(A) and (B); __.12(b). 

2271 See id. at §§ __.12(a)(1)(ii); __.12(a)(2)(ii); __.12(c).

2272 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); SSgA (Feb. 2012); T. Rowe Price; Credit Suisse 

(Williams); Allen & Overy (on behalf of Canadian Banks);TCW. 
723

investors who are unable to gain an understanding of the investment strategy, risk profile, 

and potential performance of the fund.2273

Commenters provided alternative suggestions regarding how to define the start of 

the seeding period for purposes of applying the statutory exception for investments 

during the seeding period. For example, two commenters recommended that the 

Agencies treat a private equity fund as being established on the date on which the fund 

begins its asset-acquisition phase and is closed to new investors, and a hedge fund as 

established on the date on which the fund has reached its target amount of funding and 

begins investing according to the fund’s stated investment objectives.2274 Another 

commenter suggested that the permitted seeding period begin on the date on which thirdparty investors are first admitted to the fund.2275

Several commenters expressed concern that the per-fund limitation could be 

subject to evasion unless the Agencies require that the seeding period begin at the time 

funds are first invested by the banking entity in the fund.2276 Some of these commenters 

suggested the Agencies impose a dollar cap of $10 million on the seed capital that a 

banking entity may provide to a newly organized covered fund in addition to the statutory 

limits based on the amount of the fund’s shares and the amount of the banking entity’s 

 

2273 See et al. (Covered Funds) (Feb. 2012); See also Ass’n of Institutional Investors (Feb. 2012); Bank of 

Montreal et al. (Jan. 2012); Allen & Overy (on behalf of Canadian Banks); Credit Suisse (Williams); 

Japanese Bankers Ass’n; SSgA (Feb. 2012); T. Rowe Price; Union Asset. One commenter argued that 

this limitation would constrain portfolio composition of a covered fund due to an inability of a fund to raise 

sufficient capital to make larger investments. See Credit Suisse (Williams).

2274 See AFG; Union Asset.

2275 See SIFMA (Mar. 2012); See also Credit Suisse (Williams).

2276 See AFR et al. (Feb. 2012); Occupy; Public Citizen; Sens. Merkley & Levin (Feb. 2012).
724

tier 1 capital.2277 These commenters argued that an explicit quantitative limit better 

accounted for the size of some banking entities, which otherwise made the potential 

amount of capital placed in covered funds quite large.2278 

The Agencies have considered carefully the comments on the proposal and have 

made several modifications to the final rule to more clearly explain how the limitations 

apply during the seeding period. The final rule continues to provide that a banking entity 

may invest in a covered fund that it organizes and offers either in connection with 

establishing the fund, or as a de minimis investment.2279 Importantly, the statute does not 

permit a banking entity to invest in a covered fund unless the banking entity organizes or 

offers the covered fund or qualifies for another exemption. As explained more fully in 

the discussion of § __.11 above, a wide variety of activities are encompassed in 

organizing and offering a covered fund. Under the statute, which generally prohibits 

investments in covered funds, a banking entity may invest in a covered fund under the 

exemptions provided in section 13(d)(1) of the BHC Act, including section 13(d)(1)(G) 

and the provisions of section 13(d)(4), only if the banking entity engages in one or more 

of these permitted activities with regard to that covered fund and complies with all 

applicable limitations under the final rule regarding investments in a covered fund. 

As noted above, the statute allows a banking entity to acquire and hold all of the 

ownership interests in a covered fund for the purpose of establishing the fund and

providing the fund with sufficient initial equity for investment to permit the fund to 

 

2277 See Occupy; Sens. Merkley & Levin (Feb. 2012); See also 156 Cong. Rec. S5897 (daily ed. July 15, 

2010) (statement of Sen. Merkley).

2278 See, e.g., Public Citizen.

2279 See final rule §__.12(a)(1). 
725

attract unaffiliated investors.2280 However, the statute also imposes a limit on the 

duration of an investment made in connection with seeding a covered fund. At the end of 

that period, the investment must conform to the limits on de minimis investments set by 

the statute. In keeping with the terms of the statute, the final rule, like the proposal, 

allows banking entities a seeding period of one-year for all covered funds. The statute 

also allows the Board to extend that period, upon an application by a banking entity, for 

two additional years if the Board finds an extension to be consistent with safety and 

soundness and in the public interest.2281 As explained below, the final rule, like the 

proposal, incorporates this process and sets forth the factors the Board will consider when 

determining whether to allow an extended seeding period. The Board and the Agencies 

will monitor these extension requests to ensure that banking entities do not seek 

extensions for the purpose of evading the restrictions on covered funds or to engage in 

prohibited proprietary trading. 

As noted above, the proposal did not specify “date of establishment,” and 

commenters suggested a variety of dates that could serve as the date of establishment for 

purposes of determining the duration of the seeding period and the per-fund limitations 

on ownership interests in a covered fund.2282 After considering comments received on 

the proposal, the Agencies have modified the final rule to include a definition of “date of 

establishment” for a covered fund. In general, the date of establishment is the date on 

which an investment adviser or similar party begins to make investments that execute an 

 

2280 12 U.S.C. 1851(d)(4).

2281 See id. at 1851(d)(4)(C).

2282 See SIFMA et al. (Mar. 2012); Credit Suisse (Williams); EFAMA: Hong Kong Inv. Funds Ass’n; 

AFG; Union Asset.
726

investment or trading strategy for the covered fund. The Agencies perceive the act of 

making investments to execute an investment or trading strategy as demonstrating that 

the fund has begun its existence and is no longer simply a plan or proposal. In order to 

account for the unique circumstances and manner in which securitizations are established, 

for a covered fund that is an issuing entity of asset-backed securities, the date of 

establishment under the final rule is the date on which the assets are initially transferred 

into the issuing entity of the asset-backed securities. This is the date that the entity is 

formed and the securities are generally sold around this time. The Agencies believe this 

is the appropriate time for the date of establishment for securitizations because this is the 

date that the securitization risks are transferred to the owners of the securitization vehicle. 

Once the assets have been transferred, the securitization has been established and 

securities of the issuer may typically be priced in support of organizing and offering the 

issuer. Setting a later time, such as when the fund becomes fully subscribed or the assets 

have been fully assembled, could permit a banking entity to engage in prohibited 

proprietary trading under the guise of waiting for investors that may never 

materialize.2283 

The statute also requires a banking entity to actively seek unaffiliated investors to 

reduce or dilute the entity’s ownership interest to the amount permitted under the statute. 

This requirement is included in the final rule, and underscores the nature of covered fund 

activities under section 13(d)(1)(G) as a method to provide investment advisory, trust and 

 

2283 Importantly, the statute recognizes that a banking entity may need more than the automatic one-year 

Seeding period to build a track record and/or market its interests to unaffiliated investors; therefore, a 

banking entity may apply for an extension of the Seeding period as provided in __.12(e) of the final rule as 

discussed below in Part IV.B.3.h.
727

fiduciary services to customers rather than allow the banking entity to engage in 

prohibited proprietary trading. To effectuate the requirements of the statute, under the 

final rule, banking entities that organize and offer a covered fund must develop and 

document a plan for offering shares in the covered fund to other investors and 

conforming the banking entity’s investments to the de minimis limits to help monitor and 

ensure compliance with this requirement. 

While certain commenters requested that the final rule include a quantitative 

dollar limit on the amount of funds a banking entity may use to organize and offer a 

covered fund, the Agencies have declined to add this limitation in the final rule. This 

type of limit is not required by statute. Moreover, the Agencies believe that imposing a 

strict dollar limit may not adequately permit banking entities to employ trading or 

investment strategies that will attract unaffiliated investors, thereby precluding banking 

entities from meeting the demands of customers contrary to the purpose of section 13. 

c. Limitations on Investments in a Single Covered Fund (“Per-Fund Limitation”)

Section 13(d)(4)(B) imposes limits on the amount of ownership interest a banking 

entity may have in any single covered fund at the end of the one year period (subject to 

limited extension) after the date of establishment of the fund (the “seeding period”). In 

recognition of the fact that a covered fund may have multiple classes or types of 

ownership interests with different characteristics or values, the proposal required that a 

banking entity apply the limits to both the total value of and total amount of the banking 

entity’s ownership interest in a covered fund.

The proposed rule required a banking entity to calculate the per-fund limitation 

using two methods. First, a banking entity was required to calculate the value of its 
728

investments and capital contributions made with respect to any ownership interest in a 

single covered fund as a percentage of the value of all investments and capital 

contributions made by all persons in that covered fund. Second, a banking entity was 

required to determine the total number of ownership interests held by the banking entity 

in a single covered fund as a percentage of the total number of ownership interests held 

by all persons in that covered fund.2284 Both calculations were required to be done 

without regard to committed funds not yet called for investment. The proposed rule also 

required the banking entity to calculate the value and amount of its ownership interest in 

each covered fund in the same manner and according to the same standards utilized by 

the covered fund for determining the aggregate value of the fund’s assets and ownership 

interests.2285 These calculations were designed to ensure that the banking entity’s 

investment in a covered fund could not result in more than three percent of the losses of 

the covered fund being allocated to the banking entity’s investment.2286 

Commenters did not generally object to calculating the per-fund limitation based 

on both number and value of ownership interests. Several commenters urged the 

Agencies to allow a banking entity to value its investment in a covered fund based on the 

acquisition cost of the investment, instead of fair market value, notwithstanding the 

manner in which the covered fund accounts for or values investments for its shareholders 

generally.2287 One commenter suggested that the Agencies allow a banking entity to 

choose between acquisition cost and fair value so long as the chosen valuation method is 

 

2284 See proposed rule §__.12(b)(2). 

2285 See proposed rule §__.12(b)(4). 

2286 See Joint Proposal, 76 FR at 68,904.

2287 See ABA (Keating); BoA; Arnold & Porter; BOK; Scale; SVB. 
729

applied consistently to both the numerator and denominator when calculating the perfund limitation.2288

To the extent that an issuer of an asset-backed security is a covered fund, the 

investment limitations contained in section 13(d)(4) of the BHC Act also would limit the 

ability of a banking entity to acquire or retain an investment in that issuer. Section 941 of 

the Dodd-Frank Act added a new section 15G of the Exchange Act (15 U.S.C. 78o-11) 

which requires certain parties to a securitization transaction, including banking entities, to 

retain and maintain a certain minimum interest in certain issuers or asset-backed 

securities.2289 In order to give effect to this separate requirement under the Dodd-Frank 

Act, § __.14(a)(2) of the proposed rule permitted a banking entity that is a “securitizer” 

or “originator” under that provisions of the Act to acquire or retain an ownership interest 

in an issuer of asset-backed securities, in an amount (or value of economic interest) 

required to comply with the minimum requirements of section 15G of the Exchange Act 

and any implementing regulations issued thereunder.2290 The proposal also permitted a 

banking entity to act as sponsor to the securitization. 

Commenters expressed a variety of views on the treatment of interests in 

securitizations held under risk retention pursuant to the proposed rule. Some commenters

argued that the proposal was effective as written and represented a reasonable way to 

reconcile the two sections of the Dodd-Frank Act consistent with the risk-reducing 

 

2288 See ABA (Keating) (alleging that this is similar to the SEC’s approach to the definition of venture 

capital fund for the purposes of being exempt from investment advisor registration). 

2289 The relevant agencies issued a proposed rule to implement the requirements of section 15G of the 

Exchange Act, as required under section 941 of the Dodd-Frank Act. See Credit Risk Retention, 76 FR 

24,090 (Apr. 29, 2011). Those agencies recently issued a re-proposal of the risk-retention requirements. 

See Credit Risk Retention, 78 FR 57,928 (Sept. 20, 2013).

2290 See proposed rule § __.14(a)(2)(iii).
730

objective of section 13 of the BHC Act.2291 Other commenters also supported the 

proposal’s recognition that banking entities may be required to hold a certain amount of 

risk in a securitization that would also be a covered fund, but argued that the proposed 

exemption was too narrow.2292 Some commenters argued that the exemption should be 

broadened to permit a banking entity to hold in excess of the minimum amount required 

under section 15G of the Exchange Act instead of allowing only the minimum amount 

required by that section.2293 One commenter requested that the final rule permit a 

banking entity to hold an amount of risk in a securitization that is commensurate with 

what investors demand rather than the minimum required by section 15G.2294 Some 

commenters argued that banking entities may be subject to similar generally applicable 

requirements to hold risk in securitizations under foreign law, such as Article 122a of the 

Capital Requirements Directive issued by the European Union, and that the final rule 

should permit banking entities to comply with these foreign legal requirements.2295

Conversely, a few commenters objected to the proposed rule’s exemption for riskretention as unclear and argued that if the exemption was retained, the Agencies should 

provide that any amounts held by a banking entity in a securitization that exceed the 

minimum required to satisfy section 15G of the Exchange Act should count towards the 

aggregate funds limitation of the banking entity.2296 One commenter argued that the final 

 

2291 See Sens. Merkley & Levin (Feb. 2012); Alfred Brock.

2292 See, e.g., AFME et al.; SIFMA (Securitization) (Feb. 2012); JPMC; BoA.

2293 See AFME et al.; SIFMA (Securitization) (Feb. 2012); JPMC; BoA.

2294 See BoA.

2295 See AFME et al.; Allen & Overy (on behalf of Foreign Bank Group); SIFMA (Securitization) (Feb. 

2012);BoA.

2296 See Occupy.
731

rule should impose higher capital charges for interests held in these securitizations due to 

concerns that securitizations involve heightened risks due to the complexity of their 

ownership structure.2297

The Agencies have carefully considered the comments received and are adopting 

the calculation requirements for the per-fund limitation as proposed with several 

modifications, including modifications designed to address the unique characteristics and 

ownership structure of securitizations. The final rule, like the proposal, requires that a 

banking entity calculate its per-fund investment limit in covered funds that are not issuing 

entities of asset-backed securities based on both the value of its investments and capital 

contributions in and to each covered fund and the total number of ownership interests it 

has in each covered fund. A banking entity’s investment (including investments by its 

affiliates) may not exceed either three percent of the value of the covered fund or three 

percent of the number of ownership interests in the covered fund at the end of the seeding 

period. The Agencies continue to believe that requiring the per-fund limitation to be 

calculated based on these two measures best effectuates the terms and purpose of the perfund limitation in the statute. Together, these measures ensure that a banking entity’s 

exposure to and ownership of each covered fund is limited. Each measure alone could 

provide a distorted view of the banking entity’s ownership interest and could be more 

easily manipulated, for example by issuing ownership interests with high value or special 

governance provisions. As discussed in more detail below, the final rule contains a 

separate method for calculating the value of investments in issuing entities of asset-

 

2297 See Sens. Merkley & Levin (Feb. 2012).
732

backed securities due to the fact that these entities do not have a single class of security 

and thus, the valuation of the ownership interests cannot be made on a per interest or 

single class basis. 

The per-fund limitation on ownership interests must be measured against the total 

ownership interests of the covered fund, as defined in § __.10 of the final rule and as 

discussed above in Part IV.B.1.e. In determining the amount of ownership interests held 

by the banking entity and its affiliates, the banking entity must include an ownership 

interest permitted under §§ __.4 and __.11 of the final rule.2298 Additionally, any 

banking entity that acts as underwriter or market-maker for ownership interests of a 

covered fund must do so in compliance with the limitations of §§ __.4(a) and __.4(b) of 

the final rule, including the limits on the amount, types, and risk of the underwriting 

position or market-maker inventory as well as in compliance with the per-fund limitation, 

as applicable, and the aggregate funds limitations and capital deduction in the final rule. 

The Agencies expect to monitor these activities to ensure that a banking entity does not 

engage in underwriting or market making-related activity in a manner that is inconsistent 

with the limitations of the statute and the final rule.2299

 

2298 As discussed above in Part IV.B.2.c., the per-fund limitation does not apply to ownership interests held 

by a banking entity that acts as market maker or underwriter in accordance with § __.11(c) of the final rule, 

so long as the banking entity does not also organize and offer, or act as sponsor, investment adviser or 

commodity trading advisor to, the fund, or, with respect to ownership interests in issuing entities of assetbacked securities, is not a securitizer who continues to own ownership interests or is not an entity that holds 

ownership interests in compliance with Section 15G of the Exchange Act and the implementing regulations 

adopted thereunder; however, the banking entity that is acting as market maker or underwriter that is not 

subject to the per-fund limitation must still comply with the other requirements set forth in §§ __.4(a) and 

__.4(b), respectively, and any other applicable requirements set out in § __.11(c). 

2299 The Agencies note that if a banking entity acts as investment adviser or commodity trading advisor to a 

covered fund and shares the same name or variation of the same name with the fund, then that banking 

entity would be a sponsor and therefore subject to the limitations of section 13(f).
733

The final rule requires that the value of the ownership interests and contributions 

made by a banking entity in each covered fund (that is not an issuing entity of an assetbacked security) be the fair market value of the interest or contribution. The Agencies 

have determined to use fair market value as the measurement of value for the per-fund 

value limitation in order to ensure comparability with the investments made in the 

covered fund by others and limit the potential that the valuation measure can be 

manipulated (for example by altering the percentage of gains and losses that are 

associated with a particular ownership interest). A banking entity should determine fair 

market value for purposes of the final rule, including the calculation of both the per-fund 

and aggregate funds limitations, in a manner that is consistent with its determination of 

the fair market value of its assets for financial statement purposes and that fair market 

value would be determined in a manner consistent with the valuations reported by the 

relevant covered fund unless the banking entity determines otherwise for purposes of its 

financial statements and documents the reason for any disparity. If fair market value 

cannot be determined, then the value shall be the historical cost basis of all investments 

and capital contributions made by the banking entity to the covered fund. The final rule 

also requires that, once a valuation method is chosen, the banking entity calculate the 

value of its investments and the investments of all others in the covered fund for purposes 

of the per-fund limitation in the same manner and according to the same standards.2300 

This approach is intended to ensure that, for purposes of calculating the per-fund 

 

2300 In the context of securitizations, the final rule similarly provides that the valuation methodology used 

to calculate the fair market value of the ownership interests must be the same for both the ownership 

interests held by a banking entity and the ownership interests held by all other investors in the covered fund 

in the same manner and according to the same standards.
734

limitation, a banking entity does not calculate its investment in a covered fund in a 

manner more favorable to the banking entity than the method used by the covered fund 

for valuing the investments made by others. Under the final rule and as explained in 

more detail below, any ownership interest acquired or retained by an employee or 

director of the banking entity is attributed to the banking entity for purposes of the perfund limitation if the banking entity financed the purchase of the ownership interest. 

Additionally, any amount contributed or paid by a banking entity or its employee to 

obtain an ownership interest in connection with obtaining the restricted profit interest 

must be included in calculating compliance with the per-fund and aggregate funds 

limitations (See Part IV.B.1.e. above).2301

In determining the per-fund limitation for purposes of § __.12 of the final rule, the 

banking entity should use the same methodology for valuing its investments and capital 

contributions as the banking entity uses to prepare its financial statements and regulatory 

reports.2302 In particular, the fair market value of a banking entity’s investments and any 

capital contributions made to a covered fund should be the same for purposes of § __.12 

of the final rule as reported on the banking entity’s financial statements and regulatory 

reports. Similarly, if fair market value of all investments in and capital contributions 

cannot be determined for purposes of § __.12 of the final rule, then the banking entity 

should use the same methodology to calculate the historical cost basis of the investments 

and any capital contributions as the banking entity uses to prepare its financial statements 

 

2301 See Part IV.B.1.e.

2302 For example, a depository institution or bank holding company should use the same methodology as 

used in the Report of Condition and Income (Call Report) for depository institutions and the Consolidated 

Financial Statements for Holding Companies (FR Y-9C) for bank holding companies, respectively.
735

and regulatory reports. The Agencies will review carefully the methodology that a 

banking entity uses to calculate the value of its investments in and capital contributions 

made to covered funds as part of the process to monitor compliance with the final rule.

The Agencies expect that for the majority of covered funds, the party that 

organizes and offers the fund or otherwise exercises control over the fund will provide a 

standard methodology for valuing interests in the fund. However, the Agencies 

understand that for some covered funds, including issuing entities of asset backed 

securities, there may be multiple parties that organize and offer the fund that each utilize 

a different methodology or standard for calculating the value of ownership interests of the 

fund. Going forward, the Agencies expect that in these circumstances the parties that 

organize and offer the covered fund will work together or select a responsible party to 

determine a single standard by which all ownership interests in the covered fund will be 

valued.

One commenter suggested the Agencies count both invested funds and committed 

funds not yet called for investment towards the per-fund limitation.2303 This commenter 

argued that a banking entity has already contractually allocated committed-yet-uncalled 

funds to the covered fund and that depositors face a risk of loss for such funds if the 

covered fund fails. 

The final rule, like the proposal, does not count committed-yet-uncalled funds 

towards the per-fund limitation; instead, it counts funds once they are invested. This 

approach reflects the fact that these funds may never be called while at the same time 

ensuring that the banking entity must comply with the per-fund limitation once the funds 

 

2303 See Occupy. 
736

are called. The Agencies note that a banking entity is prohibited from guaranteeing or 

bailing out a covered fund that the banking entity or one of its affiliates organizes and 

offers by the terms of the statute and the final rule and, accordingly, would not be 

permitted to provide committed funds to a covered fund in a manner inconsistent with the 

limitations in the statute and final rule.

After carefully considering the comments received on the proposal, as well as the 

language and purpose of section 13 of the BHC Act, the final rule provides that, for 

purposes of applying the per-fund limitation to an investment in a covered fund that is an 

issuing entity of an asset-backed security, the ownership interest held by the banking 

entity and its affiliates generally may not exceed three percent of the fair market value of 

the ownership interests of the fund as measured in accordance with § __.12(b)(3), unless 

a greater percentage is retained by the banking entity and its affiliates in compliance with 

the requirements of section 15G of the Exchange Act and the implementing regulations 

issued thereunder, in which case the investment by the banking entity and its affiliates in 

the covered fund may not exceed the amount, number, or value of ownership interests of 

the fund required under section 15G of the Exchange Act and the implementing 

regulations issued thereunder. A banking entity may rely on any of the options available 

to it in order to meet the requirements of section 15G, but for purposes of section 13 of 

the BHC Act and this rule, the amount held by the banking entity may not exceed the 

amount required under the chosen option. Under the final rule, if a banking entity’s 

investment in a covered fund is held pursuant to the requirements of section 15G of the 

Exchange Act, the banking entity must calculate the amount and value of its ownership 

interest for purposes of the per-fund limitation as of the date and according to the same 
737

valuation methodology applicable pursuant to the requirements of that section and the 

implementing regulations issued thereunder. 

While the amount retained in compliance with section 15G of the Exchange Act 

and the implementing regulations issued thereunder may permit a banking entity to own 

more than three percent of the ownership interests in a securitization that is a covered 

fund, this approach is appropriate to reconcile the competing policies of section 13 of the 

BHC Act and section 15G of the Exchange Act which requires that a securitizer of 

certain securitizations retain a minimum of five percent of the risk of the securitization. 

Congress enacted these two apparently conflicting provisions in the same Act, and the 

Agencies believe the more specific section regarding risk retention in securitizations was 

intended to prevail over the more general restriction on ownership of covered funds 

(which applies to a broader range of entities). The Agencies believe that the risk 

limitation goals of section 13 of the BHC Act are met by satisfying the minimum 

requirement of an applicable option under section 15G of the Exchange Act as the 

maximum initial investment limit, and applying the other limitations discussed in this 

section governing aggregate investment in covered funds and capital deductions.

As under the proposal, if a banking entity does not have a minimum risk retention 

requirement, that banking entity would remain subject to the limitations of section 

13(d)(4) of the BHC Act and § __.12 on the amount of ownership interests it may hold in 

an issuing entity of asset-backed securities. A banking entity may not combine the 

amounts under these provisions to acquire or retain ownership interests in a securitization 

that exceed the aggregate permissible amounts. 
738

Some commenters requested that the Agencies coordinate implementation of any 

exemption for risk-retention requirements under section 13 of the BHC Act with the 

issuance of rules implementing section 15G of the Exchange Act. The Agencies note that 

rules implementing section 15G have been proposed but not yet finalized, but the 

Agencies will review the interaction between the rules promulgated under section 13 of 

the BHC Act and section 15G of the Exchange Act once the rules under section 15G are 

finalized. Regardless of any action that may be taken regarding rules implementing 

section 15G, the final rule permits banking entities to own ownership interests in and 

sponsor covered funds as discussed above.

Some commenters also requested that the final rule provide an exemption to 

permit banking entities to comply with any risk retention requirement imposed under 

foreign law that is similar to section 15G of the Exchange Act. The Agencies are not 

revising the rule to permit banking entities to own ownership interests required to be 

retained pursuant to risk retention-type requirements under foreign law. The Agencies 

are providing the exemption for the required ownership arising from the risk retention 

provisions under section 15G of the Exchange Act in order to reconcile the requirements 

under the Dodd-Frank Act applicable to ownership of securitization interests; however, 

the Agencies do not believe at this time that such reconciliation is appropriate with 

respect to foreign law risk retention-type requirements and those requirements should not 

prevail over the purpose of section 13 of the BHC Act to reduce banking entities’ 

exposure to risks from investments in covered funds. 

The Agencies also note that the definition of covered fund has been modified to 

exclude certain foreign public funds and also any foreign fund that is not owned or 
739

sponsored by a U.S. banking entity. Moreover, the final rule permits foreign banking 

entities to engage in covered fund activities and investments that occur solely outside of 

the United States without regard to the investment limitations of section 13(d)(4) of the 

BHC Act and § __.12 of the final rule, which may include retaining risk in a 

securitization to the extent required under foreign law. In these manners, the final rule 

permits foreign banking entities to comply with requirements under foreign law that 

govern their securitization activities or investments abroad. However, as noted above, 

section 13 of the BHC Act applies to the global operations of U.S. banking entities and, 

as such, U.S. banking entities’ investments in foreign securitizations that are covered 

funds would remain subject to the investment limitations of section 13(d)(4) and § __.12 

of the final rule.

The proposed rule provided that a banking entity must comply with both measures 

of the per-fund limitation at all times. The preamble to the proposal explained that the 

Agencies expected a banking entity to calculate its per-fund limitation no less frequently 

than the frequency with which the fund performs such calculation or issues or redeems 

interests, and in no case less frequently than quarterly.2304

Several commenters requested that the Agencies modify the frequency of this 

calculation and monitoring requirement to a standard quarterly basis.2305 These 

commenters argued that, although some covered funds may provide daily liquidation and 

redemption rights to investors, monitoring the per-fund limitation on a continuous basis 

would be costly and burdensome and would not provide a significant offsetting benefit. 

 

2304 See proposed rule § __.12(b); Joint Proposal, 76 FR at 68,904. 

2305 See, e.g., ABA (Keating); Credit Suisse (Williams); JPMC. 
740

The Agencies continue to believe that for covered funds other than issuing entities 

of asset-backed securities the per-fund limitations apply to investments in covered funds 

at all times following the end of the seeding period. However, to relieve burden and 

costs, while also setting a minimum recordkeeping standard, the final rule has been 

modified to require that a banking entity calculate the amount and value of its ownership 

interests in covered funds other than issuing entities of asset-backed securities 

quarterly.2306 The Agencies believe that this change will assist in reducing unnecessary 

costs and burdens in connection with calculating the per-fund limitation, particularly for 

smaller banking entities, and will also facilitate consistency with the calculation for the 

aggregate funds limitation (which is also determined on a quarterly basis). Nevertheless, 

should a banking entity become aware that it has exceeded the per-fund limitation for a 

given fund at any time, the Agencies expect the banking entity to take steps to ensure that 

the banking entity complies promptly with the per-fund limitation.2307

The Agencies have also modified the timing and methodology of the per-fund 

limitation as it applies to securitizations to address the unique circumstances and 

ownership structure presented by securitizations, which typically wind down over time. 

Unlike many other covered funds, securitizations do not generally experience increases in 

the amount of investors or value of ownership interests during the life of the 

securitization; rather, they generally experience only a contraction of the investor base 

and reduction in the total outstanding value of ownership interests on an aggregate basis, 

 

2306 See final rule §_.12(b)(2)(i) and (ii). For covered funds that are an issuing entity of asset-backed 

securities, recalculation of the banking entity’s permitted ownership for purposes of the per-fund limitation 

is not required unless the covered fund sells additional securities.

2307 See 12 U.S.C. 1851(d)(4)(B)(ii)(I).
741

and may do so at different rates under the terms of the transaction agreements, meaning 

that the percentage of ownership represented by a particular ownership interest may 

increase as the fund amortizes but without the banking entity adding any funds. The 

manner in which securitizations are organized and offered, as well as the amortization of 

securitizations, differs from many other covered funds; section 15G of the Exchange Act 

also requires that certain parties to securitization transactions, which may include banking 

entities, retain a minimum amount of risk in a securitization, a requirement not applicable 

to covered funds that are not securitizations. Therefore, for purposes of calculating a 

banking entity’s per-fund limitation with respect to a securitization, the calculation of the 

per-fund limitation shall be based on whether section 15G applies and the implementing 

regulations are effective. In the case of an ownership interest in an issuing entity of an 

asset-backed security that is subject to section 15G of the Exchange Act and for which 

effective implementing regulations have been issued, the calculation of the per-fund 

limitation shall be made as of the date and pursuant to the methodology applicable 

pursuant to the requirements of section 15G of the Exchange Act and the implementing 

regulations issued. For securitizations executed after the effective date of the final rule 

and prior to the adoption and implementation of the rules promulgated under section 15G 

of the Exchange Act and for securitizations for which a fair valuation calculation is not 

required by the implementing rules promulgated under section 15G of the Exchange Act, 

the per fund limitation is calculated as of the date on which the assets are initially 

transferred into the issuing entity of the asset-backed securities or such earlier date on 

which the transferred assets have been valued for purposes of transfer to the covered 
742

fund.2308 This calculation for issuers of asset backed securities is only required to be 

performed once on the date noted above, and thereafter only upon the date on which the 

price of additional securities of the covered fund to be sold to third parties is determined. 

As noted above, the per-fund limitations for ownership interests in issuing entities 

of asset-backed securities are calculated based only on the value of the ownership interest 

in relation to the value of all ownership interests in the issuing entity of the asset-backed 

security and are not calculated on a class by class, or tranche by tranche basis. For 

purposes of the valuation, the aggregate value of all the assets that are transferred to the 

issuing entity of the asset-backed securities, and any assets otherwise held by the issuing 

entity, are determined based on the valuation methodology used for determining the value 

of the assets for financial statement purposes. This valuation will be the value of the 

ownership interests in the issuing entity for purposes of the calculation. A banking entity 

will need to determine its percentage ownership in the issuing entity based on the its 

contributions to the entity in relation to the contributions of all parties and after taking 

into account the value of any residual interest in the issuing entity. In addition, for 

purposes of the final rule, the asset valuation is as of the date of establishment (the date of 

the asset transfer to the issuing entity of the asset-backed securities). 

d. Limitation on Aggregate Permitted Investments in all Covered funds (“Aggregate Funds 

Limitation”)

 

2308 In addition, although some commenters requested that banking entities be able to hold more than the 

minimum required by section 15G, the Agencies are not revising the per fund limitation in that manner. 

One of the purposes of section 13 of the BHC Act is to reduce banking entities’ exposure to risks from 

investments in covered funds, and the Agencies believe at this time that permitting banking entities to

retain risk exposure to the covered fund in excess of the minimum required to be retained would contradict 

the purposes of section 13 of the BHC Act.
743

In addition to the per-fund limitation, section 13(d)(4) of the BHC Act provides 

that the aggregate of a banking entity’s investments in all covered funds may not exceed 

three percent of the tier 1 capital of the banking entity (referred to above as the 

“aggregate funds limitation”).2309 To implement this limitation, the proposed rule 

required a banking entity to determine the aggregate value of the banking entity’s 

investments in covered funds by calculating the sum of the value of each investment in a 

covered fund, as determined in accordance with applicable accounting standards. This 

amount was then measured as a percentage of the tier 1 capital of the banking entity for 

purposes of determining compliance with the aggregate funds limitation. For purposes of 

applying the limit, a banking entity that is subject to regulatory capital requirements was 

required under the proposed rule to measure tier 1 capital in accordance with those 

regulatory capital requirements; a banking entity that is not a subsidiary of a reporting 

banking entity and that is not itself required to report capital in accordance with the riskbased capital rules of a Federal banking agency was required by the proposed rule to 

calculate its tier 1 capital based on the total amount of shareholders’ equity of the top-tier 

entity as of the last day of the most recent calendar quarter, as determined under 

applicable accounting standards. 

Commenters expressed a variety of views regarding the aggregate funds 

limitation. One commenter argued that basing the aggregate funds limitation on the size 

of tier 1 capital of a banking entity provides an advantage to the largest institutions with 

large absolute capital bases and disadvantages smaller banks that are well capitalized but 

 

2309 See 12 U.S.C. 1851(d)(4)(B)(ii)(II). 
744

have a smaller absolute capital base.2310 This commenter urged the Agencies to permit 

all banking entities to invest in covered funds in an amount that is, in the aggregate, the 

greater of $1 billion (subject to prudential investment limitations and safety and 

soundness concerns), or three percent of tier 1 capital.2311 

In contrast, other commenters urged the Agencies to decrease the statutory limit 

in order to prevent the largest banking entities from investing amounts that, while within 

the statutory limit, could be very large in absolute terms.2312 One commenter argued that 

a loss of three percent of tier 1 capital would be a material loss reflected in a change in 

stock price.2313 Another commenter suggested the Agencies consider whether the 

investment supports a large flow of management fees linked to market volatility or has 

significant embedded leverage.2314

Some commenters argued that the final rule should calculate the value of covered 

fund investments based on acquisition cost instead of fair market value.2315 These 

commenters argued that using fair value to calculate the aggregate funds limitation 

penalizes banking entities for organizing and investing in successful funds and, 

conversely, would allow banking entities to increase investments in unsuccessful funds 

(the value of which would decline relative to the capital of the banking entity). 

 

2310 See ABA (Abernathy). 

2311 See, e.g., ABA (Abernathy). 

2312 See AFR et al. (Feb. 2012); Public Citizen.

2313 See Public Citizen.

2314 See AFR et al. (Feb. 2012).

2315 See ABA(Keating); BoA; Arnold & Porter; BOK; Scale; SVB. 
745

In contrast, another commenter argued that valuation of a covered fund 

investment should include any mark-to-market increase in a banking entity’s aggregate 

investments in order to keep pace with increases in the capital of the banking entity.2316 

Some commenters discussing the frequency of the calculation of the aggregate 

funds limitation supported determining the aggregate funds limitation on the last day of 

each calendar quarter as required in the proposal.2317 Other commenters argued that the 

statute requires compliance at all times rather than periodic calculations of 

compliance.

2318

After consideration of the comments in light of the statutory provisions, the 

Agencies have adopted the requirements for calculating the aggregate funds limitation as 

proposed with several modifications as explained below. Under the final rule, the 

aggregate value is the sum of all amounts paid or contributed by the banking entity in 

connection with acquiring or retaining an ownership interest in each covered fund 

(together with any amounts paid by the entity (or employee thereof) in connection with 

obtaining a restricted profit interest under § __.10(d)(6)(ii)), as measured on a historical 

cost basis. This aggregate value is measured against the total applicable tier 1 capital for 

the banking entity as explained below.

For purposes of determining the aggregate funds limitation, the final rule requires 

that the value of investments made by a banking entity be calculated on a historical cost 

basis. This approach limits the aggregate amount of funds a banking entity may provide 

 

2316 See Occupy.

2317 See ABA (Keating).

2318 See AFR et al. (Feb. 2012); Occupy. 
746

to covered funds as a percentage of the banking entity’s capital as required by statute. At 

the same time, this approach does not permit a banking entity to increase its exposure to 

covered funds in the event any investment in a particular covered fund declines in value 

as a result of the fund’s investment activities. Permitting a banking entity to increase its 

aggregate investments as covered funds lose value would permit the banking entity both 

to increase its exposure to covered funds at the same time the covered funds it already 

owns are losing value and to effectively bail-out investors by providing additional capital 

to troubled covered funds. Neither of these actions is consistent with the purposes of 

section 13 of the BHC Act. Moreover and as explained below, because the final rule 

requires that the banking entity deduct from the entity’s capital the greater of historical 

cost (plus earnings) or fair market value of its investments in covered funds, the 

deduction accounts for any profits resulting from investments in covered funds. 

Historical cost basis means, with respect to a banking entity’s ownership interest 

in a covered fund, the sum of all amounts paid or contributed by the banking entity to a 

covered fund in connection with acquiring or retaining an ownership interest (together 

with any amounts paid by the entity (or employee thereof) in connection with obtaining a 

restricted profit interest)), less any amounts received as a redemption, sale or distribution 

of such ownership interest or restricted profit interest. Under the final rule, any reduction 

of the historical cost would not generally include gains or losses, fees, income, expenses 

or similar items. However, as noted above, the final rule also requires that a banking 

entity deduct any earnings from its tier 1 capital even if it values its ownership interests in 

a covered fund pursuant to historical cost.
747

The concern expressed by commenters that the aggregate funds limitation should 

account for increases in the fair market value of covered funds is addressed in other ways 

under the final rule. In particular, the final rule requires that for purposes of calculating 

compliance with regulatory capital requirements the banking entity deduct from the 

entity’s capital the greater of fair market value (or historical cost plus earnings) of its 

investment in each covered fund; thus, profits resulting from investments in covered 

funds will not inflate the capital of the banking entity for regulatory compliance purposes. 

Moreover, as explained above, the per-fund limitation is generally based on fair market 

value, which maintains the relative level of a banking entity’s investment in each covered 

fund. 

As noted above, the aggregate funds limitation applies to all investments by a 

banking entity in a covered fund that the banking entity or an affiliate thereof holds under 

§§ __.4 and __.11 of the final rule. The limitation would also apply to investments by a 

banking entity made or held during the seeding period as part of organizing and offering 

a covered fund, including ownership interests held in order to satisfy the requirements of 

section 15G of the Exchange Act, as well as ownership interests held by a banking entity 

in the capacity of acting as underwriter or market-maker.

As under the proposal, this calculation must be made as of the last day of each 

calendar quarter, consistent with when tier 1 capital is reported by banking entities to the 

Agencies. Because compliance with the aggregate funds limitations is calculated based 

on tier 1 capital, the Agencies believe it is more appropriate to require the calculation to 

be performed on the same schedule as tier 1 capital is reported. While the aggregate 

funds limitation must be calculated on a quarterly basis, the Agencies expect banking 
748

entities to monitor investments in covered funds regularly and remain in compliance with 

the limitations on covered fund investments throughout the quarter. The Agencies intend, 

through their respective supervisory processes, to monitor covered fund investment 

activity to ensure that a banking entity is not attempting to evade the requirements of 

section 13.

The Agencies recognize that banks with large absolute capital bases will be able 

to place a greater amount of capital in covered funds compared to banks with small 

absolute capital bases. However, the amount of risk exposure to a covered fund, despite 

their different investment strategies, will be relatively similar across banking entities, 

which is consistent with the language and risk-limiting purpose of section 13.

e. Capital Treatment of an Investment in a Covered Fund

Section 13(d)(4)(B)(iii) of the BHC Act provides that, for purposes of 

determining compliance with applicable capital standards under section 13(d)(3) of that 

Act, the aggregate amount of outstanding investments by a banking entity under section 

13(d)(4), including retained earnings, must be deducted from the assets and tangible 

equity of the banking entity, and the amount of the deduction must increase 

commensurate with the leverage of the covered fund.2319 Section 13(d)(3) authorizes the 

Agencies, by rule, to impose additional capital requirements and quantitative limitations, 

including diversification requirements on any of the activities permitted under section 13 

of the BHC Act if the Agencies determine that such additional capital and quantitative 

 

2319 See 12 U.S.C. 1851(d)(4)(B)(iii).
749

limitations are appropriate to protect the safety and soundness of banking entities 

engaged in such activities.2320

The proposed rule implemented the capital deduction provided for under section 

13(d)(4)(B)(iii) of the BHC Act by requiring a banking entity to deduct the aggregate fair 

value of its investments in covered funds, including any attributed profits, from tier 1 

capital. As in the statute, the proposed rule applied the capital deduction to ownership 

interests in covered funds held as an investment by a banking entity pursuant to the 

provisions of section 13(d)(4) of the BHC Act, and not to ownership interests acquired 

under other permitted authorities, such as a risk-mitigating hedge under section 13 of the 

BHC Act. The proposed rule required the deduction to be calculated consistent with the 

method for calculating other deductions under the applicable risk-based capital rules. 

The proposed rule did not otherwise adopt additional capital requirements and 

quantitative limitations under section 13(d)(3) of the BHC Act. 

Some commenters supported the proposed dollar-for-dollar deduction from tier 1 

capital of a banking entity’s aggregate investments in covered funds and asserted it is 

consistent with the statute.2321 One of these commenters urged the Agencies to rely on 

their authority under section 13(d)(3) of the BHC Act to apply the capital deduction to 

other permitted ownership interests in covered funds to protect the safety and soundness 

of the banking entity.2322 In contrast, other commenters urged the Agencies to eliminate 

the capital deduction for investments in covered funds and questioned the Agencies’ 

 

2320 Id. at 1851(d)(3). 

2321 See Occupy.

2322 See Occupy. 
750

statutory authority to impose the capital deduction.2323 These commenters argued that the 

statute does not authorize or require the Agencies to require banking entities to deduct 

their investments in covered funds for purposes of calculating capital pursuant to the 

applicable capital rules. According to these commenters, section 13 only requires 

deductions for purposes of determining compliance with applicable capital standards 

under section 13 and argued the Agencies did not make the necessary safety and 

soundness findings under section 13(d)(3) to impose additional capital requirements on 

any activities permitted under section 13(d)(1).2324 One commenter urged the Agencies 

to make any capital adjustment as part of the banking agencies’ broader efforts to 

implement the Basel III capital framework.2325 Another commenter urged the Agencies 

to apply the capital deduction only for purposes of determining a banking entity’s 

compliance with the aggregate funds limitation and not for other regulatory capital 

purposes.2326 This commenter also argued that a capital deduction is normally not 

required for assets reflected on a bank’s consolidated balance sheet, and that the Agencies 

should not require a deduction for a covered fund investment that is not consolidated with 

the banking entity for financial reporting purposes under GAAP.2327 Some commenters 

urged the Agencies to apply the capital deduction only to a banking entity’s investment in 

 

2323 See ABA (Keating); BNY Mellon et al.; PNC; SIFMA et al. (Covered Funds) (Feb. 2012); SVB. 

2324 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012). 

2325 Id.

2326 See ABA (Keating). 

2327 See ABA (Keating); See also letter from PNC.
751

a covered fund that the banking entity organizes and offers and not to ownership interests 

otherwise permitted to be held under section 13 of the BHC Act.2328

Several commenters addressed the manner for valuing an investment subject to 

the deduction. One commenter urged the Agencies to permit a banking entity to calculate 

the deduction based on the acquisition cost, instead of the fair market value, of the 

banking entity’s ownership interest in the covered fund.2329 This commenter emphasized 

that valuing the investment at fair market value would penalize a banking entity if the 

covered fund performs well by reducing the amount of capital available for additional 

covered fund investments but reduce the capital charge against troubled investments. 

One commenter argued that the Agencies did not perform an appropriate cost-benefit 

analysis of the deduction in the proposed rules.2330

Other commenters sought clarification on how the capital deduction would apply 

to a foreign banking organization. Several commenters argued that the capital deduction 

should not apply to a foreign banking entity that calculates its tier 1 capital under the 

standards of its home country.2331 These commenters argued that imposing a capital 

deduction requirement on foreign banks would not be consistent with past practices on 

the application of U.S. risk-based capital requirements to foreign banking organizations. 

The Agencies have carefully considered the comments in light of the statutory 

provisions requiring a capital deduction. The statute requires that the aggregate amount 

of outstanding investments by a banking entity, including retained earnings, be deducted 

 

2328 See Arnold & Porter; SVB. 

2329 See SIFMA et al. (Covered Funds) (Feb. 2012).

2330 Id.

2331 See IIB/EBF.
752

from the assets and tangible equity of the banking entity.2332 This requirement is 

independent of the minimum regulatory capital requirements in the final capital rule 

published by the Federal Banking agencies in 2013 (“regulatory capital rule”).2333 

The Federal Banking agencies recognize that the regulatory capital rule imposes 

risk weights and deductions that do not correspond to the deduction for covered fund 

investments imposed by section 13 of the BHC Act. The Federal Banking agencies 

intend to review the interaction between the requirements of this rule and the 

requirements of the regulatory capital rule and expect to propose steps to reconcile the 

two rules.

At the same time, the Agencies believe that the dollar-for-dollar deduction of the 

fair market value of a banking entity’s investment in a covered fund is appropriate to 

protect the safety and soundness of the banking entity, as provided in section 13(d) of the 

BHC Act. This approach ensures that a banking entity can withstand the failure of a 

covered fund without causing the banking entity to breach the minimum regulatory 

capital requirements. Consistent with the language and purpose of section 13 of the BHC 

Act, this deduction will help provide that a banking entity has sufficient capital to absorb 

losses that may occur from covered fund investments without endangering the safety and 

soundness of the banking entity or the financial stability of the United States.

Accordingly, under the final rule, a banking entity must, for purposes of 

determining compliance with applicable regulatory capital requirements, deduct the 

greater of (i) the sum of all amounts paid or contributed by the banking entity in 

 

2332 See 12 U.S.C. 1851(d)(4)(B)(iii). 

2333 See 78 FR 62,018, 62,072 (Oct. 11, 2013) (Board/OCC/FDIC Basel III Final Rule); 78 FR 55,340, 

55,391 (Sept. 10, 2013) (FDIC Basel III interim final rule).
753

connection with acquiring or retaining an ownership interest (together with any amounts 

paid by the entity (or employee thereof) in connection with obtaining a restricted profit 

interest under § __.10(b)(6)(ii)), on a historical cost basis, including earnings or (ii) the 

fair market value of the sum of all amounts paid or contributed by the banking entity in 

connection with acquiring or retaining an ownership interest (together with any amounts 

paid by the entity (or employee thereof) in connection with obtaining a restricted profit 

interest under § __.10(b)(6)(ii)), if the banking entity accounts for the profits (or losses) 

of the fund investment in its financial statements.2334 This deduction must be made 

whenever the banking entity calculates its tier 1 capital, either quarterly or at such other 

time at which the appropriate Federal banking agency may request such a calculation. 

Requiring a banking entity to deduct the greater of historical cost or fair market value of 

all covered fund investments made by a banking entity from the entity’s tier 1 capital 

should result in an appropriate deduction that is consistent with the manner in which the 

banking entity accounts for its covered fund investments. For instance, if a banking 

entity accounts for its investments in covered funds using fair market value, then any 

changes in the fair market value of the banking entity’s investment in a covered fund 

should similarly be reflected in the banking entity’s tier 1 capital. Thus, this deduction 

should not unduly penalize banking entities for making successful investments or allow 

more investments in troubled covered funds. 

The final rule does not require a foreign banking entity that makes a covered fund 

investment in the United States, either directly or through a branch or agency, to deduct 

 

2334 See 12 CFR part 208, subpart D and appendixes A, B, E, and F; 12 CFR part 217 (to be codified), and 

12 CFR part 225, appendixes A, D, E, and G; See also 12 CFR 240.15c3-1 (net capital requirements for 

brokers or dealers).
754

the aggregate value of the investment from the foreign bank’s tier 1 capital calculated 

under applicable home country standards. However, any U.S. subsidiary of a foreign 

banking entity that is required to calculate tier 1 capital under U.S. risk based capital 

regulations must deduct the aggregate value of investment held through that subsidiary 

from its tier 1 capital.

While some commenters requested that additional capital charges be imposed on 

banking entity’s interests in securitizations, the Agencies have declined to do so at this 

time. Under the final rule, the banking entity must deduct the value of its investment in a 

securitization that is a covered fund from its tier 1 capital for purposes of determining 

compliance with the applicable regulatory capital requirements. This requirement 

already requires the banking entity to adjust its capital for the possibility of losses on the 

full amount of its investment. The Agencies do not believe that it is appropriate to 

impose additional capital charges on these securitizations because it would act as a 

disincentive to retain risk in securitizations for which the banking entity acts as issuer or 

sponsor, a result that would contradict the purpose of section 15G of the Exchange Act. 

Additionally and as noted in the proposal, permitting a banking entity to retain the 

minimum level of economic interest and risk in a securitization will incent banking 

entities to engage in more careful and prudent underwriting and evaluation of the risks 

and obligations that may accompany asset-backed securitizations, which would promote 

and protect the safety and soundness of banking entities and the financial stability of the 

United States.

The Agencies have also declined to impose additional quantitative limitations or 

diversification requirements on covered fund investments at this time. The Agencies 
755

believe that the per-fund and aggregate funds limitations, as well as the capital deduction 

required by the rule, acting together with the other limitations on covered fund activities, 

establish an appropriate framework for ensuring that the covered fund investments and 

activities of banking entities are conducted in a manner that is safe and sound and 

consistent with financial stability. The Agencies will continue to monitor these activities 

and investments to determine whether other limitations are appropriate over time.

f. Attribution of Ownership Interests to a Banking Entity 

The proposed rule attributed an ownership interest to a banking entity based on 

whether or not the banking entity held the interest through a controlled entity. The 

proposed rule required that any ownership interest held by any entity that is controlled, 

directly or indirectly, by a banking entity be included in the amount and value of the 

banking entity’s permitted investments in a single covered fund. The proposed rule 

required that the pro rata share of any ownership interest held by any covered fund that is 

not controlled by the banking entity, but in which the banking entity owns, controls, or 

holds with the power to vote more than 5 percent of the voting shares, be included in the 

amount and value of the banking entity’s permitted investments in a single covered fund. 

Many commenters expressed concerns regarding the proposed attribution 

requirements.2335 These commenters argued that the proposed pro rata attribution 

requirements are not required or permitted by the statute, have unintended and 

inconsistent consequences for covered fund investments, impose heavy compliance costs 

on banking entities, and would impede the ability of funds sponsored by banking entities 

 

2335 See ABA (Keating); Arnold & Porter; SIFMA et al. (Covered Funds) (Feb. 2012); SSgA (Feb. 2012). 
756

to invest in third-party funds for the benefit of clients. Some commenters argued that the 

costs and complexity of determining whether a banking entity “controls” another banking 

entity under the BHC Act and the Board’s precedent are high and urged the Agencies to 

adopt a simpler test.2336 For example, some commenters urged that shares of a company 

be attributed to a banking entity only when the banking entity maintains ownership of 25 

percent or more of voting shares of the company.2337 

Several commenters maintained that applying the attribution requirements to 

fund-of-funds structures and parallel or master-feeder structures would be 

unworkable.2338 Commenters contended that the proposed attribution rules could result 

in a banking entity calculating the per-fund limitation in a way that exceeds the banking 

entity’s actual loss exposure if the attribution rule for controlled investments is 

interpreted to require that 100 percent of all investments made by controlled entities be 

attributed to the banking entity.2339

In addition, several commenters argued that the pro rata attribution of investments 

held through non-controlled structures is not consistent with the Board’s rules and 

practices for purposes of the activity and investment limits in other sections of the BHC 

 

2336 See SIFMA et al. (Covered Funds) (Feb. 2012); BlackRock; Arnold & Porter. 

2337 See ABA (Keating); Arnold & Porter.

2338 See BoA; SIFMA et al. (Covered Funds) (Feb. 2012); SSgA (Feb. 2012). These commenters argued 

that banking entities traditionally utilize a fund-of-funds structure to offer customers the opportunity to 

invest indirectly in a portfolio of other funds (including some funds sponsored and managed by one or more 

third parties) and that these structures provide customers with certain risk-mitigating benefits and allow 

customers to gain exposure to a diverse portfolio without having to satisfy the minimum investment 

requirements of each fund directly. They also argued that parallel and feeder entities are established for a 

variety of client-driven reasons, including to accommodate tax needs of clients and that these entities 

should be viewed as a single investment program in which the master fund holds and manages investments 

in portfolio assets and the feeder fund typically makes no investments other than in the master fund.

2339 See SIFMA et al. (Covered Funds) (Feb. 2012); BoA; Arnold & Porter; SSgA (Feb. 2012). 
757

Act. Commenters also maintained that this pro rata attribution for non-controlled entities 

would be impracticable because a banking entity has only a limited ability to monitor, 

direct, or restrain investments of a covered fund that it does not control.2340 

Conversely, one commenter supported the pro rata attribution requirement in the 

proposal. This commenter argued that this requirement reduced opportunities for evasion 

through subsidiaries, affiliates or related entities.2341 

The final rule has been modified in light of the comments. Under the final rule, a 

banking entity must account for an investment in a covered fund for purposes of the perfund and aggregate funds limitations only if the investment is made by the banking entity 

or another entity controlled by the banking entity. Accordingly, the final rule does not 

generally require that a banking entity include the pro rata share of any ownership interest 

held by any entity that is not controlled by the banking entity, and thus reduces the 

potential compliance costs of the final rule. The Agencies believe that this concept of 

attribution is more consistent with how the Board has historically applied the concept of 

“control” under the BHC Act for purposes of determining whether a company subject to 

that Act is engaged in an activity or whether to attribute an investment to that company. 

Furthermore, because a banking entity does not control a non-affiliate and typically has 

less access to information about the holdings of a non-affiliate, this change is unlikely to 

present opportunity for circumvention of the per-fund and aggregate funds limitations. 

 

2340 See SIFMA et al. (Covered Funds) (Feb. 2012).

2341 See Occupy.
758

The Agencies will monitor these limitations for practices that appear to be attempts to 

circumvent them.2342

Whether a banking entity controls another entity under the BHC Act may vary 

depending on the type of entity in question. As noted above in Part IV.B.1.b.3., the 

Board’s regulations and orders have long recognized that the concept of control is 

different for funds than for operating companies.2343 In contrast to the proposal, the final 

rule incorporates these different concepts of control in part by providing that, for 

purposes of section 13 of the BHC Act and the final rule, a registered investment 

company, SEC-regulated business development company, and a foreign public fund as 

described in § __.10(c)(1) of the final rule will not be considered to be an affiliate of the 

banking entity if the banking entity owns, controls, or holds with the power to vote less 

than 25 percent of the voting shares of the company or fund, and provides investment 

advisory, commodity trading advisory, administrative, and other services to the company 

or fund only in a manner that complies with other limitations under applicable 

regulation, order, or other authority.2344

In response to commenter concerns regarding the workability of the proposed 

rule, the final rule has been modified to address how ownership interests would be 

attributed to a banking entity when those interests are held in a fund-of-funds or multitiered fund structures. For instance, banking entities may use a variety of structures to 

 

2342 The Agencies note that other provisions of the BHC Act and Savings and Loan Holding Company Act 

would prohibit a banking entity that is a bank holding company or savings and loan holding company from 

acquiring 5 percent or more of a covered fund that is itself a bank holding company or a savings and loan 

holding company, respectively, without regulatory approval. See 12 U.S.C. 1842(a); 12 U.S.C. 1467a(e). 

2343 See, e.g., First Union Letter.

2344 Id. See final rule §__.12(b)(1)(ii).
759

satisfy operational needs or meet the investment needs of customers of their trust, 

fiduciary, investment advisory or commodity trading advisory services.

First, except as explained for purposes of calculating a banking entity’s permitted 

investment in multi-tier fund structures, the final rule does not generally attribute to a 

banking entity ownership interests held by a covered fund so long as the banking entity’s 

investment in the covered fund meets the per-fund limitation in the final rule.2345 Absent 

unusual circumstances or structures, a banking entity would not control a covered fund in 

which the banking entity has an ownership interest that conforms to the per-fund and 

aggregate funds limitations contained in the final rule. Thus, the interests held by that 

covered fund would not be attributed to the banking entity for the reasons discussed 

above. 

The final rule also explains how the investment limitations apply to investments 

of a banking entity in multi-tier fund structures. The Agencies believe that master-feeder 

fund structures typically constitute a single investment program in which the master fund 

holds and manages investments and the feeder funds typically make no investments other 

than in the master fund and exist as a convenience for customers of the trust, fiduciary, 

investment advisory, or commodity trading advisory services of the banking entity. 

Similarly, trust, fiduciary, or advisory customers of a banking entity may desire to obtain 

diversified exposure to a variety of funds or investments through investing in a fund-offunds structure that the banking entity organizes and offers. 

In order to meet the demands of these customers, the final rule provides that if the 

principal investment strategy of a covered fund (the “feeder fund”) is to invest 

 

2345 See final rule §__.12(b)(1)(iii). 
760

substantially all of its assets in another single covered fund (the “master fund”), then for 

purposes of the per-fund limitation the banking entity’s permitted investment shall be 

measured only at the master fund. However, in order to appropriately capture the 

banking entity’s amount of investment in the master fund, a banking entity must include 

in this calculation any investment held by the banking entity in the master fund, as well 

as the banking entity’s pro-rata share of any ownership interest of the master fund that is 

held through the feeder fund.2346 

Similarly, regarding fund-of-funds structures, the final rule provides that if a 

banking entity organizes and offers a covered fund pursuant to § __.11 for the purpose of 

investing in other covered funds (a “fund of funds”) and that fund of funds itself invests 

in another covered fund that the banking entity organizes and offers, then the banking 

entity’s permitted investment in that other covered fund shall include any investment held 

by the banking entity in that other fund, as well as the banking entity’s pro-rata share of 

any ownership interest of the other fund that is held through the fund of funds. The 

banking entity’s investment in the fund of funds must also meet the investment 

limitations contained in § __.12. In these manners, the final rule permit a banking entity 

to meet the demands of customers of their trust, fiduciary, or advisory services while also 

limiting the ability of a banking entity to be exposed to more than the amount of risk of a 

covered fund contemplated by section 13.

As described above in the discussion of organizing and offering a covered fund, 

other provisions of section 13 contemplate investments by employees and directors of the 

 

2346 See final rule §__.12(b)(34).
761

banking entity that provide qualifying services to a covered fund.2347 The Agencies 

recognized in the proposal that employee and director investments in a covered fund may 

provide an opportunity for a banking entity to evade the limitations regarding the amount 

or value of ownership interests a banking entity may acquire in a covered fund.2348 In 

order to address this concern, the proposal attributed an ownership interest in a covered 

fund acquired or retained by a director or employee to the person’s employing banking 

entity if the banking entity either extends credit for the purposes of allowing the director 

or employee to acquire the ownership interest, guaranteed the director or employee’s 

purchase, or guarantees the director or employee against loss on the investment. 

One commenter supported the way the proposal addressed evasion concerns by 

attributing an ownership interest in a covered fund acquired or retained by a director or 

employee to a banking entity.2349 A different commenter urged the Agencies to attribute 

any employee investments in a covered fund to the banking entity itself, regardless of the 

source of funds.2350 Another commenter argued that the statute prohibits a banking entity 

from guaranteeing an investment by an employee or director.2351 

After considering the comments and the language of the statute, the Agencies 

have determined to retain the requirement that all director or employee investments in a 

covered fund be attributed to the banking entity for purposes of the per-fund limitation 

and the aggregate funds limitation whenever the banking entity provides the employee or 

 

2347 See 12U.S.C. 1851(d)(1)(G)(vii); final rule § __.11(g). 

2348 See Joint Proposal, 76 FR at 68,902. 

2349 See Ass’n. of Institutional Investors (Feb. 2012). 

2350 See Occupy.

2351 See Arnold & Porter. 
762

director funding for the purpose of acquiring the ownership interest. Specifically, under 

the final rule, an investment by a director or employee of a banking entity who acquires 

an ownership interest in his or her personal capacity in a covered fund sponsored by the 

banking entity will be attributed to the banking entity if the banking entity, directly or 

indirectly, extends financing for the purpose of enabling the director or employee to 

acquire the ownership interest in the fund and the financing is used to acquire such 

ownership interest in the covered fund.2352 It is also important to note that the statute 

prohibits a banking entity from guaranteeing the obligations or performance of a covered 

fund in which it acts as investment adviser, investment manager or sponsor, or organizes 

and offers.2353

As discussed above in the definition of ownership interest, the final rule also 

attributes to the banking entity any amounts contributed by an employee or director when 

made in order to receive a restricted profit interest, whether or not funded or guaranteed 

by the banking entity. This approach ensures that all funding provided by the banking 

entity – whether directly or through its employees or directors – and all exposures of the 

banking entity – whether directly or through a guarantee provided to or on behalf of an 

employee or director – is counted against the limits on exposure contained in the statute 

and final rule. At the same time, this approach recognizes that employees and directors 

may use their own resources, not protected by the banking entity, to invest in a covered 

fund. Employees of investment advisers in particular often invest their own resources in 

covered funds they advise, both by choice and as a method to align their personal 

 

2352 See final rule §__.12(b)(1)(iv).

2353 See 12 U.S.C. 1851(f)(1).
763

financial interests with those of other investors in the covered fund. So long as these 

investments are truly with personal resources, and are not funded by the banking entity, 

these personal investments would not expose the banking entity to loss and would not be 

attributed by the final rule to the banking entity. This approach is also consistent with the 

terms of the statute, which expressly contemplates investments by directors or employees 

of a banking entity in their individual capacity.2354 

The Agencies intend to monitor investments by directors and employees of a 

banking entity to ensure that employee ownership interests are not used to circumvent the 

per-fund and aggregate funds limitations in section 13. Among the factors the Agencies 

will consider, in addition to financing and guarantee arrangements, are whether the 

benefits of the acquisition and retention, such as dividends, inure to the benefit of the 

director or employee and not the banking entity; the voting or control of the ownership 

interests is subject to the direction of, or otherwise controlled by, the banking entity; and 

the employee or director, rather than the banking entity, determines whether the 

employee or director should make the investment. 

The proposed rule contained a provision intended to curb potential evasion of the 

per-fund limitation and aggregate limitation through parallel investments by banking 

entities that were not otherwise subject to section 13 of the BHC Act. Specifically, the 

proposed rule provided that, to the extent that a banking entity is contractually obligated 

to invest in, or is found to be acting in concert through knowing participation in a joint 

activity or parallel action toward a common goal of investing in, one or more investments 

with a covered fund that is organized and offered by the banking entity (whether or not 

 

2354 See 12 U.S.C. 1851(d)(1)(G)(vii). 
764

pursuant to an express agreement), such investment must be included in the calculation of 

a banking entity’s per-fund limitation. 

Several commenters objected to this requirement and argued that it was not 

consistent with the statute. These commenters argued that section 13 of the BHC Act 

restricts a banking entity’s investments in covered funds, and not direct investments by a 

banking entity in individual companies under other authorities, such as the merchant 

banking investment authority in section 4(k)(4)(H) of the BHC Act.2355 Some 

commenters argued that prohibiting or limiting direct investments could cause a conflict 

between a banking entity’s fiduciary duty to its clients to manage their covered fund 

investments and the banking entity’s duty to its shareholders to pursue legitimate 

merchant banking investments.2356 Some commenters urged the Agencies not to attribute 

any parallel co-investment alongside a covered fund to a banking entity unless there is a 

pattern of evasion, and some requested that there be prior notice and an opportunity for a 

hearing to determine whether such a pattern has occurred.2357 Another commenter 

recommended the Agencies provide a safe harbor for situations where a bank trustee is 

acting on behalf of customers.2358

In contrast, other commenters contended that the risks of direct investments, such 

as those made under merchant banking authority, are similar to those of many 

investments in covered funds. These commenters urged the Agencies to restrict direct 

 

2355 See 12 U.S.C. 1843(k)(4)(H); 12 CFR 225.170 et seq. See ABA (Keating); BoA; BOK; SIFMA et al.

(Covered Funds) (Feb. 2012); SVB. 

2356 See ABA (Keating).

2357 See BOK; SVB; ABA (Keating); BoA; SIFMA et al. (Covered Funds) (Feb. 2012).

2358 See BOK. 
765

investments in the underlying holdings or assets of a covered fund in the same manner as 

direct investments in covered funds.2359

After carefully considering the comments and the language of the statute, the 

Agencies have determined not to adopt the proposed prohibition on parallel investments 

in the final rule. As illustrated by commenters, banking entities rely on a number of 

investment authorities and structures to meet the needs of their clients and make 

investments under a variety of authorities that are not coordinated with investments made 

by covered funds owned or advised by the banking entity. The Agencies believe that 

many investments made by banking entities are made for the purpose of serving the 

legitimate needs of customers and shareholders, and not for the purpose of circumventing 

the per-fund and aggregate funds limitations in section 13. 

