8332 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

1See Prohibitions and Restrictions on Proprietary 

Trading and Certain Interests in, and Relationships 

With, Hedge Funds and Private Equity Funds, 76 

FR 68846, (Nov. 7, 2011). 

2See 76 FR 68944–68967 for the Joint Rule text 

adopted by the Board, the OCC, the FDIC, and the 

SEC. 

3See id. at 68846 for instructions on submitting 

comments to the OCC, the Board, the FDIC, and the 

SEC. 

4 Dodd-Frank Wall Street Reform and Consumer 

Protection Act, Public Law 111–203, 124 Stat. 1376 

(2010). 

5Application of the proposed rule to smaller, 

less-complex banking entities is discussed below in 

Part II.G of this Supplemental Information. 

6The term ‘‘banking entity’’ is defined in section 

13(h)(1) of the BHC Act, as amended by section 619 

of the Dodd-Frank Act. See 12 U.S.C. 1851(h)(1). 

The statutory definition includes any insured 

depository institution (other than certain limited 

purpose trust institutions), any company that 

controls an insured depository institution, any 

company that is treated as a bank holding company 

for purposes of section 8 of the International 

Banking Act of 1978 (12 U.S.C. 3106), and any 

affiliate or subsidiary of any of the foregoing. 

Section 13 of the BHC Act defines the terms ‘‘hedge 

fund’’ and ‘‘private equity fund’’ as an issuer that 

would be an investment company, as defined under 

the Investment Company Act of 1940 (15 U.S.C. 

80a–1 et seq.), but for section 3(c)(1) or 3(c)(7) of 

that Act, or any such similar funds as the 

appropriate Federal banking agencies (i.e., the 

Board, OCC, and FDIC), the SEC, and the CFTC 

may, by rule, determine should be treated as a 

hedge fund or private equity fund. See 12 U.S.C. 

1851(h)(2). The term banking entity that is used 

throughout this Supplemental Information only 

pertains to those banking entities that are relevant 

to the CFTC under the CFTC Rule. 

7See 12 U.S.C. 1851(a)(2) and (f)(4). A ‘‘nonbank 

financial company supervised by the Board’’ is a 

COMMODITY FUTURES TRADING 

COMMISSION 

17 CFR Part 75 

RIN 3038–AD05 

Prohibitions and Restrictions on 

Proprietary Trading and Certain 

Interests in, and Relationships With, 

Hedge Funds and Covered Funds 

AGENCY: Commodity Futures Trading 

Commission. 

ACTION: Notice of proposed rulemaking. 

SUMMARY: The Commodity Futures 

Trading Commission (‘‘CFTC’’ or 

‘‘Commission’’) is requesting comment 

on a proposed rule that would 

implement Section 619 of the DoddFrank Wall Street Reform and Consumer 

Protection Act (‘‘Dodd-Frank Act’’) 

which contains certain prohibitions and 

restrictions on the ability of a banking 

entity and nonbank financial company 

supervised by the Board of Governors of 

the Federal Reserve System (the 

‘‘Board’’) to engage in proprietary 

trading and have certain interests in, or 

relationships with, a hedge fund or 

private equity fund (‘‘CFTC Rule’’). 

On November 7, 2011, the Office of 

the Comptroller of the Currency, 

Treasury (‘‘OCC’’); the Board; the 

Federal Deposit Insurance Corporation 

(‘‘FDIC’’); and the Securities and 

Exchange Commission (‘‘SEC’’) 

published a joint proposed rule 

implementing Section 619 of the DoddFrank Act (the ‘‘Joint Release’’).1 The 

CFTC is adopting the entire text of the 

proposed common rules section from 

the Joint Release (the ‘‘Joint Rule’’) as 

part of its proposed rule.2 Similar to the 

OCC, the Board, the FDIC, and the SEC 

in the Joint Release, the CFTC is 

modifying the Joint Rule with CFTCspecific rule text. The CFTC Rule also 

contains additional questions specific to 

the CFTC in Section III and does not 

include Subpart E of the Joint Release 

because Subpart E deals exclusively 

with the Board. The Commission 

solicits comments on all aspects of this 

proposed rule. 

DATES: Comments should be received on 

or before April 16, 2012. 

ADDRESSES: Interested parties are 

encouraged to submit written comments 

to either the CFTC individually or 

jointly to the OCC, Board, FDIC 

(collectively, the ‘‘Federal Banking 

Agencies’’ or ‘‘FBA’’); SEC, and together 

with the CFTC, (the ‘‘Agencies’’).3

Commenters are encouraged to use the 

title ‘‘Restrictions on Proprietary 

Trading and Certain Interests in, and 

Relationships with, Hedge Funds and 

Private Equity Funds’’ to facilitate the 

organization and distribution of 

comments to the CFTC and among the 

Agencies. Commenters are also 

encouraged to identify the number of 

the specific question for comment to 

which they are responding. 

You may submit comments, identified 

by RIN number 3038–AD05, by any of 

the following methods: 

• Agency Web site, via its Comments 

Online process: http:// 

comments.cftc.gov. Follow the 

instructions for submitting comments 

through the Web site. 

• Mail: David A. Stawick, Secretary of 

the Commission, Commodity Futures 

Trading Commission, Three Lafayette 

Centre, 1155 21st Street NW., 

Washington, DC 20581. 

• Hand Delivery/Courier: Same as 

mail above. 

• Federal eRulemaking Portal: http:// 

www.regulations.gov. Follow the 

instructions for submitting comments. 

Please submit comments by only one 

method. 

All comments must be submitted in 

English, or if not, accompanied by an 

English translation. Comments will be 

posted as received to http:// 

www.cftc.gov. You should submit only 

information that you wish to make 

available publicly. If you wish the 

Commission to consider information 

that may be exempt from disclosure 

under the Freedom of Information Act 

(‘‘FOIA’’), a petition for confidential 

treatment of the exempt information 

may be submitted according to the 

procedures established in 17 CFR 145.9. 

The Commission reserves the right, but 

shall have no obligation, to review, 

prescreen, filter, redact, refuse, or 

remove any or all of your submission 

from http://www.cftc.gov that it may 

deem to be inappropriate for 

publication, such as obscene language. 

All submissions that have been redacted 

or removed that contain comments on 

the merits of the rulemaking will be 

retained in the public comment file and 

will be considered as required under the 

Administrative Procedure Act and other 

applicable laws, and may be accessible 

under FOIA. 

FOR FURTHER INFORMATION CONTACT: 

Steven E. Seitz, Counsel, Office of the 

General Counsel, 202–418–5615, 

sseitz@cftc.gov; Gary Barnett, Director, 

Division of Swap and Intermediary 

Oversight, (202) 418–5977, 

gbarnett@cftc.gov; Beverly Loew, 

Assistant General Counsel, Office of the 

General Counsel, (202) 418–5648, 

bloew@cftc.gov; Adedayo Banwo, 

Counsel, Office of the General Counsel, 

(202) 418–6249, abanwo@cftc.gov; 

Mathew Hargrow, Attorney Advisor, 

Office of the General Counsel, (202) 

418–5267, mhargrow@cftc.gov; Todd 

Prono, Financial Economist, Office of 

the Chief Economist, (202) 418–5640, 

tprono@cftc.gov; Commodity Futures 

Trading Commission, Three Lafayette 

Centre, 1155 21st Street NW., 

Washington, DC 20581. 

SUPPLEMENTARY INFORMATION:

I. Background 

The Dodd-Frank Act was enacted on 

July 21, 2010.4 Section 619 of the DoddFrank Act added a new section 13 to the 

Bank Holding Company Act of 1956 

(‘‘BHC Act’’) (to be codified at 12 U.S.C. 

1851) that generally prohibits any 

banking entity 5 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.6 New 

section 13 of the BHC Act also provides 

for nonbank financial companies 

supervised by the Board that engage in 

such activities or have such interests or 

relationships to be subject to additional 

capital requirements, quantitative 

limits, or other restrictions.7


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nonbank financial company or other company that 

the Financial Stability Oversight Council 

(‘‘Council’’) has determined, under section 113 of 

the Dodd-Frank Act, shall be subject to supervision 

by the Board and prudential standards. The Board 

is not proposing at this time any additional capital 

requirements, quantitative limits, or other 

restrictions on nonbank financial companies 

pursuant to section 13 of the BHC Act, as it believes 

doing so would be premature in light of the fact that 

the Council has not yet finalized the criteria for 

designation of, nor yet designated, any nonbank 

financial company. 

8See 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. See 12 U.S.C. 

1851(b)(1). Prior to publishing its study, the Council 

requested public comment on a number of issues 

to assist the Council in conducting its study. See 

75 FR 61,758 (Oct. 6, 2010). Approximately 8,000 

comments were received from the public, including 

from members of Congress, trade associations, 

individual banking entities, consumer groups, and 

individuals. As noted in the issuing release for the 

Council Study, these comments were carefully 

considered by the Council when drafting the 

Council study. 

9See Council study at 5–6. The CFTC has 

implemented this recommendation through the 

proposed compliance program requirements 

contained in Subpart D of this proposal with 

respect to both proprietary trading and covered 

fund activities and investments. 

10The CFTC also received a number of comment 

letters concerning implementation of section 13 of 

the BHC Act in advance of this proposal. The CFTC 

has carefully considered these comments in 

formulating this proposal. 

11See 76 FR 68944 through 68967 for the Joint 

Rule. 

12Section VI of the proposed CFTC Rule also 

contains the additional question 348.1. 

13The CFTC believes that Sections II and III of 

both the CFTC Rule and the Joint Release are 

substantively consistent with the exception of the 

additional questions and the deletion of Subpart E. 

Any other discrepancies between Sections II and III 

of the CFTC Rule and the Joint Release are solely 

for stylistic purposes and are not intended to create 

any substantive differences between these sections 

of the CFTC Rule and the Joint Release. 

14See 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. 

15See 12 U.S.C. 1851(b)(2)(B)(ii). The Secretary of 

the Treasury, as Chairperson of the Council, is 

responsible for coordinating the Agencies’ 

rulemakings under section 13 of the BHC Act. See 

id. 

16See id. at 1851(b)(2)(A). 

17See id. at 1851(c)(1). 

18See id. at 1851(c)(6). 

19See Conformance Period for Entities Engaged in 

Prohibited Proprietary Trading or Private Equity 

Fund or Hedge Fund Activities, 76 FR 8265 (Feb. 

14, 2011). 

20See id. (citing 156 Cong. Rec. S5898 (daily ed. 

July 15, 2010) (statement of Sen. Merkley)). 

21 12 U.S.C. 1851(a)(1)(A) and (B). 

A. Rulemaking Framework 

Section 13 of the BHC Act requires 

that implementation of its provisions 

occur in several stages. First, the 

Council was required to conduct a study 

(‘‘Council study’’) and make 

recommendations by January 21, 2011 

on the implementation of section 13 of 

the BHC Act. The Council study was 

issued on January 18, 2011, and 

included a detailed discussion of key 

issues related to implementation of 

section 13 and recommended that the 

Agencies consider taking a number of 

specified actions in issuing rules under 

section 13 of the BHC Act.8 The Council 

study also recommended that the 

Agencies adopt a four-part 

implementation and supervisory 

framework for identifying and 

preventing prohibited proprietary 

trading, which included a programmatic 

compliance regime requirement for 

banking entities, analysis and reporting 

of quantitative metrics by banking 

entities, supervisory review and 

oversight by the Agencies, and 

enforcement procedures for violations.9

The CFTC has carefully considered the 

Council study and its recommendations, 

and has consulted with staff of the other 

Agencies, in formulating this 

proposal.10

The CFTC is adopting the entire text 

of the proposed common rules from the 

Joint Release (the ‘‘Joint Rule’’) as part 

of its proposed rule.11 Similar to the 

other Agencies in the Joint Release, the 

CFTC is modifying the text of proposed 

common rules section from the Joint 

Release with CFTC-specific rule text. 

Sections II and III of the CFTC Rule 

are substantively consistent with 

Sections II and III of the Joint Release, 

with the following exceptions: (a) 

Sections II of the CFTC Rule also 

includes the following additional 

questions: 8.1, 14.1, 30.1, 30.2, 64.1, 

87.1, 88.1, 168.1, 168.2, 177.1, 218.1, 

227.1, 296.1, and 302.1 12 and (b) the 

CFTC Rule does not include Subpart E 

of the Joint Release because Subpart E 

only applies to the Board.13 The CFTC 

Rule includes these additional questions 

to ask whether certain provisions of the 

Joint Rule should be applicable to 

CFTC-regulated banking entities. In 

these questions, the CFTC generally asks 

whether the proposed CFTC Rule 

should adopt such provisions and 

requests an explanation of the rationale 

for either including or excluding such 

provision in the proposed CFTC Rule. 

Authority for developing and 

adopting regulations to implement the 

prohibitions and restrictions of section 

13 of the BHC Act is divided between 

the Agencies in the manner provided in 

section 13(b)(2) of the BHC Act.14 The 

statute also requires the Agencies, in 

developing and issuing implementing 

rules, to consult and coordinate with 

each other, as appropriate, for the 

purposes of assuring, to the extent 

possible, that such rules are comparable 

and provide for consistent application 

and implementation of the applicable 

provisions of section 13 of the BHC 

Act.15 The CFTC believes that such 

coordination will assist in ensuring that 

advantages are not unduly provided to, 

and that disadvantages are not unduly 

imposed upon, companies affected by 

section 13 of the BHC Act and that the 

safety and soundness of banking entities 

and nonbank financial companies 

supervised by the Board are protected. 

The statute requires the CFTC to 

implement rules under section 13 not 

later than 9 months after the Council 

completes its study (i.e., not later than 

October 18, 2011).16 The restrictions 

and prohibitions of section 13 of the 

BHC Act become effective 12 months 

after issuance of final rules by the CFTC, 

or July 21, 2012, whichever is earlier.17

In addition, the statute required the 

Board, acting alone, to adopt rules to 

implement the provisions of section 13 

of the BHC Act that provide a banking 

entity or a nonbank financial company 

supervised by the Board a period of time 

after the effective date of section 13 of 

the BHC Act to bring the activities, 

investments, and relationships of the 

banking entity into compliance with 

that section and the Agencies’ 

implementing regulations.18 The Board 

issued its final conformance rule as 

required under section 13(c)(6) of the 

BHC Act on February 8, 2011 (‘‘Board’s 

Conformance Rule’’).19 As noted in the 

issuing release for the Board’s 

Conformance Rule, this period is 

intended to give markets and firms an 

opportunity to adjust to section 13 of 

the BHC Act.20

B. Section 13 of the BHC Act 

Section 13 of the BHC Act generally 

prohibits banking entities from engaging 

in proprietary trading or from acquiring 

or retaining any ownership interest in, 

or sponsoring, a covered fund.21

However, section 13(d)(1) of that Act 

expressly includes exemptions from 


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8334 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

22See id. at 1851(d)(1). As described in greater 

detail in Part III.B.4 of this SUPPLEMENTARY

INFORMATION, the proposed rule applies some of 

these statutory exemptions only to the proprietary 

trading prohibition or the covered fund prohibitions 

and restrictions, but not both, where it appears 

either by plain language or by implication that the 

exemption was intended only to apply to one or the 

other. 

23 Id. at 1851(d)(1)(J). 

24See id. at 1851(d)(2). 

25See 12 U.S.C. 371c. 26 12 U.S.C. 1851(f). 27 12 U.S.C. 371c–1. 28See 12 U.S.C. 1851(a)(2), (d)(4). 

these prohibitions for certain permitted 

activities, including: 

• Trading in certain government 

obligations; 

• Underwriting and market makingrelated activities; 

• Risk-mitigating hedging activity; 

• Trading on behalf of customers; 

• Investments in Small Business 

Investment Companies (‘‘SBICs’’) and 

public interest investments; 

• Trading for the general account of 

insurance companies; 

• Organizing and offering a covered 

fund (including limited investments in 

such funds); 

• Foreign trading by non-U.S. 

banking entities; and 

• Foreign covered fund activities by 

non-U.S. banking entities.22

For purposes of this SUPPLEMENTARY

INFORMATION, trading activities subject to 

section 13 of the BHC Act, including 

those permitted under a relevant 

exemption, are sometimes referred to as 

‘‘covered trading activities.’’ Similarly, 

activities and investments with respect 

to a covered fund that are subject to 

section 13 of the BHC Act, including 

those permitted under a relevant 

exemption, are sometimes referred to as 

‘‘covered fund activities or 

investments.’’ 

Additionally, section 13 of the BHC 

Act permits the CFTC to grant, by rule, 

other exemptions from the prohibitions 

on proprietary trading and acquiring or 

retaining an ownership interest in, or 

acting as sponsor to, a covered fund if 

the CFTC determines that the exemption 

would promote and protect the safety 

and soundness of the banking entity and 

the financial stability of the United 

States.23 Furthermore, under the statute, 

no banking entity may engage in a 

permitted activity if that activity would 

(i) involve or result in a material conflict 

of interest or material exposure of the 

banking entity to high-risk assets or 

high-risk trading strategies, or (ii) pose 

a threat to the safety and soundness of 

the banking entity or to the financial 

stability of the United States.24

Section 13(f) of the BHC Act 

separately prohibits a banking entity 

that serves, directly or indirectly, as the 

investment manager, investment 

adviser, or sponsor to a covered fund, 

and any affiliate of such a banking 

entity, from entering into any 

transaction with the fund, or any other 

covered fund controlled by such fund, 

that would be a ‘‘covered transaction’’ 

as defined in section 23A of the Federal 

Reserve Act (‘‘FR Act’’),25 as if such 

banking entity or affiliate were a 

member bank and the covered fund 

were an affiliate thereof, subject to 

certain exceptions.26 Section 13(f) also 

provides that a banking entity may enter 

into certain prime brokerage 

transactions with any covered fund in 

which a covered fund managed, 

sponsored, or advised by the banking 

entity has taken an equity, partnership, 

or other ownership interest, but any 

such transaction (and any other 

permitted transaction with such funds) 

must be on market terms in accordance 

with the provisions of section 23B of the 

FR Act.27

Section 13 of the BHC Act does not 

prohibit a nonbank financial company 

supervised by the Board from engaging 

in proprietary trading, or from having 

the types of ownership interests in or 

relationships with a covered fund that a 

banking entity is prohibited or restricted 

from having under section 13 of the 

BHC Act. However, section 13 of the 

BHC Act provides for the Board or other 

appropriate Agency to impose 

additional capital charges, quantitative 

limits, or other restrictions on a 

nonbank financial company supervised 

by the Board or their subsidiaries and 

affiliates that are engaged in such 

activities or maintain such 

relationships.28

II. Overview of Proposed Rule 

A. General Approach 

In formulating the proposed rule, the 

CFTC attempted to reflect the structure 

of section 13 of the BHC Act, which is 

to prohibit a banking entity from 

engaging in proprietary trading or 

acquiring or retaining an ownership 

interest in, or having certain 

relationships with, a covered fund, 

while permitting such entities to 

continue to provide client-oriented 

financial services. However, the 

delineation of what constitutes a 

prohibited or permitted activity under 

section 13 of the BHC Act often involves 

subtle distinctions that are difficult both 

to describe comprehensively within 

regulation and to evaluate in practice. 

The CFTC appreciates that while it is 

crucial that rules under section 13 of the 

BHC Act clearly define and implement 

its requirements, any rule must also 

preserve the ability of a banking entity 

to continue to structure its businesses 

and manage its risks in a safe and sound 

manner, as well as to effectively deliver 

to its clients the types of financial 

services that section 13 expressly 

protects and permits. These clientoriented financial services, which 

include underwriting, market making, 

and traditional asset management 

services, are important to the U.S. 

financial markets and the participants in 

those markets, and the CFTC 

endeavored to develop a proposed rule 

that does not unduly constrain banking 

entities in their efforts to safely provide 

such services. At the same time, 

providing appropriate latitude to 

banking entities to provide such clientoriented services need not and should 

not conflict with clear, robust, and 

effective implementation of the statute’s 

prohibitions and restrictions. Given 

these complexities, the CFTC requests 

comment on the potential impacts the 

proposed approach may have on 

banking entities and the businesses in 

which they engage. In particular, and as 

discussed further in Part VII of this 

Supplemental Information, the CFTC 

recognizes that there are economic 

impacts that may arise from the 

proposed rule and its implementation of 

section 13 of the BHC Act, and the 

CFTC requests comment on such 

impacts, including quantitative data or 

studies, where possible. 

In light of these larger challenges and 

goals, the CFTC’s proposal takes a 

multi-faceted approach to implementing 

section 13 of the BHC Act. In particular, 

the proposed rule includes a framework 

that: (i) Clearly describes the key 

characteristics of both prohibited and 

permitted activities; (ii) requires 

banking entities to establish a 

comprehensive programmatic 

compliance regime designed to ensure 

compliance with the requirements of the 

statute and rule in a way that takes into 

account and reflects the unique nature 

of a banking entity’s businesses; and (iii) 

with respect to proprietary trading, 

requires certain banking entities to 

calculate and report meaningful 

quantitative data that will assist both 

banking entities and the CFTC in 

identifying particular activity that 

warrants additional scrutiny to 

distinguish prohibited proprietary 

trading from otherwise permissible 

activities. This multi-faceted approach, 

which is consistent with the 

implementation and supervisory 

framework recommended in the Council 

study, is intended to strike an 

appropriate balance between 

accommodating prudent risk 


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Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 8335 

29 In recognition of economic impacts that may 

arise from the proposed rule and its implementation 

of section 13 of the BHC Act, the CFTC is requesting 

comment on the relative costs and benefits of the 

proposal in Part VI of this Supplemental 

Information. 

30Under this uniform approach, the CFTC is 

proposing the same rule provisions under section 

13 of the BHC Act as the Joint Rule. The CFTC’s 

proposed rule would apply only to banking entities 

for which it has regulatory authority under section 

13(b)(2)(B) of the BHC Act. 

31A banking entity must comply with proposed 

Appendix A’s reporting and recordkeeping 

requirements only if it has, together with its 

affiliates and subsidiaries, trading assets and 

liabilities the average gross sum of which (on a 

worldwide consolidated basis) is, as measured as of 

the last day of each of the four prior calendar 

quarters, equal to or greater than $1 billion. 

32 In particular, a banking entity must comply 

with the minimum standards specified in Appendix 

C of the proposed rule (i) with respect to its covered 

trading activities, if it engages in any covered 

trading activities and has, together with its affiliates 

and subsidiaries, trading assets and liabilities the 

average gross sum of which (on a worldwide 

consolidated basis), as measured as of the last day 

of each of the four prior calendar quarters, (X) is 

equal to or greater than $1 billion or (Y) equals 10 

percent or more of its total assets; and (ii) with 

respect to its covered fund activities and 

investments, if it engages in any covered fund 

activities and investments and either (X) has, 

together with its affiliates and subsidiaries, 

aggregate investments in covered funds the average 

value of which is, as measured as of the last day 

of each of the four prior calendar quarters, equal to 

or greater than $1 billion or (Y) sponsors and 

advises, together with its affiliates and subsidiaries, 

covered funds the average total assets of which are, 

as measured as of the last day of each of the four 

prior calendar quarters, equal to or greater than $1 

billion. 

33See proposed rule § __.3(b)(1). 

34See proposed rule § __.3(b)(2). 

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

36See 76 FR 1890 (Jan. 11, 2011). 

37 In the context of regulation of government 

securities dealers under the Securities Exchange 

Act of 1934 (‘‘Exchange Act’’), the term ‘‘financial 

institution’’ as defined in section 3(a)(46) of the 

Exchange Act includes a bank (as defined in section 

3(a)(36) of the Exchange Act) and a foreign bank (as 

defined in the International Banking Act of 1978). 

See 15 U.S.C. 78c(a)(46). 

38See proposed rule § __.3(b)(2)(i)(B). 

management and the continued 

provision of client-oriented financial 

services by banking entities while 

ensuring that such entities do not 

engage in prohibited proprietary trading 

or restricted covered fund activities or 

investments.29

In addition, and consistent with the 

statutory requirement that the CFTC’s 

rule under section 13 of the BHC Act be, 

to the extent possible, comparable and 

provide for consistent application and 

implementation, the CFTC is proposing 

the Joint Rule (i.e., common rule and 

appendices) that was proposed by the 

other Agencies. This uniform approach 

to implementation is intended to 

provide the maximum degree of clarity 

to banking entities and market 

participants and ensure that section 13’s 

prohibitions and restrictions are applied 

consistently across different types of 

regulated entities.30

As a matter of structure, the proposed 

rule is generally divided into four 

subparts and contains three appendices, 

as follows: 

• Subpart A of the proposed rule 

describes the authority, scope, purpose, 

and relationship to other authorities of 

the rule and defines terms used 

commonly throughout the rule; 

• Subpart B of the proposed rule 

prohibits proprietary trading, defines 

terms relevant to covered trading 

activity, establishes exemptions from 

the prohibition on proprietary trading 

and limitations on those exemptions, 

and requires certain banking entities to 

report quantitative measurements with 

respect to their trading activities; 

• Subpart C of the proposed rule 

prohibits or restricts acquiring or 

retaining an ownership interest in, and 

certain relationships with, a covered 

fund, defines terms relevant to covered 

fund activities and investments, as well 

as establishes exemptions from the 

restrictions on covered fund activities 

and investments and limitations on 

those exemptions; 

• Subpart D of the proposed rule 

generally requires banking entities to 

establish an enhanced compliance 

program regarding compliance with 

section 13 of the BHC Act and the 

proposed rule, including written 

policies and procedures, internal 

controls, a management framework, 

independent testing of the compliance 

program, training, and recordkeeping; 

• Appendix A of the proposed rule 

details the quantitative measurements 

that certain banking entities may be 

required to compute and report with 

respect to their trading activities;31

• Appendix B of the proposed rule 

provides commentary regarding the 

factors the Agencies propose to use to 

help distinguish permitted market 

making-related activities from 

prohibited proprietary trading; and 

• Appendix C of the proposed rule 

details the minimum requirements and 

standards that certain banking entities 

must meet with respect to their 

compliance program, as required under 

subpart D.32

B. Proprietary Trading Restrictions 

Subpart B of the proposed rule 

implements the statutory prohibition on 

proprietary trading and the various 

exemptions to this prohibition included 

in the statute. Section __.3 of the 

proposed rule contains the core 

prohibition on proprietary trading and 

defines a number of related terms, 

including ‘‘proprietary trading’’ and 

‘‘trading account.’’ The proposed rule’s 

definition of proprietary trading 

generally parallels the statutory 

definition, and includes engaging as 

principal for the trading account of a 

banking entity in any transaction to 

purchase or sell certain types of 

financial positions.33

The proposed rule’s definition of 

trading account generally parallels the 

statutory definition, and provides 

further guidance regarding the 

circumstances in which a position will 

be considered to have been taken 

principally for the purpose of short-term 

resale or benefiting from actual or 

expected short-term price movements, 

recognizing the importance of providing 

as much clarity as possible regarding 

this term, which ultimately defines the 

scope of accounts subject to the 

prohibition on proprietary trading.34 In 

particular, the proposed definition of 

trading account identifies three classes 

of positions that would cause an 

account to be a trading account. First, 

the definition includes positions taken 

principally for the purpose of short-term 

resale, benefitting from short-term price 

movements, realizing short-term 

arbitrage profits, or hedging another 

trading account position.35 As described 

in this notice, this language is 

substantially similar to language for a 

‘‘trading position’’ used in the Federal 

banking agencies’ current market risk 

capital rules, as proposed to be revised 

(‘‘Market Risk Capital Rules’’),36 and the 

CFTC proposes to interpret this 

language in a similar manner. Second, 

with respect to a banking entity subject 

to the Federal banking agencies’ Market 

Risk Capital Rules, the definition 

includes all positions in financial 

instruments subject to the prohibition 

on proprietary trading that are treated as 

‘‘covered positions’’ under those capital 

rules, other than certain foreign 

exchange and commodities positions. 

Third, the definition includes all 

positions acquired or taken by certain 

registered securities and derivatives 

dealers (or, in the case of financial 

institutions 37 that are government 

securities dealers, that have filed notice 

with an appropriate regulatory agency) 

in connection with their activities that 

require such registration or notice.38

The definition of trading account also 

contains clarifying exclusions for 

certain positions that do not appear to 

involve the requisite short-term trading 

intent, such as positions arising under 

certain repurchase and reverse 

repurchase arrangements or securities 

lending transactions, positions acquired 

or taken for bona fide liquidity 


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39See proposed rule § __.3(b)(2)(iii). 

40See proposed rule § __.3(b)(3). 

41See proposed rule § __.4(a), (b). 

42See proposed rule §§ __.5(b)(1), (2). 

43See proposed rule § __.5(b)(3). 

44See proposed rule § __.6(a). 

45See proposed rule § __.6(b). 

46See proposed rule § __.6(c). 

47See proposed rule § __.6(d). 48See proposed rule § __.7. 

management purposes, and certain 

positions of derivatives clearing 

organizations or clearing agencies.39

Section __.3 of the proposed rule also 

defines a number of other relevant 

terms, including the term ‘‘covered 

financial position.’’ This term is used to 

define the scope of financial 

instruments subject to the prohibition 

on proprietary trading. Consistent with 

the statutory language, such covered 

financial positions include positions 

(including long, short, synthetic and 

other positions) in securities, 

derivatives, commodity futures, and 

options on such instruments, but do not 

include positions in loans, spot foreign 

exchange or spot commodities.40

Section __.4 of the proposed rule 

implements the statutory exemptions for 

underwriting and market making-related 

activities. For each of these permitted 

activities, the proposed rule provides a 

number of requirements that must be 

met in order for a banking entity to rely 

on the applicable exemption. These 

requirements are generally designed to 

ensure that the activities, revenues and 

other characteristics of the banking 

entity’s trading activity are consistent 

with underwriting and market makingrelated activities, respectively, and not 

prohibited proprietary trading.41 These 

requirements are intended to support 

and augment other parts of the proposed 

rule’s approach to implementing the 

prohibition on proprietary trading, 

including the compliance program 

requirement and the reporting of 

quantitative measurements, in order to 

assist banking entities and the CFTC in 

identifying prohibited trading activities 

that may be conducted in the context of, 

or mischaracterized as, permitted 

underwriting or market making-related 

activities. 

Section __.5 of the proposed rule 

implements the statutory exemption for 

risk-mitigating hedging. As with the 

underwriting and market-making 

exemptions, proposed § __.5 contains a 

number of requirements that must be 

met in order for a banking entity to rely 

on the exemption. These requirements 

are generally designed to ensure that the 

banking entity’s trading activity is truly 

risk-mitigating hedging in purpose and 

effect.42 Proposed § __.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.43 As with the 

exemptions for underwriting and market 

making-related activity, these 

requirements form part of a broader 

implementation approach that also 

includes the compliance program 

requirement and the reporting of 

quantitative measurements. 

Section __.6 of the proposed rule 

implements statutory exemptions for 

trading in certain government 

obligations, trading on behalf of 

customers, trading by a regulated 

insurance company, and trading by 

certain foreign banking entities outside 

the United States. Section __.6(a) of the 

proposed rule describes the government 

obligations in which a banking entity 

may trade notwithstanding the 

prohibition on proprietary trading, 

which include U.S. government and 

agency obligations, obligations and 

other instruments of certain government 

sponsored entities, and State and 

municipal obligations.44 Section __.6(b) 

of the proposed rule describes permitted 

trading on behalf of customers and 

identifies three categories of 

transactions that would qualify for the 

exemption.45 These categories include: 

(i) Transactions conducted by a banking 

entity as investment adviser, commodity 

trading advisor, trustee, or in a similar 

fiduciary capacity for the account of a 

customer where the customer, and not 

the banking entity, has beneficial 

ownership of the related positions; (ii) 

riskless principal transactions; and (iii) 

transactions conducted by a banking 

entity that is a regulated insurance 

company for the separate account of 

insurance policyholders, subject to 

certain conditions. Section __.6(c) of the 

proposed rule describes permitted 

trading by a regulated insurance 

company for its general account, and 

generally parallels the statutory 

language governing this exemption.46

Finally, § __.6(d) of the proposed rule 

describes permitted trading outside of 

the United States by a foreign banking 

entity.47 The proposed exemption 

clarifies when a foreign banking entity 

will be considered to engage in such 

trading pursuant to sections 4(c)(9) or 

4(c)(13) of the BHC Act, as required by 

the statute, including with respect to a 

foreign banking entity not currently 

subject to section 4 of the BHC Act. The 

exemption also clarifies when trading 

will be considered to have occurred 

solely outside of the United States, as 

required by the statute, and provides a 

number of specific criteria for 

determining whether that standard is 

met. 

Section __.7 of the proposed rule 

requires certain banking entities with 

significant covered trading activities to 

comply with the reporting and 

recordkeeping requirements specified in 

Appendix A of the proposed rule. In 

addition, § __.7 requires that a banking 

entity comply with the recordkeeping 

requirements in § __.20 of the proposed 

rule, including, where applicable, the 

recordkeeping requirements in 

Appendix C of the proposed rule. 

Section __.7 of the proposed rule also 

requires a banking entity to comply with 

any other reporting or recordkeeping 

requirements that the CFTC may impose 

to evaluate the banking entity’s 

compliance with the proposed rule.48

Proposed Appendix A requires those 

relevant banking entities with 

significant covered trading activities to 

furnish periodic reports to the CFTC 

regarding a variety of quantitative 

measurements of its covered trading 

activities and maintain records 

documenting the preparation and 

content of these reports. These proposed 

reporting and recordkeeping 

requirements vary depending on the 

scope and size of covered trading 

activities, and a banking entity must 

comply with proposed Appendix A’s 

reporting and recordkeeping 

requirements only if it has, together 

with its affiliates and subsidiaries, 

trading assets and liabilities the average 

gross sum of which (on a worldwide 

consolidated basis) is, as measured as of 

the last day of each of the four prior 

calendar quarters, equal to or greater 

than $1 billion. These thresholds are 

designed to reduce the burden on 

smaller, less complex banking entities, 

which generally engage in limited 

market-making and other trading 

activities. Other provisions of the 

proposal, and in particular the 

compliance program requirement in 

§ __.20 of the proposed rule, are likely 

to be less burdensome and equally 

effective methods for ensuring 

compliance with section 13 of the BHC 

Act by smaller, less complex banking 

entities. 

The quantitative measurements that 

must be furnished under the proposed 

rule are generally designed to reflect, 

and provide meaningful information 

regarding, certain characteristics of 

trading activities that appear to be 

particularly useful to help differentiate 

permitted market making-related 

activities from prohibited proprietary 

trading and to identify whether certain 

trading activities result in a material 


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49See proposed rule § __.8. 

50See proposed rule § __.10(b)(1). 

51See proposed rule § __.10(b)(3). 

52See proposed rule § __.10(b)(3)(ii). 

53See 156 Cong. Rec. S5889 (daily ed. July 15, 

2010) (statement of Sen. Hagan). 

54See proposed rule §ll.12. 

55See proposed rule §ll.12(a)(2). 

56See proposed rule §§ll.12(b), (c), and (d). 

57See proposed rule §ll.13(a)–(c). 

58See proposed rule §ll.13(a). 

59See proposed rule §ll.13(b)(1). 

60See proposed rule §§ll.13(b)(2)(ii)(C) and 

(D). 

exposure to high-risk assets or high-risk 

trading strategies. In addition, proposed 

Appendix B contains a detailed 

commentary regarding identification of 

permitted market making-related 

activities and distinguishing such 

activities from trading activities that 

constitute prohibited proprietary 

trading. 

As described in Part II.B.5 of the 

SUPPLEMENTARY INFORMATION below, the 

CFTC expects to utilize the conformance 

period provided in section 13(c)(2) of 

the BHC Act to further refine and 

finalize the reporting requirements, 

reflecting the substantial public 

comment, practical experience, and 

revision that will likely be required to 

ensure appropriate, effective use of 

reported quantitative data in practice. 

Section __.8 of the proposed rule 

prohibits a banking entity from relying 

on any exemption to the prohibition on 

proprietary trading if the permitted 

activity would involve or result in a 

material conflict of interest, result in a 

material exposure to high-risk assets or 

high-risk trading strategies, or pose a 

threat to the safety and soundness of the 

banking entity or to the financial 

stability of the United States.49 This 

section also defines material conflict of 

interest, high-risk asset, and high-risk 

trading strategy for these purposes. 

C. Covered Fund Activities and 

Investments 

Subpart C of the proposed rule 

implements the statutory prohibition 

on, as principal, directly or indirectly, 

acquiring and retaining an ownership 

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 proposed rule 

contains the core prohibition on covered 

fund activities and investments and 

defines a number of related terms, 

including ‘‘covered fund’’ and 

‘‘ownership interest.’’ The proposed 

rule’s definition of covered fund 

generally parallels the statutory 

definition of ‘‘hedge fund’’ and ‘‘private 

equity fund,’’ and explains the universe 

of entities that would be considered a 

‘‘covered fund’’ (including those entities 

determined by the CFTC to be ‘‘such 

similar funds’’) and, thus, subject to the 

general prohibition.50

The definition of ‘‘ownership 

interest’’ provides further guidance 

regarding the types of interests that 

would be considered to be an ownership 

interest in a covered fund.51 As 

described in this SUPPLEMENTARY

INFORMATION, these interests may take 

various forms. The definition of 

ownership interest also explicitly 

excludes from the definition ‘‘carried 

interest’’ whereby a banking entity may 

share in the profits of the covered fund 

solely as performance compensation for 

services provided to the covered fund 

by the banking entity (or an affiliate, 

subsidiary, or employee thereof).52

Section __.10 of the proposed rule 

also defines a number of other relevant 

terms, including the terms ‘‘prime 

brokerage transaction,’’ ‘‘sponsor,’’ and 

‘‘trustee.’’ 

Section ll.11 of the proposed rule 

implements the exemption for 

organizing and offering a covered fund 

provided for under section 13(d)(1)(G) 

of the BHC Act. Section ll.11(a) of the 

proposed rule outlines the conditions 

that must be met in order for a banking 

entity to organize and offer a covered 

fund under this authority. These 

requirements are contained in the 

statute and are intended to allow a 

banking entity to engage in certain 

traditional asset management and 

advisory businesses in compliance with 

section 13 of the BHC Act.53 The 

requirements are discussed in detail in 

Part III.C.2 of this SUPPLEMENTARY

INFORMATION. 

Section ll.12 of the proposed rule 

permits a banking entity to acquire and 

retain, as an investment in a covered 

fund, an ownership interest in a covered 

fund that the banking entity organizes 

and offers under §ll.11.54 This 

section implements section 13(d)(4) of 

the BHC Act and related provisions. 

Section 13(d)(4) of the BHC Act permits 

a banking entity to make an investment 

in a covered fund that the banking 

entity organizes and offers pursuant to 

section 13(d)(1)(G), or for which it acts 

as sponsor, for the purposes of (i) 

establishing the covered fund and 

providing the fund with sufficient 

initial equity for investment to permit 

the fund to attract unaffiliated investors, 

or (ii) making a de minimis investment 

in the covered fund in compliance with 

applicable requirements. Section 

ll.12 of the proposed rule implements 

this authority and related limitations, 

including limitations regarding the 

amount and value of any individual perfund investment and the aggregate value 

of all such permitted investments.55

Proposed §ll.12 also clarifies how a 

banking entity must calculate its 

compliance with these investment 

limitations (including by deducting 

such investments from applicable 

capital, as relevant), as well as sets forth 

how a banking entity may request an 

extension of the period of time within 

which it must conform an investment in 

a single covered fund.56

Section ll.13 of the proposed rule 

implements the statutory exemptions 

described in sections 13(d)(1)(C), (E), 

and (I) of the BHC Act that permit a 

banking entity: (i) to acquire and retain 

an ownership interest in, or act as 

sponsor to, one or more SBICs, a public 

welfare investment, or certain qualified 

rehabilitation expenditures; (ii) to 

acquire and retain an ownership interest 

in a covered fund as a risk-mitigating 

hedging activity; and (iii) in the case of 

a non-U.S. banking entity, to acquire 

and retain an ownership interest in, or 

act as sponsor to, a foreign covered 

fund.57 Section ll.13(a) of the 

proposed rule permits a banking entity 

to acquire and retain an ownership 

interest in, or act as sponsor to, an SBIC 

or certain public interest investments, 

without limitation as to the amount of 

ownership interests it may own, hold, or 

control with the power to vote.58

Section ll.13(b) of the proposed 

rule permits a banking entity to use an 

ownership interest in a covered fund to 

hedge, but only with respect to 

individual or aggregated obligations or 

liabilities of a banking entity that arise 

from: (i) The banking entity acting as 

intermediary on behalf of a customer 

that is not itself a banking entity to 

facilitate the customer’s exposure to the 

profits and losses of the covered fund 

(similar to acting as a ‘‘riskless 

principal’’); or (ii) a compensation 

arrangement with an employee of the 

banking entity that directly provides 

investment advisory or other services to 

that fund.59 Additionally, §ll.13(b) of 

the proposed rule requires that the 

hedge represent a substantially similar 

offsetting exposure to the same covered 

fund and in the same amount of 

ownership interest in the covered fund 

arising out of the transaction that the 

acquisition or retention of an ownership 

interest in the covered fund is intended 

to hedge or otherwise mitigate.60

Proposed §ll.13(b) also requires a 

banking entity to document, at the time 

the transaction is executed, the hedging 

rationale for all hedging transactions 


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61See proposed rule §ll.13(b)(3). 

62See 156 Cong. Rec. S5897 (daily ed. July 15, 

2010) (statement of Sen. Merkley). 

63See 12 U.S.C. 1851(g)(2). 

64See proposed rule §ll.13(d). 

65Section 13(d)(1)(J) of the BHC Act provides the 

Agencies discretion to determine that activities not 

specifically identified by sections 13(d)(1)(A)–(I) of 

the BHC Act are also exempted from the general 

prohibitions contained in section 13(a) of that Act, 

and are thus permitted activities. In order to make 

such a determination, the Agencies must find that 

such activity or activities promote and protect the 

safety and soundness of banking entities, as well as 

promote and protect the financial stability of the 

United States. See 12 U.S.C. 1851(d)(1)(J). 

66See 12 U.S.C. 1851(d)(1)(J). 

67See proposed rule §ll.13(a)(1)–(2). 

68See proposed rule at §ll.14(b). 

69Section 13(e)(1) of the BHC Act requires the 

CFTC to issue regulations regarding internal 

controls and recordkeeping to ensure compliance 

with section 13. See 12 U.S.C. 1851(e)(1). 

70See proposed rule §ll.15. 

71See proposed rule §ll.16. 

72 12 U.S.C. 371c–1. 

73See proposed rule §ll.17. 

74See proposed rule §ll.20. If a banking entity 

does not engage in covered trading activities and/ 

or covered fund activities and investments, it need 

only ensure that its existing compliance policies 

and procedures include measures that are designed 

to prevent the banking entity from becoming 

engaged in such activities and making such 

involving an ownership interest in a 

covered fund.61

Section ll.13(c) of the proposed 

rule implements section 13(d)(1)(I) of 

the BHC Act and permits certain foreign 

banking entities to acquire or retain an 

ownership interest in, or to act as 

sponsor to, a covered fund so long as 

such activity occurs solely outside of 

the United States and the entity meets 

the requirements of sections 4(c)(9) or 

4(c)(13) of the BHC Act. This statutory 

exemption limits the extraterritorial 

application of the statutory restrictions 

on covered fund activities and 

investments to foreign firms that, in the 

course of operating outside of the 

United States, engage in activities 

permitted under relevant foreign law 

outside of the United States, while 

preserving national treatment and 

competitive equality among U.S. and 

foreign firms within the United States.62

The proposed rule defines both the type 

of foreign banking entities that are 

eligible for the exemption and the 

circumstances in which covered fund 

activities or investments by such an 

entity will be considered to have 

occurred solely outside of the United 

States (including clarifying when an 

ownership interest will be considered to 

have been offered for sale or sold to a 

resident of the United States). Section 

ll.13(d) of the proposed rule also 

implements in part the rule of 

construction contained in section 

13(g)(2) of the BHC Act, which permits 

the sale and securitization of loans.63

Proposed §ll.13(d) clarifies that a 

banking entity may acquire and retain 

an ownership interest in, or act as 

sponsor to, a covered fund that is an 

issuer of asset-backed securities, the 

assets or holdings of which are solely 

comprised of: (i) Loans; (ii) contractual 

rights or assets directly arising from 

those loans supporting the asset-backed 

securities; and (iii) a limited amount of 

interest rate or foreign exchange 

derivatives that materially relate to such 

loans and that are used for hedging 

purposes with respect to the 

securitization structure.64 The authority 

contained in this section of the 

proposed rule would therefore allow a 

banking entity to acquire and retain an 

ownership interest in a loan 

securitization vehicle (which would be 

a covered fund for purposes of section 

13(h)(2) of the BHC Act and the 

proposed rule) that the banking entity 

organizes and offers, or acts as sponsor 

to, in excess of the three percent limits 

specified in section 13(d)(4) of the BHC 

Act and § ll.12 of the proposed rule. 

Section ll.14 of the proposed rule 

implements section 13(d)(1)(J) of the 

BHC Act 65 and permits a banking entity 

to engage in any covered fund activity 

or investment that the CFTC and the 

Agencies determine promotes and 

protects the safety and soundness of 

banking entities and the financial 

stability of the United States.66 The 

CFTC has proposed to permit three 

activities at this time under this 

authority. These activities involve 

acquiring and retaining an ownership 

interest in, or acting as sponsor to, 

certain bank owned life insurance 

(‘‘BOLI’’) separate accounts, investments 

in and sponsoring of certain assetbacked securitizations, and investments 

in and sponsoring of certain entities that 

rely on the exclusion from the definition 

of investment company in section 

3(c)(1) and/or 3(c)(7) of the Investment 

Company Act of 1940 (15 U.S.C. 80a–1 

et seq.) (‘‘Investment Company Act’’) 

but that are, in fact, common corporate 

organizational vehicles.67 Additionally, 

the CFTC has proposed to permit a 

banking entity to acquire and retain an 

ownership interest in, or act as sponsor 

to, a covered fund, if such acquisition or 

retention is done (i) in the ordinary 

course of collecting a debt previously 

contracted, or (ii) pursuant to and in 

compliance with the conformance or 

extended transition periods 

implemented under section 13(c)(6) of 

the BHC Act.68

Section ll.15 of the proposed rule, 

which implements section 13(e)(1) of 

the BHC Act,69 requires a relevant 

banking entity engaged in covered fund 

activities and investments to comply 

with (i) the internal controls, reporting, 

and recordkeeping requirements 

required under §ll.20 and Appendix 

C of the proposed rule, as applicable 

and (ii) such other reporting and 

recordkeeping requirements as the 

CFTC may deem necessary to 

appropriately evaluate the banking 

entity’s compliance with subpart C.70

Section ll.16 of the proposed rule 

implements section 13(f) of the BHC Act 

and generally prohibits a banking entity 

from entering into certain transactions 

with a covered fund that would be a 

covered transaction as defined in 

section 23A of the FR Act.71 Section 

ll.16(a)(2) of the proposed rule 

clarifies that, for reasons explained in 

part III.C.7 of this SUPPLEMENTARY

INFORMATION, certain transactions 

between a banking entity and a covered 

fund remain permissible. Section 

ll.16(b) of the proposed rule 

implements the statute’s requirement 

that any transaction permitted under 

section 13(f) of the BHC Act (including 

a prime brokerage transaction) between 

the banking entity and a covered fund 

is subject to section 23B of the FR Act,72

which, in general, requires that the 

transaction be on market terms or on 

terms at least as favorable to the banking 

entity as a comparable transaction by 

the banking entity with an unaffiliated 

third party. 

Section ll.17 of the proposed rule 

prohibits a banking entity from relying 

on any exemption to the prohibition on 

acquiring and retaining an ownership 

interest in, acting as sponsor to, or 

having certain relationships with, a 

covered fund, if the permitted activity 

or investment would involve or result in 

a material conflict of interest, result in 

a material exposure to high-risk assets 

or high-risk trading strategies, or pose a 

threat to the safety and soundness of the 

banking entity or to the financial 

stability of the United States.73 This 

section also defines material conflict of 

interest, high-risk asset, and high-risk 

trading strategy for these purposes. 

D. Compliance Program Requirement 

Subpart D of the proposed rule 

requires a banking entity engaged in 

covered trading activities or covered 

fund activities to develop and 

implement a program reasonably 

designed to ensure and monitor 

compliance with the prohibitions and 

restrictions on covered trading activities 

and covered fund activities and 

investments set forth in section 13 of the 

BHC Act and the proposed rule.74


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investments, and which require the banking entity 

to develop and provide for the required compliance 

program prior to engaging in such activities or 

making such investments. 

75A banking entity must comply with the 

minimum standards specified in Appendix C of the 

proposed rule (i) with respect to its covered trading 

activities, if it engages in any covered trading 

activities and has, together with its affiliates and 

subsidiaries, trading assets and liabilities the 

average gross sum of which (on a worldwide 

consolidated basis), as measured as of the last day 

of each of the four prior calendar quarters, (X) is 

equal to or greater than $1 billion or (Y) equals 10 

percent or more of its total assets; and (ii) with 

respect to its covered fund activities and 

investment, if it engages in any covered fund 

activities and investments and either (X) has, 

together with its affiliates and subsidiaries, 

aggregate investments in covered funds the average 

value of which is, as measured as of the last day 

of each of the four prior calendar quarters, equal to 

or greater than $1 billion or (Y) sponsors and 

advises, together with its affiliates and subsidiaries, 

covered funds the average total assets of which are, 

as measured as of the last day of each of the four 

prior calendar quarters, equal to or greater than $1 

billion. 

76For purposes of the proposed rule, any 

securitization entity that meets the requirements for 

an exclusion under Rule 3a–7 or section 3(c)(5) of 

the Investment Company Act, or any other 

exclusion or exemption from the definition of 

‘‘investment company’’ under the Investment 

Company Act (other than sections 3(c)(1) or 3(c)(7) 

of the Investment Company Act), would not be a 

covered fund under the proposed definition. 

Additionally, an issuer of asset-backed securities 

that is subject to legal documents mandating 

compliance with the conditions of section 3(c)(1) of 

3(c)(7) of the Investment Company Act would not 

be a covered fund if such issuer also can satisfy all 

the conditions of an alternative exclusion or 

exemption for which it is eligible. 

77For example, under the proposed rule, a 

banking entity would be able to acquire or retain 

an interest or security of an issuer of asset-backed 

securities that is a covered fund if: (i) The interest 

or security of the issuer does not qualify as an 

‘‘ownership interest’’ under §ll.10(b)(3) of the 

proposed rule; (ii) the issuer of asset-backed 

securities is comprised solely of loans, contractual 

rights or assets directly arising from those loans, 

and certain specified interest rate or foreign 

exchange derivatives used for hedging purposes, as 

permitted under §ll.13(d) or ll.14(a)(2)(v) of 

the proposed rule; (iii) the banking entity is a 

‘‘securitizer’’ or ‘‘originator’’ and acquires and 

retains such interest in compliance with the 

minimum requirements of section 15G of the 

Exchange Act and any implementing regulations 

issued thereunder, as provided under 

§ll.14(a)(2)(iii) of the proposed rule; or (v) the 

banking entity organizes and offers the issuer and 

the ownership interest is a permitted investment 

under §ll.12 of the proposed rule. The 

circumstances where a banking entity may acquire 

or retain an ownership interest in a covered fund 

are discussed in detail in Part III.C of this 

SUPPLEMENTAL INFORMATION. 

78The definitions of ‘‘affiliate’’ and ‘‘subsidiary’’ 

are discussed in detail in Part III.A.2 of this 

Supplemental Information. 

Section ll.20(b) of the proposed rule 

specifies six elements that each 

compliance program established under 

subpart D must, at a minimum, include: 

• Internal written policies and 

procedures reasonably designed to 

document, describe, and monitor the 

covered trading activities and covered 

fund activities and investments of the 

banking entity to ensure that such 

activities comply with section 13 of the 

BHC Act and the proposed rule; 

• A system of internal controls 

reasonably designed to monitor and 

identify potential areas of 

noncompliance with section 13 of the 

BHC Act and the proposed rule in the 

banking entity’s covered trading and 

covered fund activities and to prevent 

the occurrence of activities that are 

prohibited by section 13 of the BHC Act 

and the proposed rule; 

• A management framework that 

clearly delineates responsibility and 

accountability for compliance with 

section 13 of the BHC Act and the 

proposed rule; 

• Independent testing for the 

effectiveness of the compliance 

program, conducted by qualified 

banking entity personnel or a qualified 

outside party; 

• Training for trading personnel and 

managers, as well as other appropriate 

personnel, to effectively implement and 

enforce the compliance program; and 

• Making and keeping records 

sufficient to demonstrate compliance 

with section 13 of the BHC Act and the 

proposed rule, which a relevant banking 

entity must promptly provide to the 

CFTC upon request and retain for a 

period of no less than 5 years. 