Nevertheless, the Agencies continue to believe that the potential for evasion of 

these limitations may be present where a banking entity coordinates its direct investment 

decisions with the investments of covered funds that it owns or sponsors. For instance, 

the Agencies understand that it is relatively common for the sponsor of a covered fund in 

connection with a privately negotiated investment to offer investors co-investment 

opportunities when the general partner or investment manager for the covered fund 

determines that the covered fund does not have sufficient capital available to make the 

entire investment in the target portfolio company or determines that it would not be 

suitable for the covered fund to take the entire available investment. In such 

circumstances, a banking entity that sponsors the covered fund should not itself make any 

additional side by side co-investment with the covered fund in a privately negotiated 

 

2359 See Public Citizen; Sens. Merkley & Levin (Feb. 2012).
766

investment unless the value of such co-investment is less than 3% of the value of the total 

amount co-invested by other investors in such investment. Further, if the co-investment 

is made through a co-investment vehicle that is itself a covered fund (a “co-investment 

fund”), the sum of the banking entity’s ownership interests in the co-investment fund and 

the related covered fund should not exceed 3% of the sum of the ownership interests held 

by all investors in the co-investment fund and related covered fund. Finally, the 

Agencies note that if a banking entity makes investments side by side in substantially the 

same positions as the covered fund, then the value of such investments shall be included 

for purposes of determining the value of the banking entity’s investment in the covered 

fund.

g. Calculation of Tier 1 Capital 

The proposal explained that tier 1 capital is a banking law concept that, in the 

United States, is calculated and reported by certain depository institutions and bank 

holding companies in order to determine their compliance with regulatory capital 

standards. Accordingly, the proposed rule clarified that for purposes of the aggregate 

funds limitation in §__.12, a banking entity that is a bank, a bank holding company, a 

company that controls an insured depository institution that reports tier 1 capital, or 

uninsured trust company that reports tier 1 capital (each a “reporting banking entity”) 

needed to use the reporting banking entity’s tier 1 capital as of the last day of the most 

recent calendar quarter that has ended, as reported to the relevant Federal banking 

agency.

The proposal also recognizes that not all entities subject to section 13 of the BHC

Act calculate and report tier 1 capital. In order to provide a measure of equality related to 
767

the aggregate funds limitation contained in section 13(d)(4)(B)(ii)(II) of the BHC Act and 

§ __.12(c) of the proposed rule, the proposed rule clarified how the aggregate funds 

limitation should be calculated for entities that are not required to calculate and report tier 

1 capital in order to determine compliance with regulatory capital standards. Under the 

proposed rule, with respect to any banking entity that is not affiliated with a reporting 

banking entity and not itself required to report capital in accordance with the risk-based 

capital rules of a Federal banking agency, the banking entity’s tier 1 capital for purposes 

of the aggregate funds limitation was the total amount of shareholders’ equity of the toptier entity within such organization as of the last day of the most recent calendar quarter 

that has ended, as determined under applicable accounting standards.2360 For a banking 

entity that was not itself required to report tier 1 capital but was a subsidiary of a 

reporting banking entity that is a depository institution (e.g., a subsidiary of a national 

bank), the aggregate funds limitation was the amount of tier 1 capital reported by such 

depository institution.2361 For a banking entity that was not itself required to report tier 1 

capital but was a subsidiary of a reporting banking entity that is not a depository 

institution (e.g., a nonbank subsidiary of a bank holding company), the aggregate funds 

limitation was the amount of tier 1 capital reported by the top-tier affiliate of such 

banking entity that holds and reports tier 1 capital under the proposal.2362

Commenters did not generally object to the proposed approach for determining 

the applicable tier 1 capital for banking entities. One commenter advocated calculating 

 

2360 See proposed rule § __.12(c)(2)(ii)(B)(2). 

2361 See proposed rule § __.12(c)(2)(ii)(A).

2362 See proposed rule § __.12(c)(1)(B(2)(ii)(B)(1).
768

the aggregate funds limitation based on the tier 1 capital of the banking entity making the 

covered fund investment instead of the tier 1 capital of the consolidated banking 

entity.2363 In addition, the commenter urged the Agencies to require banking entities to 

divest any portions of the investment that exceeds 3 percent of that entity’s tier 1 capital.

The final rule provides that any banking entity that is required to calculate and 

report tier 1 capital (a “reporting banking entity”) must calculate the aggregate funds 

limitation using the tier 1 capital amount reported by the entity as of the last day of the 

most recent calendar quarter as reported to the relevant Federal banking agency. A nondepository institution subsidiary of a reporting banking entity may rely on the 

consolidated tier 1 capital of the reporting banking entity for purposes of calculating 

compliance with the aggregate funds limitation. In the case of a depository institution 

that is itself a reporting banking entity and that is also a subsidiary or affiliate of a 

reporting banking entity, the aggregate of all investments in covered funds held by the 

depository institution (including the investments by its subsidiaries) may not exceed three 

percent of either the tier 1 capital of the depository institution or of the top-tier reporting 

banking entity that controls such depository institution. The final rule also provides that 

any banking entity that is not itself required to report tier 1 capital but is a subsidiary of a 

reporting banking entity that is a depository institution (e.g., a subsidiary of a national 

bank) may compute compliance with the aggregate funds limitations using the amount of 

tier 1 capital reported by such depository institution. 

Several commenters argued that foreign banking organizations should be 

permitted to use the consolidated tier 1 capital at the top-tier foreign banking organization 

 

2363 See Occupy.
769

level, as calculated under applicable home country capital standards, to calculate 

compliance with the aggregate funds limitation.2364 One commenter noted that the tier 1 

capital of a banking entity may fluctuate based on specific conditions relevant only to the 

banking entity, and urged the Agencies to consider an alternative measure of capital, 

although this commenter did not suggest any alternative.2365

After considering the comments received and that purpose and language of 

section 13 of the BHC Act, the Agencies have determined that for foreign banking 

organizations, the aggregate funds limitation would be based on the consolidated tier 1 

capital of the foreign banking organization, as calculated under applicable home country 

standards. However, a U.S. bank holding company or U.S. savings and loan holding 

company that is controlled by a foreign banking entity must separately meet the per-fund 

and aggregate funds limitations for each and all (respectively) covered fund investments 

made by the U.S. holding company, based on the tier 1 capital of the U.S. bank holding 

company or U.S. savings and loan holding company. The Federal banking agencies may 

revisit this approach in light of the manner in which the Board implements the enhanced 

prudential standards and early remediation requirements for foreign banking 

organizations and foreign nonbank financial companies, including the proposed U.S. 

intermediate holding company requirements under that rule.2366

h. Extension of Time to Divest Ownership Interest in a Single Fund

 

2364 See Credit Suisse (Williams); IIB/EBF. 

2365 See Japanese Bankers Ass’n.

2366 See Enhanced Prudential Standards and Early Remediation Requirements for Foreign Banking 

Organizations and Foreign Nonbank Financial Companies, 77 FR 76,628, 76,637 (Dec. 28, 2012). 
770

The proposed rule provided that the Board may, upon application by a banking 

entity, extend the period of time that a banking entity may have to conform an investment 

to the 3 percent per-fund limitation. As in the statute, the proposed rule permitted the 

Board to grant up to an additional two years if the Board finds that an extension would be 

consistent with safety and soundness and not detrimental to the public interest. The 

proposal required a banking entity to submit an application for extension to the Board, 

and set forth the factors that the Board would consider in reviewing an application for 

extension, including a requirement that the Board consult with the primary federal 

supervisory agency for the banking entity prior to acting on an application. 

Some commenters argued that the final rule should be modified to extend 

automatically the one-year statutory period for complying with the per-fund limitation by 

an additional two years without application or approval on a case-by-case basis and to 

apply the extended conformance period to the aggregate funds limitations.2367 Some of 

these commenters suggested that Congress explicitly recognized the need for a banking 

entity to have a sufficient seeding period following establishment of a fund, and that 

funds often require more than one year to attract enough unaffiliated investors to enable 

the sponsoring banking entity to reduce its ownership interests in the fund to the level 

required by section 13(d)(4). 

Other commenters argued that the amount of a banking entity’s own capital 

involved in seeding a fund is typically “small” and suggested that, in order to prevent 

banking entities from engaging in prohibited proprietary trading through a fund, the 

 

2367 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012); SSgA (Feb. 2012); TCW; Credit Suisse 

(Williams). 
771

Board should condition the ability of a banking entity to qualify for an extension of the 

one-year statutory period on several requirements, including a requirement that the 

banking entity not have provided more than $10 million in seed capital as part of 

establishing the covered fund.2368

The Agencies have carefully considered comments received on the proposal and 

have determined instead to adopt the process and standards governing requests for 

extensions of time to divest an ownership interest in a single covered fund largely as 

proposed. The Agencies believe that this approach is consistent with the process and 

standards set out under the statute. 

As under the proposal, the final rule requires any banking entity that seeks an 

extension of the conformance period provided for the per-funds limitation to submit a 

written request to the Board. Any such request must be submitted to the Board at least 90 

days prior to the expiration of the applicable time period and provide the reasons why the 

banking entity believes the extension should be granted. In addition, the request must 

explain the banking entity’s plan for reducing the permitted investment in a covered fund 

through redemption, sale, dilution or other methods to the limits imposed by the final 

rule. To allow the Board to assess the factors provided in the statute, the final rule 

provides that any extension request by a banking entity must address: (i) whether the 

investment would result, directly or indirectly, in a material exposure by the banking 

entity to high-risk assets or high-risk trading strategies; (ii) the contractual terms 

governing the banking entity’s interest in the covered fund; (iii) the total exposure of the 

covered banking entity to the investment and the risks that disposing of, or maintaining, 

 

2368 See, e.g., Occupy; Sens. Merkley & Levin (Feb. 2012). 
772

the investment in the covered fund may pose to the banking entity and the financial 

stability of the United States; (iv) the cost to the banking entity of divesting or disposing 

of the investment within the applicable period; (v) whether the investment or the 

divestiture or conformance of the investment would involve or result in a material 

conflict of interest between the banking entity and unaffiliated parties, including clients, 

customers or counterparties to which it owes a duty; (vi) the banking entity’s prior efforts 

to reduce through redemption, sale, dilution, or other methods its ownership interests in 

the covered fund, including activities related to the marketing of interests in such covered 

fund; (vii) market conditions; and (viii) any other factor that the Board believes 

appropriate. In contrast to the proposal, the final rule does not require information on 

whether the extension would pose a threat to safety and soundness of the covered banking 

entity or to financial stability of the United States. The categories of information in final 

rule have been modified in order to eliminate redundancies.

The final rule continues to permit the Board to impose conditions on granting any 

extension granted if the Board determines conditions are necessary or appropriate to 

protect the safety and soundness of banking entities or the financial stability of the United 

States, address material conflicts of interest or otherwise unsound practices, or to 

otherwise further the purposes of section 13 of the BHC Act and the final rule. In cases 

where the banking entity is primarily supervised by another Agency, the Board will 

consult with such Agency both in connection with its review of the application and, if 

applicable, prior to imposing conditions in connection with the approval of any request 

by the banking entity for an extension of the conformance period. While some

commenters requested that the Board modify the final rule to permit a banking entity to 
773

have covered fund investments in excess of the aggregate funds limitation,2369 the final 

rule does not contain such a provision. As noted in the release for the proposed rule, the 

statutory grant of authority to provide extensions of time to comply with the investment 

limits refers specifically and only to the period for conforming a seeding investment to 

the per-fund limitation.2370 

As noted in the proposed rule, the Agencies recognize the potential for evasion of 

the restrictions contained in section 13 of the BHC Act through misuse of requests for 

extension of the seeding period for covered funds. Therefore, the Board and the 

Agencies will monitor requests for extensions of the seeding period for activity in 

covered funds that is inconsistent with the requirements of section 13 of the BHC Act. 

4. 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 riskmitigating hedging activities.2371 In the context of covered fund activities, the proposed 

rule implemented this authority narrowly and permitted a banking entity to acquire or 

retain an ownership interest in a covered fund as a risk-mitigating hedge only in two 

situations: (i) when acting as intermediary on behalf of a customer that is not itself a 

banking entity to facilitate exposure by the customer to the profits and losses of the 

covered fund; and (ii) with respect to a compensation arrangement with an employee of 

the banking entity that directly provides investment advisory or other services to that 

 

2369 See ABA (Keating).

2370 See 12 U.S.C. 1851(d)(4)(C).

2371 See 12 U.S.C. 1851(d)(1)(C).
774

fund.2372 The proposed rule imposed specific requirements on a banking entity seeking to 

rely on this exemption.

2373

The Agencies received a range of comments on the proposed risk-mitigating 

hedging exemption for ownership interests in covered funds. Some commenters objected 

to the limited applicability of the statutory risk-mitigating hedging exemption in the 

covered funds context and urged the Agencies to allow ownership interests in covered 

funds to be used in any appropriate risk-mitigating hedging.2374 In contrast, other 

commenters urged the Agencies to delete one or both of the risk-mitigating hedging 

exemptions as the commenters argued they were inconsistent with the statute or 

otherwise inappropriate.2375 Commenters also argued that a separate risk-mitigating 

hedging exemption for covered funds is unnecessary because the statute provides a single 

risk-mitigating hedging exemption.2376

Some commenters argued that the proposed rule would impede banking entities 

from offering covered-fund linked products to customers, including hedging these 

products, and would, in particular, impair the ability of banking entities to hedge the risks 

of fund-linked derivatives with fund-linked swaps or shares of covered funds referenced 

 

2372 See proposed rule § __.13(b)(1)(i)(A) and (B). 

2373 These requirements were substantially similar to the requirements for the risk-mitigating hedging 

exemption for trading activities contained in proposed §__.5. In addition, proposed §__.13(b) also required 

that: (i) the hedge represent a substantially similar offsetting exposure to the same covered fund and in the 

same amount of ownership interest in that covered fund arising out of the transaction to accommodate a 

specific customer request or directly connected to the banking entity’s compensation arrangement with an 

employee; and (ii) the banking entity document, at the time the transaction is executed, the hedging 

rationale for all hedging transactions involving an ownership interest in a covered fund.

2374 See BoA; Credit Suisse (Williams); Deutsche Bank (Fund-Linked Products); ISDA (Feb. 2012); 

SIFMA et al. (Covered Funds) (Feb. 2012).

2375 See AFR et al. (Feb. 2012); Occupy; Public Citizen; Sens. Merkley & Levin (Feb. 2012).

2376 See BoA.
775

in fund-linked products.2377 These commenters argued this limitation would increase 

risks at banking entities and was inconsistent with the purpose of the risk-mitigating 

hedging exemption. Commenters also proposed modifying the proposal to permit riskmitigating hedging activities that facilitate a customer’s exposure to profits and/or losses 

of the covered fund, to permit portfolio or dynamic hedging strategies involving covered 

fund interests, and to eliminate the proposed condition that a customer would not itself be 

a banking entity.2378 Some commenters also urged the Agencies to grandfather existing 

risk-mitigating hedging activities with respect to any covered-fund linked products that 

comply with the hedging requirements for proprietary trading under §__.5 of the 

proposed rule.2379 

In contrast, other commenters objected to the exemption for hedging covered 

fund-linked products sold to customers. These commenters asserted that this activity 

would authorize investment in covered funds in a manner that would not be subject to the 

three percent per-fund limitation;2380 or would be inconsistent with the statutory 

requirement that a banking entity actively seek additional investors for a fund.2381 

Some commenters urged the Agencies to expand the hedging exemption to allow 

banking entities to invest in covered funds in order to hedge obligations relating to 

deferred compensation plans for employees who do not directly provide services to the 

 

2377 See ISDA (Feb. 2012); BoA; Credit Suisse (Williams); Deutsche Bank (Fund-Linked Products); ISDA 

(Feb. 2012); SIFMA et al. (Covered Funds) (Feb. 2012).

2378 See, e.g., BoA; SIFMA et al. (Covered Funds) (Feb. 2012); Deutsche Bank (Fund-Linked Products).

2379 See SIFMA et al. (Covered Funds) (Feb. 2012); BoA.

2380 See Sens. Merkley & Levin (Feb. 2012).

2381 See AFR et al. (Feb. 2012).
776

covered fund for which the hedge relates.2382 Another commenter argued that banking 

entities should be permitted to hedge compensation investment accounts for executive 

officers who are not involved in the management of the investment accounts.2383 In 

contrast, other commenters objected to the hedging exemption for compensation 

arrangements, arguing that it may increase risk to banking entities,2384 is unnecessary,2385

or may provide banking entities with an opportunity to evade the limitations on the 

amount of ownership interests they may have as an investment in a covered fund.2386

After review of the comments, the Agencies believe at this time that permitting 

only limited risk-mitigating hedging activities involving ownership interests in covered 

funds is consistent with the safe and sound conduct of banking entities, and that increased 

use of ownership interests in covered funds could result in exposure to higher risks.2387

In particular, the Agencies have determined that transactions by a banking entity 

to act as principal in providing exposure to the profits and losses of a covered fund for a 

customer, even if hedged by the entity with ownership interests of the covered fund, is a 

high risk strategy that could threaten the safety and soundness of the banking entity. 

These transactions expose the banking entity to the risk that the customer will fail to 

perform, thereby effectively exposing the banking entity to the risks of the covered fund. 

Furthermore, a customer’s failure to perform may be concurrent with a decline in value 

 

2382 See Arnold & Porter.

2383 See BOK.

2384 See Occupy.

2385 See AFR et al. (Feb. 2012); Public Citizen.

2386 See Occupy.

2387 See 12 U.S.C. 1851(d)(2).
777

of the covered fund, which could expose the banking entity to additional losses. 

Accordingly, the Agencies believe that these transactions pose a significant potential to 

expose banking entities to the same or similar economic risks that section 13 of the BHC 

Act sought to eliminate, and have not adopted the proposed exemption for using 

ownership interests in covered funds to hedge these types of transactions in the final rule.

As argued by some commenters, modifying the proposal to eliminate the 

exemption for permitting banking entities to acquire covered fund interests in connection 

with customer facilitation may impact banking entities ability to hedge the risks of fundlinked derivatives through the use of fund-linked swaps or shares of covered funds 

referenced by fund-linked products.2388 Some commenters on the proposal argued that 

innovation of financial products may potentially be reduced if the final rule does not 

permit this type of activity related to fund-linked products.2389 The Agencies recognize 

that U.S. banking entities may no longer be able to participate in offering certain 

customer facilitation products relating to covered funds, but believe it is consistent with 

the purposes of section 13 to restrict these activities.

The final rule maintains the proposed exemption for hedging employee 

compensation arrangements with several changes. To ensure that exempt hedging 

activities are designed to reduce one or more specific risks, as required by section 

13(d)(1)(C) of the BHC Act, the proposed rule required that permitted hedging activity be 

designed to reduce the specific risks to the banking entity in connection with and related 

 

2388 See ISDA (Feb. 2012); BoA; Credit Suisse (Williams); Deutsche Bank (Fund-Linked Products); 

SIFMA et al. (Covered Funds) (Feb. 2012).

2389 See SIFMA et al. (Covered Funds) (Feb. 2012); Credit Suisse (Williams).
778

to its obligations or liabilities. The final rule permits a banking entity to acquire or retain 

an ownership interest in a covered fund provided that the ownership interest is designed 

to demonstrably reduce or otherwise significantly mitigate the specific, identifiable risks 

to the banking entity in connection with a compensation arrangement with an employee 

who directly provides investment advisory or other services to the covered fund. Under 

the final rule, a banking entity may not use as a hedge ownership interests of a covered 

fund for which the employee does not provide services. The requirement under the final 

rule that the hedging activity be designed to demonstrably reduce or otherwise 

significantly mitigate the specific, identifiable risks to the banking entity is consistent 

with the requirement in § __.5 of the final rule, as discussed above in Part IV.A.4. The 

final rule permits a banking entity to hedge its exposures to price and other risks based on 

fund performance that arise from restricted profit interest and other performance based 

compensation arrangements with its investment managers.

Section 13(a)(2) of the final rule describes the criteria a banking entity must meet 

in order to rely on the risk-mitigating hedging exemption for covered funds. These 

requirements, which are based on the requirements for the risk-mitigating hedging 

exemption for trading activities under § __.5 of the final rule and which are discussed in 

detail above in Part IV.A.4, have been modified from the proposal to reflect the more 

limited scope of this section.2390 In particular, the final rule permits a banking entity to 

engage in risk-mitigating hedging activities involving ownership interests in a covered 

fund only if the banking entity has established and implements, maintains and enforces an 

 

2390 See final rule §__.13(a)(2).
779

internal compliance program that is reasonably designed to ensure the covered banking 

entity’s compliance with the requirements of the hedging exemption, including 

reasonably designed written policies and procedures and internal controls and ongoing 

monitoring and authorization procedures, and has acquired or retained the ownership 

interest in accordance with these written policies, procedures and internal controls. 

Furthermore, the acquisition or retention of an ownership interest must demonstrably 

reduce or otherwise significantly mitigate, at the inception of the hedge, one or more 

specific, identifiable risks arising in connection with the compensation arrangement with 

an employee that directly provides investment advisory or other services to the covered 

fund. The acquisition or retention also may not, at the inception of the hedge, result in 

any significant new or additional risk that is not itself hedged contemporaneously in 

accordance with the hedging exemption, and the hedge must be subject to continuing 

review, monitoring and management by the banking entity. 

The final rule also permits a banking entity to engage in risk-mitigating hedging 

activities in connection with a compensation arrangement, subject to the conditions noted 

above, only if the compensation arrangement relates solely to the covered fund in which 

the banking entity or any affiliate thereof has acquired an ownership interest and the 

losses on such ownership interest are offset by corresponding decreases in the amounts 

payable in connection with the related employee compensation arrangement.2391

b. Permitted Covered Fund Activities and Investments Outside of the United States

 

2391 See final rule § __.13(a)(2)(iii).
780

Section 13(d)(1)(I) of the BHC Act2392 permits foreign banking entities to acquire 

or retain an ownership interest in, or act as sponsor to, covered funds, so long as those 

activities and investments occur solely outside the United States and certain other 

conditions are met (the “foreign fund exemption”).2393 As described in the proposal, the 

purpose of this statutory exemption appears to be to limit the extraterritorial application 

of the statutory restrictions on covered fund activities and investments, while preserving 

national treatment and competitive equality among U.S. and foreign banking entities 

within the United States.2394 The statute does not explicitly define what is meant by 

“solely outside of the United States.”

The proposed rule allowed foreign banking entities that met certain qualifications 

to engage in covered fund activities, including owning, organizing and offering, and 

sponsoring funds outside the United States. The proposed rule defined both the type of 

foreign banking entity that is eligible for the exemption and when an activity or 

 

2392 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).

2393 This section’s discussion of the concept “solely outside of the United States” is provided solely for 

purposes of the final rule’s implementation of section 13(d)(1)(I) of the BHC Act, and does not affect a 

banking entity’s obligation to comply with additional or different requirements under applicable securities, 

banking, or other laws.

2394 See 156 Cong. Rec. S5897 (daily ed. July 15, 2010) (statement of Sen. Merkley). (“Subparagraphs (H) 

and (I) recognize rules of international regulatory comity by permitting foreign banks, regulated and backed 

by foreign taxpayers, in the course of operating outside of the United States to engage in activities 

permitted under relevant foreign law. However, these subparagraphs are not intended to permit a U.S. 

banking entity to avoid the restrictions on proprietary trading simply by setting up an offshore subsidiary or 

reincorporating offshore, and regulators should enforce them accordingly. In addition, the subparagraphs 

Seek to maintain a level playing field by prohibiting a foreign bank from improperly offering its hedge fund 

and private equity fund services to U.S. persons when such offering could not be made in the United 

States.”).
781

investment would occur “solely outside of the United States.” The proposed rule allowed 

a qualifying foreign banking entity to acquire or retain an ownership interest in, or act as 

sponsor to, a covered fund under the exemption only if no subsidiary, affiliate or 

employee of the banking entity that’s incorporated or physically located in the United 

States engaged in offering or selling the covered fund. The proposed rule also 

implemented the statutory requirement that prohibited an ownership interest in the 

covered fund from being offered for sale or sold to a resident of the United States.

Commenters generally expressed support for an exemption to allow foreign 

banking entities to conduct foreign covered fund activities and make investments outside 

the United States.2395 A number of commenters also expressed concerns that the 

proposed foreign fund exemption was too narrow and would not be effective in 

permitting foreign banking entities to engage in covered fund activities and investments 

outside of the United States. For instance, many commenters argued that several of the 

proposal’s restrictions on the exemption were not required by statute and were 

inconsistent with congressional intent to limit the extraterritorial impact of section 13 of 

the BHC Act.2396 These commenters argued that the foreign funds exemption should 

focus on whether a prohibited activity, such as sponsoring or investing in a covered fund, 

involves principal risk taken or held by the foreign banking entity that poses risk to U.S. 

 

2395 See, e.g., IIB/EBF; SIFMA et al. (Covered Funds) (Feb. 2012); See also Occupy.

2396 See Ass’n. of German Banks; BVI; Allen & Overy (on behalf of Canadian Banks); EFAMA; F&C; 

HSBC; IIB/EBF; ICSA; PEGCC; Société Générale; Union Asset; Ass’n. of Banks in Malaysia; EBF; 

Credit Suisse (Williams); Cadwalader (on behalf of Thai Banks).
782

banking entities or the financial stability of the United States.2397 Commenters also 

argued that a broader exemption would better recognize the regulation and supervision of 

the home country supervisor of the foreign banking entity and of its covered fund 

activities.2398 

Some commenters contended that the proposal represented an improper 

extraterritorial application of U.S. law that could be found to violate international treaty 

obligations of the United States, such as those under the North American Free Trade 

Agreement, and might result in retaliation by foreign countries in their treatment of U.S. 

banking entities abroad.2399 Commenters also alleged that the proposal would impose 

significant compliance costs on the foreign operations of foreign banking entities 

conducting activity pursuant to this exemption.2400 These commenters argued that 

foreign banking entities relying on the foreign fund exemption should not be subject to 

the compliance program requirements contained in Appendix C with respect to their nonU.S. operations.2401

 

2397 See IIB/EBF; EBF; Allen & Overy (on behalf of Canadian Banks); Credit Suisse (Williams); Katten 

(on behalf of Int’l Clients).

2398 See Credit Suisse (Williams); PEGCC; See also Commissioner Barnier.

2399 See e.g., Norinchukin; Cadwalader (on behalf of Thai Banks); Barclays; EBF; Ass’n. of German 

Banks; Société Générale; Chamber (Feb. 2012).

2400 See BaFin/Deutsche Bundesbank; Norinchukin; IIF; Allen & Overy (on behalf of Canadian Banks); 

ICFR; BoA. As discussed below in Part IV.C.1, other parts of the final rule address commenters’ concerns 

regarding the compliance burden on foreign banking entities.

2401 See AFG; Ass’n. of German Banks; BVI; Comm. on Capital Markets Regulation; IIB/EBF; Japanese 

Bankers Ass’n.; Norinchukin; Union Asset. As discussed in greater detail below in Part IV.C.1, activities 

and investments of a foreign bank that are conducted under the foreign funds exemption are generally not 

subject to the specific requirements of § __.20 and Appendices A and B. The U.S. operations of foreign 

banking entities are expected to have policies and procedures in place to ensure that they conduct activities 

under this part in full compliance with this part.
783

Several commenters argued that the restrictions of section 13(f), which limits 

transactions between a banking entity and certain covered funds, would not apply to 

activities and investments made in reliance on the foreign fund exemption.2402 Some 

commenters argued that the Agencies should grandfather all existing foreign covered 

funds and argued that failure to provide relief for existing relationships could cause 

substantial disruption to foreign covered funds and significantly harm investors in 

existing funds without producing a clear offsetting benefit.2403

In response to comments received on the proposal, the final rule contains a 

number of modifications to more effectively implement the foreign fund exemption in 

light of the language and purpose of the statute. Importantly, as explained in the section 

defining covered funds, the Agencies also believe that the more circumscribed definition 

of covered fund, including the exclusion for foreign public funds, should alleviate many 

of the concerns raised and potential burdens identified by commenters with respect to the 

funds activities of foreign banking entities.2404 

 

2402 See Australian Bankers Ass’n.; AFMA; Allen & Overy (on behalf of Foreign Bank Group); British 

Bankers’ Ass’n.; F&C; French Banking Fed’n.; IIB/EBF; Japanese Bankers Ass’n; Katten (on behalf of 

Int’l Clients); Union Asset. See also infra Part IV.B.5.

2403 See BVI; Credit Suisse (Williams); EFAMA; IIB/EBF; PEGCC; Union Asset. See supra Part II for a 

discussion regarding the conformance period. 

2404 For instance, many commenters raised concerns regarding the treatment of foreign public funds such 

as UCITS. As discussed in greater detail above in Part IV.B.1, the definition of covered fund under the 

final rule has been modified from the proposal and tailored to include only the types of foreign funds that 

the Agencies believe are intended to be the focus of the statute (e.g., certain foreign funds that are 

established by U.S. banking entities). Foreign public funds are also excluded from the definition of 

covered fund under the final rule. The modifications in the final rule in part address commenters’ request 

that foreign funds be grandfathered. To the extent that an entity qualifies for one or more of the exclusions 

from the definition of covered fund, that entity would not be a covered fund under the final rule. Moreover, 

any entity that would be a covered fund would still be able to rely on the conformance period in order to 

come into compliance with the requirements of section 13 and the final rule.
784

1. Foreign banking entities eligible for the exemption

The statutory language of section 13(d)(1)(I) provides that, in order to be eligible 

for the foreign funds exemption, the banking entity must not be directly or indirectly 

controlled by a banking entity that is organized under the laws of the United States or of 

one or more States. Consistent with this statutory language, the proposed rule limited the 

scope of the exemption to banking entities that are organized under foreign law and, as 

applicable, controlled only by entities organized under foreign law. 

The Agencies did not receive substantive comment on this aspect of the proposal 

related to the foreign fund exemption, though some commenters offered suggestions to 

clarify various parts of the wording of the scope of the definition of banking entities that 

may qualify for the exemption. The final rule makes only minor, technical changes to 

more fully carry out the purposes of the statute.

Consistent with the statutory language and purpose of section 13(d)(1)(I) of the 

BHC Act, the final rule provides that the exemption is available only if the banking entity 

is not organized under2405 or directly or indirectly controlled by a banking entity that is 

organized under the laws of the United States or of one or more States. As noted above, 

section 13(d)(1)(I) of the BHC Act specifically provides that its exemption is available 

only to a banking entity that is not “directly or indirectly” controlled by a banking entity 

 

2405 The final rule clarifies the eligibility requirements for banking entities Seeking to rely on the foreign 

fund exemption. Section 13(d)(1)(I) of the BHC Act and § __.13(c)(1)(i) of the proposal require that a 

banking entity Seeking to rely on the foreign fund exemption not be directly or indirectly controlled by a 

banking entity that is organized under the laws of the United States or of one or more states. For 

clarification purposes, in addition to the eligibility requirement in Section 13(d)(1)(I) of the BHC Act and 

the proposal, the final rule also expressly requires that the banking entity not itself be organized under the 

laws of the United States. 
785

that is organized under the laws of the United States or of one or more States.2406 

Because of this express statutory requirement, a foreign subsidiary controlled, directly or 

indirectly, by a banking entity organized under the laws of the United States or one of its 

States, and a foreign branch office of a banking entity organized under the laws of the 

United States or one of the States, may not take advantage of this exemption. 

Like the proposal, the final rule incorporates the statutory requirement that the 

banking entity conduct its sponsorship or investment activities pursuant to sections 

4(c)(9) or 4(c)(13) of the BHC Act. The final rule retains the tests in the proposed rule 

for determining when a banking entity would meet that requirement. The final rule also 

provides qualifying criteria for both a banking entity that is a qualifying foreign banking 

organization under the Board’s Regulation K and a banking entity that is not a foreign 

banking organization for purposes of Regulation K.2407 

Section 4(c)(9) of the BHC Act applies to any company organized under the laws 

of a foreign country the greater part of whose business is conducted outside the United 

States, if the Board by regulation or order determines that the exemption would not be 

substantially at variance with the purposes of the BHC Act and would be in the public 

interest.2408 The Board has implemented section 4(c)(9) as part of subpart B of the 

 

2406 See 12 U.S.C. 1851(d)(1)(I).

2407 Section __.13(b)(2) only addresses when a transaction will be considered to have been conducted 

pursuant to section 4(c)(9) of the BHC Act. Although the statute also references section 4(c)(13) of the 

BHC Act, the Board has to date applied the general authority contained in that section solely to the foreign 

activities of U.S. banking organizations which, by the express terms of section 13(d)(1)(I) of the BHC Act, 

are unable to rely on the foreign funds exemption.

2408 See 12 U.S.C. 1843(c)(9).
786

Board’s Regulation K,2409 which specifies a number of conditions and requirements that a 

foreign banking organization must meet in order to act pursuant to that authority.2410 The 

qualifying conditions and requirements include, for example, that the foreign banking 

organization demonstrate that more than half of its worldwide business is banking and 

that more than half of its banking business is outside the United States.2411 Under the 

final rule a banking entity that is a qualifying foreign banking organization for purposes 

of the Board’s Regulation K, other than a foreign bank as defined in section 1(b)(7) of the 

International Banking Act of 1978 that is organized under the laws of any 

commonwealth, territory, or possession of the United States, will qualify for the foreign 

fund exemption.

2412

 

2409 See 12 CFR 211.20 et seq.

2410 Some commenters argued that the Board’s Regulation K contains a number of limitations that may not 

be appropriate to include as part of the requirements of the foreign fund exemption. For example, subpart 

B of the Board’s Regulation K includes various approval requirements and interstate office location 

restrictions. See Allen & Overy (on behalf of Foreign Bank Group); HSBC Life. The final rule does not 

retain the proposal’s requirement that the activity be conducted in compliance with all of subpart B of the 

Board’s Regulation K (12 CFR 211.20 through 211.30). However, the foreign fund exemption in section 

13(d)(1)(I) of the BHC Act and the final rule operates as an exemption and is not a separate grant of 

authority to engage in an otherwise impermissible activity. To the extent a banking entity is a foreign 

banking organization, it remains subject to the Board’s Regulation K and must, as a separate matter, 

comply with any and all applicable rules and requirements of that regulation.

2411 See 12 CFR 211.23(a), (c), and (e). The proposed rule only referenced the qualifying test under 

section 211.23(a) of the Board’s Regulation K; however, because there are two other methods by which a 

foreign banking organization may meet the requirements to be considered a qualified foreign banking 

organization, the final rule incorporates a reference to those provisions as well.

2412 This modification to the definition of foreign banking organization from the proposed definition is 

necessary because, under the International Banking Act and the Board’s Regulation K, depository 

institutions that are located in, or organized under the laws of a commonwealth, territory, or possession of 

the United States, are foreign banking organizations. However, for purposes of the Federal securities laws 

and certain banking statutes, such as section 2(c)(1) of the BHC Act and section 3 of the FDI Act, these 

same entities are defined to be and treated as domestic entities. For instance, these entities act as domestic 

broker-dealers under U.S. securities laws and their deposits are insured by the FDIC. Because one of the 

purposes of section 13 is to protect insured depository institutions and the U.S. financial system from the 

perceived risks of proprietary trading and covered fund activities, the Agencies believe that these entities 

should be considered to be located within the United States for purposes of section 13. The final rule 

includes within the definition of State any State, the District of Columbia, the Commonwealth of Puerto 
787

Section 13 of the BHC Act also applies to foreign companies that control a U.S. 

insured depository institution but that are not subject to the BHC Act generally or to the 

Board’s Regulation K – for example, because the foreign company controls a savings 

association or an FDIC-insured industrial loan company. Accordingly, the final rule also 

provides that a foreign banking entity that is not a foreign banking organization would be 

considered to be conducting activities “pursuant to section 4(c)(9)” for purposes of the 

foreign fund exemption2413 if the entity, on a fully-consolidated basis2414, meets at least 

two of three requirements that evaluate the extent to which the foreign banking entity’s 

business is conducted outside the United States, as measured by assets, revenues, and 

income.2415 This test largely mirrors the qualifying foreign banking organization test that 

is made applicable under section 4(c)(9) of the BHC Act and § 211.23(a), (c), or (e) of 

the Board’s Regulation K, except that the test does not require the foreign entity to 

demonstrate that more than half of its banking business is outside the United States.2416 

This difference reflects the fact that foreign entities subject to section 13 of the BHC Act, 

but not the BHC Act generally, are likely to be, in many cases, predominantly 

commercial firms. A requirement that such firms also demonstrate that more than half of 

 Rico, Guam, American Samoa, the United States Virgin Islands, and the Commonwealth of the Northern 

Mariana Islands. 

2413 This clarification would be applicable solely in the context of section 13(d)(1) of the BHC Act. The 

application of section 4(c)(9) to foreign companies in other contexts is likely to involve different legal and 

policy issues and may therefore merit different approaches.

2414 For clarification purposes, the final rule has been modified from the proposal to provide that the 

requirements for this provision must be met on a fully-consolidated basis. 

2415 See final rule § __.13(b)(2)(ii)(B). For purposes of determining whether, on a fully consolidated basis, 

it meets the requirements under § __.13(b)(2)(ii)(B), a foreign banking entity that is not a foreign banking 

organization should base its calculation on the consolidated global assets, revenues, and income of the toptier affiliate within the foreign banking entity’s structure.

2416 See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a), (c), and (e); final rule § __.13(b)(2)(ii)(B).
788

their banking business is outside the United States would likely make the exemption 

unavailable to such firms and subject their global activities to the restrictions on covered 

fund activities and investments, a result that the Agencies do not believe was intended.

2. Activities or investments solely outside of the United States

As noted above, the proposed rule adopted a transaction-based approach to 

implementing the foreign fund exemption and focused on the extent to which the foreign 

fund transactions occur within, or are carried out by personnel, subsidiaries or affiliates 

within, the United States. In particular, § __.13(c)(3) of the proposed rule provided that a 

transaction or activity be considered to have occurred solely outside of the United States 

only if: (i) the transaction or activity is conducted by a banking entity that is not 

organized under the laws of the United States or of one or more States; (ii) no subsidiary, 

affiliate, or employee of the banking entity that is involved in the offer or sale of an 

ownership interest in the covered fund is incorporated or physically located in the United 

States; and (iii) no ownership interest in such covered fund is offered for sale or sold to a 

resident of the United States.

Commenters suggested that, like the foreign trading exemption, the foreign fund 

exemption should focus on the location of activities that a banking entity engages in as 

principal.2417 These commenters argued that the location of sales activities of a fund 

should not determine whether a banking entity has sponsored or acquired an ownership 

interest in a covered fund solely outside of the United States. Commenters also argued 

 

2417 See Credit Suisse (Williams); IIB/EBF; Katten (on behalf of Int’l Clients).
789

that foreign banking entities typically locate marketing and sales personnel for foreign 

funds in the United States in order to serve customers, including those that are not 

residents of the United States, and that the proposal would needlessly force all covered 

fund sales activities to shift outside of the United States. These commenters alleged that 

the restrictions under the proposal would cause foreign banking entities to relocate their 

personnel from the United States to overseas, diminishing U.S. jobs with no concomitant 

benefit.2418 

Many commenters requested removal of the proposal’s prohibition on a U.S. 

subsidiary, affiliate, or employee of the foreign banking entity offering or selling fund 

interests in order to qualify for the foreign fund exemption.2419 Commenters argued that 

this limitation was not included in the statute and that the limited involvement of persons 

located in the U.S. in the distribution of ownership interests in a foreign covered fund 

should not, by itself, disqualify the banking entity from relying on the foreign fund 

exemption so long as the fund is offered only outside the United States.2420 These 

commenters argued that organizing and offering a fund is not a prohibited activity so long 

as it is not accompanied by ownership or sponsorship of the covered fund. One 

commenter urged that the final rule permit U.S. personnel of a foreign banking entity to 

 

2418 See Allen & Overy (on behalf of Foreign Bank Group); Ass’n. of German Banks; Credit Suisse 

(Williams); IIB/EBF; Société Générale; Union Asset.

2419 See Allen & Overy (on behalf of Foreign Bank Group); Ass’n. of German Banks; Credit Suisse 

(Williams); IIB/EBF; Katten (on behalf of Int’l Clients); TCW; Union Asset. 

2420 See IIB/EBF; Société Générale; TCW; Union Asset; Credit Suisse (Williams); See also Katten (on 

behalf of Int’l Clients) (recommending that, similar to the SEC’s Regulation S, the final rule provide that 

involvement of persons located in the United States in the distribution of a non-U.S. covered fund’s 

securities to potential purchasers outside of the United States not affect the analysis of whether a non-U.S. 

banking entity’s investment or sponsorship occurs outside the United States). 
790

engage in non-selling activities related to a covered fund, including acting as investment 

advisor, establishing fund vehicles, conducting back-office functions such as day-to-day 

management and deal sourcing tax structuring, obtaining licenses, interfacing with 

regulators, and other related activities that do not involve U.S. sales activity.2421

Instead of the proposal’s transaction-based approach to implementing the foreign 

fund exemption, many commenters suggested the final rule adopt a risk-based

approach.2422 These commenters argued that a risk-based approach would prohibit or 

significantly limit the amount of financial risk from such activities that could be 

transferred to the United States by the foreign activity of foreign banking entities in line 

with the purpose of the statue.2423 Commenters also contended that foreign activities of 

most foreign banking entities are already subject to activities limitations, capital 

requirements, and other prudential requirements of their home-country supervisor(s).2424

In response to commenters’ concerns and in order to more effectively implement 

both the statutory prohibition as well as the foreign fund exemption, the final rule has 

been modified to better reflect the purpose of the statute by ensuring that the principal 

risks of covered fund investments and sponsorship by foreign banking entities permitted 

under the foreign funds exemption occur and remain solely outside of the United States. 

One of the principal purposes of section 13 is to limit the risks that covered fund 

 

2421 See Allen & Overy (on behalf of Foreign Bank Group).

2422 See BaFin/Deutsche Bundesbank; ICSA; IIB/EBF; EBF; Allen & Overy (on behalf of Canadian 

Banks); Credit Suisse (Williams); George Osborne.

2423 See IIB/EBF.

2424 See IIB/EBF.
791

investments and activities pose to the safety and soundness of U.S. banking entities and 

the U.S. financial system. Another purpose of the foreign fund exemption was to limit 

the extraterritorial application of section 13 as it applies to foreign banking entities 

subject to section 13. 

To accomplish these purposes in light of the structure and purpose of the statute 

and in response to commenters, the final rule adopts a risk-based approach rather than a 

transaction approach to the foreign fund exemption. In order to ensure these risks remain 

solely outside of the United States, the final rule also includes several conditions on the 

availability of the foreign fund exemption. Specifically, the final rule provides that an 

activity or investment occurs solely outside the United States for purposes of the foreign 

fund exemption only if: 

• The banking entity acting as sponsor, or engaging as principal in the 

acquisition or retention of an ownership interest in the covered fund, is not 

itself, and it not controlled directly or indirectly by, a banking entity that is 

located in the United States or established under the laws of the United 

States or of any State;

• The banking entity (including relevant personnel) that makes the decision 

to acquire or retain the ownership interest or act as sponsor to the covered 

fund is not located in the United States or organized under the laws of the 

United States or of any State;

• The investment or sponsorship, including any transaction arising from 

risk-mitigating hedging related to an ownership interest, is not accounted 
792

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.2425

These requirements are designed to ensure that any foreign banking entity 

engaging in activity under the foreign fund exemption does so in a manner that ensures 

the risk and sponsorship of the activity or investment occurs and resides solely outside of 

the United States.

The final rule has been modified from the proposal to specifically recognize that, 

for purposes of the foreign fund exemption, a U.S. branch, agency, or subsidiary of a 

foreign bank, is located in the United States; however, a foreign bank that operates or 

controls that branch, agency, or subsidiary is not considered to be located in the United 

States solely by virtue of operation of the U.S. branch, agency, or subsidiary.2426 A 

subsidiary (wherever located) of a U.S. branch, agency, or subsidiary of a foreign bank is 

also considered itself to be located in the United States. This provision helps give effect 

to the statutory language limiting the foreign fund exemption to activities of foreign 

banking entities that occur “solely outside of the United States” by clarifying that the 

 

2425 See final rule § __.13(b)(4).

2426 See final rule § __.13(b)(5).
793

U.S. operations of foreign banking entities may not sponsor or acquire or retain an 

ownership interest in a covered fund as principal based on this exemption. 

Because so-called “back office” activities do not involve sponsoring or acquiring 

or retaining an ownership interest in a covered fund, the final rule does not impose 

restrictions on U.S. personnel of a foreign banking entity engaging in these activities in 

connection with one or more covered funds. This allows providing administrative 

services or similar functions to the covered fund as an incident to the activity conducted 

under the foreign fund exemption (such as clearing and settlement, maintaining and 

preserving records of the fund, furnishing statistical and research data, or providing 

clerical support for the fund).

The foreign fund exemption in the final rule also permits the U.S. personnel and 

operations of a foreign banking entity to act as investment adviser to a covered fund in 

certain circumstances. For instance, the U.S. personnel of a foreign banking entity may 

provide investment advice and recommend investment selections to the manager or 

general partner of a covered fund so long as that investment advisory activity in the 

United States does not result in the U.S. personnel participating in the control of the 

covered fund or offering or selling an ownership interest to a resident of the United 

States. As explained above, the final rule also explicitly provides that acquiring or 

retaining an ownership interest does not include acquiring or retaining an ownership 

interest in a covered fund by a banking entity acting solely as agent, broker, or custodian, 

subject to certain conditions, or acting on behalf of customers as a trustee, or in a similar 

fiduciary capacity for a customer that is not a covered fund, so long as the activity is 

conducted for the account of the customer and the banking entity and its affiliates do not 
794

have or retain beneficial ownership of the ownership interest.2427 The final rule would 

thus allow a foreign bank to engage in any of these capacities in the U.S. without the 

need to rely on the foreign fund exemption. 

3. Offered for sale or sold to a resident of the United States

The proposed rule provided that no ownership interest in the covered fund be 

offered for sale or sold to a resident of the United States, a requirement of the statute.2428 

Numerous commenters focused on the definition of “resident of the United States” in the 

proposed rule and the manner in which the restriction on offers and sales to such persons 

would interrelate with Regulation S under the Securities Act of 1933. Commenters 

asserted that, since market participants have long conducted offerings of foreign funds in 

reliance on Regulation S2429 in order to comply with U.S. securities law obligations, these 

same securities law principles should be applied to determine whether a person is a 

resident of the United States for purposes of section 13 and the final rule to determine 

whether an offer or sale is made to residents of the United States.2430

Certain commenters argued that because of the way the restriction in the statute 

and proposed rule was written, it was unclear whether the restriction on offering for sale 

to a resident of the United States applied to the foreign banking entity or to any third 

party that establishes a fund.2431 Commenters argued the prohibition against offers or 

 

2427 See final rule § __.10(a)(2). 

2428 See proposed rule §__.13(c)(1)(iii).

2429 See 17 CFR 230.901-905.

2430 See IIB/EBF; EFAMA; ICI Global.

2431 See Cadwalader (on behalf of Thai Banks); Grosvenor; SIFMA et al. (Covered Funds) (Feb. 2012).
795

sales of ownership interests to residents of the United States should apply only to offers 

and sales of covered funds organized and offered by the foreign banking entity but not to 

covered funds established by unaffiliated third parties.2432 These commenters reasoned 

that a foreign banking entity should be permitted to make a passive investment in a 

covered fund sponsored and controlled by an unaffiliated third party that has U.S. 

investors as long as the foreign banking entity does not itself offer or sell ownership 

interest in the covered fund to residents of the United States.2433 Commenters contended 

that this interpretation would be consistent with section 13’s purpose to prevent foreign 

banks from using the foreign fund exemption to market and sell covered funds to U.S. 

investors, while simultaneously limiting the extraterritorial impact of section 13.2434 

Commenters argued that the proposal’s foreign fund exemption would negatively impact 

U.S. asset managers unaffiliated with any banking entity because they would either be 

forced to exclude foreign banking entities from investing in their funds or would need to 

ensure that no residents of the United States hold ownership interests in funds offered to 

these entities.2435 Commenters also contended that foreign banking entities, including 

sovereign wealth funds that own or control foreign banking organizations, invest tens of 

billions of dollars in U.S. covered funds and that if these types of investments were not 

 

2432 See Ass’n. of German Banks; BAROC; Cadwalader (on behalf of Thai Banks); Comm. on Capital 

Markets Regulation; Credit Suisse (Williams); IIB/EBF; Japanese Bankers Ass’n.; Katten (on behalf of 

Int’l Clients); PEGCC. 

2433 See Grosvenor; IIB/EBF; Japanese Bankers Ass’n.; Katten (on behalf of Int’l Clients); Sens. Merkley 

& Levin (Feb.2012); Norinchukin; SIFMA et al. (Covered Funds) (Feb. 2012).

2434 See BAROC; Credit Suisse (Williams); Grosvenor; IIB/EBF.

2435 See Comm. on Capital Markets Regulation; Credit Suisse (Williams); PEGCC. 
796

permitted under the foreign fund exemption an important source of foreign investment in 

the U.S. could be eliminated.2436 

Commenters argued that an investment by a foreign banking entity in a third-party 

unaffiliated fund does not pose any risk to a U.S. banking entity or to the U.S. financial 

system. Moreover, commenters argued that a foreign banking entity that has invested in 

a fund sponsored and advised by a third party has no control over whether – and may 

have no knowledge - that the third party has determined to offer or sell the fund to U.S. 

residents.2437

As noted above, one of the purposes of section 13 is to limit the risk to banking 

entities and the financial system of the United States. Another purpose of the statute 

appears to be to permit foreign banking entities to engage in foreign activities without 

being subject to the restrictions of section 13 while also ensuring that these foreign 

entities do not receive a competitive advantage over U.S. banking entities with respect to 

offering and selling their covered fund services in the United States.2438 As such, the 

final rule does not prohibit a foreign banking entity from making an investment in or 

sponsoring a foreign fund. However, a foreign banking entity would not be permitted 

under the foreign fund exemption to invest in, or engage in the sponsorship of, a U.S. or 

foreign covered fund that offers ownership interests to residents in the United States 

unless it does so pursuant to and subject to the limitations of the permitted activity 

 

2436 See SIFMA et al. (Covered Funds) (Feb. 2012); See also Grosvenor; PEGCC.

2437 See AFG; BAROC; Cadwalader (on behalf of Thai Banks); Japanese Bankers Ass’n.

2438 See 156 Cong. Rec. S5897 (daily ed. July 15, 2010) (statement of Sen. Merkley).
797

exemption for organizing and offering a covered fund, for example, which has the same 

effect for U.S. banking entities. The final rule ensures that the risk of the sponsoring and 

investing in non-U.S. covered funds by foreign banking entities remains outside of the 

United States and that the foreign fund exemption does not advantage foreign banking 

entities relative to U.S. banking entities with respect to providing their covered fund 

services in the United States by prohibiting the offer or sale of ownership interests in 

related covered funds to residents of the United States.

Commenters also argued that foreign investors in a foreign covered fund should 

not be treated as residents of the United States for purposes of the final rule if, after 

purchasing their interest in the covered fund, they relocate to the U.S.,2439 or travel to the 

U.S. on a temporary basis.2440 Commenters also argued that non-U.S. investors in a fund 

offered by a foreign banking entity should not be prohibited from transferring their 

interests to residents of the United States in the secondary market. 2441 One commenter 

alleged that, notwithstanding the reasonable efforts of foreign banking entities to prevent 

residents of the United States from investing in their foreign covered funds, investors 

may find ways to circumvent and invest in covered funds without knowledge or 

assistance from the foreign banking entity.2442

Certain commenters argued that there was a substantial risk that foreign funds 

offered by foreign banking entities would not be able to rely on the exemption due to the 

 

2439 See IIB/EBF; Katten (on behalf of Int’l Clients); Union Asset.

2440 See IFIC; See also Allen & Overy (on behalf of Canadian Banks).

2441 See Ass’n. of German Banks; Credit Suisse (Williams); IIB/EBF; Katten (on behalf of Int’l Clients).

2442 See Credit Suisse (Williams).
798

presence of a limited number of investors who are residents of the United States.2443 A 

few commenters suggested that the final rule should require that, for both related and 

unrelated covered funds, a banking entity need only have a reasonable belief that an 

ownership interest in a covered fund is not offered or sold to residents of the United 

States in order to qualify for the foreign fund exemption. Commenters argued that only 

active targeting or marketing towards a resident of the United States by the foreign 

banking entity should be prohibited by the final rule, and that the incidental presence of a 

limited number of investors that are residents of the United States in a foreign covered 

fund offered by a foreign banking entity should not prohibit the foreign banking entity 

from relying on the foreign fund exemption.2444 One commenter argued that, for certain 

complex fund structures (e.g., a structure with a master fund and multiple feeder funds 

that investors invest in or a parallel fund structure both managed by the same fund 

manager), eligibility for the foreign fund exemption should not be precluded for a fund 

with no ownership interests offered for sale or sold to U.S. residents even if a related 

covered fund is offered to residents of the United States.2445

After considering comments received on the proposal, the final rule retains the 

statutory requirement that no ownership interest in the covered fund be offered for sale to 

a resident of the United States.2446 The final rule provides that an ownership interest in a 

covered fund is offered for sale or sold to a resident of the United States for purposes of 

 

2443 See BVI; EFAMA; Union Asset.

2444 See AFG; Union Asset; See also BVI; Allen & Overy (on behalf of Canadian Banks); Katten (on 

behalf of Int’l Clients).

2445 See Japanese Bankers Ass’n.

2446 See final rule §__.13(b)(1)(iii). 
799

the foreign fund exemption only if it is sold or has been sold pursuant to an offering that 

targets residents of the United States.2447 

Absent circumstances otherwise indicating a nexus with residents of the United 

States, the sponsor of a foreign fund would not be viewed as targeting U.S. residents for 

purposes of the foreign fund exemption if it conducts an offering directed to residents of 

one or more countries other than the United States; includes in the offering materials a 

prominent disclaimer that the securities are not being offered in the United States or to 

residents of the United States; and includes other reasonable procedures to restrict access 

to offering and subscription materials to persons that are not residents of the United 

States.2448 If ownership interests that are issued in a foreign offering are listed on a 

foreign exchange, secondary market transactions could be undertaken by the banking 

entity outside the United States in accordance with Regulation S under the foreign fund 

exemption.2449 Foreign banking entities should use precautions not to send offering 

materials into the United States or conduct discussions with persons located in the United 

States (other than to or with a person known to be a dealer or other professional fiduciary 

acting on behalf of a discretionary account or similar account for a person who is not a 

 

2447 See final rule §__.13(b)(3).

2448 See Statement of the Commission Regarding Use of Internet Web Sites to Offer Securities, Solicit 

Securities Transactions or Advertise Investment Services Offshore, Securities Act Release No. 7516 (Mar. 

23, 1998). Reliance on these principles only applies with respect to whether an ownership interest in a 

covered fund is offered for sale or sold to a resident of the United States for purposes of section 13 of the 

BHC Act. In addition, reliance would not be appropriate if a foreign fund engages in a private placement 

of ownership interests in the United States in reliance on Section 4(a)(2) of the Securities Act of 1933 or 

Regulation D (17 CFR 230.501-506).

2449 An offer or sale is made in an “offshore transaction” under Regulation S if, among other conditions, 

the transaction is executed in, on or through the facilities of a “designated offshore securities market” as 

described in Regulation S, which includes a number of foreign stock exchanges and markets and any others 

the SEC designates. See Securities Act rule 902(h).
800

resident of the United States).2450 In order to comply with the rule as adopted, sponsors 

of covered funds established outside of the United States must examine the facts and 

circumstances of their particular offerings and confirm that the offering does not target 

residents of the United States.

With respect to the treatment of multi-tiered fund structures under the foreign 

fund exemption, the Agencies expect that activities related to certain complex fund 

structures should be integrated in order to determine whether an ownership interest in a 

covered fund is offered for sale to a resident of the United States. For example, a 

banking entity may not be able to rely on the foreign fund exemption to sponsor or invest 

in an initial covered fund (that is offered for sale only overseas and not to residents of the 

United States) that is itself organized or operated for the purpose of investing in another 

covered fund (that is sold pursuant to an offering that targets U.S. residents) and that is 

either organized and offered or is advised by that banking entity.

4. Definition of “resident of the United States”

As discussed in greater detail above in Part IV.B.1, section 13(d)(1)(I) of the BHC 

Act provides that a foreign banking entity may acquire or retain an ownership interest in 

or act as sponsor to a covered fund, but only if that activity is conducted according to the 

requirements of the statute, including that no ownership interest in the covered fund is 

offered for sale or sold to a “resident of the United States.” As noted above in Part 

 

2450 See Securities Act rule 902(k)(2). 
801

IV.B.1.f describing the definition of “resident of the United States,” the statute does not 

define this term. 

After carefully considering comments received, the Agencies have defined the 

term “resident of the United States” in the final rule to mean a “U.S. person” as defined 

in the SEC’s Regulation S.2451 The Agencies note, however, that it would not be 

permissible under the foreign fund exemption for a foreign banking entity to facilitate or 

participate in the formation of a non-U.S. investment vehicle for a person or entity that is 

itself a U.S. person for the specific purpose of investing in a foreign fund. The Agencies 

believe that this type of activity would constitute an evasion of the requirements of 

section 13 of the BHC Act. 

c. Permitted Covered Fund Interests and Activities by a Regulated Insurance Company

As discussed above, section 13(d)(1)(F) of the BHC Act permits a banking entity 

that is a regulated insurance company acting for its general account, or an affiliate of an 

insurance company acting for the insurance company’s general account, to purchase or 

sell a financial instrument subject to certain conditions.2452 Section 13(d)(1)(D) of the 

Act permits a banking entity to purchase or sell a financial instrument on behalf of 

customers.2453 The proposal implemented these exemptions with respect to the 

proprietary trading activities of insurance companies by permitting a banking entity that 

is an insurance company to purchase or sell a financial instrument for the general account 

of the insurance company or for a separate account, in each case subject to certain 

 

2451 See final rule § __.10(d)(8). 

2452 See 12 U.S.C. 1851(d)(1)(F).

2453 See 12 U.S.C. 1851(d)(1)(D).
802

restrictions.2454 The proposal did not apply these exemptions to covered fund activities or 

investments.

A number of commenters argued that section 13 was designed to accommodate 

the business of insurance by exempting both the proprietary trading and covered fund 

activities of insurance companies.2455 These commenters argued that providing an 

exemption for covered fund activities and investments through both the general account 

and separate accounts of an insurance company was integral to the business of insurance 

and that, absent an exemption from the covered fund provisions, insurance companies 

would lack an effective means to diversify their holdings and obtain adequate rates of 

return in order to maintain affordable premiums for customers.2456 

Some commenters argued that section 13 of the BHC Act specifically provides 

exemptions from both the covered fund prohibition of section 13(a)(1), and the 

prohibition on proprietary trading.2457 Commenters contended that the exemptions in 

section 13(d)(1)(F) (referencing activity in general accounts of insurance companies) and 

13(d)(1)(D) (referencing activities on behalf of customers) cross-reference the 

instruments described in section 13(h)(4) and not activity described in section 13(h)(4). 

On this basis, commenters argued the statute exempts both proprietary trading in these 

 

2454 See proposed rule §§ __.6(b)(2)(iii); __.6(c). 

2455 See, e.g., Sutherland (on behalf of Comm. of Annuity Insurers); ACLI (Jan. 2012); Country Fin. et al.;

Nationwide; NAMIC; Fin. Services Roundtable (Feb. 3, 2012) (citing FSOC study at 71); HSBC Life; 

Chamber (Feb. 2012); Country Fin. et al.; Mutual of Omaha; See also Rep. McCarthy et al.; Sen. Nelson; 

Sen. Hagan; Sens. Brown & Harkin.

2456 See, e.g., Fin. Services Roundtable (Feb. 3, 2012); TIAA-CREF (Feb. 13, 2012); Sutherland (on behalf 

of Comm. of Annuity Insurers); USAA (citing FSOC study at 71); HSBC Life; ACLI; NAMIC; 

Nationwide.

2457 See Sutherland (on behalf of Comm. of Annuity Insurers); Nationwide; See also Rep. McCarthy et al.; 

Sens. Brown & Harkin.
803

instruments described in section 13(h)(4) and investments in those instruments (including 

when those instruments are ownership interests in covered funds).2458

Alternatively, commenters argued that the Agencies should use their authority in 

section 13(d)(1)(J) of the BHC Act to provide an exemption for the covered fund 

activities and investments of insurance companies.2459 These commenters argued that 

exempting covered funds activities and investments of insurance companies would 

promote and protect the safety and soundness of the banking entity and financial stability 

of the United States and provide certain benefits to the U.S. financial system by allowing 

insurance companies to access important asset classes (for better investment diversity and 

returns), provide more diverse product offerings to customers, better manage their 

investment risks through diversification and more closely matching the maturity of their 

assets and liabilities, contribute liquidity to capital markets, and support economic growth 

through the provision of capital to entrepreneurs and businesses.2460 Commenters also 

argued that an exemption for insurance companies from the covered fund prohibitions 

was necessary to permit insurance companies that are banking entities to effectively 

compete with insurance companies not affiliated with an insured depository 

institution.2461 Commenters alleged that insurance companies are already subject to 

extensive regulation under state insurance laws that specifically include provisions 

 

2458 See, e.g., Fin. Services Roundtable (Feb. 3, 2012); USAA; HSBC Life; Country Fin. et al.; Sutherland 

(on behalf of Comm. of Annuity Insurers); Nationwide (discussing the exemption for the general account 

of an insurance company); ACLI; Nationwide (discussing the exemption for separate accounts).

2459 See, e.g., Sutherland (on behalf of Comm. of Annuity Insurers).

2460 See Fin. Services Roundtable (Feb. 3, 2012); TIAA-CREF (Feb. 13, 2012); USAA; HSBC Life; ACLI

(Jan. 2012); NAMIC; Nationwide.

2461 See, e.g., Nationwide.
804

designed to diversify risk among investment categories, limit exposure to particular types 

of asset classes including covered fund investments, and protect the safety and soundness 

of the insurance company.2462

After careful review of the comments in light of the statutory provisions, the final 

rule has been modified to permit an insurance company or its affiliate2463 to acquire or 

retain an ownership interest in, or act as sponsor to, a covered fund for either the general 

account of the insurance company or one or more separate accounts established by the 

insurance company.

2464 

These activities are only permitted under the final rule so long as: (1) the 

insurance company or its affiliate acquires and retains the ownership interest solely for 

the general account of the insurance company or for one or more separate accounts 

established by the insurance company; (2) the acquisition and retention of the ownership 

interest is conducted in compliance with, and subject to, the insurance company 

investment laws, regulations, and written guidance of the State or jurisdiction in which 

 

2462 See, e.g., ACLI (Jan. 2012); Fin. Services Roundtable (Feb. 3, 2012); USAA; Chamber (Feb. 2012); 

Country Fin. et al.; Mutual of Omaha; NAMIC; Nationwide; Rep. McCarthy et al. See also 156 Cong. 

Reg. S.5896 (daily ed. July 15, 2010) (statement of Sen. Merkley) (arguing that activities of insurance 

companies “are heavily regulated by State insurance regulators, and in most cases do not pose the same 

level of risk as other proprietary trading”).

2463 Some commenters urged the Agencies to provide that an affiliate or subsidiary of an insurance 

company could purchase covered funds for the insurance company’s general account or a separate account.

See e.g., Fin. Services Roundtable (Feb. 3, 2012); TIAA-CREF (Feb. 13, 2012). The Agencies note that 

the final rule provides (as does the statute) an exemption that permits an insurance company or its affiliate 

to acquire and retain an ownership interest in a covered fund solely for the insurance’s company general 

account (or one or more of its separate account); such an affiliate or subsidiary also may be a whollyowned subsidiary, as defined in the final rule. 

2464 The final rule defines the terms “general account” and “separate account” largely as proposed, and 

includes the new defined term “insurance company,” defined as a company that is organized as an 

insurance company, primarily and predominantly engaged in writing insurance or reinsuring risks 

underwritten by insurance companies, subject to supervision as such by a state insurance regulator or a 

foreign insurance regulator, and not operated for the purpose of evading the provisions of section 13 of the 

BHC Act. Cf. section 2(a)(17) of the Investment Company Act (defining the term insurance company). 
805

the insurance company is domiciled; and (3) the appropriate Federal banking agencies, 

after consultation with the Financial Stability Oversight Council and the relevant 

insurance commissioners of the States and relevant foreign jurisdictions, as appropriate, 

have not jointly determined, after notice and comment, that a particular law, regulation, 

or written guidance described in § __.13(c)(2) of the final rule is insufficient to protect 

the safety and soundness of the banking entity, or the financial stability of the United 

States.2465 

The Agencies believe that exempting insurance activities and investments from 

the covered fund restrictions is supported by the language of sections 13(d)(1)(D) and (F) 

of the BHC Act,2466 and more fully carries out Congressional intent and the statutory 

purpose of appropriately accommodating the business of insurance within an insurance 

company.2467 Section 13(d)(1)(F) of the statute specifically exempts general accounts of 

insurance companies, and, as explained above in Part IV.A.7, separate accounts are 

managed and maintained on behalf of customers, an activity exempt under section 

13(d)(1)(D) of the statute. By their terms, these are statutory exemptions from the 

prohibitions in section 13(a), which includes both the prohibition on proprietary trading 

and the prohibition on covered fund investments and sponsorship. Moreover, the 

statutory language of sections 13(d)(1)(D) and 13(d)(1)(F), both cross-reference the 

instruments described in section 13(h)(4) and not activity described in section 13(h)(4). 