For a banking entity with significant 

covered trading activities or covered 

fund activities and investments, the 

compliance program must also meet a 

number of minimum standards that are 

specified in Appendix C of the proposed 

rule.75 The application of detailed 

minimum standards for these types of 

banking entities is intended to reflect 

the heightened compliance risks of large 

covered trading activities and covered 

fund activities and investments and to 

provide clear, specific guidance to such 

banking entities regarding the 

compliance measures that would be 

required for purposes of the proposed 

rule. For banking entities with smaller, 

less complex covered trading activities 

and covered fund activities and 

investments, these detailed minimum 

standards are not applicable, though the 

CFTC expects that such smaller entities 

will consider these minimum standards 

as guidance in designing an appropriate 

compliance program. 

E. Conformance Provisions 

Subpart E of the Board’s proposed 

rule, as set forth in the Joint Release, is 

not included in the proposed CFTC Rule 

because this Subpart E only applies to 

the Board. 

F. Treatment of Smaller, Less-Complex 

Banking Entities 

In formulating the proposed rule, the 

CFTC has carefully considered and 

taken into account the potential impact 

of the proposed rule on small banking 

entities and banking entities that engage 

in little or no covered trading activities 

or covered fund activities and 

investments, including the burden and 

cost that might be associated with such 

banking entities’ compliance with the 

proposed rule. In particular, the CFTC 

has proposed to reduce the effect of the 

proposed rule on such banking entities 

by limiting the application of certain 

requirements, such as the reporting and 

recordkeeping requirements of §ll.7 

and Appendix A of the proposed rule 

and the compliance program 

requirements contained in subpart D 

and Appendix C of the proposed rule, 

to those banking entities that engage in 

little or no covered trading activities or 

covered fund activities and investments. 

The CFTC also requested comment (i) 

throughout this SUPPLEMENTARY

INFORMATION on a number of questions 

related to the costs and burdens 

associated with particular aspects of the 

proposal, as well as (ii) in Part VII.B of 

this Supplementary Information on any 

significant alternatives that would 

minimize the impact of the proposal on 

small banking entities. 

G. Application of Section 13 of the BHC 

Act to Securitization Vehicles or Issuers 

of Asset-Backed Securities 

Many issuers of asset-backed 

securities may be included within the 

definition of covered fund since they 

would be an investment company but 

for the exclusions contained in section 

3(c)(1) or 3(c)(7) of the Investment 

Company Act.76 If an issuer of assetbacked securities is considered to be a 

covered fund, then a banking entity 

would not be permitted to acquire or 

retain any ownership interest issued by 

such issuer except as otherwise 

permitted under section 13 of the BHC 

Act and the proposed rule.77 Separately, 

issuers of asset-backed securities may be 

included within the definition of 

banking entity, as noted in Part III.A.2 

of this Supplementary Information. 

Although the proposed definition of 

banking entity would not include any 

entity that is a covered fund, an issuer 

of asset-backed securities that is both (i) 

an affiliate or subsidiary of a banking 

entity,78 and (ii) does not rely on an 

exclusion contained in section 3(c)(1) of 

3(c)(7) of the Investment Company Act, 

would be a banking entity and thus 

subject to the requirements of section 13 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
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79See proposed rule §ll.1(d). 

80See 12 U.S.C. 1851(c)(1). 

81See id. at 1851(c)(2)—(6). 

82See proposed rule §ll.1. 

83Note that each additional question asked by the 

CFTC in the CFTC Rule retains the same base 

question number as in the Joint Release (e.g. when 

the CFTC has included a question on whether 

question number 168 may be applicable to the 

CFTC, the new additional question is listed as 

question 168.1). 

84See proposed rule §ll.2(e). Sections 

ll.2(a) and (bb) of the proposed rule clarify that 

the terms ‘‘affiliate’’ and ‘‘subsidiary’’ have the 

same meaning as in sections 2(d) and (k) of the BHC 

Act (12 U.S.C. 1841(d) and (k)). 

of the BHC Act and the proposed rule, 

including: (i) the prohibition on 

proprietary trading; (ii) limitations on 

investments in and relationships with a 

covered fund; (iii) the establishment and 

implementation of a compliance 

program as required under the proposed 

rule; and (iv) recordkeeping and 

reporting requirements. Given the 

breadth of the definition of ‘‘affiliate,’’ 

these requirements may apply to a 

significant portion of the outstanding 

securitization market, including issuers 

of asset-backed securities that rely on 

rule 3a–7 or section 3(c)(5) of the 

Investment Company Act. 

In recognition of these concerns, the 

CFTC, similar to the Agencies in the 

Joint Rule, has requested comment 

throughout this SUPPLEMENTARY

INFORMATION on the potential effects of 

section 13 of the BHC Act and the 

proposed rule on the securitization 

industry and issuers of asset-backed 

securities. 

III. Section by Section Summary of 

Proposed Rule 

A. Subpart A—Authority and 

Definitions 

1. Section ll.1: Authority, Purpose, 

Scope, and Relationship to Other 

Authorities 

a. Authority and Scope 

Section ll.1 of the proposed rule 

describes the authority under which the 

CFTC is issuing the proposed rule, the 

purpose of the proposed rule, and the 

banking entities to which the CFTC’s 

rule applies. In addition, §ll.1(d) of 

the proposed rule implements section 

13(g)(1) of the BHC Act, which provides 

that the prohibitions and restrictions of 

section 13 apply to the activities of a 

banking entity regardless of whether 

such activities are authorized for a 

banking entity under other applicable 

provisions of law.79

b. Effective Date 

Section 13(c)(1) of the BHC Act 

provides that section 13 will take effect 

on the earlier of (i) 12 months after the 

date of issuance of final rules 

implementing that section, or (ii) 2 years 

after the date of enactment of section 13, 

which is July 21, 2012.80 Because the 

CFTC did not issue final rules 

implementing section 13 of the BHC Act 

by July 21, 2011, §ll.1 of the 

proposed rule specifies that the effective 

date for its provisions will be July 21, 

2012. 

The CFTC notes that the proposed 

effective date will impact not only the 

date on which the proposed rule’s 

prohibitions and restrictions on 

proprietary trading and covered fund 

activities and investments go into effect 

(subject to the conformance period or 

extended transition period provided by 

section 13(c) of the BHC Act),81 but also 

the date on which a banking entity must 

comply with (i) the reporting and 

recordkeeping requirements of §ll.7 

and Appendix A of the proposed rule 

and (ii) the compliance program 

mandate of §ll.20 and Appendix C of 

the proposed rule. As proposed, §ll.1 

would require a banking entity subject 

to either the reporting and 

recordkeeping or compliance program 

requirements to begin complying with 

these requirements as of July 21, 2012.82

With respect to the compliance program 

requirement of the proposed rule, 

§ ll.1 would require a banking entity 

to have developed and implemented the 

required program by the proposed 

effective date, though the CFTC notes 

that prohibited activities and 

investments may not be fully conformed 

by that date. The CFTC expects a 

banking entity to fully conform all 

investments and activities to the 

requirements of the proposed rule as 

soon as practicable within the 

conformance periods provided in 

section 13 of the BHC Act and the 

Board’s rules thereunder, which define 

the conformance periods. With respect 

to the reporting and recordkeeping 

requirements of the proposed rule, 

§ ll.1 of the proposed rule would 

require a banking entity to begin 

furnishing these reports for all trading 

units or asset management units as of 

the effective date, though the 

quantitative measurements furnished for 

proprietary trading activities that are 

conducted in reliance on the authority 

provided by the conformance period 

would not be used to identify prohibited 

proprietary trading until such time as 

the relevant trading activities must be 

conformed. 

The CFTC expects that a banking 

entity may need a period of time to 

prepare for effectiveness of the proposed 

rule and, in particular, to implement 

both the compliance program and the 

reporting and recordkeeping 

requirements provided under the 

proposed rule. Accordingly, in order to 

help assess the effects and impact of the 

proposed effective date and any 

alternative compliance dates, the CFTC 

requests comment on the following 

questions: 

Question 1. Does the proposed 

effective date provide banking entities 

with sufficient time to prepare to 

comply with the prohibitions and 

restrictions on proprietary trading and 

covered fund activities and 

investments? If not, what other period of 

time is needed and why? 83

Question 2. Does the proposed 

effective date provide banking entities 

with sufficient time to implement the 

proposal’s compliance program 

requirement? If not, what are the 

impediments to implementing specific 

elements of the compliance program 

and what would be a more effective 

time period for implementing each 

element and why? 

Question 3. Does the proposed 

effective date provide banking entities 

sufficient time to implement the 

proposal’s reporting and recordkeeping 

requirements? If not, what are the 

impediments to implementing specific 

elements of the proposed reporting and 

recordkeeping requirements and what 

would be a more effective time period 

for implementing each element and 

why? 

Question 4. Should the CFTC use a 

gradual, phased in approach to 

implement the statute rather than 

having the implementing rules become 

effective at one time? If so, what 

prohibitions and restrictions should be 

implemented first? Please explain. 

2. Section ll.2: Definitions 

Section ll.2 of the proposed rule 

defines a variety of terms used 

throughout the proposed rule, including 

‘‘banking entity,’’ which defines the 

scope of entities to which the proposed 

rule applies. Consistent with the 

statutory definition of that term, 

§ ll.2(e) of the proposed rule provides 

that a ‘‘banking entity’’ includes: (i) Any 

insured depository institution; (ii) any 

company that controls an insured 

depository institution; (iii) any company 

that is treated as a bank holding 

company for purposes of section 8 of the 

International Banking Act of 1978 (12 

U.S.C. 3106); and (iv) any affiliate or 

subsidiary of any of the foregoing.84 In 

addition, in order to avoid application 

of section 13 of the BHC Act in a way 

that appears unintended by the statute 

and would create internal 

inconsistencies in the statutory scheme, 


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85The CFTC notes that since the proposed rule 

implements section 13 of the BHC Act, it 

incorporates that Act’s definition of ‘‘affiliate’’ and 

‘‘subsidiary.’’ See proposed rule §§ll.2(a) and 

(bb). The terms affiliate and subsidiary are generally 

defined in section 2 of the BHC Act according to 

whether such entity controls or is controlled by 

another relevant entity. See 12 U.S.C. 1841(d), (k). 

The concept of control under the proposed rule, in 

turn, is as defined in section 2 of the BHC Act and 

as implemented by the Board. See 12 U.S.C. 

1841(a)(2); 12 CFR 225.2(e). 

86Under section 2 of the BHC Act and the Board’s 

Regulation Y (12 CFR part 225), a banking entity 

acting as general partner or managing member of 

another company would be deemed to control that 

company and, as such, the company would be both 

an ‘‘affiliate’’ and ‘‘subsidiary’’ of the banking entity 

for purposes of the BHC Act. See 12 U.S.C. 1841(d), 

(k). 

87See, e.g., 12 U.S.C. 1483(c)(6), (c)(8), and (k); 12 

CFR 225.28(b)(6), 225.86(b)(3). 

88See proposed rule §§ll.2(g), (v); 15 U.S.C. 

78c(a)(13), (14). 

89For purposes of this SUPPLEMENTAL

INFORMATION, ‘‘existing issuers of asset-backed 

securities’’ means issuers that issued asset-backed 

securities prior to the effective date of the proposed 

rule. 

90For purposes of this SUPPLEMENTAL

INFORMATION, ‘‘existing asset-backed securities’’ 

means asset-backed securities that were issued prior 

to the effective date of the proposed rule. 

the proposed rule also clarifies that the 

term ‘‘banking entity’’ does not include 

any affiliate or subsidiary of a banking 

entity, if that affiliate or subsidiary is (i) 

a covered fund, or (ii) any entity 

controlled by such a covered fund.85

This clarification is proposed because 

the definition of ‘‘affiliate’’ and 

‘‘subsidiary’’ under the BHC Act is 

broad, and could include a covered fund 

that a banking entity has permissibly 

sponsored or made an investment in 

because, for example, the banking entity 

acts as general partner or managing 

member of the covered fund as part of 

its permitted sponsorship activities.86 If 

such a covered fund were considered a 

‘‘banking entity’’ for purposes of the 

proposed rule, the fund itself would 

become subject to all of the restrictions 

and limitations of section 13 of the BHC 

Act and the proposed rule, which would 

be inconsistent with the purpose and 

intent of the statute. For example, such 

a covered fund would then generally be 

prohibited from investing in other 

covered funds, notwithstanding the fact 

that section 13(f)(3) of the BHC Act 

specifically contemplates such 

investments. Accordingly, the proposed 

rule would exclude from the definition 

of banking entity any fund that a 

banking entity may invest in or sponsor 

as permitted by the proposed rule. 

An entity such as a mutual fund 

would generally not be a subsidiary or 

affiliate of a banking entity under this 

definition if the banking entity only 

provides advisory or administrative 

services to, has certain limited 

investments in, or organizes, sponsors, 

and manages a mutual fund (which 

includes a registered investment 

company) in accordance with BHC Act 

rules.87

Section ll.2(j) of the proposed rule 

defines the term ‘‘covered banking 

entity,’’ which is used to describe the 

specific types of banking entities to 

which the CFTC’s rule applies. In 

addition, a number of other definitions 

contained in § ll.2 are discussed in 

further detail below in connection with 

the separate sections of the proposed 

rule in which they are used. 

The proposed rule also defines the 

terms ‘‘buy and purchase’’ and ‘‘sell and 

sale,’’ which are used throughout the 

proposed rule to describe the scope of 

transactions that are subject to subparts 

B and C of the proposed rule. These 

definitions are substantially similar to 

the definitions of the same terms under 

the Exchange Act, except that the 

proposed definitions provide additional 

clarity regarding the types of 

transactions that would be considered 

the purchase or sale of a commodity 

future or derivative or ownership 

interest in a covered fund.88 These 

definitions are purposefully broad in 

scope, and are intended to include a 

wide range of transaction types that 

would permit a banking entity to gain or 

eliminate, or increase or reduce, 

exposure to a covered financial position 

or ownership interest in a covered fund. 

Request for comment. 

The CFTC requests comment on the 

proposed rule’s definition of ‘‘banking 

entity.’’ In particular, the CFTC requests 

comment on the following questions: 

Question 5. Is the proposed rule’s 

definition of banking entity effective? 

What alternative definitions might be 

more effective in light of the language 

and purpose of the statute? 

Question 6. Are there any entities that 

should not be included within the 

definition of banking entity since their 

inclusion would not be consistent with 

the language or purpose of the statute or 

could otherwise produce unintended 

results? Should a registered investment 

company be expressly excluded from 

the definition of banking entity? Why or 

why not? 

Question 7. Is the proposed rule’s 

exclusion of a covered fund that is 

organized, offered and held by a 

banking entity from the definition of 

banking entity effective? Should the 

definition of banking entity be modified 

to exclude any covered fund? Why or 

why not? 

Question 8. Banking entities 

commonly structure their registered 

investment company relationships and 

investments such that the registered 

investment company is not considered 

an affiliate or subsidiary of the banking 

entity. Should a registered investment 

company be expressly excluded from 

the definition of banking entity? Why or 

why not? Are there circumstances in 

which such companies should be 

treated as banking entities subject to 

section 13 of the BHC Act? How many 

such companies would be covered by 

the proposed definition? 

Question 8.1. What is the best method 

for the CFTC and the other regulators to 

coordinate regarding the allocation of 

supervisory responsibilities under the 

proposed CFTC Rule? 

Question 9. Under the proposed rule, 

would issuers of asset-backed securities 

be captured by the proposed definition 

of ‘‘banking entity’’? If so, are issuers of 

asset-backed securities within certain 

asset classes particularly impacted? Are 

particular types of securitization 

vehicles (trusts, LLCs, etc.) more likely 

than others to be included in the 

definition of banking entity? Should 

issuers of asset-backed securities be 

excluded from the proposed definition 

of ‘‘banking entity,’’ and if so, why? 

How would such an exclusion be 

consistent with the language and 

purpose of the statute? 

Question 10. What would be the 

potential impact of including existing 

issuers of asset-backed securities 89 in 

the proposed definition of ‘‘banking 

entity’’ on existing issuers of assetbacked securities and the securitization 

market generally? How many existing 

issuers of asset-backed securities might 

be included in the proposed definition 

of ‘‘banking entity’’? Are there ways in 

which the proposed rule could be 

amended to mitigate or eliminate 

potential impact, if any, on existing 

asset-backed securities 90 without 

compromising the intent of the statute? 

Question 11. What would be the legal 

and economic impact to an issuer of 

asset-backed securities of being 

considered a ‘‘banking entity’’? What 

additional costs would be incurred in 

the establishment and implementation 

of a compliance program related to the 

provisions of the proposed rule as 

required by §ll.20 of the proposed 

rule (including Appendix C, where 

applicable)? Who would pay those 

additional costs? 

Question 12. If the ownership 

requirement under the proposed rule for 

credit risk retention (section 15G of the 

Exchange Act) combined with the 

control inherent in the position of 

servicer or investment manager means 

that more securitization vehicles would 

be considered affiliates of banking 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8342 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

91See proposed rule §ll.3(b)(1). 

92See 12 U.S.C. 1851(h)(4); see also proposed rule 

§ll.3(b)(1). Although the statutory definition 

refers to the ‘‘purchase, sale, acquisition, or 

disposition of’’ covered financial positions, the 

proposed rule uses the simpler terms ‘‘purchase’’ 

and ‘‘sale,’’ which are defined broadly in 

§§ll.2(g) and (v) of the proposed rule. 93See 12 U.S.C. 1851(h)(6). 94The CFTC notes that the structure of the 

proposed definition, which defines a trading 

account by reference to the positions that the 

account is used to acquire or take, is consistent with 

the structure of the statutory language used in 

section 13(h)(6) of the BHC Act. 

95See proposed rule §ll.3(b)(2)(i)(A). 

96See proposed rule §ll.3(b)(2)(i)(B). 

97See proposed rule §l.3(b)(2)(i)(C). 

entities, would fewer banking entities be 

willing to (i) serve as the servicer or 

investment manager of securitization 

transactions and/or (ii) serve as the 

originator or securitizer (as defined in 

section 15G of the Exchange Act) of 

securitization transactions? What other 

impact might the potential interplay 

between these rules have on future 

securitization transactions? Could there 

be other potential unintended 

consequences? 

Question 13. Are the proposed rule’s 

definitions of buy and purchase and sale 

and sell appropriate? If not, what 

alternative definitions would be more 

appropriate? Should any other terms be 

defined? If so, are there existing 

definitions in other rules or regulations 

that could be used in this context? Why 

would the use of such other definitions 

be appropriate? 

B. Subpart B—Proprietary Trading 

Restrictions 

1. Section ll.3: Prohibition on 

Proprietary Trading 

Section ll.3 of the proposed rule 

describes the scope of the prohibition 

on proprietary trading and defines a 

number of terms related to proprietary 

trading. The CFTC notes that the 

definition of ‘‘proprietary trading’’ in 

the statute and under the proposed rule 

is broad. This definition must be viewed 

in light of the exemptions described 

later in the proposed rule, which reflect 

statutory provisions permitting a 

number of activities. 

a. Prohibition on Proprietary Trading 

Section ll.3(a) of the proposed rule 

implements section 13(a)(1)(A) of the 

BHC Act and prohibits a banking entity 

from engaging in proprietary trading 

unless otherwise permitted under 

§§ ll.4 through ll.6 of the proposed 

rule. Section ll.3(b)(1) of the 

proposed rule defines proprietary 

trading in accordance with section 

13(h)(4) of the BHC Act.91 This 

definition is a key element of the 

proposal because, unless an activity 

covered by the definition is specifically 

permitted under one of the exemptions 

contained in §§ll.4 through ll.6 of 

the proposed rule, a banking entity is 

prohibited from engaging in that 

activity. Specifically, the proposal 

largely restates the statutory definition 

of proprietary trading, defining that 

term to mean engaging in the purchase 

or sale of one or more covered financial 

positions as principal for the trading 

account of the banking entity.92 The 

terms ‘‘trading account’’ and ‘‘covered 

financial position’’ are defined in 

§§ ll.3(b)(2) and ll.3(b)(3) of the 

proposed rule, respectively. The 

proposed definition of proprietary 

trading also clarifies that proprietary 

trading does not include acting as agent, 

broker, or custodian for an unaffiliated 

third party, because acting in these 

types of capacities does not involve 

trading as principal, which is one of the 

requisite aspects of the statutory 

definition. 

b. ‘‘Trading Account’’ 

i. Definition of ‘‘Trading Account’’ 

Section 13(h)(6) of the BHC Act 

defines the term ‘‘trading account’’ as 

‘‘any account used for acquiring or 

taking positions in securities [or other 

enumerated instruments] principally for 

the purpose of selling in the near-term 

(or otherwise with the intent to resell in 

order to profit from short-term price 

movements),’’ as well as any such other 

accounts that the CFTC by rule 

determine.93 As an initial matter, the 

CFTC notes that it is often difficult to 

clearly identify the purpose for which a 

position is acquired or taken and 

whether that purpose is short-term in 

nature, particularly since identification 

of that purpose generally depends on 

the intent with which the position is 

acquired or taken. Moreover, the statute 

does not define the terms ‘‘near-term’’ or 

‘‘short-term’’ for these purposes. 

In implementing the statutory 

definition of trading account, the 

proposed rule generally restates the 

statutory definition, with the addition of 

certain details intended to provide 

banking entities with greater clarity 

regarding the scope of positions that fall 

within the definition of trading 

account.94 The proposed definition of 

trading account has three prongs. First, 

under the proposed rule, a trading 

account includes any account that is 

used by a banking entity to acquire or 

take one or more covered financial 

positions for the purpose of: (i) Shortterm resale; (ii) benefitting from actual 

or expected short-term price 

movements; (iii) realizing short-term 

arbitrage profits; or (iv) hedging one or 

more such positions.95 Second, the 

proposed definition of trading account 

also includes any account used by a 

banking entity that is subject to the 

Market Risk Capital Rules to acquire or 

take one or more covered financial 

positions that are subject to those rules, 

other than certain foreign exchange and 

commodity positions.96 Third, the 

proposed definition of trading account 

also includes any account used by a 

banking entity that is a securities dealer, 

swap dealer, or security-based swap 

dealer to acquire or take positions in 

connection with its dealing activities.97

To provide additional clarity and 

guidance regarding the trading account 

definition, the proposed rule also 

includes a rebuttable presumption that 

any account used to acquire or take a 

covered financial position that is held 

for sixty days or less is a trading account 

under the first prong, unless the banking 

entity can demonstrate that the position 

was not acquired principally for shortterm trading purposes. The proposed 

definition also clarifies that no account 

will be a trading account to the extent 

that it is used to acquire or take certain 

positions under repurchase or reverse 

repurchase arrangements or securities 

lending transactions, positions for bona 

fide liquidity management purposes, or 

certain positions held by derivatives 

clearing organizations or clearing 

agencies. Each of the three definitional 

prongs is independent of the others— 

any one prong would, if met, cause the 

relevant account to fall within the 

definition of ‘‘trading account.’’ 

The CFTC has drawn on existing 

rules, in particular the Market Risk 

Capital Rules and various securities and 

commodities laws, in identifying 

trading accounts and defining related 

terms in the proposal. 

ii. Positions Acquired or Taken for 

Short-Term Trading Purposes 

The first prong of the proposed 

trading account definition refers to 

positions that a banking entity acquires 

or takes principally for short-term 

purposes—that is, for one of the 

following enumerated purposes 

described in §§ll.3(b)(2)(i)(A)(1) 

through (4) of the proposed rule: 

• Short-term resale; 

• Benefitting from actual or expected 

short-term price movements; 

• Realizing short-term arbitrage 

profits; or 

• Hedging one or more such 

positions. 

This prong reflects the statutory 

definition’s reference to positions 

acquired or taken ‘‘principally for the 


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98See 12 U.S.C. 1851(h)(6); see also proposed rule 

§ll.3(b)(2)(i). 

99See proposed rule §ll.3(b)(2)(i)(A)(1). 

100See proposed rule §ll.3(b)(2)(i)(A)(2). 

101See proposed rule §ll.3(b)(2)(i)(A)(3). 

102See proposed rule §ll.3(b)(2)(i)(A)(4). 

103The Federal banking agencies’ current Market 

Risk Capital Rules are located at 12 CFR 3, 

Appendix B (OCC), 12 CFR 208, Appendix E and 

12 CFR 225, Appendix E (Board), and 12 CFR 325, 

Appendix C (FDIC), and apply on a consolidated 

basis to banks and bank holding companies with 

trading activity (on a worldwide consolidated basis) 

that equals 10 percent or more of the institution’s 

total assets, or $1 billion or more. On January 11, 

2011, the Federal banking agencies proposed 

revisions to the Market Risk Capital Rules that 

include, inter alia, changes to the definition of 

covered position. Proposed revisions to the Market 

Risk Capital Rules include (i) changes to portions 

of the covered position definition not relevant to 

the statutory definition of trading account in section 

13 of the BHC Act and (ii) the addition of a 

requirement that any position in a trading account 

also be a ‘‘trading position’’ in order to be 

considered a covered position. See 76 FR 1890 (Jan. 

11, 2011). The revised definition of ‘‘trading 

position’’ that has been proposed for those purposes 

is generally identical to this proposed rule’s 

definition of trading account (i.e., a position 

acquired or taken: (i) For the purpose of short-term 

resale; (ii) with the intent of benefitting from actual 

or expected short-term price movements; (iii) to 

lock in short-term arbitrage profits; or (iv) to hedge 

another trading position). The CFTC also notes that 

the first prong of the proposed rule’s trading 

account definition is also substantially similar to 

the Basel Committee’s definition of ‘‘trading book.’’ 

See Basel Committee on Banking Supervision, 

Amendment to the Capital Accord to Incorporate 

Market Risks, available at http://bis.org/publ/ 

bcbs119.pdf. 

104The CFTC notes that the Market Risk Capital 

Rules, both in their current and proposed form, also 

(i) include within the definition of covered position 

other positions not captured by the reference to 

positions acquired for the purpose of short-term 

resale or with the intent of benefitting from actual 

or expected short-term price movements (e.g., all 

commodity and foreign exchange positions, 

Continued 

purpose of selling in the near-term (or 

otherwise with the intent to resell in 

order to profit from short-term price 

movements).’’ 98

Section ll.3(b)(2)(i)(A)(1) of the 

proposed rule’s definition of trading 

account includes covered financial 

positions acquired or taken principally 

for the purpose of short-term resale.99

This part of the trading account 

definition restates language contained in 

the statutory definition of trading 

account and describes one class of 

positions that are acquired or taken for 

short-term trading purposes. 