These instruments are “any security, any derivative, any contract of sale of a commodity 

 

2465 See final rule § __.13(c). 

2466 See 12 U.S.C. 1851(d)(1)(D), (F). 

2467 See 12 U.S.C. 1851(b)(1)(F). See also 156 Cong. Reg. S.5896 (daily ed. July 15, 2010) (statement of 

Sen. Merkley) (arguing that “section 13 of the BHC Act] was never meant to affect the ordinary business of 

insurance”).
806

for future delivery, any option on any such security, derivative or contract or any other 

security or financial instrument that [the Agencies determine by rule.]” This reference 

covers an ownership interest in a covered fund. The Agencies believe these exemptions 

as modified more fully carry out Congressional intent and the statutory purpose of 

appropriately accommodating the business of insurance within an insurance company.2468 

Insurance companies are already subject to a robust regulatory regime including 

limitations on their investment activities.

5. Section __.14: Limitations on Relationships With a Covered Fund

Section 13(f) of the BHC Act generally prohibits a banking entity that, directly or 

indirectly, serves as investment manager, investment adviser, or sponsor to a covered 

fund (or that organizes and offers a covered fund pursuant to section 13(d)(1)(G) of the 

BHC Act) from entering into a transaction with a covered fund that would be a covered 

transaction as defined in section 23A of the Federal Reserve Act (“FR Act”).2469 The 

statute also provides an exemption for prime brokerage transactions between a banking 

entity and a covered fund in which a covered fund managed, sponsored, or advised by 

that banking entity has taken an ownership interest. Section 13(f) subjects any 

transaction permitted under section 13(f) of the BHC Act (including a permitted prime 

brokerage transaction) between the banking entity and covered fund to section 23B of the 

 

2468 See 12 U.S.C. 1851(b)(1)(F). See also 156 Cong. Reg. S.5896 (daily ed. July 15, 2010) (statement of 

Sen. Merkley) (arguing that “section 13 of the BHC Act] was never meant to affect the ordinary business of 

insurance”).

2469 12 U.S.C. § 371c. The Agencies note that this does not alter the applicability of section 23A of the FR 

Act and the Board’s Regulation W to covered transactions between insured depository institutions and their 

affiliates.
807

FR Act.2470 In general, section 23B of the FR Act requires that the transaction be on 

market terms or on terms at least as favorable to the banking entity as a comparable 

transaction by the banking entity with an unaffiliated third party. Section __.16 of the 

proposed rule implemented these provisions.2471

a. Scope of Application

Section 13(f) of the BHC Act and the related provisions of the proposal were 

among the most commented upon aspects of the covered funds section. The majority of 

commenters argued that the broad definition of “covered fund” under the proposal made 

the proposed implementation of section 13(f) unworkable and disruptive to existing 

market practices because it would prohibit corporate funding transactions with ordinary 

corporate entities that do not engage in hedge fund or private equity activities.2472 

Commenters also argued that activities that the proposal appeared to permit as a 

permitted activity exemption (e.g., investments in public welfare funds) would be 

prohibited by the restrictions in 13(f)2473 and that the Agencies should construe section 

13(d)(1)(J) of the BHC Act as allowing them to permit banking entities to enter into 

covered transactions with a covered fund, if those activities would promote and protect 

the safety and soundness of banking entities and the financial stability of the United 

 

2470 12 U.S.C. § 371c-1.

2471 See proposed rule § __.16. 

2472 See, e.g., Allen & Overy (on behalf of Foreign Bank Group); BoA; Barclays; Credit Suisse (Williams); 

Deutsche Bank (Fund-Linked Products); GE (Feb. 2012); Goldman Sachs (Covered Funds); ICI Global; 

ISDA (Feb. 2012); RMA; SIFMA et al. (Covered Funds) (Feb. 2012). 

2473 See SunTrust; AHIC; SBIA.
808

States.2474 However, many of the comments discussed above and some of the economic 

burdens noted by these commenters have been addressed by revisions discussed above in 

Part IV.B.1 to the definition of covered fund.2475 A number of these and related 

comments are also addressed by portions of the final rule that provide that the 

prohibitions of section 13 do not apply to interests acquired, for example, as agent, 

broker, custodian, in satisfaction of a debt previously contracted, through a pension fund, 

or as trustee or fiduciary (all within the limits defined in the final rule). 

Several commenters argued that applying the restrictions in section 13(f) to 

foreign activities of foreign banking entities would be inconsistent with the presumption 

against extraterritorial application of U.S. law and principles of international comity, 

including deference to home-country regulation.2476 For example, one commenter 

expressed concern that rules being developed around custody obligations in the European 

Union may require a prime broker or custodian to indirectly guarantee assets of a fund, 

which would directly conflict with the prohibition on guarantees in section 13(f) of the 

BHC Act.2477 As explained above, the final rule has been modified to more narrowly 

focus the scope of the definition of covered fund as it applies to foreign funds.2478 These 

changes substantially address the issues raised by commenters regarding the applicability 

of section 13(f) of the BHC Act to foreign funds. 

 

2474 See SIFMA et al. (Covered Funds) (Feb. 2012).

2475 See final rule § __.10(b). See supra Part IV.B.1.

2476 See IIB/EBF; Katten (on behalf of Int’l Clients); EBF; EFAMA; French Banking Fed’n.; Japanese 

Bankers Ass’n.

2477 See AIMA. 

2478 See final rule § __.10(b)(1)(ii) & (c)(1). See supra Part IV.B.1.
809

Commenters also raised a number of other issues. For instance, some 

commenters argued that applying section 13(f) to securitization entities would in some 

instances run counter to the rule of construction contained in section 13(g)(2) regarding 

the sale and securitization of loans.2479 These commenters recommended that the final 

rule, at a minimum, grandfather pre-existing relationships between banking entities and 

existing securitization vehicles to reduce the potential effects of the final rule on 

agreements and positions entered into before the enactment of the statute.2480 

One commenter argued that a banking entity that delegates its responsibility for 

acting as sponsor, investment manager, or investment adviser to an unaffiliated entity 

should no longer be subject to the restrictions of section 13(f).2481 By its terms, section 

13(f) of the BHC Act applies to a banking entity that, directly or indirectly, serves as 

investment manager, investment adviser, or sponsor to a covered fund (or that relies on 

section 13(d)(1)(G) of the BHC Act in connection with organizing and offering a covered 

fund). The Agencies believe that a banking entity that delegates its responsibility to act 

as sponsor, investment manager, or investment adviser to an unaffiliated party would still 

 

2479 Section __.11(b) of the final rule provides that for purposes of securitizations, organizing and offering 

includes acting as the securitizer. As discussed in greater detail above in Part IV.B.2.b, a banking entity 

that continues to hold interests in a securitization in reliance on this exemption must comply with certain 

requirements, including the requirements of §__.14. Accordingly, § __.14 of the final rule has also been 

modified from the proposal to prohibit a banking entity that continues to hold an ownership interest in 

accordance with § __11(b), and its affiliates, from entering into a covered transaction with a covered fund, 

subject to certain exceptions. 

2480 See AFME et al.: ASF (Feb. 2012); Ashurst; BoA; Barclays; Cadwalader (Municipal Securities); 

Credit Suisse (Williams); Commercial Real Estate Fin. Council; Deutsche Bank (Fund-Linked Products); 

Fidelity; GE (Feb. 2012); Goldman Sachs (Covered Funds); ICI (Feb. 2012); IIB/EBF; ISDA (Feb. 2012); 

JPMC; PNC et al.; PNC; RBC; SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA (Securitization) (Feb. 

2012); Chamber (Feb. 2012). These comments are addressed above in Part II regarding availability of the 

conformance period provisions of section 13 of the BHC Act.

2481 See Katten (on behalf of Int’l Clients).
810

be subject to the limitations of section 13(f) if the banking entity retains the ability to 

select, remove, direct, or otherwise exert control over the sponsor, investment manager, 

or investment adviser designee. In addition, the unaffiliated party designated as sponsor, 

investment manager, or investment adviser would be subject to the restrictions of section 

13(f) if the third party is a banking entity.

b. Transactions that Would Be a “Covered Transaction”

Section 13(f) of the BHC Act prohibits covered transactions as defined in section 

23A of the FR Act between a banking entity that serves as investment manager, 

investment advisor or sponsor to a covered fund or that relies on the exemption in section 

13(d)(1)(G) and a covered fund.2482 A number of commenters contended that the 

definition of “covered transaction” in section 13(f) of the BHC Act should incorporate 

the exemptions available under section 23A and the Board’s Regulation W.2483 These 

commenters alleged that the statute’s general reference to section 23A suggests that the 

term “covered transaction” should be construed in light of section 23A as a whole, 

 

2482 The term “covered transaction” is defined in section 23A of the FR Act to mean, with respect to an 

affiliate of a member bank: (i) a loan or extension of credit to the affiliate, including a purchase of assets 

subject to an agreement to repurchase; (ii) a purchase of or an investment in securities issued by the 

affiliate; (iii) a purchase of assets from the affiliate, except such purchase of real and personal property as 

may be specifically exempted by the Board by order or regulation; (iv) the acceptance of securities or other 

debt obligations issued by the affiliate as collateral security for a loan or extension of credit to any person 

or company; (v) the issuance of a guarantee, acceptance, or letter of credit, including an endorsement or 

standby letter of credit, on behalf of an affiliate; (vi) a transaction with an affiliate that involves the 

borrowing or lending of securities, to the extent that the transaction causes a member bank or subsidiary to 

have credit exposure to the affiliate; or (vii) a derivative transaction, as defined in paragraph (3) of section 

5200(b) of the Revised Statutes of the United States (12 U.S.C. 84(b)), with an affiliate, to the extent that 

the transaction causes a member bank or a subsidiary to have credit exposure to the affiliate. See 12 U.S.C. 

371c(b)(7), as amended by section 608 of the Dodd-Frank Act.

2483 See 12 U.S.C. 371c(d); 12 CFR 223.42; ABA (Keating); Ass’n. of Institutional Investors (Feb. 2012); 

BoA; BNY Mellon et al.; Credit Suisse (Williams); SIFMA et al. (Covered Funds) (Feb. 2012); See also

Allen & Overy (on behalf of Foreign Bank Group).
811

including the exemptions in subsection (d) of that Act and as implemented in the Board’s 

Regulation W.2484 These commenters also argued that the Board’s authority to interpret 

and issue rules pursuant to section 23A of the FR Act and section 5(b) of the BHC Act, 

the general rule-making authority contained in section 13(b) of the BHC Act, and the 

exemptive authority in section 13(d)(1)(J) all provide a basis for providing such 

exemptions.2485

 In particular, commenters argued that intraday extensions of credit;2486

transactions fully secured by cash or U.S. government securities;2487 purchases of liquid 

assets and marketable securities from covered funds;2488 and riskless principal 

transactions with covered funds all should be exempt from the restrictions in section 13(f) 

of the BHC Act.2489 These commenters argued that providing an exemption for intraday 

extensions of credit in particular was necessary to allow a banking entity to continue to 

provide affiliated covered funds with standard custody, clearing, and settlement services 

that include intra-day or overnight overdrafts necessary to facilitate securities settlement, 

contractual settlement, pre-determined income, or similar custody-related transactions. 

Some commenters argued that transactions fully secured by cash or U.S. government 

securities do not expose banking entities to inappropriate risks, are permitted in unlimited 

 

2484 See ABA (Keating); Ass’n. of Institutional Investors (Feb. 2012); BoA; BNY Mellon et al.; SIFMA et 

al. (Covered Funds) (Feb. 2012).

2485 See BNY Mellon et al.; SIFMA et al. (Covered Funds) (Feb. 2012); See also Credit Suisse (Williams).

2486 See ABA (Keating); AFG; Ass’n. of Institutional Investors (Feb. 2012); BoA; BNY Mellon et al.; 

Credit Suisse (Williams); EFAMA; French Treasury et al.; JPMC; IMA; RMA; SIFMA et al. (Covered 

Funds) (Feb. 2012); State Street (Feb. 2012); SSgA (Feb. 2012); Vanguard.

2487 See BoA; Credit Suisse (Williams); SIFMA et al. (Covered Funds) (Feb. 2012).

2488 See Credit Suisse (Williams).

2489 See, e.g., Credit Suisse (Williams).
812

amounts under section 23A, and should not be entirely prohibited under the rule.2490 A 

few commenters argued that the proposal would prohibit securities lending transactions 

and argued that borrower default indemnifications by a banking entity in agency 

securities lending arrangements should not be prohibited under section 13(f).2491 Some 

commenters argued that a banking entity should be allowed to accept the shares of a 

sponsored covered fund as collateral for a loan to any person or entity, in particular where 

the loan is not for the purpose of purchasing interests in the covered fund.2492 

One commenter argued that no exceptions should be granted to the definition of 

covered transaction, and financing of covered funds would relate to greater fund risk.2493 

In addition, that commenter contended that the Agencies should prohibit a sale of 

securities by a banking entity to a covered fund even though these transactions are not 

within the definition of covered transaction for purposes of section 23A of the FR 

Act.2494

The final rule continues to apply the same definition of covered transaction as the 

proposal. Section 13(f) refers to a covered transaction, as defined in section 23A of the 

FR Act. Section 13(f) of the BHC Act does not incorporate or reference the exemptions 

contained in section 23A of the FR Act or the Board’s Regulation W. Indeed, the 

exemptions for these transactions are not included in the definition of covered 

 

2490 See BoA; Credit Suisse (Williams); SIFMA et al. (Covered Funds) (Feb. 2012).

2491 See State Street (Feb. 2012); RMA. 

2492 See BoA; SIFMA et al. (Covered Funds) (Feb. 2012); See also Katten (on behalf of Int’l Clients). 

2493 See Occupy.

2494 See 12 U.S.C. 371c(b)(7); See also 12 U.S.C. 371c-1(a)(2)(B) (including the sale of securities or other 

assets to an affiliate as a transaction subject to section 23B). 
813

transactions in section 23A; the exemptions are instead in a different subsection of 

section 23A and provide an exemption from only some (but not all) of the provisions of 

section 23A governing covered transactions.2495 Therefore, the final rule does not 

incorporate the exemptions in section 23A.

Similarly, the final rule incorporates the statutory restriction as written, which 

provides that a banking entity that serves in certain specified roles may not enter into a 

transaction with a covered fund that would be a covered transaction as defined in section 

23A of the FR Act as if the banking entity were a member bank and the covered fund 

were an affiliate thereof. There are certain occasions when the restrictions of section 23A 

apply to transactions that involve a third party other than an affiliate of a member bank. 

For example, section 23A would apply to an extension of credit by a member bank to a 

customer where the extension of credit is secured by shares of an affiliate. The Agencies 

believe that these transactions between a banking entity and a third party that is not a 

covered fund are not covered by the terms of section 13(f), which (as discussed above) 

make specific reference to transactions by the banking entity with the covered fund. A 

contrary reading would prohibit securities margin lending, which Congress has 

specifically addressed (and permitted) in other statutes. There is no indication in the 

legislative history that Congress intended section 13(f) to prohibit margin lending that 

occurs in accordance with other specific statutes. Thus, section 13(f) does not prohibit a 

banking entity from extending credit to a customer secured by shares of a covered fund 

(as well as, perhaps, other securities) held in a margin account. However, the Agencies 

 

2495 See 12 U.S.C. 371c(d).
814

expect banking entities not to structure transactions with third parties in an attempt to 

evade the restrictions on transactions with covered funds, and the Agencies will use their 

supervisory authority to monitor and restrict transactions that appear to be evasions of 

section 13(f). 

c. Certain Transactions and Relationships Permitted

While section 13(f)(1) of the BHC Act generally prohibits a banking entity from 

entering into a transaction with a related covered fund that would be a covered 

transaction as defined under section 23A of the FR Act, other specific portions of the 

statute permit a banking entity to engage in certain transactions or relationships with such 

funds. 

1. Permitted investments and ownerships interests

The proposed rule permitted a banking entity to acquire or retain an ownership 

interest in a covered fund in accordance with the requirements of section 13.2496 This 

was consistent with the text of section 13(f), which by its terms is triggered by the 

presence of certain ownership interests. This view also resolved an apparent conflict 

between the text of section 13(f) and the reference in section 13(f) prohibiting covered 

transactions under section 23A of the FR Act, which includes acquiring or retaining an 

interest in securities issued by an affiliate. 

 

2496 See proposed rule § __.16(a)(2)(i).
815

Several commenters supported this aspect of the proposal.2497 There is no 

evidence that Congress intended section 13(f)(1) of the BHC Act to override the other 

provisions of section 13 with regard to the acquisition or retention of ownership interests 

specifically permitted by the section. Moreover, a contrary reading would make these 

more specific sections that permit covered transactions between a banking entity and a 

covered fund mere surplusage. Therefore, the final rule adopts this provision as 

proposed.2498

2. Prime brokerage transactions

Section 13(f) provides an exception from the prohibition on covered transactions 

with a covered fund for any prime brokerage transaction with a covered fund in which a 

covered fund managed, sponsored, or advised by a banking entity has taken an ownership 

interest (a “second-tier fund”). However, the statute does not define prime brokerage 

transaction. The proposed rule defined prime brokerage transaction to include providing 

one or more products or services, such as custody, clearance, securities borrowing or 

lending services, trade execution, or financing, data, operational, and portfolio 

management support.2499 

A few commenters argued that the proposed definition of prime brokerage 

transaction was overly broad and should not permit securities lending or borrowing 

services. These commenters argued that securities lending and borrowing (and certain 

 

2497 See, e.g., SIFMA et al. (Covered Funds) (Feb. 2012).

2498 The final rule modifies the proposal to clarify that a banking entity may acquire and retain an 

ownership interest in a covered fund by express reference to the permitted activities described in §§ __.11, 

__.12 and __.13. 

2499 See proposed rule §__.10(b)(4).
816

other services) could increase leverage by covered funds and the risk that a banking entity 

would bailout these funds.2500 

Other commenters argued that the proposed definition of prime brokerage 

transaction was confusing because it included transactions (such as data or portfolio 

management support) that were not “covered transactions” under section 23A of the FR 

Act and thus not prohibited as an initial matter by section 13(f). These commenters 

argued that including otherwise permissible transactions within the definition of prime 

brokerage transaction created uncertainty about the permissibility of other transactions or 

services that are not expressly covered transactions under section 23A of the FR Act and 

thus not prohibited under section 13(f). One commenter proposed defining prime 

brokerage transaction as any “covered transaction” entered into by a banking entity with 

a covered fund “for purposes of custody, clearance, securities borrowing or lending 

services, trade execution and settlement, financing and related hedging, intermediation, or 

a similar purpose.”2501

A few commenters supported expanding the definition of prime brokerage 

transaction to include any service or transaction “related to” a specific list of permissible 

transactions. For instance, one commenter argued that acting as agent in providing 

contractual income and settlement services and intraday and overnight overdraft 

protection should expressly be included within the definition of prime brokerage 

transaction.2502 This commenter also urged that borrower default indemnification should 

 

2500 See, e.g., Occupy; Public Citizen.

2501 See SIFMA et al. (Mar. 2012).

2502 See RMA.
817

be included as a prime brokerage transaction to the extent it would be a covered 

transaction that is prohibited by section 13(f).2503 Another commenter recommended that 

the definition of prime brokerage transaction expressly include transactions in 

commodities, futures and foreign exchange, as well as securities, and transactions 

effected through OTC derivatives, including, without limitation, contracts for differences, 

various swaps and security-based swaps, foreign exchange swaps and forwards and “FX 

prime brokerage”.2504 

Based on review of the comments, the definition of prime brokerage transaction 

has been modified in several ways. For purposes of the final rule, prime brokerage 

transaction is defined to mean any transaction that would be a covered transaction, as 

defined in section 23A(b)(7) of the FR Act (12 U.S.C. 371c(b)(7)), that is provided in 

connection with custody, clearance and settlement, securities borrowing or lending 

services, trade execution, financing, or data, operational, and administrative support. The 

definition of prime brokerage transaction under the final rule generally recognizes the 

same relationships that were considered when defining prime brokerage transaction under 

the proposal,2505 without certain of the modifications suggested by some commenters that 

are discussed above. The Agencies carefully considered comments received on the 

definition of prime brokerage transaction. As noted above, certain commenters requested 

that various types of transactions be included in or omitted from the definition. The 

Agencies believe it appropriate to include within the definition of prime brokerage 

 

2503 See RMA. 

2504 See Katten (on behalf of Int’l Clients).

2505 See final rule §__.10(d)(5).
818

transaction those transactions that the Agencies believe generally constitute the typical 

type of prime brokerage transactions provided in the market. Including this list of 

relationships provides clarity and certainty for transactions that are commonly considered 

to be prime brokerage transactions. 

The final rule incorporates within the definition of prime brokerage transaction a 

reference to covered transactions under section 23A(b)(7) of the FR Act. This change 

aligns the final rules with section 13(f) of the BHC Act and is designed to eliminate 

confusion and provide certainty regarding both the breath of the prohibition on covered 

transactions in section 13(f) and the scope of the exception for prime brokerage 

transactions. Thus, a transaction or relationship that is not a covered transaction under 

section 13(f) of the BHC Act is not prohibited in the first instance (unless prohibited 

elsewhere in section 13). Within the category of transactions prohibited by section 13(f), 

transactions within the definition of prime brokerage transaction are permitted.

Some commenters argued that the Agencies should provide an exemption for 

prime brokerage transactions with a broader array of funds than the proposal permitted. 

For instance, some commenters argued that the Agencies should permit a banking entity 

to enter into a prime brokerage transaction with any covered fund or fund structure that 

the banking entity organizes and offers or for which it directly serves as investment 

manager, investment adviser, or sponsor, and should not limit the exception for prime 

brokerage transactions to only a second-tier covered fund.2506 Conversely, a few 

commenters argued that the prime brokerage exemption should only permit a banking 

 

2506 See RMA; Katten (on behalf of Int’l Clients); EFAMA; See also Hong Kong Inv. Funds Ass'n.; IMA; 

Union Asset.
819

entity to provide these services to a third-party fund in order to ensure that the provision 

of prime brokerage services does not give rise to the same risks that section 13 was 

designed more generally to limit.2507 

The Agencies note that the statute by its terms does not restrict prime brokerage 

transactions generally. As noted above, section 13(f)(3)(A) of the BHC Act provides that 

a banking entity may enter into any prime brokerage transaction with a second-tier fund. 

The statute by its terms permits a banking entity with a relationship to a covered fund 

described in section 13(f) to engage in prime brokerage transactions (that are covered 

transactions) only with second-tier funds and does not extend to covered funds more 

generally. Neither the statute nor the final rule limit covered transactions between a 

banking entity and a covered fund for which the banking entity does not serve as 

investment manager, investment adviser, or sponsor (as defined in section 13 of the BHC 

Act) or have an interest in reliance on section 13(d)(1)(G) of the BHC Act. Under the 

statute, the exemption for prime brokerage transactions is available only so long as 

certain enumerated conditions are satisfied.2508 The conditions are that (i) the chief 

executive officer (or equivalent officer) of the banking entity certifies in writing annually 

that the banking entity does not, directly or indirectly, guarantee, assume, or otherwise 

insure the obligations or performance of the covered fund or of any covered fund in 

which such covered fund invests, and (ii) the Board has not determined that such 

transaction is inconsistent with the safe and sound operation and condition of the banking 

 

2507 See Sens. Merkley & Levin (Feb. 2012); Occupy.

2508 See 12 U.S.C. 1851(f)(3).
820

entity. The proposed rule incorporated each of these provisions. The final rule provides 

that this certification be made to the appropriate Federal supervisor for the banking entity. 

A few commenters argued that the proposal did not adequately address how the 

CEO attestation requirement in section 13(f) would apply to foreign banking 

organizations. They argued that a senior officer with authority for the U.S. operations of 

the foreign bank should be permitted to make the required attestation.2509 

 The statute allows the attestation for purposes of the prime brokerage exception 

in section 13(f) of the BHC Act to be from the chief executive officer or “equivalent 

officer.”2510 In the case of the U.S. operations of foreign banking entities, the senior 

officer of the foreign banking entity’s U.S. operations or the chief executive officer of the 

U.S. banking entity may provide the required attestation.

d. Restrictions on Transactions With Any Permitted Covered Fund

Sections 13(f)(2) and 13(f)(3)(B) of the BHC Act apply section 23B of the FR 

Act2511 to certain transactions and investments between a banking entity and a covered 

fund as if such banking entity were a member bank and such covered fund were an 

affiliate thereof.2512 Section 23B provides that transactions between a member bank and 

an affiliate must be on terms and under circumstances, including credit standards, that are 

substantially the same or at least as favorable to the banking entity as those prevailing at 

 

2509 See proposed rule § __.16(a)(2)(ii); IIB/EBF; Credit Suisse (Williams). 

2510 See 12 U.S.C. 1851(f)(3)(A)(ii).

2511 12 U.S.C. 371c-1.

2512 See proposed rule § __.16(b).
821

the time for comparable transactions with or involving unaffiliated companies or, in the 

absence of comparable transactions, on terms and under circumstances, including credit 

standards, that in good faith would be offered to, or would apply to, non-affiliated 

companies.2513

Mirroring the statute, the proposal applied this requirement to transactions 

between a banking entity that serves as investment manager, investment adviser, or 

sponsor to a covered fund and that fund and any other fund controlled by that fund. It 

also applied this condition to a permissible prime brokerage transaction in which a 

banking entity may engage under the proposal. 

Commenters generally did not raise any issues regarding the proposal’s 

implementation of section 13(f)(2) and 13(f)(3)(B). The final rule generally implements 

these requirements in the same manner as the proposal.2514

6. Section __.15: Other limitations on permitted covered fund activities

Like § __.8, § __.17 of the proposed rule implemented section 13(d)(2) of the 

BHC Act, which places certain limitations on the permitted covered fund activities and 

investments in which a banking entity may engage. Consistent with the statute and § 

 

2513 12 U.S.C. 371c-1(a); 12 CFR 223.51. 

2514 See final rule § __.14(b). As discussed above, § __.11(b) of the final rule provides that for purposes of 

securitizations, organizing and offering includes acting as the securitizer. A banking entity that continues 

to own interests in a securitization in reliance on this exemption must comply, among other things, with the 

requirements of §__.14. Accordingly, § __.14(b) of the final rule has been modified to require that a 

banking entity that continues to hold an ownership interest in accordance with § __.11(b) is subject to 

section 23B of the Federal Reserve Act, as if such banking entity were a member bank and the covered 

fund were an affiliate. 
822

__.8 of the proposed rule, § __.17 provided that no transaction, class of transactions, or 

activity was permissible under §§ __.11 through __.14 and § __.16 of the proposed rule if 

the transaction, class of transactions, or activity would: (i) involve or result in a material 

conflict of interest between the banking entity and its clients, customers, or 

counterparties; (ii) result, directly or indirectly, in a material exposure by the banking 

entity to a high-risk asset or a high-risk trading strategy; or (iii) pose a threat to the safety 

and soundness of the banking entity or the financial stability of the United States.

Section __.17 of the proposed rule defined “material conflict of interest,” “highrisk assets,” and “high-risk trading strategies” for these purposes in a fashion identical to 

the definitions of the same terms for purposes of § __.8 of the proposed rule related to 

proprietary trading. In the final rule, other than the permitted activities to which §§ __.7 

and __.15 apply, §§ __.7 and __.15 are also identical. Comments received on the 

definitions in these sections, as well as the treatment of these concepts under the final 

rule, are described in detail in Part IV.A.9 above.

The Agencies also note that some concerns identified by commenters regarding 

the rule’s extraterritorial application are addressed by modifications in the final rule to 

the definition of a covered fund under § __.10. As noted above, commenters requested 

that the Agencies clarify that the limitations in §§ __.8 or __.17 of the proposed rule

apply only to a foreign banking entity’s U.S. activities and affiliates.2515 As discussed in 

greater detail above in Part IV.B.1, the final rule has been modified to more narrowly 

focus the scope of the definition of covered fund as it applies to foreign funds. Pursuant 

 

2515 See EBF; Ass’n. of German Banks.
823

to the definition of a covered fund in §__.10(b)(1), a foreign fund may be a covered fund 

with respect to the U.S. banking entity that sponsors the fund, but not be a covered fund 

with respect to a foreign bank that invests in the fund solely outside the United States. 

Foreign public funds, as defined in §__.10(c)(1) of the final rule, are also excluded from 

the definition of a covered fund. By excluding foreign public funds from the definition of 

covered fund and by narrowing the scope of the definition of a covered fund with respect 

to foreign funds, the Agencies have addressed some commenters’ concerns regarding the 

burdens imposed by proposed rule §__.17. 

C. Subpart D and Appendices A and B – Compliance Program, Reporting, and 

Violations

Subpart D of the proposed rule implemented section 13(e)(1) of the BHC Act and 

required certain banking entities to develop and provide for the continued administration 

of a program reasonably designed to ensure and monitor compliance with the prohibitions 

and restrictions on activities and investments set forth in section 13 and the proposed 

rule.

As explained in detail below, in response to comments on the compliance 

program requirements and Appendix C (Minimum Standards for Programmatic 

Compliance) and to conform to modifications to other sections of the proposed rule, the 

Agencies are adopting a variety of modifications to Subpart D of the proposed rule, 

which requires certain banking entities to develop and provide for the continued 

administration of a program reasonably designed to ensure and monitor compliance with 

the prohibitions and restrictions on proprietary trading activities and covered fund 

activities and investments set forth in section 13 of the BHC Act and the final rule. As 
824

described above, this compliance program requirement forms a key part of the multifaceted approach to implementing section 13 of the BHC Act, and is intended to ensure 

that banking entities establish, maintain and enforce compliance procedures and controls 

to prevent violation or evasion of the prohibitions and restrictions on proprietary trading 

activities and covered fund activities and investments.

The proposal adopted a tiered approach to implementing the compliance program 

mandate, requiring a banking entity engaged in proprietary trading activities or covered 

fund activities and investments to establish a compliance program that contained specific 

elements and, if the banking entity’s activities were significant, meet a number of more 

detailed minimum standards. If a banking entity did not engage in proprietary trading 

activities and covered fund activities and investments, it was required to ensure that its 

existing compliance policies and procedures included measures that were designed to 

prevent the banking entity from becoming engaged in such activities and making such 

investments and to develop and provide for the required program under § __.20(a) of the 

proposed rule prior to engaging in such activities or making such investments, but was 

not otherwise required to meet the requirements of subpart D of the proposed rule. 

1. Section __.20: Compliance Program Mandate

a. Program Requirement

A number of commenters argued that the compliance program requirements of the 

proposal were overly specific, too prescriptive and complex to be workable, and not 
825

justified by the costs and benefits of having a compliance program.2516 For instance, one 

commenter expressed concern that the complexity of the proposed compliance regime 

would undermine compliance efforts because the requirements were overlapping, 

imprecise, and did not provide sufficient clarity to traders or banking entities as to what 

types or levels of activities would be viewed as permissible trading.2517 Some 

commenters argued that the compliance program would be challenging to enforce or 

administer with any consistency across different banking entities and jurisdictions.2518 A 

few commenters objected to any attempt to identify every possible instance of prohibited 

proprietary trading in otherwise permitted activity.2519 By contrast, some commenters 

supported the proposed compliance program as effective and consistent with the statute 

but also suggested a number of ways that the proposal’s compliance program could be 

improved.2520

A few commenters argued that the proposed compliance program should be 

replaced with a more principles-based framework that provides banking entities the 

discretion and flexibility to customize compliance programs tailored to the structure and 

 

2516 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); Citigroup (Feb. 2012); Wells Fargo (Prop. 

Trading); See also Barclays; BlackRock; Chamber (Dec. 2011); Comm. on Capital Markets Regulation; 

Credit Suisse (Williams); FIA; Goldman (Covered Funds); Investure; NYSE Euronext; RBC; STANY; 

Wedbush; See also Northern Trust; Chamber (Feb. 2012). 

2517 See Citigroup (Feb. 2012).

2518 See ABA (Abernathy); IIB/EBF; ICFR. While the Agencies recognize these issues, the Agencies 

believe the final rule’s modifications to the proposal – for example, providing for simplified programs for 

smaller, less active banking entities and increasing the asset threshold that triggers enhanced compliance 

requirements – helps balance enforceability and consistency concerns with implementing a program that 

helps to ensure compliance consistent with section 13(e)(1) of the BHC Act. See 12 U.S.C. 1851(e)(1).

2519 See, e.g., SIFMA et al. (Prop. Trading) (Feb. 2012); RBC; STANY; See also Barclays. 

2520 See AFR (Nov. 2012); Occupy; Sens. Merkley & Levin (Feb. 2012)
826

activities of their organizations.2521 A few commenters argued that building on 

compliance regimes that already exist at banking entities, including risk limits, risk 

management systems, board-level governance protocols, and the level at which 

compliance is monitored, would reduce the costs and complexity of the proposal while 

also enabling a robust compliance mechanism for section 13.2522

Another commenter suggested that the focus of the compliance program be on the 

key goal of reducing risk at banking entities by requiring each banking entity to establish 

a risk architecture that prescribes a customer-focused business model for market makingrelated activities including a comprehensive set of risk limits that focuses on servicing 

customers and ensuring safety and soundness.2523 This commenter suggested the 

proposal’s compliance requirements be replaced by a simpler compliance framework that 

could be harmonized with the broader systemic capital and risk management framework 

under the Basel accord. This commenter argued such a framework would increase 

transparency as well as reduce overall complexity and costs of regulation, and that 

information relevant to the compliance infrastructure, including customer orientation 

policies and procedures, target customer and product lists, trade histories, and risk limit 

calibration methodology and analyses, should all be made available to examiners.2524 

Another commenter urged that the compliance program could be generally improved by 

 

2521 See SIFMA et al. (Prop. Trading) (Feb. 2012); Wells Fargo (Prop. Trading); See also M&T Bank; 

Credit Suisse (Seidel); State Street (Feb. 2012); See also NYSE Euronext; Stephen Roach. 

2522 See Citigroup (Feb. 2012); SIFMA et al. (Prop. Trading) (Feb. 2012); See also ABA (Abernathy); Paul 

Volcker. 

2523 See Citigroup (Feb. 2012); See also SIFMA et al. (Prop. Trading) (Feb. 2012). 

2524 See Citigroup (Feb. 2012). 
827

having a greater focus on the compensation incentives within the compliance program of 

banking entities.2525

A number of other commenters requested certain types of banking entities be 

specifically excluded from having to implement the requirements of the compliance 

program. For example, some commenters urged that the details required in proposed 

Appendix C apply only to those banking entities and business lines within a banking 

group that have “significant” covered funds or trading activities and not apply to an 

affiliate of a banking entity that does not engage in the types of activities section 13 is 

designed to address (e.g., an industrial affiliate that manufactures machinery).2526 One 

commenter argued that the final rule should not impose a compliance program 

requirement on a banking entity that owns 50 percent or less of another banking entity in 

order to ensure the compliance program did not discourage joint ventures or other 

arrangements where a banking entity does not have actual control over an affiliate.2527 

As discussed in Part IV.B.4.c. above,2528 other commenters argued that the reporting and 

recordkeeping and compliance requirements of the rule should not apply to permitted 

insurance company investment activities because insurance companies are already 

subject to comprehensive regulation of the kinds and amounts of investments they can 

 

2525 See Occupy. 

2526 See, e.g., Credit Suisse (Williams); GE (Feb. 2012); See also NAIB et al.; Chamber (Feb. 2012).

2527 See GE (Feb. 2012). Under the BHC Act, an entity would generally be considered an affiliate of a 

banking entity, and therefore a banking entity itself, if it controls, is controlled by, or is under common 

control with an insured depository institution. Pursuant to the BHC Act, a company controls another 

company if, for instance, the company directly or indirectly or acting through one or more other persons 

owns, controls, or has power to vote 25 per cent or more of any class of voting securities of the company. 

See 12 U.S.C. 1841(a)(2). The compliance program requirement applies to all banking entities in order to 

ensure their compliance with the final rule.

2528 See Part IV.B.4.c.
828

make under State or foreign insurance laws and regulations.2529 However, another 

commenter suggested that insurance company affiliates of banking entities expressly be 

made subject to data collection and reporting requirements to prevent possible evasion of 

the restrictions of section 13 and the final rule using their insurance affiliates.2530 

A few commenters argued that requiring securitization vehicles to establish even 

the minimal requirements set forth in § __.20(d) would impose unnecessary costs and 

burdens on these entities.2531 By contrast, another commenter argued that, because of the 

perceived risks of these entities, securitization vehicles related to a banking entity should 

be required to comply fully with the proposed rule regardless of how such compliance 

procedures are funded by the banking entity.2532

Several commenters urged that foreign activities of foreign banking entities, 

which are already subject to their own prudential regulation under applicable home 

country regulation, be excluded from the compliance program and argued that to do 

otherwise would be an extraterritorial expansion of U.S. law.2533 These commenters 

contended that the compliance program requirements for foreign banking entities should, 

 

2529 See, e.g., ACLI (Jan. 2012); Country Fin. et al.; NAMIC.

2530 See Sens. Merkley & Levin (Feb. 2012). As noted above, the compliance program requirement applies 

to all banking entities, including insurance companies that are considered banking entities, in order to 

ensure their compliance with the final rule.

2531 See ASF (Feb. 2012); AFME et al.; SIFMA (Securitization) (Feb. 2012); Commercial Real Estate Fin. 

Council. 

2532 See Occupy.

2533 See, e.g., Société Générale; IIB/EBF; Australian Bankers Ass'n. (Feb. 2012); Banco de México; 

Norinchukin; Cadwalader (on behalf of Thai Banks); Cadwalader (on behalf of Singapore Banks); Allen & 

Overy (on behalf of Canadian Banks); BAROC; Comm. on Capital Markets Regulation; Credit Suisse 

(Williams); EFAMA; Hong Kong Inv. Funds Ass'n.; HSBC; IIAC; IMA; Katten (on behalf of Int'l Clients); 

Ass'n. of Banks in Malaysia; RBC; Sumitomo Trust; See also AFME et al.; British Bankers' Ass'n.; EBF; 

Commissioner Barnier; French Banking Fed'n.; UBS; Union Asset. 
829

in any event, be narrowly circumscribed.2534 One commenter proposed that the foreign 

activity of foreign banking entities be excluded from compliance, reporting and other 

obligations where the risk of the activity is outside of the United States because those 

risks do not pose a threat to U.S. taxpayers.2535 Another commenter argued that only 

U.S. affiliates of foreign banking entities engaged in proprietary trading and covered fund 

activities as principal in the United States should be required to institute the compliance 

and reporting systems required in the proposal, and that all foreign affiliates only be 

required to have policies and procedures designed to prevent the banking entity from 

engaging in relevant trading and covered fund activities in the United States.2536 This 

commenter also expressed concern that the reporting and recordkeeping requirements 

could be interpreted to apply to an entire trading unit, even trading activities with no U.S. 

nexus, if any portion of a trading unit’s activities, even a single trade, would be required 

to rely on the market-making, hedging, underwriting or U.S. government security 

exemptions.2537

Commenters also offered thoughts on the timeframe within which banking entities 

must establish a compliance program. One commenter urged that reporting begin 

immediately,2538 while another commenter contended that the effective date provided 

banking entities with sufficient time to implement the proposal’s compliance 

 

2534 See, e.g., AFME et al.; IIB/EBF; BaFin/Deutsche Bundesbank; Credit Suisse (Williams); HSBC. 

2535 See Australian Bankers Ass'n. (Feb. 2012); See also RBC. 

2536 See IIB/EBF. 

2537 See IIB/EBF.

2538 See Occupy. 
830

program.2539 Other commenters, however, argued that banking entities should have 

additional time to establish compliance programs.2540 Some commenters argued banking 

entities should have one-year from the date of publication of the final rule to implement 

their compliance programs,2541 while others urged that banking entities have a two-year 

period to build compliance systems.2542 One commenter suggested the Board amend its 

conformance rule to provide U.S. banking entities with an additional year for 

implementing the compliance requirements with respect to their foreign operations.2543

After considering comments on the proposal, the final rule retains the compliance 

program requirement with a variety of modifications. In particular, the modifications are 

designed to make the compliance program requirements clearer and more tailored to the 

size, complexity and type of activity conducted by each banking entity. 2544 The 

Agencies also believe that the revisions build on the limits, procedures and elements of 

 

2539 See Alfred Brock. 

2540 See Wells Fargo (Prop. Trading); PNC et al.; Australian Bankers Ass'n. (Feb. 2012); SIFMA et al.

(Prop.Trading) (Feb. 2012); ABA (Keating); AFME et al.; BoA; Barclays; SIFMA et al. (Covered Funds) 

(Feb. 2012); SIFMA et al. (Mar. 2012); Comm. on Capital Markets Regulation; Credit Suisse (Williams); 

T. Rowe Price; See also Citigroup (Feb. 2012); Société Générale; IIB/EBF; Am. Express; Arnold & Porter; 

BDA (Mar. 2012).

2541 See Wells Fargo (Prop. Trading); PNC et al.; Australian Bankers Ass'n. (Feb. 2012); BoA; Barclays; 

SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA et al. (Mar. 2012); Credit Suisse (Seidel); See also

BDA (Mar. 2012).

2542 See SIFMA et al. (Prop.Trading) (Feb. 2012); ABA (Keating); AFME et al.; GE; Credit Suisse 

(Williams); Goldman (Prop. Trading); Morgan Stanley; RBC; SVB.

2543 See Morgan Stanley.

2544 The Agencies believe these modifications, such as increasing the threshold that triggers enhanced 

compliance standards and allowing smaller banking entities to customize their compliance programs, help 

address concerns that the proposed requirement was too complex and unworkable. See, e.g., SIFMA et al.

(Prop.Trading) (Feb. 2012); Citigroup (Feb. 2012); Wells Fargo (Prop. Trading).
831

risk management programs that many banking entities have already developed to monitor 

and control the risk of existing trading and investment activities.2545

The final rule builds on the proposed rule’s tiered approach by adjusting asset 

thresholds and by adding a new provision allowing a banking entity with modest covered 

activities to customize its compliance program. Specifically, the final rule allows 

banking entities with total assets below $10 billion to fold compliance measures into their 

existing compliance program in a manner that addresses the types and amounts of 

activities the entity conducts.2546 The proposal did not contain such a provision. Similar 

to the proposal, the final rule requires that a banking entity that conducts no activity 

subject to section 13 of the BHC Act is not required to develop any compliance program 

until it begins conducting activities subject to section 13.2547 The final rule further 

modifies the proposal by requiring that a banking entity with total assets greater than $10 

billion but less than $50 billion is generally required to establish a compliance program 

suited to its activities which includes the six elements described in the final rule.2548 

Additionally, the final rule requires that the largest and most active banking entities, with 

total assets above $50 billion, or that are subject to the quantitative measurements 

 

2545 Some commenters argued that the requirement should build on banking entities’ existing compliance 

regimes. See Citigroup (Feb. 2012); SIFMA et al. (Prop.Trading) (Feb. 2012); See also ABA (Abernathy);

Paul Volcker.

2546 See final rule § __.20(f)(2). 

2547 See final rule § __.20(f)(1). In response to a few commenters, the final rule, unlike §__.20(d) of the 

proposed rule, no longer requires a banking entity include measures that are designed to prevent such entity 

from becoming engaged in covered trading activities or covered fund investments and activities.

2548 Under the proposal, each banking entity was required to have a compliance program that addressed the 

elements described in the rule, unless the banking entity did not engage in prohibited activities or 

investments, in which case it need only have existing policies and procedures requiring the banking entity 

to develop a compliance program before engaging in such activities. Further, a banking entity that has 

trading assets and liabilities equal to or greater than $1 billion, or equal to 10% or more of total assets, 

would have been subject to additional standards under the proposed rule. See proposed rule §§ __.20(a), 

(c), (d).
832

requirement due to the size of their trading assets and liabilities, adopt an enhanced 

compliance program that addresses the six elements described in the rule plus a number 

of more detailed requirements described in Appendix B.2549 

In response to commenters’ concerns regarding compliance program burdens in 

connection with covered fund activities and investments, the final rule is further modified

with respect to thresholds for covered fund activities and investments. As noted above, 

this and the other modifications are designed to make the compliance program 

requirement clearer and more tailored to the size, complexity and type of activity 

conducted by each banking entity. The final rule, unlike the proposal, does not require a 

banking entity to adopt the enhanced compliance program if the banking entity, together 

with its affiliates and subsidiaries, invests in the aggregate more than $1 billion in 

covered funds or if they sponsor or advise covered funds, the average total assets of 

which are equal to or greater than $1 billion. Banking entities would look to the total 

asset thresholds discussed above, instead of the amount of covered fund investments and 

activities, in determining whether they would be subject to the enhanced compliance 

program requirements. The Agencies have also modified the compliance program 

reporting obligations of foreign banking entities with respect to their covered trading and 

covered fund activities that are conducted pursuant to the exemptions contained in §§ 

__.6(e) and __.13(b).2550

 

2549 Because the Agencies have determined not to retain proposed Appendix B in the final rule, proposed 

Appendix C is now Appendix B under the final rule. 

2550 See, e.g., Société Générale; IIB/EBF; Australian Bankers Ass'n. (Feb. 2012); Banco de México; 

Norinchukin; Cadwalader (on behalf of Thai Banks); Cadwalader (on behalf of Singapore Banks); Allen & 

Overy (on behalf of Canadian Banks); BAROC; Comm. on Capital Markets Regulation; Credit Suisse 

(Williams); EFAMA; Hong Kong Inv. Funds Ass'n.; HSBC; IIAC; IMA; Katten (on behalf of Int'l Clients); 
833

The final rule also responds to commenters’ concerns regarding the timeframe 

within which a banking entity must establish and implement the compliance program 

required for that entity under § __.20. Under the final rule, each banking entity must 

establish the compliance program required for that entity under § __.20 as soon as 

practicable and in no case later than the end of the conformance period.2551 The Agencies 

expect that during this period a banking entity will develop and implement the 

compliance program requirements of the final rule as part of its good-faith efforts to fully 

conform its activities and investments to the requirements of section 13 and the final rule. 

As explained below in the discussion of the enhanced minimum standards for compliance 

programs under Appendix B, the final rule also requires larger and more active banking 

entities to report certain data regarding their trading activities. These requirements have 

been phased-in to provide banking entities an opportunity to develop the necessary 

systems to capture and report the relevant data.2552 In addition, as explained below, the 

Agencies will consider, after a period to gain experience with the data, revisiting these 

 

Ass'n. of Banks in Malaysia; RBC; Sumitomo Trust; See also AFME et al.; British Bankers' Ass'n.; EBF; 

Commissioner Barnier; French Banking Fed'n.; UBS; Union Asset.

2551 As discussed in Part II., the Board is extending the conformance period by one year. Extension of the 

conformance period will, among other things, provide banking entities with additional time to establish the 

required compliance program. The Agencies believe the extension of the conformance period, as well as 

the phased-in approach to implementing the enhanced compliance program in Appendix B, address certain 

commenters’ requests for additional time to establish a compliance program. See Wells Fargo (Prop. 

Trading); PNC et al.; Australian Bankers Ass'n. (Feb. 2012); SIFMA et al. (Prop.Trading) (Feb. 2012); 

ABA (Keating); AFME et al.; BoA; Barclays; SIFMA et al. (Covered Funds) (Feb. 2012); SIFMA et al.

(Mar. 2012); Comm. on Capital Markets Regulation; Credit Suisse (Williams); T. Rowe Price; See also

Citigroup (Feb. 2012); Société Générale; IIB/EBF; Am. Express; Arnold & Porter; BDA (Mar. 2012);

Morgan Stanley. 

2552 Commenters provided a wide range of feedback regarding the timeframe for establishing a compliance 

program, from requesting that reporting begin immediately to requesting two years from the date of 

publication of the final rule. See, e.g., Occupy; Alfred Brock; Wells Fargo (Prop. Trading); PNC et al.; 

SIFMA et al. (Prop.Trading) (Feb. 2012). The Agencies believe that the final rule’s approach appropriately 

balances the desire for effective regulation with requests for additional time to establish a compliance 

program.
834

data collections to determine their usefulness in monitoring the risk and types of activities 

conducted by banking entities.

b. Compliance Program Elements

Section __.20 of the final rule specifies six elements that each compliance 

program required under that section must at a minimum contain. With some minor 

modifications, these are the same six elements that were included in the proposed rule. 

The changes reflect modifications made in requirements and limits in the other provisions 

of the rule and, in particular, acknowledge the importance of trading and hedging limits, 

appropriate setting, monitoring and management review of trading and hedging limits, 

strategies, and activities and investments, incentive compensation and other matters. 

The six elements specified in § __.20(b) are:

• Written policies and procedures reasonably designed to document, describe, 

monitor and limit trading activities and covered fund activities and investments 

conducted by the banking entity to ensure that all activities and investments that 

are subject to section 13 of the BHC Act and the rule comply with section 13 of 

the BHC Act and the rule;2553

• A system of internal controls reasonably designed to monitor compliance with 

section 13 of the BHC Act and the rule and to prevent the occurrence of activities 

or investments that are prohibited by section 13 of the BHC Act and the rule;2554

• A management framework that clearly delineates responsibility and accountability 

for compliance with section 13 of the BHC Act and the rule and includes 

appropriate management review of trading limits, strategies, hedging activities, 

investments, incentive compensation and other matters identified in the rule or by 

management as requiring attention;2555

 

2553 This requirement is substantially the same as the proposed written policies and procedures 

requirement. See proposed rule § __20(b)(1).

2554 This requirement is substantially the same as the proposed internal controls requirement. See proposed 

rule § __.20(b)(2).

2555 The final rule modifies the proposed management framework requirement by adding that the 

management framework element must include appropriate management review of trading limits, strategies, 
835

• Independent testing and audit of the effectiveness of the compliance program 

conducted periodically by qualified personnel of the banking entity or by a 

qualified outside party; 2556

• Training for trading personnel and managers, as well as other appropriate 

personnel, to effectively implement and enforce the compliance program;2557 and 

• Making and keeping records sufficient to demonstrate compliance with section 13 

of the BHC Act and the rule, which a banking entity must promptly provide to the 

relevant supervisory Agency upon request and retain for a period of no less than 5 

years. 

Under the final rule, these six elements must be part of the compliance program of each 

banking entity with total consolidated assets greater than $10 billion that engages in 

activities covered by section 13 of the BHC Act. 

As discussed above, the Agencies have moved particular elements with respect to 

the required compliance program for the exemptions contained in § __.4(a), § __.4(b), 

and § __.5 into the specific requirements of these exemptions. The Agencies believe this 

structure more effectively conveys that satisfying the requirements of these exemptions 

involves specific compliance measures or, with respect to underwriting and market 

making, a customer-focused business model, as requested by some commenters.2558

 

hedging activities, incentive compensation, and other matters. See final rule § __.20(b)(3). See also

proposed rule § __20(b)(3). One commenter suggested that the compliance program requirement have a 

greater focus on compensation incentives. See Citigroup (Feb. 2012).

2556 The final rule modifies the proposed independent testing requirement by specifying that such testing 

must be done “periodically.” See final rule § __.20(b)(4). See also proposed rule § __.20(b)(4). The 

meaning of “independent testing” is discussed in more detail below in Part IV.C.2.e. The reference to 

“audit” does not mean that the independent testing must be performed by a designated auditor, whether 

internal or external.

2557 The final rule retains the proposed training requirement. See final rule § __.20(b)(5). See also

proposed rule § __.20(b)(5).

2558 One of these commenters suggested the Agencies adopt a simpler compliance framework that could be 

harmonized with the Basel accord. See Citigroup (Feb. 2012). The Agencies believe the final framework 

described above helps address concerns about streamlining the compliance program requirement while 

meeting the statutory requirement to issue regulations “in order to insure compliance” with section 13. 12 

U.S.C. 1851(e)(1).
836

In addition to the generally required compliance program elements specified in 

§ __.20(b), a banking entity relying on any of these exemptions should employ the 

specific compliance tools specified within the relevant section of this rule to facilitate 

compliance with the applicable exemption and should appropriately tailor the required 

compliance program elements to the individual trading activities and strategies of each 

trading desk on an ongoing basis. By specifying particular compliance program-related 

requirements in the exemptions, the Agencies have sought to provide additional guidance 

and clarity as to how a compliance program should be structured,2559 while at the same 

time providing the banking entity with sufficient discretion to consider the type, size, 

scope and complexity of its activities and business structure in designing a compliance 

program to meet the requirements set forth in § __.20(b).2560

For a banking entity with more than $10 billion in total consolidated assets, the 

compliance program requires additional documentation with respect to funds. For 

example, the banking entity is required to maintain records that include documentation of 

exclusions or exemptions other than sections 3(c)(1) and 3(c)(7) of the Investment 

Company Act of 1940 relied on by each fund sponsored by the banking entity (including 

all subsidiaries and affiliate) in determining that such fund is not a covered fund.2561 The 

 

2559 One commenter stated that the proposed rule did not provide sufficient clarity as to what types or 

levels of activities would be permissible. See Citigroup (Feb. 2012).

2560 Some commenters requested a more principles-based framework that allows banking entities to 

customize compliance programs to the structure and activities of their organizations. See SIFMA et al.

(Prop.Trading) (Feb. 2012); Wells Fargo (Prop. Trading); See also M&T Bank; Credit Suisse (Seidel); 

State Street (Feb. 2012); NYSE Euronext; Stephen Roach.

2561 See final rule § __.20(e)(1). As discussed under § __.10 regarding entities excluded from the 

definition of covered fund, the Agencies recognize that the final rule’s definition of covered fund does not 

include certain pooled investment vehicles. The Agencies expect that the types of pooled investment 

vehicles sponsored by the financial services industry will continue to evolve, including in response to the 

final rule, and the Agencies will be monitoring this evolution to determine whether excluding these and 
837

banking entity is also required to maintain, with respect to each fund sponsored by the 

banking entity (including all subsidiaries and affiliates) for which the banking entity 

relies on one or more of the exclusions provided by §§ __.10(c)(1), __.10(c)(5), 

__.10(c)(8), __.10(c)(9), or__.10(c)(10) of subpart C, documentation supporting the 

banking entity’s determination that the fund is not a covered fund pursuant to one or 

more of those exclusions.2562 If the banking entity operates a seeding vehicle described 

in §§ __.10(c)(12)(i) or __.10(c)(12)(iii) of subpart C that will become a registered 

investment company or SEC-regulated business development company, the compliance 

program must also include a written plan documenting the banking entity’s determination 

that the seeding vehicle will become a registered investment company or SEC-regulated 

business development company; the period of time during which the vehicle will operate 

as a seeding vehicle; and the banking entity’s plan to market the vehicle to third-party 

investors and convert it into a registered investment company or SEC-regulated business 

development company within the time period specified in § __.12(a)(2)(i)(B) of subpart 

C.2563 Furthermore, for any banking entity that is, or is controlled directly or indirectly 

by a banking entity that is, located in or organized under the laws of the United States or 

of any State, if the aggregate amount of ownership interest in foreign public funds as 

described in §__.10(c)(1) of subpart C owned by such banking entity (including 

 

other types of entities remains appropriate. The Agencies will also monitor use of the exclusions for 

attempts to evade the requirements of section 13 and intend to use their authority where appropriate to 

prevent evasions of the rule. The Agencies are adopting this additional documentation requirement to 

facilitate such monitoring activities.

2562 See final rule § __.20(e)(2). The Agencies are adopting this additional documentation requirement for 

the same reasons discussed above with respect to § __.20(e)(1). 

2563 See final rule § __.20(e)(3). The rationale for this additional documentation requirement is provided 

under the discussion regarding registered investment companies and business development companies in § 

__.10.
838

ownership interests owned by any affiliate that is controlled directly or indirectly by a 

banking entity that is located in or organized under the laws of the United States or of any 

State) exceeds $50 million at the end of two or more consecutive calendar quarters, 

beginning with the next succeeding calendar quarter, such banking entity must include in 

its compliance program documentation the value of the ownership interests owned by the 

banking entity (and such affiliates) in each foreign public fund and each jurisdiction in 

which any such foreign public fund is organized. Such calculation must be done at the 

end of each calendar quarter and must continue until the banking entity’s aggregate 

amount of ownership interests in foreign public funds is below $50 million for two 

consecutive calendar quarters.2564

c. Simplified Programs for Less Active Banking Entities

The proposed rule provided that the six elements of the compliance program 

required by § __.20 would apply to all banking entities engaged in covered trading 

activities or covered fund activities and investments and that the minimum detailed 

standards of Appendix C would apply to only those banking entities above specified 

thresholds. The application of detailed minimum standards was intended to reflect the 

heightened compliance risks of significant covered trading and significant covered fund 

activities and investments. 

 

2564 See final rule §__.20(e)(4). The rationale for this additional documentation requirement is provided 

under the discussion regarding foreign public funds in § __.10. For purposes of this requirement, a U.S. 

branch, agency, or subsidiary of a foreign banking entity is located in the United States; however, the 

foreign bank that operates or controls that branch, agency, or subsidiary is not considered to be located in 

the United States solely by virtue of operating or controlling the U.S. branch, agency, or subsidiary. See

final rule §__.20(e)(5).
839

The proposed rule provided that a banking entity with no covered activities or 

investments could satisfy the requirements of § __.20 if its existing compliance policies 

and procedures were amended to include measures that were designed to prevent the 

banking entity from becoming engaged in such activities or making such investments and 

required the banking entity to develop and provide for the required compliance program 

prior to engaging in covered activities or making covered investments. 

Several commenters expressed concern over the requirement in § __.20(d) of the 

proposed rule that a banking entity that did not engage in any covered trading activities or 

covered fund activities or investments must ensure that its existing compliance policies 

and procedures include measures designed to prevent the banking entity from becoming 

engaged in such activities and making such investments.2565 In particular, some 

commenters expressed concern that the proposal would have a burdensome impact on 

community banks and force community banks to hire specialists to amend their policies 

and procedures to ensure compliance with section 13 and the final regulations. These 

commenters argued that a banking entity should not be required to amend its compliance 

policies and procedures and set up a monitoring program if the banking entity does not 

engage in prohibited activities.2566 

A few commenters argued that the Agencies should more carefully consider the 

burden of the compliance program on smaller institutions that engage in a modest level of 

permissible trading or covered fund activity.2567 One commenter recommended that 

 

2565 See, e.g., ICBA; ABA (Keating); Conf. of State Bank Supervisors; NAIB; Ryan Kamphuis; Wisconsin 

Bankers Ass’n. 

2566 See, e.g., ICBA; ABA (Keating).

2567 See Sens. Merkley & Levin (Feb. 2012); Conf. of State Bank Supervisors; Ryan Kamphuis; SVB.
840

smaller banks be given the benefit of the doubt regarding compliance.2568 For instance, 

one commenter recommended that banking entities with consolidated assets of $10 

billion or less be permitted to engage in a limited amount of interest rate swaps and 

certain other traditional banking activities without being required to establish a 

compliance program.2569

The Agencies have considered carefully the comments received and, as noted 

above, have modified the rule in order to limit the implementation, operational or other 

burdens or expenses associated with the compliance requirements for a banking entity 

that engages in no covered activities or investments. The final rule permits banking 

entities that have no covered activities or investments (other than covered transactions in 

obligations of or guaranteed by the United States or an agency of the United States and 

municipal securities) to satisfy the compliance program requirements by establishing the 

required compliance program prior to becoming engaged in such activities or making 

such investments. This eliminates the burden on banking entities that do not engage in 

covered activities or investments. 

Similarly, § __.20(f)(2) of the final rule provides that a banking entity with total 

consolidated assets of $10 billion or less as measured on December 31 of the previous 

two years that does engage in covered activities and investments may satisfy the 

requirements of § __.20 by including in its existing compliance policies and procedures 

references to the requirements of section 13 and subpart D as appropriate given the 

 

2568 See Sens. Merkley & Levin (Feb. 2012).

2569 See ICBA. 
841

activities, size, scope and complexity of the banking entity. 2570 This could include 

appropriate references to the limits on trading activities permitted in reliance upon any of 

the exemptions contained in § ___.4(a), § ___.4(b) or § ___.5.

d. Threshold for Application of Enhanced Minimum Standards

Under the proposed rule, banking entities with significant covered trading 

activities or covered fund activities and investments were required to establish an 

enhanced compliance program in accordance with Appendix C, which contained detailed 

compliance program requirements. The proposed rule required a banking entity to 

implement the enhanced compliance program under Appendix C if the banking entity 

engaged in covered activities and investments and either: (i) has, on a consolidated basis, 

trading assets and liabilities the average gross sum of which (on a worldwide 

consolidated basis), as measured as of the last day of each of the four prior calendar 

quarters, is equal to or greater than $1 billion or equals 10 percent or more of its total 

assets; or (ii) has, on a consolidated basis, aggregate investments in covered funds the 

average value of which (on a worldwide consolidated basis), as measured as of the last 

day of each of the four prior calendar quarters, is equal to or greater than $1 billion, or

sponsors and advises one or more covered funds the total assets of which are, as 

 

2570 Some commenters asked the Agencies to consider the burden of the compliance program requirement 

on smaller institutions and recommended that small banks be given the benefit of the doubt regarding 

compliance. See Sens. Merkley & Levin (Feb. 2012); Conf. of State Bank Supervisors; Ryan Kamphuis; 

SVB. The Agencies decline to follow the approach suggested by another commenter to allow banking 

entities with assets of $10 billion or less be permitted to engage in certain limited activities without having 

to establish a compliance program. See ICBA. The Agencies believe that requiring a banking entity 

engaged in covered trading or covered fund activity to establish a compliance program is a fundamental 

part of the multi-faceted approach to implementing section 13 of the BHC Act, which requires the Agencies 

to implement rules “to insure compliance with this section.” 12 U.S.C. 1851(e)(1). Further, the Agencies 

believe that the final rule’s modification of the proposal to allow banking entities with total assets under 

$10 billion to customize their compliance programs helps ease the burden of this requirement on smaller 

institutions.
842

measured as of the last day of each of the four prior calendar quarters, equal to or greater 

than $1 billion.