Section ll.3(b)(2)(i)(A)(2) of the 

proposed rule includes covered 

financial positions acquired or taken 

principally for the purpose of 

benefitting from actual or expected 

short-term price movements.100 This 

part of the trading account definition 

does not require the resale of the 

position; rather, it requires only an 

intent to engage in any form of 

transaction on a short-term basis 

(including a transaction separate from, 

but related to, the initial acquisition of 

the position) for the purpose of 

benefitting from a short-term movement 

in the price of the underlying position. 

This part of the proposed definition 

would, for example, include a derivative 

or other position where the banking 

entity enters into (or intends to enter 

into) a subsequent transaction in the 

near-term to simply offset or ‘‘close 

out,’’ rather than sell, all or a portion of 

the risks of the initial position, in order 

to benefit from a price movement 

occurring between the acquisition of the 

underlying position and the subsequent 

offsetting transaction. Similarly, it 

would also include a derivative, 

commodity future, or other position 

that, regardless of the term of that 

position, is subject to the exchange of 

short-term variation margin through 

which the banking entity intends to 

benefit from short-term price 

movements. The proposed definition 

would also capture the acquisition of a 

debt instrument where the banking 

entity intends to enter into a short-term 

transaction to simply offset, rather than 

sell, the credit, interest rate and/or other 

material risk elements of the initial 

position so as to benefit from a price 

movement occurring between 

acquisition of the underlying position 

and the subsequent offsetting 

transaction. 

Section ll.3(b)(2)(i)(A)(3) of the 

proposed rule’s definition of trading 

account includes covered financial 

positions acquired or taken principally 

to lock in short-term arbitrage profits.101

Although similar to the positions 

described in §ll.3(b)(2)(i)(A)(2) of the 

proposed definition (i.e., those acquired 

for the purpose of benefitting from 

actual or expected short-term price 

movements), this part of the definition 

focuses on short-term arbitrage profits 

more generally, without regard to 

whether the transaction is predicated on 

expected or actual movements in price. 

Rather, a position acquired to lock in 

arbitrage profits would include 

positions acquired or taken with the 

intent to benefit from differences in 

multiple market prices, even in cases in 

which no movement in those prices is 

necessary to realize the intended profit. 

Such arbitrage-based transactions might 

involve profiting from the difference in 

the market price of multiple related 

positions or assets, or might instead 

involve the difference in market price 

for particular price or risk elements 

associated with positions or assets. This 

would include, for example, arbitrage 

profits resulting from the convergence 

or divergence in prices between 

different positions held by a banking 

entity engaged in relative value 

convergence arbitrage, which involves 

marrying a long and short position to 

benefit from a convergence or 

divergence in price between the two, or 

any similar strategy, because such 

convergence or divergence could 

happen at any time (i.e., in one day, in 

sixty-one days, or some other time 

period). 

Section ll.3(b)(2)(i)(A)(4) of the 

proposed rule’s definition of trading 

account includes covered financial 

positions acquired or taken for the 

purpose of hedging another position 

that is itself held in a trading 

account.102 In particular, the CFTC 

assumes that, with respect to any 

position the purpose of which is to 

hedge another covered financial 

position in the trading account, the 

banking entity generally intends to hold 

the hedging position, whatever its 

nominal duration, for only so long as 

the underlying position is held. 

Accordingly, the proposed rule makes 

clear that such hedging positions fall 

within the definition of trading account. 

iii. Overview of Current Market Risk 

Capital Rules Approach to Short-Term 

Trading Positions 

The first prong of the proposed 

trading account definition, which 

references positions acquired 

principally for short-term trading 

purposes, is, like the statutory definition 

it implements, substantially similar to a 

key portion of the definition of a 

‘‘covered position’’ under the Market 

Risk Capital Rules.103 For the reasons 

discussed below, the CFTC has taken 

this similarity into account and propose 

to construe the first prong of the 

definition of trading account under the 

proposed rule—and in particular its 

reference to ‘‘short-term’’—in a manner 

that is consistent with the Market Risk 

Capital Rules’ approach to identifying 

positions taken with short-term trading 

intent. 

The Market Risk Capital Rules define 

a covered position to include all 

positions in a bank’s ‘‘trading account,’’ 

as that term is defined, in part, in the 

Report of Condition and Income that 

banks are required to file periodically 

with respect to their financial condition 

(‘‘Call Report’’). Under the Market Risk 

Capital Rules, a covered position is one 

that is subject to a risk-based capital 

charge that is based, at least in part, on 

the banking organization’s internal risk 

management models for purposes of 

calculating the banking organization’s 

risk-based capital requirement.104 In 


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regardless of the intended holding period) and (ii) 

exclude from that definition certain positions 

otherwise acquired with short-term trading intent 

for a variety of policy reasons. The CFTC has not 

proposed to incorporate such inclusions or 

exclusions for purposes of the proposed rule’s 

definition of trading account; rather, the Market 

Risk Capital Rules and related concepts have been 

referred to only to the extent that they pertain to 

positions acquired for the purpose of short-term 

resale or with the intent of benefitting from actual 

or expected short-term price movements. 

105Report of Condition and Income at A78a (also 

including, in the definition of ‘‘trading account,’’ 

‘‘regularly underwriting or dealing in securities; 

interest rate, foreign exchange rate, commodity, 

equity, and credit derivative contracts; other 

financial instruments; and other assets for resale 

* * * and * * * acquiring or taking positions in 

such items as an accommodation to customers or 

for other trading purposes.’’). Accordingly, given its 

broader scope, the Call Report ‘‘trading account’’ 

includes trading positions that fall outside the 

statutory ‘‘trading account’’ for purposes of 

determining what is prohibited and permitted 

covered trading activity under section 13 of the 

BHC Act. 

106See Report of Condition and Income at A78a, 

referring to ASC Topic 320, Investments-Debt and 

Equity Securities (formerly FASB Statement of 

Financial Accounting Standards No. 115, 

‘‘Accounting for Certain Investments in Debt and 

Equity Securities’’). 

107See id. In formulating the proposed rule, the 

CFTC carefully considered whether to define 

trading account for purposes of the proposed rule 

in a manner that formally incorporated the 

accounting standards governing trading securities. 

The CFTC has not proposed this approach because: 

(i) The statutory proprietary trading prohibition 

under section 13 of the BHC Act applies to financial 

instruments, such as derivatives, to which the 

trading security accounting standards may not 

apply; (ii) these accounting standards permit 

companies to classify, at their discretion, assets as 

trading securities even where the assets would not 

otherwise meet the definition of trading security; 

and (iii) these accounting standards could change 

in the future without consideration of the potential 

impact on section 13 of the BHC Act. 

108See FASB ASC Master Glossary definition of 

‘‘trading.’’ Although §ll.3(b)(2)(ii) of the 

proposed rule includes a rebuttable presumption 

that an account used to acquire or take certain 

covered financial positions that are held for 60 days 

or less is a trading account, the CFTC notes that 

U.S. GAAP does not include a presumption that 

securities sold within 60 days of acquisition were 

held for the purpose of selling them in the near 

term. 

109The CFTC has excluded positions that are 

foreign exchange derivatives, commodity 

derivatives, or contracts of sale of a commodity for 

future delivery from this prong of the proposed 

trading account definition because all foreign 

exchange and commodity positions are considered 

‘‘covered positions’’ under the Market Risk Capital 

Rules regardless of whether they involve the shortterm trading intent required under the statutory 

definition of trading account in section 13(h)(6) of 

the BHC Act. 

110See proposed rule §ll.3(c)(8). Accordingly, 

in the context of a subsidiary of a bank holding 

company (other than a subsidiary, such as a bank, 

to which a market risk capital rule is already 

directly applicable), if that bank holding company 

is subject to a market risk capital rule, any position 

of that subsidiary that meets the definition of a 

‘‘covered position’’ under the market risk capital 

rule applicable to the bank holding company would 

be subject to §ll.3(b)(2)(i)(B) of the proposed 

rule. 

defining the term ‘‘trading account,’’ the 

Call Report notes that trading activities 

typically include, among other 

activities, ‘‘acquiring or taking positions 

in such items principally for the 

purpose of selling in the near-term or 

otherwise with the intent to resell in 

order to profit from short-term price 

movements.’’ 105 This language is 

substantially identical to the statutory 

definition of trading account in section 

13 of the BHC Act in that it refers to 

acquiring or taking positions (i) 

principally for the purpose of selling in 

the near-term or (ii) otherwise with the 

intent to resell in order to profit from 

short-term price movements. 

In providing guidance regarding the 

application of ‘‘trading account,’’ the 

Call Report also states that trading 

account positions include any position 

that is classified as ‘‘trading securities’’ 

under relevant U.S. Generally Accepted 

Accounting Principles (‘‘GAAP’’) 

standards for accounting.106 Under the 

referenced accounting standards, 

trading securities are defined as those 

‘‘that are bought and held principally 

for the purpose of selling them in the 

near-term’’ and ‘‘generally used with the 

objective of generating profits on shortterm differences in price.’’ 107 The CFTC 

notes that the definition of a trading 

security under the relevant U.S. GAAP 

accounting standards is similar to both 

(i) the financial positions described in 

the second prong of the Call Report’s 

definition of trading account and (ii) the 

financial positions described in the 

statutory definition of trading account 

under section 13 of the BHC Act. 

Although neither the Market Risk 

Capital Rules, the Call Report, nor 

relevant accounting standards provide a 

precise definition of what constitutes 

‘‘near-term’’ or ‘‘short-term’’ for 

purposes of evaluating whether a 

position is of the type held in a trading 

account or is a trading security, 

guidance provided under relevant 

accounting standards notes that ‘‘nearterm’’ for purposes of classifying trading 

activities is ‘‘generally measured in 

hours and days rather than months or 

years.’’ 108 The CFTC expects that the 

precise period of time that may be 

considered near-term or short-term for 

purposes of evaluating any particular 

covered financial position would 

depend on a variety of factors, including 

the facts and circumstances of the 

covered financial position’s acquisition, 

the banking entity’s trading and 

business strategies, and the nature of the 

relevant markets. In considering the 

purpose for which a covered financial 

position is acquired or taken and 

evaluating whether such position is 

acquired or taken for short-term 

purposes, the CFTC intends to rely on 

a variety of information, including 

quantitative measurements of banking 

entities’ covered trading activities (as 

described below in Part II.B.5 of this 

SUPPLEMENTARY INFORMATION), 

supervisory review of banking entities’ 

compliance practices and internal 

controls, and supervisory review of 

individual transactions. 

In order to better reinforce the general 

consistency between the proposal’s 

approach to defining a trading account 

and the ‘‘trading account’’ concept 

embedded in the Market Risk Capital 

Rules, the second prong of the proposed 

definition of trading account, contained 

in §ll.3(b)(2)(i)(B) of the proposed 

rule, provides that a trading account 

includes any account used to acquire or 

take one or more covered financial 

positions, other than positions that are 

foreign exchange derivatives, 

commodity derivatives, or contracts of 

sale of a commodity for future delivery 

(unless the position is otherwise held 

with short-term intent), that are also 

market risk capital rule covered 

positions, if the banking entity, or any 

affiliate of the banking entity that is a 

bank holding company, calculates riskbased capital ratios under the Market 

Risk Capital Rules.109 For these 

purposes, a ‘‘market risk capital rule 

covered position’’ is defined as any 

covered position as that term is defined 

for purposes of (i) in the case of a 

banking entity that is a bank holding 

company or insured depository 

institution, the market risk capital rule 

that is applicable to the banking entity, 

and (ii) in the case of a banking entity 

that is affiliated with a bank holding 

company, other than a banking entity to 

which a market risk capital rule is 

applicable, the market risk capital rule 

that is applicable to the affiliated bank 

holding company.110 In particular, for 

banking entities already subject to the 

Market Risk Capital Rules, it appears 

that positions subject to trading account 

treatment under those rules because 

they involve short-term trading intent 

are generally the type of positions to 

which the proprietary trading 

restrictions of section 13 of the BHC Act 

were intended to apply. In addition, 

including all covered financial positions 

that receive trading account treatment 

under the Market Risk Capital Rules 

because they meet a nearly identical 

standard regarding short-term trading 

intent would also eliminate the 

potential for inconsistency or regulatory 

arbitrage in which a banking entity 

might characterize a position as 


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111 In particular, the CFTC notes that under the 

proposed revisions to the Market Risk Capital 

Rules, but not the existing Market Risk Capital Rule, 

the term ‘‘covered position’’ expressly includes, 

other than with respect to commodity and foreign 

exchange positions, only positions taken with shortterm trading intent. See 76 FR 1890 (Jan. 11, 2011). 

The CFTC does not intend to incorporate ‘‘covered 

positions’’ under the Market Risk Capital Rules in 

a way that includes positions lacking short-term 

trading intent. 

112See 15 U.S.C. 78c(a)(42)(E); 15 U.S.C. 78o– 

5(a)(1)(B); 17 CFR 400.5(b); 17 CFR 449.1. Section 

15C(a)(1)(A) of the Exchange Act requires any 

government securities dealer, other than a 

registered broker-dealer or a financial institution, to 

register with the SEC pursuant to section 15C(a)(2). 

Registered broker-dealers and financial institutions 

are required to file written notice with their 

appropriate regulatory agency, as defined in section 

3(a)(34) of the Exchange Act, prior to acting as a 

government securities dealer. See 15 U.S.C. 78o– 

5(a)(1)(B). The proposed definition of trading 

account would cover positions of all three forms of 

government securities dealers: (i) those registered 

with the SEC; (ii) registered broker-dealers; and (iii) 

financial institutions that have filed notice with an 

appropriate regulatory agency. 

113See proposed rule §ll.3(b)(2)(i)(C)(1)–(4). 

The CFTC emphasizes that this provision applies 

only to positions taken in connection with the 

activities that require the banking entity to be 

registered as one of the listed categories of dealer, 

not to all of the activities of that banking entity. For 

example, an insured depository institution may be 

registered as a swap dealer, but only the swap 

dealing activities that require it to be so registered 

would be covered by the second prong of the 

trading account definition. A position taken in 

connection with other activities of the insured 

depository institution that do not trigger registration 

as a swap dealer, such as lending, deposit-taking, 

the hedging of business risks, or other end-user 

activity, would only be included within the trading 

account if the position met one of the other prongs 

of the trading account definition (i.e., 

§§ll.3(b)(2)(i)(A) or (B) of the proposed rule). 

114See proposed rule §ll.3(b)(2)(i)(C)(5). 115See proposed rule §ll.3(b)(2)(ii). 

‘‘trading’’ for capital purposes but not 

for purposes of the proposed rule. 

The CFTC emphasizes that this 

second prong of the trading account 

definition is being proposed in 

contemplation of the proposed revisions 

to the Market Risk Capital Rules and, in 

particular, the proposed definition of 

‘‘covered position’’ under those 

proposed revisions. To the extent that 

those proposed revisions with respect to 

the definition of ‘‘covered position’’ are 

not adopted, or adopted in a form other 

than as proposed, the CFTC would 

expect to take that into account in 

determining whether or how to include 

the proposed second prong of the 

trading account definition for purposes 

of the final rule to implement section 13 

of the BHC Act. 111

iv. Positions Acquired or Taken by 

Securities Dealers, Swap Dealers, and 

Security-Based Swap Dealers 

The third prong of the proposed 

definition of trading account is 

contained in § ll.3(b)(2)(i)(C) of the 

proposed rule and provides that a 

trading account includes any account 

used to acquire or take one or more 

covered financial positions by a banking 

entity that is: (i) A SEC-registered 

securities or municipal securities dealer; 

(ii) a government securities dealer that 

registered, or that has filed notice, with 

an appropriate regulatory agency; 112

(iii) a CFTC-registered swap dealer; or 

(iv) a SEC-registered security-based 

swap dealer, in each case to the extent 

that the covered financial position is 

acquired or taken in connection with 

the activities that require the banking 

entity to be registered, or to file notice, 

as such.113 Similarly included is any 

covered financial position acquired or 

taken by a banking entity that is engaged 

in the business of a dealer, swap dealer, 

or security-based swap dealer outside of 

the United States, if such position is 

acquired or taken in connection with 

the activities of such business.114 As a 

result of this third prong, all covered 

financial positions acquired or taken by 

a registered dealer, swap dealer or 

security-based swap dealer, a 

government securities dealer that has 

filed notice with an appropriate 

regulatory agency, or a banking entity 

engaged in the same type of dealing 

activities outside the United States, are 

automatically included within the scope 

of positions described in the trading 

account definition, if they are acquired 

or taken in connection with the 

activities that require the banking entity 

to be registered, or file notice, as such 

(or, in the case of a banking entity 

engaged in the business of a dealer, 

swap dealer, or security-based swap 

dealer outside of the United States, in 

connection with the activities of such 

business). As discussed below, the 

proposed rule contains exemptions that 

permit a variety of covered trading 

activity in which these types of entities 

typically engage, notwithstanding the 

inclusion of all covered financial 

positions of such entities within the 

definition of trading account. 

The CFTC has proposed this third 

prong of the trading account definition 

because all assets or other positions 

held by firms that register or file notice 

as securities or derivatives dealers as 

part of their dealing activity are 

generally held for sale to customers 

upon request or otherwise support the 

firm’s trading activities (e.g., by hedging 

its dealing positions), and so would 

appear to involve the requisite shortterm intent and be captured within the 

statutory definition of trading account. 

To the extent that a covered financial 

position is acquired or taken by such a 

banking entity outside the scope of the 

dealing activities that require the 

banking entity to be registered, or to file 

notice, as a dealer, swap dealer, or 

security-based swap dealer, that 

position may still cause the relevant 

account to be a trading account under 

the proposed rule if the account holding 

such a position otherwise meets the 

terms of the first or second prong of the 

trading account definition (i.e., 

positions acquired or taken for shortterm trading purposes or certain Market 

Risk Capital Rules positions). 

v. Rebuttable Presumption for Certain 

Positions 

In order to provide greater clarity and 

guidance on the application of the 

trading account definition, and in 

particular for those banking entities 

with no experience in evaluating shortterm trading intent or that are not 

subject to the Market Risk Capital Rules, 

the proposed rule also includes a 

rebuttable presumption regarding 

certain positions that, by reason of their 

holding period, are presumed to be 

trading account positions. In particular, 

§ ll.3(b)(2)(ii) of the proposed rule 

provides that an account would be 

presumed to be a trading account if it is 

used to acquire or take a covered 

financial position, other than dealing 

positions or certain Market Risk Capital 

Rules covered positions that are 

automatically considered part of the 

trading account, that the banking entity 

holds for a period of sixty days or less. 

However, the presumption does not 

apply if the banking entity can 

demonstrate, based on all the facts and 

circumstances, that the covered 

financial position, either individually or 

as a category, was not acquired or taken 

principally for the purpose of short-term 

resale, benefitting from short-term price 

movements, realizing short-term 

arbitrage profits, or hedging another 

trading account position.115 Because it 

appears likely that most positions held 

for sixty days or less would have been 

acquired with short-term trading intent, 

the proposal presumes such positions 

are trading account positions unless the 

banking entity can demonstrate 

otherwise. The purpose of the proposed 

rebuttable presumption is to simplify 

the process of evaluating whether 

individual positions are included in the 

definition of trading account. The 

proposal does not apply this rebuttable 

presumption to positions described in 

§ ll.3(b)(2)(i)(B) or (C) of the proposed 

rule (i.e., certain Market Risk Capital 

Rules positions and dealing positions), 

because these positions are 

automatically part of the trading 

account, and cannot be rebutted. 


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116 In such cases, the documented intention for 

acquiring or taking the position should be 

consistent with the intention articulated for 

financial reporting and other purposes. 

However, the CFTC recognizes that, 

for a variety of reasons, a banking entity 

may acquire a covered financial position 

for purposes other than short-term 

trading but nonetheless dispose of that 

position within the sixty-day period 

covered by the presumption. 

Accordingly, §ll.3(b)(2)(ii) is only a 

presumption, and may be rebutted by 

reference to all the facts and 

circumstances surrounding the 

acquisition of a particular position. For 

example, if a banking entity acquired a 

covered financial position with the 

demonstrable intent of holding it for 

investment or other non-trading 

purposes but, because of developments 

not expected or anticipated at the time 

of acquisition (e.g., increased customer 

demand, an unexpected increase in its 

volatility or a need to liquidate the 

position to meet unexpected liquidity 

demands), held it for less than sixty 

days, those facts and circumstances 

would generally suggest that the 

position was not acquired with shortterm trading intent, notwithstanding the 

presumption.116 The proposed rule also 

makes clear that this rebuttal may be 

made not only with respect to a 

particular transaction, but also with 

respect to a particular category of 

transactions, recognizing that it may be 

possible to identify a category of similar 

transactions that clearly do not involve 

short-term trading, notwithstanding the 

typical holding period of the related 

positions. 

It is important to note that these 

presumptions are designed to help 

determine whether a transaction is 

within the definition of ‘‘proprietary 

trading,’’ not whether a transaction is 

permissible under section 13 of the BHC 

Act. A transaction may fall within the 

definition of ‘‘proprietary trading’’ and 

yet be permissible if it meets one of the 

exemptions provided in the proposed 

rule, such as the exemption for market 

making-related activities. 

vi. Request for Comment 

The CFTC requests comment on the 

proposed rule’s approach to defining 

trading account. In particular, the CFTC 

requests comment on the following 

questions: 

Question 14. Is the proposed rule’s 

definition of trading account effective? 

Is it over- or under-inclusive in this 

context? What alternative definition 

might be more effective in light of the 

language and purpose of the statute? 

How would such definition better 

identify the accounts that are intended 

to be covered by section 13 of the BHC 

Act? 

Question 14.1. Should the CFTC 

Rule’s proposed definition of trading 

account include: (i) §ll.3(b)(2)(i)(B), 

relating to Federal Banking Agencies’ 

Market Risk Capital Rules; or (ii) 

§§ ll.3(b)(2)(i)(C)(1),(2) and/or (4), 

relating to SEC registered dealers and 

dealers who have filed notice with the 

appropriate regulatory agency? Please 

explain the rationale for including or 

excluding the provisions in the 

proposed CFTC Rule. 

Question 15. Is the proposed rule’s 

approach for determining when a 

position falls within the definition of 

‘‘trading account’’ for purposes of the 

proposed rule from when it must be 

reported in the ‘‘trading account’’ for 

purpose of filing the Call Report 

effective? What additional guidance 

could the CFTC provide on this 

distinction? Are there alternative 

approaches that would be more effective 

in light of the language and purpose of 

the statute? Is this approach workable 

for affiliates of bank holding companies 

that are not subject to the Federal 

banking agencies’ Market Risk Capital 

Rules (e.g., affiliated investment 

advisers)? If not, why not? Are affiliates 

of bank holding companies familiar 

with the concepts from the Market Risk 

Capital Rules that are being 

incorporated into the proposed rule? If 

not, what steps would an affiliate of a 

bank holding company have to take to 

become familiar with these concepts 

and what would be the costs and/or 

benefits of such actions? Is application 

of the trading account concept from the 

Federal banking agencies’ Market Risk 

Capital Rules to affiliates of bank 

holding companies necessary to 

promote consistency and prevent 

regulatory arbitrage? Please explain. 

Question 16. Is the manner in which 

the CFTC intends to take into account, 

and substantially adopt, the approach 

used in the Market Risk Capital Rules 

and related concepts for determining 

whether a position is acquired with 

short-term trading intent effective? 

Question 17. Should the proposed 

rule’s definition of trading account, or 

its use of the term ‘‘short-term,’’ be 

clarified? Are there particular 

transactions or positions to which its 

application would be unclear? Should 

the proposed rule define ‘‘short-term’’ 

for these purposes? What alternative 

approaches to construing the term 

‘‘short-term’’ should the CFTC consider 

and/or adopt? 

Question 18. Are there particular 

transactions or positions to which the 

application of the proposed definition of 

trading account is unclear? Is additional 

regulatory language, guidance, or clarity 

necessary? 

Question 19. Is the exchange of 

variation margin as a potential indicator 

of short-term trading in derivative or 

commodity future transactions 

appropriate for the definition of trading 

account? How would this impact such 

transactions or the manner by which 

banking entities conduct such 

transactions? For instance, would 

banking entities seek to avoid the use of 

variation margin to avoid this rule? 

What are the costs and benefits of 

referring to the exchange of variation 

margin to determine if positions should 

be included in a banking entity’s trading 

account? Please explain. 

Question 20. Are there particular 

transactions or positions that are 

included in the definition of trading 

account that should not be? If so, what 

transactions or positions and why? 

Question 21. Are there particular 

transactions or positions that are not 

included in the definition of trading 

account that should be? If so, what 

transactions or positions and why? 

Question 22. Is the proposed rule of 

construction for positions acquired or 

taken by dealers, swap dealers and 

security-based swap dealers appropriate 

and consistent with the purpose and 

language of section 13 of the BHC Act? 

Is its application to any particular type 

of entity, such as an insured depository 

institution engaged in derivatives 

dealing activities, sufficiently clear and 

effective? If not, what alternative would 

be clearer and/or more effective? 

Question 23. Is the rebuttable 

presumption included in the proposed 

rule appropriate and effective? Are there 

more effective ways in which to provide 

clarity regarding the determination of 

whether or not a position is included 

within the definition of trading account? 

If so, what are they? 

Question 24. Are records currently 

created and retained that could be used 

to demonstrate investment or other nontrading purposes in connection with 

rebutting the presumption in the 

proposed rule? If yes, please identify 

such records and explain when they are 

created and whether they would be 

useful in connection with a single 

transaction or a category of similar 

transactions. If no, we seek commenter 

input regarding the manner in which 

banking entities might demonstrate 

investment or other non-trading intent. 

Should the CFTC require banking 

entities to create and keep records to 

demonstrate investment or non-trading 

intent with respect to their covered 

financial positions? 


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117See proposed rule §ll.3(b)(2)(iii)(A). 

118See proposed rule §l.3(b)(2)(iii)(B). The 

language describing securities lending transactions 

in the proposed rule generally mirrors that 

contained in Rule 3a5–3 under the Exchange Act. 

See 17 CFR 240.3a5–3. 119See proposed rule §ll.3(b)(2)(iii)(C). 

Question 25. How should the 

proposed trading account definition 

address arbitrage positions? Should all 

arbitrage positions be included in the 

definition of trading account, unless the 

timing of such profits is long-term and 

established at the time the arbitrage 

position is acquired or taken? Please 

explain in detail, including a discussion 

of different arbitrage trading strategies 

and whether subjecting such strategies 

to the proposed rule would be 

consistent with the language and 

purpose of section 13 of the BHC Act. 