In general, commenters argued that the activities and investments subject to 

section 13 are conducted by only a small number of the nation’s largest financial firms 

and that the compliance program requirements should be tailored to target these firms.2571 

Some commenters urged the Agencies to raise substantially the proposed $1 billion 

threshold for trading assets and liabilities in § __.20(c)(2) of the proposal to $10 billion or 

higher due to the high costs of implementing the enhanced compliance program. A few 

commenters argued that even if the threshold were raised to $10 billion, an overwhelming 

percentage of trading assets and liabilities in the banking industry (approximately 98 

percent) would still remain subject to heightened compliance requirements included in 

Appendix C.2572 Some of these commenters recommended the threshold for trading 

assets for compliance should be increased to no less than $10 billion to mitigate the costs 

and impact on regional banking organizations that do not engage proprietary trading 

subject to the prohibition of section 13. These commenters argued that the compliance 

requirements of § __.20(a)-(b) are sufficient to ensure that regional banking organizations 

have appropriate compliance programs.2573 One commenter suggested the threshold for 

the enhanced compliance requirement be increased to $50 billion in combined trading 

assets and liabilities.2574 One commenter also argued that banking entities required to 

 

2571 See, e.g., Sens. Merkley & Levin (Feb. 2012); PNC et al.

2572 See ABA (Keating); M&T Bank; PNC et al. 

2573 See PNC et al.; M&T Bank; See also ABA (Abernathy). 

2574 See State Street (Feb. 2012).
843

establish enhanced compliance programs should no longer be required to do so if they fall 

below the threshold.2575

Commenters also offered a number of suggestions for modifying the activity that 

would be considered in meeting the thresholds for determining which compliance 

program requirements apply to a banking entity. Several commenters argued that certain 

types of trading assets or fund investments should not be included for purposes of 

determining whether the relevant dollar threshold triggering the enhanced compliance 

was met, particularly those that are not prohibited activities or investments. For instance, 

some commenters urged that trading in U.S. government obligations should not count 

toward the calculation of whether a banking organization meets the trading threshold 

triggering Appendix C.2576 These commenters also argued that other positions or 

transactions that do not involve financial instruments and that may constitute trading 

assets and liabilities, such as loans, should be excluded from the thresholds because 

exempt activities should not determine the type of compliance program a banking entity 

must implement.2577 One commenter urged that foreign exchange swaps and forwards be 

excluded from the definition of a “derivative” and not be subject to compliance 

requirements as a result.2578 Conversely, one commenter urged that all assets and 

liabilities defined as trading assets for purposes of the Market Risk Capital Rule should 

 

2575 See ABA (Keating). 

2576 See PNC et al.

2577 See PNC et al.

2578 See Northern Trust.
844

be included in the $1 billion standard for becoming subject to any reporting and 

recordkeeping requirements under the final rule.2579

A few commenters argued that the $1 billion threshold for establishing an 

enhanced compliance program should not include the amount of investments in, or assets 

of, funds that are SBICs or similar funds that contain, SBICs or other investments 

specified under section 13(d)(1)(E) of the BHC Act, such as investments in and funds 

that qualify for low-income housing tax credits, or New Markets Tax Credits or that 

qualify for Federal historic tax credits or similar state programs.2580 These commenters 

argued that each of these types of funds is expressly permitted by the statute and that 

including these investments and funds in the dollar thresholds that trigger the 

programmatic compliance requirements of Appendix C would provide a disincentive to 

banking entities investing in or sponsoring these funds, a result inconsistent with 

permitting these types of investments. Similarly, one commenter urged that investments 

by a banking entity in, and assets held by, loan securitizations not be included in these 

thresholds because these activities and investments are expressly excluded from coverage 

under the rule of construction contained in section 13(g)(2) of the BHC Act regarding the 

securitization of loans.2581 Another commenter urged that this threshold not include 

investments in, or assets of, any securitization vehicle that would be considered a covered 

fund because many smaller and regional banking entities that were not intended to be 

subject to Appendix C likely would exceed the $1 billion threshold if these assets are 

 

2579 See Occupy.

2580 See ABA (Keating); PNC et al.

2581 See PNC et al. 
845

included.2582 A few commenters also argued that, during the conformance period, 

investments in, and relationships with, a covered fund that a banking entity is required to 

terminate or otherwise divest in order to comply with section 13 should not be included 

for purposes of calculating the compliance thresholds.2583

After considering comments received on the proposal and in order to implement a 

compliance program requirement that is consistent with the purpose and language of the 

statute and rule while at the same time appropriately calibrating the associated resource 

burden on banking entities, the final rule applies the enhanced minimum standards 

contained in Appendix B to only those banking entities with the most significant covered 

trading activities or those that meet a specified threshold of total consolidated assets. The 

final rule, unlike the proposal, does not require a banking entity to adopt the enhanced 

compliance program if the banking entity, together with its affiliates and subsidiaries, 

invest in the aggregate more than $1 billion in covered funds or if they sponsor or advise 

covered funds, the average total assets of which are equal to or greater than $1 billion. 

Banking entities would look to the total consolidated asset thresholds, instead of the 

amount of covered fund investments and activities, in determining whether they would be 

subject to the enhanced compliance program requirements. The Agencies believe that 

commenters’ concerns about whether certain types of covered fund investments or 

activities (e.g., amounts or relationships held during the conformance period) are 

included for purposes of calculating the enhanced compliance thresholds are addressed 

because under the final rule, the enhanced compliance thresholds are based on total 

 

2582 See ASF (Feb. 2012). 

2583 See PNC et al.; SIFMA et al. (Covered Funds) (Feb. 2012).
846

consolidated assets and not the amount of covered fund investments and activities. 

Similar to the proposed rule, which provided that a banking entity could be subject to the 

enhanced compliance program if the Agency deemed it appropriate, the final rule’s 

enhanced compliance program also could apply if the Agency notifies the banking entity 

in writing that it must satisfy the requirements.2584 

Section __.20 provides that three categories of banking entities will be subject to 

the enhanced minimum standards contained in Appendix B. The first category is any 

banking entity that engages in proprietary trading and is required to report metrics 

regarding its trading activities to its primary Federal supervisory agency under the final 

rule.2585 This category includes a banking entity that has, together with its affiliates and 

subsidiaries, trading assets and liabilities that equal or exceed $50 billion based on the 

average gross sum of trading assets and liabilities (on a worldwide consolidated basis and 

after excluding trading assets and liabilities involving obligations of or guaranteed by the 

United States or any agency of the United States) over the previous consecutive four 

quarters, as measured as of the last day of each of the four prior calendar quarters. A 

foreign banking entity with U.S. operations is required to adopt an enhanced compliance 

program if its total trading assets and liabilities across all its U.S. operations equal or 

exceed $50 billion (after excluding trading assets and liabilities involving obligations of 

or guaranteed by the US or any agency of the U.S.). While these banking entities will be 

required to begin to report and record quantitative measurements by June 30, 2014, they 

will not be required to implement an enhanced compliance program by this date. Instead, 

 

2584 See proposed rule § __.20(c)(2)(iii); final rule § __.20(c)(3).

2585 Issues related to the threshold for reporting quantitative measurements are discussed in detail in Part 

IV.C.3., below.
847

as discussed above, a banking entity must establish a compliance program as soon as 

practicable and in no event later than the end of the conformance period. As explained 

more fully in Part IV.C.3., this category expands over time to include any banking entity 

with trading assets and liabilities that equal or exceed $10 billion (as measured in the 

manner described above). For banking entities below the $50 billion threshold that 

become subject to the quantitative measurements requirement through the phased-in 

approach, they will not become subject to the enhanced compliance program until the 

date they are required to comply with the quantitative measurements requirement. 

However, these banking entities will be required to have a compliance program that 

meets the requirements of § __.20(b) by the end of the conformance period. Thus, 

banking entities with between $25 billion and $50 billion trading assets and liabilities (as 

described in § __.20(d)) will be required to implement an enhanced compliance program 

under Appendix B by April 30, 2016. Similarly, banking entities with between $10 

billion and $25 billion trading assets and liabilities will be subject to the requirements of 

Appendix B by December 31, 2016. 

After considering comments, the Agencies have increased the trading asset and 

liability thresholds triggering the enhanced compliance program requirements. The 

Agencies believe that banking entities with a significant amount of trading assets should 

have the most detailed programs for ensuring compliance with the trading and other 

requirements of section 13 of the BHC Act and the final rule. Specifically, consistent 

with the thresholds for reporting and recording quantitative measurements, the threshold 

will initially be $50 billion trading assets and liabilities and, over time, will be reduced to 
848

$10 billion.2586 As noted by commenters, these thresholds will continue to capture a 

significant percentage of the total trading assets and liabilities in the banking system, but 

will reduce the burdens to smaller, less complex banking entities.2587 With respect to this 

first category, the Agencies determined, in response to comments,2588 that the threshold 

for proprietary trading should not include trading assets and liabilities involving 

obligations of or guaranteed by the United States or any agency of the United States. 

This approach reduces the burdens associated with the enhanced minimum compliance 

program on banking entities whose trading operations consist primarily of trading U.S. 

government or agency obligations, which are generally exempt from the proprietary 

trading prohibition under § __.6(a)(1)(i). While some commenters argued that additional 

assets or liabilities, such as securitizations or investments in SBICs, should be excluded 

from the calculation,2589 the Agencies believe that trading in other assets involves more 

complex trading activity and warrants being included in the threshold calculation for 

applying the enhanced compliance program requirement. 

To balance the increased trading asset and liability threshold with the goal of 

requiring appropriate specificity and rigor for large and complex banking organizations’ 

compliance programs, the Agencies have determined to also require an enhanced 

 

2586 Some commenters requested raising this dollar threshold to at least $10 billion. See PNC et al.; PNC; 

ABA (Keating). One commenter suggested the threshold be increased to $50 billion. See State Street (Feb. 

2012).

2587 See PNC et al.; M&T Bank; See also ABA (Abernathy); ABA (Keating). The Agencies recognize 

that, at the $10 billion threshold, a significant percentage of the trading assets and liabilities in the banking 

industry will remain subject to the enhanced compliance program requirement. See PNC.

2588 See PNC et al.

2589 See, e.g., ABA (Keating) (suggesting the threshold should not include the amount of investments in or 

assets of SBICs, or those that qualify for low-income housing tax credits (LIHTC) New Markets Tax 

Credits (NMTC), or Federal historic tax credits (HTC)); PNC et al. (loans); Northern Trust. 
849

compliance program for any banking entity that has reported total consolidated assets, as 

of the previous calendar year-end, of $50 billion or more. Banking entities with total 

assets of $50 billion or more are among the most complex banking entities and have been 

found by Congress to pose sufficient risk to the financial stability of the United States to 

warrant being generally subject to enhanced prudential standards under section 165 of the 

Dodd-Frank Act. With respect to foreign banking entities, this threshold is calculated by 

reference solely to the aggregate assets of the foreign banking entity’s U.S. operations, 

including its U.S. branches and agencies. This approach is consistent with the statute’s 

focus on the risks posed by covered trading activities and investments within the United 

States and also responds to commenters’ concerns regarding the level of burden placed 

on foreign banking entities with respect to their foreign operations.2590 

The third category includes any banking entity that is notified by its primary 

Federal supervisory Agency in writing that it must satisfy the requirements and other

standards contained in Appendix B. By retaining the flexibility to impose enhanced 

compliance requirements on a given banking entity upon specific notice to the firm, the 

Agencies have the ability to apply additional standards to any banking entity with a mix, 

level, complexity or risk of activities that, in the judgment of the relevant supervisory 

Agency, indicates that the firm should appropriately have in place an enhanced 

compliance program.

 

2590 Several commenters requested that foreign activities of foreign banking entities be excluded from the 

compliance program requirement. See, e.g., Société Générale; IIB/EBF; Australian Bankers Ass’n. (Feb. 

2012); Banco de Mexico; Norinchukin. One commenter stated the only U.S. affiliates of foreign banking 

entities should be required to institute the proposed reporting and compliance requirements. See IIB/EBF.
850

Some commenters argued that the final rule should not require a banking entity to 

establish the type of detailed compliance regime dictated by Appendix C for both trading 

and covered fund activities and investments simply because the banking entity engages in 

one but not the other activity.2591 

To comply with the applicable compliance program requirements under § __.20 

and Appendix B of the final rule, banking entities should appropriately take into account 

the type, size, scope and complexity of their activities and business structure in 

determining the terms, scope and detail of the compliance program to be instituted.2592 

For example, if all of a banking entity’s activities subject to the rule involve covered fund 

activities or investments, it would be expected that the banking entity would have an 

appropriate compliance program governing those activities (including an enhanced 

compliance program if applicable) and it would not be expected that the banking entity 

would construct the same detailed compliance program under the proprietary trading 

provision of the rule. Similarly, if a banking entity engages only in activities that are 

subject to the proprietary trading provisions of the rule and does not engage in any 

covered fund activities or investments, it would not be expected that the banking entity 

would implement the same detailed compliance program under the covered funds section 

as would be required for its proprietary trading activities. In each of these situations, the 

banking entity would be expected to put in place sufficient controls to ensure that an 

appropriate compliance program is established before the banking entity commences a 

 

2591 See, e.g., SIFMA et al. (Prop.Trading) (Feb. 2012). 

2592 This is generally consistent with the proposed rule’s compliance program requirement. See proposed 

rule § __.20(a) (requiring that the banking entity’s compliance program be appropriate for the size, scope 

and complexity of activities and business structure of the banking entity).
851

new covered activity. The Agencies believe that this treatment is consistent with the 

statutory language regarding internal controls and recordkeeping to ensure compliance 

with section 13 and also reduces unnecessary costs and burdens associated with requiring 

banking entities to implement compliance requirements that are not appropriate to the 

size, scope and risk of their relevant activities.

2. Appendix B: Enhanced Minimum Standards for Compliance Programs 

The proposed rule contained an appendix (Appendix C) which specified a variety 

of minimum standards applicable to the compliance program of a banking entity with 

significant covered trading activities or covered fund activities and investments. The 

Agencies proposed to include these minimum standards as part of the regulation itself, 

rather than as accompanying guidance, reflecting the compliance program’s importance 

within the general implementation framework for the rule. 

As explained above, the Agencies continue to believe that the inclusion of 

specified minimum standards for the compliance program within the regulation itself 

rather than as accompanying guidance serves to reinforce the importance of the 

compliance program in the implementation framework for section 13 of the BHC Act. 

As explained above, the Agencies believe that large banking entities and banking entities 

engaged in significant trading activities should establish, maintain and enforce an 

enhanced compliance program. The requirements for an enhanced compliance program 

have been consolidated in Appendix B of the final rule. 

Similar to the proposed rule, section I 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; 
852

identify, monitor and promptly address the risks of these covered activities and 

investments and potential areas of noncompliance; and prevent activities or 

investments prohibited by, or that do not comply with, section 13 of the BHC Act 

and the rule;

• Establish and enforce appropriate limits on the covered activities and investments 

of the banking entity, including limits on the size, scope, complexity, and risks of 

the individual activities or investments consistent with the requirements of section 

13 of the BHC Act and the rule;

• Subject the effectiveness of the compliance program to periodic independent 

review and testing, and ensure that the entity’s internal audit, corporate 

compliance and internal control functions involved in review and testing are 

effective and independent;

• Make senior management, and others as appropriate, accountable for the effective 

implementation of the compliance program, and ensure that the board of directors 

and CEO (or equivalent) of the banking entity review the effectiveness of the 

compliance program; and

• Facilitate supervision and examination by the Agencies of the banking entity’s 

covered trading and covered fund activities and investments.

The proposed rule included several definitions within the appendix. In the final 

rule, all definitions have been moved to other sections of the rule or into Appendix A 

(governing metrics). Any banking entity subject to the enhanced minimum standards 

contained in Appendix B may incorporate existing policies, procedures and internal 

controls into the compliance program required by Appendix B to the extent that such 

existing policies, procedures and internal controls assist in satisfying the requirements of 

Appendix B. 

Section II of Appendix B contains two parts: one that sets forth the enhanced 

minimum compliance program standards applicable to covered trading activities of a 

banking entity and one that sets forth the corresponding enhanced minimum compliance 

program standards with respect to covered fund activities and investments. As noted 

above, if all of a banking entity’s activities subject to the final rule involve only covered 

trading activities (or only covered fund activities and investments), it would be expected 
853

that the banking entity would have an appropriate compliance program governing those 

activities (including an enhanced compliance program if applicable) and it would not be 

expected that the banking entity would construct the same detailed compliance program 

under the covered funds (or proprietary trading) provisions of the rule. As discussed 

below, the Agencies have determined not to include the provisions regarding enterprisewide compliance programs. 

a. Proprietary Trading Activities

Like the proposed compliance appendix, section II.A of Appendix B requires a 

banking entity subject to the enhanced minimum standards contained in Appendix B to 

establish, maintain and enforce a compliance program that includes written policies and 

procedures that are appropriate for the types, size, and complexity of, and risks associated 

with, its permitted trading activities.2593 This portion of Appendix B requires a banking 

entity to devote adequate resources and use knowledgeable personnel in conducting, 

supervising and managing its covered trading activities, and to promote consistency, 

independence and rigor in implementing its risk controls and compliance efforts. The 

compliance program must be updated with a frequency sufficient to account for changes 

in the activities of the banking entity, results of independent testing of the program, 

identification of weaknesses in the program and changes in legal, regulatory or other 

requirements. 

Similar to the proposed rule, section II.A of Appendix B requires a banking entity 

subject to the Appendix to: (i) have written policies and procedures governing each 

 

2593 See Joint Proposal, 76 FR at 68,963.
854

trading desk that include a description of certain information specific to each trading desk 

that will delineate its processes, mission and strategy, risks, limits, types of clients, 

customers and counterparties and its compensation arrangements; (ii) include a 

comprehensive description of the risk management program for the trading activity of the 

banking entity, as well as a description of the governance, approval, reporting, escalation, 

review and other processes that the banking entity will use to reasonably ensure that 

trading activity is conducted in compliance with section 13 of the BHC Act and subpart 

B; (iii) implement and enforce limits and internal controls for each trading desk that are 

reasonably designed to ensure that trading activity is conducted in conformance with 

section 13 of the BHC Act and subpart B and with the banking entity’s policies and 

procedures, and establish and enforce risk limits appropriate for the activity of each 

trading desk; and (iv) for any hedging activities that are conducted in reliance on the 

exemption contained in § __.5, establish, maintain and enforce policies and procedures 

regarding the use of risk-mitigating hedging instruments and strategies that describe the 

positions, techniques and strategies that each trading desk may use, the manner in which 

the banking entity will determine that the risks generated by each trading desk have been 

properly and effectively hedged, the level of the organization at which hedging activity 

and management will occur, the management in which such hedging strategies will be 

monitored and the personnel responsible for such monitoring, the risk management 

processes used to control unhedged or residual risks, and a description of the process for 

developing, documenting, testing, approving and reviewing all hedging positions, 

techniques and strategies permitted for each trading desk and for the banking entity in 

reliance on § __.5. 
855

To the extent that any of the standards contained in Appendix B may be 

appropriately met by policies and procedures, internal controls and other requirements 

that are common to more than one trading desk, a banking entity may satisfy the 

requirements for the enhanced minimum standards of the compliance program by 

implementing such common requirements with respect to any such desks as to which 

they are appropriately applicable.2594 To the extent the required elements of the 

compliance program apply differently to different trading desks that conduct trading in 

the same financial instruments, a banking entity must document the differences and adopt 

policies and procedures and implement internal controls specific to each of the different 

trading desks. Overall, the policies and procedures should provide the Agencies with a 

clear, comprehensive picture of a banking entity’s covered trading activities that can be 

effectively reviewed. 

Appendix B also requires that the banking entity perform robust analysis and 

quantitative measurement of its covered trading activities that is reasonably designed to 

ensure that the trading activity of each trading desk is consistent with the banking entity’s 

compliance program; monitor and assist in the identification of potential and actual 

prohibited proprietary trading activity; and prevent the occurrence of prohibited 

proprietary trading. In particular, the banking entity must incorporate into its compliance 

program any quantitative measure reported by the banking entity pursuant to Appendix A 

where applicable, and include at a minimum: (i) internal controls and written policies and 

procedures reasonably designed to ensure the accuracy and integrity of the quantitative 

 

2594 This is consistent with proposed Appendix C, except that the term “trading unit” from the proposal has 

been replaced with the term “trading desk.” See Joint Proposal, 76 FR at 68,965.
856

measures employed; (ii) ongoing timely monitoring and review of calculated quantitative 

measurements; (iii) the establishment of thresholds and trading measures for each trading 

desk and heightened review of any trading activity that is inconsistent with those 

thresholds; and (iv) review, investigation and escalation with respect to matters that 

suggest a reasonable likelihood that a trading desk has violated any part of section 13 of 

the BHC Act or the rule.2595 

Where a banking entity is subject to the reporting requirements of Appendix A, 

any additional quantitative measurements developed and implemented by the banking 

entity under the compliance program requirement are not required to be routinely 

submitted to the relevant Agency as provided in Appendix A, but are subject to the 

recordkeeping requirements set forth in subpart D, including the requirement to promptly 

produce such records to the relevant Agency upon request. Where a banking entity is not 

subject to the requirements of Appendix A, that banking entity would likewise not be 

required by this rule to routinely submit these additional quantitative measurements to the 

relevant Agency, but would be subject to the recordkeeping requirements set forth in 

subpart D, including the requirement to promptly produce such records to the relevant 

Agency upon request. 

In addition to the other requirements that are specific to proprietary trading, the 

banking entity’s compliance program must identify the activities of each trading desk that 

will be conducted in reliance on the exemptions contained in §§ __.4 through __.6, 

including an explanation of (i) how and where in the organization such activity occurs, 

and (ii) which exemption is being relied on and how the activity meets the specific 

 

2595 See Joint Proposal, 76 FR at 68,965.
857

requirements of such exemption. For trading activities that rely on an exemption 

contained in §§ __.4 through § __.6, the banking entity’s compliance program should 

include an explanation of how, and its policies, procedures and internal controls that 

demonstrate that, such trading activities satisfy such exemption and any other 

requirements of section 13 of the BHC Act and the final rule that are applicable to such 

activities. A foreign banking entity that engages in proprietary trading in reliance on the 

exemption contained in § __.6(e) will be expected to provide information regarding the 

compliance program implemented to ensure compliance with the requirements of that 

section, including compliance by the U.S. operations of the foreign banking firm, but will 

only be expected to provide trading information regarding activity conducted within the 

United States (absent an indication of activity conducted or designed to evade the 

requirements of section 13 of the BHC Act of the final rule).2596 

In addition, the compliance program must describe the process for ensuring that 

liquidity management activities are conducted in conformance with the limits and 

policies contained in 

§ __.3(d)(3). This includes processes for ensuring that liquidity management activities 

are not conducted for the purpose of prohibited proprietary trading.

The banking entity’s compliance program must be reasonably designed and 

established to effectively monitor and identify for further analysis any proprietary trading 

activity that may indicate potential violations of section 13 of the BHC Act and subpart B 

and to prevent violations of section 13 of the BHC Act and subpart B. The standards set 

 

2596 See AFME et al.; IIB/EBF; BaFin/Deutsche Bundesbank; Credit Suisse (Seidel); HSBC.
858

forth in subpart D direct the banking entity to include requirements in its compliance 

program for documenting remediation efforts, assessing the extent to which modification 

of the compliance program is warranted and providing prompt notification to appropriate 

management and the board of directors of material weakness or significant deficiencies in 

the implementation of the compliance program.

b. Covered Fund Activities or Investments

Section II.B of Appendix B requires a banking entity subject to the enhanced 

minimum standards contained in Appendix B to establish, maintain and enforce a 

compliance program that includes written policies and procedures that are appropriate for 

the types, size, complexity and risks of the covered fund and related activities conducted 

and investments made, by the banking entity. 

The enhanced compliance program requirements for covered funds and 

investments focus on: (i) ensuring that the compliance program provides a process for 

identifying all covered funds that the banking entity sponsors, organizes or offers, and 

covered funds in which the banking entity invests; (ii) ensuring that the compliance 

program provides a method for identifying all funds and pools that the banking entity 

sponsors or has an interest in and the type of exemption from the Investment Company 

Act or Commodity Exchange Act (whether or not the fund relies on section 3(c)(1) or 

3(c)(7) of the Investment Company Act or section 4.7 of the regulations under the 

Commodity Exchange Act), and the amount of ownership interest the banking entity has 

in those funds or pools; (iii) identifying, documenting, and mapping where any covered 

fund activities are permitted to be conducted within the banking entity; and (iv) including 

an explanation of compliance; (v) describing sponsorship activities related to covered 
859

funds; and (vi) establishing, maintaining and enforcing internal controls that are 

reasonably designed to ensure that its covered fund activities or investments comply with 

the requirements of section 13 of the BHC Act and subpart C, and (vii) monitoring of the 

banking entity’s investments in and transactions with any covered funds.

In addition, the banking entity’s compliance program must document the banking 

entity’s plan for seeking unaffiliated investors to ensure that any investment by the 

banking entity in a covered fund conforms to the limits contained in the final rule or that 

the covered fund is registered in compliance with the securities laws within the 

conformance period provided in the final rule. Similarly, the compliance program must 

ensure that the banking entity complies with any limits on transactions or relationships 

with the covered fund contained in the final rule, including in situations in which the 

banking entity is designated as a sponsor, investment manager, investment adviser or 

commodity trading adviser by another banking entity.

The banking entity’s compliance program must be reasonably designed and 

established to effectively monitor and identify for further analysis any covered fund 

activity that may indicate potential violations of section 13 of the BHC Act and subpart 

C. The standards set forth in subpart D require the banking entity to include requirements 

in its compliance program for documenting remediation efforts, assessing the extent to 

which modification of the compliance program is warranted and providing prompt 

notification to appropriate management and the board of directors of material weakness 

or significant deficiencies in the design or implementation of the compliance program. 

c. Enterprise-Wide Programs
860

Appendix C in the proposed rule contained a provision that permitted a banking 

entity to establish a compliance program on an enterprise-wide basis. Some commenters 

argued that a less specific and more flexible compliance regime would be essential to 

make the enterprise-wide compliance structures contemplated in Appendix C effective 

because requiring individualized policies and procedures for each business line would 

diminish the benefits of enterprise-wide compliance and prevent consistency of these 

policies and procedures within the banking entity.2597 One of these commenters 

recommended the Agencies provide greater options for developing a compliance program 

and not limit a banking entity to a choice between a single enterprise-wide program or a 

separate program for each subsidiary engaged in activities covered by the proposed 

rule.2598 

In contrast, one commenter argued that any enterprise-wide compliance program 

would only be effective if combined with additional programs at the trading unit or 

subsidiary level to train all employees at a banking entity.2599 This commenter argued 

that each trading unit is different and suggested that it would be more efficient to 

mandate enterprise-wide default internal controls, but provide each individual trading 

unit the flexibility to tailor these requirements to its own specific business.2600 This 

commenter also urged that Appendix C’s elements III (internal controls), IV 

 

2597 See SIFMA et al. (Prop.Trading) (Feb. 2012); Wells Fargo (Prop. Trading).

2598 See Wells Fargo (Prop. Trading). 

2599 See Occupy. 

2600 See Occupy. 
861

(responsibility and accountability) and VII (recordkeeping) should not be imposed solely 

at the enterprise-wide level.2601

After considering carefully the comments on the proposal, the Agencies have 

removed the reference to an enterprise-wide compliance program from the final rule; 

however, the Agencies acknowledge that a banking entity may establish a compliance 

program on an enterprise-wide basis, as long as the program satisfies the requirements of 

§ __.20 and, where applicable, Appendix B. A banking entity may employ common 

policies and procedures that are established at the enterprise-wide level or at a businessunit level to the extent that such policies and procedures are appropriately applicable to

more than one trading desk or activity, as long as the required elements of Appendix B 

and all of the other applicable compliance-related provisions of the rule are incorporated 

in the compliance program and effectively administered across trading desks and banking 

entities within the consolidated enterprise or designated business. If a banking entity 

establishes an enterprise-wide program, like a non-enterprise wide program, that program 

will be subject to supervisory review and examination by any Agency vested with rule 

writing authority under section 13 of the BHC Act with respect to the compliance 

program and the activities or investments of each banking entity for which the Agency 

has such authority.2602 The banking organization would be expected to provide each 

appropriate Agency with access to all records related to the enterprise-wide compliance 

program pertaining to any banking entity that is supervised by the Agency vested with 

such rule writing authority.

 

2601 See Occupy. 

2602 See 12 U.S.C. 1851(b)(2)(B)(i).
862

For similar reasons, the Agencies have determined not to adopt some 

commenters’ requests that a single agency be responsible for determining compliance 

with section 13.2603 At this time the Agencies do not believe such an approach would be 

consistent with the statute, which requires each Agency to adopt a rule for the types of 

banking entities under its jurisdiction,2604 or effective given the different authorities and 

expertise of each Agency. The Agencies expect to continue to coordinate their 

supervisory efforts related to section 13 of the BHC Act and to share information as 

appropriate in order to effectively implement the requirements of that section and the 

final rule.2605

d. Responsibility and Accountability

Section III of Appendix B includes the enhanced minimum standards for 

responsibility and accountability. Section III contains many of the provisions contained 

in the proposed rule relating to responsibility and accountability, with certain 

modifications.2606 Section III requires a banking entity to establish, maintain and enforce 

both a governance and management framework to manage its business and employees 

with a view to preventing violations of section 13 of the BHC Act and the rule. The 

standards in Section III focus on four key constituencies – the board of directors, the 

CEO, senior management, and business line managers. Certain of the standards 

 

2603 See Barclays; Goldman (Prop. Trading); BoA; SIFMA Funds et al. (Prop. Trading) (Feb. 2012); 

Comm. on Capital Markets Regulation.

2604 See 12 U.S.C. 1851(b)(2)(B).

2605 Accordingly, the SEC’s and CFTC’s final rules, unlike the applicable proposals, do not incorporate by 

reference the rules and interpretations of the Federal banking agencies with respect to covered fund 

activities or investments. See SEC proposed rule 255.10(a)(2), Joint Proposal, 76 FR at 68,942-68,943, and 

CFTC proposed rule, 77 FR at 8421-8423.

2606 See Joint Proposal, 76 FR at 68,966.
863

contained in the proposed rule relating to business management are separately covered by 

specific requirements contained in sections II.A and II.B of Appendix B. Section III 

makes it clear that the board of directors, or similar corporate body, and the CEO and 

senior management are responsible for creating an appropriate “tone at the top” by setting 

an appropriate culture of compliance and establishing clear policies regarding the 

management of the firm’s trading activities and its fund activities and investments. 

Senior management must be made responsible for communicating and reinforcing the 

culture of compliance established by it and the board of directors, for the actual 

implementation and enforcement of the approved compliance program, and for taking 

corrective action where appropriate. 

In response to a question in the preamble to the proposed rule regarding whether 

the chief executive officer or similar officer of a banking entity should be required to 

provide a certification regarding the compliance program requirements, a few 

commenters urged that the final rule should not require that the board of directors or CEO 

of a banking entity review or certify the effectiveness of the compliance program.2607 

These commenters argued that existing processes developed by large, complex banking 

entities for board of director reporting and governance processes ensure that compliance 

programs work appropriately, and argued that these protocols would establish appropriate 

management and board of directors’ oversight of the section 13 compliance program.2608 

By contrast, several commenters advocated requiring CEO attestation regarding 

 

2607 See SIFMA et al. (Prop.Trading) (Feb. 2012); Wells Fargo (Prop. Trading). 

2608 See SIFMA et al. (Prop.Trading); See also Wells Fargo (Prop. Trading). 
864

compliance with section 13.2609 One commenter suggested that the rule require an annual 

assessment by management of the effectiveness of internal controls and policies and 

require a public accounting firm to attest to the accuracy of those annual assessments.2610

After considering comments received on the proposal, the Agencies have 

determined to include a requirement in the final rule that a banking entity’s CEO annually 

attest in writing to the appropriate Agency for the banking entity that the banking entity 

has in place processes to establish, maintain, enforce, review, test and modify the 

compliance program established pursuant to Appendix B and § __.20 of the rule in a 

manner reasonably designed to achieve compliance with section 13 of the BHC Act and 

this rule. Although some commenters stated that existing protocols of certain banking 

entities would establish appropriate oversight of the rule’s compliance program,2611 the 

Agencies believe this requirement will better help to ensure that a strong governance 

framework is implemented with respect to compliance with section 13 of the BHC Act, 

and that it more directly underscores the importance of CEO engagement in the 

governance and management framework supporting compliance with the rule. In the 

case of the U.S. operations of a foreign banking entity, including a U.S. branch or agency 

of a foreign banking entity, the attestation may be provided for the entire U.S. operations 

of the foreign banking entity by the senior management officer of the U.S. operations of 

the foreign banking entity who is located in the United States. 

 

2609 See Occupy; AFR et al. (Feb. 2012); Sens. Merkley & Levin (Feb. 2012); Public Citizen; Ralph Saul 

(Oct. 2011); John Reed; See also BEC et al. (Oct. 2011); Matthew Richardson.

2610 See Merkley & Levin (Feb. 2012).

2611 See SIFMA et al. (Prop.Trading) (Feb. 2012); See also Wells Fargo (Prop. Trading).
865

e. Independent Testing

Section IV of the Appendix B includes the enhanced minimum standards for 

independent testing, which are substantially similar to the proposed independent testing 

standards.2612 A banking entity subject to Appendix B must ensure that independent 

testing regarding the effectiveness of the banking entity’s compliance program is 

conducted by a qualified independent party, such as the banking entity’s internal audit 

department, compliance personnel or risk managers independent of the trading desk or 

other organizational unit being tested, outside auditors, consultants, or other qualified 

independent parties. If a banking entity uses internal personnel to conduct the 

independent testing, the Agencies would expect that the banking entity ensure that the 

personnel responsible for the testing are separate from the unit and functions being tested 

(e.g., the personnel do not report to a person who is directly responsible for the unit or 

involved in the functions being tested) and have knowledge of the requirements of 

section 13 and its implementing rules. Although an external audit is not required to meet 

the independent testing requirement, the Agencies would expect that, when external 

auditors are engaged to review compliance by a banking entity with laws and regulations, 

the banking entity would give appropriate consideration to the need to review the 

compliance program required under this rule. 

While one commenter suggested the final rule prescribe the precise manner in 

which a banking entity must conduct its compliance testing,2613 the Agencies believe 

 

2612 See Joint Proposal, 76 FR at 68,967.

2613 One commenter suggested that any compliance testing under the final rule be monitored by the 

Agencies and initially tested by internal audit personnel of the banking entity who are subject to a specific 

licensing and registration process for section 13 of the BHC Act and supplemented by an annual 
866

such a requirement is unnecessary because the standards in the final rule will ensure that 

independent testing of the effectiveness of a banking entity’s compliance program is 

objective and robust. The independent testing must examine both the banking entity’s 

compliance program and its actual compliance with the rule. This testing must include 

not only testing of the overall adequacy and effectiveness of the compliance program and 

compliance efforts, but also the effectiveness of each element of the compliance program 

and the banking entity’s compliance with each provision of the rule. This requirement is 

intended to ensure that a banking entity continually reviews and assesses, in an objective 

manner, the strength of its compliance efforts and promptly identifies and remedies any 

weaknesses or matters requiring attention within the compliance framework.

f. Training 

Like the proposed compliance appendix, Section V of Appendix B includes the 

enhanced minimum standards for training.2614 It requires that a banking entity provide 

adequate training to its trading personnel and managers, as well as other appropriate 

personnel, in order to effectively implement and enforce the compliance program. In 

particular, personnel engaged in covered trading activities and investments should be 

educated with respect to applicable prohibitions and restrictions, exemptions, and 

compliance program elements to an extent sufficient to permit them to make informed, 

day-to-day decisions that support the banking entity’s compliance with section 13 of the 

BHC Act and the rule. In particular, any personnel with discretionary authority to trade, 

 

independent external review. See Occupy; See also proposed rule §__.20(b)(4). The Agencies believe it 

would be unnecessarily burdensome to require particular licensing and registration processes for internal 

auditors that are specific to section 13 of the BHC Act.

2614 See Joint Proposal, 76 FR at 68,967.
867

in any amount, should be appropriately trained regarding the differentiation of prohibited 

proprietary trading and permitted trading activities and given detailed guidance regarding 

what types of trading activities are prohibited. Similarly, personnel providing investment 

management or advisory services, or acting as general partner, managing member, or 

trustee of a covered fund, should be appropriately trained regarding what covered fund 

activities and investments are permitted and prohibited. 

g. Recordkeeping

Section VI of Appendix B contains the enhanced minimum standards for 

recordkeeping which are consistent with the proposed recordkeeping standards.2615 

Generally, a banking entity must create records sufficient to demonstrate compliance and 

support the operation and effectiveness of its compliance program (i.e., records 

demonstrating the banking entity’s compliance with the requirements of section 13 of the 

BHC Act and the rule, any scrutiny or investigation by compliance personnel or risk 

managers, and any remedies taken in the event of a violation or non-compliance), and 

retain these records for no less than five years in a form that allows the banking entity to 

promptly produce these records to any relevant Agency upon request. Records created 

and retained under the compliance program must include trading records of the trading 

units, including trades and positions of each such unit. Records created and retained 

under the enhanced compliance program must also include documentation of any 

exemption in the final rule relied on by the banking entity to invest in or sponsor a 

covered fund. 

 

2615 See Joint Proposal, 76 FR at 68,967.
868

While one commenter requested that the period for retaining records be extended 

from 5 years to 6 years, the final rule does not make this change.2616 The Agencies 

believe that 5 years is an appropriate minimum period for requiring retention of records 

to demonstrate compliance with the final rule. The final rule allows the Agencies to 

require a banking entity to retain records for a longer period if appropriate.

3. Section __.20(d) and Appendix A: Reporting and Recordkeeping Requirements 

Applicable to Trading Activities

Section __.7 of the proposed rule, which the Agencies proposed to implement in 

part section 13(e)(1) of the BHC Act,2617 required certain banking entities to comply with 

the reporting and recordkeeping requirements specified in Appendix A of the proposed 

rule. In addition, §__.7 required banking entities to comply with the recordkeeping 

requirements in §__.20 of the proposed rule, related to the banking entity’s compliance 

program,2618 as well as any other reporting or recordkeeping requirements that the 

relevant Agency may impose to evaluate the banking entity’s compliance with the 

proposed rule.2619

Proposed Appendix A required a banking entity with significant trading activities 

to furnish periodic reports to the relevant Agency regarding various quantitative 

 

2616 One commenter specifically urged that records for any type of compliance program be required to be 

kept on all hedges, rather than only those placed at a different level or trading unit as under the proposal, 

and that the retention period for all compliance records be changed from 5 years to 6 years in line with the 

statute of limitations on civil suits for fraud, contracts and collection of debt in accounts in New York State. 

See Occupy. 

2617 Section 13(e)(1) of the BHC Act requires the Agencies to issue regulations regarding internal controls 

and recordkeeping to ensure compliance with section 13. See 12 U.S.C. 1851(e)(1). Section __.20 and 

Appendix C of the proposed rule also implemented section 13(e)(1) of the BHC Act.

2618 See Part III.D. of this Supplementary Information.

2619 See proposed rule § __.7.
869

measurements of its trading activities and create and retain records documenting the 

preparation and content of these reports. The measurements varied depending on the 

scope, type, and size of trading activities. In addition, proposed Appendix B contained a 

detailed commentary regarding the characteristics of permitted market making-related 

activities and how such activities may be distinguished from trading activities that, even 

if conducted in the context of a banking entity’s market-making operations, would 

constitute prohibited proprietary trading.2620 Under the proposal, a banking entity was 

required to comply with proposed Appendix A’s reporting and recordkeeping 

requirements only if it had, together with its affiliates and subsidiaries, trading assets and

liabilities the average gross sum of which (on a worldwide consolidated basis) was, as 

measured as of the last day of each of the four prior calendar quarters, equal to or greater 

than $1 billion.2621 The Agencies did not propose to extend the reporting and

recordkeeping requirements to banking entities with smaller amounts of trading activity, 

as it appeared that the more limited benefits of applying these requirements to such 

banking entities, whose trading activities are typically small, less complex, and easier to 

supervise, would not justify the burden associated with complying with the reporting and 

recordkeeping requirements. 

a. Approach to Reporting and Recordkeeping Requirements under the Proposal

The proposal explained that the reporting and recordkeeping requirements of § 

__.7 and Appendix A of the proposed rule were an important part of the proposed rule’s 

 

2620 See supra Part IV.A.3.c.8 (explaining why Appendix B was removed from the final rule).

2621 See proposed rule § __.7(a). 
870

multi-faceted approach to implementing the prohibition on proprietary trading. These 

requirements were intended, in particular, to address some of the difficulties associated 

with (i) identifying permitted market making-related activities and distinguishing such 

activities from prohibited proprietary trading, and (ii) identifying certain trading activities 

resulting in material exposure to high-risk assets or high-risk trading strategies. To do so, 

the proposed rule required certain banking entities to calculate and report detailed 

quantitative measurements of their trading activity, by trading unit. These measurements 

were meant to help banking entities and the Agencies in assessing whether such trading 

activity is consistent with permitted trading activities in scope, type and profile. The 

quantitative measurements required to be reported under the proposed rule were generally 

designed to reflect, and to provide meaningful information regarding, certain 

characteristics of trading activities that appear to be particularly useful in differentiating 

permitted market making-related activities from prohibited proprietary trading. For 

example, the proposed quantitative measurements measured the size and type of revenues 

generated, and the types of risks taken, by a trading unit. Each of these measurements 

appeared to be useful in assessing whether a trading unit was (i) engaged in permitted 

market making-related activity or (ii) materially exposed to high-risk assets or high-risk 

trading strategies. Similarly, the proposed quantitative measurements also measured how 

much revenue was generated per such unit of risk, the volatility of a trading unit’s

profitability, and the extent to which a trading unit trades with customers. Each of those 

characteristics appeared to be useful in assessing whether a trading unit is engaged in 

permitted market making-related activity. 
871

However, as noted in the proposal, the Agencies recognize that no single 

quantitative measurement or combination of measurements can accurately identify 

prohibited proprietary trading without further analysis of the context, facts, and 

circumstances of the trading activity. In addition, certain quantitative measurements may 

be useful for assessing one type of trading activity, but not helpful in assessing another 

type of trading activity. As a result, the Agencies proposed to use a variety of 

quantitative measurements to help identify transactions or activities that warrant more indepth analysis or review. 

To be effective, this approach requires identification of useful quantitative 

measurements as well as judgment regarding the type of measurement results that suggest 

a further review of the trading unit’s activity is warranted. The Agencies proposed to 

take a heuristic approach to implementation in this area that recognized that quantitative 

measurements can only be usefully identified and employed after a process of substantial 

public comment, practical experience, and revision. In particular, the Agencies noted 

that, although a variety of quantitative measurements have traditionally been used by 

market participants and others to manage the risks associated with trading activities, these 

quantitative tools have not been developed, nor have they previously been utilized, for 

the explicit purpose of identifying trading activity that warrants additional scrutiny in 

differentiating prohibited proprietary trading from permitted market making-related 

activities.2622 

 

2622 Joint Proposal, 76 FR at 68,883. 
872

Consistent with this heuristic approach, the proposed rule included a large number 

of potential quantitative measurements on which public comment was sought, many of 

which overlap to some degree in terms of their informational value. The proposal 

explained that not all of these quantitative measurements may ultimately be adopted in 

the final rule, depending on their relative strengths, weaknesses, costs, and benefits. The 

Agencies noted that some of the proposed quantitative measurements may not be relevant 

to all types of trading activities or may provide only limited benefits, relative to cost, 

when applied to certain types of trading activities. In addition, certain quantitative 

measurements may be difficult or impracticable to calculate for a specific covered trading 

activity due to differences between asset classes, market structure, or other factors. The 

Agencies therefore requested comment on a large number of issues related to the 

relevance, practicability, costs, and benefits of the quantitative measurements proposed. 

The Agencies also sought comment on whether the quantitative measurements described 

in the proposal were appropriate to use to help assess compliance with section 13 of the 

BHC Act.

In addition to the proposed quantitative measurements, the proposal explained 

that a banking entity may itself develop and implement other quantitative measurements 

in order to effectively monitor its covered trading activities for compliance with section 

13 of the BHC Act and the proposed rule and to establish, maintain, and enforce an 

effective compliance program, as required by § __.20 of the proposed rule and Appendix 

C. The Agencies noted that the proposed quantitative measurements in Appendix A were 

intended to assist banking entities and Agencies in monitoring compliance with the 

proprietary trading restrictions and would not necessarily provide all the data necessary 
873

for the banking entity to establish an effective compliance program. The Agencies also 

recognized that appropriate and effective quantitative measurements may differ based on 

the profile of the banking entity’s businesses in general and, more specifically, of the 

particular trading unit, including types of instruments traded, trading activities and 

strategies, and history and experience (e.g., whether the trading desk is an established, 

successful market maker or a new entrant to a competitive market). In all cases, banking 

entities needed to ensure that they have robust measures in place to identify and monitor 

the risks taken in their trading activities, to ensure the activities are within risk tolerances 

established by the banking entity, and to monitor for compliance with the proprietary 

trading restrictions in the proposed rule.

To the extent that data regarding measurements, as set forth in the proposed rule, 

are collected, the Agencies proposed to utilize the conformance period provided in 

section 13 of the BHC Act to carefully review that data, further study the design and 

utility of these measurements, and if necessary, propose changes to the reporting 

requirements as the Agencies believe are needed to ensure that these measurements are as 

effective as possible.2623 This heuristic, gradual approach to implementing reporting 

requirements for quantitative measurements was intended to ensure that the requirements 

are formulated in a manner that maximizes their utility for identifying trading activity 

that warrants additional scrutiny in assessing compliance with the prohibition on 

proprietary trading, while limiting the risk that the use of quantitative measurements 

 

2623 See 12 U.S.C. 1851(c)(2); Joint Proposal, 76 FR at 68,883.
874

could inadvertently curtail permissible market making-related activities that provide an 

important service to market participants and the capital markets at large.

In addition, the Agencies requested comment on the use of numerical thresholds 

for certain quantitative measurements that, if reported by a banking entity, would require 

the banking entity to review its trading activities for compliance and summarize that 

review to the relevant Agency. The Agencies did not propose specific numerical 

thresholds in the proposal because substantial public comment and analysis would be 

beneficial prior to formulating and proposing specific numerical thresholds. Instead, the 

Agencies intended to carefully consider public comments provided on this issue and to 

separately determine whether it would be appropriate to propose, subsequent to finalizing 

the current proposal, such numerical thresholds.

Part III of proposed Appendix A defined the scope of the reporting requirements. 

The proposed rule adopted a tiered approach that required banking entities with the most 

extensive trading activities to report the largest number of quantitative measurements, 

while banking entities with smaller trading activities had fewer or no reporting 

requirements. This tiered approach was intended to reflect the heightened compliance 

risks of banking entities with extensive trading activities and limit the regulatory burden 

imposed on banking entities with relatively small or no trading activities, which appear to 

pose significantly less compliance risk.

Under the proposal, any banking entity that had, together with its affiliates and 

subsidiaries, trading assets and liabilities the average gross sum of which (on a worldwide 

consolidated basis), as measured as of the last day of each of the four prior calendar 
875

quarters, equals or exceeds $5 billion would be required the banking entity to furnish 

quantitative measurements for all trading units of the banking entity engaged in trading 

activity subject to §§ __.4, __.5, or __.6(a) of the proposed rule (i.e., permitted 

underwriting and market making-related activity, risk-mitigated hedging, and trading in 

certain government obligations). The scope of data to be furnished depended on the

activity in which the trading unit was engaged. First, for the trading units of such a 

banking entity that are engaged in market making-related activity pursuant to § __.4(b) of 

the proposed rule, proposed Appendix A required that a banking entity furnish seventeen 

quantitative measurements.2624 Second, all trading units of such a banking entity engaged 

in trading activity subject to §§ __.4(a), __.5, or __.6(a) of the proposed rule were 

required to report five quantitative measurements designed to measure the general risk 

and profitability of the trading unit.2625 The Agencies expected that each of these general 

types of measurements would be useful in assessing the extent to which any permitted 

trading activity involves exposure to high-risk assets or high-risk trading strategies. 

These requirements would apply to all type of trading units engaged in underwriting and 

market making-related activity, risk-mitigated hedging, and trading in certain government 

obligations. These additional measurements applicable only to trading units engaged in 

market making-related activities were designed to help evaluate the extent to which the 

 

2624 See proposed rule Appendix A.III.A. These seventeen quantitative measurements are discussed further 

below.

2625 See proposed rule Appendix A.III.A. These five quantitative measurements are: (i) Comprehensive 

Profit and Loss; (ii) Comprehensive Profit and Loss Attribution; (iii) VaR and Stress VaR; (iv) Risk Factor 

Sensitivities; and (v) Risk and Position Limits. Each of these and other quantitative measurements 

discussed in proposed Appendix A are discussed in detail below.
876

quantitative profile of a trading unit’s activities is consistent with permissible market 

making-related activities.

Under the proposal, any banking entity that had, together with its affiliates and 

subsidiaries, trading assets and liabilities the average gross sum of which (on a worldwide 

consolidated basis), as measured as of the last day of each of the four prior calendar 

quarters, equals or exceeds $1 billion but is less than $5 billion would be required to 

provide quantitative measurements to be furnished for trading units that engaged in 

market making-related activity subject to § __.4(b) of the proposed rule. Trading units of 

such banking entities that engaged in market making-related activities needed to report 

eight quantitative measurements designed to help evaluate the extent to which the 

quantitative profile of a trading unit’s activities is consistent with permissible market

making-related activities.2626 The proposal applied a smaller number of measurements to 

a smaller universe of trading units for this class of banking entities because they are 

likely to pose lesser compliance risk and fewer supervisory and examination challenges. 

The Agencies noted in the proposal that a less burdensome reporting regime, coupled 

with other elements of the proposal (e.g., the compliance program requirement), was 

likely to be equally as effective in ensuring compliance with section 13 of the BHC Act 

and the proposed rule for banking entities with smaller trading operations.

 

2626 See proposed rule Appendix A.III.A. These eight quantitative measurements are: (i) Comprehensive 

Profit and Loss; (ii) Comprehensive Profit and Loss Attribution; (iii) Portfolio Profit and Loss; (iv) Fee 

Income and Expense; (v) Spread Profit and Loss; (vi) VaR; (vii) Volatility of Comprehensive Profit and 

Loss and Volatility of Portfolio Profit and Loss; and (viii) Comprehensive Profit and Loss to Volatility 

Ratio and Portfolio Profit and Loss to Volatility Ratio.
877

Section III.B of proposed Appendix A specified the frequency of required 

calculation and reporting of quantitative measurements. Under the proposed rule, each 

required quantitative measurement needed to be calculated for each trading day. 

Required quantitative measurements were required to be reported to the relevant Agency 

on a monthly basis, within 30 days of the end of the relevant calendar month, or on such 

other reporting schedule as the relevant Agency may require. Section III.C of proposed 

Appendix A required a banking entity to create and retain records documenting the 

preparation and content of any quantitative measurement furnished by the banking entity, 

as well as such information as is necessary to permit the relevant Agency to verify the 

accuracy of such measurements, for a period of 5 years. This included records for each 

trade and position.

b. General Comments on the Proposed Metrics

A number of commenters were supportive of metrics. A few commenters argued 

that the metrics could reveal prohibited proprietary trading activity and be an appropriate 

and valuable tool in analyzing positions.2627 One commenter argued that metrics are the 

single most valuable tool available to the Agencies for distinguishing between prohibited 

and permitted activities and recommended the compliance program be structured around 

metrics.2628 Another commenter stated that the identification of metrics is one of the 

strengths of the proposed rule and offered great promise for successful implementation of 

 

2627 See, e.g., Paul Volcker; SIFMA et al. (Prop.Trading) (Feb. 2012); Invesco; Comm. on Capital Markets 

Regulation. 

2628 See Goldman (Prop. Trading). 
878

the rule.2629 One commenter expressed support for the metrics and argued that there 

would be substantial evasion of the rule without reporting of these measurements.2630 

Some commenters proposed a presumption of compliance so long as trading activity is 

conducted in a manner consistent with tailored quantitative metrics and related specific 

thresholds as coordinated and agreed with the relevant Agency.2631 A few of commenters 

suggested that metrics not be used as a bright-line trigger and recommended flexibility in 

the application of metrics for assessing market-making activities.2632 Two commenters 

supported metrics as part of a bright lines approach.2633 

A number of commenters felt that some metrics might be more relevant than 

others, depending upon the particular asset class, activity, particular market, and unique 

characteristics of each banking entity.2634 These commenters advocated an approach 

where banking entities and examiners would determine over time the usefulness and 

relevance of particular metrics.2635 One commenter expressed support for the 5 metrics 

required for trading in U.S. government obligations.2636 A number of commenters 

recommended that metrics be tailored to different asset classes and markets, to avoid the 

 

2629 See Sens. Merkley & Levin (Feb. 2012). 

2630 See Occupy. 

2631 See Barclays; See also BoA; Invesco; ISDA (Feb. 2012); JPMC; Morgan Stanley; SIFMA et al.

(Prop.Trading) (Feb. 2012). 

2632 See SIFMA et al. (Prop.Trading) (Feb. 2012); Wells Fargo (Prop. Trading); NYSE Euronext; Oliver 

Wyman (Feb. 2012); UBS; Western Asset Mgmt.; Goldman (Prop. Trading); Northern Trust. 

2633 See John Reed; Public Citizen. 

2634 See Morgan Stanley; SIFMA et al. (Prop.Trading) (Feb. 2012); Stephen Roach. 

2635 See Wells Fargo (Prop. Trading); Morgan Stanley; SIFMA et al. (Prop.Trading) (Feb. 2012); Stephen 

Roach. 

2636 See UBS. 
879

drawbacks of a one-size-fits-all approach.2637 One commenter argued that application of 

metrics to market-making activities at different firms may produce very different results, 

all of which might reflect legitimate market-making.2638 Commenters also indicated that 

not all metrics are meaningful and calculable for all trading units and some would be 

unnecessarily burdensome.2639 

Other commenters did not support the use of metrics. These commenters argued 

that metrics reporting was one aspect of the complexity of the proposal that increased the 

cost and difficulty of distinguishing market-making from prohibited proprietary 

trading.2640 One commenter argued that banking entities may avoid legitimate market 

making activities that would produce “worse” metrics results.2641 

Several commenters expressed concern that the costs exceeded the benefits of the 

required quantitative metrics in the proposal. In particular, commenters argued that the 

17 metrics in the proposal calculated at each trading unit was excessive, would generate 

an unmanageable amount of data, would yield numerous false positives, and would 

require the construction and programming of highly sophisticated systems that are not 

currently employed.2642 A few commenters suggested that a more limited set of metrics 

 

2637 See Goldman (Prop. Trading); Northern Trust; See also UBS. 

2638 See Comm. on Capital Markets Regulation. 

2639 See Morgan Stanley; See also ISDA (Feb. 2012). 

2640 See ABA (Keating); Barclays; Citigroup (Feb. 2012); ISDA (Feb. 2012); UBS; Oliver Wyman (Feb. 

2012); Prof. Duffie; Wellington. 

2641 See Oliver Wyman (Feb. 2012). 

2642 See BoA (expressing concern about the need for new systems to distinguish bid-ask spreads from price 

appreciation); UBS; Wellington. 
880

would reduce compliance complexity.2643 Some commenters noted that many of these 

metrics have not been historically reported by banking entities and some of the metrics 

would require substantial resources and investment infrastructure to produce some of the 

metrics without a clear functional purpose.2644According to other commenters, however, 

banking entities currently use all or nearly all of the proposed metrics.2645 One 

commenter urged that it would be good to make metrics consistent with the banking 

entities’ internal reporting and control systems.2646 Some commenters argued it was 

critical for the Agencies to get the metrics right,2647 while others indicated it was unclear 

how the Agencies could analyze such information to draw useful conclusions.2648 

Some commenters expressed concern that metrics were vulnerable to 

manipulation and arbitrage.2649 These commenters generally felt that the quantitative 

measurements were only appropriate for certain liquid and transparent trading activities 

but not meaningful for illiquid markets, including opaque securities and derivatives.2650 

These commenters also argued that the vast majority of proprietary trading would not be 

 

2643 See BoA; Barclays; Citigroup (Feb. 2012). 

2644 See Credit Suisse (Seidel); Morgan Stanley; UBS; Wells Fargo (Prop. Trading); Société Générale

(arguing that many calculation questions need to be resolved before banking entities can create necessary 

systems to measure metrics).

2645 See Occupy; AFR et al. (Feb. 2012); Western Asset Mgmt.; Public Citizen. For example, one 

commenter cited a study finding that 14 out of 17 of the proposed metrics are either in wide use today or 

are possible to implement fairly easily using data already collected for internal risk management and profit 

and loss purposes. See AFR et al. (Feb. 2012) (citing John Lester and Dylan Walsh, “The Volcker Rule 

Ban On Prop Trading: A Step Closer to Reality, Point of View,” Oliver Wyman Company (Oct. 2011)).

2646 See Paul Volcker.

2647 See, e.g., UBS. 

2648 See BoA; UBS; Wellington. 

2649 See AFR (Nov. 2012); See also Occupy; Public Citizen. 

2650 See Occupy; AFR (Nov. 2012); Wells Fargo (Prop. Trading). 
881

differentiable through analysis of the data.2651 Other commenters expressed concern that 

the use of metrics not replace regulatory review of actual specific trading positions held 

by banking entities.2652 One commenter argued that in relying on metrics to be 

elaborated upon and discussed in the examination process, the proposed rule did not meet 

the fundamental fair notice goal of regulation.2653

A few commenters also recommended creation of a central data repository or data 

sharing protocol that would promote consistency and accountability in oversight and 

regulation and suggested the Office of Financial Research (“OFR”) be given access to 

this data so that it can provide centralized analysis and monitoring to identify any trends 

that give rise to systemic risk.2654 These commenters generally supported compliance 

benefits that would result from increased public disclosure of banking entities’ trading 

and funds activities, including all of their trading positions, their valuation models, and 

their compliance metrics.2655

Some commenters expressed support for the reporting thresholds contained in 

Appendix A.2656 One commenter suggested that all banking entities that engage in any 

trading (regardless of threshold) report certain metrics.2657 Other commenters supported 

metrics reporting, but recommended the threshold for trading assets and liabilities be 

 

2651 See Occupy. 

2652 See Sens. Merkley & Levin (Feb. 2012). 

2653 See ISDA (Feb. 2012) (citing Mason v. Florida Bar, 208 F.3d 952, 958-59 (11th Cir. 2000)). 

2654 See Sens. Merkley & Levin (Feb. 2012); See also Occupy; Public Citizen. 

2655 See Sens. Merkley & Levin (Feb. 2012); See also Public Citizen; John Reed.

2656 See ICBA; Occupy.

2657 See Occupy (suggesting all banking entities that engage in trading be required to provide VaR 

Exceedance, Risk Factor Sensitivities and Risk and Position Limits). 
882

increased from $1 billion to $10 billion to mitigate any cost and burden impact on smaller 

banking entities.2658 These commenters pointed out that even if the minimum dollar 

threshold were raised to $10 billion, an overwhelming percentage of trading assets and

liabilities in the banking industry (approximately 98 percent) would still remain subject to 

heightened compliance requirements including Appendix A.2659 One commenter 

suggested the threshold be raised to $50 billion in combined trading assets and 

liabilities.2660

Commenters also offered a number of suggestions for modifying the activity that 

would be considered in meeting the thresholds for determining which reporting 

requirements apply to a banking entity. Several commenters argued that certain types of 

trading assets or fund investments should not be included for purposes of determining 

whether the relevant dollar threshold for compliance was met, particularly those that are 

not prohibited activities or investments. For instance, some commenters urged that 

trading in U.S. government obligations should not count toward the calculation of 

whether a banking organization meets the trading threshold triggering metrics 

reporting.2661 These commenters also argued that other positions or transactions that do 

not involve financial instruments and that may constitute trading assets and liabilities, 

such as loans, should be excluded from the thresholds because exempt activities should 

 

2658 See PNC et al.; M&T Bank; See also ABA (Abernathy). 

2659 See ABA (Keating); M&T Bank; PNC et al. 

2660 See State Street (Feb. 2012).

2661 See PNC et al.
883

not determine the type of compliance program a banking entity must implement.2662 One 

commenter urged that foreign exchange swaps and forwards be excluded from the 

definition of a “derivative” and not be subject to compliance requirements as a result.2663 

Conversely, one commenter urged that all assets and liabilities defined as trading assets 

for purposes of the Market Risk Capital Rule should be included in the $1 billion 

standard for becoming subject to any reporting and record-keeping requirements under 

the final rule.2664

A number of commenters argued that monthly reporting was too frequent because 

of the complexity of the process that surrounds generation of regulatory reports and 

suggested that the frequency of reporting should be quarterly.2665 One commenter 

supported the reporting frequency as extremely effective and said it should not be 

reduced in any way.2666 

A number of comments were received on the implementation timeframe for 

metrics reporting. Several commenters urged allowing banking entities the use of the full 

conformance period for creating the systems and processes to capture and report the 

quantitative metrics.2667 Some commenters suggested that metrics should not be required 

to be reported until one year after adoption of final regulations.2668 A different 

 

2662 See PNC et al.

2663 See Northern Trust.

2664 See Occupy at 60.

2665 See JPMC; See also Stephen Roach.

2666 See Occupy.

2667 See BoA; Barclays; Citigroup (Feb. 2012); Goldman (Prop. Trading); JPMC; Morgan Stanley; SIFMA 

et al. (Prop.Trading) (Feb. 2012); UBS; Stephen Roach. 

2668 See Credit Suisse (Seidel); JPMC; Wells Fargo (Prop. Trading). 
884

commenter suggested that the Agencies provide a one-year period during which they

determine which metrics will be employed for different asset classes and an additional 

one-year period during which such metrics could be reviewed so metrics would be a 

required component of a banking entity’s compliance program no sooner than 2 years 

after issuance of the final rule.2669 Another commenter suggested that banking entities 

and regulators use the first year of the conformance period to consult with one another 

and determine the usefulness and relevance of individual metrics for different activities, 

asset classes, and markets and the second year of the conformance period to test the 

metrics systems to validate the accuracy and relevance of metrics that are agreed upon the 

first year.2670 One commenter suggested a subset of metrics be rolled out gradually 

across trading units before implementing the full suite of metrics that are ultimately 

adopted or metrics could be rolled out one trading unit at a time.2671 Another commenter 

said the Agencies should identify key metrics that are clearly workable across all ranges 

of trading activity and most likely to provide useful data and require those metrics be 

implemented first and require other metrics to be phased in over time in consultation with 

the banking entity’s primary federal regulator.2672 One commenter supported the 

heuristic approach of the proposal and suggested the Agencies should draw on resources 

 

2669 See BoA. 

2670 See Morgan Stanley; See also SIFMA et al. (Prop.Trading) (Feb. 2012). 

2671 See Goldman (Prop. Trading). 

2672 See Wells Fargo (Prop. Trading). 
885

and comment from the public and the industry in continuing the process of developing 

and building out metrics.2673

Another commenter requested that the final rule specify how trading assets and 

liabilities should be reported for savings and loan holding companies.2674 This 

commenter requested clarification that positions held for hedging or liquidity 

management purposes should not count as trading assets or liabilities for the $5 billion 

threshold in Appendix A. Another commenter expressed concern that derivatives 

valuation may value derivatives substantially lower than their notional exposure and 

thereby make high reporting thresholds not meaningful or reflective of inherent risk.2675 

Many commenters expressed concern that the smallest trading unit level was too 

low a level for collecting metrics data and suggested the final rule provide a higher 

reporting level.2676 These commenters stated that calculating at too low of a level would 

be more likely to generate false positives2677 and would be burdensome, particularly for 

firms with large trading operations.2678 In addition, some commenters indicated that it 

would be problematic if the definition of “trading unit” is applied at a legal entity level 

and cannot be applied across multiple legal entities within the same affiliate group.2679 

 

2673 See AFR et al. (Feb. 2012). 

2674 See GE (Feb. 2012). 

2675 See Occupy. 

2676 See, e.g., BoA; Goldman (Prop. Trading); JPMC; SIFMA et al. (Prop.Trading) (Feb. 2012); Morgan 

Stanley; RBC. 

2677 See JPMC; Goldman (Prop. Trading); SIFMA et al. (Prop.Trading) (Feb. 2012); BoA. See also Sen. 

Gillibrand. 

2678 See Goldman (Prop. Trading); SIFMA et al. (Prop.Trading) (Feb. 2012); BoA.

2679 See Goldman (Prop. Trading); SIFMA et al. (Prop.Trading) (Feb. 2012).
886

By contrast, two commenters supported the collection of metrics at the trading desk level 

and appropriate levels above the trading desk.

2680 One of these commenters expressed 

concern that the rule allowed for an inappropriately large trading desk unit that could 

combine significantly unrelated trading desks, which would impede detection of 

proprietary trading and supported measurements at multiple levels of organization to 

combat evasion concerns.

In response to questions in the proposal about whether the Agencies should 

establish numerical thresholds for some or all of the proposed quantitative measurements, 

a number of commenters expressed opposition to establishing numerical thresholds for 

purposes of the rule,2681 while others stated that thresholds should be established over 

time.2682 In opposition of thresholds, one commenter expressed concern that numerical 

thresholds could be easily abused and evaded and may need to be constantly revised and 

updated as financial markets evolve.2683 In addition, another commenter stated that 

numerical thresholds should not be imposed because metric levels will differ by asset 

class and type of activity.2684 A few commenters suggested that numerical thresholds, 

based on the specific asset class or market, would be useful to provide clarity or 

consistency about the types of activity that are permitted under the rule.2685 Two 

commenters expressed support for banking entities establishing numerical thresholds, in 

 

2680 See Sens. Merkley & Levin (Feb. 2012); Occupy. 

2681 See SIFMA et al. (Prop.Trading) (Feb. 2012); Occupy; Alfred Brock.

2682 See Wellington; Barclays; Goldman (Prop. Trading); CalPERS; John Reed.

2683 See Occupy.

2684 See SIFMA et al. (Prop.Trading) (Feb. 2012).

2685 See Wellington; CalPERS; John Reed.
887

consultation with the relevant regulator, for different trading units based on differences 

between markets and asset classes.2686

c. Approach of the Final Rule

As explained below, the Agencies have reduced the number of metrics that 

banking entities must report under Appendix A from the 17 metrics in the proposal to 7 

metrics in the final rule. The final rule also increases the level of activity that is required 

to trigger mandatory reporting of metrics data and phases in the reporting requirement 

over time. 