Question 26. Is the holding period 

referenced in the rebuttable 

presumption appropriate? If not, what 

holding period would be more 

appropriate, and why? 

Question 27. Should the proposed 

rule include a rebuttable presumption 

regarding positions that are presumed 

not to be within the definition of trading 

account? If so, why, and what would the 

presumption be? 

Question 28. Should any additional 

accounts be included in the proposed 

rule pursuant to the authority granted 

under section 13(h)(6) of the BHC Act? 

If so, what accounts and why? For 

example, should accounts used to 

acquire or take certain long-term 

positions be included in the definition? 

If so, how would subjecting such 

accounts to the proposed rule’s 

prohibitions and restrictions be 

consistent with the language and 

purpose of section 13 of the BHC Act? 

Question 29. Do any of the activities 

currently engaged in by issuers of assetbacked securities that would be 

considered a banking entity constitute 

proprietary trading as defined by 

§ ll.3(b) of this rule proposal? Would 

any activities relating to investment of 

funds in accounts held by issuers of 

asset-backed securities (e.g., reserve 

accounts, prefunding accounts, 

reinvestment accounts, etc.) or the 

purchase and sale of securities as part 

of the management of a collateralized 

debt obligation portfolio be considered 

proprietary trading under the proposed 

rule? What would be the potential 

impact of the prohibition on proprietary 

trading on the use of such accounts in 

(i) existing securitization transactions 

and (ii) future securitization 

transactions? Would any of the 

securities typically acquired and 

retained using these accounts be 

considered an ownership interest in a 

covered fund under the proposed rule? 

Does the exclusion of trading in certain 

government obligations in §ll.6(a) of 

the proposed rule mitigate the impact of 

the proposed rule on such issuers of 

asset-backed securities and their 

activities? Why or why not? 

c. Excluded Positions 

i. Excluded Positions Under Certain 

Repurchase and Reverse Repurchase 

Arrangements 

Section ll.3(b)(2)(iii)(A) of the 

proposed rule’s definition of trading 

account provides that an account will 

not be a trading account to the extent 

that such account is used to acquire or 

take one or more covered financial 

positions that arise under a repurchase 

or reverse repurchase agreement 

pursuant to which the banking entity 

has simultaneously agreed, in writing at 

the start of the transaction, to both 

purchase and sell a stated asset, at 

stated prices, and on stated dates or on 

demand with the same counterparty.117

This clarifying exclusion is proposed 

because positions held under a 

repurchase or reverse repurchase 

agreement operate in economic 

substance as a secured loan, and are not 

based on expected or anticipated 

movements in asset prices. Accordingly, 

these types of asset purchases and sales 

do not appear to be the type of 

transaction intended to be covered by 

the statutory definition of trading 

account. 

ii. Excluded Positions Under Securities 

Lending Transactions 

Section ll.3(b)(2)(iii)(B) of the 

proposed rule’s definition of trading 

account provides that an account will 

not be a trading account to the extent 

that such account is used to acquire or 

take one or more covered financial 

positions that arise under a transaction 

in which the banking entity lends or 

borrows a security temporarily to or 

from another party pursuant to a written 

securities lending agreement under 

which the lender retains the economic 

interests of an owner of such security, 

and has the right to terminate the 

transaction and to recall the loaned 

security on terms agreed to by the 

parties.118 This clarifying exclusion is 

proposed because a position held under 

a securities lending arrangement can be 

used, for example, to operate in 

economic substance and function, as a 

means to facilitate settlement of 

securities transactions, and is not based 

on expected or anticipated movements 

in asset prices. Accordingly, securities 

lending transactions do not appear to be 

the type of transaction intended to be 

covered by the statutory definition of 

trading account. 

iii. Excluded Positions Acquired or 

Taken for Liquidity Management 

Purposes 

Section ll.3(b)(2)(iii)(C) of the 

proposed definition of trading account 

provides that an account will not be a 

trading account to the extent that such 

account is used to acquire or take a 

position for the purpose of bona fide 

liquidity management, so long as 

important criteria are met.119

This proposed clarifying exclusion is 

intended to make clear that, where the 

purpose for which a banking entity 

acquires or takes a position is to ensure 

that it has sufficient liquid assets to 

meet its short-term cash demands, and 

the related position is held as part of the 

banking entity’s liquidity management 

process, that transaction falls outside of 

the types of transactions described in 

the proposed rule’s definition of trading 

account. Maintaining liquidity 

management positions is a critical 

aspect of the safe and sound operation 

of certain banking entities, and does not 

involve the requisite short-term trading 

intent that forms the basis of the 

statutory definition of ‘‘trading 

account.’’ In the context of bona fide 

liquidity management activity that 

would qualify for the clarifying 

exclusion, a banking entity’s purpose for 

acquiring or taking these types of 

positions is not to benefit from shortterm profit or short-term price 

movements, but rather to ensure that it 

has sufficient, readily-marketable assets 

available to meet its expected short-term 

liquidity needs. 

However, the CFTC is concerned with 

the potential for abuse of this clarifying 

exclusion—specifically, that a banking 

entity might attempt to improperly 

mischaracterize positions acquired or 

taken for prohibited proprietary trading 

purposes as positions acquired or taken 

for liquidity management purposes. To 

address this, the proposed rule requires 

that the transaction be conducted in 

accordance with a documented liquidity 

management plan that meets five 

criteria. First, the plan would be 

required to specifically contemplate and 

authorize any particular instrument 

used for liquidity management 

purposes, its profile with respect to 

market, credit and other risks, and the 

liquidity circumstances in which the 

position may or must be used. Second, 

the plan would have to require that any 

transaction contemplated and 

authorized by the plan be principally for 

the purpose of managing the liquidity of 


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8348 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

120Any instance in which positions characterized 

as taken for liquidity purposes do give rise to 

appreciable profits or losses as a result of short-term 

price movements will be subject to significant CFTC 

scrutiny and, absent compelling explanatory facts 

and circumstances, would be viewed as prohibited 

proprietary trading under the proposal. 

121See proposed rule §ll.3(b)(2)(iii)(D). 

the banking entity, and not for the 

purpose of short-term resale, benefitting 

from actual or expected short-term price 

movements, realizing short-term 

arbitrage profits, or hedging a position 

acquired or taken for such short-term 

purposes. Third, the plan would have to 

require that any positions acquired or 

taken for liquidity management 

purposes be highly liquid and limited to 

financial instruments the market, credit 

and other risks of which are not 

expected to give rise to appreciable 

profits or losses as a result of short-term 

price movements.120 Fourth, the plan 

would be required to limit any position 

acquired or taken for liquidity 

management purposes, together with 

any other positions acquired or taken for 

such purposes, to an amount that is 

consistent with the banking entity’s 

near-term funding needs, including 

deviations from normal operations, as 

estimated and documented pursuant to 

methods specified in the plan. Fifth, the 

plan would be required to be consistent 

with the CFTC’s supervisory 

requirements, guidance and 

expectations regarding liquidity 

management. The CFTC would review 

these liquidity plans and transactions 

effected in accordance with these plans 

through supervisory and examination 

processes to ensure that the applicable 

criteria are met and that any position 

acquired or taken in reliance on the 

clarifying exclusion for liquidity 

management transactions is fully 

consistent with such plans. 

iv. Excluded Positions of Derivatives 

Clearing Organizations and Clearing 

Agencies 

Section ll.3(b)(2)(iii)(D) of the 

proposed rule’s definition of trading 

account provides that an account will 

not be a trading account to the extent 

that such account is used to acquire or 

take one or more covered financial 

positions that are acquired or taken by 

a banking entity that is a derivatives 

clearing organization registered under 

section 5b of the Commodity Exchange 

Act (7 U.S.C. 7a–1) or a clearing agency 

registered with the SEC under section 

17A of the Exchange Act (15 U.S.C. 

78q–1) in connection with clearing 

derivatives or securities transactions.121

This clarifying exclusion is proposed 

because, in the case of a banking entity 

that acts as a registered, central 

counterparty in the securities or 

derivatives markets, these types of 

transactions do not appear to be the type 

of transaction intended to be covered by 

the statutory definition of trading 

account, as the purpose of such 

transactions is to provide a clearing 

service to third parties and not to profit 

from short-term resale or short-term 

price movements. 

v. Request for Comment 

The CFTC requests comment 

regarding the proposed clarifying 

exclusions and whether any other types 

of activity or transactions should be 

excluded from the proposed definition 

of trading account for clarity. In 

particular, the CFTC requests comment 

on the following questions: 

Question 30. Are the proposed 

clarifying exclusions for positions under 

certain repurchase and reverse 

repurchase arrangements and securities 

lending transactions over- or 

under-inclusive and could they have 

unintended consequences? Is there an 

alternative approach to these clarifying 

exclusions that would be more 

effective? Are the proposed clarifying 

exclusions broad enough to include 

bona fide arrangements that operate in 

economic substance as secured loans 

and are not based on expected or 

anticipated movements in asset prices? 

Are there other types of arrangements, 

such as open dated repurchase 

arrangements, that should be excluded 

for clarity and, if so, how should the 

proposed rule be revised? Alternatively, 

are the proposed clarifying exclusions 

broad enough to not inadvertently 

exclude from coverage any similar 

arrangements or transactions that have 

these characteristics? 

Question 30.1. Should the proposed 

CFTC Rule include the clarifying 

exclusion for certain positions taken by 

clearing agencies that are registered 

with the SEC under section 17A of the 

Exchange Act? Please explain the 

rationale for including or excluding the 

provision in the proposed CFTC Rule. 

Question 30.2. The CFTC notes that 

only the actual repurchase or reverse 

repurchase arrangements would be 

exempt from the definition of trading 

account, and not the collateral or 

position that is being financed by the 

repurchase or reverse repurchase 

arrangement. The CFTC further notes 

that if a banking entity used a 

repurchase arrangement to finance a 

purchase of a covered financial position, 

that covered financial position would be 

considered in the trading account if it 

satisfied, at the time of its purchase, one 

of the three prongs set forth in the 

definition of trading account. Is this 

treatment of repurchase and reverse 

repurchase arrangements appropriate for 

the proposed CFTC Rule? 

Question 31. Are repurchase and 

reverse repurchase arrangements and 

securities lending transactions 

sufficiently similar such that they 

should be treated in the same way for 

purposes of the proposed rule? Are 

there aspects of repurchase and reverse 

repurchase arrangements or securities 

lending transactions that should be 

highlighted in considering the 

application of the proposed rule? Do 

repurchase and reverse repurchase 

arrangements or securities lending 

transactions raise any additional or 

heightened concerns regarding risk? 

Please identify and explain how these 

concerns should be reflected in the 

proposed rule. 

Question 32. Are the proposed 

exclusions for repurchase and reverse 

repurchase arrangements and securities 

lending transactions appropriate or are 

there conditions that commenters 

believe would be appropriate as a prerequisite to relying on these exclusions? 

Please identify such conditions and 

explain. Alternatively, we seek 

commenter input regarding why 

repurchase and reverse repurchase 

arrangements and securities lending 

transactions do not present the potential 

for abuse, namely, that a banking entity 

might attempt to improperly 

mischaracterize prohibited proprietary 

trading as activity that qualifies for the 

proposed exclusions. 

Question 33. Is the proposed 

clarifying exclusion for liquidity 

management transactions effective and 

appropriate? If not, what alternative 

would be more effective and 

appropriate, and why? Is the proposed 

exclusion under- or over-inclusive? 

Does the proposed clarifying exclusion 

place sufficient limitations on liquidity 

management transactions to prevent 

abuse of the clarifying exclusion? If not, 

what additional limitations should be 

specified? Are any of the limitations 

contained in the proposed rule 

inappropriate or unnecessary? If so, how 

could such limitations be eliminated or 

altered in a way that does not permit 

abuse of the clarifying exclusion? 

Question 34. Is the proposed 

exclusion for liquidity management 

positions necessary? If not excluded, 

would such activity otherwise qualify 

for an exemption contained in the 

proposed rule (e.g., the exemptions 

contains in §§ll.5 and ll.6(a) of the 

proposed rule)? What types of banking 

entities are likely to engage in the 

liquidity management activities 

described in the proposed exclusion? 


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122The CFTC also notes that such an exclusion 

would be similar to the express exclusion of similar 

positions under the Federal banking agencies’ most 

recent proposed revisions to the Market Risk 

Capital Rules. See 76 FR 1890, 1912 (Jan. 11, 2011) 

(excluding from the definition of a covered position 

any position the material risk elements of which the 

holder is unable to hedge in a two-way market). 

123See 76 FR 8265 (Feb. 14, 2011). The Board’s 

conformance rule defines ‘‘illiquid asset’’ as ‘‘any 

real property, security obligation, or other asset that 

(i) is not a liquid asset; (ii) because of statutory or 

regulatory restrictions applicable to the hedge fund, 

private equity fund or asset, cannot be offered, sold, 

or otherwise transferred by the hedge fund or 

private equity fund to a person that is unaffiliated 

with the relevant banking entity; or (iii) because of 

contractual restrictions applicable to the hedge 

fund, private equity fund or asset, cannot be 

offered, sold, or otherwise transferred by the hedge 

fund or private equity fund for a period of 3 years 

or more to a person that is unaffiliated with the 

relevant banking entity.’’ 12 CFR 225.180(g). A 

‘‘liquid asset’’ is defined in paragraph (h) of the 

conformance rule. See 12 CFR 225.180(h). 

124The proposed definition’s reference to any 

‘‘long, short, synthetic or other position’’ is 

intended to make clear that a position in an 

identified category of financial instrument qualifies 

as a covered financial position regardless of 

whether the position is (i) an asset or liability or 

(ii) is acquired through acquisition or sale of the 

financial instrument or synthetically through a 

derivative or other transaction. 

125Section 13(h)(4) of the BHC Act also permits 

the CFTC to extend the scope of the proprietary 

trading restrictions to other financial instruments. 

The CFTC has not proposed to do so at this time. 

126See proposed rule §ll.3(b)(ii). 

127The types of commodity- and foreign 

exchange-related derivatives that are included 

within the definition of ‘‘derivative’’ under the 

proposed rule are discussed in detail below in Part 

III.B.2.d.ii of this Supplementary Information. 

Question 35. What types of 

instruments do particular types of 

banking entities currently use in 

connection with liquidity management 

activities (e.g., Treasuries)? Why are 

such instruments chosen for liquidity 

management purposes? Would such 

instruments meet the proposed 

requirement that the position be highly 

liquid and limited to financial 

instruments the market, credit and other 

risk of which are not expected to give 

rise to appreciable profits or losses as a 

result of short-term price movements? 

Why or why not? 

Question 36. What methodologies do 

banking entities currently use for 

estimating deviations from normal 

operations in connection with liquidity 

management programs? 

Question 37. Which unit or units 

within a banking entity are typically 

responsible for liquidity management? 

What is the typical reporting line 

structure used to control and supervise 

that unit or units? Are the 

responsibilities of personnel in the unit 

limited to liquidity management or do 

they perform other functions in addition 

to liquidity management? How is 

compensation determined for personnel 

in the unit of the banking entity 

responsible for liquidity management? 

Question 38. Would current liquidity 

management programs meet the five 

proposed criteria for liquidity 

management programs? If not which 

criteria would not be met, and why? 

What effect would the proposed 

liquidity management exclusions have 

on current liquidity management 

programs and banking entities in 

general? 

Question 39. Are liquidity 

management programs used for 

purposes other than ensuring the 

banking entity has sufficient assets 

available to it that are readily 

marketable to meet expected short-term 

liquidity needs? If so, for what 

purposes, and why? 

Question 40. What costs or other 

burdens would arise if the proposal did 

not contain an exclusion for positions 

acquired or taken for liquidity 

management purpose? Please explain 

and quantify these costs or other 

burdens in detail. 

Question 41. Is the proposed liquidity 

management exclusion sufficiently 

clear? If not, why is the exclusion 

unclear and how should the CFTC 

clarify the terms of this exclusion? 

Question 42. Is the proposed 

clarifying exclusion for certain positions 

taken by derivatives clearing 

organizations and clearing agencies 

effective and appropriate? If not, what 

alternative would be more effective and 

appropriate, and why? 

Question 43. Are any additional 

clarifying exclusions warranted? If so, 

what clarifying exclusion, and why? 

Question 44. Should the proposed 

definition exclude any position the 

market risk of which cannot be hedged 

by the banking entity in a two-way 

market? 122 If so, what would be the 

basis for concluding that such positions 

are clearly not within the statutory 

definition of trading account? 

Question 45. Should the proposed 

definition include a clarifying exclusion 

for any position in illiquid assets? If so, 

what would be the basis for concluding 

that such positions are clearly not 

within the statutory definition of trading 

account? How should ‘‘illiquid assets’’ 

be defined for these purposes? Should 

the definition be consistent with the 

definition given that term in the Board’s 

Conformance Rule under section 13 of 

the BHC Act (12 CFR 225.180 et 

seq.)? 123

d. Covered Financial Position 

i. Definition of ‘‘Covered Financial 

Position’’ 

Section ll.3(b)(3)(i) of the proposed 

rule defines a covered financial position 

as any long, short, synthetic or other 

position 124 in: (i) A security, including 

an option on a security; (ii) a derivative, 

including an option on a derivative; or 

(iii) a contract of sale of a commodity for 

future delivery, or an option on such a 

contract. The types of financial 

instruments described in the proposed 

definition are consistent with those 

referenced in section 13(h)(4) of the 

BHC Act as part of the statutory 

definition of proprietary trading.125

To provide additional clarity, 

§ ll.3(b)(3)(ii) of the proposed rule 

provides that, consistent with the 

statute, the term covered financial 

position does not include any position 

that is itself a loan, a commodity, or 

foreign exchange or currency.126 The 

exclusion of these types of positions is 

intended to eliminate potential 

confusion by making clear that the 

purchase and sale of loans, commodities 

and foreign exchange—none of which 

are referred to in section 13(h)(4) of the 

BHC Act—are outside the scope of 

transactions to which the proprietary 

trading restrictions apply. The reference 

in §ll.3(b)(3)(ii) to a position that is, 

rather than a position that is in, a loan, 

a commodity, or foreign exchange or 

currency is intended to capture only the 

purchase and sale of these instruments 

themselves. This reflects the fact that, 

consistent with section 13(h)(4) of the 

BHC Act and the proposed rule, 

although a position that is a foreign 

exchange derivative or commodity 

derivative is included in the definition 

of covered financial position and 

therefore subject to the prohibition on 

proprietary trading, a position that is a 

commodity or foreign currency is not.127

For example, the spot purchase of a 

commodity would meet the terms of the 

exclusion, but the acquisition of a 

futures position in the same commodity 

would not. The CFTC requests comment 

on the proposed rule’s definition of 

covered financial position. In particular, 

the CFTC requests comment on the 

following questions: 

Question 46. Is the proposed rule’s 

definition of covered financial position 

effective? Is the definition over- or 

under-inclusive? What alternative 

approaches might be more effective in 

light of the language and purpose of 

section 13 of the BHC Act, and why? 

Question 47. Are there definitions in 

other rules or regulations that might 

inform the proposed definition of 

covered financial position? If so, what 

rule or regulation? How should that 

approach be incorporated into the 

proposed definition? Why would that 

approach be more appropriate? 


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128See proposed rule §ll.2(w). 

129See proposed rule §§ll.3(c)(1), (2). 

130See proposed rule §ll.2(l). 

131The CFTC notes that it has not included a 

variety of security-related derivatives within the 

proposed definition of derivative, as such 

transactions are ‘‘securities’’ for purposes of both 

the Exchange Act and the proposed rule and, as a 

result, already included in the broader definition of 

‘‘covered financial position’’ to which the 

prohibition on proprietary trading applies. 

132The CFTC notes that foreign exchange swaps 

and foreign exchange forwards are considered 

swaps for purposes of the Commodity Exchange Act 

definition of that term unless the Secretary of the 

Treasury determines, pursuant to section 1a(47)(E) 

of that Act (7 U.S.C. 1a(47)(E)), that foreign 

exchange swaps and forwards should not be 

regulated as swaps under the Commodity Exchange 

Act and are not structured to evade certain 

provisions of the Dodd-Frank Act. On May 5, 2011, 

the Treasury Secretary proposed to exercise that 

authority to exclude foreign exchange forwards and 

foreign exchange swaps from the definition of 

‘‘swap.’’ See Determination of Foreign Exchange 

Swaps and Foreign Exchange Forwards Under the 

Commodity Exchange Act, 76 FR 25774 (May 5, 

2011). If the Secretary of the Treasury issues a final 

determination, as proposed, a ‘‘foreign exchange 

swap’’ and ‘‘foreign exchange forward’’ would be 

excluded from the definition of ‘‘swap’’ under the 

Commodity Exchange Act and, therefore, would fall 

outside of the proposed rule’s definition of 

‘‘derivative.’’ Accordingly, the CFTC has proposed 

to expressly include such transactions in the 

proposed definition of derivative, but have 

requested comment on a variety of questions related 

to whether foreign exchange swaps and forwards 

should be included or excluded from the definition 

of derivative. The CFTC notes that, aside from 

foreign exchange swaps and forwards, the 

Commodity Exchange Act’s definition of ‘‘swap’’ 

(and therefore the proposed definition of 

‘‘derivative’’) also includes other types of foreign 

exchange derivatives, including non-deliverable 

foreign exchange forwards (NDFs), foreign exchange 

options, and currency options, which fall outside of 

the Secretary of the Treasury’s authority to issue a 

determination to exclude certain transactions from 

the ‘‘swap’’ definition. 

133Section 2(c)(2)(C)(i) was added to the 

Commodity Exchange Act in 2008 to address retail 

foreign exchange transactions that were 

documented as automatically renewing spot 

contracts (so-called rolling spot transactions) and 

therefore not futures contracts subject to the 

Commodity Exchange Act, but which were 

functionally and economically similar to futures. 

See Retail Foreign Exchange Transactions, 76 FR 

41375, 47376–77 (July 15, 2011). However, section 

2(c)(2)(C)(i) of the Commodity Exchange Act does 

not apply to transactions entered into by U.S. 

financial institutions, including insured depository 

institutions, brokers, dealers, and certain retail 

foreign exchange dealers. See 7 U.S.C. 

2(c)(2)(C)(i)(I)(aa). To apply this definitional prong 

to such banking entities, the definition of derivative 

includes a transaction ‘‘described in’’ section 

2(c)(2)(C)(i) of the Commodity Exchange Act. In 

other words, the use of this phrase is intended to 

capture any transaction described in section 

2(c)(2)(C)(i) without regard to the identity of the 

counterparty. 

Question 48. Are there particular 

transactions or positions to which the 

application of the proposed definition of 

covered financial position is unclear? Is 

additional regulatory language, 

guidance, or clarity necessary? 

Question 49. The proposal would 

apply to long, short, synthetic, or other 

positions in one of the listed categories 

of financial instruments. Does this 

language adequately describe the type of 

positions that are intended to fall within 

the proposed definition of covered 

financial position? If not, why not? Are 

there different or additional concepts 

that should be specified in this context? 

Please explain. 

Question 50. Should the CFTC 

expand the scope of covered financial 

positions to include other transactions, 

such as spot commodities or foreign 

exchange or currency, or certain subsets 

of transaction (e.g., spot commodities or 

foreign exchange or currency traded on 

a high-frequency basis)? If so, which 

instruments and why? 

Question 51. What factors should the 

CFTC consider in deciding whether to 

extend the scope of the proprietary 

trading restriction to other financial 

instruments under the authority granted 

in section 13(h)(4) of the BHC Act? 

Please explain. 

Question 52. Is the proposed 

exclusion of any position that is a loan, 

a commodity, or foreign exchange or 

currency effective? If not, what 

alternative approaches might be more 

effective in light of the language and 

purpose of section 13 of the BHC Act? 

Should additional positions be 

excluded? If so, why and under what 

authority? 

ii. Other Terms Used in the Definition 

of Covered Financial Position 

The proposal also defines a number of 

terms used in the proposed definition of 

covered financial position. The term 

‘‘security’’ is defined by reference to 

that same term under the Exchange 

Act.128 The terms ‘‘commodity’’ and 

‘‘contract of sale of a commodity for 

future delivery’’ are defined by 

reference to those same terms under the 

Commodity Exchange Act.129 The CFTC 

has proposed to reference these existing 

definitions from the securities and 

commodities laws because these 

existing definitions are generally wellunderstood by market participants and 

have been subject to extensive 

interpretation in the context of 

securities and commodities trading 

activities. 

The proposed rule also defines the 

term ‘‘derivative.’’ 130 In particular, the 

definition of ‘‘derivative’’ under the 

proposed rule includes any ‘‘swap’’ (as 

that term is defined in the Commodity 

Exchange Act) and any ‘‘security-based 

swap’’ (as that term is defined in the 

Exchange Act), in each case as further 

defined by the CFTC and SEC by joint 

regulation, interpretation, guidance, or 

other action, in consultation with the 

Board pursuant to section 712(d) of the 

Dodd-Frank Act. The CFTC has 

proposed to incorporate these 

definitions of ‘‘swap’’ and ‘‘securitybased swap’’ under the Federal 

securities and commodities laws 

because those definitions: (i) Govern the 

primary Federal regulatory scheme 

applicable to exchange-traded and overthe-counter derivatives; (ii) will be 

frequently evaluated and applied by 

banking entities in the course of their 

trading activities; and (iii) capture 

agreements and contracts that are, or 

function as, derivatives.131 The 

proposed rule also includes within the 

definition of derivative certain other 

transactions that, although not included 

within the definition of ‘‘swap’’ or 

‘‘security-based swap.’’ Specifically, the 

proposed definition of derivative also 

includes: (i) any purchase or sale of a 

nonfinancial commodity for deferred 

shipment or delivery that is intended to 

be physically settled; (ii) any foreign 

exchange forward or foreign exchange 

swap (as those terms are defined in the 

Commodity Exchange Act); 132 (iii) 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)); 133 (iv) any 

agreement, contract, or transactions in a 

commodity other than foreign currency 

described in section 2(c)(2)(D)(i) of the 

Commodity Exchange Act (7 U.S.C. 

2(c)(2)(D)(i)); and (v) any transaction 

authorized under section 19 of the 

Commodity Exchange Act (7 U.S.C. 

23(a) or (b)). The CFTC is requesting 

comment on whether including these 

five types of transactions within the 

proposed definition of derivative is 

appropriate. 

To provide additional clarity, the 

proposed definition of derivative also 

clarifies two types of transactions that 

are outside the scope of the definition. 

First, the proposed definition of 

derivative would not include any 

consumer, commercial, or other 

agreement, contract, or transaction that 

the CFTC and SEC have further defined 

by joint regulation, interpretation, 

guidance, or other action as not within 

the definition of swap, as that term is 

defined in the Commodity Exchange 

Act, or security-based swap, as that term 

is defined in the Exchange Act. The SEC 

and CFTC have, in proposing rules 

further defining the terms ‘‘swap’’ and 

‘‘security-based swap,’’ proposed to not 

include a variety of agreements, 

contracts, and transactions within those 

definitions by joint regulation or 

interpretation, and the CFTC has 

proposed to expressly reflect such 


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134See 76 FR 29818 (May 23, 2011). For example, 

the SEC and CFTC have proposed to not include (i) 

certain insurance products within the definitions of 

‘‘swap’’ and ‘‘security-based swap’’ by regulation 

and (ii) certain consumer agreements (e.g., 

agreements to acquire or lease real property or 

purchase products at a capped price) and 

commercial agreements (e.g., employment contracts 

or the purchase of real property, intellectual 

property, equipment or inventory) by joint 

interpretation. See id. at 29832–34. The CFTC has 

proposed to define ‘‘derivative’’ in the proposed 

rule by reference to the definition of ’’swap’’ and 

‘‘security-based swap’’ under the Federal securities 

and commodities laws in contemplation of the SEC 

and CFTC’s proposed regulatory and interpretative 

exclusions; to the extent that such exclusions are 

not included in any final action taken by the SEC 

and CFTC, the CFTC will consider whether to state 

such exclusions expressly within the proposed 

rule’s definition of derivative. 

135Examples of excluded identified banking 

products are deposit accounts, savings accounts, 

certificates of deposit, or other deposit instruments 

issued by a bank. 

136See proposed rule §ll.2(q). 137See 12 U.S.C. 1851(d)(1)(B). 

exclusions in the proposed rule’s 

definition in order to avoid the potential 

application of its restrictions to 

transactions that are not commonly 

thought to be derivatives.134 Second, the 

proposed definition of derivative also 

does not include any identified banking 

product, as defined in section 402(b) of 

the Legal Certainty for Bank Products 

Act of 2000 (7 U.S.C. 27(b)), that is 

subject to section 403(a) of that Act (7 

U.S.C. 27a(a)). This provision is 

proposed to clearly exclude identified 

banking products that are expressly 

excluded (i) from the definition of 

‘‘security-based swap’’ and (ii) from 

Commodity Exchange Act and CFTC 

jurisdiction pursuant to section 403(a) 

of the Legal Certainty for Bank Products 

Act of 2000.135

The proposed rule defines a ‘‘loan’’ as 

any loan, lease, extension of credit, or 

secured or unsecured receivable.136 The 

CFTC notes that the proposed definition 

of loan is expansive, and includes a 

broad array of loans and similar credit 

transactions, but does not include any 

asset-backed security that is issued in 

connection with a loan securitization or 

otherwise backed by loans. 

The CFTC requests comment on the 

proposed rule’s definition of terms used 

in the definition of covered financial 

position. In particular, the CFTC 

requests comment on the following 

questions: 

Question 53. Are the proposed rule’s 

definitions of commodity and contract 

of sale of a commodity for future 

delivery appropriate? If not, what 

alternative definitions would be more 

appropriate? 

Question 54. Is the proposed 

definition of derivative effective? If not, 

what alternative definition would be 

more effective? Should the proposed 

rule expressly incorporate the definition 

of ‘‘swap’’ and ‘‘security-based swap’’ 

under the Federal commodities and 

securities laws? If not, what alternative 

approach should be taken? Are there 

transactions included in those 

incorporated definitions that should not 

be included in the proposed rule’s 

definition? If so, what transactions and 

why? Are there transactions excluded 

from those incorporated definitions that 

should be included within the proposed 

rule’s definition? If so, what 

transactions and why? 

Question 55. Is the proposed 

inclusion of foreign exchange forwards 

and swaps in the definition of derivative 

effective? If not, why not? On what basis 

would the CFTC conclude that such 

transactions are not derivatives? Are 

these transactions economically or 

functionally more similar to secured 

loans or repurchase arrangements than 

to commodity forwards and swaps? 

Would there be any unintended 

consequences to banking entities if such 

transactions are included in the 

proposal’s definition of derivative? 

What effect is including foreign 

exchange swaps and forwards in the 

definition of derivative likely to have on 

banking entities, participants in the 

foreign exchange markets, and the 

liquidity and efficiency of foreign 

exchange markets generally? If included 

within the definition of derivative, 

should transactions in foreign exchange 

swaps and forwards be permitted under 

section 13(d)(1)(J) of the BHC Act? If so, 

why and on what basis? Please quantify 

your responses, to the extent feasible. 

Question 56. Is the proposed 

inclusion of any purchase or sale of a 

nonfinancial commodity for deferred 

shipment or delivery that is intended to 

be physically settled in the definition of 

derivative effective? If not, why not? 

Would there be any unintended 

consequences to banking entities if such 

transactions are included in the 

proposal’s definition of derivative? 

Question 57. Is the proposed 

inclusion of foreign currency 

transactions described in section 

2(c)(2)(C)(i) of the Commodity Exchange 

Act in the definition of derivative 

effective? If not, why not? Would there 

be any unintended consequences to 

banking entities if such transactions are 

included in the proposal’s definition of 

derivative? 

Question 58. Is the proposed 

inclusion of commodity transactions 

described in section 2(c)(2)(D)(i) of the 

Commodity Exchange Act in the 

definition of derivative effective? If not, 

why not? Would there be any 

unintended consequences to banking 

entities if such transactions are included 

in the proposal’s definition of 

derivative? 

Question 59. Is the proposed 

inclusion of any transaction authorized 

under section 19 of the Commodity 

Exchange Act (7 U.S.C. 23(a) or (b)) in 

the definition of derivative effective? If 

not, why not? Would there be any 

unintended consequences to banking 

entities if such transactions are included 

in the proposal’s definition of 

derivative? 

Question 60. Is the manner in which 

the proposed definition of derivative 

excludes any transaction that the CFTC 

or SEC exclude by joint regulation, 

interpretation, guidance, or other action 

from the definition of ‘‘swap’’ or 

‘‘security-based swap’’ effective? If not, 

what alternative approach would be 

more appropriate? Should such 

exclusions be restated in the proposed 

rule’s definition? If so, why? 

Question 61. Is the proposed rule’s 

definition of loan appropriate? If not, 

what alternative definition would be 

more appropriate? Should the definition 

of ‘‘loan’’ exclude a security? Should 

other types of traditional banking 

products be included in the definition 

of ‘‘loan’’? If so, why? 

iii. Definition of Other Terms Related to 

Proprietary Trading 

Section ll.3(d) of the proposed rule 

defines a variety of other terms used 

throughout subpart B of the proposed 

rule. These definitions are discussed in 

further detail below in the relevant 

summary of the separate sections of the 

proposed rule in which they are used. 

The CFTC requests comment on the 

proposed rule’s definition of other terms 

used in subpart B of the proposed rule. 

In particular, the CFTC requests 

comment on the following questions: 

Question 62. Are the proposed rule’s 

definitions of other terms in §ll.3(d) 

appropriate? If not, what alternative 

definitions would be more appropriate? 

Question 63. Is the definition of 

additional terms for purposes of subpart 

B of the proposed rule necessary? If so, 

what terms should be defined? How 

should those terms be defined? 

2. Section ll.4: Permitted 

Underwriting and Market Makingrelated Activities 

Section ll.4 of the proposed rule 

implements section 13(d)(1)(B) of the 

BHC Act, which permits banking 

entities to engage in certain 

underwriting and market making-related 

activities, notwithstanding the 

prohibition on proprietary trading.137


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138The CFTC notes, however, that a derivative or 

commodity future transaction may be otherwise 

permitted under another exemption (e.g., the 

exemptions for market making-related or riskmitigating hedging activities). 

139 17 CFR 242.100 et seq. 

140See proposed rule §§ll.4(a)(3), (4); 17 CFR 

242.100(b). 

141 17 CFR 242.100. 

142See Review of Antimanipulation Regulation of 

Securities Offering, Exchange Act Release No. 

33924 (Apr. 19, 1994), 59 FR 21681, 21684 (Apr. 26, 

1994) (‘‘Regulation M Concept Release’’). 

143See Regulation M Concept Release, 59 FR at 

21684–85. 

144See proposed rule §ll.4(a)(4)(ii). 

145The CFTC notes, however, that such sale 

would have to be made in compliance with other 

applicable provisions of the Federal securities laws 

and regulations. 

Section ll.4(a) addresses permitted 

underwriting activities, and §ll.4(b) 

addresses permitted market makingrelated activities. 

a. Permitted Underwriting Activities 

Section ll.4(a) of the proposed rule 

permits a banking entity to purchase or 

sell a covered financial position in 

connection with the banking entity’s 

underwriting activities to the extent that 

such activities are designed not to 

exceed the reasonably expected nearterm demands of clients, customers, or 

counterparties (the ‘‘underwriting 

exemption’’). In order to rely on this 

exemption, a banking entity’s 

underwriting activities must meet all 

seven of the criteria listed in 

§ ll.4(a)(2). These seven criteria are 

intended to ensure that any banking 

entity relying on the underwriting 

exemption is engaged in bona fide 

underwriting activities, and conducts 

those activities in a way that is not 

susceptible to abuse through the taking 

of speculative, proprietary positions as 

a part of, or mischaracterized as, 

underwriting activity. 

First, the banking entity must have 

established the internal compliance 

program required by subpart D of the 

proposed rule, as further described 

below in Part III.D of this 

SUPPLEMENTARY INFORMATION. This 

requirement is intended to ensure that 

any banking entity relying on the 

underwriting exemption has reasonably 

designed written policies and 

procedures, internal controls, and 

independent testing in place to support 

its compliance with the terms of the 

exemption. 

Second, the covered financial position 

that is being purchased or sold must be 

a security. This requirement reflects the 

common usage and understanding of the 

term ‘‘underwriting.’’ 138

Third, the transaction must be 

effected solely in connection with a 

distribution of securities for which the 

banking entity is acting as an 

underwriter. This prong is intended to 

give effect to the essential element of the 

underwriting exemption—i.e., that the 

transaction be in connection with 

underwriting activity. For these 

purposes, the proposed rule defines 

both (i) a distribution of securities and 

(ii) an underwriter. The definitions of 

these terms are generally identical to the 

definitions provided for the same terms 

in the SEC’s Regulation M,139 which 

governs the activities of underwriters, 

issuers, selling security holders, and 

others in connection with offerings of 

securities under the Exchange Act.140

The CFTC has proposed to use similar 

definitions because the meanings of 

these terms under Regulation M are 

generally well-understood by market 

participants and define the scope of 

underwriting activities in which 

banking entities typically engage, 

including underwriting of SECregistered offerings, underwriting of 

unregistered distributions, and acting as 

a placement agent in private 

placements. 

With respect to the definition of 

distribution, the CFTC notes that 

Regulation M defines a distribution of 

securities as ‘‘an offering of securities, 

whether or not subject to registration 

under the Securities Act that are 

distinguished from ordinary trading 

transactions by the magnitude of the 

offering and the presence of special 

selling efforts.’’ 141 The manner in 

which this Regulation M definition 

distinguishes a distribution of securities 

from other transactions appears to be 

relevant in the context of the 

underwriting exemption and useful to 

address potential evasion of the general 

prohibition on proprietary trading, 

while permitting bona fide underwriting 

activities. Accordingly, in order to 

qualify as a distribution for purposes of 

the proposal, as with Regulation M, the 

offering must meet the two elements— 

‘‘magnitude’’ and ‘‘special selling efforts 

and selling methods.’’ The CFTC has not 

defined the terms ‘‘magnitude’’ and 

‘‘special selling efforts and selling 

methods’’ in the proposed rule, but 

would expect to rely on the same factors 

considered under Regulation M in 

assessing these elements. For example, 

the number of shares to be sold, the 

percentage of the outstanding shares, 

public float, and trading volume that 

those shares represent are all relevant to 

an assessment of magnitude.142 In 

addition, delivering a sales document, 

such as a prospectus, and conducting 

road shows are generally indicative of 

special selling efforts and selling 

methods.143 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. Similar to the approach taken 

under Regulation M, the CFTC notes 

that ‘‘magnitude’’ does not imply that a 

distribution must be large; instead, this 

factor is a means to distinguish a 

distribution from ordinary trading, and 

therefore does not preclude small 

offerings or private placements from 

qualifying for the underwriting 

exemption. 

The definition of ‘‘underwriter’’ in the 

proposed rule is generally similar to that 

under the SEC’s Regulation M, except 

that the proposed rule’s definition 

would also include, within that 

definition, a person who has an 

agreement with another underwriter to 

engage in a distribution of securities for 

or on behalf of an issuer or selling 

security holder.144 Consistent with 

current practices and the Council study, 

the CFTC proposes to take into 

consideration the extent to which the 

banking entity is engaged in the 

following activities when determining 

whether a banking entity is acting as an 

underwriter as part of a distribution of 

securities: 

• Assisting an issuer in capital 

raising; 

• Performing due diligence; 

• Advising the issuer on market 

conditions and assisting in the 

preparation of a registration statement 

or other offering documents; 

• Purchasing securities from an 

issuer, a selling security holder, or an 

underwriter for resale to the public; 

• Participating in or organizing a 

syndicate of investment banks; 

• Marketing securities; and 

• Transacting to provide a postissuance secondary market and to 

facilitate price discovery. 

The CFTC notes that the precise 

activities performed by an underwriter 

may vary depending on the liquidity of 

the securities being underwritten and 

the type of distribution being 

conducted. For example, each factor 

need not be present in a private 

placement. 

There may be circumstances in which 

an underwriter would hold securities 

that it could not sell in the distribution 

for investment purposes. If the 

acquisition of such unsold securities 

were in connection with the 

underwriting pursuant to the permitted 

underwriting activities exemption, the 

underwriter would also be able to 

dispose of such securities at a later 

time.145


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146See proposed rule §ll.4(a)(2)(iv). For 

example, if a banking entity is a bank engaged in 

underwriting asset-backed securities for which it 

would be required to register as a securities dealer 

but for the exclusion contained in section 

3(a)(5)(C)(iii) of the Exchange Act, the proposed 

rule would not require that banking entity be a 

registered securities dealer in order to rely on the 

underwriting exemption for that transaction. The 

proposed rule does not apply the dealer 

registration/notice requirement to the underwriting 

of exempted securities, security-based swaps, 

commercial paper, bankers acceptances or 

commercial bills because the underwriting of such 

instruments does not require registration as a 

securities dealer under the Exchange Act. 

147See proposed rule §ll.4(a)(2)(v). 

148For these purposes, 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. 

Fourth, to the extent that the 

transaction involves a security for 

which a person must generally be a 

registered securities dealer, municipal 

securities dealer or government 

securities dealer in order to underwrite 

the security, the banking entity must 

have the appropriate dealer registration 

(or in the case of a financial institution 

that is a government securities dealer, 

has filed notice of that status as required 

by section 15C(a)(1)(B) of the Exchange 

Act) or otherwise be exempt from 

registration or excluded from regulation 

as a dealer.146 Similarly, if the banking 

entity is engaged in the business of a 

dealer outside the United States in a 

manner for which no U.S. registration is 

required, the banking entity must be 

subject to substantive regulation of its 

dealing business in the jurisdiction in 

which the business is located. This 

requirement is intended to ensure that 

(i) any underwriting activity conducted 

in reliance on the exemption is subject 

to appropriate regulation and (ii) 

banking entities are not simultaneously 

characterizing the transaction as 

underwriting for purposes of the 

exemption while characterizing it in a 

different manner for purposes of 

applicable securities laws. 

Fifth, the underwriting activities of 

the banking entity with respect to the 

covered financial position must be 

designed not to exceed the reasonably 

expected near-term demands of clients, 

customers and counterparties.147 This 

requirement restates the statutory 

limitation on the underwriting 

exemption. 

Sixth, the underwriting activities of 

the banking entity must be designed to 

generate revenues primarily from fees, 

commissions, underwriting spreads or 

other income, and not from appreciation 

in the value of covered financial 

positions it holds related to such 

activities or the hedging of such covered 

financial position.148 This requirement 

is intended to ensure that activities 

conducted in reliance on the 

underwriting exemption demonstrate 

patterns of revenue generation and 

profitability consistent with, and related 

to, the services an underwriter provides 

to its customers in bringing securities to 

market, rather than changes in the 

market value of the securities 

underwritten. 

Seventh, the compensation 

arrangements of persons performing 

underwriting activities at the banking 

entity must be designed not to 

encourage proprietary risk-taking. 

Activities for which a banking entity has 

established a compensation incentive 

structure that rewards speculation in, 

and appreciation of, the market value of 

securities underwritten, rather than 

success in bringing securities to market 

for a client, are inconsistent with 

permitted underwriting activities under 

the proposed rule. Although a banking 

entity relying on the underwriting 

exemption may appropriately take into 

account revenues resulting from 

movements in the price of securities 

that the banking entity underwrites to 

the extent that such revenues reflect the 

effectiveness with which personnel 

have managed underwriting risk, the 

banking entity should provide 

compensation incentives that primarily 

reward client revenues and effective 

client service, not proprietary risktaking. 

The CFTC requests comment on the 

proposed rule’s implementation of the 

underwriting exemption. In particular, 

the CFTC requests comment on the 

following questions: 

Question 64. Is the proposed rule’s 

implementation of the underwriting 

exemption effective? If not, what 

alternative approach would be more 

effective? For example, should the 

exemption include other transactions 

that do not involve a distribution of 

securities for which the banking entity 

is acting as underwriter? 

Question 64.1. Should the proposed 

CFTC Rule include the underwriting 

exemption? Please explain the rationale 

for including or excluding the provision 

in the proposed CFTC Rule. 

Question 65. Are the seven 

requirements included in the 

underwriting exemption effective? Is the 

application of each requirement to 

potential transactions sufficiently clear? 

Should any of the requirements be 

changed or eliminated? Should other 

requirements be added in order to better 

provide an exemption that is not 

susceptible to abuse through the taking 

of speculative, proprietary positions in 

the context of, or mischaracterized as, 

underwriting? Alternatively, are any of 

the proposed requirements 

inappropriately restrictive in that they 

would be inconsistent with the statutory 

exemption for certain underwriting 

activities? If so, how? 

Question 66. Do underwriters 

currently have processes in place that 

would prevent or reduce the likelihood 

of taking speculative, proprietary 

positions in the context of, or 

mischaracterized as, underwriting? If so, 

what are those processes? 

Question 67. Would any of the 

proposed requirements cause 

unintended consequences? Would the 

proposed requirements alter current 

underwriting practices in any way? 

Would any of the proposed 

requirements trigger an unwillingness to 

engage in underwriting? What impact, if 

any, would the proposed exemption 

have on capital raising? Please explain. 

Question 68. What increased costs, if 

any, would underwriters incur to satisfy 

the seven proposed requirements of the 

underwriting exemption? Would 

underwriters pass the increased costs 

onto issuers, selling security holders, or 

their customers in connection with 

qualifying for the proposed exemption? 

Question 69. In addition to the 

specific activities highlighted above for 

purposes of evaluating whether a 

banking entity is acting as an 

underwriter as part of distribution of 

securities (e.g., assisting an issuer in 

capital raising, performing due 

diligence, etc.), are there other or 

alternative activities that should be 

considered? Please explain. 

Question 70. Should the requirement 

that a covered financial position be a 

security be expanded to include other 

financial instruments? If so, why? How 

are such other instruments underwritten 

within the meaning of section 

13(d)(1)(B) of the BHC Act? 

Question 71. Is the proposed 

definition of a ‘‘distribution’’ of 

securities appropriate, or over- or underinclusive in this context? Is there any 

category of underwriting activity that 

would not be captured by the proposed 

definition? If so, what are the mechanics 

of that underwriting activity? Should it 

be permitted under the proposed rule, 

and, if so, why? Would an alternative 

definition better identify offerings 

intended to be covered by the proposed 

definition? If so, what alternative 

definition, and why? 

Question 72. Is the proposed 

definition of ‘‘underwriter’’ appropriate, 

or over- or under-inclusive in this 

context? Would an alternative 

definition, such as the statutory 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8354 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

149With respect to certain kinds of market 

making-related activities, such as market making in 

securities, these principal positions are often 

referred to as ‘‘inventory’’ or ‘‘inventory positions.’’ 

However, since certain types of market makingrelated activities, such as market making in 

derivatives, involve the retention of principal 

positions arising out of multiple derivatives 

transactions in particular risks (e.g., retained 

principal interest rate risk), rather than retention of 

actual financial instruments, the broader term 

‘‘principal positions’’ is used in this discussion. 

150The Council study contains a detailed 

discussion of the challenges involved in delineating 

prohibited proprietary trading from permitted 

market making-related activities. See Council study 

at 15–18. 

definition of ‘‘underwriter’’ under the 

Securities Act, better identify persons 

intended to be covered by the proposed 

definition? If so, why? 

Question 73. How accurately can a 

banking entity engaging in underwriting 

predict the near-term demands of 

clients, customers, and counterparties 

with respect to an offering? How can 

principal risk that is retained in 

connection with underwriting activities 

to support near-term client demand be 

distinguished from positions taken for 

speculative purposes? 

Question 74. Is the requirement that 

the underwriting activities of a banking 

entity relying on the underwriting 

exemption be designed to generate 

revenues primarily from fees, 

commissions, underwriting spreads or 

similar income effective? If not, how 

should the requirement be changed? 

Does the requirement appropriately 

capture the type and nature of revenues 

typically generated by underwriting 

activities? Is any further clarification or 

additional guidance necessary? 

Question 75. Is the requirement that 

the compensation arrangements of 

persons performing underwriting 

activities at a banking entity be designed 

not to reward proprietary risk-taking 

effective? If not, how should the 

requirement be changed? Are there 

other types of compensation incentives 

that should be clearly referenced as 

consistent, or inconsistent, with 

permitted underwriting activity? Are 

there specific and identifiable 

characteristics of compensation 

arrangements that clearly incentivize 

prohibited proprietary trading? 

Question 76. Are there other types of 

underwriting activities that should also 

be included within the scope of the 

underwriting exemption? If so, what 

additional activities and why? How 

would an exemption for such additional 

activities be consistent with the 

language and purpose of section 13 of 

the BHC Act? What criteria, 

requirements, or restrictions would be 

appropriate to include with respect to 

such additional activities to prevent 

misuse or evasion of the prohibition on 

proprietary trading? 

Question 77. Does the proposed 

underwriting exemption appropriately 

accommodate private placements? If 

not, what changes are necessary to do 

so? 

Question 78. The creation, offer and 

sale of certain structured securities such 

as trust preferred securities or tender 

option bonds, among others, may 

involve the purchase of another security 

and repackaging of that security through 

an intermediate entity. Should the sale 

of the security by a banking entity to an 

intermediate entity as part of the 

creation of the structured security be 

permitted under one of the exemptions 

to the prohibition on proprietary trading 

currently included in the proposed rule 

(e.g., underwriting or market making)? 

Why or why not? For purposes of 

determining whether an exemption is 

available under these circumstances, 

should gain on sale resulting from the 

sale of the purchased security to the 

intermediate entity as part of the 

creation of the structured security be 

considered a relevant factor? Why or 

why not? What other factors should be 

considered in connection with the 

creation of the structured securities and 

why? Would the analysis be different if 

the banking entity acquired and retained 

the security to be sold to the 

intermediate entity as part of the 

creation of the structured securities as 

part of its underwriting of the 

underlying security? Why or why not? 

Question 79. We seek comment on the 

application of the proposed exemption 

to a banking entity retaining a portion 

of an underwriting. Please discuss 

whether or not firms frequently retain 

securities in connection with a 

distribution in which the firm is acting 

as underwriter. Please identify the types 

of offerings in which this may be done 

(e.g., fixed income offerings, securitized 

products, etc.). Please identify and 

discuss any circumstances which can 

contribute to the decision regarding 

whether or not to retain a portion of an 

offering. Please describe the treatment of 

retained securities (e.g., the time period 

of retention, the type of account in 

which securities are retained, the 

potential disposition of the securities). 

Please discuss whether or not the 

retention is documented and, if so, how. 

Should the CFTC require disclosure of 

securities retained in connection with 

underwritings? Should the CFTC 

require specific documentation to 

demonstrate that the retained portion is 

connected to an underwriting pursuant 

to the proposed rule? If so, what kind of 

documentation should be required? 

Please discuss how you believe 

retention should be addressed under the 

proposal. 

b. Permitted Market Making-related 

Activities 

Section ll.4(b) of the proposed rule 

permits a banking entity to purchase or 

sell a covered financial position in 

connection with the banking entity’s 

market making-related activities (the 

‘‘market-making exemption’’). 

i. Approach to Implementing the 

Exemption for Market Making-Related 

Activities 

As the Council study noted, 

implementing the statutory exception 

for permitted market making-related 

activities requires a regulatory regime 

that differentiates permitted market 

making-related activity, and in 

particular the taking of principal 

positions in the course of making a 

market in particular financial 

instruments, from prohibited 

proprietary trading. Although the 

purpose and function of these two 

activities are markedly different— 

market making-related activities provide 

intermediation and liquidity services to 

customers, while proprietary trading 

involves the generation of profit through 

speculative risk-taking—clearly 

distinguishing these activities may be 

difficult in practice. Market makingrelated activities, like prohibited 

proprietary trading, sometimes require 

the taking of positions as principal, and 

the amount of principal risk that must 

be assumed by a market maker varies 

considerably by asset class and differing 

market conditions.149 It may be difficult 

to distinguish principal positions that 

appropriately support market makingrelated activities from positions taken 

for short-term, speculative purposes. In 

particular, it may be difficult to 

determine whether principal risk has 

been retained because (i) the retention 

of such risk is necessary to provide 

intermediation and liquidity services for 

a relevant financial instrument or (ii) 

the position is part of a speculative 

trading strategy designed to realize 

profits from price movements in 

retained principal risk.150

In order to address these 

complexities, the CFTC has proposed a 

multi-faceted approach that draws on 

several key elements. First, similar to 

the underwriting exemption, the 

proposed rule includes a number of 

criteria that a banking entity’s activities 

must meet in order to rely on the 

exemption for market making-related 


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151The definition of ‘‘trading unit’’ for this 

purpose is discussed in detail in Part III.B.5 of this 

SUPPLEMENTARY INFORMATION. 

activities. These criteria are intended to 

ensure that the banking entity is 

engaged in bona fide market making. As 

described in greater detail in Part III.D 

of the Supplementary Information, 

among these criteria is the requirement 

that the banking entity have in place a 

programmatic compliance regime to 

guide its compliance with section 13 of 

the BHC Act and the proposed rule. 