Under the final rule, a banking entity engaged in significant trading activity as 

defined by §__.20 must furnish the following quantitative measurements for each of its 

trading desks engaged in covered trading activity calculated in accordance with Appendix 

A:

• Risk and Position Limits and Usage;

• Risk Factor Sensitivities;

• Value-at-Risk and Stress VaR;

• Comprehensive Profit and Loss Attribution;

• Inventory Turnover;

• Inventory Aging; and 

• Customer Facing Trade Ratio.

 

2686 See Goldman (Prop. Trading); Barclays.
888

In response to comments, the final rule raises the threshold for metrics reporting 

from the proposal to capture only firms that engage in significant trading activity, 

identified at specified aggregate trading asset and liability thresholds, and delays the 

dates for reporting metrics through a phased-in approach based on the size of trading 

assets and liabilities.2687 Banking entities that meet the relevant thresholds must collect 

and report metrics for all trading desks engaged in covered trading activity beginning on 

the dates established in § __.20 of the final rule. Specifically, the Agencies have delayed 

the reporting of metrics until June 30, 2014 for the largest banking entities that, together 

with their affiliates and subsidiaries, have trading assets and liabilities the average gross 

sum of which equal or exceed $50 billion on a worldwide consolidated basis over the 

previous four calendar quarters (excluding trading assets and liabilities involving 

obligations of or guaranteed by the United States or any agency of the United States). 

Banking entities with less than $50 billion and greater than or equal to $25 billion in 

trading assets and liabilities and banking entities with less than $25 billion and greater 

than or equal to $10 billion in trading assets and liabilities would also be required to 

report these metrics beginning on April 30, 2016, and December 31, 2016, respectively. 

 

2687 As noted above, a number of commenters suggested setting a higher threshold than the proposed $1 

billion and $5 billion trading asset and liability thresholds because even thresholds of $10 billion to $50 

billion would capture a significant percentage of the total trading assets and liabilities in the banking 

system. See ABA (Keating); M&T Bank; PNC et al.; State Street (Feb. 2012). The Agencies believe that 

the phase-in approach to the metrics requirement established in the final rule should generally address 

commenters’ concerns about the implementation timeframe by providing time for analysis, development of 

systems (if needed), and implementation of the quantitative measurements requirement. See, e.g., BoA; 

Barclays; Citigroup (Feb. 2012); Goldman (Prop. Trading); JPMC; Morgan Stanley; SIFMA et al.

(Prop.Trading) (Feb. 2012); UBS; Stephen Roach; Credit Suisse (Seidel); Wells Fargo (Prop. Trading). 

The Agencies are establishing a phase-in approach, rather than requiring all banking entities above the $10 

billion threshold to report metrics within the same timeframe, to strike a balance between the benefits of 

receiving data to help monitor compliance with the rule against the need for time to assess the effectiveness 

and usefulness of the quantitative measurements in practice and for some firms to develop additional 

systems for purposes of this requirement.
889

The Agencies believe that these delayed dates for reporting metrics should allow firms 

adequate time to develop systems to calculate and report the quantitative metrics. The 

Agencies will review the data collected and revise this collection requirement as 

appropriate based on a review of the data collected prior to September 30, 2015. 

Under the final rule, a banking entity required to report metrics must calculate 

any applicable quantitative measurement for each trading day. Each banking entity 

required to report must report each applicable quantitative measurement to its primary 

supervisory Agency on the reporting schedule established in § __.20 unless otherwise 

requested by the primary supervisory Agency for the entity. The largest banking entities 

with $50 billion or greater in trading assets and liabilities must report the metrics on a 

monthly basis. Other banking entities required to report metrics must do so on a 

quarterly basis.2688 All quantitative measurements for any calendar month must be 

reported no later than 10 days after the end of the calendar month required by § __.20, 

unless another time is requested by the primary supervisory Agency for the entity except 

for a preliminary period when reporting will be required no later than 30 days after the 

end of the calendar month. Banking entities subject to quarterly reporting will be 

required to report quantitative measurements within 30 days of the end of the quarter, 

 

2688 Consistent with certain commenters’ requests, the final rule generally requires less frequent reporting 

than was proposed. However, the Agencies continue to believe that monthly reporting is appropriate for 

the largest banking entities above the $50 billion threshold. More frequent reporting for these firms is 

appropriate to allow for more effective supervision of their large-scale trading operations. See JPMC; 

Stephen Roach.
890

unless another time is requested by the primary supervisory Agency for the entity in 

writing.2689 

The Agencies believe that together the reduced number of metrics, the higher 

thresholds for reporting metrics, delayed reporting dates, and modified reporting 

frequency reduce the costs and burden from the proposal while allowing collection of 

data to permit better monitoring of compliance with section 13 of the BHC Act. The 

Agencies also believe that the delayed dates for reporting quantitative metrics will 

provide banking entities with the time to develop systems to calculate and report these 

metrics. The Agencies are not applying these reporting and recordkeeping requirements 

to banking entities with smaller amounts of trading activity, as it appears that the more 

limited benefits of applying these requirements to banking entities with lower levels of 

trading activities, which represent entities that are typically small, less complex, and 

easier to supervise, would not justify the burden associated with complying with the 

reporting and recordkeeping requirements of Appendix A. 

The final rule defines “trading desk” to replace the concept of “trading unit” in the 

proposal.2690 Under the final rule, trading desk means the smallest discrete unit of 

organization of a banking entity that buys or sells financial instruments for the trading 

account of the banking entity or an affiliate thereof. The Agencies believe that applying 

quantitative measurements to a level that aggregates a variety of distinct trading 

 

2689 See final rule § __.20(d)(3). The final rule includes a shorter period of time for reporting quantitative 

measurements after the end of the relevant period than was proposed for the largest banking entities. Like 

the monthly reporting requirement for these firms, this is intended to allow for more effective supervision 

of their large-scale trading operations.

2690 See final rule § __.3(e)(13); See also supra Parts IV.A.2.c.1.c.ii. and IV.A.3.c.1.c.i.
891

activities may obscure or “smooth” differences between distinct lines of business, asset 

categories and risk management processes in a way that renders the measurement 

relatively uninformative because it does not adequately reflect the specific characteristics 

of the trading activities being conducted. 

While the Agencies recognize that applying quantitative measurements at the 

trading desk level may result in some “noise” in the data and false positives, the Agencies 

believe it is necessary to apply the quantitative measurements at the trading desk level to 

enhance consistency with other provisions of the final rule. For example, because the 

requirements of the market-making exemption apply at the trading desk level of 

organization, the Agencies believe quantitative measurements used to monitor a banking 

entity’s market making-related activities should also calculated, reported, and recorded at 

the trading desk level. In response to commenters’ concerns that trading desk level 

measurements are more likely to generate false positives, the Agencies emphasize that 

quantitative measurements will not be used as a dispositive tool for determining 

compliance and, rather, will be used to monitor patterns and identify activity that may 

warrant further review. 

Like the proposal, the final rule does not include specific numerical thresholds. 

Commenters did not suggest specific thresholds for particular metrics or provide data and 

analysis that would support particular thresholds.2691 Given the range of financial 

instruments and trading activity covered by the final rule, as well as potential differences 

among banking entities’ organizational structures, trading strategies, and level of 

 

2691 See Wellington; CalPERS; John Reed.
892

presence in a particular market, the Agencies are concerned that numerical thresholds for 

specific metrics would not account for these differences and could inappropriately 

constrain legitimate activity.2692 Further, mandated thresholds for the metrics would not 

recognize the impact changing market conditions may have on a given trading desk’s 

quantitative measurements. Consistent with two commenters’ suggested approach, 

banking entities will be required to establish their own numerical thresholds for 

quantitative measurements under the enhanced compliance program requirement in 

Appendix B.2693 

d. Proposed Quantitative Measurements and Comments on Specific Metrics

Section IV of proposed Appendix A described, in detail, the individual 

quantitative measurements that must be furnished. These measurements were grouped 

into the following five broad categories, each of which is described in more detail below: 

• Risk-management measurements – VaR, Stress VaR, VaR Exceedance, 

Risk Factor Sensitivities, and Risk and Position Limits;

• Source-of-revenue measurements – Comprehensive Profit and Loss, 

Portfolio Profit and Loss, Fee Income and Expense, Spread Profit and Loss, and 

Comprehensive Profit and Loss Attribution;

• Revenues-relative-to-risk measurements – Volatility of Comprehensive 

Profit and Loss, Volatility of Portfolio Profit and Loss, Comprehensive Profit and Loss to 

Volatility Ratio, Portfolio Profit and Loss to Volatility Ratio, Unprofitable Trading Days 

based on Comprehensive Profit and Loss, Unprofitable Trading Days based on Portfolio

Profit and Loss, Skewness of Portfolio Profit and Loss, and Kurtosis of Portfolio Profit 

and Loss;

 

2692 See SIFMA et al. (Prop.Trading) (Feb. 2012).

2693 See Goldman (Prop. Trading); Barclays. See also final rule Appendix B.
893

• Customer-facing activity measurements – Inventory Turnover, Inventory 

Aging, and Customer-facing Trade Ratio; and

• Payment of fees, commissions, and spreads measurements – Pay-toReceive Spread Ratio.

The Agencies proposed these quantitative measurements because, taken together, 

these measurements appeared useful for understanding the context in which trading 

activities occur and identifying activities that may warrant additional scrutiny to 

determine whether these activities involve prohibited proprietary trading because the 

trading activity either is inconsistent with permitted market making-related activities or 

presents a material exposure to high-risk assets or high-risk trading strategies. As 

described below, different quantitative measurements were proposed to identify different 

aspects and characteristics of trading activity for the purpose of helping to identify 

prohibited proprietary trading, and the Agencies stated in the proposal that they expected 

that the quantitative measurements would be most useful for this purpose when 

implemented and reviewed collectively, rather than in isolation. The Agencies stated in 

the proposal that they believed that, in the aggregate, many banking entities already 

collect and review many of these measurements as part of their risk management 

activities, and stated that they expected that many of the quantitative measurements 

proposed would be readily computed and monitored at the multiple levels of organization 

included in proposed Appendix A’s definition of “trading unit,” to which they would 

apply. 

Under the proposal, the first set of quantitative measurements related to risk 

management, and included VaR, Stress VaR, VaR Exceedance, Risk Factor Sensitivities, 

and Risk and Position Limits. Commenters generally supported the use of risk-
894

management metrics as the most important measure of compliance, indicating that these 

metrics could potentially provide useful supervisory information.2694 

In general, commenters supported the use of the VaR metric.2695 One of these 

commenters argued that VaR was not particularly indicative of proprietary trading, but 

could be helpful to reveal a trading unit’s overall size and risk profile.2696 Another 

commenter indicated that significant, abrupt or inconsistent changes to VaR may need to 

be absorbed by market makers who absorb large demand and supply shocks into their 

inventories.2697 This commenter contended that the six largest bank holding companies 

had proprietary trading losses that frequently exceeded their VaR estimates and the 

design and supervision of such risk measures should be revisited. 

One commenter argued that the definition of VaR was not made clear in the 

proposal and was missing some important information regarding methodology as VaR 

methodologies tend to vary among banking entities.2698 This commenter recommended 

the development of a standard methodology by the OFR including a central repository for 

historical calculation data for each asset for the purpose of ensuring standard calculation 

across the industry. This commenter also expressed concern that VaR calculations are 

heavily reliant on the quality of input data and stated that many markets are unable to 

 

2694 See, e.g., AFR et al. (Feb. 2012); Barclays; Citigroup (Feb. 2012); Prof. Duffie; Goldman (Prop. 

Trading); Invesco; JPMC; Occupy; Public Citizen; See also BNY Mellon et al. (suggesting the use of VaR 

measures for foreign exchange trading activity). 

2695 See, e.g., Citigroup (Feb. 2012); Prof. Duffie; Goldman (Prop. Trading); Invesco; Public Citizen.

2696 See Goldman (Prop. Trading). 

2697 See Prof. Duffie. 

2698 See Occupy.
895

provide sufficient information such that VaR calculations are meaningful, including 

markets for illiquid products for which accurate historical price and market information is 

sparse and could severely under represent true potential losses under VaR 

calculations.2699 

A few commenters expressed concern about the applicability of VaR when 

applied to ALM activities.2700 These commenters argued that risk management metrics 

such as VaR would not help to distinguish ALM and valid risk mitigating hedging 

activities from prohibited proprietary trading. For instance, one of these commenters 

stated that the proposed reliance on VaR and Stress VaR to demonstrate bona fide 

hedging is misleading for ALM activities due to the typical accounting asymmetry in 

ALM where, for example, managed liabilities such as deposits are not marked to market 

but the corresponding hedge may be.

One commenter argued that the use of stress VaR would be important to guard 

against excessive risk taking.2701 A few commenters suggested that additional guidance 

be provided for Stress VaR including linking it to the broader stress testing regime and 

based on extreme conditions that are not based on historic precedent.2702 These 

commenters also argued that a one-day holding period assumption is inadequate, 

 

2699 See Occupy. 

2700 See JPMC; State Street (Feb. 2012); See also BoA; CH/ABASA. For instance, one of these 

commenters stated that the proposed reliance on VaR and Stress VaR to demonstrate bona fide hedging is 

misleading for ALM activities due to the typical accounting asymmetry in ALM where, for example, 

managed liabilities such as deposits are not mark-to-market but the corresponding hedge may be. See State 

Street (Feb. 2012). 

2701 See Public Citizen. 

2702 See AFR et al. (Feb. 2012); Public Citizen. 
896

especially for less liquid asset classes, and recommended that stress be measured over a 

longer period. One commenter argued that Stress VaR should be removed from the list 

of required metrics as it is not in regular use for day-to-day risk management and 

provides little relevant information about the intent or proportionality between risk 

assumed and client demands.2703

A number of commenters requested that VaR Exceedance be removed from the 

list of metrics. These commenters argued that the primary function of VaR Exceedance 

is to analyze the quality of a VaR model and that VaR backtesting is already reported to 

regulators as part of the supervisory process. These commenters argued that VaR 

Exceedance does not reveal trading intent or actual risk taken.2704 One commenter

argued that VaR Exceedance may be useful to the Agencies as an indicator of the quality 

of the VaR measure relative to the profit and loss of the trading unit but that a more 

rigorous back-testing process would serve as a better analytical tool than VaR 

Exceedance to evaluate the quality of the VaR model result and should be included as an 

additional metric.2705 One commenter suggested that risk-based metrics should measure 

risk as a function of capital.2706 Another commenter warned that risk metrics could be 

significantly higher during times of market stress and volatility than during normal 

times.2707

 

2703 See JPMC. 

2704 See ABA (Keating); Barclays; Goldman (Prop. Trading); SIFMA et al. (Prop.Trading) (Feb. 2012); 

Wells Fargo (Prop. Trading); UBS. 

2705 See Occupy. 

2706 See Citigroup (Feb. 2012).

2707 See SIFMA et al. (Prop. Trading) (Feb. 2012).
897

A few commenters expressed support for risk factor sensitivities as useful, 

supervisory information.2708 One of these commenters suggested that risk factor 

sensitivities could orient regulators to a trading unit’s overall size and risk profile,2709

while another commenter stated that risk factor sensitivities would be the most useful tool 

for identifying the accumulation of market risk in different areas of a banking entity.2710 

One commenter suggested that several risk factor sensitivity snapshots be taken 

throughout the day with an average value reported at the end of day.2711 This commenter 

also recommended that trading strategies that rely heavily on models to calculate risk 

exposures (e.g., correlation trading portfolios), should trigger additional disclosures in 

risk factor sensitivity reporting.2712 

Commenters also supported risk and position limits as providing useful, 

supervisory information. Several commenters indicated that these limits could be helpful 

to orient regulators to a trading unit’s overall size and risk profile.2713 Another 

commenter expressed the view risk and position limits are the most comprehensive 

measures of risk taking and incorporate VaR, Stress VaR, and Risk Factor 

Sensitivities.2714 A different commenter argued it was unclear how position limits are in 

 

2708 See Citigroup (Feb. 2012); Prof. Duffie; Occupy.

2709 See Goldman (Prop. Trading). 

2710 See Occupy.

2711 See Occupy. 

2712 See Occupy. 

2713 See, e.g., Barclays; Citigroup (Feb. 2012); Prof. Duffie; Goldman (Prop. Trading). 

2714 See Barclays.
898

fact a quantitative metric and not a description of a banking entity’s internal risk 

policies.2715

After carefully considering the comments received, the final rule retains the riskmanagement metrics other than VaR Exceedance. The collection of information 

regarding Risk and Position Limits, VaR, Stress VaR, and Risk Factor Sensitivities is 

consistent with the aim of providing a means of characterizing the overall risk profile of 

the trading activities of each trading desk and evaluating the extent to which the 

quantitative profile of a trading desk’s activities is consistent with permissible activities. 

Moreover, a number of commenters indicated that the risk management measures would 

be effective at achieving these goals.2716 The risk management measure that was not 

retained in the final rule, VaR Exceedance, was considered, in light of the comments, as 

not offering significant additional information on the overall risk profile and activities of 

the trading desk relative to the burden associated with computing, auditing and reporting 

it on an ongoing basis.2717 

The risk-management measurements included in the final rule are widely used by 

banking entities to measure and manage trading risks and activities.2718 VaR, Stress VaR, 

and Risk Factor Sensitivities provide internal, model-based assessments of overall risk, 

stated in terms of large but plausible losses that may occur or changes in revenue that 

 

2715 See Occupy. 

2716 See, e.g., AFR et al. (Feb. 2012); Barclays; Citigroup (Feb. 2012); Prof. Duffie; Goldman (Prop. 

Trading); Invesco; JPMC; Occupy; Public Citizen; See also Northern Trust; State Street (Feb. 2012).

2717 See ABA (Keating); Barclays; Goldman (Prop. Trading); SIFMA et al. (Prop.Trading) (Feb. 2012);

Wells Fargo (Prop. Trading); UBS.

2718 See Joint Proposal, 76 FR at 68,887.
899

would be expected to result from movements in underlying risk factors. The provided 

description and calculation guidance for each of these measures is consistent with both 

current market practice and regulatory capital requirements for banks. The final rule does 

not provide a prescriptive definition of each of these measurements as these measures 

must be flexible enough to be tailored to the specific trading activities of each trading 

desk. Supervisory guidance and comparisons of these measures across similarly situated 

trading desks at a given entity as well as across entities will be used to ensure that the 

provided measurements conform to the description and calculation guidance provided in 

Appendix A. Risk and Position Limits and Usage provide an explicit assessment of 

management’s expectation of how much risk is required to perform permitted marketmaking, underwriting and hedging activities. The final rule requires that the usage of 

each risk and position limit be reported so that the risk taking by each trading desk can be 

monitored and assessed on an ongoing basis.2719 

With the exception of Stress VaR, each of these measurements are routinely used 

to manage and control risk taking activities, and are also used by some banking entities 

for purposes of calculating regulatory capital and allocating capital internally.2720 In the 

context of permitted market making-related activities, these risk management measures 

are useful in assessing whether the actual risk taken is consistent with the level of 

principal risk that a banking entity must retain in order to service the near-term demands 

of customers. Significant, abrupt or inconsistent changes to key risk management 

 

2719 The Agencies believe this clarification responds to one commenter’s question regarding how risk and 

position limits will be used and assessed for purposes of the rule. See Occupy.

2720 See Joint Proposal, 76 FR at 68,887.
900

measures, such as VaR, that are inconsistent with prior experience, the experience of 

similarly situated trading desks and management’s stated expectations for such measures 

may indicate impermissible proprietary trading, and may warrant further review. In 

addition, indicators of unanticipated or unusual levels of risk taken, such as breaches of 

internal Risk and Position Limits, may suggest behavior that is inconsistent with 

appropriate levels of risk and may warrant further scrutiny. The limits required under § 

__.4(b)(2)(iii) and § __.5(b)(1)(i) must meet the applicable requirements under §

__.4(b)(2)(iii) and § __.5(b)(1)(i) and also must include appropriate metrics for the 

trading desk limits including, at a minimum, the “Risk Factor Sensitivities” and “Valueat-Risk and Stress Value-at-Risk” metrics except to the extent any of the “Risk Factor 

Sensitivities” or “Value-at-Risk and Stress Value-at-Risk” metrics are demonstrably 

ineffective for measuring and monitoring the risks of a trading desk based on the types of 

positions traded by, and risk exposures of, that desk. 

Under the proposal, the second set of quantitative measurements related to the 

source of revenues, and included Comprehensive Profit and Loss, Portfolio Profit and 

Loss, Fee Income, Spread Profit and Loss, and Comprehensive Profit and Loss 

Attribution. A few commenters expressed support for Comprehensive Profit and Loss as 

a reasonable contextual metric and contended that the metric could inform the analysis of 

whether market-making revenues are from customer transactions.2721 

 

2721 See Goldman (Prop.Trading); Japanese Bankers Ass’n; Occupy; See also Barclays.
901

As described above, a number of commenters expressed concern about a focus on 

revenues as part of evaluating market-making.2722 For instance, one commenter argued 

that the rule should not require, even in guidance, that market making-related permitted 

activities be “designed to generate revenues from fees, commissions, bid-asks spreads or 

other income,” arguing that this prejudges appropriate results for revenue metrics and 

implies that a bona fide market maker is not permitted to benefit from revenues from 

market movements.2723 One commenter expressed concern that the source-of-revenue 

metrics are subject to manipulation as these metrics depend on correctly classifying 

revenue into market bid-ask spreads as opposed to other sources of revenue.2724 One 

commenter stated that this metric should serve as a secondary indication of risk levels 

because it could be subject to manipulation.2725 Another commenter recommended use 

of the sub-metric in Comprehensive P&L Attribution.2726 A different commenter 

recommended the adoption of clearer metrics to distinguish customer revenues from 

revenues from price movements.2727 One commenter indicated that after-the-fact 

application of quantitative measurements such as Comprehensive Profit and Loss may 

cause firms to reconsider their commitment to market making and recommended that, to 

the extent this metric is used, it should be applied flexibly in light of market conditions 

 

2722 See supra Part IV.A.3.c.7.b.

2723 See SIFMA (May 2012). 

2724 See AFR (Nov. 2012).

2725 See Occupy. 

2726 See Barclays.

2727 See Public Citizen.
902

prevailing during the relevant time period, and as one of many factors relevant to an 

overall assessment of bona fide market making.2728 

A few commenters supported Portfolio Profit and Loss as a reasonable contextual 

metric to inform whether revenues from market-making transactions are from customer 

transactions.2729 However, one of these commenters argued that this metric would not 

necessarily be indicative of prohibited proprietary trading and profits may reflect bona

fide market making-related, underwriting, and hedging activities.2730 Another commenter 

argued that this metric should serve as a secondary indication of risk levels and may be 

subject to manipulation.2731

Some commenters felt that Fee Income and Expense was a useful metric.2732 One 

of these commenters argued this metric has the potential to help distinguish permitted 

activities from prohibited proprietary trading.2733 Another commenter felt this metric 

would be useful in liquid markets that trade with the convention of fees and commissions 

but less useful, but still indicative, in other markets that use inter-dealer brokers to 

conduct client-related activities.2734 One commenter argued that it would be 

 

2728 See NYSE Euronext.

2729 See Goldman (Prop. Trading); Japanese Bankers Ass’n; Occupy.

2730 See Goldman (Prop. Trading).

2731 See Occupy. 

2732 See Goldman (Prop. Trading); Japanese Bankers Ass’n; Occupy.

2733 See Goldman (Prop. Trading). This commenter urged that fee income and expense should be 

considered together with Spread P&L arguing that these two both measures of customer revenues and, in 

practice, may function as substitutes for each other.

2734 See Occupy. 
903

impracticable to produce Fee Income and Expense data for foreign exchange trading, 

which is predominantly based on bid/offer spread.2735 

A few commenters thought that Spread P&L could be useful.2736 One of these 

commenters argued that Spread P&L has the potential to help distinguish permitted 

activities from prohibited proprietary trading.2737 This commenter suggested that the 

final rule remove the proposal’s revenue requirement as part of market-making and 

instead rely on revenue metrics such as Spread P&L.2738 This commenter argued, 

however, that it will not always be clear how to best calculate Spread P&L and it would 

be critical for the Agencies to be flexible and work with banking entities to determine the 

appropriate proxies for spreads on an asset-class-by-asset class and trading desk-bytrading-desk basis. One commenter contended that the proposed implementation in the 

proposal was more difficult than necessary and suggested End of Day Spread Proxy is 

sufficient. Another commenter suggested expanding the flexibility offered in choosing a 

bid-offer source to calculate Spread P&L.2739 

However, the majority of commenters recommended removal of Spread P&L as a 

metric.2740 These commenters argued that a meaningful measure for Spread P&L cannot 

 

2735 See Northern Trust.

2736 See, e.g., Goldman (Prop. Trading); JPMC; UBS. 

2737 See Goldman (Prop. Trading). 

2738 See Goldman (Prop. Trading); See also Paul Volcker (supporting a metric considering the extent to 

which earnings are generated by pricing spreads rather than changes in price). 

2739 See JPMC; UBS; See also SIFMA et al. (Prop. Trading) (Feb. 2012). 

2740 See ABA et al.; BoA; Barclays; Credit Suisse (Seidel); Japanese Bankers Ass’n; Northern Trust; 

SIFMA et al. (Prop. Trading) (Feb. 2012); Wells Fargo (Prop.Trading); See also AFR et al. (Feb. 2012); 

Occupy. 
904

be calculated in the absence of a continuous bid-ask spread, making this metric 

misleading especially for illiquid positions and shallow markets.

A few commenters generally expressed support for the inclusion of 

Comprehensive Profit and Loss Attribution.2741 One of these commenters stated that this 

metric was the most comprehensive metric for measuring sources of revenue and 

included other metrics as sub-metrics, such as Comprehensive Profit and Loss, Portfolio 

Profit and Loss, and Fee Income and Expense. Another commenter contended the 

mention of “customer spreads” and “bid-ask spreads” was unclear and that both of these 

terms should be removed from the calculation guidance. Other commenters argued that 

the benefits of this metric do not justify the costs of generating a report of 

Comprehensive P&L Attribution on a daily basis.2742 One commenter urged the 

Agencies to ensure that each institution be permitted to calculate this metric in a way that 

reflects the institution’s unique characteristics.2743

After carefully considering the comments received, the final rule maintains only a 

modified version of Comprehensive P&L Attribution metric and does not retain the 

proposed Comprehensive Profit and Loss, Portfolio Profit and Loss, Fee Income, or 

Spread Profit and Loss metrics. The final rule also requires volatility of comprehensive 

profit and loss to be reported. As pointed out by a number of commenters, 

Comprehensive Profit and Loss Attribution provides a holistic attribution of each trading 

 

2741 See Barclays; Occupy. 

2742 See BOK; Goldman (Prop. Trading); SIFMA et al. (Prop Trading) (Feb. 2012); Wells Fargo (Prop. 

Trading). 

2743 See SIFMA et al. (Prop Trading) (Feb. 2012). 
905

desk’s profit and loss and contains much of the information content that is provided by 

many of the other metrics, such as Fee Income and Expense.2744 Accordingly, the use of 

Comprehensive Profit and Loss Attribution in the final rule greatly simplifies the metric 

reporting requirement and reduces burden while retaining much of the information and 

analysis that was provided in the full set of five metrics that were contained in the 

proposal. In addition, in response to commenters’ concerns about the burdens of 

separately identifying specific revenue sources (e.g., revenues from bid-ask spreads, 

revenues from price appreciation), the Agencies have modified the focus of the proposed 

source of revenue metrics to focus on when revenues are generated, rather than the 

specific sources of revenue.2745 This approach should also help address one commenter’s 

concern about the need for new, sophisticated systems to differentiate bid-ask spreads 

from price appreciation.2746 The utility of this modified approach is discussed in more 

detail in the discussion of the market-making exemption.2747 Finally, the Comprehensive 

Profit and Loss Attribution metric will ensure that all components of a trading desk’s 

profit and loss are measured in a consistent and comprehensive fashion so that each 

individual component can be reliably compared against other components of a trading 

desk’s profit and loss without being considered in isolation or taken out of context. 

This measurement is intended to capture the extent, scope, and type of profits and 

losses generated by trading activities and provide important context for understanding 

 

2744 See Barclays.

2745 See JPMC; UBS; SIFMA et al. (Prop Trading) (Feb. 2012); ABA (Keating); BoA; Barclays; Credit 

Suisse (Seidel).

2746 See BoA.

2747 See supra Part IV.A.3.c.7.c.
906

how revenue is generated by trading activities. Because permitted market making-related 

activities seek to generate profits by providing customers with intermediation and related 

services while ,managing, and to the extent practicable minimizing, the risks associated 

with any asset or risk inventory required to meet customer demands, these revenue 

measurements would appear to provide helpful information to banking entities and the 

Agencies regarding whether actual revenues are consistent with these expectations. 

Under the proposal, the third set of measurements related to realized risks and 

revenue relative to realized risks, and includes Volatility of Profit and Loss, 

Comprehensive Profit and Loss to Volatility Ratio and Portfolio Profit and Loss to 

Volatility Ratio, Unprofitable Trading Days based on Comprehensive Profit and Loss and 

Unprofitable Trading Days based on Portfolio Profit and Loss, and Skewness of Portfolio 

Profit and Loss and Kurtosis of Portfolio Profit and Loss. 

A few commenters indicated support for these metrics as appropriate, contextual 

metrics.2748 These commenters indicated that these metrics may serve to highlight areas 

requiring further investigation, since high P&L volatility may indicate a deviation from 

traditional client related activities and that a well-structured trading operation should be 

able to obtain relatively high ratios of revenue-to-risk (as measured by various metrics), 

low volatility, and relatively high turnover.2749 One commenter recommended that New 

Trades P&L be substituted for Portfolio P&L for purposes of computing Volatility of 

P&L because New Trades P&L captures customer revenues more completely and is 

 

2748 See, e.g., Goldman (Prop. Trading); Volcker; John S. Reed; See also AFR et al. (Feb. 2012); Sen. 

Merkley; Occupy; Public Citizen. 

2749 See Occupy; Public Citizen; Sen. Merkley. 
907

therefore more useful for distinguishing market making from proprietary trading.2750 

Another commenter indicated that Skewness of Portfolio Profit and Loss and Kurtosis of 

Portfolio Profit and Loss incorporates (and therefore obviates the need for a separate 

calculation of) the metric Volatility of Portfolio Profit and Loss.2751

One commenter urged that after-the-fact application of Comprehensive Profit and 

Loss to Volatility Ratio may cause firms to reconsider their commitment to market 

making and argued that this metric should be applied flexibly in light of market 

conditions prevailing during the relevant time period and as one of many factors relevant 

to an assessment of overall bona fide market making.2752 One commenter supported 

monitoring Portfolio Profit and Loss to Volatility Ratio and argued that the Agencies 

should establish a clear pattern of profit and loss results of individual trading units 

through iterative application of the metrics.2753

One commenter expressed support for Unprofitable Trading Days based on 

Comprehensive Profit and Loss and Unprofitable Trading Days based on Portfolio Profit 

and Loss indicating that these metrics may serve to highlight areas requiring further 

investigation, since a significant number of unprofitable trading days may indicate a 

deviation from traditional client-related activities.2754 Another commenter suggested that 

 

2750 See Goldman (Prop. Trading) (also suggesting that New Trades P&L be substituted for Portfolio P&L 

in Comprehensive Profit and Loss to Volatility Ratio and Portfolio Profit and Loss to Volatility Ratio and 

Unprofitable Trading Days based on Comprehensive Profit and Loss and Unprofitable Trading Days based 

on Portfolio Profit and Loss).

2751 See Barclays.

2752 See NYSE Euronext. 

2753 See AFR et al. (Feb. 2012). 

2754 See Occupy.
908

these metrics be removed as they would result in market makers being less likely to take 

client-facing positions due to reluctance to incur unprofitable trading days that could 

indicate the presence of impermissible activity despite the utility of such trades in 

providing liquidity to customers.2755

One commenter requested including Skewness of Portfolio Profit and Loss and 

Kurtosis of Portfolio Profit and Loss in the metrics set as the most comprehensive metric 

in the revenue-relative-to-risk category making other metrics unnecessary in this area.2756 

Another commenter argued that this metric would produce inconsistent results within and 

across trading units and would generally not support any meaningful conclusions 

regarding the permissibility or risk of trading activities.2757 

After carefully considering the comments received, the final rule does not include 

any of the proposed revenue-relative-to-risk measurements. Each of these measures 

provides information that may generally be useful for characterizing the overall risk 

profile of the trading activities of each trading unit and evaluating the extent to which the 

quantitative profile of a trading unit’s activities is consistent with permissible trading 

activities. The broad information content of these measures, however, can largely be 

reproduced from transformations of information that will be provided in the 

Comprehensive Profit and Loss Attribution and, as noted above, volatility of 

comprehensive profit and loss must be reported. Analogs to the other metrics such as 

 

2755 See Barclays.

2756 See Barclays.

2757 See Goldman (Prop. Trading).
909

Skewness of Portfolio Profit and Loss and Kurtosis of Portfolio Profit and Loss can be 

computed similarly from information that will be provided in the Comprehensive Profit 

and Loss Attribution. Accordingly, the information contained in these metrics is retained 

in the final rule while the burden associated with computing, auditing and reporting these 

additional metrics on an ongoing basis has been eliminated. 

Under the proposal, the fourth set of quantitative measurements related to 

customer-facing activity measurements. These metrics include Inventory Risk Turnover, 

Inventory Aging, and Customer-facing Trade Ratio. 

A few commenters supported the proposal’s Inventory Risk Turnover metric 

though some of these commenters suggested modifications to the metric.2758 One 

commenter argued that this metric could indicate whether a given trading unit holds risk 

and inventory consistently with the asset class in which such trading unit deals, the types 

of trading activity in which the trading unit engages, and the scale and scope of the client 

activity that such trading unit serves.2759 Another commenter argued that the final rule 

should explicitly state that a trading unit’s inventory management practices will be 

evaluated using this metric.2760 Some commenters expressed the view that this metric 

might be useful in the case of liquid positions but not in the case of illiquid or difficult-to-

 

2758 See Goldman (Prop. Trading); Barclays; John Reed; JPMC; SIFMA et al. (Prop. Trading) (Feb. 2012); 

Wells Fargo (Prop. Trading). 

2759 See Barclays.

2760 See Goldman (Prop. Trading).
910

hedge products, which naturally have lower risk turnover. Others noted support for this

metric tailored on an asset-by-asset basis.2761 

A few commenters requested that the final rule clarify that this metric will not be 

required to be calculated for every possible Risk Factor Sensitivity measurement for the 

applicable portfolio and that a banking entity and its regulator should determine one or 

two core risk factors per asset classes with respect to which this metric that will be 

calculated to strike a reasonable balance between costs of calculations and benefits of this 

metric.2762 Other commenters argued the Inventory Risk Turnover Metric was difficult to 

measure, burdensome, and would create uncertainty for derivatives counterparties.2763

A few commenters supported the Inventory Aging metric. One commenter 

argued it should be included in the metrics set to indicate whether a given trading desk 

holds risk and inventory consistently within the asset class in which such trading desk 

deals, the type of trading activity in which the trading unit engages, and the scale and 

scope of the client activity that such trading desk serves.2764 This commenter suggested 

tailoring the metric based on the market for a particular asset class and market conditions 

because aging levels may be higher in less liquid markets. A number of commenters 

argued that application of the Inventory Aging metric is only appropriate for cash 

products and should not be used for trading units engaged in transactions in financial 

 

2761 See, e.g., Barclays; Goldman (Prop. Trading); JPMC; John Reed.

2762 See Goldman (Prop. Trading); JPMC; SIFMA et al. (Prop. Trading) (Feb. 2012); See also Morgan 

Stanley. 

2763 See Japanese Bankers Ass’n; SIFMA (Asset Mgmt.) (Feb. 2012); Morgan Stanley.

2764 See Barclays; See also Invesco. 
911

instruments such as derivatives.2765 Another commenter argued that the Inventory Aging 

metric is generally not useful for derivatives, and for non-derivatives it provides 

essentially similar information to Inventory Risk Turnover.2766 One commenter 

requested additional guidance on how to calculate this metric.2767 

A few commenters indicated that the Customer-Facing Trade Ratio could be 

helpful in distinguishing prohibited proprietary trading from market making and would 

be more effective than the proposal’s negative presumption against interdealer trading to 

evaluate the amount of interdealer trading that is consistent with market making-related 

or hedging activity in a particular business.2768 Some commenters suggested that the 

metric could be improved and argued that the number of transactions executed over a 

calculation period does not provide an adequate measure for the level of customer-facing 

trading because it does not reflect the size of transactions or the amount of risk. These 

commenters suggested replacing the metric with a more risk-sensitive metric or defining 

the ratio so that it measures notional principal risk associated with customer transactions 

and is appropriately tailored to the relevant asset class or market.2769 

A number of commenters raised concerns about the definition of customer for 

purposes of this metric. One commenter argued that a failure to define “customer” to 

differentiate between customers and non-customers would render this metric 

 

2765 See Barclays; Goldman (Prop. Trading); Japanese Bankers Ass’n; Morgan Stanley; SIFMA (Prop. 

Trading) (Feb. 2012).

2766 See Goldman (Prop. Trading).

2767 See Société Générale.

2768 See Goldman (Prop. Trading); See also Invesco.

2769 See Barclays; Goldman (Prop. Trading) ; JPMC; SIFMA (Prop. Trading) (Feb. 2012); UBS. 
912

meaningless.2770 Another commenter contended that the metric would be appropriate as 

long as banking entities have the flexibility to determine who is a customer.2771 One 

commenter argued that using a definition of “customer” that is different between the 

market making-related activity and the reported metric could make legitimate market 

making-related activity with customers appear to be prohibited proprietary trading.2772 

This commenter argued that other dealers and other registered market participants should 

be recognized as customers of the banking entity. A few commenters contended that this 

metric would be burdensome if it required a banking entity to tag individual trades as 

customer or non-customer.2773 A few commenters argued that interdealer trading should 

be allowed as part of market making and argued this metric would not provide a useful 

measure of customer-facing activity.2774 Some commenters also expressed concern about 

the implications of such a metric for hedging activity, which may involve relatively less 

customer-facing activity.2775

After carefully considering the comments received, the final rule retains all three 

of the customer-facing activity measurements from the proposal, though each measure 

has been modified. A number of commenters raised issues regarding the complexities 

associated with computing the Inventory Risk Turnover metric. In particular, as noted 

above, some commenters argued that computing the metric for every reported risk factor 

 

2770 See Occupy.

2771 See Wells Fargo (Prop. Trading).

2772 See SIFMA (Prop. Trading) (Feb. 2012).

2773 See SIFMA (Prop. Trading) (Feb. 2012); See also Goldman (Prop Trading).

2774 See Barclays; Japanese Bankers Ass’n; Oliver Wyman (Dec. 2011); SIFMA (Prop. Trading) (Feb. 

2012).

2775 See Barclays; Wells Fargo (Prop. Trading).
913

sensitivity would be burdensome and would not be informative.2776 The inventory metric 

required in the final rule, Inventory Turnover, is applied at the transaction level and not at 

the risk factor sensitivity level. Accordingly, for a given trading desk and calculation 

period, e.g., 30 days, there is only one value of the Inventory Turnover metric rather than 

one value for each risk factor sensitivity that is managed and reported by the trading desk. 

In this sense, the turnover metric required in the final rule is similar to more traditional 

and common measures of inventory turnover. Moreover, the required turnover metric is 

simpler and less costly to track and record while still providing banking entities and 

Agencies with meaningful information regarding the extent to which the size and volume 

of trading activities are directed at servicing the demands of customers. In addition, the 

description of Inventory Turnover in the final rule provides explicit guidance on how to 

apply the metric to derivative positions.2777 

Inventory Aging provides banking entities and Agencies with meaningful 

information regarding the extent to which the size and volume of trading activities are 

directed at servicing the demands of customers. In the case of Inventory Aging, the 

proposal required that the aging schedule be organized according to a specific set of age 

ranges (i.e., 0-30 days, 30-60 days, 60-90 days, 90-180 days, 180-360 days, and more 

than 360 days). This requirement has not been adopted in the final rule in order to 

provide greater flexibility and to recognize that specific age ranges that may be relevant 

for one asset class may be less relevant for another asset class. Also, to address 

 

2776 See Goldman (Prop. Trading); JPMC; SIFMA (Prop. Trading) (Feb. 2012).

2777 The Agencies believe that this should address commenters’ uncertainty with respect to how the 

Inventory Risk Turnover metric would work for derivatives. See Japanese Bankers Ass’n; SIFMA (Asset 

Mgmt.) (Feb. 2012) ; Morgan Stanley.
914

commenters’ uncertainty about how this metric would apply to derivatives, the final 

rule’s description of the Inventory Aging metric provides guidance on how to apply the 

metric to derivative positions.2778 

The Customer Facing Trade Ratio provides directionally useful information 

regarding the extent to which trading transactions are conducted with customers. In the 

case of the Customer Facing Trade Ratio, the proposal required that customer trades be 

measured on a trade count basis. The final rule requires that the Customer Facing Trade 

Ratio be computed in two ways. As in the proposal, the metric must be computed by 

measuring trades on a trade count basis. Additionally, as suggested by some 

commenters, the final rule requires that the metric be computed by measuring trades on a 

notional value basis. The value based approach is required to reflect the fact noted by 

some commenters, that a trade count based measure may not accurately represent the 

amount of customer facing activity if customer trade sizes systematically differ from the 

sizes of non-customer trades. In addition, the term “customer” for purposes of the 

Customer-Facing Trade Ratio is defined in the same manner as the terms client, 

customer, and counterparty used for purposes of the market-making exemption. This will 

ensure that the information provided by this metric is useful for purposes of monitoring 

compliance with the market-making exemption.2779 

The fifth set of quantitative measurements relates to the payment of fees, 

commissions, and spreads, and includes the Pay-to-Receive Spread Ratio. This 

 

2778 See Barclays; Goldman (Prop. Trading) ; Japanese Bankers Ass’n; Morgan Stanley; SIFMA (Prop. 

Trading) (Feb. 2012).

2779 See SIFMA (Prop. Trading) (Feb. 2012).
915

measurement was intended to measure the extent to which trading activities generate 

revenues for providing intermediation services, rather than generate expenses paid to 

other intermediaries for such services. Because market making-related activities 

ultimately focus on servicing customer demands, they typically generate substantially 

more fees, spreads and other sources of customer revenue than must be paid to other 

intermediaries to support customer transactions. Proprietary trading activities, however, 

that generate almost no customer facing revenue will typically pay a significant amount 

of fees, spreads and commissions in the execution of trading strategies that are expected 

to benefit from short-term price movements. Accordingly, the Agencies expected that the 

proposed Pay-to-Receive Spread Ratio measurement would be useful in assessing 

whether permitted market making-related activities are primarily generating, rather than 

paying, fees, spreads and other transactional revenues or expenses. A level of fees, 

commissions, and spreads paid that is inconsistent with prior experience, the experience 

of similarly situated trading desks and management’s stated expectations for such 

measures could indicate impermissible proprietary trading.

One commenter expressed concern that after-the-fact application of the Pay-toReceive Spread Ratio could cause firms to reconsider their commitment to market 

making. This commenter suggested that if this measure is used, it be applied flexibly, in 

light of market conditions prevailing during the relevant time period, and as one of many 

factors relevant to an overall assessment of bona fide market making.2780 Another 

commenter suggested expanding the flexibility offered in choosing a bid-offer source to 

 

2780 See NYSE Euronext. 
916

the entire process of calculating Pay-to-Receive Spread Ratio.2781 A number of 

commenters argued for removing this metric because its calculation incorporates the 

Spread P&L metric.2782 Some of these commenters argued that the metric requires a 

trade-by-trade analysis which would be expensive to compute and would not provide any 

additional information that is not available from other metrics. One commenter alleged 

that this metric was not calculable by any methodology.2783

The Pay-to-Receive Spread Ratio has not been retained in the final rule. As noted 

by some commenters, the broad information content of this metric will largely be 

captured in the Comprehensive Profit and Loss Attribution measurement. In addition, the 

Comprehensive Profit and Loss Attribution will place such factors that are related to the 

proposed Pay-to-Receive Spread Ratio in context with other factors that determine total 

profitability. Accordingly, factors relating to the payment of fees, commissions and 

spreads will not be considered in isolation but will be viewed in a context that is 

appropriate to the entirety of the trading desk’s activities. Finally, using the information 

contained in the Comprehensive Profit and Loss Attribution to holistically assess the 

range of factors that determine overall profitability, rather than requiring a large number 

of separate and distinct measurements, will reduce the resulting compliance burden while 

ensuring an integrated and holistic approach to assessing the activities of each trading 

desk.

 

2781 See UBS. 

2782 See CH/ABASA; Goldman (Prop. Trading) ; Japanese Bankers Ass’n; Occupy; SIFMA (Prop. 

Trading) (Feb. 2012); Wells Fargo (Prop. Trading). 

2783 See Morgan Stanley. 
917

Commenters also suggested a number of additional metrics be added to the final 

rule that were not contained in the proposal. One commenter, who advocated for an 

alternative framework for market making supported by structural and transactional 

metrics, suggested that structural metrics could include the ratio of salespeople to traders 

and the level of resources devoted to client research and trading content.2784 Two 

commenters supported the use of a counterparty risk exposure measure, not only to the 

risk of counterparty default but also to potential gains and losses to major counterparties 

for each of a list of systemically important scenarios.2785 One of these commenters 

suggested that entity-wide inflation risk assessments be produced on a daily basis.2786 

This commenter also argued that an important metric that is missing is a Liquidity Gap 

Risk metric that estimates the price change that occurs following a sudden disruption in 

liquidity for a product, arguing that there needs to be an industry-wide effort to more 

accurately measure and account for the significant effect that liquidity and changes in its 

prevailing level have on the valuation of each asset.

One commenter argued that the metrics regime was well-designed for marketmaking but lacking in other areas like hedging. This commenter recommended the 

addition of additional metrics more applicable to other non-market making activities like 

a net profit metric for hedging.2787 Two commenters argued that quantitative 

measurement for underwriting was not included in the proposal and stated that in a bona 

 

2784 See Morgan Stanley. 

2785 See Prof. Duffie; Occupy. 

2786 See Occupy. 

2787 See AFR et al. (Feb. 2012). 
918

fide underwriting, unsold balances should be relatively small so a marker for potential 

non-bona fide underwriting should be recognized if VaR (unhedged and uncovered) of 

the unsold balance that is allocated to a banking entity is large relative to the expected 

revenue measured by the pro rata underwriting spread.2788

After carefully considering the comments received, these and other proposed 

metrics have not been included as part of the final rule. One major concern raised by a 

range of commenters was the degree of complexity and burden that would be required by 

the metrics reporting regime. In light of these comments, the final rule includes a number 

of quantitative measurements that are expected to provide a means of characterizing the 

overall risk profile of the trading activities of each trading desk and evaluating the extent 

to which the quantitative profile of a trading desk’s activities is consistent with 

permissible trading activities in a cost effective and efficient manner while being 

appropriate for a range of different trading activities. Moreover, while many commenters 

suggested a number of different alternative metrics, many of these alternatives are 

consistent with the broad themes, risk management, sources of revenues, customer facing 

activity, that inform the quantitative measurements that are retained in the final rule. 

Finally, banking entities will be expected to develop their own metrics, as appropriate, to 

further inform and improve their own monitoring and understanding of their trading 

activities. Many of the alternative metrics that were suggested by commenters, especially 

those that relate to a specific market or type of instrument, may be used by banking 

entities as they develop their own quantitative measurements. 

 

2788 See AFR et al. (Feb. 2012); See also Public Citizen.
919

For each individual quantitative measurement in the final rule, Appendix A 

describes the measurement, provides general guidance regarding how the measurement 

should be calculated and specifies the period over which each calculation should be 

made. The proposed quantitative measurements attempt to incorporate, wherever 

possible, measurements already used by banking entities to manage risks associated with 

their trading activities. Of the measurements proposed, the Agencies expect that a large 

majority of measurements proposed are either (i) already routinely calculated by banking 

entities or (ii) based solely on underlying data that are already routinely calculated by 

banking entities. However, calculating these measurements according to the 

specifications described in Appendix A and at the trading desk level mandated by the 

final rule may require banking entities to implement new processes to calculate and 

furnish the required data.2789

The extent of the burden associated with calculating and reporting quantitative 

measurements will likely vary depending on the particular measurements and differences 

in the sophistication of management information systems at different banking entities. 

As noted, the proposal tailored these data collections to the size and type of activity 

conducted by each banking entity in an effort to minimize the burden in particular on 

firms that engage in few or no trading activities subject to the proposed rule.

The Agencies have also attempted to provide, to the extent possible, a 

standardized description and general method of calculating each quantitative 

 

2789 See Credit Suisse (Seidel) ; Morgan Stanley; UBS; Wells Fargo (Prop. Trading); Société Générale; 

Occupy; Paul Volcker; AFR et al. (Feb. 2012); Western Asset Mgmt.; Public Citizen.
920

measurement that, while taking into account the potential variation among trading 

practices and asset classes, would facilitate reporting of sufficiently uniform information 

across different banking entities so as to permit horizontal reviews and comparisons of 

the quantitative profile of trading desks across firms.

The Agencies expect to evaluate the data collected during the compliance period 

both for its usefulness as a barometer of impermissible trading activity and excessive 

risk-taking and for its costs. This evaluation will consider, among other things, whether 

all of the quantitative measurements are useful for all asset classes and markets, as well 

as for all the trading activities subject to the metrics requirement, or if further tailoring is 

warranted.2790 The Agencies propose to revisit the metrics and determine, based on a 

review of the data collected by September 30, 2015, whether to modify, retain or replace 

the metrics. To allow firms to develop systems to calculate and report these metrics, the 

Agencies have delayed all reporting of the metrics until July 2014, phased in the 

reporting requirements over a multi-year period, and reduced the category of banking 

entities that must report the metrics to a smaller number of firms that engage in 

significant trading activity. These steps, combined with the reduction in the number of 

metrics required to be reported, are designed to reduce the cost and burden associated 

with compiling and reporting the metrics while retaining the usefulness of this data 

collection in helping to ensure that trading activities are conducted in compliance with 

 

2790 The Agencies believe this review, along with the fact that quantitative measurements will not be used 

as a dispositive tool for determining compliance and the removal of many of the proposed metrics, should 

help address commenters’ concerns that some of the proposed quantitative measurements will not be as 

relevant for certain asset classes, markets, and activities. See Morgan Stanley; SIFMA et al. (Prop. 

Trading); Stephen Roach. 
921

section 13 of the BHC Act and the final rule and in a manner that monitors, assesses and 

controls the risks associated with these activities.

4. Section __.21: Termination of Activities or Investments; Authorities for 

Violations

Section __.21 implements section 13(e)(2) of the BHC Act, which authorizes an 

Agency to order a banking entity subject to its jurisdiction to terminate activities or 

investments that violate or function as an evasion of section 13 of the Act.2791 Section 

13(e)(2) further provides that this paragraph shall not be construed to limit the inherent 

authority of any Federal agency or State regulatory authority to further restrict any 

investments or activities under otherwise applicable provisions of law.2792 

The proposed rule implemented section 13(e)(2) in two parts. First, § __.21(a) of 

the proposal required any banking entity that engages in an activity or makes an 

investment in violation of section 13 of the BHC Act or the proposed rule, or in a manner 

that functions as an evasion of the requirements of section 13 of the BHC Act or the 

proposed rule, including through an abuse of any activity or investment permitted under 

subparts B or C, or otherwise violates the restrictions and requirements of section 13 of 

the BHC Act or the proposed rule, to terminate the activity and, as relevant, dispose of

the investment.2793 Second, § __.21(b) of the proposal provided that if, after due notice 

and an opportunity for hearing, the respective Agency finds reasonable cause to believe 

 

2791 See 12 U.S.C. 1851(e)(2). 

2792 Id.

2793 See proposed rule § __.21(a). The proposal noted that the Agencies included §__.21(a), in addition to 

the provisions of § __.21(b) of the proposed rule, to clarify that the requirement to terminate an activity or, 

as relevant, dispose of an investment would be triggered when a banking entity discovers the violation or 

evasion, regardless of whether an Agency order has been issued. 
922

that any banking entity has engaged in an activity or made an investment described in 

paragraph (a), the Agency may, by order, direct the entity to restrict, limit, or terminate 

the activity and, as relevant, dispose of the investment.2794

Several commenters urged the Agencies to strengthen the authorities provided for 

under § __.21,2795 with some commenters expressing concern that the proposed rule does 

not establish sufficient enforcement mechanisms and penalties for violations of the rule’s 

requirements.2796 Some commenters suggested the Agencies add language in § __.21 

authorizing the imposition of automatic and significant financial penalties – as significant 

as the potential gains from illegal proprietary trading – on traders, supervisors, 

executives, and firms for violating section 13 of the BHC Act and the final rule.2797 

These commenters suggested the Agencies incorporate reference to the Board’s authority 

under section 8 of the BHC Act into the rule,2798 and others encouraged the Agencies to 

rely on their inherent authority to impose automatic penalties and fines.2799 A few 

commenters stated that traders, management, and banking entities should be held 

 

2794 See proposed rule § __.21(b).

2795 See Sen. Merkley; Better Markets (Feb. 2012); Occupy; AFR et al. (Feb. 2012); Public Citizen.

2796 See, e.g., BEC et al. (Jan. 2012); John Reed; Better Markets (Feb. 2012); AFR et al. (Feb. 2012); 

Occupy; Sen. Merkley; Public Citizen.

2797 See, e.g., Form Letter Type A; Form Letter Type B; Sarah McKee; David R. Wilkes; Ben Leet; Karen 

Michaelis; Barry Rein; Allan Richardson; Ronald Gedrim; Susan Pashkoff; Joan Budd; Frances Vreman; 

Lisa Kazmier; Michael Wenger; Dyanne DiRosario; Alexander Clayton; James Ofsink; Richard Leining 

(arguing that violators should face penalties such as seizure and discharge of the board and executives); Lee 

Smith; See also Occupy; Public Citizen.

2798 See Better Markets (Feb. 2012) (contending that penalties should include specific administrative 

penalties, including monetary penalties, bars, cease and desist orders, strengthened penalties for recurring 

violations, and sanctioning of employees involved in the violation and public reporting of such sanctions); 

AFR et al. (arguing that section 8 of the BHC Act provides civil penalties for violations by a company or 

individual and criminal penalties for willful violations of the BHC Act). See also Occupy (requesting the 

Agencies provide penalties that are specific to this rule in addition to the general framework for criminal 

and civil penalties in section 8 of the BHC Act).

2799 See Better Markets (Feb. 2012); Occupy; AFR et al. (Feb. 2012).
923

responsible for violations under certain circumstances.2800 Finally, another commenter 

recommended that officers and directors of a banking entity be removed from office, be 

prohibited from being affiliated with a banking entity, and be subject to salary clawbacks 

for violations of section 13 of the BHC Act and the final rule.2801

The Agencies note that the authorities provided for in § __.21 are not exclusive. 

The Agencies have a number of enforcement tools at their disposal to carry out their 

obligations to ensure compliance with section 13 of the BHC Act and the final rule, and 

need not reference them expressly in § __.21 in order to exercise them. Specifically, the 

Agencies may rely on their inherent authorities under otherwise applicable provisions of 

banking, securities, and commodities laws to bring enforcement actions against banking 

entities, their officers and directors, and other institution-affiliated parties for violations 

of law.2802 For example, a banking entity that violates section 13 of the BHC Act and the 

final rule may be subject to criminal and civil penalties under section 8 of the BHC Act. 

Banking entities may also be subject to formal enforcement actions under section 8 of the

Federal Deposit Insurance Act (FDIA), such as cease and desist orders or civil money 

penalty actions,2803 or safety and soundness orders under section 39 of the FDIA which 

may be enforceable through assessment of civil money penalties and through the federal

 

2800 See John Reed; Better Markets (Feb. 2012). See also BEC et al. (Jan. 2012) (arguing that CEOs and 

CFOs should be held fully responsible for any violations of the rule by any employees above the clerical 

level); Occupy (recommending that traders relying on an exemption in the proposed rule be held personally 

liable for any losses on trading positions).

2801 See Occupy.

2802 See 12 U.S.C. 1851(g)(3).

2803 See, e.g., 12 U.S.C. 1818(i) (authorizing imposition of civil money penalties up to the maximum daily 

amount of $1,000,000 for, among other things, knowing violations of law or regulation). 
924

court system. In addition, officers, directors, and other institution-affiliated parties2804

may be subject to civil money penalties, prohibition or removal actions, and personal 

cease and desist orders under section 8 of the FDIA. Submission of late, false, or 

misleading reports, including false statements on compliance with section 13 of the BHC 

Act or the final rule, may also result in actions under applicable securities, commodities, 

banking, and criminal laws, including imposition of civil money and criminal 

penalties.2805 Therefore, the final rule is consistent with the proposal and does not 

mention other enforcement actions available to address violations of section 13 of the 

BHC Act and this final rule. 

Section 13 of the BHC Act and the final rule do not limit the reach or applicability 

of the antifraud and other provisions of the federal laws to banking entities, including, for 

example, section 17(a) of the Securities Act of 1933 or section 10(b) and 15(c) of the 

Exchange Act and the rules promulgated thereunder.

One commenter also suggested that the Agencies use their authority under section 

13(d)(3) of the BHC Act to impose additional capital requirements and quantitative 

limitations on banking entities for repeat violations of the prohibition on proprietary 

trading.2806 The Agencies believe they can rely on other inherent enforcement authorities 

to address repeat violations. The Agencies note that several other commenters also 

 

2804 See 12 U.S.C. 1813(u) (defining “institution-affiliated party”). 

2805 See, e.g., 12 U.S.C. 164 (authorizing imposition of civil money penalties for, among other things, 

submitting false or misleading reports or information to the OCC); 18 U.S.C. 1005 (authorizing imposition 

of fines of not more than $1,000,000 or imprisonment not more than 30 years, or both, for, among other 

things, making a false entry in the books, reports or statements of a bank with intent to injure, defraud or 

deceive). 

2806 See Better Markets (Feb. 2012).
925

requested the Agencies to exercise their authority under section 13(d)(3).2807 The 

Agencies do not believe that it is appropriate to exercise their authority under this section 

at this time, primarily because the capital treatment of banking entities’ trading activities 

is currently being addressed through the Agencies’ risk-based capital rulemakings.2808 

Additionally, the Agencies believe Congress intended section 13(d)(3) to serve the 

prudential purposes of bolstering the safety and soundness of individual banking entities 

and the wider U.S. financial system. To the extent commenters suggested section 

13(d)(3) be employed for a punitive purpose, the Agencies do not believe the provision 

was designed to serve such a purpose nor do the Agencies believe that would be an 

appropriate use of the provision. Thus, the Agencies believe section 13(d)(3) is more 

appropriately employed for the prudential purposes of bolstering the safety and 

soundness of individual banking entities and the wider financial stability of the U.S. 

financial system.

Commenters also urged the Agencies to clearly delineate in the final rule the 

jurisdictional authority of each of the Agencies to enforce compliance with section 13 of 

the BHC Act and the implementing final rule. A number of commenters recommended 

approaches to coordinating examinations and enforcement among the Agencies, as well 

as to providing interpretive guidance.2809 For example, some commenters observed that 

more than one Agency would have jurisdiction over a given banking entity, and 

 

2807 See Sen. Merkley; Public Citizen; Better Markets (Feb. 2012); Profs. Admati & Pfleiderer.

2808 See Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, 

Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market 

Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk 

Capital Rule; Final Rule, 78 FR 62,017 (Friday, October 11, 2013). 

2809 See SIFMA et al. (Prop. Trading) (Feb. 2012); JPMC; Barclays; Goldman (Prop. Trading); BoA; ABA 

(Keating); Comm. on Capital Market Regulation; BEC et al.; ISDA (Apr. 2012).
926

recommended that supervision and enforcement of the final rule for all entities within a 

banking enterprise remain completely with one Agency. 2810 Further, some commenters 

recommended that a single Agency be appointed to provide interpretations, supervision, 

and enforcement of section 13 and the rules thereunder for all banking entities.2811 

Similarly, one commenter suggested that the Board be given initial authority to supervise 

the implementation of the rule because it is the primary enforcer of the BHC Act and the 

single regulator that can currently look across a banking group’s entire global businesses, 

regardless of legal entity. This commenter stated that the Board could then determine 

whether an activity should be delegated to one of the other Agencies for further 

examination or enforcement.2812 In addition, with respect to interpretive authority, some 

commenters indicated that the Board should be given sole interpretive authority of the 

statute and the rules thereunder.2813 Other commenters urged the Agencies to supervise 

 

2810 See Barclays (arguing that ideally the umbrella federal regulator of the enterprise should take this role); 

Goldman (Prop. Trading).

2811 See BoA; BEC et al.

2812 See Comm. on Capital Market Regulation.

2813 See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA (recommending that the Board be responsible for 

resolving potentially conflicting supervisory recommendations or matters requiring attention arising from 

examinations as well); ISDA (Apr. 2012). See also ABA (Keating) (arguing that the Agencies should defer 

to the Board’s sole authority to interpret provisions of Volcker that intersect with other statutory provisions 

subject to the Board’s jurisdictional authority, such as Super 23A); JPMC (contending that the Agencies 

should adopt and Seek comment on a protocol for supervision and enforcement that will ensure a given 

banking entity will face one set of rules and different banking entities will face the same set of rules). The 

Agencies decline to adopt the commenter’s suggested approach of deferring to the Board’s sole interpretive 

authority with respect to the provisions of the final rule. The Agencies believe at this time that such an 

approach would be neither appropriate nor effective given the different authorities and expertise of each 

Agency. See Part IV.C (discussing the Agencies’ decision not to adopt some commenters’ requests that a 

single agency be responsible for determining compliance with section 13).
927

and enforce the rule on a coordinated basis so as to minimize duplicative enforcement 

efforts, reduce costs, and promote certainty.2814

Section 13(e)(2) mandates that each Agency enforce compliance of section 13 

with respect to a banking entity “under the respective [A]gency’s jurisdiction.”2815 This 

section provides the Agencies with the authority to order a banking entity to terminate 

activities or investments that violate or function as an evasion of section 13 of the BHC 

Act.2816 Decisions about whether to issue such orders could be made after examinations 

or otherwise. Nothing in the final rule limits an Agency’s inherent authority to conduct 

examinations or otherwise inspect banking entities to ensure compliance with the final 

rule. Section __.1 of each Agency’s proposed rule described the specific types of 

banking entities to which that Agency’s rule applies. The Agencies acknowledge 

commenters’ concerns about overlapping jurisdictional authority. The Agencies 

recognize that, on occasion, a banking entity may be subject to jurisdiction by more than 

one Agency. As is customary, the Agencies plan to coordinate their examination and 

enforcement proceedings under section 13, to the extent possible and practicable, so as to 

limit duplicative actions and undue costs and burdens for banking entities.2817

The Agencies are adopting § __.21 substantially as proposed. Accordingly, 

§__.21(a) of the final rule provides that any banking entity that engages in an activity or 

 

2814 See SIFMA et al. (Prop. Trading) (Feb. 2012); BoA (stating that the Agencies should issue one set of 

exam findings under these circumstances); ISDA (Apr. 2012).

2815 See 12 U.S.C. 1851(c)(2).

2816 See 12 U.S.C. 1851(e)(2) (requiring “due notice and opportunity for hearing”). 

2817 See 12 U.S.C. 1844 (establishing jurisdictional boundaries for regulation of bank holding companies); 

See also 12 U.S.C. 1828a (antievasion statute empowering OCC, FDIC, and the Board to impose 

restrictions on relationships or transactions between banks and their subsidiaries and affiliates).
928

makes an investment in violation of section 13 of the BHC Act or the final rule or acts in 

a manner that functions as an evasion of the requirements of section 13 of the BHC Act 

or the final rule, including through an abuse of any activity or investment permitted or 

expressly excluded by the terms of the final rule, or otherwise violates the restrictions and 

requirements of section 13 of the BHC Act or the final rule, shall, upon discovery, 

promptly terminate the activity and, as relevant, dispose of the investment. This 

provision allows the Agencies to enforce the rule’s prohibitions against proprietary

trading and sponsoring or owning interests in covered funds regardless of how banking 

entities classify their actions, while also providing banking entities the freedom to 

legitimately engage in those banking activities which are outside the scope of the statute.

V. Administrative Law Matters

A. Use of Plain Language

Section 722 of the Gramm-Leach Bliley Act (Pub L. 106-102, 113 Stat. 1338, 1471, 

12 U.S.C. 4809) requires the Federal banking agencies to use plain language in all 

proposed and final rules published after January 1, 2000. The OCC, Board and FDIC 

invited comment on whether the proposed rule was written plainly and clearly, or 

whether there were ways the Federal banking agencies could make the rule easier to 

understand. The Federal banking agencies received no comments on these matters and 

believe that the final rule is written plainly and clearly.