This compliance regime includes 

requirements that a banking entity have 

effective policies, procedures, and 

internal controls that are designed to 

ensure that prohibited proprietary 

trading positions are not taken under 

the guise of permitted market makingrelated activity. Second, as described in 

greater detail in Part III.B.5 of this 

SUPPLEMENTARY INFORMATION: Appendix 

B of the proposed rule contains a 

detailed commentary regarding how the 

CFTC proposes to identify permitted 

market making-related activities. This 

commentary includes six principles the 

CFTC proposes to use as a guide to help 

distinguish market-making related 

activities from prohibited proprietary 

trading. Third, also as described in 

greater detail in Part III.B.5 of this 

Supplementary Information, §ll.7 

and Appendix A of the proposed rule 

require a banking entity with significant 

covered trading activities to report 

certain quantitative measurements for 

each of its trading units.151 These 

quantitative measurements are intended 

to assist both banking entities and the 

CFTC in assessing whether the 

quantitative profile of a trading unit 

(e.g., the types of revenues it generates 

and the risks it retains) is consistent 

with permitted market making-related 

activities under the proposed rule. 

The proposal’s multi-faceted 

approach is intended, through the 

incorporation of multiple regulatory and 

supervisory tools, to strike an 

appropriate balance in implementing 

the market-making exemption in a way 

that articulates the scope of permitted 

activities and meaningfully addresses 

the potential for misuse of the 

exemption, while not unduly 

constraining the important liquidity and 

intermediation services that market 

makers provide to their customers and 

to the capital markets at large. 

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the exemption for 

permitted market making-related 

activities. In particular, the CFTC 

requests comment on the following 

questions: 

Question 80. Is the proposed rule’s 

approach to implementing the 

exemption for permitted market makingrelated activities (i) appropriate and (ii) 

likely to be effective? If not, what 

alternative approach would be more 

appropriate or effective? 

Question 81. Does the proposed 

multi-faceted approach appropriately 

take into account and address the 

challenges associated with 

differentiating prohibited proprietary 

trading from permitted market makingrelated activities? Should the approach 

include other elements? If so, what 

elements and why? Should any of the 

proposed elements be revised or 

eliminated? If so, why and how? 

Question 82. Does the proposed 

multi-faceted approach provide banking 

entities and market participants with 

sufficient clarity regarding what 

constitutes permitted market makingrelated activities? If not, how could 

greater clarity be provided? 

Question 83. What impact will the 

proposed multi-faceted approach have 

on the market making-related services 

that a banking entity provides to its 

customers? How will the proposed 

approach impact market participants 

who use the services of market makers? 

How will the approach impact the 

capital markets at large, and in 

particular the liquidity, efficiency and 

price transparency of capital markets? If 

any of these impacts are positive, how 

can they be amplified? If any of these 

impacts are negative, how can they be 

mitigated? Would the proposed rule’s 

prohibition on proprietary trading and 

exemption for market making-related 

activity reduce incentives or 

opportunities for banking entities to 

trade against customers, as opposed to 

trading on behalf of customers? If so, 

please discuss the benefits arising from 

such reduced incentives or 

opportunities. 

Question 84. What burden will the 

proposed multi-faceted approach have 

on banking entities, their customers, 

and other market participants? How can 

any burden be minimized or eliminated 

in a manner consistent with the 

language and purpose of the statute? 

Question 85. Are there particular asset 

classes that raise special concerns in the 

context of market making-related 

activity that should be considered in 

connection with the proposed marketmaking exemption? If so, what asset 

class(es) and concern(s), and how 

should the concerns be addressed in the 

proposed exemption? 

Question 86. Are there other market 

making-related activities that the rule 

text should more clearly permit? Why or 

why not? 

ii. Required Criteria for Permitted 

Market Making-Related Activities 

As part of the proposal’s multi-faceted 

approach to implementing the 

exemption for permitted market makingrelated activities, §ll.4(b)(2) of the 

proposed rule specifies seven criteria 

that a banking entity’s market makingrelated activities must meet in order to 

rely on the exemption, each of which 

are described in detail below. These 

criteria are designed to ensure that any 

banking entity relying on the exemption 

is engaged in bona fide market makingrelated activities and conducts those 

activities in a way that is not susceptible 

to abuse through the taking of 

speculative, proprietary positions as a 

part of, or mischaracterized as, market 

making-related activity. 

First Criterion—Establishment of 

Internal Compliance Program 

Section ll.4(b)(2)(i) of the proposed 

rule requires a banking entity to 

establish a comprehensive compliance 

program to monitor and control its 

market making-related activities. 

Subpart D of the proposed rule further 

describes the appropriate elements of an 

effective compliance program. This 

criterion is intended to ensure that any 

banking entity relying on the marketmaking exemption has reasonably 

designed written policies and 

procedures, internal controls, and 

independent testing in place to support 

its compliance with the terms of the 

exemption. 

Second Criterion—Bona Fide Market 

Making 

Section ll.4(b)(2)(ii) of the 

proposed rule articulates the core 

element of the statutory exemption, 

which is that the activity must be 

market making-related. In order to give 

effect to this requirement, 

§ ll.4(b)(2)(ii) of the proposed rule 

requires the trading desk or other 

organizational unit that purchases or 

sells a particular covered financial 

position to hold itself out as being 

willing to buy and sell, or otherwise 

enter into long and short positions in, 

the covered financial position for its 

own account on a regular or continuous 

basis. Notably, this criterion requires 

that a banking entity relying on the 

exemption with respect to a particular 

transaction must actually make a market 

in the covered financial position 

involved; simply because a banking 

entity makes a market in one type of 

covered financial position does not 

permit it to rely on the market-making 

exemption for another type of covered 


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152The CFTC notes that a market maker may 

often make a market in one type of covered 

financial positions and hedge its activities using 

different covered financial positions in which it 

does not make a market. Such hedging transactions 

would meet the terms of the market-making 

exemption if the hedging transaction met the 

requirements of §ll.4(b)(3) of the proposed rule. 

153 7 U.S.C. 1a(49). The Exchange Act includes a 

similar test for a security-based swap dealer. 15 

U.S.C. 78c(a)(71). 

154Section 3(a)(38) of the Exchange Act defines 

‘‘market maker’’ as ‘‘any specialist permitted to act 

as a dealer, any dealer acting in the capacity of 

block positioner, and any dealer who, with respect 

to a security, holds himself out (by entering 

quotations in an inter-dealer quotation 

communications system or otherwise) as being 

willing to buy and sell such security for his own 

account on a regular or continuous basis.’’ 15 U.S.C. 

78c(a)(38). 

155The CFTC notes that these indicia are 

generally consistent with the indicia of bona fide 

market making in equity markets articulated by the 

SEC for purposes of describing the exception to the 

locate requirement of the SEC’s Regulation SHO for 

market makers engaged in bona fide market-making 

activities. See Exchange Act Release No. 58775 

(October 14, 2008), 73 FR 61690, 61698–61699 (Oct. 

17, 2008); see also 17 CFR 242.203(b)(2)(iii). 

156The frequency of such regular quotations will 

itself vary; less illiquid markets may involve 

quotations on a daily or more frequent basis, while 

highly illiquid markets may trade only by 

appointment. 

157The definition of ‘‘market maker’’ in the 

Exchange Act includes a dealer acting in the 

capacity of a block positioner. Although the term 

‘‘block positioner’’ is not defined in the proposed 

rule, the Agencies note that the SEC has adopted 

a definition of ‘‘qualified block positioner’’ in the 

SEC’s Rule 3b–8(c) (17 CFR 240.3b–8(c)), which 

may serve as guidance in determining whether a 

block positioner engaged in block positioning is 

engaged in bona fide market making-related 

activities for purposes of §ll.4(b)(2)(ii) of the 

proposed rule. Under the SEC’s Rule 3b–8(c), 

among other things, a qualified block positioner 

must meet all of the following conditions: (i) 

Engages in the activity of purchasing long or selling 

short, from time to time, from or to a customer 

(other than a partner or a joint venture or other 

entity in which a partner, the dealer, or a person 

associated with such dealer participates) a block of 

stock with a current market value of $200,000 or 

more in a single transaction, or in several 

transactions at approximately the same time, from 

a single source to facilitate a sale or purchase by 

such customer; (ii) has determined in the exercise 

of reasonable diligence that the block could not be 

sold to or purchased from others on equivalent or 

better terms; and (iii) sells the shares comprising 

the block as rapidly as possible commensurate with 

the circumstances. The CFTC notes that the rule 

establishes a minimum dollar value threshold for a 

block. The size of a block will vary among different 

asset classes. 

financial position.152 Similarly, the 

particular trading desk or other 

organizational unit of the banking entity 

that is relying on the exemption for a 

particular type of covered financial 

position must also be the trading desk 

or other organizational unit that is 

actually making the market in that 

covered financial position; market 

making in a particular covered financial 

position by one trading desk of a 

banking entity does not permit another 

trading desk of the banking entity to rely 

on the market-making exemption for 

that type of covered financial position. 

As previously noted, the CFTC is 

adopting the entire text of the Joint Rule 

as part of its proposed rule. Similarly, 

the CFTC is proposing the same criteria 

and considerations to determine bonafide market making activities as was 

previously proposed in the Joint 

Release. Both prior to and since the 

issuance of the Joint Release, the CFTC 

and the SEC have been working toward 

the issuance of a joint final rule to 

further define the terms ‘‘swap dealer’’ 

and ‘‘security-based swap dealer’’ (the 

‘‘Entities Definition Rulemaking’’). The 

Commodity Exchange Act defines the 

term ‘‘swap dealer’’ to include any 

person who ‘‘(i) holds itself out as a 

dealer in swaps; (ii) makes a market in 

swaps; (iii) regularly enters into swaps 

with counterparties as an ordinary 

course of business for its own account; 

or (iv) engages in any activity causing 

the person to be commonly known in 

the trade as a dealer or market maker in 

swaps.’’ 153 The CFTC has received a 

number of comments in the Entities 

Definition Rulemaking regarding the 

criteria for determining whether a 

person is engaging in market making 

activity for the purposes of determining 

whether a person is a swap dealer. 

Accordingly, the CFTC anticipates that 

the final rule further defining the term 

‘‘swap dealer’’ will provide guidance on 

these criteria as to market making. 

Therefore, following the issuance of the 

Entities Definition Rulemaking, the 

CFTC also may consider the extent to 

which ‘‘market making’’ for purposes of 

determining whether a person is a swap 

dealer should be considered ‘‘bona fide 

market making’’ for purposes of this 

Rule. 

The language used in §ll.4(b)(2)(ii) 

of the proposed rule to describe bona 

fide market making-related activity is 

similar to the definition of ‘‘market 

maker’’ under section 3(a)(38) of the 

Exchange Act.154 The CFTC has 

proposed to use similar language 

because the Exchange Act definition is 

generally well-understood by market 

participants and is consistent with the 

scope of bona fide market makingrelated activities in which banking 

entities typically engage. 

In assessing whether a particular 

trading desk or other organizational unit 

holds itself out as being willing to buy 

and sell, or otherwise enter into long 

and short positions in, a covered 

financial position for its own account on 

a regular or continuous basis in liquid 

markets, the CFTC expects to take an 

approach similar to that used by the 

SEC in the context of assessing whether 

a person is engaging in bona fide market 

making. The precise nature of a market 

maker’s activities often varies 

depending on the liquidity, trade size, 

market infrastructure, trading volumes 

and frequency, and geographic location 

of the market for any particular covered 

financial position. In the context of 

relatively liquid positions, such as 

equity securities or other exchangetraded instruments, a trading desk or 

other organizational unit’s market 

making-related activity should generally 

include: 

• Making continuous, two sided 

quotes and holding oneself out as 

willing to buy and sell on a continuous 

basis; 

• A pattern of trading that includes 

both purchases and sales in roughly 

comparable amounts to provide 

liquidity; 

• Making continuous quotations that 

are at or near the market on both sides; 

and 

• Providing widely accessible and 

broadly disseminated quotes.155

In less liquid markets, such as over-thecounter markets for debt and equity 

securities or derivatives, the appropriate 

indicia of market making-related 

activities will vary, but should generally 

include: 

• Holding oneself out as willing and 

available to provide liquidity by 

providing quotes on a regular (but not 

necessarily continuous) basis; 156

• With respect to securities, regularly 

purchasing covered financial positions 

from, or selling the positions to, clients, 

customers, or counterparties in the 

secondary market; and 

• Transaction volumes and risk 

proportionate to historical customer 

liquidity and investments needs. 

The CFTC would apply these indicia 

when evaluating when a banking entity 

is eligible for the market making-related 

activities exemption, but also recognize 

that these indicia cannot be applied at 

all times and under all circumstances 

because some may be inapplicable to 

the specific asset class or market in 

which the market making activity is 

conducted. 

The bona fide market making-related 

activity described in §ll.4(b)(2)(ii) of 

the proposed rule would include block 

positioning if undertaken by a trading 

desk or other organizational unit of a 

banking entity for the purpose of 

intermediating customer trading.157 In 

addition, bona fide market makingrelated activity may include taking 

positions in securities in anticipation of 

customer demand, so long as any 


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158The CFTC emphasizes that the status of being 

a registered market maker is not, on its own, a 

sufficient basis for relying on the exemption for 

market making-related activity contained in 

§ll.4(b); however, being a registered market 

maker is required under these circumstances if the 

applicable exchange or organized trading facility 

registers market makers. Registration as a market 

maker generally involves filing a prescribed form 

with an exchange or organized trading facility, in 

accordance with its rules and procedures, and 

complying with the applicable requirements for 

market makers set forth in the rules of that 

exchange or organized trading facility. See, e.g., 

Nasdaq Rule 4612, New York Stock Exchange Rule 

104, CBOE Futures Exchange Rule 515, BATS 

Exchange Rule 11.5. 

159See proposed rule §§ll.4(b)(2)(iv)(A), (D), 

(E). For example, if a banking entity is a bank 

engaged in market-making in qualified Canadian 

government obligations for which it would be 

required to register as a securities dealer but for the 

exclusion contained in section 3(a)(5)(C)(i)(I) of the 

Exchange Act, the proposed rule would not require 

that banking entity to be a registered securities 

dealer in order to rely on the market-making 

exemption for that market-making transaction. Such 

a bank would, however, be required to file notice 

that it is a government securities dealer and comply 

with rules applicable to financial institutions that 

are government securities dealers. See 15 U.S.C. 

78c(a)(42)(E); 15 U.S.C. 78o–5(a)(1)(B); 17 CFR 

400.5(b); 17 CFR 449.1. Similar to the underwriting 

exemption, the proposed rule does not apply the 

dealer registration requirement to market making in 

securities that are exempted securities, commercial 

paper, bankers acceptances or commercial bills 

because dealing in such securities does not require 

registration as securities dealer under the Exchange 

Act; however, registering as a municipal securities 

dealer or government securities dealer is required, 

if applicable. 

160See proposed rule §§ll.4(b)(2)(iv)(B), (C). A 

banking entity may be required to be a registered 

securities dealer if it engages in market-making 

transactions involving security-based swaps with 

persons that are not eligible contract participants. 

See 15 U.S.C. 78c(a)(5) (the definition of ‘‘dealer’’ 

in section 3(a)(5) of the Exchange Act, 15 U.S.C. 

78c(a)(5), generally includes ‘‘any person engaged 

in the business of buying and selling securities (not 

including security-based swaps, other than securitybased swaps with or for persons that are not eligible 

contract participants), for such person’s own 

account.’’). 

anticipatory buying or selling activity is 

reasonable and related to clear, 

demonstrable trading interest of clients, 

customers, or counterparties. 

Third Criterion—Reasonably Expected 

Near-Term Demands of Clients, 

Customers, and Counterparties 

Under §ll.4(b)(2)(iii) of the 

proposed rule, the market makingrelated activities of the trading desk or 

other organization unit that conducts a 

transaction in reliance on the marketmaking exemption must be designed not 

to exceed the reasonably expected nearterm demands of clients, customers, and 

counterparties. This criterion 

implements the language in section 

13(d)(1)(B) of the BHC Act and is 

intended to prevent a trading desk 

relying on the market-making 

exemption from taking a speculative 

proprietary position unrelated to 

customer needs as part of its purported 

market making-related activities. As 

described in further detail in Parts 

III.B.5 and III.D of the SUPPLEMENTARY

INFORMATION, the proposed rule also 

includes a programmatic compliance 

requirement and requires reporting of 

quantitative measurements for certain 

banking entities, both of which are 

designed, in part, to meaningfully 

circumscribe the principal positions 

taken as part of market making-related 

activities to those which are necessary 

to meet the reasonably expected nearterm demands of clients, customers and 

counterparties. The CFTC expects that 

the programmatic compliance 

requirement and required reporting of 

quantitative measurements will play an 

important role in assessing a banking 

entity’s compliance with 

§ ll.4(b)(2)(iii)’s requirement. In 

addition, as described in Part II.B.5 of 

the Supplementary Information, 

Appendix B of the proposed rule 

provides additional, detailed 

commentary regarding how the CFTC 

expects a firm relying on the marketmaking exemption to manage principal 

positions and how the CFTC proposes to 

assess whether such positions are 

consistent with market making-related 

activities under the proposed rule. 

In order for a banking entity’s 

expectations regarding near-term 

customer demand to be considered 

reasonable, such expectations should be 

based on more than a simple 

expectation of future price appreciation 

and the generic increase in marketplace 

demand that such price appreciation 

reflects. Rather, a banking entity’s 

expectation should generally be based 

on the unique customer base of the 

banking entity’s specific market-making 

business lines and the near-term 

demands of those customers based on 

particular factors beyond a general 

expectation of price appreciation. To the 

extent that a trading desk or other 

organizational unit of a banking entity is 

engaged wholly or principally in trading 

that is not in response to, or driven by, 

customer demands, the CFTC would not 

expect those activities to qualify under 

§ ll.4(b) of the proposed rule, 

regardless of whether those activities 

promote price transparency or liquidity. 

For example, a trading desk or other 

organizational unit of a banking entity 

that is engaged wholly or principally in 

arbitrage trading with non-customers 

would not meet the terms of the 

proposed rule’s market making 

exemption. In the case of a market 

maker engaging in market making in a 

security that is executed on an 

organized trading facility or exchange, 

that market maker’s activities are 

generally consistent with reasonably 

expected near-term customer demand 

when such activities involve passively 

providing liquidity by submitting 

resting orders that interact with the 

orders of others in a non-directional or 

market-neutral trading strategy and the 

market maker is registered, if the 

exchange or organized trading facility 

registers market makers.158 However, 

activities by such a person that 

primarily takes liquidity on an 

organized trading facility or exchange, 

rather than provides liquidity, would 

not qualify for the market-making 

exemption under the proposed rule, 

even if those activities were conducted 

by a registered market maker. 

Fourth Criterion—Registration Under 

Securities or Commodities Laws 

Under §ll.4(b)(2)(iv) of the 

proposed rule, a banking entity relying 

on the market-making exemption with 

respect to trading in securities or certain 

derivatives must be appropriately 

registered as a dealer, or exempt from 

registration or excluded from regulation 

as a dealer, under applicable securities 

or commodities laws. With respect to a 

market-making transaction in one or 

more covered financial positions that 

are securities, other than exempted 

securities, security-based swaps, 

commercial paper, bankers acceptances 

or commercial bills, for which a person 

must be a registered securities dealer, 

municipal securities dealer or 

government securities dealer in order to 

deal in the security, the banking entity 

must have the appropriate dealer 

registration (or in the case of a financial 

institution that is a government 

securities dealer, has filed notice of that 

status as required by section 

15C(a)(1)(B) of the Exchange Act) or 

otherwise be exempt from registration or 

excluded from regulation as a dealer.159

Similarly, with respect to a marketmaking transaction involving a swap or 

security-based swap for which a person 

must generally be a registered swap 

dealer or security-based swap dealer, 

respectively, the banking entity must be 

appropriately registered or otherwise be 

exempt from registration or excluded 

from regulation as a swap dealer or 

security-based swap dealer.160 If the 

banking entity is engaged in the 

business of a securities dealer, swap 

dealer or security-based swap dealer 

outside the United States in a manner 

for which no U.S. registration is 

required, the banking entity must be 

subject to substantive regulation of its 

dealing business in the jurisdiction in 

which the business is located. This 

requirement is intended to ensure that 


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8358 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

(i) any market making-related activity 

conducted in reliance on the exemption 

is subject to appropriate regulation and 

(ii) a banking entity does not 

simultaneously characterize the 

transaction as market making-related for 

purposes of the exemption while 

characterizing it in a different manner 

for purposes of applicable securities or 

commodities laws. 

Fifth Criterion—Revenues From Fees, 

Commissions, Bid/Ask Spreads or Other 

Similar Income 

Under §ll.4(b)(2)(v) of the 

proposed rule, the market makingrelated activities of the banking entity 

must be designed to generate revenues 

primarily from fees, commissions, bid/ 

ask spreads or other income not 

attributable to appreciation in the value 

of covered financial positions it holds in 

trading accounts or the hedging of such 

positions. This criterion is intended to 

ensure that activities conducted in 

reliance on the market-making 

exemption demonstrate patterns of 

revenue generation and profitability 

consistent with, and related to, the 

intermediation and liquidity services a 

market maker provides to its customers, 

rather than changes in the market value 

of the positions or risks held in 

inventory. Similar to the requirement 

that a firm relying on the market-making 

exemption design its activities not to 

exceed reasonably expected near-term 

client, customer, or counterparty 

demands, the Agencies expect that the 

programmatic compliance requirement 

and required reporting of quantitative 

measurements will play an important 

role in assessing a banking entity’s 

compliance with §ll.4(b)(2)(v)’s 

requirement. In addition, as described 

in Part III.B.5 of this SUPPLEMENTARY

INFORMATION, Appendix B of the 

proposed rule provides additional, 

detailed commentary regarding how the 

CFTC proposes to assess whether the 

types of revenues generated by a 

banking entity relying on the marketmaking exemption are consistent with 

market making-related activities. 

Sixth Criterion—Compensation 

Incentives 

Under §ll.4(b)(2)(vii) of the 

proposed rule, the compensation 

arrangements of persons performing 

market making-related activities at the 

banking entity must be designed not to 

encourage or reward proprietary risktaking. Activities for which a banking 

entity has established a compensation 

incentive structure that rewards 

speculation in, and appreciation of, the 

market value of a covered financial 

position held in inventory, rather than 

success in providing effective and 

timely intermediation and liquidity 

services to customers, are inconsistent 

with permitted market making-related 

activities. Although a banking entity 

relying on the market-making 

exemption may appropriately take into 

account revenues resulting from 

movements in the price of principal 

positions to the extent that such 

revenues reflect the effectiveness with 

which personnel have managed 

principal risk retained, a banking entity 

relying on the market-making 

exemption should provide 

compensation incentives that primarily 

reward customer revenues and effective 

customer service, not proprietary risktaking. In addition, as described in Part 

III.B.5 of this Supplementary 

Information, Appendix B of the 

proposed rule provides further 

commentary regarding how the CFTC 

proposes to assess whether the 

compensation incentives provided to 

trading personnel performing trading 

activities in reliance on the marketmaking exemption are consistent with 

market making-related activities. 

Seventh Criterion—Consistency With 

Appendix B Commentary 

Under §ll.4(b)(2)(vi) of the 

proposed rule, the market makingrelated activities of the trading desk or 

other organizational unit that conducts 

the purchase or sale are required to be 

consistent with the commentary 

provided in Appendix B, which 

provides guidance that the CFTC 

proposes to apply to help distinguish 

permitted market making-related 

activities from prohibited proprietary 

trading. Appendix B’s proposed 

commentary, which is described in 

detail below in Part III.B.5 of this 

Supplementary Information, discusses 

various factors by which the CFTC 

proposes to distinguish prohibited 

proprietary trading from permitted 

market making-related activities (e.g., 

how and to what extent a market maker 

hedges the risk of its market-making 

transactions, including (i) further detail 

related directly to other criteria in 

§ ll.4(b)(2) (e.g., the types of revenues 

generated by market makers), and (ii) 

expectations regarding other factors not 

expressly included in §ll.4(b)(2)). 

ii. Market Making-Related Hedging 

Section ll.4(b)(3) of the proposed 

rule provides that certain hedging 

transactions related to market-making 

positions and holdings will also be 

deemed to be made in connection with 

a banking entity’s market makingrelated activities for purposes of the 

market-making exemption. In particular, 

§ ll.4(b)(3) provides that the purchase 

or sale of a covered financial position 

for hedging purposes will qualify for the 

market-making exemption if it meets 

two requirements. First, the purchase or 

sale must be conducted in order to 

reduce the specific risks to the banking 

entity in connection with and related to 

individual or aggregated positions, 

contracts, or other holdings acquired 

pursuant to the market-making 

exemption. Where the purpose of a 

transaction is to hedge a market makingrelated position, it would appear to be 

market making-related activity of the 

type described in section 13(d)(1)(B) of 

the BHC Act. Second, the hedging 

transaction must also meet the criteria 

specified in the general exemption for 

risk-mitigating hedging activity for 

purposes of the proprietary trading 

prohibition, which is contained in 

§§ ll.5(b) and (c) of the proposed rule 

and described in detail in Part III.B.3 of 

this Supplementary Information. Those 

criteria are intended to clearly define 

the scope of appropriate risk-mitigating 

hedging activities, to foreclose reliance 

on the exemption for prohibited 

proprietary trading that is conducted in 

the context of, or mischaracterized as, 

hedging activity, and to require 

documentation regarding the hedging 

purpose of certain transactions that are 

established at a level of organization 

that is different than the level of 

organization establishing or responsible 

for the underlying risk or risks that are 

being hedged, which in the context of 

the market making-related activity 

would generally be the trading desk. 

iii. Request for Comment 

The CFTC requests comment on the 

proposed criteria that must be met in 

order to rely on the market-making 

exemption. In particular, the CFTC 

requests comment on the following 

questions (as well as related questions 

in Part III.B.5 of this Supplementary 

Information): 

Question 87. Are the seven criteria 

included in the market-making 

exemption effective? Is the application 

of each criterion to potential 

transactions sufficiently clear? Should 

any of the criteria be changed or 

eliminated? Should other criteria be 

added? 

Question 87.1. Should the proposed 

CFTC Rule’s market making exemption 

include the requirements set forth in 

§§ ll.4(b)(2)(iv)(A),(C), (D) and (E), 

relating to SEC registered dealers and 

dealers who have filed notice with the 

appropriate regulatory agency? Please 

explain the rationale for including or 

excluding the provision in the proposed 

CFTC Rule. 