B. Paperwork Reduction Act Analysis

Certain provisions of the final rule contain “collection of information” 

requirements within the meaning of the Paperwork Reduction Act (PRA) of 1995 (44 
929

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 OCC, FDIC, and Board will obtain OMB control numbers. The 

information collection requirements contained in this joint final rule, to the extent they 

apply to insured financial institutions that are not under a holding company, have been 

submitted to OMB for review and approval by the OCC and FDIC under section 3507(d) 

of the PRA and § 1320.11 of OMB’s implementing regulations (5 CFR 1320). The 

Board reviewed the final rule under the authority delegated to the Board by OMB.

PRA Submission to OMB

The Board will submit information collection burden estimates to OMB and the 

submission will include burden for Federal Reserve-supervised institutions, as well as 

burden for OCC-, FDIC-, SEC-, and CFTC-supervised institutions under a holding 

company. The OCC and the FDIC will take burden for banking entities that are not 

under a holding company. 

The FDIC and OCC submitted these information collection estimates to OMB at 

the proposed rule stage as well. OMB filed comments instructing the OCC and FDIC to 

examine public comment in response to the notice of proposed rulemaking and include in 

the supporting statement of the next Information Collection Request (ICR), to be 

submitted to OMB at the final rule stage, a description of how the OCC and FDIC have 

responded to any public comments in response to the ICR.
930

Provisions Requiring PRA Clearance

The final rule contains requirements subject to the PRA. The reporting 

requirements are found in §§ __.12(e) and __.20(d); the recordkeeping requirements are 

found in §§ __.3(d)(3), __.4(b)(3)(i)(A), __.5(c), __.11(a)(2), and __.20(b)-(f); and the 

disclosure requirements are found in § __.11(a)(8)(i). The recordkeeping burden for §§ 

__.4(a)(2)(iii), __.4(b)(2)(iii), __.5(b)(1), __.5(b)(2)(i), __.5(b)(2)(iv), __.13(a)(2)(i), and 

__.13(a)(2)(ii)(A) is accounted for in § __.20(b); the recordkeeping burden for Appendix 

B is accounted for in § __.20(c); the reporting and recordkeeping burden for Appendix A 

is accounted for in § __.20(d); and the recordkeeping burden for §§ __.10(c)(12)(i) and 

__.10(c)(12)(iii) is accounted for in § __.20(e). These information collection 

requirements would implement section 619 of the Dodd-Frank Act, as mentioned in the 

Abstract below. The respondent/recordkeepers are for-profit financial institutions, 

including small businesses. A covered entity must retain these records for a period that is 

no less than 5 years in a form that allows it to promptly produce such records to [the 

Agency] on request.

Comments Received on PRA

Of the comments received in response to the proposed rule, three specifically 

referenced the PRA.2818 They were received from five industry trade groups and focused 

on the analysis of the regulatory burden imposed by regulation. They referenced the 

PRA burden as an example of the significance of the burden imposed by the regulation 

 

2818 See BoA (acknowledging that the Agencies performed an analysis of the information costs as required 

by the Paperwork Reduction Act); SIFMA et al. (Covered Funds) (Feb. 2012) (noting that the Agencies 

conducted a limited cost/benefit analysis of the information requirements of the proposed rules under the 

PRA); Chamber (Nov. 2013) (noting that the burden estimates for the proposed rule stand at almost 

6,600,000 hours per year).
931

but did not address burden in the context of the PRA. A number of other comments 

addressed reporting and recordkeeping requirements and the utility of the information to 

be collected outside the context of the PRA. As a result of these and other comments, the 

Agencies made changes to the rule. These comments are discussed throughout the 

release.

Proposed Information Collection

Title of Information Collection: Reporting, Recordkeeping, and Disclosure Requirements 

Associated with Proprietary Trading and Certain Interests in and Relationships with 

Covered Funds.

Frequency of Response: Annual, monthly, quarterly, and on occasion.

Affected Public: Businesses or other for-profit.

Respondents:

Board: State member banks, bank holding companies, savings and loan holding 

companies, mutual holding companies, foreign banking organizations, U.S. branches or 

agencies of foreign banks, and other holding companies that control an insured 

depository institution. The Board will take burden for all institutions under a holding 

company including:

• OCC-supervised institutions,

• FDIC-supervised institutions,

• Banking entities for which the CFTC is the primary financial regulatory agency, 

as defined in section 2(12)(C) of the Dodd-Frank Act, and

• Banking entities for which the SEC is the primary financial regulatory agency, as 

defined in section 2(12)(B) of the Dodd-Frank Act.
932

OCC: National banks, federal savings associations, federal savings banks not 

under a holding company, and their respective subsidiaries, and their affiliates not under 

a holding company, and U.S. branches or agencies of foreign banks. The OCC will take 

the burden with respect to registered investment advisers and commodity trading advisers 

and commodity pool operators that are subsidiaries of national banks, federal savings 

associations, and federal savings banks not under a bank holding company.

FDIC: Insured state nonmember banks not under a holding company; state 

savings associations and state savings banks not under a holding company; subsidiaries of 

state nonmember banks, state savings associations, and state savings banks not under a 

holding company; and foreign banks having an insured branch and their branches and 

agencies.

Abstract: 

Section 619 of the Dodd-Frank Act added a new section 13 to the BHC Act (to be 

codified at 12 U.S.C. 1851) that generally prohibits any banking entity from engaging in 

proprietary trading or from investing in, sponsoring, or having certain relationships with a 

hedge fund or private equity fund, subject to certain exemptions. As noted above, the 

final rule contains requirements subject to the PRA. The Agencies believe that the 

reporting, recordkeeping, and disclosure requirements associated with the rule will permit 

banking entities and the Agencies to enforce compliance with section 13 of the BHC Act 

and the final rule and to identify, monitor and limit risks of activities permitted under 

section 13, particularly involving banking entities posing the greatest risk to financial 

stability. Compliance with the information collections would be mandatory. As noted 

above, a number of commenters addressed reporting and recordkeeping requirements and 
933

the utility of the information to be collected outside the context of the PRA. As a result 

of these comments, the Agencies made changes to the rule, which are discussed 

throughout the release. The final burden estimates take these changes into account and 

reflect the anticipated burden under the final rules. As discussed in the release, in brief, 

the purpose for the recordkeeping, disclosure, and reporting requirements contained 

within the rule is to facilitate compliance with section 13 of the BHC and implementing 

rules.

Section-by-Section Analysis

PRA Reporting Requirements

Section __.12(e) states that, upon application by a banking entity, the Board may 

extend the period of time to meet the requirements on ownership limitations in this 

section for up to 2 additional years, if the Board finds that an extension would be 

consistent with safety and soundness and not detrimental to the public interest. An 

application for extension must (1) be submitted to the Board at least 90 days prior to 

expiration, (2) provide the reasons for application including information that addresses 

the factors in paragraph (e)(2) of § __.12, and (3) explain the banking entity’s plan for 

reducing the permitted investment in a covered fund through redemption, sale, dilution or 

other methods.

Section __.20(d) provides that a banking entity engaged in proprietary trading 

activity must comply with the reporting requirements described in Appendix A, if (1) the 

banking entity has, together with its affiliates and subsidiaries, trading assets and 

liabilities the average gross sum of which over the previous consecutive four quarters, as 

measured as of the last day of each of the four prior calendar quarters, equals or exceeds 
934

the established threshold; (2) in the case of a foreign banking entity, the average gross 

sum of the trading assets and liabilities of the combined U.S. operations of the foreign 

banking entity (including all subsidiaries, affiliates, branches and agencies of the foreign 

banking entity operating, located or organized in the United States and excluding trading 

assets and liabilities involving obligations of or guaranteed by the United States or any 

agency of the United States) over the previous consecutive four quarters, as measured as 

of the last day of each of the four prior calendar quarters, equals or exceeds the 

established threshold; or (3) the appropriate agency notifies the banking entity in writing 

that it must satisfy the reporting requirements contained in Appendix A of this part. The 

threshold for reporting is $50 billion beginning on June 30, 2014; $25 billion beginning 

on April 30, 2016; and $10 billion beginning on December 31, 2016. Unless the 

appropriate agency notifies the banking entity in writing that it must report on a different 

basis, a banking entity with $50 billion or more in trading assets and liabilities shall 

report the information required by Appendix A for each calendar month within 30 days of 

the end of the relevant calendar month; beginning with information for the month of 

January 2015, such information shall be reported within 10 days of the end of that 

calendar month. Any other banking entity subject to Appendix A shall report the 

information required by Appendix A for each calendar quarter within 30 days of the end 

of that calendar quarter unless the appropriate agency notifies the banking entity in 

writing that it must report on a different basis. Appendix A requires banking entities to 

furnish the following quantitative measurements for each trading desk of the banking 

entity: (1) risk and position limits and usage; (2) risk factor sensitivities; (3) Value-at-
935

Risk and stress VaR; (4) comprehensive profit and loss attribution; (5) inventory 

turnover; (6) inventory aging; and (7) customer facing trade ratio.

Recordkeeping Requirements

Section __.3(d)(3) specifies that proprietary trading does not include any purchase 

or sale of a security by a banking entity for the purpose of liquidity management in 

accordance with a documented liquidity management plan of the banking entity that (1) 

specifically contemplates and authorizes the particular securities to be used for liquidity 

management purposes, the amount, types, and risks of these securities that are consistent 

with liquidity management, and the liquidity circumstances in which the particular 

securities may or must be used; (2) requires that any purchase or sale of securities 

contemplated and authorized by the plan be principally for the purpose of managing the 

liquidity of the banking entity, and not for the purpose of short-term resale, benefitting 

from actual or expected short-term price movements, realizing short-term arbitrage 

profits, or hedging a position taken for such short-term purposes; (3) requires that any 

securities purchased or sold for liquidity management purposes be highly liquid and 

limited to securities the market, credit and other risks of which the banking entity does 

not reasonably expect to give rise to appreciable profits or losses as a result of short-term 

price movements; (4) limits any securities purchased or sold for liquidity management 

purposes, together with any other instruments purchased or sold for such purposes, to an 

amount that is consistent with the banking entity’s near-term funding needs, including 

deviations from normal operations of the banking entity or any affiliate thereof, as 

estimated and documented pursuant to methods specified in the plan; (5) includes written 

policies and procedures, internal controls, analysis and independent testing to ensure that 
936

the purchase and sale of securities that are not permitted under § __.6(a) or (b) of this part 

are for the purpose of liquidity management and in accordance with the liquidity 

management plan described in this paragraph; and (6) is consistent with the appropriate 

agency’s supervisory requirements, guidance and expectations regarding liquidity 

management.

Section __.4(b)(3)(i)(A) provides that a trading desk or other organizational unit 

of another entity with more than $50 billion in trading assets and liabilities is not a client, 

customer, or counterparty unless the trading desk documents how and why a particular 

trading desk or other organizational unit of the entity should be treated as a client, 

customer, or counterparty of the trading desk for purposes of § __.4(b). This 

modification responds to comments received on the proposal regarding the definition of 

client, customer, or counterparty for purposes of the market making exemption.

Section __.5(c) requires documentation for any purchase or sale of a financial 

instrument for risk-mitigating hedging purposes that is: (1) not established by the specific 

trading desk establishing the underlying positions, contracts, or other holdings the risks of 

which the hedging activity is designed to reduce; (2) established by the specific trading 

desk establishing or responsible for the underlying positions, contracts, or other holdings 

but that is not specifically identified in the trading desk’s written policies and procedures; 

or (3) established to hedge aggregated positions across two or more trading desks. In 

connection with any purchase or sale that meets these specified circumstances, a banking 

entity must, at a minimum and contemporaneously with the purchase or sale, document 

(1) the specific, identifiable risk(s) of the identified positions, contracts, or other holdings 

of the banking entity that the purchase or sale is designed to reduce; (2) the specific risk-
937

mitigating strategy that the purchase or sale is designed to fulfill; and (3) the trading 

desks or other business unit that is establishing and responsible for the hedge. The 

banking entity must also create and retain records sufficient to demonstrate compliance 

with this section for at least 5 years in a form that allows the banking entity to promptly 

produce such records to the appropriate agency on request, or such longer period as 

required under other law or this part.

Section __.11(a)(2) requires that covered funds generally must be organized and 

offered only in connection with the provision of bona fide trust, fiduciary, investment 

advisory, or commodity trading advisory services and only to persons that are customers 

of such services of the banking entity, pursuant to a written plan or similar documentation 

outlining how the banking entity intends to provide advisory or other similar services to 

its customers through organizing and offering the covered fund.

Section __.20(b) specifies the contents of the compliance program for a banking 

entity with total consolidated assets of $10 billion or more. It includes: (1) written 

policies and procedures reasonably designed to document, describe, monitor and limit 

trading activities, including setting and monitoring required limits set out in § __.4 and § 

__.5 and activities and investments with respect to a covered fund (including those 

permitted under §§ __.3 through __.6 or §§ __.11 through __.14) to ensure that all 

activities and investments conducted by the banking entity that are subject to section 13 

of the BHC Act and this part comply with section 13 of the BHC Act and applicable 

regulations; (2) a system of internal controls reasonably designed to monitor compliance 

with section 13 of the BHC Act and this part and to prevent the occurrence of activities or 

investments that are prohibited by section 13 of the BHC Act and applicable regulations; 
938

(3) a management framework that clearly delineates responsibility and accountability for 

compliance with section 13 of the BHC Act and this part and includes appropriate 

management review of trading limits, strategies, hedging activities, investments, 

incentive compensation and other matters identified in this part or by management as 

requiring attention; (4) independent testing and audit of the effectiveness of the 

compliance program conducted periodically by qualified personnel of the banking entity 

or by a qualified outside party; (5) training for trading personnel and managers, as well as 

other appropriate personnel, to effectively implement and enforce the compliance 

program; and (6) records sufficient to demonstrate compliance with section 13 of the 

BHC Act and applicable regulations, which a banking entity must promptly provide to 

the [Agency] upon request and retain for a period of no less than 5 years or such longer 

period as required by [Agency].

Section __.20(c) specifies that the compliance program of a banking entity must 

satisfy the requirements and other standards contained in Appendix B, if (1) the banking 

entity engages in proprietary trading permitted under subpart B and is required to comply 

with the reporting requirements of § __.20(d); (2) the banking entity has reported total 

consolidated assets as of the previous calendar year end of $50 billion or more or, in the 

case of a foreign banking entity, has total U.S. assets as of the previous calendar year end 

of $50 billion or more (including all subsidiaries, affiliates, branches and agencies of the 

foreign banking entity operating, located or organized in the United States); or (3) the 

[Agency] notifies the banking entity in writing that it must satisfy the requirements and 

other standards contained in Appendix B. Appendix B provides enhanced minimum 

standards for compliance programs for banking entities that meet the thresholds in § 
939

__.20(c) as described above. These include the establishment, maintenance, and 

enforcement of the enhanced compliance program and meeting the minimum written 

policies and procedures, internal controls, management framework, independent testing, 

training, and recordkeeping. The program must: (1) be reasonably designed to identify, 

document, monitor and report the permitted trading and covered fund activities and 

investments; identify, monitor and promptly address the risk of these covered activities 

and investments and potential areas of noncompliance; and prevent activities or 

investments prohibited by, or that do not comply with, section 13 of the BHC Act and 

this part; (2) establish and enforce appropriate limits on covered activities and 

investments, including limits on size, scope, complexity, and risks of individual activities 

or investments consistent with the requirements of section 13 of the BHC Act and this 

part; (3) subject the effectiveness of the compliance program to periodic independent 

review and testing, and ensure that internal audit, corporate compliance and internal 

control functions involved in review and testing are effective and independent; (4) make 

senior management and others accountable for effective implementation of compliance 

program and ensure that board of directors and chief executive officer (or equivalent) of 

the banking entity review effectiveness of the compliance program; and (5) facilitate 

supervision and examination by Agencies of permitted trading and covered fund 

activities and investments.

Section __.20(d) provides that certain banking entities engaged in certain 

proprietary trading activities must comply with the reporting requirements described in 

Appendix A. A banking entity must also, for any quantitative measurement furnished to 

the appropriate agency pursuant to § __.20(d) and Appendix A, create and maintain 
940

records documenting the preparation and content of these reports, as well as such 

information as is necessary to permit the appropriate agency to verify the accuracy of 

such reports, for a period of 5 years from the end of the calendar year for which the 

measurement was taken.

Section __.20(e) specifies additional documentation required for covered funds. 

Any banking entity that has more than $10 billion in total consolidated assets as reported 

on December 31 of the previous two calendar years shall maintain records that include: 

(1) documentation of the exclusions or exemptions other than sections 3(c)(1) and 3(c)(7) 

of the Investment Company Act of 1940 relied on by each fund sponsored by the banking 

entity (including all subsidiaries and affiliates) in determining that such fund is not a 

covered fund; (2) for each fund sponsored by the banking entity (including all 

subsidiaries and affiliates) for which the banking entity relies on one or more of the 

exclusions from the definition of covered fund provided by §§ __.10(c)(1),__.10(c)(5), 

__.10(c)(8), __.10(c)(9), or __.10(c)(10) of subpart C, documentation supporting the 

banking entity’s determination that the fund is not a covered fund pursuant to one or 

more of those exclusions; (3) for each seeding vehicle described in §§ __.10(c)(12)(i) or 

__.10(c)(12)(iii) of subpart C that will become a registered investment company or SECregulated business development company, a written plan documenting the banking 

entity’s determination that the seeding vehicle will become a registered investment 

company or 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 
941

specified in § __.12(a)(2)(i)(B) of subpart C; and (4) for any banking entity that is, or is 

controlled directly or indirectly by a banking entity that is, located in or organized under 

the laws of the United States or of any State, if the aggregate amount of ownership 

interests in foreign public funds that are described in §__.10(c)(1) of subpart C owned by 

such banking entity (including ownership interests owned by any affiliate that is 

controlled directly or indirectly by a banking entity that is located in or organized under 

the laws of the United States or of any State) exceeds $50 million at the end of two or 

more consecutive calendar quarters, beginning with the next succeeding calendar quarter, 

documentation of the value of the ownership interests owned by the banking entity (and 

such affiliates) in each foreign public fund and each jurisdiction in which any such 

foreign public fund is organized, calculated as of the end of each calendar quarter, which 

documentation must continue until the banking entity’s aggregate amount of ownership 

interests in foreign public funds is below $50 million for two consecutive calendar 

quarters.

Section __.20(f)(1) applies to banking entities with no covered activities. A 

banking entity that does not engage in activities or investments pursuant to subpart B or 

subpart C (other than trading activities permitted pursuant to §__.6(a) of subpart B) may 

satisfy the requirements of this section by establishing the required compliance program 

prior to becoming engaged in such activities or making such investments (other than 

trading activities permitted pursuant to §__.6(a) of subpart B).

Section __.20(f)(2) applies to banking entities with modest activities. A banking 

entity with total consolidated assets of $10 billion or less as reported on December 31 of 

the previous two calendar years that engages in activities or investments pursuant to 
942

subpart B or subpart C of this part (other than trading activities permitted under section 

__.6(a)) may satisfy the requirements of this section by including in its existing 

compliance policies and procedures appropriate references to the requirements of section 

13 and this part and adjustments as appropriate given the activities, size, scope and 

complexity of the banking entity. 

Disclosure Requirements

Section __.11(a)(8)(i) requires that a banking entity must clearly and 

conspicuously disclose, in writing, to any prospective and actual investor in the covered 

fund (such as through disclosure in the covered fund’s offering documents) (1) that “any 

losses in [such covered fund] will be borne solely by investors in [the covered fund] and 

not by [the banking entity]; therefore, [the banking entity’s] losses in [such covered fund] 

will be limited to losses attributable to the ownership interests in the covered fund held 

by [the banking entity] in its capacity as investor in the [covered fund] or as beneficiary 

of a restricted profit interest held by [the banking entity]”; (2) that such investor should 

read the fund offering documents before investing in the covered fund; (3) that the 

“ownership interests in the covered fund are not insured by the FDIC, and are not 

deposits, obligations of, or endorsed or guaranteed in any way, by any banking entity” 

(unless that happens to be the case); and (4) the role of the banking entity and its affiliates 

and employees in sponsoring or providing any services to the covered fund.

PRA Burden Estimates

In determining the method for estimating the paperwork burden, the Agencies 

made the assumption that affiliated entities under a holding company would act in 

concert with one another to take advantage of efficiencies that may exist. 
943

Estimated PRA Burden per Response:

Reporting Burden

§ __.12(e) – 20 hours (Initial set up 50 hours).

§ __.20(d) – 2 hours (Initial setup 6 hours).

PRA Recordkeeping Burden

§ __.3(d)(3) – 1 hour (Initial setup 3 hours).

§ __.4(b)(3)(i)(A) – 2 hours.

§ __.5(c) – 100 hours (Initial setup 50 hours).

§ __.11(a)(2) – 10 hours.

§ __.20(b) – 265 hours (Initial setup 795 hours).

§ __.20(c) – 1,200 hours (Initial setup 3,600 hours).

§ __.20(d) – 440 hours for entities with $50 billion or more in trading assets/liabilities; 

350 hours for entities with $10 to $50 billion in trading assets/liabilities.

§ __.20(e) – 200 hours.

§ __.20(f)(1) – 8 hours.

§ __.20(f)(2) – 40 (Initial setup 100 hours).

PRA Disclosure Burden

§ __.11(a)(8)(i) – 0.1 hours.

Board
944

Number of respondents: 5,027.

Total estimated annual burden: 2,336,190 hours (968,488 hours for initial setup and 

1,367,702 hours for ongoing compliance).

FDIC

Number of respondents: 797.

Total estimated annual burden: 28,234 hours (14,165 hours for initial setup and 14,069 

hours for ongoing compliance).

OCC

Number of respondents: 381.

Total estimated annual burden: 28,016 hours (14,386 hours for initial setup and 13,630 

hours for ongoing compliance).

C. Regulatory Flexibility Act Analysis

In general, section 4 of the Regulatory Flexibility Act (5 U.S.C. 604) (RFA) 

requires an agency to prepare a final regulatory flexibility analysis (FRFA) for a final rule 

unless the agency certifies that the rule will not, if promulgated, have a significant 

economic impact on a substantial number of small entities (defined as of July 22, 2013, to 

include banking entities with total assets of $500 million or less (“small banking 

entities”).2819 Pursuant to section 605(b) of the RFA, a FRFA is not required if an agency 

certifies that the final rule will not have a significant economic impact on a substantial 

number of small entities. The Agencies have considered the potential economic impact 

 

2819 See 13 CFR 121.201; See also 13 CFR § 121.103(a)(6) (noting factors that the Small Business 

Administration considers in determining whether an entity qualifies as a small business, including receipts, 

employees, and other measures of its domestic and foreign affiliates). 
945

of the final rule on small banking entities in accordance with the RFA. The Agencies 

believe that the final rule will not have a significant economic impact on a substantial 

number of small banking entities for the reasons described below.

The Agencies previously considered the impact of the proposed rule for purposes 

of the RFA and concluded that the proposed rule would not appear to have a significant 

economic impact on a substantial number of small banking entities. In support of this 

conclusion, the proposed rule, among other things, noted that the thresholds for the 

metrics reporting requirements under §_.7 and Appendix A and for the enhanced and core 

compliance program requirements under §_.20 and Appendix C of the proposed rule 

would not capture small banking entities.2820 

The Agencies received several comments on the impact of the proposed rule on 

small entities. Commenters argued that the Agencies incorrectly concluded that the 

proposed rule would not have a significant economic impact on a substantial number of 

small entities.2821 Commenters asserted that the proposed rule would have a significant 

economic impact on numerous small non-banking entities by restricting their access to a 

variety of products and services, including covered fund-linked products for investment 

and hedging purposes and underwriting and market-making related services.2822

The Agencies have carefully considered these comments in developing a final 

rule. To minimize burden on small banking entities, section __.20(f)(1) of the final rule 

provides that a banking entity that does not engage in covered trading activities (other 

 

2820 See Joint Proposal, 76 FR at 68,938-68,939.

2821 See BoA; SIFMA et al. (Covered Funds) (Feb. 2012); Chamber (Feb. 2012); ABA (Keating).

2822 See SIFMA et al. (Covered Funds) (Feb. 2012); Chamber (Feb. 2012).
946

than trading in U.S. government or agency obligations, obligations of specified 

government sponsored entities, and state and municipal obligations) or covered fund 

activities and investments need only establish a compliance program prior to becoming 

engaged in such activities or making such investments. In addition, to minimize the 

burden on small banking entities, a banking entity with total consolidated assets of $10 

billion or less that engages in covered trading activities and/or covered fund activities 

may satisfy the requirements of the final rule by including in its existing compliance 

policies and procedures appropriate references to the requirements of section 13 and the 

final rule and adjustments as appropriate given the activities, size, scope and complexity 

of the banking entity. Only those banking entities with total assets of greater than $10 

billion will need to adopt more detailed or enhanced compliance requirements under the 

final rule. (For purposes of the enhanced compliance program in Appendix B of the final 

rule, the threshold for banking entities is total consolidated assets of $50 billion or more.) 

Accordingly, the compliance requirements under the final rule do not have a significant 

economic impact on a substantial number of small banking entities.

Likewise, the final rule raises the threshold for metrics reporting from the 

proposed rule to capture only firms that engage in significant trading activities. 

Specifically, the metrics reporting requirements under § _.20 and Appendix A of the final 

rule apply only to banking entities with average trading assets and liabilities on a 

consolidated, worldwide basis for the preceding year equal to or greater than $10 billion. 

Accordingly, the metrics reporting requirements under the final rule do not impact small 

banking entities. 
947

Moreover, the Agencies have revised the definition of covered fund in the final 

rule to address many of the concerns raised by commenters regarding the unintended 

consequences of the proposed definition.2823 The definition of covered fund under the 

final rule contains a number of exclusions for entities that may rely on exclusions from 

the Investment Company Act of 1940 contained in section 3(c)(1) or 3(c)(7) of that Act 

but that are not engaged in investment activities of the type contemplated by section 13 of 

the BHC Act. These include, for example, exclusions for wholly owned subsidiaries, 

joint ventures, acquisition vehicles, insurance company separate accounts, registered 

investments companies, and public welfare investment funds. The Agencies believe that 

these changes will further minimize the burden for small banking entities such as those 

that may use wholly owned subsidiaries for organizational convenience or make public 

welfare investments to achieve their financial and Community Reinvestment Act goals.

Finally, in response to commenters’ assertion that the proposed rule would have 

had a significant economic impact on numerous small non-banking entities by restricting 

their access to a variety of products and services,2824 the Agencies note that the RFA does

not require the Agencies to consider the impact of the final rule, including its indirect 

 

2823 See Part IV.B.1. of this Supplementary Information.

2824 See SIFMA et al. (Covered Funds) (Feb. 2012); Chamber (Feb. 2012).
948

economic effects, on small entities that are not subject to the requirements of the final 

rule.2825 

For the reasons stated above, the OCC, FDIC, SEC, and CFTC certify, for the 

banking entities subject to each such Agency’s jurisdiction, that the final rule will not 

result in a significant economic impact on a substantial number of small entities. In light 

of the foregoing, the Board does not believe, for the banking entities subject to the 

Board’s jurisdiction, that the final rule would have a significant economic impact on a 

substantial number of small entities.

D. OCC Unfunded Mandates Reform Act of 1995 Determination

The Unfunded Mandates Reform Act of 1995, Pub. L. 104-4 (2 U.S.C. 1532) 

(UMRA) requires a Federal agency to prepare a budgetary impact statement before 

promulgating any rule likely to result in a Federal mandate that may result in the 

expenditure by State, local, and tribal governments, in the aggregate, or by the private 

sector of $100 million or more (adjusted annually for inflation) in any one year. If a 

budgetary impact statement is required, Section 205 of the UMRA also requires an 

agency to identify and consider a reasonable number of regulatory alternatives before 

promulgating a rule. 

 

2825 See e.g., In Mid-Tex Electric Cooperative v. FERC, 773 F.2d 327 (D.C. Cir. 1985); United Distribution 

Cos. v. FERC, 88 F.3d 1105, 1170 (D.C. Cir. 1996); Cement Kiln Recycling Coalition v. EPA, 255 F.3d 

855 (D.C. Cir. 2001). Commenters relied on Aeronautical Repair Station Association v. Federal Aviation 

Administration, 494 F.3d 161 (D.C. Cir 2007) to argue that the Agencies must consider the indirect 

economic effects of the final rule on small non-banking entities. This case is inapposite, however, because 

there the agency’s own rulemaking release expressly stated that the rule imposed responsibilities directly

on certain small business contractors. The court reaffirmed its prior holdings that the RFA limits its 

application to small entities “which will be subject to the proposed regulation – that is, those small entities 

to which the proposed rule will apply.” Id. at 176 (emphasis and internal quotations omitted). 
949

The OCC previously determined that the proposed rule would not impose any 

Federal mandates resulting in expenditures by State, local, and tribal governments, in the 

aggregate, or by the private sector of $100 million or more (adjusted annually for 

inflation) in any one year. Several commenters argued that the OCC failed to consider all 

relevant expenditures and that that the proposed rule should have qualified as a 

significant regulatory action under UMRA.2826 

The OCC has carefully considered these comments in completing its UMRA 

analysis of the final rule. The OCC has determined that the final rule qualifies as a 

significant regulatory action under the UMRA because its Federal mandates may result in 

expenditures by the private sector in excess of $100 million or more (adjusted annually 

for inflation) in any one year. 

 

2826 See BoA; SIFMA et al. (Covered Funds); Chamber. 
950

Text of Common Rule

PART [ ] PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND 

RELATIONSHIPS WITH COVERED FUNDSSec.

Subpart A Authority and Definitions

Sec.

___.1 Authority, purpose, scope, and relationship to other authorities [Reserved].

___.2 Definitions.

Subpart B Proprietary Trading 

___.3 Prohibition on proprietary trading.

___.4 Permitted underwriting and market making-related activities.

___.5 Permitted risk-mitigating hedging activities.

___.6 Other permitted proprietary trading activities.

___.7 Limitations on permitted proprietary trading activities.

___.8 [Reserved]

___.9 [Reserved]

Subpart C Covered Fund Activities and Investments

___.10 Prohibition on acquiring or retaining an ownership interest in and having certain 

relationships with a covered fund.

___.11 Permitted organizing and offering, underwriting, and market making with respect 

to a covered fund.

___.12 Permitted investment in a covered fund.

___.13 Other permitted covered fund activities and investments.

___.14 Limitations on relationships with a covered fund.
951

___.15 Other limitations on permitted covered fund activities and investments.

___.16 [Reserved]

___.17 [Reserved]

___.18 [Reserved]

___.19 [Reserved]

Subpart D Compliance Program Requirement; Violations

___.20 Program for compliance; reporting.

___.21 Termination of activities or investments; penalties for violations.

Appendix A Reporting and Recordkeeping Requirements for Covered Trading Activities

Appendix B Enhanced Minimum Standards for Compliance Programs

Subpart A – Authority and Definitions

§ ___.1 Authority, purpose, scope, and relationship to other authorities [Reserved]

§ ___.2 Definitions.

Unless otherwise specified, for purposes of this part:

(a) Affiliate has the same meaning as in section 2(k) of the Bank Holding 

Company Act of 1956 (12 U.S.C. 1841(k)).

(b) Bank holding company has the same meaning as in section 2 of the Bank 

Holding Company Act of 1956 (12 U.S.C. 1841).

(c) Banking entity. (1) Except as provided in paragraph (c)(2) of this 

section, banking entity means:

(i) Any insured depository institution; 

(ii) Any company that controls an insured depository institution;
952

(iii) Any company that is treated as a bank holding company for purposes of 

section 8 of the International Banking Act of 1978 (12 U.S.C. 3106); and

(iv) Any affiliate or subsidiary of any entity described in paragraphs (c)(1)(i), 

(ii), or (iii) of this section. 

(2) Banking entity does not include:

(i) A covered fund that is not itself a banking entity under paragraphs 

(c)(1)(i), (ii), or (iii) of this section; 

(ii) A portfolio company held under the authority contained in section 

4(k)(4)(H) or (I) of the BHC Act (12 U.S.C. 1843(k)(4)(H), (I)), or any portfolio concern, 

as defined under 13 CFR 107.50, that is controlled by a small business investment 

company, as defined in section 103(3) of the Small Business Investment Act of 1958 (15 

U.S.C. 662), so long as the portfolio company or portfolio concern is not itself a banking 

entity under paragraphs (c)(1)(i), (ii), or (iii) of this section; or

(iii) The FDIC acting in its corporate capacity or as conservator or receiver 

under the Federal Deposit Insurance Act or Title II of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act.

(d) Board means the Board of Governors of the Federal Reserve System.

(e) CFTC means the Commodity Futures Trading Commission.

(f) Dealer has the same meaning as in section 3(a)(5) of the Exchange Act (15 

U.S.C. 78c(a)(5)).

(g) Depository institution has the same meaning as in section 3(c) of the 

Federal Deposit Insurance Act (12 U.S.C. 1813(c)).
953

(h) Derivative. (1) Except as provided in paragraph (h)(2) of this section, 

derivative means:

(i) Any swap, as that term is defined in section 1a(47) of the Commodity 

Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as that term is defined in section 

3(a)(68) of the Exchange Act (15 U.S.C. 78c(a)(68));

(ii) Any purchase or sale of a commodity, that is not an excluded commodity,

for deferred shipment or delivery that is intended to be physically settled;

(iii) Any foreign exchange forward (as that term is defined in section 1a(24) of 

the Commodity Exchange Act (7 U.S.C. 1a(24)) or foreign exchange swap (as that term 

is defined in section 1a(25) of the Commodity Exchange Act (7 U.S.C. 1a(25)); 

(iv) Any agreement, contract, or transaction in foreign currency described in 

section 2(c)(2)(C)(i) of the Commodity Exchange Act (7 U.S.C. 2(c)(2)(C)(i));

(v) Any agreement, contract, or transaction in a commodity other than foreign 

currency described in section 2(c)(2)(D)(i) of the Commodity Exchange Act (7 U.S.C. 

2(c)(2)(D)(i)); and 

(vi) Any transaction authorized under section 19 of the Commodity Exchange 

Act (7 U.S.C. 23(a) or (b)); 

(2) A derivative does not include:

(i) Any consumer, commercial, or other agreement, contract, or transaction that 

the CFTC and SEC have further defined by joint regulation, interpretation, guidance, or 

other action as not within the definition of swap, as that term is defined in section 1a(47) 

of the Commodity Exchange Act (7 U.S.C. 1a(47)), or security-based swap, as that term 

is defined in section 3(a)(68) of the Exchange Act (15 U.S.C. 78c(a)(68)); or
954

(ii) Any identified banking product, as defined in section 402(b) of the Legal 

Certainty for Bank Products Act of 2000 (7 U.S.C. 27(b)), that is subject to section 

403(a) of that Act (7 U.S.C. 27a(a)).

(i) Employee includes a member of the immediate family of the employee.

(j) Exchange Act means the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.).

(k) Excluded commodity has the same meaning as in section 1a(19) of the 

Commodity Exchange Act (7 U.S.C. 1a(19)).

(l) FDIC means the Federal Deposit Insurance Corporation

(m) Federal banking agencies means the Board, the Office of the Comptroller of 

the Currency, and the FDIC.

(n) Foreign banking organization has the same meaning as in section 211.21(o) 

of the Board’s Regulation K (12 CFR 211.21(o)), but does not include a foreign bank, as 

defined in section 1(b)(7) of the International Banking Act of 1978 (12 U.S.C. 3101(7)), 

that is organized under the laws of the Commonwealth of Puerto Rico, Guam, American 

Samoa, the United States Virgin Islands, or the Commonwealth of the Northern Mariana 

Islands.

(o) Foreign insurance regulator means the insurance commissioner, or a similar 

official or agency, of any country other than the United States that is engaged in the 

supervision of insurance companies under foreign insurance law.

(p) General account means all of the assets of an insurance company except 

those allocated to one or more separate accounts.

(q) Insurance company means a company that is organized as an insurance 

company, primarily and predominantly engaged in writing insurance or reinsuring risks 
955

underwritten by insurance companies, subject to supervision as such by a state insurance 

regulator or a foreign insurance regulator, and not operated for the purpose of evading the 

provisions of section 13 of the BHC Act (12 U.S.C. 1851).

(r) Insured depository institution has the same meaning as in section 3(c) of the 

Federal Deposit Insurance Act (12 U.S.C. 1813(c)), but does not include an insured 

depository institution that is described in section 2(c)(2)(D) of the BHC Act (12 U.S.C. 

1841(c)(2)(D)).

(s) Loan means any loan, lease, extension of credit, or secured or unsecured 

receivable that is not a security or derivative. 

(t) Primary financial regulatory agency has the same meaning as in section 

2(12) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (12 U.S.C. 

5301(12)).

(u) Purchase includes any contract to buy, purchase, or otherwise acquire. For 

security futures products, purchase includes any contract, agreement, or transaction for 

future delivery. With respect to a commodity future, purchase includes any contract, 

agreement, or transaction for future delivery. With respect to a derivative, purchase 

includes the execution, termination (prior to its scheduled maturity date), assignment, 

exchange, or similar transfer or conveyance of, or extinguishing of rights or obligations 

under, a derivative, as the context may require.

(v) Qualifying foreign banking organization means a foreign banking 

organization that qualifies as such under section 211.23(a), (c) or (e) of the Board’s 

Regulation K (12 CFR 211.23(a), (c), or (e)).

(w) SEC means the Securities and Exchange Commission.
956

(x) Sale and sell each include any contract to sell or otherwise dispose of. For 

security futures products, such terms include any contract, agreement, or transaction for 

future delivery. With respect to a commodity future, such terms include any contract, 

agreement, or transaction for future delivery. With respect to a derivative, such terms 

include the execution, termination (prior to its scheduled maturity date), assignment, 

exchange, or similar transfer or conveyance of, or extinguishing of rights or obligations 

under, a derivative, as the context may require.

(y) Security has the meaning specified in section 3(a)(10) of the Exchange 

Act (15 U.S.C. 78c(a)(10)).

(z) Security-based swap dealer has the same meaning as in section 3(a)(71) of 

the Exchange Act (15 U.S.C. 78c(a)(71)).

(aa) Security future has the meaning specified in section 3(a)(55) of the 

Exchange Act (15 U.S.C. 78c(a)(55)).

(bb) Separate account means an account established and maintained by an

insurance company in connection with one or more insurance contracts to hold assets that 

are legally segregated from the insurance company’s other assets, under which income, 

gains, and losses, whether or not realized, from assets allocated to such account, are, in 

accordance with the applicable contract, credited to or charged against such account 

without regard to other income, gains, or losses of the insurance company.

(cc) State means any State, the District of Columbia, the Commonwealth of 

Puerto Rico, Guam, American Samoa, the United States Virgin Islands, and the 

Commonwealth of the Northern Mariana Islands.
957

(dd) Subsidiary has the same meaning as in section 2(d) of the Bank Holding 

Company Act of 1956 (12 U.S.C. 1841(d)).

(ee) State insurance regulator means the insurance commissioner, or a similar 

official or agency, of a State that is engaged in the supervision of insurance companies 

under State insurance law.

(ff) Swap dealer has the same meaning as in section 1(a)(49) of the 

Commodity Exchange Act (7 U.S.C. 1a(49)).

Subpart B – Proprietary Trading 

§ ___.3 Prohibition on proprietary trading.

(a) Prohibition. Except as otherwise provided in this subpart, a banking entity

may not engage in proprietary trading. Proprietary trading means engaging as principal 

for the trading account of the banking entity in any purchase or sale of one or more 

financial instruments.

(b) Definition of trading account. (1) Trading account means any account 

that is used by a banking entity to:

(i) Purchase or sell one or more financial instruments principally for the purpose of:

(A) Short-term resale;

(B) Benefitting from actual or expected short-term price movements;

(C) Realizing short-term arbitrage profits; or

(D) Hedging one or more positions resulting from the purchases or sales of 

financial instruments described in paragraphs (b)(1)(i)(A), (B), or (C) of this section; 

(ii) Purchase or sell one or more financial instruments that are both market 

risk capital rule covered positions and trading positions (or hedges of other market risk 
958

capital rule covered positions), if the banking entity, or any affiliate of the banking entity, 

is an insured depository institution, bank holding company, or savings and loan holding 

company, and calculates risk-based capital ratios under the market risk capital rule; or

(iii) Purchase or sell one or more financial instruments for any purpose, if the 

banking entity:

(A) Is licensed or registered, or is required to be licensed or registered, to 

engage in the business of a dealer, swap dealer, or security-based swap dealer, to the 

extent the instrument is purchased or sold in connection with the activities that require the 

banking entity to be licensed or registered as such; or

(B) Is engaged in the business of a dealer, swap dealer, or security-based swap 

dealer outside of the United States, to the extent the instrument is purchased or sold in 

connection with the activities of such business.

(2) Rebuttable presumption for certain purchases and sales. The purchase (or 

sale) of a financial instrument by a banking entity shall be presumed to be for the trading 

account of the banking entity under paragraph (b)(1)(i) of this section if the banking 

entity holds the financial instrument for fewer than sixty days or substantially transfers 

the risk of the financial instrument within sixty days of the purchase (or sale), unless the 

banking entity can demonstrate, based on all relevant facts and circumstances, that the 

banking entity did not purchase (or sell) the financial instrument principally for any of the 

purposes described in paragraph (b)(1)(i) of this section.

(c) Financial instrument. (1) Financial instrument means: 

(i) A security, including an option on a security;

(ii) A derivative, including an option on a derivative; or
959

(iii) A contract of sale of a commodity for future delivery, or option on a 

contract of sale of a commodity for future delivery.

(2) A financial instrument does not include:

(i) A loan;

(ii) A commodity that is not:

(A) An excluded commodity (other than foreign exchange or currency);

(B) A derivative;

(C) A contract of sale of a commodity for future delivery; or 

(D) An option on a contract of sale of a commodity for future delivery; or

(iii) Foreign exchange or currency.

(d) Proprietary trading. Proprietary trading does not include: 

(1) Any purchase or sale of one or more financial instruments by a banking 

entity that arises under a repurchase or reverse repurchase agreement pursuant to which 

the banking entity has simultaneously agreed, in writing, to both purchase and sell a 

stated asset, at stated prices, and on stated dates or on demand with the same 

counterparty; 

(2) Any purchase or sale of one or more financial instruments by a banking 

entity that arises under a transaction in which the banking entity lends or borrows a 

security temporarily to or from another party pursuant to a written securities lending 

agreement under which the lender retains the economic interests of an owner of such 

security, and has the right to terminate the transaction and to recall the loaned security on 

terms agreed by the parties;
960

(3) Any purchase or sale of a security by a banking entity for the purpose of 

liquidity management in accordance with a documented liquidity management plan of the 

banking entity that:

(i) Specifically contemplates and authorizes the particular securities to be 

used for liquidity management purposes, the amount, types, and risks of these securities 

that are consistent with liquidity management, and the liquidity circumstances in which 

the particular securities may or must be used; 

(ii) Requires that any purchase or sale of securities contemplated and 

authorized by the plan be principally for the purpose of managing the liquidity of the 

banking entity, and not for the purpose of short-term resale, benefitting from actual or 

expected short-term price movements, realizing short-term arbitrage profits, or hedging a 

position taken for such short-term purposes;

(iii) Requires that any securities purchased or sold for liquidity management 

purposes be highly liquid and limited to securities the market, credit, and other risks of 

which the banking entity does not reasonably expect to give rise to appreciable profits or 

losses as a result of short-term price movements; 

(iv) Limits any securities purchased or sold for liquidity management 

purposes, together with any other instruments purchased or sold for such purposes, to an 

amount that is consistent with the banking entity’s near-term funding needs, including

deviations from normal operations of the banking entity or any affiliate thereof, as 

estimated and documented pursuant to methods specified in the plan; 

(v) Includes written policies and procedures, internal controls, analysis, and 

independent testing to ensure that the purchase and sale of securities that are not 
961

permitted under §§ __.6(a) or (b) of this subpart are for the purpose of liquidity 

management and in accordance with the liquidity management plan described in 

paragraph (d)(3) of this section; and 

(vi) Is consistent with [Agency]’s supervisory requirements, guidance, and 

expectations regarding liquidity management;

(4) Any purchase or sale of one or more financial instruments by a banking 

entity that is a derivatives clearing organization or a clearing agency in connection with 

clearing financial instruments; 

(5) Any excluded clearing activities by a banking entity that is a member of a 

clearing agency, a member of a derivatives clearing organization, or a member of a 

designated financial market utility;

(6) Any purchase or sale of one or more financial instruments by a banking 

entity, so long as:

(i) The purchase (or sale) satisfies an existing delivery obligation of the 

banking entity or its customers, including to prevent or close out a failure to deliver, in 

connection with delivery, clearing, or settlement activity; or

(ii) The purchase (or sale) satisfies an obligation of the banking entity in 

connection with a judicial, administrative, self-regulatory organization, or arbitration 

proceeding; 

(7) Any purchase or sale of one or more financial instruments by a banking 

entity that is acting solely as agent, broker, or custodian;

(8) Any purchase or sale of one or more financial instruments by a banking 

entity through a deferred compensation, stock-bonus, profit-sharing, or pension plan of 
962

the banking entity that is established and administered in accordance with the law of the 

United States or a foreign sovereign, if the purchase or sale is made directly or indirectly 

by the banking entity as trustee for the benefit of persons who are or were employees of 

the banking entity; or 

(9) Any purchase or sale of one or more financial instruments by a banking 

entity in the ordinary course of collecting a debt previously contracted in good faith, 

provided that the banking entity divests the financial instrument as soon as practicable, 

and in no event may the banking entity retain such instrument for longer than such period 

permitted by the [Agency].

(e) Definition of other terms related to proprietary trading. For purposes of 

this subpart:

(1) Anonymous means that each party to a purchase or sale is unaware of the 

identity of the other party(ies) to the purchase or sale.

(2) Clearing agency has the same meaning as in section 3(a)(23) of the 

Exchange Act (15 U.S.C. 78c(a)(23)).

(3) Commodity has the same meaning as in section 1a(9) of the Commodity 

Exchange Act (7 U.S.C. 1a(9)), except that a commodity does not include any security;

(4) Contract of sale of a commodity for future delivery means a contract of 

sale (as that term is defined in section 1a(13) of the Commodity Exchange Act (7 U.S.C. 

1a(13)) for future delivery (as that term is defined in section 1a(27) of the Commodity 

Exchange Act (7 U.S.C. 1a(27))).

(5) Derivatives clearing organization means: 
963

(i) A derivatives clearing organization registered under section 5b of the 

Commodity Exchange Act (7 U.S.C. 7a-1);

(ii) A derivatives clearing organization that, pursuant to CFTC regulation, is 

exempt from the registration requirements under section 5b of the Commodity Exchange 

Act (7 U.S.C. 7a-1); or 

(iii) A foreign derivatives clearing organization that, pursuant to CFTC 

regulation, is permitted to clear for a foreign board of trade that is registered with the 

CFTC.

(6) Exchange, unless the context otherwise requires, means any designated 

contract market, swap execution facility, or foreign board of trade registered with the 

CFTC, or, for purposes of securities or security-based swaps, an exchange, as defined 

under section 3(a)(1) of the Exchange Act (15 U.S.C. 78c(a)(1)), or security-based swap 

execution facility, as defined under section 3(a)(77) of the Exchange Act (15 U.S.C. 

78c(a)(77)).

(7) Excluded clearing activities means:

(i) With respect to customer transactions cleared on a derivatives clearing 

organization, a clearing agency, or a designated financial market utility, any purchase or 

sale necessary to correct trading errors made by or on behalf of a customer provided that 

such purchase or sale is conducted in accordance with, for transactions cleared on a 

derivatives clearing organization, the Commodity Exchange Act, CFTC regulations, and 

the rules or procedures of the derivatives clearing organization, or, for transactions 

cleared on a clearing agency, the rules or procedures of the clearing agency, or, for 

transactions cleared on a designated financial market utility that is neither a derivatives 
964

clearing organization nor a clearing agency, the rules or procedures of the designated 

financial market utility;

(ii) Any purchase or sale in connection with and related to the management of 

a default or threatened imminent default of a customer provided that such purchase or 

sale is conducted in accordance with, for transactions cleared on a derivatives clearing 

organization, the Commodity Exchange Act, CFTC regulations, and the rules or 

procedures of the derivatives clearing organization, or, for transactions cleared on a 

clearing agency, the rules or procedures of the clearing agency, or, for transactions 

cleared on a designated financial market utility that is neither a derivatives clearing 

organization nor a clearing agency, the rules or procedures of the designated financial 

market utility; 

(iii) Any purchase or sale in connection with and related to the management of 

a default or threatened imminent default of a member of a clearing agency, a member of a 

derivatives clearing organization, or a member of a designated financial market utility;

(iv) Any purchase or sale in connection with and related to the management of 

the default or threatened default of a clearing agency, a derivatives clearing organization, 

or a designated financial market utility; and

(v) Any purchase or sale that is required by the rules or procedures of a 

clearing agency, a derivatives clearing organization, or a designated financial market 

utility to mitigate the risk to the clearing agency, derivatives clearing organization, or 

designated financial market utility that would result from the clearing by a member of 

security-based swaps that reference the member or an affiliate of the member.
965

(8) Designated financial market utility has the same meaning as in section 

803(4) of the Dodd-Frank Act (12 U.S.C. 5462(4)).

(9) Issuer has the same meaning as in section 2(a)(4) of the Securities Act of 

1933 (15 U.S.C. 77b(a)(4)).

(10) Market risk capital rule covered position and trading position means a

financial instrument that is both a covered position and a trading position, as those terms

are respectively defined:

(i) In the case of a banking entity that is a bank holding company, savings 

and loan holding company, or insured depository institution, under the market risk capital 

rule that is applicable to the banking entity; and

(ii) In the case of a banking entity that is affiliated with a bank holding 

company or savings and loan holding company, other than a banking entity to which a 

market risk capital rule is applicable, under the market risk capital rule that is applicable 

to the affiliated bank holding company or savings and loan holding company.

(11) Market risk capital rule means the market risk capital rule that is contained 

in subpart F of 12 CFR part 3, 12 CFR parts 208 and 225, or 12 CFR part 324, as 

applicable.

(12) Municipal security means a security that is a direct obligation of or issued 

by, or an obligation guaranteed as to principal or interest by, a State or any political 

subdivision thereof, or any agency or instrumentality of a State or any political 

subdivision thereof, or any municipal corporate instrumentality of one or more States or 

political subdivisions thereof.
966

(13) Trading desk means the smallest discrete unit of organization of a banking 

entity that purchases or sells financial instruments for the trading account of the banking 

entity or an affiliate thereof.

§ ___.4 Permitted underwriting and market making-related activities. 

(a) Underwriting activities—(1) Permitted underwriting activities. The 

prohibition contained in § __.3(a) does not apply to a banking entity’s underwriting 

activities conducted in accordance with this paragraph (a).

(2) Requirements. The underwriting activities of a banking entity are 

permitted under paragraph (a)(1) of this section only if:

(i) The banking entity is acting as an underwriter for a distribution of 

securities and the trading desk’s underwriting position is related to such distribution; 

(ii) The amount and type of the securities in the trading desk’s underwriting 

position are designed not to exceed the reasonably expected near term demands of clients, 

customers, or counterparties, and reasonable efforts are made to sell or otherwise reduce 

the underwriting position within a reasonable period, taking into account the liquidity, 

maturity, and depth of the market for the relevant type of security; 

(iii) The banking entity has established and implements, maintains, and 

enforces an internal compliance program required by subpart D of this part that is 

reasonably designed to ensure the banking entity’s compliance with the requirements of 

paragraph (a) of this section, including reasonably designed written policies and 

procedures, internal controls, analysis and independent testing identifying and 

addressing:
967

(A) The products, instruments or exposures each trading desk may purchase, 

sell, or manage as part of its underwriting activities;

(B) Limits for each trading desk, based on the nature and amount of the 

trading desk’s underwriting activities, including the reasonably expected near term 

demands of clients, customers, or counterparties, on the:

(1) Amount, types, and risk of its underwriting position; 

(2) Level of exposures to relevant risk factors arising from its underwriting 

position; and 

(3) Period of time a security may be held; 

(C) Internal controls and ongoing monitoring and analysis of each trading 

desk’s compliance with its limits; and

(D) Authorization procedures, including escalation procedures that require 

review and approval of any trade that would exceed a trading desk’s limit(s), 

demonstrable analysis of the basis for any temporary or permanent increase to a trading 

desk’s limit(s), and independent review of such demonstrable analysis and approval;

(iv) The compensation arrangements of persons performing the activities 

described in this paragraph (a) are designed not to reward or incentivize prohibited 

proprietary trading; and

(v) The banking entity is licensed or registered to engage in the activity 

described in this paragraph (a) in accordance with applicable law.

(3) Definition of distribution. For purposes of this paragraph (a), a 

distribution of securities means:
968

(i) An offering of securities, whether or not subject to registration under the 

Securities Act of 1933, that is distinguished from ordinary trading transactions by the 

presence of special selling efforts and selling methods; or

(ii) An offering of securities made pursuant to an effective registration 

statement under the Securities Act of 1933.

(4) Definition of underwriter. For purposes of this paragraph (a), underwriter

means: 

(i) A person who has agreed with an issuer or selling security holder to:

(A) Purchase securities from the issuer or selling security holder for 

distribution; 

(B) Engage in a distribution of securities for or on behalf of the issuer or 

selling security holder; or 

(C) Manage a distribution of securities for or on behalf of the issuer or selling 

security holder; or 

(ii) A person who has agreed to participate or is participating in a distribution 

of such securities for or on behalf of the issuer or selling security holder.

(5) Definition of selling security holder. For purposes of this paragraph (a), 

selling security holder means any person, other than an issuer, on whose behalf a 

distribution is made.

(6) Definition of underwriting position. For purposes of this paragraph (a), 

underwriting position means the long or short positions in one or more securities held by 

a banking entity or its affiliate, and managed by a particular trading desk, in connection 
969

with a particular distribution of securities for which such banking entity or affiliate is 

acting as an underwriter.

(7) Definition of client, customer, and counterparty. For purposes of this 

paragraph (a), the terms client, customer, and counterparty, on a collective or individual 

basis, refer to market participants that may transact with the banking entity in connection 

with a particular distribution for which the banking entity is acting as underwriter.

(b) Market making-related activities—(1) Permitted market making-related 

activities. The prohibition contained in § __.3(a) does not apply to a banking entity’s 

market making-related activities conducted in accordance with this paragraph (b).

(2) Requirements. The market making-related activities of a banking entity 

are permitted under paragraph (b)(1) of this section only if:

(i) The trading desk that establishes and manages the financial exposure 

routinely stands ready to purchase and sell one or more types of financial instruments 

related to its financial exposure and is willing and available to quote, purchase and sell, 

or otherwise enter into long and short positions in those types of financial instruments for 

its own account, in commercially reasonable amounts and throughout market cycles on a 

basis appropriate for the liquidity, maturity, and depth of the market for the relevant types 

of financial instruments; 

(ii) The amount, types, and risks of the financial instruments in the trading 

desk’s market-maker inventory are designed not to exceed, on an ongoing basis, the 

reasonably expected near term demands of clients, customers, or counterparties, based 

on:
970

(A) The liquidity, maturity, and depth of the market for the relevant types of 

financial instrument(s); and

(B) Demonstrable analysis of historical customer demand, current inventory of 

financial instruments, and market and other factors regarding the amount, types, and 

risks, of or associated with financial instruments in which the trading desk makes a 

market, including through block trades; 

(iii) The banking entity has established and implements, maintains, and 

enforces an internal compliance program required by subpart D of this part that is 

reasonably designed to ensure the banking entity’s compliance with the requirements of 

paragraph (b) of this section, including reasonably designed written policies and 

procedures, internal controls, analysis and independent testing identifying and 

addressing:

(A) The financial instruments each trading desk stands ready to purchase and 

sell in accordance with paragraph (b)(2)(i) of this section;

(B) The actions the trading desk will take to demonstrably reduce or otherwise 

significantly mitigate promptly the risks of its financial exposure consistent with the 

limits required under paragraph (b)(2)(iii)(C) of this section; the products, instruments, 

and exposures each trading desk may use for risk management purposes; the techniques 

and strategies each trading desk may use to manage the risks of its market making-related 

activities and inventory; and the process, strategies, and personnel responsible for 

ensuring that the actions taken by the trading desk to mitigate these risks are and continue 

to be effective;
971

(C) Limits for each trading desk, based on the nature and amount of the 

trading desk’s market making-related activities, that address the factors prescribed by 

paragraph (b)(2)(ii) of this section, on:

(1) The amount, types, and risks of its market-maker inventory; 

(2) The amount, types, and risks of the products, instruments, and exposures 

the trading desk may use for risk management purposes;

(3) The level of exposures to relevant risk factors arising from its financial 

exposure; and 

(4) The period of time a financial instrument may be held; 

(D) Internal controls and ongoing monitoring and analysis of each trading 

desk’s compliance with its limits; and

(E) Authorization procedures, including escalation procedures that require 

review and approval of any trade that would exceed a trading desk’s limit(s), 

demonstrable analysis that the basis for any temporary or permanent increase to a trading 

desk’s limit(s) is consistent with the requirements of this paragraph (b), and independent 

review of such demonstrable analysis and approval;

(iv) To the extent that any limit identified pursuant to paragraph (b)(2)(iii)(C) 

of this section is exceeded, the trading desk takes action to bring the trading desk into 

compliance with the limits as promptly as possible after the limit is exceeded;

(v) The compensation arrangements of persons performing the activities 

described in this paragraph (b) are designed not to reward or incentivize prohibited 

proprietary trading; and
972

(vi) The banking entity is licensed or registered to engage in activity described in 

this paragraph (b) in accordance with applicable law. 

(3) Definition of client, customer, and counterparty. For purposes of 

paragraph (b) of this section, the terms client, customer, and counterparty, on a collective 

or individual basis refer to market participants that make use of the banking entity’s 

market making-related services by obtaining such services, responding to quotations, or 

entering into a continuing relationship with respect to such services, provided that:

(i) A trading desk or other organizational unit of another banking entity is not 

a client, customer, or counterparty of the trading desk if that other entity has trading 

assets and liabilities of $50 billion or more as measured in accordance with § __.20(d)(1) 

of subpart D, unless:

(A) The trading desk documents how and why a particular trading desk or 

other organizational unit of the entity should be treated as a client, customer, or 

counterparty of the trading desk for purposes of paragraph (b)(2) of this section; or

(B) The purchase or sale by the trading desk is conducted anonymously on an 

exchange or similar trading facility that permits trading on behalf of a broad range of 

market participants.

(4) Definition of financial exposure. For purposes of this paragraph (b), 

financial exposure means the aggregate risks of one or more financial instruments and 

any associated loans, commodities, or foreign exchange or currency, held by a banking 

entity or its affiliate and managed by a particular trading desk as part of the trading desk’s 

market making-related activities.
973

(5) Definition of market-maker inventory. For the purposes of this paragraph 

(b), market-maker inventory means all of the positions in the financial instruments for 

which the trading desk stands ready to make a market in accordance with paragraph 

(b)(2)(i) of this section, that are managed by the trading desk, including the trading desk’s 

open positions or exposures arising from open transactions. 

§ ___.5 Permitted risk-mitigating hedging activities. 

(a) Permitted risk-mitigating hedging activities. The prohibition contained in 

§ __.3(a) does not apply to the risk-mitigating hedging activities of a banking entity in 

connection with and related to individual or aggregated positions, contracts, or other 

holdings of the banking entity and designed to reduce the specific risks to the banking 

entity in connection with and related to such positions, contracts, or other holdings.

(b) Requirements. The risk-mitigating hedging activities of a banking entity 

are permitted under paragraph (a) of this section only if:

(1) The banking entity has established and implements, maintains and 

enforces an internal compliance program required by subpart D of this part that is 

reasonably designed to ensure the banking entity’s compliance with the requirements of 

this section, including:

(i) Reasonably designed written policies and procedures regarding the 

positions, techniques and strategies that may be used for hedging, including 

documentation indicating what positions, contracts or other holdings a particular trading 

desk may use in its risk-mitigating hedging activities, as well as position and aging limits 

with respect to such positions, contracts or other holdings; 
974

(ii) Internal controls and ongoing monitoring, management, and authorization 

procedures, including relevant escalation procedures; and

(iii) The conduct of analysis, including correlation analysis, and independent 

testing designed to ensure that the positions, techniques and strategies that may be used 

for hedging may reasonably be expected to demonstrably reduce or otherwise 

significantly mitigate the specific, identifiable risk(s) being hedged, and such correlation 

analysis demonstrates that the hedging activity demonstrably reduces or otherwise 

significantly mitigates the specific, identifiable risk(s) being hedged;

(2) The risk-mitigating hedging activity:

(i) Is conducted in accordance with the written policies, procedures, and 

internal controls required under this section;

(ii) At the inception of the hedging activity, including, without limitation, any 

adjustments to the hedging activity, is designed to reduce or otherwise significantly 

mitigate and demonstrably reduces or otherwise significantly mitigates one or more 

specific, identifiable risks, including market risk, counterparty or other credit risk, 

currency or foreign exchange risk, interest rate risk, commodity price risk, basis risk, or 

similar risks, arising in connection with and related to identified positions, contracts, or 

other holdings of the banking entity, based upon the facts and circumstances of the 

identified underlying and hedging positions, contracts or other holdings and the risks and 

liquidity thereof;

(iii) Does not give rise, at the inception of the hedge, to any significant new or 

additional risk that is not itself hedged contemporaneously in accordance with this 

section; 
975

(iv) Is subject to continuing review, monitoring and management by the 

banking entity that:

(A) Is consistent with the written hedging policies and procedures required 

under paragraph (b)(1) of this section;

(B) Is designed to reduce or otherwise significantly mitigate and demonstrably 

reduces or otherwise significantly mitigates the specific, identifiable risks that develop 

over time from the risk-mitigating hedging activities undertaken under this section and 

the underlying positions, contracts, and other holdings of the banking entity, based upon 

the facts and circumstances of the underlying and hedging positions, contracts and other 

holdings of the banking entity and the risks and liquidity thereof; and

(C) Requires ongoing recalibration of the hedging activity by the banking 

entity to ensure that the hedging activity satisfies the requirements set out in paragraph 

(b)(2) of this section and is not prohibited proprietary trading; and

(3) The compensation arrangements of persons performing risk-mitigating 

hedging activities are designed not to reward or incentivize prohibited proprietary 

trading.

(c) Documentation requirement—(1) A banking entity must comply with 

the requirements of paragraphs (c)(2) and (3) of this section with respect to any purchase 

or sale of financial instruments made in reliance on this section for risk-mitigating 

hedging purposes that is: 

(i) Not established by the specific trading desk establishing or responsible for 

the underlying positions, contracts, or other holdings the risks of which the hedging 

activity is designed to reduce;
976

(ii) Established by the specific trading desk establishing or responsible for the 

underlying positions, contracts, or other holdings the risks of which the purchases or sales 

are designed to reduce, but that is effected through a financial instrument, exposure, 

technique, or strategy that is not specifically identified in the trading desk’s written 

policies and procedures established under paragraph (b)(1) of this section or under § 

__.4(b)(2)(iii)(B) of this subpart as a product, instrument, exposure, technique, or strategy 

such trading desk may use for hedging; or

(iii) Established to hedge aggregated positions across two or more trading 

desks.

(2) In connection with any purchase or sale identified in paragraph (c)(1) of 

this section, a banking entity must, at a minimum, and contemporaneously with the 

purchase or sale, document:

(i) The specific, identifiable risk(s) of the identified positions, contracts, or 

other holdings of the banking entity that the purchase or sale is designed to reduce;

(ii) The specific risk-mitigating strategy that the purchase or sale is designed 

to fulfill; and

(iii) The trading desk or other business unit that is establishing and responsible 

for the hedge.

(3) A banking entity must create and retain records sufficient to demonstrate 

compliance with the requirements of this paragraph (c) for a period that is no less than 

five years in a form that allows the banking entity to promptly produce such records to 

[Agency] on request, or such longer period as required under other law or this part.

§ ___.6 Other permitted proprietary trading activities. 
977

(a) Permitted trading in domestic government obligations. The prohibition 

contained in § __.3(a) does not apply to the purchase or sale by a banking entity of a 

financial instrument that is:

(1) An obligation of, or issued or guaranteed by, the United States;

(2) An obligation, participation, or other instrument of, or issued or 

guaranteed by, an agency of the United States, the Government National Mortgage 

Association, the Federal National Mortgage Association, the Federal Home Loan 

Mortgage Corporation, a Federal Home Loan Bank, the Federal Agricultural Mortgage 

Corporation or a Farm Credit System institution chartered under and subject to the 

provisions of the Farm Credit Act of 1971 (12 U.S.C. 2001 et seq.); 

(3) An obligation of any State or any political subdivision thereof, including 

any municipal security; or

(4) An obligation of the FDIC, or any entity formed by or on behalf of the 

FDIC for purpose of facilitating the disposal of assets acquired or held by the FDIC in its 

corporate capacity or as conservator or receiver under the Federal Deposit Insurance Act 

or Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

(b) Permitted trading in foreign government obligations—(1) Affiliates of 

foreign banking entities in the United States. The prohibition contained in § __.3(a) does 

not apply to the purchase or sale of a financial instrument that is an obligation of, or 

issued or guaranteed by, a foreign sovereign (including any multinational central bank of 

which the foreign sovereign is a member), or any agency or political subdivision of such

foreign sovereign, by a banking entity, so long as:
978

(i) The banking entity is organized under or is directly or indirectly controlled 

by a banking entity that is organized under the laws of a foreign sovereign and is not 

directly or indirectly controlled by a top-tier banking entity that is organized under the 

laws of the United States;

(ii) The financial instrument is an obligation of, or issued or guaranteed by,

the foreign sovereign under the laws of which the foreign banking entity referred to in 

paragraph (b)(1)(i) of this section is organized (including any multinational central bank 

of which the foreign sovereign is a member), or any agency or political subdivision of 

that foreign sovereign; and

(iii) The purchase or sale as principal is not made by an insured depository 

institution. 

(2) Foreign affiliates of a U.S. banking entity. The prohibition contained in § 

__.3(a) does not apply to the purchase or sale of a financial instrument that is an 

obligation of, or issued or guaranteed by, a foreign sovereign (including any 

multinational central bank of which the foreign sovereign is a member), or any agency or 

political subdivision of that foreign sovereign, by a foreign entity that is owned or 

controlled by a banking entity organized or established under the laws of the United 

States or any State, so long as:

(i) The foreign entity is a foreign bank, as defined in section 211.2(j) of the 

Board’s Regulation K (12 CFR 211.2(j)), or is regulated by the foreign sovereign as a 

securities dealer;

(ii) The financial instrument is an obligation of, or issued or guaranteed by, 

the foreign sovereign under the laws of which the foreign entity is organized (including 
979

any multinational central bank of which the foreign sovereign is a member), or any

agency or political subdivision of that foreign sovereign; and

(iii) The financial instrument is owned by the foreign entity and is not financed 

by an affiliate that is located in the United States or organized under the laws of the 

United States or of any State. 

(c) Permitted trading on behalf of customers—(1) Fiduciary transactions. 

The prohibition contained in § __.3(a) does not apply to the purchase or sale of financial 

instruments by a banking entity acting as trustee or in a similar fiduciary capacity, so long 

as: 

(i) The transaction is conducted for the account of, or on behalf of, a

customer; and 

(ii) The banking entity does not have or retain beneficial ownership of the 

financial instruments.

(2) Riskless principal transactions. The prohibition contained in § __.3(a) 

does not apply to the purchase or sale of financial instruments by a banking entity acting 

as riskless principal in a transaction in which the banking entity, after receiving an order 

to purchase (or sell) a financial instrument from a customer, purchases (or sells) the 

financial instrument for its own account to offset a contemporaneous sale to (or purchase 

from) the customer.

(d) Permitted trading by a regulated insurance company. The prohibition 

contained in § __.3(a) does not apply to the purchase or sale of financial instruments by a 

banking entity that is an insurance company or an affiliate of an insurance company if:
980

(1) The insurance company or its affiliate purchases or sells the financial 

instruments solely for:

(i) The general account of the insurance company; or 

(ii) A separate account established by the insurance company;

(2) The purchase or sale is conducted in compliance with, and subject to, the 

insurance company investment laws, regulations, and written guidance of the State or 

jurisdiction in which such insurance company is domiciled; and

(3) The appropriate Federal banking agencies, after consultation with the 

Financial Stability Oversight Council and the relevant insurance commissioners of the 

States and foreign jurisdictions, as appropriate, have not jointly determined, after notice 

and comment, that a particular law, regulation, or written guidance described in 

paragraph (d)(2) of this section is insufficient to protect the safety and soundness of the 

covered banking entity, or the financial stability of the United States.

(e) Permitted trading activities of foreign banking entities. (1) The 

prohibition contained in § __.3(a) does not apply to the purchase or sale of financial 

instruments by a banking entity if:

(i) The banking entity is not organized or directly or indirectly controlled by a

banking entity that is organized under the laws of the United States or of any State;

(ii) The purchase or sale by the banking entity is made pursuant to paragraph 

(9) or (13) of section 4(c) of the BHC Act; and

(iii) The purchase or sale meets the requirements of paragraph (e)(3) of this 

section.
981

(2) A purchase or sale of financial instruments by a banking entity is made 

pursuant to paragraph (9) or (13) of section 4(c) of the BHC Act for purposes of 

paragraph (e)(1)(ii) of this section only if:

(i) The purchase or sale is conducted in accordance with the requirements of 

paragraph (e) of this section; and

(ii)(A) With respect to a banking entity that is a foreign banking organization, the 

banking entity meets the qualifying foreign banking organization requirements of section 

211.23(a), (c) or (e) of the Board’s Regulation K (12 CFR 211.23(a), (c) or (e)), as 

applicable; or

(B) With respect to a banking entity that is not a foreign banking organization, the 

banking entity is not organized under the laws of the United States or of any State and the 

banking entity, on a fully-consolidated basis, meets at least two of the following 

requirements:

(1) Total assets of the banking entity held outside of the United States exceed 

total assets of the banking entity held in the United States;

(2) Total revenues derived from the business of the banking entity outside of 

the United States exceed total revenues derived from the business of the banking entity in 

the United States; or

(3) Total net income derived from the business of the banking entity outside 

of the United States exceeds total net income derived from the business of the banking 

entity in the United States.

(3) A purchase or sale by a banking entity is permitted for purposes of this 

paragraph (e) if:
982

(i) The banking entity engaging as principal in the purchase or sale (including 

any personnel of the banking entity or its affiliate that arrange, negotiate or execute such 

purchase or sale) is not located in the United States or organized under the laws of the 

United States or of any State;

(ii) The banking entity (including relevant personnel) that makes the decision 

to purchase or sell as principal is not located in the United States or organized under the 

laws of the United States or of any State;

(iii) The purchase or sale, including any transaction arising from riskmitigating hedging related to the instruments purchased or sold, is not accounted for as 

principal directly or on a consolidated basis by any branch or affiliate that is located in 

the United States or organized under the laws of the United States or of any State;

(iv) No financing for the banking entity’s purchases or sales is provided, 

directly or indirectly, by any branch or affiliate that is located in the United States or 

organized under the laws of the United States or of any State; and

(v) The purchase or sale is not conducted with or through any U.S. entity, 

other than:

(A) A purchase or sale with the foreign operations of a U.S. entity if no 

personnel of such U.S. entity that are located in the United States are involved in the 

arrangement, negotiation, or execution of such purchase or sale;

(B) A purchase or sale with an unaffiliated market intermediary acting as 

principal, provided the purchase or sale is promptly cleared and settled through a clearing 

agency or derivatives clearing organization acting as a central counterparty; or
983

(C) A purchase or sale through an unaffiliated market intermediary acting as 

agent, provided the purchase or sale is conducted anonymously on an exchange or similar 

trading facility and is promptly cleared and settled through a clearing agency or 

derivatives clearing organization acting as a central counterparty,.

(4) For purposes of this paragraph (e), a U.S. entity is any entity that is, or is 

controlled by, or is acting on behalf of, or at the direction of, any other entity that is, 

located in the United States or organized under the laws of the United States or of any 

State.

(5) For purposes of this paragraph (e), a U.S. branch, agency, or subsidiary of 

a foreign banking entity is considered to be located in the United States; however, the 

foreign bank that operates or controls that branch, agency, or subsidiary is not considered 

to be located in the United States solely by virtue of operating or controlling the U.S. 

branch, agency, or subsidiary.

(6) For purposes of this paragraph (e), unaffiliated market intermediary means 

an unaffiliated entity, acting as an intermediary, that is:

(i) A broker or dealer registered with the SEC under section 15 of the 

Exchange Act or exempt from registration or excluded from regulation as such; 

(ii) A swap dealer registered with the CFTC under section 4s of the 

Commodity Exchange Act or exempt from registration or excluded from regulation as 

such; 

(iii) A security-based swap dealer registered with the SEC under section 15F 

of the Exchange Act or exempt from registration or excluded from regulation as such; or 
984

(iv) A futures commission merchant registered with the CFTC under section 4f 

of the Commodity Exchange Act or exempt from registration or excluded from regulation 

as such.

§ ___.7 Limitations on permitted proprietary trading activities. 

(a) No transaction, class of transactions, or activity may be deemed 

permissible under §§ __.4 through __.6 if the transaction, class of transactions, or activity 

would:

(1) Involve or result in a material conflict of interest between the banking 

entity and its clients, customers, or counterparties;

(2) Result, directly or indirectly, in a material exposure by the banking entity 

to a high-risk asset or a high-risk trading strategy; or

(3) Pose a threat to the safety and soundness of the banking entity or to the 

financial stability of the United States.

(b) Definition of material conflict of interest. (1) For purposes of this section, 

a material conflict of interest between a banking entity and its clients, customers, or 

counterparties exists if the banking entity engages in any transaction, class of 

transactions, or activity that would involve or result in the banking entity’s interests being 

materially adverse to the interests of its client, customer, or counterparty with respect to 

such transaction, class of transactions, or activity, and the banking entity has not taken at 

least one of the actions in paragraph (b)(2) of this section.

(2) Prior to effecting the specific transaction or class or type of transactions, or engaging 

in the specific activity, the banking entity:
985

(i) Timely and effective disclosure. (A) Has made clear, timely, and effective

disclosure of the conflict of interest, together with other necessary information, in 

reasonable detail and in a manner sufficient to permit a reasonable client, customer, or 

counterparty to meaningfully understand the conflict of interest; and

(B) Such disclosure is made in a manner that provides the client, customer, or 

counterparty the opportunity to negate, or substantially mitigate, any materially adverse 

effect on the client, customer, or counterparty created by the conflict of interest; or

(ii) Information barriers. Has established, maintained, and enforced 

information barriers that are memorialized in written policies and procedures, such as 

physical separation of personnel, or functions, or limitations on types of activity, that are 

reasonably designed, taking into consideration the nature of the banking entity’s business, 

to prevent the conflict of interest from involving or resulting in a materially adverse 

effect on a client, customer, or counterparty. A banking entity may not rely on such 

information barriers if, in the case of any specific transaction, class or type of transactions 

or activity, the banking entity knows or should reasonably know that, notwithstanding the 

banking entity’s establishment of information barriers, the conflict of interest may 

involve or result in a materially adverse effect on a client, customer, or counterparty.

(c) Definition of high-risk asset and high-risk trading strategy. For purposes 

of this section:

(1) High-risk asset means an asset or group of related assets that would, if

held by a banking entity, significantly increase the likelihood that the banking entity 

would incur a substantial financial loss or would pose a threat to the financial stability of 

the United States.
986

(2) High-risk trading strategy means a trading strategy that would, if engaged 

in by a banking entity, significantly increase the likelihood that the banking entity would 

incur a substantial financial loss or would pose a threat to the financial stability of the 

United States.

§ __.8 [Reserved]

§ __.9 [Reserved]

Subpart C – Covered Funds Activities and Investments

§ __.10 Prohibition on acquiring or retaining an ownership interest in and 

having certain relationships with a covered fund.

(a) Prohibition. (1) Except as otherwise provided in this subpart, a banking 

entity may not, as principal, directly or indirectly, acquire or retain any ownership interest 

in or sponsor a covered fund.

(2) Paragraph (a)(1) of this section does not include acquiring or retaining an 

ownership interest in a covered fund by a banking entity:

(i) Acting solely as agent, broker, or custodian, so long as;

(A) The activity is conducted for the account of, or on behalf of, a customer; 

and

(B) The banking entity and its affiliates do not have or retain beneficial 

ownership of such ownership interest;

(ii) Through a deferred compensation, stock-bonus, profit-sharing, or pension 

plan of the banking entity (or an affiliate thereof) that is established and administered in 

accordance with the law of the United States or a foreign sovereign, if the ownership 

interest is held or controlled directly or indirectly by the banking entity as trustee for the 
987

benefit of persons who are or were employees of the banking entity (or an affiliate 

thereof);

(iii) In the ordinary course of collecting a debt previously contracted in good 

faith, provided that the banking entity divests the ownership interest as soon as 

practicable, and in no event may the banking entity retain such ownership interest for 

longer than such period permitted by the [Agency]; or

(iv) On behalf of customers as trustee or in a similar fiduciary capacity for a 

customer that is not a covered fund, so long as:

(A) The activity is conducted for the account of, or on behalf of, the customer; and

(B) The banking entity and its affiliates do not have or retain beneficial 

ownership of such ownership interest.

(b) Definition of covered fund. (1) Except as provided in paragraph (c) of this 

section, covered fund means:

(i) An issuer that would be an investment company, as defined in the 

Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.), but for section 3(c)(1) or 

3(c)(7) of that Act (15 U.S.C. 80a-3(c)(1) or (7)); 

(ii) Any commodity pool under section 1a(10) of the Commodity Exchange 

Act (7 U.S.C. 1a(10)) for which:

(A) The commodity pool operator has claimed an exemption under 17 CFR 4.7; or

(B)(1) A commodity pool operator is registered with the CFTC as a commodity pool 

operator in connection with the operation of the commodity pool;

(2) Substantially all participation units of the commodity pool are owned by 

qualified eligible persons under 17 CFR 4.7(a)(2) and (3); and
988

(3) Participation units of the commodity pool have not been publicly offered 

to persons who are not qualified eligible persons under 17 CFR 4.7(a)(2) and (3); or

(iii) For any banking entity that is, or is controlled directly or indirectly by a 

banking entity that is, located in or organized under the laws of the United States or of 

any State, an entity that:

(A) Is organized or established outside the United States and the ownership 

interests of which are offered and sold solely outside the United States;

(B) Is, or holds itself out as being, an entity or arrangement that raises money 

from investors primarily for the purpose of investing in securities for resale or other 

disposition or otherwise trading in securities; and

(C)(1) Has as its sponsor that banking entity (or an affiliate thereof); or

(2) Has issued an ownership interest that is owned directly or indirectly by 

that banking entity (or an affiliate thereof).

(2) An issuer shall not be deemed to be a covered fund under paragraph 

(b)(1)(iii) of this section if, were the issuer subject to U.S. securities laws, the issuer 

could rely on an exclusion or exemption from the definition of “investment company” 

under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) other than the 

exclusions contained in section 3(c)(1) and 3(c)(7) of that Act.

(3) For purposes of paragraph (b)(1)(iii) of this section, a U.S. branch, agency,

or subsidiary of a foreign banking entity is located in the United States; however, the 

foreign bank that operates or controls that branch, agency, or subsidiary is not considered 
989

to be located in the United States solely by virtue of operating or controlling the U.S. 

branch, agency, or subsidiary.

(c) Notwithstanding paragraph (b) of this section, unless the appropriate 

Federal banking agencies, the SEC, and the CFTC jointly determine otherwise, a covered 

fund does not include:

(1) Foreign public funds. (i) Subject to paragraphs (ii) and (iii) below, an

issuer that: 

(A) Is organized or established outside of the United States; 

(B) Is authorized to offer and sell ownership interests to retail investors in the 

issuer’s home jurisdiction; and

(C) Sells ownership interests predominantly through one or more public 

offerings outside of the United States. 

(ii) With respect to a banking entity that is, or is controlled directly or 

indirectly by a banking entity that is, located in or organized under the laws of the United 

States or of any State and any issuer for which such banking entity acts as sponsor, the 

sponsoring banking entity may not rely on the exemption in paragraph (c)(1)(i) of this 

section for such issuer unless ownership interests in the issuer are sold predominantly to 

persons other than 

(A) Such sponsoring banking entity; 

(B) Such issuer; 

(C) Affiliates of such sponsoring banking entity or such issuer; and 

(D) Directors and employees of such entities. 
990

(iii) For purposes of paragraph (c)(1)(i)(C) of this section, the term “public 

offering” means a distribution (as defined in § __.4(a)(3) of subpart B) of securities in 

any jurisdiction outside the United States to investors, including retail investors, provided 

that: 

(A) The distribution complies with all applicable requirements in the 

jurisdiction in which such distribution is being made; 

(B) The distribution does not restrict availability to investors having a 

minimum level of net worth or net investment assets; and

(C) The issuer has filed or submitted, with the appropriate regulatory authority 

in such jurisdiction, offering disclosure documents that are publicly available.

(2) Wholly-owned subsidiaries. An entity, all of the outstanding ownership 

interests of which are owned directly or indirectly by the banking entity (or an affiliate 

thereof), except that: 

(i) Up to five percent of the entity’s outstanding ownership interests, less any 

amounts outstanding under paragraph (c)(2)(ii) of this section, may be held by employees 

or directors of the banking entity or such affiliate (including former employees or 

directors if their ownership interest was acquired while employed by or in the service of 

the banking entity); and

(ii) Up to 0.5 percent of the entity’s outstanding ownership interests may be 

held by a third party if the ownership interest is acquired or retained by the third party for 

the purpose of establishing corporate separateness or addressing bankruptcy, insolvency, 

or similar concerns. 
991

(3) Joint ventures. A joint venture between a banking entity or any of its 

affiliates and one or more unaffiliated persons, provided that the joint venture: 

(i) Is comprised of no more than 10 unaffiliated co-venturers; 

(ii) Is in the business of engaging in activities that are permissible for the 

banking entity or affiliate, other than investing in securities for resale or other disposition; 

and 

(iii) Is not, and does not hold itself out as being, an entity or arrangement that 

raises money from investors primarily for the purpose of investing in securities for resale 

or other disposition or otherwise trading in securities. 

(4) Acquisition vehicles. An issuer: 

(i) Formed solely for the purpose of engaging in a bona fide merger or 

acquisition transaction; and

(ii) That exists only for such period as necessary to effectuate the transaction.

(5) Foreign pension or retirement funds. A plan, fund, or program providing 

pension, retirement, or similar benefits that is: 

(i) Organized and administered outside the United States; 

(ii) A broad-based plan for employees or citizens that is subject to regulation 

as a pension, retirement, or similar plan under the laws of the jurisdiction in which the 

plan, fund, or program is organized and administered; and 

(iii) Established for the benefit of citizens or residents of one or more foreign 

sovereigns or any political subdivision thereof. 
992

(6) Insurance company separate accounts. A separate account, provided that 

no banking entity other than the insurance company participates in the account’s profits 

and losses.

(7) Bank owned life insurance. A separate account that is used solely for the 

purpose of allowing one or more banking entities to purchase a life insurance policy for 

which the banking entity or entities is beneficiary, provided that no banking entity that 

purchases the policy: 

(i) Controls the investment decisions regarding the underlying assets or 

holdings of the separate account; or

(ii) Participates in the profits and losses of the separate account other than in 

compliance with applicable supervisory guidance regarding bank owned life insurance. 

(8) Loan securitizations. (i) Scope. An issuing entity for asset-backed 

securities that satisfies all the conditions of this paragraph (c)(8) and the assets or 

holdings of which are comprised solely of: 

(A) Loans as defined in § __.2(s) of subpart A; 

(B) Rights or other assets designed to assure the servicing or timely 

distribution of proceeds to holders of such securities and rights or other assets that are 

related or incidental to purchasing or otherwise acquiring and holding the loans, provided 

that each asset meets the requirements of paragraph (c)(8)(iii) of this section;

(C) Interest rate or foreign exchange derivatives that meet the requirements of 

paragraph (c)(8)(iv) of this section; and

(D) Special units of beneficial interest and collateral certificates that meet the 

requirements of paragraph (c)(8)(v) of this section.
993

(ii) Impermissible assets. For purposes of this paragraph (c)(8), the assets or 

holdings of the issuing entity shall not include any of the following:

(A) A security, including an asset-backed security, or an interest in an equity 

or debt security other than as permitted in paragraph (c)(8)(iii) of this section;

(B) A derivative, other than a derivative that meets the requirements of 

paragraph (c)(8)(iv) of this section; or

(C) A commodity forward contract.

(iii) Permitted securities. Notwithstanding paragraph (c)(8)(ii)(A) of this 

section, the issuing entity may hold securities if those securities are:

(A) Cash equivalents for purposes of the rights and assets in paragraph 

(c)(8)(i)(B) of this section; or

(B) Securities received in lieu of debts previously contracted with respect to 

the loans supporting the asset-backed securities. 

(iv) Derivatives. The holdings of derivatives by the issuing entity shall be 

limited to interest rate or foreign exchange derivatives that satisfy all of the following 

conditions:

(A) The written terms of the derivative directly relate to the loans, the assetbacked securities, or the contractual rights of other assets described in paragraph 

(c)(8)(i)(B) of this section; and

(B) The derivatives reduce the interest rate and/or foreign exchange risks 

related to the loans, the asset-backed securities, or the contractual rights or other assets 

described in paragraph (c)(8)(i)(B) of this section.
994

(v) Special units of beneficial interest and collateral certificates. The assets or 

holdings of the issuing entity may include collateral certificates and special units of 

beneficial interest issued by a special purpose vehicle, provided that:

(A) The special purpose vehicle that issues the special unit of beneficial 

interest or collateral certificate meets the requirements in this paragraph (c)(8);

(B) The special unit of beneficial interest or collateral certificate is used for 

the sole purpose of transferring to the issuing entity for the loan securitization the 

economic risks and benefits of the assets that are permissible for loan securitizations 

under this paragraph (c)(8) and does not directly or indirectly transfer any interest in any 

other economic or financial exposure;

(C) The special unit of beneficial interest or collateral certificate is created 

solely to satisfy legal requirements or otherwise facilitate the structuring of the loan 

securitization; and

(D) The special purpose vehicle that issues the special unit of beneficial 

interest or collateral certificate and the issuing entity are established under the direction 

of the same entity that initiated the loan securitization.

(9) Qualifying asset-backed commercial paper conduits. (i) An issuing entity 

for asset-backed commercial paper that satisfies all of the following requirements:

(A) The asset-backed commercial paper conduit holds only:

(1) Loans and other assets permissible for a loan securitization under 

paragraph (c)(8)(i) of this section; and

(2) Asset-backed securities supported solely by assets that are permissible for 

loan securitizations under paragraph (c)(8)(i) of this section and acquired by the asset-
995

backed commercial paper conduit as part of an initial issuance either directly from the 

issuing entity of the asset-backed securities or directly from an underwriter in the 

distribution of the asset-backed securities; 

(B) The asset-backed commercial paper conduit issues only asset-backed 

securities, comprised of a residual interest and securities with a legal maturity of 397 

days or less; and

(C) A regulated liquidity provider has entered into a legally binding 

commitment to provide full and unconditional liquidity coverage with respect to all of the 

outstanding asset-backed securities issued by the asset-backed commercial paper conduit 

(other than any residual interest) in the event that funds are required to redeem maturing 

asset-backed securities.

(ii) For purposes of this paragraph (c)(9), a regulated liquidity provider means: 

(A) A depository institution, as defined in section 3(c) of the Federal Deposit 

Insurance Act (12 U.S.C. 1813(c));

(B) A bank holding company, as defined in section 2(a) of the Bank Holding 

Company Act of 1956 (12 U.S.C. 1841(a)), or a subsidiary thereof; 

(C) A savings and loan holding company, as defined in section 10a of the 

Home Owners’ Loan Act (12 U.S.C. 1467a), provided all or substantially all of the 

holding company’s activities are permissible for a financial holding company under 

section 4(k) of the Bank Holding Company Act of 1956 (12 U.S.C. 1843(k)), or a 

subsidiary thereof;

(D) A foreign bank whose home country supervisor, as defined in § 211.21(q) 

of the Board’s Regulation K (12 CFR 211.21(q)), has adopted capital standards consistent 
996

with the Capital Accord for the Basel Committee on banking Supervision, as amended, 

and that is subject to such standards, or a subsidiary thereof; or

(E) The United States or a foreign sovereign.

(10) Qualifying covered bonds—(i) Scope. An entity owning or holding a 

dynamic or fixed pool of loans or other assets as provided in paragraph (c)(8) of this 

section for the benefit of the holders of covered bonds, provided that the assets in the 

pool are comprised solely of assets that meet the conditions in paragraph (c)(8)(i) of this 

section. 

(ii) Covered bond. For purposes of this paragraph (c)(10), a covered bond 

means: 

(A) A debt obligation issued by an entity that meets the definition of foreign 

banking organization, the payment obligations of which are fully and unconditionally 

guaranteed by an entity that meets the conditions set forth in paragraph (c)(10)(i) of this 

section; or

(B) A debt obligation of an entity that meets the conditions set forth in 

paragraph (c)(10)(i) of this section, provided that the payment obligations are fully and 

unconditionally guaranteed by an entity that meets the definition of foreign banking 

organization and the entity is a wholly-owned subsidiary, as defined in paragraph (c)(2) 

of this section, of such foreign banking organization.

(11) SBICs and public welfare investment funds. An issuer: 

(i) That is a small business investment company, as defined in section 103(3)

of the Small Business Investment Act of 1958 (15 U.S.C. 662), or that has received from 
997

the Small Business Administration notice to proceed to qualify for a license as a small 

business investment company, which notice or license has not been revoked; or

(ii) The business of which is to make investments that are: 

(A) Designed primarily to promote the public welfare, of the type permitted 

under paragraph (11) of section 5136 of the Revised Statutes of the United States (12 

U.S.C. 24), including the welfare of low- and moderate-income communities or families 

(such as providing housing, services, or jobs); or

(B) Qualified rehabilitation expenditures with respect to a qualified 

rehabilitated building or certified historic structure, as such terms are defined in section 

47 of the Internal Revenue Code of 1986 or a similar State historic tax credit program.

(12) Registered investment companies and excluded entities. An issuer: 

(i) That is registered as an investment company under section 8 of the 

Investment Company Act of 1940 (15 U.S.C. 80a-8), or that is formed and operated 

pursuant to a written plan to become a registered investment company as described in § 

__.20(e)(3) of subpart D and that complies with the requirements of section 18 of the 

Investment Company Act of 1940 (15 U.S.C. 80a-18);

(ii) That may rely on an exclusion or exemption from the definition of

“investment company” under the Investment Company Act of 1940 (15 U.S.C. 80a-1 et

seq.) other than the exclusions contained in section 3(c)(1) and 3(c)(7) of that Act; or

(iii) That has elected to be regulated as a business development company 

pursuant to section 54(a) of that Act (15 U.S.C. 80a-53) and has not withdrawn its 

election, or that is formed and operated pursuant to a written plan to become a business 

development company as described in § __.20(e)(3) of subpart D and that complies with 
998

the requirements of section 61 of the Investment Company Act of 1940 (15 U.S.C. 80a60). 

(13) Issuers in conjunction with the FDIC’s receivership or conservatorship 

operations. An issuer that is an entity formed by or on behalf of the FDIC for the purpose 

of facilitating the disposal of assets acquired in the FDIC’s capacity as conservator or 

receiver under the Federal Deposit Insurance Act or Title II of the Dodd-Frank Wall 

Street Reform and Consumer Protection Act.

(14) Other excluded issuers. (i) Any issuer that the appropriate Federal 

banking agencies, the SEC, and the CFTC jointly determine the exclusion of which is 

consistent with the purposes of section 13 of the BHC Act. 

(ii) A determination made under paragraph (c)(14)(i) of this section will be 

promptly made public. 

(d) Definition of other terms related to covered funds. For purposes of this 

subpart: 

(1) Applicable accounting standards means U.S. generally accepted 

accounting principles, or such other accounting standards applicable to a banking entity 

that the [Agency] determines are appropriate and that the banking entity uses in the 

ordinary course of its business in preparing its consolidated financial statements.

(2) Asset-backed security has the meaning specified in Section 3(a)(79) of the 

Exchange Act (15 U.S.C. 78c(a)(79).

(3) Director has the same meaning as provided in section 215.2(d)(1) of the 

Board’s Regulation O (12 CFR 215.2(d)(1)).
999

(4) Issuer has the same meaning as in section 2(a)(22) of the Investment 

Company Act of 1940 (15 U.S.C. 80a-2(a)(22)).

(5) Issuing entity means with respect to asset-backed securities the special 

purpose vehicle that owns or holds the pool assets underlying asset-backed securities and 

in whose name the asset-backed securities supported or serviced by the pool assets are 

issued.

(6) Ownership interest—(i) Ownership interest means any equity, partnership, 

or other similar interest. An “other similar interest” means an interest that: 

(A) Has the right to participate in the selection or removal of a general partner, 

managing member, member of the board of directors or trustees, investment manager, 

investment adviser, or commodity trading advisor of the covered fund (excluding the 

rights of a creditor to exercise remedies upon the occurrence of an event of default or an 

acceleration event);

(B) Has the right under the terms of the interest to receive a share of the 

income, gains or profits of the covered fund;

(C) Has the right to receive the underlying assets of the covered fund after all 

other interests have been redeemed and/or paid in full (excluding the rights of a creditor 

to exercise remedies upon the occurrence of an event of default or an acceleration event);

(D) Has the right to receive all or a portion of excess spread (the positive 

difference, if any, between the aggregate interest payments received from the underlying 

assets of the covered fund and the aggregate interest paid to the holders of other 

outstanding interests);
1000

(E) Provides under the terms of the interest that the amounts payable by the 

covered fund with respect to the interest could be reduced based on losses arising from 

the underlying assets of the covered fund, such as allocation of losses, write-downs or 

charge-offs of the outstanding principal balance, or reductions in the amount of interest 

due and payable on the interest;

(F) Receives income on a pass-through basis from the covered fund, or has a 

rate of return that is determined by reference to the performance of the underlying assets 

of the covered fund; or

(G) Any synthetic right to have, receive, or be allocated any of the rights in 

paragraphs (d)(6)(i)(A) through (F) of this section. 

(ii) Ownership interest does not include: Restricted profit interest. An interest 

held by an entity (or an employee or former employee thereof) in a covered fund for 

which the entity (or employee thereof) serves as investment manager, investment adviser, 

commodity trading advisor, or other service provider so long as: 

(A) The sole purpose and effect of the interest is to allow the entity (or 

employee or former employee thereof) to share in the profits of the covered fund as 

performance compensation for the investment management, investment advisory, 

commodity trading advisory, or other services provided to the covered fund by the entity 

(or employee or former employee thereof), provided that the entity (or employee or 

former employee thereof) may be obligated under the terms of such interest to return 

profits previously received; 

(B) All such profit, once allocated, is distributed to the entity (or employee or 

former employee thereof) promptly after being earned or, if not so distributed, is retained 
1001

by the covered fund for the sole purpose of establishing a reserve amount to satisfy 

contractual obligations with respect to subsequent losses of the covered fund and such 

undistributed profit of the entity (or employee or former employee thereof) does not share 

in the subsequent investment gains of the covered fund; 

(C) Any amounts invested in the covered fund, including any amounts paid by 

the entity (or employee or former employee thereof) in connection with obtaining the 

restricted profit interest, are within the limits of § __.12 of this subpart; and 

(D) The interest is not transferable by the entity (or employee or former 

employee thereof) except to an affiliate thereof (or an employee of the banking entity or 

affiliate), to immediate family members, or through the intestacy, of the employee or 

former employee, or in connection with a sale of the business that gave rise to the 

restricted profit interest by the entity (or employee or former employee thereof) to an 

unaffiliated party that provides investment management, investment advisory, commodity 

trading advisory, or other services to the fund.

(7) Prime brokerage transaction means any transaction that would be a 

covered transaction, as defined in section 23A(b)(7) of the Federal Reserve Act (12 

U.S.C. 371c(b)(7)), that is provided in connection with custody, clearance and settlement, 

securities borrowing or lending services, trade execution, financing, or data, operational, 

and administrative support.

(8) Resident of the United States means a person that is a “U.S. person” as 

defined in rule 902(k) of the SEC’s Regulation S (17 CFR 230.902(k)).

(9) Sponsor means, with respect to a covered fund:
1002

(i) To serve as a general partner, managing member, or trustee of a covered 

fund, or to serve as a commodity pool operator with respect to a covered fund as defined 

in (b)(1)(ii) of this section;

(ii) In any manner to select or to control (or to have employees, officers, or 

directors, or agents who constitute) a majority of the directors, trustees, or management 

of a covered fund; or

(iii) To share with a covered fund, for corporate, marketing, promotional, or 

other purposes, the same name or a variation of the same name.

(10) Trustee. (i) For purposes of paragraph (d)(9) of this section and § __.11 

of subpart C, a trustee does not include:

(A) A trustee that does not exercise investment discretion with respect to a 

covered fund, including a trustee that is subject to the direction of an unaffiliated named 

fiduciary who is not a trustee pursuant to section 403(a)(1) of the Employee’s Retirement 

Income Security Act (29 U.S.C. 1103(a)(1)); or

(B) A trustee that is subject to fiduciary standards imposed under foreign law 

that are substantially equivalent to those described in paragraph (d)(10)(i)(A) of this 

section;

(ii) Any entity that directs a person described in paragraph (d)(10)(i) of this 

section, or that possesses authority and discretion to manage and control the investment 

decisions of a covered fund for which such person serves as trustee, shall be considered 

to be a trustee of such covered fund.

§ __.11 Permitted organizing and offering, underwriting, and market making 

with respect to a covered fund.
1003

(a) Organizing and offering a covered fund in general. Notwithstanding 

§ __.10(a) of this subpart, a banking entity is not prohibited from acquiring or retaining 

an ownership interest in, or acting as sponsor to, a covered fund in connection with, 

directly or indirectly, organizing and offering a covered fund, including serving as a 

general partner, managing member, trustee, or commodity pool operator of the covered 

fund and in any manner selecting or controlling (or having employees, officers, directors, 

or agents who constitute) a majority of the directors, trustees, or management of the 

covered fund, including any necessary expenses for the foregoing, only if:

(1) The banking entity (or an affiliate thereof) provides bona fide trust, 

fiduciary, investment advisory, or commodity trading advisory services;

(2) The covered fund is organized and offered only in connection with the 

provision of bona fide trust, fiduciary, investment advisory, or commodity trading 

advisory services and only to persons that are customers of such services of the banking 

entity (or an affiliate thereof), pursuant to a written plan or similar documentation 

outlining how the banking entity or such affiliate intends to provide advisory or similar 

services to its customers through organizing and offering such fund;

(3) The banking entity and its affiliates do not acquire or retain an ownership 

interest in the covered fund except as permitted under § __.12 of this subpart;

(4) The banking entity and its affiliates comply with the requirements of

§ __.14 of this subpart;

(5) The banking entity and its affiliates do not, directly or indirectly, 

guarantee, assume, or otherwise insure the obligations or performance of the covered 

fund or of any covered fund in which such covered fund invests;
1004

(6) The covered fund, for corporate, marketing, promotional, or other 

purposes:

(i) Does not share the same name or a variation of the same name with the 

banking entity (or an affiliate thereof); and 

(ii) Does not use the word “bank” in its name;

(7) No director or employee of the banking entity (or an affiliate thereof) 

takes or retains an ownership interest in the covered fund, except for any director or 

employee of the banking entity or such affiliate who is directly engaged in providing 

investment advisory, commodity trading advisory, or other services to the covered fund at 

the time the director or employee takes the ownership interest; and

(8) The banking entity: 

(i) Clearly and conspicuously discloses, in writing, to any prospective and 

actual investor in the covered fund (such as through disclosure in the covered fund’s 

offering documents):

(A) That “any losses in [such covered fund] will be borne solely by investors 

in [the covered fund] and not by [the banking entity] or its affiliates; therefore, [the 

banking entity’s] losses in [such covered fund] will be limited to losses attributable to the 

ownership interests in the covered fund held by [the banking entity] and any affiliate in 

its capacity as investor in the [covered fund] or as beneficiary of a restricted profit

interest held by [the banking entity] or any affiliate”; 

(B) That such investor should read the fund offering documents before 

investing in the covered fund;
1005

(C) That the “ownership interests in the covered fund are not insured by the 

FDIC, and are not deposits, obligations of, or endorsed or guaranteed in any way, by any 

banking entity” (unless that happens to be the case); and

(D) The role of the banking entity and its affiliates and employees in 

sponsoring or providing any services to the covered fund; and

(ii) Complies with any additional rules of the appropriate Federal banking 

agencies, the SEC, or the CFTC, as provided in section 13(b)(2) of the BHC Act, 

designed to ensure that losses in such covered fund are borne solely by investors in the 

covered fund and not by the covered banking entity and its affiliates. 

(b) Organizing and offering an issuing entity of asset-backed securities. (1) 

Notwithstanding § __.10(a) of this subpart, a banking entity is not prohibited from 

acquiring or retaining an ownership interest in, or acting as sponsor to, a covered fund 

that is an issuing entity of asset-backed securities in connection with, directly or 

indirectly, organizing and offering that issuing entity, so long as the banking entity and its 

affiliates comply with all of the requirements of paragraph (a)(3) through (8) of this 

section. 

(2) For purposes of this paragraph (b), organizing and offering a covered fund 

that is an issuing entity of asset-backed securities means acting as the securitizer, as that 

term is used in section 15G(a)(3) of the Exchange Act (15 U.S.C. 78o-11(a)(3)) of the 

issuing entity, or acquiring or retaining an ownership interest in the issuing entity as 

required by section 15G of that Act (15 U.S.C.78o-11) and the implementing regulations 

issued thereunder.
1006

(c) Underwriting and market making in ownership interests of a covered fund. 

The prohibition contained in § __.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 

§__.4(a) or § __.4(b) of subpart B, respectively; 

(2) With respect to any banking entity (or any affiliate thereof) that: acts as a 

sponsor, investment adviser or commodity trading advisor to a particular covered fund or 

otherwise acquires and retains an ownership interest in such covered fund in reliance on 

paragraph (a) of this section; acquires and retains an ownership interest in such covered 

fund and is either a securitizer, as that term is used in section 15G(a)(3) of the Exchange 

Act (15 U.S.C. 78o-11(a)(3)), or is acquiring and retaining an ownership interest in such 

covered fund in compliance with section 15G of that Act (15 U.S.C.78o-11) and the 

implementing regulations issued thereunder each as permitted by paragraph (b) of this 

section; or, directly or indirectly, guarantees, assumes, or otherwise insures the 

obligations or performance of the covered fund or of any covered fund in which such 

fund invests, then in each such case any ownership interests acquired or retained by the 

banking entity and its affiliates in connection with underwriting and market making 

related activities for that particular covered fund are included in the calculation of 

ownership interests permitted to be held by the banking entity and its affiliates under the 

limitations of § __.12(a)(2)(ii) and § __.12(d) of this subpart; and

(3) With respect to any banking entity, the aggregate value of all ownership 

interests of the banking entity and its affiliates in all covered funds acquired and retained 
1007

under § __.11 of this subpart, including all covered funds in which the banking entity 

holds an ownership interest in connection with underwriting and market making related 

activities permitted under this paragraph (c), are included in the calculation of all 

ownership interests under § __.12(a)(2)(iii) and § __.12(d) of this subpart.

§ __.12 Permitted investment in a covered fund.

(a) Authority and limitations on permitted investments in covered funds. (1) 

Notwithstanding the prohibition contained in § __.10(a) of this subpart, a banking entity 

may acquire and retain an ownership interest in a covered fund that the banking entity or 

an affiliate thereof organizes and offers pursuant to § __.11, for the purposes of:

(i) Establishment. Establishing the fund and providing the fund with 

sufficient initial equity for investment to permit the fund to attract unaffiliated investors, 

subject to the limits contained in paragraphs (a)(2)(i) and (iii) of this section; or

(ii) De minimis investment. Making and retaining an investment in the 

covered fund subject to the limits contained in paragraphs (a)(2)(ii) and (iii) of this 

section. 

(2) Investment limits—(i)Seeding period. With respect to an investment in 

any covered fund made or held pursuant to paragraph (a)(1)(i) of this section, the banking 

entity and its affiliates:

(A) Must actively seek unaffiliated investors to reduce, through redemption, 

sale, dilution, or other methods, the aggregate amount of all ownership interests of the 

banking entity in the covered fund to the amount permitted in paragraph (a)(2)(i)(B) of 

this section; and
1008

(B) Must, no later than 1 year after the date of establishment of the fund (or 

such longer period as may be provided by the Board pursuant to paragraph (e) of this 

section), conform its ownership interest in the covered fund to the limits in paragraph 

(a)(2)(ii) of this section;

(ii) Per-fund limits. (A) Except as provided in paragraph (a)(2)(ii)(B) of this 

section, an investment by a banking entity and its affiliates in any covered fund made or 

held pursuant to paragraph (a)(1)(ii) of this section may not exceed 3 percent of the total 

number or value of the outstanding ownership interests of the fund.

(B) An investment by a banking entity and its affiliates in a covered fund that 

is an issuing entity of asset-backed securities may not exceed 3 percent of the total fair 

market value of the ownership interests of the fund measured in accordance with 

paragraph (b)(3) of this section, unless a greater percentage is retained by the banking 

entity and its affiliates in compliance with the requirements of section 15G of the 

Exchange Act (15 U.S.C. 78o-11) and the implementing regulations issued thereunder, in 

which case the investment by the banking entity and its affiliates in the covered fund may 

not exceed the amount, number, or value of ownership interests of the fund required 

under section 15G of the Exchange Act and the implementing regulations issued 

thereunder.

(iii) Aggregate limit. The aggregate value of all ownership interests of the 

banking entity and its affiliates in all covered funds acquired or retained under this 

section may not exceed 3 percent of the tier 1 capital of the banking entity, as provided 

under paragraph (c) of this section, and shall be calculated as of the last day of each 

calendar quarter.
1009

(iv) Date of establishment. For purposes of this section, the date of 

establishment of a covered fund shall be:

(A) In general. The date on which the investment adviser or similar entity to 

the covered fund begins making investments pursuant to the written investment strategy 

for the fund;

(B) Issuing entities of asset-backed securities. In the case of an issuing entity

of asset-backed securities, the date on which the assets are initially transferred into the 

issuing entity of asset-backed securities.

(b) Rules of construction—(1) Attribution of ownership interests to a 

covered banking entity. (i) For purposes of paragraph (a)(2) of this section, the amount 

and value of a banking entity’s permitted investment in any single covered fund shall 

include any ownership interest held under § __.12 directly by the banking entity, 

including any affiliate of the banking entity.

(ii) Treatment of registered investment companies, SEC-regulated business 

development companies and foreign public funds. For purposes of paragraph (b)(1)(i) of 

this section, a registered investment company, SEC-regulated business development 

companies or foreign public fund as described in §__.10(c)(1) of this subpart will not be 

considered to be an affiliate of the banking entity so long as the banking entity:

(A) Does not own, control, or hold with the power to vote 25 percent or more 

of the voting shares of the company or fund; and 

(B) Provides investment advisory, commodity trading advisory, 

administrative, and other services to the company or fund in compliance with the 

limitations under applicable regulation, order, or other authority.
1010

(iii) Covered funds. For purposes of paragraph (b)(1)(i) of this section, a 

covered fund will not be considered to be an affiliate of a banking entity so long as the 

covered fund is held in compliance with the requirements of this subpart.

(iv) Treatment of employee and director investments financed by the banking 

entity. For purposes of paragraph (b)(1)(i) of this section, an investment by a director or 

employee of a banking entity who acquires an ownership interest in his or her personal 

capacity in a covered fund sponsored by the banking entity will be attributed to the 

banking entity if the banking entity, directly or indirectly, extends financing for the 

purpose of enabling the director or employee to acquire the ownership interest in the fund 

and the financing is used to acquire such ownership interest in the covered fund.

(2) Calculation of permitted ownership interests in a single covered fund. 

Except as provided in paragraph (b)(3) or (4), for purposes of determining whether an 

investment in a single covered fund complies with the restrictions on ownership interests 

under paragraphs (a)(2)(i)(B) and (a)(2)(ii)(A) of this section: 

(i) The aggregate number of the outstanding ownership interests held by the 

banking entity shall be the total number of ownership interests held under this section by 

the banking entity in a covered fund divided by the total number of ownership interests 

held by all entities in that covered fund, as of the last day of each calendar quarter (both 

measured without regard to committed funds not yet called for investment);

(ii) The aggregate value of the outstanding ownership interests held by the 

banking entity shall be the aggregate fair market value of all investments in and capital 

contributions made to the covered fund by the banking entity, divided by the value of all 

investments in and capital contributions made to that covered fund by all entities, as of 
1011

the last day of each calendar quarter (all measured without regard to committed funds not 

yet called for investment). If fair market value cannot be determined, then the value shall 

be the historical cost basis of all investments in and contributions made by the banking 

entity to the covered fund; 

(iii) For purposes of the calculation under paragraph (b)(2)(ii) of this section, 

once a valuation methodology is chosen, the banking entity must calculate the value of its 

investment and the investments of all others in the covered fund in the same manner and 

according to the same standards.

(3) Issuing entities of asset-backed securities. In the case of an ownership 

interest in an issuing entity of asset-backed securities, for purposes of determining 

whether an investment in a single covered fund complies with the restrictions on 

ownership interests under paragraphs (a)(2)(i)(B) and (a)(2)(ii)(B) of this section:

(i) For securitizations subject to the requirements of section 15G of the 

Exchange Act (15 U.S.C. 78o-11), the calculations shall be made as of the date and 

according to the valuation methodology applicable pursuant to the requirements of 

section 15G of the Exchange Act (15 U.S.C. 78o-11) and the implementing regulations 

issued thereunder; or 

(ii) For securitization transactions completed prior to the compliance date of 

such implementing regulations (or as to which such implementing regulations do not 

apply), the calculations shall be made as of the date of establishment as defined in 

paragraph (a)(2)(iv)(B) of this section or such earlier date on which the transferred assets 

have been valued for purposes of transfer to the covered fund, and thereafter only upon 
1012

the date on which additional securities of the issuing entity of asset-backed securities are 

priced for purposes of the sales of ownership interests to unaffiliated investors. 

(iii) For securitization transactions completed prior to the compliance date of 

such implementing regulations (or as to which such implementing regulations do not 

apply), the aggregate value of the outstanding ownership interests in the covered fund 

shall be the fair market value of the assets transferred to the issuing entity of the 

securitization and any other assets otherwise held by the issuing entity at such time, 

determined in a manner that is consistent with its determination of the fair market value 

of those assets for financial statement purposes.

(iv) For purposes of the calculation under paragraph (b)(3)(iii) of this section, 

the valuation methodology used to calculate the fair market value of the ownership 

interests must be the same for both the ownership interests held by a banking entity and 

the ownership interests held by all others in the covered fund in the same manner and 

according to the same standards.

(4) Multi-tier fund investments—(i) Master-feeder fund investments. If the 

principal investment strategy of a covered fund (the “feeder fund”) is to invest 

substantially all of its assets in another single covered fund (the “master fund”), then for 

purposes of the investment limitations in paragraphs (a)(2)(i)(B) and (a)(2)(ii) of this 

section, the banking entity’s permitted investment in such funds shall be measured only 

by reference to the value of the master fund. The banking entity’s permitted investment 

in the master fund shall include any investment by the banking entity in the master fund, 

as well as the banking entity’s pro-rata share of any ownership interest of the master fund 

that is held through the feeder fund; and
1013

(ii) Fund-of-funds investments. If a banking entity organizes and offers a 

covered fund pursuant to §__.11 of this subpart for the purpose of investing in other 

covered funds (a “fund of funds”) and that fund of funds itself invests in another covered 

fund that the banking entity is permitted to own, then the banking entity’s permitted 

investment in that other fund shall include any investment by the banking entity in that 

other fund, as well as the banking entity’s pro-rata share of any ownership interest of the 

fund that is held through the fund of funds. The investment of the banking entity may not 

represent more than 3 percent of the amount or value of any single covered fund. 

(c) Aggregate permitted investments in all covered funds. (1) For purposes 

of paragraph (a)(2)(iii) of this section, the aggregate value of all ownership interests held 

by a banking entity shall be the sum of all amounts paid or contributed by the banking 

entity in connection with acquiring or retaining an ownership interest in covered funds 

(together with any amounts paid by the entity (or employee thereof) in connection with 

obtaining a restricted profit interest under § __.10(d)(6)(ii) of this subpart), on a historical 

cost basis. 

(2) Calculation of tier 1 capital. For purposes of paragraph (a)(2)(iii) of this 

section: 

(i) Entities that are required to hold and report tier 1 capital. If a banking 

entity is required to calculate and report tier 1 capital, the banking entity’s tier 1 capital 

shall be equal to the amount of tier 1 capital of the banking entity as of the last day of the 

most recent calendar quarter, as reported to its primary financial regulatory agency; and

(ii) If a banking entity is not required to calculate and report tier 1 capital, the 

banking entity’s tier 1 capital shall be determined to be equal to: 
1014

(A) In the case of a banking entity that is controlled, directly or indirectly, by a

depository institution that calculates and reports tier 1 capital, be equal to the amount of 

tier 1 capital reported by such controlling depository institution in the manner described 

in paragraph (c)(2)(i) of this section; 

(B) In the case of a banking entity that is not controlled, directly or indirectly, 

by a depository institution that calculates and reports tier 1 capital: 

(1) Bank holding company subsidiaries. If the banking entity is a subsidiary 

of a bank holding company or company that is treated as a bank holding company, be 

equal to the amount of tier 1 capital reported by the top-tier affiliate of such covered 

banking entity that calculates and reports tier 1 capital in the manner described in 

paragraph (c)(2)(i) of this section; and

(2) Other holding companies and any subsidiary or affiliate thereof. If the 

banking entity is not a subsidiary of a bank holding company or a company that is treated 

as a bank holding company, be equal to the total amount of shareholders’ equity of the 

top-tier affiliate within such organization as of the last day of the most recent calendar 

quarter that has ended, as determined under applicable accounting standards.

(iii) Treatment of foreign banking entities—(A) Foreign banking entities. 

Except as provided in paragraph (c)(2)(iii)(B) of this section, with respect to a banking 

entity that is not itself, and is not controlled directly or indirectly by, a banking entity that 

is located or organized under the laws of the United States or of any State, the tier 1 

capital of the banking entity shall be the consolidated tier 1 capital of the entity as 

calculated under applicable home country standards.
1015

(B) U.S. affiliates of foreign banking entities. With respect to a banking entity 

that is located or organized under the laws of the United States or of any State and is 

controlled by a foreign banking entity identified under paragraph (c)(2)(iii)(A) of this 

section, the banking entity’s tier 1 capital shall be as calculated under paragraphs (c)(2)(i) 

or (ii) of this section. 

(d) Capital treatment for a permitted investment in a covered fund. For 

purposes of calculating compliance with the applicable regulatory capital requirements, a 

banking entity shall deduct from the banking entity’s tier 1 capital (as determined under 

paragraph (c)(2) of this section) the greater of:

(1) The sum of all amounts paid or contributed by the banking entity in 

connection with acquiring or retaining an ownership interest (together with any amounts 

paid by the entity (or employee thereof) in connection with obtaining a restricted profit 

interest under § __.10(d)(6)(ii) of subpart C), on a historical cost basis, plus any earnings 

received; and

(2) The fair market value of the banking entity’s ownership interests in the 

covered fund as determined under paragraph (b)(2)(ii) or (b)(3) of this section (together 

with any amounts paid by the entity (or employee thereof) in connection with obtaining a 

restricted profit interest under § __.10(d)(6)(ii) of subpart C), if the banking entity 

accounts for the profits (or losses) of the fund investment in its financial statements.

(e) Extension of time to divest an ownership interest. (1) Upon application 

by a banking entity, the Board may extend the period under paragraph (a)(2)(i) of this 

section for up to 2 additional years if the Board finds that an extension would be 
1016

consistent with safety and soundness and not detrimental to the public interest. An 

application for extension must:

(i) Be submitted to the Board at least 90 days prior to the expiration of the 

applicable time period;

(ii) Provide the reasons for application, including information that addresses 

the factors in paragraph (e)(2) of this section; and

(iii) Explain the banking entity’s plan for reducing the permitted investment in 

a covered fund through redemption, sale, dilution or other methods as required in 

paragraph (a)(2) of this section.

(2) Factors governing Board determinations. In reviewing any application 

under paragraph (e)(1) of this section, the Board may consider all the facts and 

circumstances related to the permitted investment in a covered fund, including:

(i) Whether the investment would result, directly or indirectly, in a material 

exposure by the banking entity to high-risk assets or high-risk trading strategies;

(ii) The contractual terms governing the banking entity’s interest in the 

covered fund;

(iii) The date on which the covered fund is expected to have attracted sufficient 

investments from investors unaffiliated with the banking entity to enable the banking 

entity to comply with the limitations in paragraph (a)(2)(i) of this section;

(iv) The total exposure of the covered banking entity to the investment and the 

risks that disposing of, or maintaining, the investment in the covered fund may pose to 

the banking entity and the financial stability of the United States;
1017

(v) The cost to the banking entity of divesting or disposing of the investment 

within the applicable period;

(vi) Whether the investment or the divestiture or conformance of the 

investment would involve or result in a material conflict of interest between the banking 

entity and unaffiliated parties, including clients, customers or counterparties to which it 

owes a duty; 

(vi) The banking entity’s prior efforts to reduce through redemption, sale, 

dilution, or other methods its ownership interests in the covered fund, including activities 

related to the marketing of interests in such covered fund; 

(viii) Market conditions; and

(ix) Any other factor that the Board believes appropriate. 

(3) Authority to impose restrictions on activities or investment during any 

extension period. The Board may impose such conditions on any extension approved 

under paragraph (e)(1) of this section as the Board determines are necessary or 

appropriate to protect the safety and soundness of the banking entity or the financial 

stability of the United States, address material conflicts of interest or other unsound 

banking practices, or otherwise further the purposes of section 13 of the BHC Act and 

this part.

(4) Consultation. In the case of a banking entity that is primarily regulated by 

another Federal banking agency, the SEC, or the CFTC, the Board will consult with such 

agency prior to acting on an application by the banking entity for an extension under 

paragraph (e)(1) of this section.

§ __.13 Other permitted covered fund activities and investments.
1018

(a) Permitted risk-mitigating hedging activities. (1) The prohibition 

contained in § ___.10(a) of this subpart does not apply with respect to an ownership 

interest in a covered fund acquired or retained by a banking entity that is designed to 

demonstrably reduce or otherwise significantly mitigate the specific, identifiable risks to 

the banking entity in connection with a compensation arrangement with an employee of 

the banking entity or an affiliate thereof that directly provides investment advisory, 

commodity trading advisory or other services to the covered fund.

(2) Requirements. The risk-mitigating hedging activities of a banking entity 

are permitted under this paragraph (a) only if:

(i) The banking entity has established and implements, maintains and 

enforces an internal compliance program required by subpart D of this part that is 

reasonably designed to ensure the banking entity’s compliance with the requirements of 

this section, including:

(A) Reasonably designed written policies and procedures; and 

(B) Internal controls and ongoing monitoring, management, and authorization 

procedures, including relevant escalation procedures; and

(ii) The acquisition or retention of the ownership interest:

(A) Is made in accordance with the written policies, procedures and internal 

controls required under this section;

(B) At the inception of the hedge, is designed to reduce or otherwise 

significantly mitigate and demonstrably reduces or otherwise significantly mitigates one 

or more specific, identifiable risks arising in connection with the compensation 
1019

arrangement with the employee that directly provides investment advisory, commodity 

trading advisory, or other services to the covered fund;

(C) Does not give rise, at the inception of the hedge, to any significant new or 

additional risk that is not itself hedged contemporaneously in accordance with this 

section; and

(D) Is subject to continuing review, monitoring and management by the 

banking entity.

(iii) The compensation arrangement relates solely to the covered fund in which 

the banking entity or any affiliate has acquired an ownership interest pursuant to this 

paragraph and such compensation arrangement provides that any losses incurred by the 

banking entity on such ownership interest will be offset by corresponding decreases in 

amounts payable under such compensation arrangement.

(b) Certain permitted covered fund activities and investments outside of the 

United States. (1) The prohibition contained in § __.10(a) of this subpart does not 

apply to the acquisition or retention of any ownership interest in, or the sponsorship of, a 

covered fund by a banking entity only if: 

(i) The banking entity is not organized or directly or indirectly controlled by a 

banking entity that is organized under the laws of the United States or of one or more 

States;

(ii) The activity or investment by the banking entity is pursuant to paragraph 

(9) or (13) of section 4(c) of the BHC Act;

(iii) No ownership interest in the covered fund is offered for sale or sold to a 

resident of the United States; and
1020

(iv) The activity or investment occurs solely outside of the United States.

(2) An activity or investment by the banking entity is pursuant to paragraph 

(9) or (13) of section 4(c) of the BHC Act for purposes of paragraph (b)(1)(ii) of this 

section only if:

(i) The activity or investment is conducted in accordance with the 

requirements of this section; and 

(ii) (A) With respect to a banking entity that is a foreign banking organization, 

the banking entity meets the qualifying foreign banking organization requirements of 

section 211.23(a), (c) or (e) of the Board’s Regulation K (12 CFR 211.23(a), (c) or (e)), 

as applicable; or

(B) With respect to a banking entity that is not a foreign banking organization, 

the banking entity is not organized under the laws of the United States or of one or more 

States and the banking entity, on a fully-consolidated basis, meets at least two of the 

following requirements:

(1) Total assets of the banking entity held outside of the United States exceed 

total assets of the banking entity held in the United States;

(2) Total revenues derived from the business of the banking entity outside of 

the United States exceed total revenues derived from the business of the banking entity in 

the United States; or

(3) Total net income derived from the business of the banking entity outside 

of the United States exceeds total net income derived from the business of the banking 

entity in the United States.
1021

(3) An ownership interest in a covered fund is not offered for sale or sold to a 

resident of the United States for purposes of paragraph (b)(1)(iii) of this section only if it 

is sold or has been sold pursuant to an offering that does not target residents of the United 

States. 

(4) An activity or investment occurs solely outside of the United States for 

purposes of paragraph (b)(1)(iv) of this section only if:

(i) The banking entity acting as sponsor, or engaging as principal in the 

acquisition or retention of an ownership interest in the covered fund, is not itself, and is 

not controlled directly or indirectly by, a banking entity that is located in the United 

States or organized under the laws of the United States or of any State;

(ii) The banking entity (including relevant personnel) that makes the decision 

to acquire or retain the ownership interest or act as sponsor to the covered fund is not 

located in the United States or organized under the laws of the United States or of any 

State;

(iii) The investment or sponsorship, including any transaction arising from 

risk-mitigating hedging related to an ownership interest, is not accounted for as principal 

directly or indirectly on a consolidated basis by any branch or affiliate that is located in 

the United States or organized under the laws of the United States or of any State; and

(iv) No financing for the banking entity’s ownership or sponsorship is 

provided, directly or indirectly, by any branch or affiliate that is located in the United 

States or organized under the laws of the United States or of any State.

(5) For purposes of this section, a U.S. branch, agency, or subsidiary of a 

foreign bank, or any subsidiary thereof, is located in the United States; however, a 
1022

foreign bank of which that branch, agency, or subsidiary is a part is not considered to be 

located in the United States solely by virtue of operation of the U.S. branch, agency, or 

subsidiary.

(c) Permitted covered fund interests and activities by a regulated insurance 

company. The prohibition contained in § __.10(a) of this subpart does not apply to the 

acquisition or retention by an insurance company, or an affiliate thereof, of any 

ownership interest in, or the sponsorship of, a covered fund only if:

(1) The insurance company or its affiliate acquires and retains the ownership 

interest solely for the general account of the insurance company or for one or more 

separate accounts established by the insurance company;

(2) The acquisition and retention of the ownership interest is conducted in 

compliance with, and subject to, the insurance company investment laws, regulations, 

and written guidance of the State or jurisdiction in which such insurance company is 

domiciled; and

(3) The appropriate Federal banking agencies, after consultation with the 

Financial Stability Oversight Council and the relevant insurance commissioners of the 

States and foreign jurisdictions, as appropriate, have not jointly determined, after notice 

and comment, that a particular law, regulation, or written guidance described in 

paragraph (c)(2) of this section is insufficient to protect the safety and soundness of the 

banking entity, or the financial stability of the United States.

§ __.14 Limitations on relationships with a covered fund.

(a) Relationships with a covered fund. (1) Except as provided for in 

paragraph (a)(2) of this section, no banking entity that serves, directly or indirectly, as the 
1023

investment manager, investment adviser, commodity trading advisor, or sponsor to a 

covered fund, that organizes and offers a covered fund pursuant to § __.11 of this subpart,

or that continues to hold an ownership interest in accordance with § __.11(b) of this 

subpart, and no affiliate of such entity, may enter into a transaction with the covered 

fund, or with any other covered fund that is controlled by such covered fund, that would 

be a covered transaction as defined in section 23A of the Federal Reserve Act (12 U.S.C. 

371c(b)(7)), as if such banking entity and the affiliate thereof were a member bank and 

the covered fund were an affiliate thereof.

(2) Notwithstanding paragraph (a)(1) of this section, a banking entity may:

(i) Acquire and retain any ownership interest in a covered fund in accordance 

with the requirements of § __.11, § __.12, or § __.13 of this subpart; and

(ii) Enter into any prime brokerage transaction with any covered fund in 

which a covered fund managed, sponsored, or advised by such banking entity (or an 

affiliate thereof) has taken an ownership interest, if:

(A) The banking entity is in compliance with each of the limitations set forth 

in § __.11 of this subpart with respect to a covered fund organized and offered by such 

banking entity (or an affiliate thereof);

(B) The chief executive officer (or equivalent officer) of the banking entity 

certifies in writing annually to [Agency] (with a duty to update the certification if the 

information in the certification materially changes) that the banking entity does not, 

directly or indirectly, guarantee, assume, or otherwise insure the obligations or 

performance of the covered fund or of any covered fund in which such covered fund 

invests; and
1024

(C) The Board has not determined that such transaction is inconsistent with 

the safe and sound operation and condition of the banking entity.

(b) Restrictions on transactions with covered funds. A banking entity that 

serves, directly or indirectly, as the investment manager, investment adviser, commodity 

trading advisor, or sponsor to a covered fund, or that organizes and offers a covered fund 

pursuant to § __.11 of this subpart, or that continues to hold an ownership interest in 

accordance with § __.11(b) of this subpart, shall be subject to section 23B of the Federal 

Reserve Act (12 U.S.C. 371c-1), as if such banking entity were a member bank and such 

covered fund were an affiliate thereof.

(c) Restrictions on prime brokerage transactions. A prime brokerage 

transaction permitted under paragraph (a)(2)(ii) of this section shall be subject to section 

23B of the Federal Reserve Act (12 U.S.C. 371c-1) as if the counterparty were an affiliate 

of the banking entity.

§ __.15 Other limitations on permitted covered fund activities.

(a) No transaction, class of transactions, or activity may be deemed 

permissible under §§ __.11 through __.13 of this subpart if the transaction, class of 

transactions, or activity would:

(1) Involve or result in a material conflict of interest between the banking 

entity and its clients, customers, or counterparties;

(2) Result, directly or indirectly, in a material exposure by the banking entity 

to a high-risk asset or a high-risk trading strategy; or

(3) Pose a threat to the safety and soundness of the banking entity or to the 

financial stability of the United States.
1025

(b) Definition of material conflict of interest. (1) For purposes of this 

section, a material conflict of interest between a banking entity and its clients, customers, 

or counterparties exists if the banking entity engages in any transaction, class of 

transactions, or activity that would involve or result in the banking entity’s interests being 

materially adverse to the interests of its client, customer, or counterparty with respect to 

such transaction, class of transactions, or activity, and the banking entity has not taken at 

least one of the actions in paragraph (b)(2) of this section.

(2) Prior to effecting the specific transaction or class or type of transactions, 

or engaging in the specific activity, the banking entity:

(i) Timely and effective disclosure. (A) Has made clear, timely, and effective 

disclosure of the conflict of interest, together with other necessary information, in 

reasonable detail and in a manner sufficient to permit a reasonable client, customer, or 

counterparty to meaningfully understand the conflict of interest; and

(B) Such disclosure is made in a manner that provides the client, customer, or 

counterparty the opportunity to negate, or substantially mitigate, any materially adverse 

effect on the client, customer, or counterparty created by the conflict of interest; or

(ii) Information barriers. Has established, maintained, and enforced 

information barriers that are memorialized in written policies and procedures, such as 

physical separation of personnel, or functions, or limitations on types of activity, that are 

reasonably designed, taking into consideration the nature of the banking entity’s business, 

to prevent the conflict of interest from involving or resulting in a materially adverse 

effect on a client, customer, or counterparty. A banking entity may not rely on such 

information barriers if, in the case of any specific transaction, class or type of transactions 
1026

or activity, the banking entity knows or should reasonably know that, notwithstanding the 

banking entity’s establishment of information barriers, the conflict of interest may 

involve or result in a materially adverse effect on a client, customer, or counterparty.

(c) Definition of high-risk asset and high-risk trading strategy. For purposes 

of this section:

(1) High-risk asset means an asset or group of related assets that would, if

held by a banking entity, significantly increase the likelihood that the banking entity 

would incur a substantial financial loss or would pose a threat to the financial stability of 

the United States.

(2) High-risk trading strategy means a trading strategy that would, if engaged 

in by a banking entity, significantly increase the likelihood that the banking entity would 

incur a substantial financial loss or would pose a threat to the financial stability of the 

United States.

§ __.16 [Reserved]

§ __.17 [Reserved]

§ __.18 [Reserved]

§ __.19 [Reserved]

Subpart D – Compliance Program Requirement; Violations

§ __.20 Program for compliance; reporting

(a) Program requirement. Each banking entity shall develop and provide for 

the continued administration of a compliance program reasonably designed to ensure and 

monitor compliance with the prohibitions and restrictions on proprietary trading and 

covered fund activities and investments set forth in section 13 of the BHC Act and this 
1027

part. The terms, scope and detail of the compliance program shall be appropriate for the 

types, size, scope and complexity of activities and business structure of the banking 

entity. 

(b) Contents of compliance program. Except as provided in paragraph (f) of 

this section, the compliance program required by paragraph (a) of this section, at a 

minimum, shall include:

(1) Written policies and procedures reasonably designed to document, 

describe, monitor and limit trading activities subject to subpart B (including those 

permitted under §§ __.3 to __.6 of subpart B), including setting, monitoring and 

managing required limits set out in §_4 and §_5, and activities and investments with 

respect to a covered fund subject to subpart C (including those permitted under §§ __.11 

through __.14 of subpart C) conducted by the banking entity to ensure that all activities 

and investments conducted by the banking entity that are subject to section 13 of the 

BHC Act and this part comply with section 13 of the BHC Act and this part;

(2) A system of internal controls reasonably designed to monitor compliance 

with section 13 of the BHC Act and this part and to prevent the occurrence of activities or 

investments that are prohibited by section 13 of the BHC Act and this part;

(3) A management framework that clearly delineates responsibility and 

accountability for compliance with section 13 of the BHC Act and this part and includes 

appropriate management review of trading limits, strategies, hedging activities, 

investments, incentive compensation and other matters identified in this part or by 

management as requiring attention;
1028

(4) Independent testing and audit of the effectiveness of the compliance 

program conducted periodically by qualified personnel of the banking entity or by a 

qualified outside party; 

(5) Training for trading personnel and managers, as well as other appropriate 

personnel, to effectively implement and enforce the compliance program; and

(6) Records sufficient to demonstrate compliance with section 13 of the BHC 

Act and this part, which a banking entity must promptly provide to [Agency] upon 

request and retain for a period of no less than 5 years or such longer period as required by 

[Agency]. 

(c) Additional standards. In addition to the requirements in paragraph (b) of 

this section, the compliance program of a banking entity must satisfy the requirements 

and other standards contained in Appendix B, if:

(1) The banking entity engages in proprietary trading permitted under subpart 

B and is required to comply with the reporting requirements of paragraph (d) of this 

section;

(2) The banking entity has reported total consolidated assets as of the previous 

calendar year end of $50 billion or more or, in the case of a foreign banking entity, has 

total U.S. assets as of the previous calendar year end of $50 billion or more (including all 

subsidiaries, affiliates, branches and agencies of the foreign banking entity operating, 

located or organized in the United States); or

(3) [Agency] notifies the banking entity in writing that it must satisfy the 

requirements and other standards contained in Appendix B to this part.
1029

(d) Reporting requirements under Appendix A to this part. (1) A banking 

entity engaged in proprietary trading activity permitted under subpart B shall comply 

with the reporting requirements described in Appendix A, if:

(i) The banking entity (other than a foreign banking entity as provided in 

paragraph (d)(1)(ii) of this section) has, together with its affiliates and subsidiaries, 

trading assets and liabilities (excluding trading assets and liabilities involving obligations 

of or guaranteed by the United States or any agency of the United States) the average 

gross sum of which (on a worldwide consolidated basis) over the previous consecutive 

four quarters, as measured as of the last day of each of the four prior calendar quarters, 

equals or exceeds the threshold established in paragraph (d)(2) of this section; 

(ii) In the case of a foreign banking entity, the average gross sum of the 

trading assets and liabilities of the combined U.S. operations of the foreign banking entity 

(including all subsidiaries, affiliates, branches and agencies of the foreign banking entity 

operating, located or organized in the United States and excluding trading assets and 

liabilities involving obligations of or guaranteed by the United States or any agency of 

the United States) over the previous consecutive four quarters, as measured as of the last 

day of each of the four prior calendar quarters, equals or exceeds the threshold 

established in paragraph (d)(2) of this section; or

(iii) [Agency] notifies the banking entity in writing that it must satisfy the 

reporting requirements contained in Appendix A. 

(2) The threshold for reporting under paragraph (d)(1) of this section shall be 

$50 billion beginning on June 30, 2014; $25 billion beginning on April 30, 2016; and $10 

billion beginning on December 31, 2016.
1030

(3) Frequency of reporting: Unless [Agency] notifies the banking entity in 

writing that it must report on a different basis, a banking entity with $50 billion or more 

in trading assets and liabilities (as calculated in accordance with paragraph (d)(1) of this 

section) shall report the information required by Appendix A for each calendar month 

within 30 days of the end of the relevant calendar month; beginning with information for 

the month of January 2015, such information shall be reported within 10 days of the end 

of each calendar month. Any other banking entity subject to Appendix A shall report the 

information required by Appendix A for each calendar quarter within 30 days of the end 

of that calendar quarter unless [Agency] notifies the banking entity in writing that it must 

report on a different basis. 

(e) Additional documentation for covered funds. Any banking entity that has 

more than $10 billion in total consolidated assets as reported on December 31 of the 

previous two calendar years shall maintain records that include:

(1) Documentation of the exclusions or exemptions other than sections 3(c)(1) 

and 3(c)(7) of the Investment Company Act of 1940 relied on by each fund sponsored by 

the banking entity (including all subsidiaries and affiliates) in determining that such fund 

is not a covered fund; 

(2) For each fund sponsored by the banking entity (including all subsidiaries 

and affiliates) for which the banking entity relies on one or more of the exclusions from 

the definition of covered fund provided by §§ __.10(c)(1),__.10(c)(5), __.10(c)(8), 

__.10(c)(9), or __.10(c)(10) of subpart C, documentation supporting the banking entity’s 

determination that the fund is not a covered fund pursuant to one or more of those 

exclusions;
1031

(3) For each seeding vehicle described in § __.10(c)(12)(i) or (iii) of subpart 

C that will become a registered investment company or SEC-regulated business 

development company, a written plan documenting the banking entity’s determination 

that the seeding vehicle will become a registered investment company or SEC-regulated 

business development company; the period of time during which the vehicle will operate 

as a seeding vehicle; and the banking entity’s plan to market the vehicle to third-party 

investors and convert it into a registered investment company or SEC-regulated business 

development company within the time period specified in § __.12(a)(2)(i)(B) of subpart 

C; 

(4) For any banking entity that is, or is controlled directly or indirectly by a 

banking entity that is, located in or organized under the laws of the United States or of 

any State, if the aggregate amount of ownership interests in foreign public funds that are 

described in §__.10(c)(1) of subpart C owned by such banking entity (including 

ownership interests owned by any affiliate that is controlled directly or indirectly by a 

banking entity that is located in or organized under the laws of the United States or of any 

State) exceeds $50 million at the end of two or more consecutive calendar quarters, 

beginning with the next succeeding calendar quarter, documentation of the value of the 

ownership interests owned by the banking entity (and such affiliates) in each foreign 

public fund and each jurisdiction in which any such foreign public fund is organized, 

calculated as of the end of each calendar quarter, which documentation must continue 

until the banking entity’s aggregate amount of ownership interests in foreign public funds 

is below $50 million for two consecutive calendar quarters; and
1032

(5) For purposes of paragraph (e)(4) of this section, a U.S. branch, agency, or 

subsidiary of a foreign banking entity is located in the United States; however, the 

foreign bank that operates or controls that branch, agency, or subsidiary is not considered 

to be located in the United States solely by virtue of operating or controlling the U.S. 

branch, agency, or subsidiary.

(f) Simplified programs for less active banking entities—(1) Banking 

entities with no covered activities. A banking entity that does not engage in activities or 

investments pursuant to subpart B or subpart C (other than trading activities permitted 

pursuant to §__.6(a) of subpart B) may satisfy the requirements of this section by 

establishing the required compliance program prior to becoming engaged in such 

activities or making such investments (other than trading activities permitted pursuant to 

§__.6(a) of subpart B). 

(2) Banking entities with modest activities. A banking entity with total 

consolidated assets of $10 billion or less as reported on December 31 of the previous two 

calendar years that engages in activities or investments pursuant to subpart B or subpart C

(other than trading activities permitted under § __.6(a) of subpart B) may satisfy the 

requirements of this section by including in its existing compliance policies and 

procedures appropriate references to the requirements of section 13 of the BHC Act and 

this part and adjustments as appropriate given the activities, size, scope and complexity 

of the banking entity.

§ __.21 Termination of activities or investments; penalties for violations.

(a) Any banking entity that engages in an activity or makes an investment in 

violation of section 13 of the BHC Act or this part, or acts in a manner that functions as 
1033

an evasion of the requirements of section 13 of the BHC Act or this part, including 

through an abuse of any activity or investment permitted under subparts B or C, or 

otherwise violates the restrictions and requirements of section 13 of the BHC Act or this 

part, shall, upon discovery, promptly terminate the activity and, as relevant, dispose of 

the investment.

(b) Whenever [Agency] finds reasonable cause to believe any banking entity 

has engaged in an activity or made an investment in violation of section 13 of the BHC 

Act or this part, or engaged in any activity or made any investment that functions as an 

evasion of the requirements of section 13 of the BHC Act or this part, [Agency] may take 

any action permitted by law to enforce compliance with section 13 of the BHC Act and 

this part, including directing the banking entity to restrict, limit, or terminate any or all 

activities under this part and dispose of any investment.
1034

Appendix A to Part __--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 § __.20(d), this 

appendix generally applies to a banking entity that, together with its affiliates and 

subsidiaries, has significant trading assets and liabilities. These entities are required to (i) 

furnish periodic reports to [Agency] regarding a variety of quantitative measurements of 

their covered trading activities, which vary depending on the scope and size of covered 

trading activities, and (ii) create and maintain records documenting the preparation and 

content of these reports. The requirements of this appendix must be incorporated into the 

banking entity’s internal compliance program under § __.20 and Appendix B.

b. The purpose of this appendix is to assist banking entities and [Agency] in:

(i) Better understanding and evaluating the scope, type, and profile of the 

banking entity’s covered trading activities;

(ii) Monitoring the banking entity’s covered trading activities; 

(iii) Identifying covered trading activities that warrant further review or 

examination by the banking entity to verify compliance with the proprietary trading 

restrictions;

(iv) Evaluating whether the covered trading activities of trading desks engaged 

in market making-related activities subject to § __.4(b) are consistent with the 

requirements governing permitted market making-related activities;
1035

(v) Evaluating whether the covered trading activities of trading desks that are 

engaged in permitted trading activity subject to §§ __.4, __.5, or __.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 highrisk trading strategies;

(vi) Identifying the profile of particular covered trading activities of the

banking entity, and the individual trading desks of the banking entity, to help establish 

the appropriate frequency and scope of examination by [Agency] of such activities; and

(vii) Assessing and addressing the risks associated with the banking entity’s 

covered trading activities. 

c. The quantitative measurements that must be furnished pursuant to this appendix 

are not intended to serve as a dispositive tool for the identification of permissible or 

impermissible activities.

d. In order to allow banking entities and the Agencies to evaluate the effectiveness 

of these metrics, banking entities must collect and report these metrics for all trading 

desks beginning on the dates established in §__.20 of the final rule. The Agencies will 

review the data collected and revise this collection requirement as appropriate based on a 

review of the data collected prior to September 30, 2015. 

e. In addition to the quantitative measurements required in this appendix, a banking 

entity may need to develop and implement other quantitative measurements in order to 

effectively monitor its covered trading activities for compliance with section 13 of the BHC 

Act and this part and to have an effective compliance program, as required by § __.20 and 
1036

Appendix B to this part. The effectiveness of particular quantitative measurements may 

differ based on the profile of the banking entity’s businesses in general and, more 

specifically, of the particular trading desk, including types of instruments traded, trading 

activities and strategies, and history and experience (e.g., whether the trading desk is an 

established, successful market maker or a new entrant to a competitive market). In all cases, 

banking entities must ensure that they have robust measures in place to identify and monitor 

the risks taken in their trading activities, to ensure that the activities are within risk 

tolerances established by the banking entity, and to monitor and examine for compliance 

with the proprietary trading restrictions in this part. 

f. On an ongoing basis, banking entities must carefully monitor, review, and 

evaluate all furnished quantitative measurements, as well as any others that they choose 

to utilize in order to maintain compliance with section 13 of the BHC Act and this part. 

All measurement results that indicate a heightened risk of impermissible proprietary 

trading, including with respect to otherwise-permitted activities under §§ __.4 through 

__.6(a) and (b), or that result in a material exposure to high-risk assets or high-risk 

trading strategies, must be escalated within the banking entity for review, further 

analysis, explanation to [Agency], and remediation, where appropriate. The quantitative 

measurements discussed in this appendix should be helpful to banking entities in 

identifying and managing the risks related to their covered trading activities. 

II. Definitions

The terms used in this appendix have the same meanings as set forth in §§ __.2

and __.3. In addition, for purposes of this appendix, the following definitions apply:
1037

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 §§ 

__.4, __.5, __.6(a), or __.6(b). A banking entity may include trading under §§ __.3(d), 

__.6(c), __.6(d) or __.6(e).

Measurement frequency means the frequency with which a particular quantitative 

metric must be calculated and recorded.

Trading desk means the smallest discrete unit of organization of a banking entity 

that purchases or sells financial instruments for the trading account of the banking entity 

or an affiliate thereof.

III. Reporting and Recordkeeping of Quantitative Measurements

a. Scope of Required Reporting

General scope. Each banking entity made subject to this part by §__.20 must 

furnish the following quantitative measurements for each trading desk of the banking 

entity, calculated in accordance with this appendix:

• Risk and Position Limits and Usage;

• Risk Factor Sensitivities;

• Value-at-Risk and Stress VaR;
1038

• Comprehensive Profit and Loss Attribution; 

• Inventory Turnover; 

• Inventory Aging; and

• Customer-Facing Trade Ratio 

b. Frequency of Required Calculation and Reporting

A banking entity must calculate any applicable quantitative measurement for each 

trading day. A banking entity must report each applicable quantitative measurement to 

[Agency] on the reporting schedule established in §__.20 unless otherwise requested by 

[Agency]. All quantitative measurements for any calendar month must be reported 

within the time period required by §__.20.

c. Recordkeeping

A banking entity must, for any quantitative measurement furnished to [Agency] 

pursuant to this appendix and § __.20(d), create and maintain records documenting the 

preparation and content of these reports, as well as such information as is necessary to 

permit [Agency] to verify the accuracy of such reports, for a period of 5 years from the 

end of the calendar year for which the measurement was taken.

IV. Quantitative Measurements

a. Risk-Management Measurements

1. Risk and Position Limits and Usage

i. Description: For purposes of this appendix, Risk and Position Limits are the 

constraints that define the amount of risk that a trading desk is permitted to take at a point 

in time, as defined by the banking entity for a specific trading desk. Usage represents the 

portion of the trading desk’s limits that are accounted for by the current activity of the 
1039

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 § -

__.4 and § __.5. A number of the metrics that are described below, including “Risk 

Factor Sensitivities” and “Value-at-Risk and Stress Value-at-Risk,” relate to a trading 

desk’s risk and position limits and are useful in evaluating and setting these limits in the 

broader context of the trading desk’s overall activities, particularly for the market making 

activities under § __.4(b) and hedging activity under § __.5. Accordingly, the limits 

required under § __.4(b)(2)(iii) and § __.5(b)(1)(i) must meet the applicable 

requirements under § __.4(b)(2)(iii) and § __.5(b)(1)(i) and also must include appropriate 

metrics for the trading desk limits including, at a minimum, the “Risk Factor 

Sensitivities” and “Value-at-Risk and Stress Value-at-Risk” metrics except to the extent 

any of the “Risk Factor Sensitivities” or “Value-at-Risk and Stress Value-at-Risk” 

metrics are demonstrably ineffective for measuring and monitoring the risks of a trading 

desk based on the types of positions traded by, and risk exposures of, that desk. 

ii. General Calculation Guidance: Risk and Position Limits must be reported in 

the format used by the banking entity for the purposes of risk management of each 

trading desk. Risk and Position Limits are often expressed in terms of risk measures,

such as VaR and Risk Factor Sensitivities, but may also be expressed in terms of other 

observable criteria, such as net open positions. When criteria other than VaR or Risk 

Factor Sensitivities are used to define the Risk and Position Limits, both the value of the 

Risk and Position Limits and the value of the variables used to assess whether these

limits have been reached must be reported. 

iii. Calculation Period: One trading day.
1040

iv. Measurement Frequency: Daily. 

2. Risk Factor Sensitivities

i. Description: For purposes of this appendix, Risk Factor Sensitivities are 

changes in a trading desk’s Comprehensive Profit and Loss that are expected to occur in 

the event of a change in one or more underlying variables that are significant sources of 

the trading desk’s profitability and risk. 

ii. General Calculation Guidance: A banking entity must report the Risk Factor 

Sensitivities that are monitored and managed as part of the trading desk’s overall risk 

management policy. The underlying data and methods used to compute a trading desk’s 

Risk Factor Sensitivities will depend on the specific function of the trading desk and the

internal risk management models employed. The number and type of Risk Factor 

Sensitivities that are monitored and managed by a trading desk, and furnished to 

[Agency], will depend on the explicit risks assumed by the trading desk. In general, 

however, reported Risk Factor Sensitivities must be sufficiently granular to account for a 

preponderance of the expected price variation in the trading desk’s holdings. 

A. Trading desks must take into account any relevant factors in calculating Risk 

Factor Sensitivities, including, for example, the following with respect to particular asset 

classes:

• Commodity derivative positions: risk factors with respect to the related 

commodities set out in 17 CFR §20.2, the maturity of the positions, volatility and/or 

correlation sensitivities (expressed in a manner that demonstrates any significant nonlinearities), and the maturity profile of the positions;
1041

• Credit positions: risk factors with respect to credit spreads that are 

sufficiently granular to account for specific credit sectors and market segments, the 

maturity profile of the positions, and risk factors with respect to interest rates of all 

relevant maturities;

• Credit-related derivative positions: risk factor sensitivities, for example 

credit spreads, shifts (parallel and non-parallel) in credit spreads -- volatility, and/or 

correlation sensitivities (expressed in a manner that demonstrates any significant nonlinearities), and the maturity profile of the positions;

• Equity derivative positions: risk factor sensitivities such as equity positions, 

volatility, and/or correlation sensitivities (expressed in a manner that demonstrates any 

significant non-linearities), and the maturity profile of the positions;

• Equity positions: risk factors for equity prices and risk factors that 

differentiate between important equity market sectors and segments, such as a small 

capitalization equities and international equities;

• Foreign exchange derivative positions: risk factors with respect to major 

currency pairs and maturities, exposure to interest rates at relevant maturities, volatility,

and/or correlation sensitivities (expressed in a manner that demonstrates any significant 

non-linearities), as well as the maturity profile of the positions; and

• Interest rate positions, including interest rate derivative positions: risk 

factors with respect to major interest rate categories and maturities and volatility and/or 

correlation sensitivities (expressed in a manner that demonstrates any significant nonlinearities), and shifts (parallel and non-parallel) in the interest rate curve, as well as the 

maturity profile of the positions. 
1042

B. The methods used by a banking entity to calculate sensitivities to a common 

factor shared by multiple trading desks, such as an equity price factor, must be applied 

consistently across its trading desks so that the sensitivities can be compared from one 

trading desk to another. 

iii. Calculation Period: One trading day.

iv. Measurement Frequency: Daily. 

3. Value-at-Risk and Stress Value-at-Risk 

i. Description: For purposes of this appendix, Value-at-Risk (“VaR”) is the 

commonly used percentile measurement of the risk of future financial loss in the value of 

a given set of aggregated positions over a specified period of time, based on current 

market conditions. For purposes of this appendix, Stress Value-at-Risk (“Stress VaR”) is 

the percentile measurement of the risk of future financial loss in the value of a given set 

of aggregated positions over a specified period of time, based on market conditions 

during a period of significant financial stress. 

ii. General Calculation Guidance: Banking entities must compute and report VaR 

and Stress VaR by employing generally accepted standards and methods of calculation. 

VaR should reflect a loss in a trading desk that is expected to be exceeded less than one 

percent of the time over a one-day period. For those banking entities that are subject to 

regulatory capital requirements imposed by a Federal banking agency, VaR and Stress 

VaR must be computed and reported in a manner that is consistent with such regulatory 

capital requirements. In cases where a trading desk does not have a standalone VaR or 

Stress VaR calculation but is part of a larger aggregation of positions for which a VaR or 

Stress VaR calculation is performed, a VaR or Stress VaR calculation that includes only 
1043

the trading desk’s holdings must be performed consistent with the VaR or Stress VaR

model and methodology used for the larger aggregation of positions. 

iii. Calculation Period: One trading day.

iv. Measurement Frequency: Daily.

b. Source-of-Revenue Measurements

1. Comprehensive Profit and Loss Attribution

i. Description: For purposes of this appendix, Comprehensive Profit and Loss

Attribution is an analysis that attributes the daily fluctuation in the value of a trading 

desk’s positions to various sources. First, the daily profit and loss of the aggregated 

positions is divided into three categories: (i) profit and loss attributable to a trading desk’s 

existing positions that were also positions held by the trading desk as of the end of the 

prior day (“existing positions”); (ii) profit and loss attributable to new positions resulting 

from the current day’s trading activity (“new positions”); and (iii) residual profit and loss 

that cannot be specifically attributed to existing positions or new positions. The sum of 

(i), (ii), and (iii) must equal the trading desk’s comprehensive profit and loss at each point 

in time. In addition, profit and loss measurements must calculate volatility of 

comprehensive profit and loss (i.e., the standard deviation of the trading desk’s one-day 

profit and loss, in dollar terms) for the reporting period for at least a 30-, 60- and 90-day 

lag period, from the end of the reporting period, and any other period that the banking 

entity deems necessary to meet the requirements of the rule.
1044

A. The comprehensive profit and loss associated with existing positions must 

reflect changes in the value of these positions on the applicable day. The comprehensive 

profit and loss from existing positions must be further attributed, as applicable, to 

changes in (i) the specific Risk Factors and other factors that are monitored and managed 

as part of the trading desk’s overall risk management policies and procedures; and (ii) 

any other applicable elements, such as cash flows, carry, changes in reserves, and the 

correction, cancellation, or exercise of a trade. 

B. The comprehensive profit and loss attributed to new positions must reflect 

commissions and fee income or expense and market gains or losses associated with 

transactions executed on the applicable day. New positions include purchases and sales 

of financial instruments and other assets/liabilities and negotiated amendments to existing 

positions. The comprehensive profit and loss from new positions may be reported in the 

aggregate and does not need to be further attributed to specific sources. 

C. The portion of comprehensive profit and loss that cannot be specifically 

attributed to known sources must be allocated to a residual category identified as an 

unexplained portion of the comprehensive profit and loss. Significant unexplained profit 

and loss must be escalated for further investigation and analysis.

ii. General Calculation Guidance: The specific categories used by a trading desk 

in the attribution analysis and amount of detail for the analysis should be tailored to the 

type and amount of trading activities undertaken by the trading desk. The new position 
1045

attribution must be computed by calculating the difference between the prices at which 

instruments were bought and/or sold and the prices at which those instruments are 

marked to market at the close of business on that day multiplied by the notional or 

principal amount of each purchase or sale. Any fees, commissions, or other payments 

received (paid) that are associated with transactions executed on that day must be added 

(subtracted) from such difference. These factors must be measured consistently over time 

to facilitate historical comparisons. 

iii. Calculation Period: One trading day.

iv. Measurement Frequency: Daily.

c. Customer-Facing Activity Measurements

1. Inventory Turnover

i. Description: For purposes of this appendix, Inventory Turnover is a ratio that 

measures the turnover of a trading desk’s inventory. The numerator of the ratio is the 

absolute value of all transactions over the reporting period. The denominator of the ratio 

is the value of the trading desk’s inventory at the beginning of the reporting period. 

ii. General Calculation Guidance: For purposes of this appendix, for derivatives, 

other than options and interest rate derivatives, value means gross notional value, for 

options, value means delta adjusted notional value, and for interest rate derivatives, value 

means 10-year bond equivalent value. 

iii. Calculation Period: 30 days, 60 days, and 90 days.

iv. Measurement Frequency: Daily.
1046

2. Inventory Aging

i. Description: For purposes of this appendix, Inventory Aging generally 

describes a schedule of the trading desk’s aggregate assets and liabilities and the amount 

of time that those assets and liabilities have been held. Inventory Aging should measure 

the age profile of the trading desk’s assets and liabilities. 

ii. General Calculation Guidance: In general, Inventory Aging must be computed 

using a trading desk’s trading activity data and must identify the value of a trading desk’s 

aggregate assets and liabilities. Inventory Aging must include two schedules, an assetaging schedule and a liability-aging schedule. Each schedule must record the value of 

assets or liabilities held over all holding periods. For derivatives, other than options, and 

interest rate derivatives, value means gross notional value, for options, value means delta 

adjusted notional value and, for interest rate derivatives, value means 10-year bond 

equivalent value. 

iii. Calculation Period: One trading day.

iv. Measurement Frequency: Daily.

3. Customer-Facing Trade Ratio – Trade Count Based and Value Based

i. Description: For purposes of this appendix, the Customer-Facing Trade Ratio is 

a ratio comparing (i) the transactions involving a counterparty that is a customer of the 

trading desk to (ii) the transactions involving a counterparty that is not a customer of the 

trading desk. A trade count based ratio must be computed that records the number of 

transactions involving a counterparty that is a customer of the trading desk and the 
1047

number of transactions involving a counterparty that is not a customer of the trading 

desk. A value based ratio must be computed that records the value of transactions 

involving a counterparty that is a customer of the trading desk and the value of 

transactions involving a counterparty that is not a customer of the trading desk. 

ii. General Calculation Guidance: For purposes of calculating the CustomerFacing Trade Ratio, a counterparty is considered to be a customer of the trading desk if 

the counterparty is a market participant that makes use of the banking entity’s market 

making-related services by obtaining such services, responding to quotations, or entering 

into a continuing relationship with respect to such services. However, a trading desk or 

other organizational unit of another banking entity would not be a client, customer, or 

counterparty of the trading desk if the other entity has trading assets and liabilities of $50 

billion or more as measured in accordance with §__.20(d)(1) unless the trading desk 

documents how and why a particular trading desk or other organizational unit of the 

entity should be treated as a client, customer, or counterparty of the trading desk. 

Transactions conducted anonymously on an exchange or similar trading facility that 

permits trading on behalf of a broad range of market participants would be considered 

transactions with customers of the trading desk. For derivatives, other than options, and 

interest rate derivatives, value means gross notional value, for options, value means delta 

adjusted notional value, and for interest rate derivatives, value means 10-year bond 

equivalent value.

iii. Calculation Period: 30 days, 60 days, and 90 days.

iv. Measurement Frequency: Daily.
1048

Appendix B to Part __--Enhanced Minimum Standards for Compliance Programs 

I. Overview 

Section __.20(c) requires certain banking entities to establish, maintain, and 

enforce an enhanced compliance program that includes the requirements and standards in 

this Appendix as well as the minimum written policies and procedures, internal controls, 

management framework, independent testing, training, and recordkeeping provisions 

outlined in § __.20. This Appendix sets forth additional minimum standards with respect 

to the establishment, oversight, maintenance, and enforcement by these banking entities 

of an enhanced internal compliance program for ensuring and monitoring compliance 

with the prohibitions and restrictions on proprietary trading and covered fund activities 

and investments set forth in section 13 of the BHC Act and this part. 

a. This compliance program must:

1. Be reasonably designed to identify, document, monitor, and report the permitted 

trading and covered fund activities and investments of the banking entity; 

identify, monitor and promptly address the risks of these covered activities and 

investments and potential areas of noncompliance; and prevent activities or 

investments prohibited by, or that do not comply with, section 13 of the BHC Act 

and this part; 

2. Establish and enforce appropriate limits on the covered activities and investments 

of the banking entity, including limits on the size, scope, complexity, and risks of

the individual activities or investments consistent with the requirements of section 

13 of the BHC Act and this part; 
1049

3. Subject the effectiveness of the compliance program to periodic independent 

review and testing, and ensure that the entity’s internal audit, corporate 

compliance and internal control functions involved in review and testing are 

effective and independent; 

4. Make senior management, and others as appropriate, accountable for the effective 

implementation of the compliance program, and ensure that the board of directors 

and chief executive officer (or equivalent) of the banking entity review the 

effectiveness of the compliance program; and

5. Facilitate supervision and examination by the Agencies of the banking entity’s 

permitted trading and covered fund activities and investments.

II. Enhanced Compliance Program

a. Proprietary Trading Activities. A banking entity must establish, maintain and 

enforce a compliance program that includes written policies and procedures that are 

appropriate for the types, size, and complexity of, and risks associated with, its permitted 

trading activities. The compliance program may be tailored to the types of trading 

activities conducted by the banking entity, and must include a detailed description of 

controls established by the banking entity to reasonably ensure that its trading activities 

are conducted in accordance with the requirements and limitations applicable to those 

trading activities under section 13 of the BHC Act and this part, and provide for 

appropriate revision of the compliance program before expansion of the trading activities 

of the banking entity. A banking entity must devote adequate resources and use 

knowledgeable personnel in conducting, supervising and managing its trading activities, 
1050

and promote consistency, independence and rigor in implementing its risk controls and 

compliance efforts. The compliance program must be updated with a frequency 

sufficient to account for changes in the activities of the banking entity, results of 

independent testing of the program, identification of weaknesses in the program, and 

changes in legal, regulatory or other requirements.

1. Trading Desks: The banking entity must have written policies and procedures 

governing each trading desk that include a description of:

i. The process for identifying, authorizing and documenting financial instruments 

each trading desk may purchase or sell, with separate documentation for market 

making-related activities conducted in reliance on § __.4(b) and for hedging activity 

conducted in reliance on § __.5;

ii. A mapping for each trading desk to the division, business line, or other 

organizational structure that is responsible for managing and overseeing the 

trading desk’s activities;

iii. The mission (i.e., the type of trading activity, such as market-making, trading 

in sovereign debt, etc.) and strategy (i.e., methods for conducting authorized 

trading activities) of each trading desk;

iv. The activities that the trading desk is authorized to conduct, including (i) 

authorized instruments and products, and (ii) authorized hedging strategies, 

techniques and instruments;

v. The types and amount of risks allocated by the banking entity to each trading 

desk to implement the mission and strategy of the trading desk, including an 

enumeration of material risks resulting from the activities in which the trading 
1051

desk is authorized to engage (including but not limited to price risks, such as 

basis, volatility and correlation risks, as well as counterparty credit risk). Risk 

assessments must take into account both the risks inherent in the trading activity 

and the strength and effectiveness of controls designed to mitigate those risks;

vi. How the risks allocated to each trading desk will be measured; 

vii. Why the allocated risks levels are appropriate to the activities authorized for 

the trading desk; 

viii. The limits on the holding period of, and the risk associated with, financial 

instruments under the responsibility of the trading desk;

ix. The process for setting new or revised limits, as well as escalation procedures 

for granting exceptions to any limits or to any policies or procedures governing 

the desk, the analysis that will be required to support revising limits or granting 

exceptions, and the process for independently reviewing and documenting those 

exceptions and the underlying analysis;

x. The process for identifying, documenting and approving new products, trading 

strategies, and hedging strategies;

xi. The types of clients, customers, and counterparties with whom the trading desk

may trade; and

xii. The compensation arrangements, including incentive arrangements, for 

employees associated with the trading desk, which may not be designed to 
1052

reward or incentivize prohibited proprietary trading or excessive or imprudent 

risk-taking.

2. Description of risks and risk management processes: The compliance program 

for the banking entity must include a comprehensive description of the risk management 

program for the trading activity of the banking entity. The compliance program must 

also include a description of the governance, approval, reporting, escalation, review and 

other processes the banking entity will use to reasonably ensure that trading activity is 

conducted in compliance with section 13 of the BHC Act and this part. Trading activity 

in similar financial instruments should be subject to similar governance, limits, testing, 

controls, and review, unless the banking entity specifically determines to establish 

different limits or processes and documents those differences. Descriptions must include, 

at a minimum, the following elements:

i. A description of the supervisory and risk management structure governing all 

trading activity, including a description of processes for initial and senior-level 

review of new products and new strategies;

ii. A description of the process for developing, documenting, testing, approving and 

reviewing all models used for valuing, identifying and monitoring the risks of trading 

activity and related positions, including the process for periodic independent testing 

of the reliability and accuracy of those models;

iii. A description of the process for developing, documenting, testing, approving and 

reviewing the limits established for each trading desk; 

iv. A description of the process by which a security may be purchased or sold 

pursuant to the liquidity management plan, including the process for authorizing and 
1053

monitoring such activity to ensure compliance with the banking entity’s liquidity 

management plan and the restrictions on liquidity management activities in this part;

v. A description of the management review process, including escalation procedures, 

for approving any temporary exceptions or permanent adjustments to limits on the 

activities, positions, strategies, or risks associated with each trading desk; and

vi. The role of the audit, compliance, risk management and other relevant units for 

conducting independent testing of trading and hedging activities, techniques and 

strategies.

3. Authorized risks, instruments, and products. The banking entity must 

implement and enforce limits and internal controls for each trading desk that are 

reasonably designed to ensure that trading activity is conducted in conformance with 

section 13 of the BHC Act and this part and with the banking entity’s written policies and 

procedures. The banking entity must establish and enforce risk limits appropriate for the 

activity of each trading desk. These limits should be based on probabilistic and nonprobabilistic measures of potential loss (e.g., Value-at-Risk and notional exposure, 

respectively), and measured under normal and stress market conditions. At a minimum, 

these internal controls must monitor, establish and enforce limits on:

i. The financial instruments (including, at a minimum, by type and exposure) that 

the trading desk may trade; 

ii. The types and levels of risks that may be taken by each trading desk; and

iii. The types of hedging instruments used, hedging strategies employed, and the 

amount of risk effectively hedged. 
1054

4. Hedging policies and procedures. The banking entity must establish, maintain, 

and enforce written policies and procedures regarding the use of risk-mitigating hedging 

instruments and strategies that, at a minimum, describe:

i. The positions, techniques and strategies that each trading desk may use to hedge 

the risk of its positions;

ii. The manner in which the banking entity will identify the risks arising in 

connection with and related to the individual or aggregated positions, contracts or 

other holdings of the banking entity that are to be hedged and determine that those 

risks have been properly and effectively hedged;

iii. The level of the organization at which hedging activity and management will 

occur;

iv. The manner in which hedging strategies will be monitored and the personnel 

responsible for such monitoring;

v. The risk management processes used to control unhedged or residual risks; and

vi. The process for developing, documenting, testing, approving and reviewing all 

hedging positions, techniques and strategies permitted for each trading desk and 

for the banking entity in reliance on § __.5.

5. Analysis and quantitative measurements. The banking entity must perform 

robust analysis and quantitative measurement of its trading activities that is reasonably 

designed to ensure that the trading activity of each trading desk is consistent with the 

banking entity’s compliance program; monitor and assist in the identification of potential 

and actual prohibited proprietary trading activity; and prevent the occurrence of 

prohibited proprietary trading. Analysis and models used to determine, measure and limit 
1055

risk must be rigorously tested and be reviewed by management responsible for trading 

activity to ensure that trading activities, limits, strategies, and hedging activities do not 

understate the risk and exposure to the banking entity or allow prohibited proprietary 

trading. This review should include periodic and independent back-testing and revision 

of activities, limits, strategies and hedging as appropriate to contain risk and ensure 

compliance. In addition to the quantitative measurements reported by any banking entity 

subject to Appendix A to this part, each banking entity must develop and implement, to 

the extent appropriate to facilitate compliance with this part, additional quantitative 

measurements specifically tailored to the particular risks, practices, and strategies of its 

trading desks. The banking entity’s analysis and quantitative measurements must 

incorporate the quantitative measurements reported by the banking entity pursuant to 

Appendix A (if applicable) and include, at a minimum, the following:

i. Internal controls and written policies and procedures reasonably designed to 

ensure the accuracy and integrity of quantitative measurements;

ii. Ongoing, timely monitoring and review of calculated quantitative 

measurements;

iii. The establishment of numerical thresholds and appropriate trading measures 

for each trading desk and heightened review of trading activity not consistent with 

those thresholds to ensure compliance with section 13 of the BHC Act and this 

part, including analysis of the measurement results or other information, 

appropriate escalation procedures, and documentation related to the review; and

iv. Immediate review and compliance investigation of the trading desk’s 

activities, escalation to senior management with oversight responsibilities for the 
1056

applicable trading desk, timely notification to [Agency], appropriate remedial 

action (e.g., divesting of impermissible positions, cessation of impermissible 

activity, disciplinary actions), and documentation of the investigation findings and 

remedial action taken when quantitative measurements or other information, 

considered together with the facts and circumstances, or findings of internal audit, 

independent testing or other review suggest a reasonable likelihood that the 

trading desk has violated any part of section 13 of the BHC Act or this part.

6. Other Compliance Matters. In addition to the requirements specified above, the 

banking entity’s compliance program must:

i. Identify activities of each trading desk that will be conducted in reliance on 

exemptions contained in §§ __.4 through __.6, including an explanation of:

A. How and where in the organization the activity occurs; and

B. Which exemption is being relied on and how the activity meets the specific 

requirements for reliance on the applicable exemption;

ii. Include an explanation of the process for documenting, approving and reviewing 

actions taken pursuant to the liquidity management plan, where in the organization 

this activity occurs, the securities permissible for liquidity management, the process 

for ensuring that liquidity management activities are not conducted for the purpose of 

prohibited proprietary trading, and the process for ensuring that securities purchased 

as part of the liquidity management plan are highly liquid and conform to the 

requirements of this part;

iii. Describe how the banking entity monitors for and prohibits potential or actual 

material exposure to high-risk assets or high-risk trading strategies presented by each 
1057

trading desk that relies on the exemptions contained in §§ __.3(d)(3), and __.4 

through __.6 , which must take into account potential or actual exposure to:

A. Assets whose values cannot be externally priced or, where valuation is 

reliant on pricing models, whose model inputs cannot be externally validated;

B. Assets whose changes in value cannot be adequately mitigated by effective 

hedging;

C. New products with rapid growth, including those that do not have a market

history;

D. Assets or strategies that include significant embedded leverage;

E. Assets or strategies that have demonstrated significant historical volatility;

F. Assets or strategies for which the application of capital and liquidity 

standards would not adequately account for the risk; and

G. Assets or strategies that result in large and significant concentrations to 

sectors, risk factors, or counterparties; 

iv. Establish responsibility for compliance with the reporting and recordkeeping 

requirements of subpart B and § __.20; and

v. Establish policies for monitoring and prohibiting potential or actual material 

conflicts of interest between the banking entity and its clients, customers, or 

counterparties. 

7. Remediation of violations. The banking entity’s compliance program must be 

reasonably designed and established to effectively monitor and identify for further 

analysis any trading activity that may indicate potential violations of section 13 of the 

BHC Act and this part and to prevent actual violations of section 13 of the BHC Act and 
1058

this part. The compliance program must describe procedures for identifying and 

remedying violations of section 13 of the BHC Act and this part, and must include, at a 

minimum, a requirement to promptly document, address and remedy any violation of 

section 13 of the BHC Act or this part, and document all proposed and actual remediation 

efforts. The compliance program must include specific written policies and procedures 

that are reasonably designed to assess the extent to which any activity indicates that 

modification to the banking entity’s compliance program is warranted and to ensure that 

appropriate modifications are implemented. The written policies and procedures must 

provide for prompt notification to appropriate management, including senior management 

and the board of directors, of any material weakness or significant deficiencies in the 

design or implementation of the compliance program of the banking entity.

b. Covered Fund Activities or Investments. A banking entity must establish, 

maintain and enforce a compliance program that includes written policies and procedures 

that are appropriate for the types, size, complexity and risks of the covered fund and 

related activities conducted and investments made, by the banking entity.

1. Identification of covered funds. The banking entity’s compliance program 

must provide a process, which must include appropriate management review and 

independent testing, for identifying and documenting covered funds that each unit within 

the banking entity’s organization sponsors or organizes and offers, and covered funds in 

which each such unit invests. In addition to the documentation requirements for covered 

funds, as specified under § __.20(e), the documentation must include information that 

identifies all pools that the banking entity sponsors or has an interest in and the type of 

exemption from the Commodity Exchange Act (whether or not the pool relies on section 
1059

4.7 of the regulations under the Commodity Exchange Act), and the amount of ownership 

interest the banking entity has in those pools.

2. Identification of covered fund activities and investments. The banking entity’s 

compliance program must identify, document and map each unit within the organization 

that is permitted to acquire or hold an interest in any covered fund or sponsor any covered 

fund and map each unit to the division, business line, or other organizational structure 

that will be responsible for managing and overseeing that unit’s activities and 

investments. 

3. Explanation of compliance. The banking entity’s compliance program must 

explain how:

i. The banking entity monitors for and prohibits potential or actual material 

conflicts of interest between the banking entity and its clients, customers, or 

counterparties related to its covered fund activities and investments;

ii. The banking entity monitors for and prohibits potential or actual 

transactions or activities that may threaten the safety and soundness of the 

banking entity related to its covered fund activities and investments; and

iii. The banking entity monitors for and prohibits potential or actual material 

exposure to high-risk assets or high-risk trading strategies presented by its 

covered fund activities and investments, taking into account potential or actual 

exposure to:
1060

A. Assets whose values cannot be externally priced or, where 

valuation is reliant on pricing models, whose model inputs cannot be 

externally validated; 

B. Assets whose changes in values cannot be adequately mitigated 

by effective hedging;

C. New products with rapid growth, including those that do not have 

a market history;

D. Assets or strategies that include significant embedded leverage;

E. Assets or strategies that have demonstrated significant historical 

volatility;

F. Assets or strategies for which the application of capital and 

liquidity standards would not adequately account for the risk; and

G. Assets or strategies that expose the banking entity to large and 

significant concentrations with respect to sectors, risk factors, or 

counterparties;

4. Description and documentation of covered fund activities and investments. 

For each organizational unit engaged in covered fund activities and investments, the 

banking entity’s compliance program must document: 

i. The covered fund activities and investments that the unit is authorized to 

conduct; 

ii. The banking entity’s plan for actively seeking unaffiliated investors to ensure 

that any investment by the banking entity conforms to the limits contained in § 
1061

__.12 or registered in compliance with the securities laws and thereby exempt 

from those limits within the time periods allotted in§ __.12; and

iii. How it complies with the requirements of subpart C. 

5. Internal Controls. A banking entity must establish, maintain, and enforce 

internal controls that are reasonably designed to ensure that its covered fund activities or 

investments comply with the requirements of section 13 of the BHC Act and this part and 

are appropriate given the limits on risk established by the banking entity. These written 

internal controls must be reasonably designed and established to effectively monitor and 

identify for further analysis any covered fund activity or investment that may indicate 

potential violations of section 13 of the BHC Act or this part. The internal controls must, 

at a minimum require:

i. Monitoring and limiting the banking entity’s individual and aggregate 

investments in covered funds;

ii. Monitoring the amount and timing of seed capital investments for 

compliance with the limitations under subpart C (including but not limited to 

the redemption, sale or disposition requirements) of § __.12, and the 

effectiveness of efforts to seek unaffiliated investors to ensure compliance 

with those limits;

iii. Calculating the individual and aggregate levels of ownership interests in 

one or more covered fund required by § __.12;

iv. Attributing the appropriate instruments to the individual and aggregate 

ownership interest calculations above;
1062

v. Making disclosures to prospective and actual investors in any covered fund 

organized and offered or sponsored by the banking entity, as provided under § 

__.11(a)(8); 

vi Monitoring for and preventing any relationship or transaction between the 

banking entity and a covered fund that is prohibited under § __.14, including 

where the banking entity has been designated as the sponsor, investment 

manager, investment adviser, or commodity trading advisor to a covered fund 

by another banking entity; and

vii. Appropriate management review and supervision across legal entities of 

the banking entity to ensure that services and products provided by all 

affiliated entities comply with the limitation on services and products 

contained in § __.14. 

6. Remediation of violations. The banking entity’s compliance program must be 

reasonably designed and established to effectively monitor and identify for further 

analysis any covered fund activity or investment that may indicate potential violations of 

section 13 of the BHC Act or this part and to prevent actual violations of section 13 of the 

BHC Act and this part. The banking entity’s compliance program must describe 

procedures for identifying and remedying violations of section 13 of the BHC Act and 

this part, and must include, at a minimum, a requirement to promptly document, address 

and remedy any violation of section 13 of the BHC Act or this part, including § __.21, 

and document all proposed and actual remediation efforts. The compliance program 

must include specific written policies and procedures that are reasonably designed to 

assess the extent to which any activity or investment indicates that modification to the 
1063

banking entity’s compliance program is warranted and to ensure that appropriate 

modifications are implemented. The written policies and procedures must provide for 

prompt notification to appropriate management, including senior management and the 

board of directors, of any material weakness or significant deficiencies in the design or 

implementation of the compliance program of the banking entity.

III. Responsibility and Accountability for the Compliance Program

a. A banking entity must establish, maintain, and enforce a governance and 

management framework to manage its business and employees with a view to preventing 

violations of section 13 of the BHC Act and this part. A banking entity must have an 

appropriate management framework reasonably designed to ensure that: appropriate 

personnel are responsible and accountable for the effective implementation and 

enforcement of the compliance program; a clear reporting line with a chain of 

responsibility is delineated; and the compliance program is reviewed periodically by 

senior management. The board of directors (or equivalent governance body) and senior 

management should have the appropriate authority and access to personnel and 

information within the organizations as well as appropriate resources to conduct their 

oversight activities effectively. 

1. Corporate governance. The banking entity must adopt a written compliance 

program approved by the board of directors, an appropriate committee of the board, or 

equivalent governance body, and senior management.
1064

2. Management procedures. The banking entity must establish, maintain, and 

enforce a governance framework that is reasonably designed to achieve compliance with 

section 13 of the BHC Act and this part, which, at a minimum, provides for:

i. The designation of appropriate senior management or committee of senior 

management with authority to carry out the management responsibilities of the 

banking entity for each trading desk and for each organizational unit engaged in 

covered fund activities;

ii. Written procedures addressing the management of the activities of the banking 

entity that are reasonably designed to achieve compliance with section 13 of the 

BHC Act and this part, including:

A. A description of the management system, including the titles, 

qualifications, and locations of managers and the specific responsibilities 

of each person with respect to the banking entity’s activities governed by 

section 13 of the BHC Act and this part; and

B. Procedures for determining compensation arrangements for traders 

engaged in underwriting or market making-related activities under § __.4 

or risk-mitigating hedging activities under § __.5 so that such 

compensation arrangements are designed not to reward or incentivize 

prohibited proprietary trading and appropriately balance risk and financial 

results in a manner that does not encourage employees to expose the 

banking entity to excessive or imprudent risk.
1065

3. Business line managers. Managers with responsibility for one or more trading 

desks of the banking entity are accountable for the effective implementation and 

enforcement of the compliance program with respect to the applicable trading desk(s).

4. Board of directors, or similar corporate body, and senior management. The 

board of directors, or similar corporate body, and senior management are responsible for 

setting and communicating an appropriate culture of compliance with section 13 of the 

BHC Act and this part and ensuring that appropriate policies regarding the management 

of trading activities and covered fund activities or investments are adopted to comply 

with section 13 of the BHC Act and this part. The board of directors or similar corporate 

body (such as a designated committee of the board or an equivalent governance body) 

must ensure that senior management is fully capable, qualified, and properly motivated to 

manage compliance with this part in light of the organization’s business activities and the 

expectations of the board of directors. The board of directors or similar corporate body 

must also ensure that senior management has established appropriate incentives and 

adequate resources to support compliance with this part, including the implementation of 

a compliance program meeting the requirements of this appendix into management goals 

and compensation structures across the banking entity. 

5. Senior management. Senior management is responsible for implementing and 

enforcing the approved compliance program. Senior management must also ensure that 

effective corrective action is taken when failures in compliance with section 13 of the 

BHC Act and this part are identified. Senior management and control personnel charged 

with overseeing compliance with section 13 of the BHC Act and this part should review 

the compliance program for the banking entity periodically and report to the board, or an 
1066

appropriate committee thereof, on the effectiveness of the compliance program and 

compliance matters with a frequency appropriate to the size, scope, and risk profile of the 

banking entity’s trading activities and covered fund activities or investments, which shall 

be at least annually.

6. CEO attestation. Based on a review by the CEO of the banking entity, the 

CEO of the banking entity must, annually, attest in writing to [Agency] that the banking 

entity has in place processes to establish, maintain, enforce, review, test and modify the 

compliance program established under this Appendix and § __.20 of this part in a manner 

reasonably designed to achieve compliance with section 13 of the BHC Act and this part. 

In the case of a U.S. branch or agency of a foreign banking entity, the attestation may be 

provided for the entire U.S. operations of the foreign banking entity by the senior 

management officer of the United States operations of the foreign banking entity who is 

located in the United States.

IV. Independent Testing

a. Independent testing must occur with a frequency appropriate to the size, scope, 

and risk profile of the banking entity’s trading and covered fund activities or investments, 

which shall be at least annually. This independent testing must include an evaluation of:

1. The overall adequacy and effectiveness of the banking entity’s compliance 

program, including an analysis of the extent to which the program contains all the 

required elements of this appendix;

2. The effectiveness of the banking entity’s internal controls, including an analysis 

and documentation of instances in which such internal controls have been breached, 

and how such breaches were addressed and resolved; and

3. The effectiveness of the banking entity’s management procedures.
1067

b. A banking entity must ensure that independent testing regarding the 

effectiveness of the banking entity’s compliance program is conducted by a qualified 

independent party, such as the banking entity’s internal audit department, compliance 

personnel or risk managers independent of the organizational unit being tested, outside 

auditors, consultants, or other qualified independent parties. A banking entity must 

promptly take appropriate action to remedy any significant deficiencies or material 

weaknesses in its compliance program and to terminate any violations of section 13 of the 

BHC Act or this part.

V. Training

Banking entities must provide adequate training to personnel and managers of the 

banking entity engaged in activities or investments governed by section 13 of the BHC 

Act or this part, as well as other appropriate supervisory, risk, independent testing, and 

audit personnel, in order to effectively implement and enforce the compliance program. 

This training should occur with a frequency appropriate to the size and the risk profile of 

the banking entity’s trading activities and covered fund activities or investments.

VI. Recordkeeping

Banking entities must create and retain records sufficient to demonstrate 

compliance and support the operations and effectiveness of the compliance program. A 

banking entity must retain these records for a period that is no less than 5 years or such 

longer period as required by [Agency] in a form that allows it to promptly produce such 

records to [Agency] on request.

End of Common Rule

List of Subjects 

12 CFR Part 44
1068

Banks, Banking, Capital Compensation, Credit, Derivatives, Government 

securities, Insurance, Investments, National banks, Federal savings associations, 

Federal branches and agencies, Penalties, Reporting and recordkeeping 

requirements, Risk, Risk retention, Securities, Trusts and trustees

12 CFR Part 248

Administrative practice and procedure, Banks and banking, Capital, 

Compensation, Conflict of interests, Credit, Derivatives, Foreign banking, 

Government securities, Holding companies, Insurance, Insurance companies, 

Investments, Penalties, Reporting and recordkeeping requirements, Risk, Risk 

retention, Securities, Trusts and trustees.

12 CFR Part 351

Banks, Banking, Capital, Compensation, Conflicts of interest, Credit, Derivatives, 

Government securities, Insurance, Insurance companies, Investments, Penalties, 

Reporting and recordkeeping requirements, Risk, Risk retention, Securities, State 

nonmember banks, State savings associations, Trusts and trustees. 

17 CFR Part 255

Banks, Brokers, Dealers, Investment advisers, Recordkeeping, Reporting, 

Securities.

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

Authority and Issuance

For the reasons stated in the Common Preamble, the Office of the Comptroller of 

the Currency hereby amends chapter I of Title 12, Code of Federal Regulations as 

follows:
1069

PART 44 – PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND 

RELATIONSHIPS WITH COVERED FUNDS

1. The authority for part 44 is added to read as follows:

Authority: 7 U.S.C. 27 et seq., 12 U.S.C. 1, 24, 92a, 93a, 161, 1461, 1462a, 

1463, 1464, 1467a, 1813(q), 1818, 1851, 3101 3102, 3108, 5412.

2. Part 44 is added as set forth at the end of the Common Preamble.

3. Part 44 is amended by: 

a. Removing “[Agency]” wherever it appears and adding in its place “the OCC”; 

and

b. Removing “the [Agency]” wherever it appears and adding in its place “the 

OCC”.

4. Section 44.1 is revised to read as follows:

§ 44.1 Authority, purpose, scope, and relationship to other authorities.

(a) Authority. This part is issued by the OCC under section 13 of the Bank 

Holding Company Act of 1956, as amended (12 U.S.C. 1851).

(b) Purpose. Section 13 of the Bank Holding Company Act establishes 

prohibitions and restrictions on proprietary trading and on investments in or relationships 

with covered funds by certain banking entities, including national banks, Federal 

branches and agencies of foreign banks, Federal savings associations, and certain 

subsidiaries thereof. This part implements section 13 of the Bank Holding Company Act 

by defining terms used in the statute and related terms, establishing prohibitions and 

restrictions on proprietary trading and on investments in or relationships with covered 

funds, and explaining the statute’s requirements.

(c) Scope. This part implements section 13 of the Bank Holding Company 

Act with respect to banking entities for which the OCC is authorized to issue regulations 

under section 13(b)(2) of the Bank Holding Company Act (12 U.S.C. 1851(b)(2)) and 
1070

take actions under section 13(e) of that Act (12 U.S.C. 1851(e)). These include national 

banks, Federal branches and Federal agencies of foreign banks, Federal savings 

associations, Federal savings banks, and any of their respective subsidiaries (except a 

subsidiary for which there is a different primary financial regulatory agency, as that term 

is defined in this part). 

(d) Relationship to other authorities. Except as otherwise provided under 

section 13 of the Bank Holding Company Act or this part, and notwithstanding any other 

provision of law, the prohibitions and restrictions under section 13 of the Bank Holding 

Company Act and this part shall apply to the activities and investments of a banking 

entity identified in paragraph (c) of this section, even if such activities and investments 

are authorized for the banking entity under other applicable provisions of law.

(e) Preservation of authority. Nothing in this part limits in any way the 

authority of the OCC to impose on a banking entity identified in paragraph (c) of this 

section additional requirements or restrictions with respect to any activity, investment, or 

relationship covered under section 13 of the Bank Holding Company Act or this part, or 

additional penalties for violation of this part provided under any other applicable 

provision of law.

BOARD OF GOVERNORS OF THE FEDERAL RESERVE

Authority and Issuance

For the reasons set forth in the Supplementary Information, the Board of Governors of 

the Federal Reserve System is adding the text of the common rule as set forth at the end 

of the Supplementary Information as Part 248 to 12 CFR Chapter II as follows:
1071

PART 248—PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND 

RELATIONSHIPS WITH COVERED FUNDS (Regulation VV)

5. The authority for part 248 is added to read as follows:

Authority: 12 U.S.C. 1851, 12 U.S.C. 221 et seq., 12 U.S.C. 1818, 12 U.S.C. 1841 et

seq., and 12 U.S.C. 3103 et seq.

6. Part 248 is added as set forth at the end of the Common Preamble.

7. Part 248 is amended by removing “[Agency]” wherever it appears and adding in its 

place “the Board.”

8. Part 248 is amended by removing “the [Agency]” wherever it appears and adding in its 

place “the Board.”

9. Section 248.1 is revised to read as follows:

§ 248.1 Authority, purpose, scope, and relationship to other authorities.

(a) Authority. This part (Regulation VV) is issued by the Board under section 13 

of the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1851), as well as 

under the Federal Reserve Act, as amended (12 U.S.C. 221 et seq.); section 8 of the 

Federal Deposit Insurance Act, as amended (12 U.S.C. 1818); the Bank Holding 

Company Act of 1956, as amended (12 U.S.C. 1841 et seq.); and the International 

Banking Act of 1978, as amended (12 U.S.C. 3101 et seq.).

(b) Purpose. Section 13 of the Bank Holding Company Act establishes

prohibitions and restrictions on proprietary trading and on investments in or relationships 

with covered funds by certain banking entities, including state member banks, bank 

holding companies, savings and loan holding companies, other companies that control an 

insured depository institution, foreign banking organizations, and certain subsidiaries 
1072

thereof. This part implements section 13 of the Bank Holding Company Act by defining 

terms used in the statute and related terms, establishing prohibitions and restrictions on 

proprietary trading and on investments in or relationships with covered funds, and 

explaining the statute’s requirements.

(c) Scope. This part implements section 13 of the Bank Holding Company Act 

with respect to banking entities for which the Board is authorized to issue regulations 

under section 13(b)(2) of the Bank Holding Company Act (12 U.S.C. 1851(b)(2)) and 

take actions under section 13(e) of that Act (12 U.S.C. 1851(e)). These include any state 

bank that is a member of the Federal Reserve System, any company that controls an 

insured depository institution (including a bank holding company and savings and loan 

holding company), any company that is treated as a bank holding company for purposes 

of section 8 of the International Banking Act (12 U.S.C. 3106), and any subsidiary of the 

foregoing other than a subsidiary for which the OCC, FDIC, CFTC, or SEC is the 

primary financial regulatory agency (as defined in section 2(12) of the Dodd-Frank Wall 

Street Reform and Consumer Protection Act of 2010 (12 U.S.C. 5301(12)).

(d) Relationship to other authorities. Except as otherwise provided under section 

13 of the BHC Act or this part, and notwithstanding any other provision of law, the 

prohibitions and restrictions under section 13 of BHC Act and this part shall apply to the 

activities of a banking entity, even if such activities are authorized for the banking entity

under other applicable provisions of law.

(e) Preservation of authority. Nothing in this part limits in any way the authority 

of the Board to impose on a banking entity identified in paragraph (c) of this section 

additional requirements or restrictions with respect to any activity, investment, or 
1073

relationship covered under section 13 of the Bank Holding Company Act or this part, or 

additional penalties for violation of this part provided under any other applicable 

provision of law.

FEDERAL DEPOSIT INSURANCE CORPORATION

Authority and Issuance

For the reasons set forth in the Supplementary Information, the Federal Deposit Insurance 

Corporation is adding the text of the common rule as set forth at the end of the 

Supplementary Information as Part 351 to chapter III of Title 12, Code of Federal 

Regulations, modified as follows: 

PART 351 — PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND 

RELATIONSHIPS WITH COVERED FUNDS 

10. The authority for part 351 is added to read as follows: 

Authority: 12 U.S.C. 1851; 1811 et seq.; 3101 et seq.; and 5412.

11. Part 351 is added as set forth at the end of the Common Preamble. 

12. Part 351 is amended by:

a. Removing “[Agency]” wherever it appears and adding in its place “the FDIC;” and

b. Removing “the [Agency]” wherever it appears and adding in its place “the FDIC.”

13. Section 351.1 is revised to read as follows: 

§ 351.1 Authority, purpose, scope, and relationship to other authorities. 

(a) Authority. This part is issued by the FDIC under section 13 of the Bank 

Holding Company Act of 1956, as amended (12 U.S.C. 1851). 

(b) Purpose. Section 13 of the Bank Holding Company Act establishes 

prohibitions and restrictions on proprietary trading and investments in or relationships 
1074

with covered funds by certain banking entities, including any insured depository 

institution as defined in section 3(c)(2) of the Federal Deposit Insurance Act (12 U.S.C. 

1813(c)(2)) and certain subsidiaries thereof for which the FDIC is the appropriate Federal 

banking agency as defined in section 3(q) of the Federal Deposit Insurance Act (12 

U.S.C. 1813(q)). This part implements section 13 of the Bank Holding Company Act by 

defining terms used in the statute and related terms, establishing prohibitions and 

restrictions on proprietary trading and investments in or relationships with covered funds, 

and explaining the statute’s requirements. 

(c) Scope. This part implements section 13 of the Bank Holding Company Act 

with respect to insured depository institutions for which the FDIC is the appropriate 

Federal banking agency, as defined in section 3(q) of the Federal Deposit Insurance Act, 

and certain subsidiaries of the foregoing.

(d) Relationship to other authorities. Except as otherwise provided in under 

section 13 of the Bank Holding Company Act, and notwithstanding any other provision 

of law, the prohibitions and restrictions under section 13 of Bank Holding Company Act 

shall apply to the activities and investments of a banking entity, even if such activities 

and investments are authorized for a banking entity under other applicable provisions of 

law. 

(e) Preservation of authority. Nothing in this part limits in any way the authority 

of the FDIC to impose on a banking entity identified in paragraph (c) of this section 

additional requirements or restrictions with respect to any activity, investment, or 

relationship covered under section 13 of the Bank Holding Company Act or this part, or 
1075

additional penalties for violation of this part provided under any other applicable 

provision of law. 

SECURITIES AND EXCHANGE COMMISSION

Authority and Issuance

For the reasons stated in the Common Preamble, the Securities and Exchange 

Commission is adding the text of the common rule as set forth at the end of the 

Supplementary Information as Part 255 to chapter II of Title 17, Code of Federal 

Regulations, modified as follows:

PART 255—PROPRIETARY TRADING AND CERTAIN INTERESTS IN AND 

RELATIONSHIPS WITH COVERED FUNDS

14. The authority for part 255 is added to read as follows:

Authority: 12 U.S.C. 1851.

15. Part 255 is added as set forth at the end of the Common Preamble.

16. Part 255 is amended by:

a. Removing “[Agency]” wherever it appears and adding in its place “the SEC;” and

b. Removing “the [Agency]” wherever it appears and adding in its place “the SEC.”

17. Section 255.1 is revised to read as follows:

§ 255.1 Authority, purpose, scope, and relationship to other authorities.

(a) Authority. This part is issued by the SEC under section 13 of the Bank 

Holding Company Act of 1956, as amended (12 U.S.C. 1851).

(b) Purpose. Section 13 of the Bank Holding Company Act establishes 

prohibitions and restrictions on proprietary trading and investments in or relationships 

with covered funds by certain banking entities, including registered broker-dealers, 
1076

registered investment advisers, and registered security-based swap dealers, among others 

identified in section 2(12)(B) of the Dodd-Frank Wall Street Reform and Consumer 

Protection Act of 2010 (12 U.S.C. 5301(12)(B)). This part implements section 13 of the 

Bank Holding Company Act by defining terms used in the statute and related terms, 

establishing prohibitions and restrictions on proprietary trading and investments in or 

relationships with covered funds, and explaining the statute’s requirements.

(c) Scope. This part implements section 13 of the Bank Holding Company 

Act with respect to banking entities for which the SEC is the primary financial regulatory 

agency, as that term is defined in this part.

(d) Relationship to other authorities. Except as otherwise provided under

section 13 of the Bank Holding Company Act, and notwithstanding any other provision 

of law, the prohibitions and restrictions under section 13 of Bank Holding Company Act 

shall apply to the activities and investments of a banking entity identified in paragraph (c) 

of this section, even if such activities and investments are authorized for the banking 

entity under other applicable provisions of law.

(e) Preservation of authority. Nothing in this part limits in any way the 

authority of the SEC to impose on a banking entity identified in paragraph (c) of this 

section additional requirements or restrictions with respect to any activity, investment, or 

relationship covered under section 13 of the Bank Holding Company Act or this part, or 

additional penalties for violation of this part provided under any other applicable 

provision of law.

Dated: December 10, 2013
1077

Thomas J. Curry,

Comptroller of the Currency.

By order of the Board of Governors of the Federal Reserve System, December 23, 2013.

Robert deV. Frierson,

Secretary of the Board.

By order of the Board of Directors.

Dated at Washington, DC this 10th day of December, 2013.

Federal Deposit Insurance Corporation

Robert E. Feldman,

Executive Secretary

By the Securities and Exchange Commission.

Elizabeth M. Murphy

Secretary

Date: December 10, 2013