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Question 88. Is incorporation of 

concepts from the definition of ‘‘market 

maker’’ under the Exchange Act useful 

for purposes of section 13 of the BHC 

Act and consistent with its purposes? If 

not, what alternative definition would 

be more useful or more consistent? 

Question 88.1. Alternatively, to what 

extent should the CFTC incorporate 

concepts regarding market making from 

the Entities Definitions Rulemaking for 

purposes of section 13 of the BHC Act? 

Question 89. Is the proposed 

exemption overly broad or narrow? For 

example, would it encompass activity 

that should be considered prohibited 

proprietary trading under the proposed 

rule? Alternatively, would it prohibit 

forms of market making or market 

making-related activities that are 

permitted under other rules or 

regulations? 

Question 90. We seek commenter 

input on the types of banking entities 

and forms of activities that would not 

qualify for the proposed market-making 

exemption but that commenters 

consider to otherwise be market making. 

Please discuss the impact of not 

permitting such activities under the 

proposed exemption (e.g., the impact on 

liquidity). 

Question 91. Is the requirement that a 

trading desk or other organizational unit 

relying on the market-making 

exemption hold itself out as being 

willing to buy and sell, or otherwise 

enter into long and short positions in, 

the relevant covered financial position 

for its own account on a regular or 

continuous basis effective? If not, what 

alternative would be more effective? 

Does the proposed requirement 

appropriately differentiate between 

market making-related activities in 

different markets and asset classes? If 

not, how could such differences be 

better reflected? Should the requirement 

be modified to include certain arbitrage 

trading activities engaged in by market 

makers that promote liquidity or price 

transparency, but do not serve customer, 

client or counterparty demands, within 

the scope of market making-related 

activity? If so why? How could such 

liquidity- or price transparencypromoting activities be meaningfully 

identified and distinguished from 

prohibited proprietary trading practices 

that also may incidentally promote 

liquidity or price transparency? Do 

particular markets or instruments, such 

as the market for exchange-traded funds, 

raise particular issues that are not 

adequately or appropriately addressed 

in the proposal? If so, how could the 

proposal better address those 

instruments, markets or market features? 

Question 92. Do the proposed indicia 

of market making in liquid markets 

accurately reflect the factors that should 

generally be used to analyze whether a 

banking entity is engaged in market 

making-related activities for purposes of 

section 13 of the BHC Act and the 

proposed rule? If not, why not? Should 

any of the proposed factors be 

eliminated or modified? Should any 

additional factors be included? Is 

reliance on the SEC’s indicia of bona 

fide market making for purposes of 

Regulation SHO under the Exchange Act 

and the equity securities market 

appropriate in the context of section 13 

of the BHC Act and the proposed rule 

with respect to liquid markets? If not, 

why not? 

Question 93. Do the proposed indicia 

of market making in illiquid markets 

accurately reflect the factors that should 

generally be used to analyze whether a 

banking entity is engaged in market 

making-related activities for purposes of 

section 13 of the BHC Act and the 

proposed rule? If not, why not? Should 

any of the proposed factors be 

eliminated or modified? Should any 

additional factors be included? 

Question 94. How accurately can a 

banking entity predict the near-term 

demands of clients, customers, and 

counterparties? Are there measures that 

can distinguish the amount of principal 

risk that should be retained to support 

such near-term client, customer, or 

counterparty demand from positions 

taken for speculative purposes? How is 

client, customer, or counterparty 

demand anticipated in connection with 

market making-related activities, and 

how does such approach vary by asset 

class? 

Question 95. Is the requirement that a 

banking entity relying on the marketmaking exemption be registered as a 

dealer (or in the case of a financial 

institution that is a government 

securities dealer, has filed notice of that 

status as required by section 

15C(a)(1)(B) of the Exchange Act), or 

exempt from registration or excluded 

from regulation as a dealer under 

relevant securities or commodities laws 

effective? If not, how should the 

requirement be changed? Does the 

requirement appropriately take into 

account the particular registration 

requirements applicable to dealing in 

different types of financial instruments? 

If not, how could it better do so? Does 

the requirement appropriately take into 

account the various registration 

exemptions and exclusions available to 

certain entities, such as banks, under 

the securities and commodities laws? If 

not, how could it better do so? 

Question 96. Is the requirement that a 

trading desk or other organizational unit 

of a banking entity relying on the 

market-making exemption be designed 

to generate revenues primarily from 

fees, commissions, bid/ask spreads or 

similar income effective? If not, how 

should the requirement be changed? 

Does the requirement appropriately 

capture the type and nature of revenues 

typically generated by market makingrelated activities? Is any further 

clarification or additional guidance 

necessary? Can revenues primarily from 

fees, commissions, bid/ask spreads or 

similar income be meaningfully 

separated from other types of revenues? 

Question 97. Is the requirement that 

the compensation arrangements of 

persons performing market makingrelated activities at a banking entity not 

be designed to encourage proprietary 

risk-taking effective? If not, how should 

the requirement be changed? Are there 

other types of compensation incentives 

that should be clearly referenced as 

consistent, or inconsistent, with 

permitted market making-related 

activity? Are their specific and 

identifiable characteristics of 

compensation arrangements that clearly 

incentivize prohibited proprietary 

trading? 

Question 98. Is the inclusion of 

market making-related hedging 

transactions within the market-making 

exemption effective and appropriate? 

Are the proposed requirements that 

certain hedging transactions must meet 

in order to be considered to have been 

made in connection with market 

making-related activity effective and 

sufficiently clear? If not, what 

alternative requirements would be more 

effective and/or clearer? Should any of 

the proposed requirements be 

eliminated? If so, which ones, and why? 

Question 99. Should the terms 

‘‘client,’’ ‘‘customer,’’ or ‘‘counterparty’’ 

be defined for purposes of the marketmaking exemption? If so, how should 

these terms be defined? For example, 

would an appropriate definition of 

‘‘customer’’ be: (i) A continuing 

relationship in which the banking entity 

provides one or more financial products 

or services prior to the time of the 

transaction; (ii) a direct and substantive 

relationship between the banking entity 

and a prospective customer prior to the 

transaction; (iii) a relationship initiated 

by the banking entity to a prospective 

customer to induce transactions; or (iv) 

a relationship initiated by the 

prospective customer with a view to 

engaging in transactions? 

Question 100. Are there other types of 

market making-related activities that 

should also be included within the 


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8360 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

161These aspects of the compliance program 

requirement are described in further detail in Part 

III.D of this Supplementary Information. 

162See, e.g., proposed rule Appendix C.II.a. 

scope of the market-making exemption? 

If so, what additional activities and 

why? How would an exemption for such 

additional activities be consistent with 

the language and intent of section 13 of 

the BHC Act? What criteria, 

requirements, or restrictions would be 

appropriate to include with respect to 

such additional activities? How would 

such criteria, requirements, or 

restrictions prevent circumvention or 

evasion of the prohibition on 

proprietary trading? 

Question 101. Do banking entities 

currently have processes in place that 

would prevent or reduce the likelihood 

of taking speculative, proprietary 

positions in the context of, or 

mischaracterized as, market makingrelated activities? If so, what processes? 

3. Section ll.5: Permitted RiskMitigating Hedging Activities 

Section ll .5 of the proposed rule 

permits a banking entity to purchase or 

sell a covered financial position if the 

transaction is made in connection with, 

and related to, individual or aggregated 

positions, contracts, or other holdings of 

a banking entity and is designed to 

reduce the specific risks to the banking 

entity in connection with and related to 

such positions, contracts, or other 

holdings (the ‘‘hedging exemption’’). 

This section of the proposed rule 

implements, in relevant part, section 

13(d)(1)(C) of the BHC Act, which 

provides an exemption from the 

prohibition on proprietary trading for 

certain risk-mitigating hedging 

activities. 

a. Approach To Implementing the 

Hedging Exemption 

Like market making-related activities, 

risk-mitigating hedging activities 

present certain implementation 

challenges because of the potential that 

prohibited proprietary trading could be 

conducted in the context of, or 

mischaracterized as, a hedging 

transaction. This is because it may often 

be difficult to identify in retrospect 

whether a banking entity engaged in a 

particular transaction to manage or 

eliminate risks arising from related 

positions, on the one hand, or to profit 

from price movements related to the 

hedge position itself, on the other. The 

intent with which a purported hedge 

position is acquired may often be 

difficult to discern in practice. 

In light of these complexities, the 

CFTC has again proposed a multifaceted approach to implementation. As 

with the underwriting and marketmaking exemptions, the CFTC has 

proposed a set of criteria that must be 

met in order for a banking entity to rely 

on the hedging exemption. The 

proposed criteria are intended to define 

the scope of permitted risk-mitigating 

hedging activities and to foreclose 

reliance on the exemption for prohibited 

proprietary trading that is conducted in 

the context of, or mischaracterized as, 

permitted hedging activity. This 

includes implementation of the 

programmatic compliance regime 

required under subpart D of the 

proposed rule and, in particular, 

requires that a banking entity with 

significant trading activities implement 

robust, detailed hedging policies and 

procedures and related internal controls 

that are designed to prevent prohibited 

proprietary trading in the context of 

permitted hedging activity.161 In 

particular, a banking entity’s 

compliance regime must include written 

hedging policies at the trading unit level 

and clearly articulated trader mandates 

for each trader to ensure that the 

decision of when and how to put on a 

hedge is consistent with such policies 

and mandates, and not fully left to a 

trader’s discretion.162 In addition, to 

address potential supervisory concerns 

raised by certain types of hedging 

transactions, §ll .5 of the proposed 

rule also requires a banking entity to 

document certain hedging transactions 

at the time the hedge is established. 

This multi-faceted approach is intended 

to articulate the CFTC’s expectations 

regarding the scope of permitted riskmitigating hedging activities in a 

manner that limits potential abuse of the 

hedging exemption while not unduly 

constraining the important risk 

management function that is served by 

a banking entity’s hedging activities. 

b. Required Criteria for Permitted RiskMitigating Hedging Activities 

Section ll .5(b) of the proposed rule 

describes the seven criteria that a 

banking entity must meet in order to 

rely on the hedging exemption. First, 

§ ll .5(b)(1) of the proposed rule 

requires the banking entity to have 

established an internal compliance 

program, consistent with the 

requirements of subpart D, that is 

designed to ensure the banking entity’s 

compliance with the requirements of 

this paragraph, including reasonablydesigned written policies and 

procedures, internal controls, and 

independent testing. This criterion is 

intended to ensure that any banking 

entity relying on the exemption has 

appropriate internal control processes in 

place to support its compliance with the 

terms of the exemption. 

Second, §ll .5(b)(2)(i) of the 

proposed rule requires that a transaction 

for which a banking entity is relying on 

the hedging exemption have been made 

in accordance with written policies, 

procedures and internal controls 

established by the banking entity 

pursuant to subpart D. This criterion 

would preclude reliance on the hedging 

exemption if the transaction was 

inconsistent with a banking entity’s own 

hedging policies and procedures, as 

such inconsistency would appear to be 

indicative of prohibited proprietary 

trading. 

Third, §ll .5(b)(2)(ii) of the 

proposed rule requires that the 

transaction hedge or otherwise mitigate 

one or more specific risks, including 

market risk, counterparty or other credit 

risk, currency or foreign exchange risk, 

interest rate risk, basis risk, or similar 

risks, arising in connection with and 

related to individual or aggregated 

positions, contracts, or other holdings of 

a banking entity. This criterion 

implements the essential element of the 

hedging exemption—i.e., that the 

transaction be risk-mitigating. Notably, 

and consistent with the statutory 

reference to mitigating risks of 

individual or aggregated positions, this 

criterion would include the hedging of 

risks on a portfolio basis. For example, 

it would include the hedging of one or 

more specific risks arising from a 

portfolio of diverse holdings, such as 

the hedging of the aggregate risk of one 

or more trading desks. However, in each 

case, the CFTC would expect that the 

transaction or series of transactions 

being used to hedge is, in the aggregate, 

demonstrably risk-reducing with respect 

to the positions, contracts, or other 

holdings that are being hedged. A 

banking entity relying on the exemption 

should be prepared to identify the 

specific position or portfolio of 

positions that is being hedged and 

demonstrate that the hedging 

transaction is risk-reducing in the 

aggregate, as measured by appropriate 

risk management tools. 

In addition, this criterion would 

include a series of hedging transactions 

designed to hedge movements in the 

price of a portfolio of positions. For 

example, a banking entity may need to 

engage in dynamic hedging, which 

involves rebalancing its current hedge 

position(s) based on a change in the 

portfolio resulting from permissible 

activities or from a change in the price, 

or other characteristic, of the individual 

or aggregated positions, contracts, or 

other holdings. The CFTC recognizes 

that, in such dynamic hedging, material 


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163This corresponding modification to the hedge 

should also be reasonably correlated to the material 

changes in risk that are intended to be hedged or 

otherwise mitigated, as required by proposed rule 

§ll.5(b)(2)(iii). 

164Although certain accounting standards, such 

as FASB ASC Topic 815 hedge accounting, address 

circumstances in which a transaction may be 

considered a hedge of another transaction, the 

proposed rule does not refer to or rely on these 

accounting standards, because such standards (i) 

are designed for financial statement purposes, not 

to identify proprietary trading and (ii) change often 

and are likely to change in the future without 

consideration of the potential impact on section 13 

of the BHC Act. 

165 Interest rate risk in an equity derivative 

transaction is one example—the hedging of interest 

rate risk in an equity derivative position may only 

result in a small reduction in overall risk and 

interest rates may only exhibit a small correlation 

with the value of the equity derivative, but the lack 

of perfect or significant correlation would not 

impair reliance on the hedging exemption. 

166The CFTC notes that in some cases, it may be 

appropriate for a banking entity to unwind a hedge, 

even if the underlying risk remains, if the cost of 

that hedge become uneconomic, better hedging 

options become available, or the overall risk profile 

of the banking entity has changed such that no 

longer hedging the risk is consistent with 

appropriate risk management practices. 

changes in risk may require a 

corresponding modification to the 

banking entity’s current hedge 

positions.163

The CFTC also expects that a banking 

entity relying on the exemption would 

be able to demonstrate that the banking 

entity is already exposed to the specific 

risks being hedged; generally, the 

purported hedging of risks to which the 

banking entity is not actually exposed 

would not meet the terms of the 

exemption. However, the hedging 

exemption would be available in certain 

cases where the hedge is established 

slightly before the banking entity 

becomes exposed to the underlying risk 

if such anticipatory hedging activity: (i) 

Is consistent with appropriate risk 

management practices; (ii) otherwise 

meets the terms of the hedging 

exemption; and (iii) does not involve 

the potential for speculative profit. For 

example, if a banking entity was 

contractually obligated, or otherwise 

highly likely, to become exposed to a 

particular risk and there was a sound 

risk management rationale for hedging 

that risk slightly in advance of actual 

exposure, the hedging transaction 

would generally be consistent with the 

requirement described in 

§ ll.5(b)(2)(ii) of the proposed rule. 

Fourth, §ll.5(b)(2)(iii) of the 

proposed rule requires 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. A transaction that is 

only tangentially related to the risks that 

it purportedly mitigates would appear to 

be indicative of prohibited proprietary 

trading. Importantly, the CFTC has not 

proposed that a transaction relying on 

the hedging exemption be fully 

correlated; instead, only reasonable 

correlation is required.164 The degree of 

correlation that may be reasonable will 

vary depending on the underlying risks 

and the availability of alternative 

hedging options—risks that can be 

easily and cost-effectively hedged with 

extremely high or near-perfect 

correlation would typically be expected 

to be so hedged, whereas other risks 

may be difficult or impossible to hedge 

with anything greater than partial 

correlation. Moreover, it is important to 

consider the fact that trading positions 

are often subject to a number of different 

risks, and some risks may be hedged 

easily and at low cost but may only 

account for a small proportion of the 

total risk in the position.165 More 

generally, potential correlation levels 

between asset classes can differ 

significantly, and analysis of the 

reasonableness of correlation would 

depend on the facts and circumstances 

of the initial position(s), risk(s) created, 

liquidity of the instrument, and the 

legitimacy of the hedge. Regardless of 

the precise degree of correlation, if the 

predicted performance of a hedge 

position during the period that the 

hedge position and the related position 

are held would result in a banking 

entity earning appreciably more profits 

on the hedge position than it stood to 

lose on the related position, the hedge 

would appear likely to be a proprietary 

trade designed to result in profit rather 

than an exempt hedge position. 

Fifth, §ll.5(b)(2)(iv) of the 

proposed rule requires 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. A transaction that creates 

significant new risk exposure that is not 

itself hedged at the same time would 

appear to be indicative of prohibited 

proprietary trading. For example, overhedging, correlation trading, or pairs 

trading strategies that generate profits 

through speculative, proprietary risktaking would fail to meet this criterion. 

Similarly, a transaction involving a pair 

of positions that hedge each other with 

respect to one type of risk exposure, but 

create or contain a residual risk 

exposure would, taken together, 

constitute prohibited proprietary trading 

and not risk-mitigating hedging if those 

positions were taken collectively for the 

purpose of profiting from short-term 

movements in the effective price of the 

residual risk exposure. However, the 

proposal also recognizes that any 

hedging transaction will inevitably give 

rise to certain types of new risk, such as 

counterparty credit risk or basis risk 

reflecting the differences between the 

hedge position and the related position; 

the proposed criterion only prohibits 

the introduction of additional 

significant exposures through the 

hedging transaction. In addition, 

proposed §ll.5(b)(2)(iv) only requires 

that no new and significant exposures 

be introduced at the inception of the 

hedge, and not during the entire period 

that the hedge is maintained, reflecting 

the fact that new, unanticipated risks 

can and sometimes do arise out of 

hedging positions after the hedge is 

established. The CFTC has proposed to 

address the appropriate management of 

risks that arise out of a hedge position 

after inception through §ll.5(b)(2)(v) 

of the proposed rule. 

Sixth, §ll.5(b)(2)(v) of the proposed 

rule requires that any transaction 

conducted in reliance on the hedging 

exemption be subject to continuing 

review, monitoring and management 

after the hedge position is established. 

Such review, monitoring, and 

management must: (i) be consistent with 

the banking entity’s written hedging 

policies and procedures; (ii) maintain a 

reasonable level of correlation, based 

upon the facts and circumstances of the 

underlying and hedging positions and 

the risks and liquidity of those 

positions, to the risk or risks the 

purchase or sale is intended to hedge or 

otherwise mitigate; and (iii) mitigate any 

significant exposure arising out of the 

hedge after inception. In accordance 

with a banking entity’s written internal 

hedging policies, procedures, and 

internal controls, a banking entity 

should actively review and manage its 

hedging positions and the risks that may 

arise out of those positions over time. A 

banking entity’s internal hedging 

policies should be designed to ensure 

that hedges remain effective as 

correlations or other factors change. In 

particular, a risk-mitigating hedge 

position typically should be unwound 

as exposure to the underlying risk is 

reduced or increased as underlying risk 

increases, as selective hedging activity 

would appear to be indicative of 

prohibited proprietary trading.166 A 

banking entity’s written internal 

hedging policies, procedures, and 

internal controls for monitoring and 

managing its hedges also should be 

reasonably designed to prevent the 

occurrence of such prohibited 


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167For example, a hedge would be established at 

a different level of organization of the banking 

entity if multiple market making desks were 

exposed to similar risks and, to hedge such risks, 

a portfolio hedge was established at the direction 

of a supervisor or risk manager responsible for more 

than one desk rather than at each of the market 

making desks that established the initial positions, 

contracts, or other holdings. 

proprietary trading activity and be 

reasonably specific about the level of 

hedging that is expected to be 

maintained regardless of opportunities 

for profit associated with over- or underhedging. 

Seventh, §ll.5(b)(2)(vi) of the 

proposed rule requires that the 

compensation arrangements of persons 

performing the risk-mitigating hedging 

activities are designed not to reward 

proprietary risk-taking. Hedging 

activities for which a banking entity has 

established a compensation incentive 

structure that rewards speculation in, 

and appreciation of, the market value of 

a covered financial position, rather than 

success in reducing risk, are 

inconsistent with permitted riskmitigating hedging activities. 

c. Documentation Requirement 

Section ll.5(c) of the proposed rule 

imposes a documentation requirement 

on certain types of hedging transactions. 

Specifically, for any transaction that a 

banking entity conducts in reliance on 

the hedging exemption that involves a 

hedge established at a level of 

organization that is different than the 

level of organization establishing the 

positions, contracts, or other holdings 

the risks of which the hedging 

transaction is designed to reduce, the 

banking entity must, at a minimum, 

document the risk-mitigating purpose of 

the transaction and identify the risks of 

the individual or aggregated positions, 

contracts, or other holdings of a banking 

entity that the transaction is designed to 

reduce.167 Such documentation must be 

established at the time the hedging 

transaction is effected, not after the fact. 

The CFTC is concerned that hedging 

transactions established at a different 

level of organization than the positions 

being hedged may present or reflect 

heightened potential for prohibited 

proprietary trading, as a banking entity 

may be able, after the fact, to point to 

a particular, offsetting exposure within 

its organization after a position is 

established and characterize that 

position as a hedge even when, at the 

time the position was established, it was 

intended to generate speculative 

proprietary gains, not mitigate risk. To 

address this concern, the CFTC has 

proposed to require a banking entity, 

when establishing a hedge at a different 

level of organization than that 

establishing or responsible for the 

underlying positions or risks being 

hedged, to document the hedging 

purpose of the transaction and risks 

being hedged so as to establish a 

contemporaneous, documentary record 

that will assist the CFTC in assessing 

the actual reasons for which the 

position was established. 

d. Request for Comment 

The CFTC requests comment on the 

proposed implementation of the riskmitigating hedging exemption with 

respect to proprietary trading. In 

particular, the CFTC requests comment 

on the following questions: 

Question 102. Is the proposed rule’s 

approach to implementing the hedging 

exemption effective? If not, what 

alternative approach would be more 

effective? 

Question 103. Does the proposed 

multi-faceted approach appropriately 

take into account and address the 

challenges associated with 

differentiating prohibited proprietary 

trading from permitted hedging 

activities? Should the approach include 

other elements? If so, what elements and 

why? Should any of the proposed 

elements be revised or eliminated? If so, 

why and how? 

Question 104. Does the proposed 

approach to implementing the hedging 

exemption provide banking entities and 

market participants with sufficient 

clarity regarding what constitutes 

permitted hedging activities? If not, how 

could greater clarity be provided? 

Question 105. What impact will the 

proposed approach to implementing the 

hedging exemption have on the hedging 

and risk management activities of a 

banking entity and the services it 

provides to its clients? If any of these 

impacts are positive, how can they be 

amplified? If any of these impacts are 

negative, how can they be mitigated? 

Question 106. What burden will the 

proposed approach to implementing the 

hedging exemption have on banking 

entities? How can any burden be 

minimized or eliminated in a manner 

consistent with the language and 

purpose of the statute? 

Question 107. Are the criteria 

included in the hedging exemption 

effective? Is the application of each 

criterion to potential transactions 

sufficiently clear? Should any of the 

criteria be changed or eliminated? 

Should other requirements be added? 

Question 108. Is the requirement that 

a transaction hedge or otherwise 

mitigate one or more specific risks, 

including market risk, counterparty or 

other credit risk, currency or foreign 

exchange risk, interest rate risk, basis 

risk, or similar risks, arising in 

connection with and related to 

individual or aggregated positions, 

contracts, or other holdings of a banking 

entity effective? If not, what 

requirement would be more effective? 

Does the proposed approach sufficiently 

articulate the types of risks that a 

banking entity typically hedges? Does 

the proposal sufficiently address 

application of the hedging exemption to 

portfolio hedging strategies? If not, how 

should the proposal be changed? 

Question 109. Does the manner in 

which section ll.5 of the proposal 

implements the risk-mitigating hedging 

exemption effectively address 

transactions that hedge or otherwise 

mitigate specific risks arising in 

connection with and related to 

aggregated positions, contracts, or other 

holdings of a banking entity? Do certain 

hedging strategies or techniques that 

involve hedging the risks of aggregated 

positions (e.g., portfolio hedging) (i) 

create the potential for abuse of the 

hedging exemption or (ii) give rise to 

challenges in determining whether a 

banking entity is engaged in exempt, 

risk-mitigating hedging activity or 

prohibited proprietary trading? If so, 

what hedging strategies and techniques, 

and how? Should additional 

restrictions, conditions, or requirements 

be placed on the use of the hedging 

exemption with respect to aggregated 

positions so as to limit potential abuse 

of the exemption, assist banking entities 

and the CFTC in determining 

compliance with the exemption, or 

otherwise improve the effectiveness of 

the rule? If so, what additional 

restrictions, conditions, or 

requirements, and why? 

Question 110. Is the requirement that 

the transaction be reasonably correlated 

to the risk or risks the transaction is 

intended to hedge or otherwise mitigate 

effective? If not, how should the 

requirement be changed? Should some 

specific level of correlation and/or 

hedge effectiveness be required? Should 

the proposal specify in greater detail 

how correlation should be measured? 

Should the proposal require hedges to 

be effective in periods of financial 

stress? Does the proposal sufficiently 

reflect differences in levels of 

correlation among asset classes? If not, 

how could it better do so? 

Question 111. Is the requirement that 

the transaction not give rise, at the 

inception of the hedge, to significant 

exposures that are not themselves 

hedged in a contemporaneous 

transaction effective? Does the 

requirement establish an appropriate 

range for legitimate hedging while 


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168 In particular, the proposed rule does not apply 

(i) the exemption in section 13(d)(1)(E) of the BHC 

Act for SBICs and certain public welfare or 

qualified rehabilitation investments, or (ii) the 

exemptions in sections 13(d)(1)(G) and 13(d)(1)(I) of 

the BHC Act for certain covered funds activities and 

investments, to the proprietary trading provisions of 

subpart B. 

169Section 13(d)(1)(A) of the BHC Act permits a 

banking entity to purchase, sell, acquire or dispose 

securities and other instruments described in 

section 13(h)(4) of the BHC Act if those securities 

or other instruments are specified types of 

government obligations, notwithstanding the 

prohibition on proprietary trading. See 12 U.S.C. 

1851(d)(1)(A). 

170The CFTC proposes that United States 

‘‘agencies’’ for this purpose will include those 

agencies described in section 201.108(b) of the 

Board’s Regulation A. See 12 CFR 201.108(b). The 

CFTC also notes 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). 

171Consistent with the statutory language, the 

proposed rule does not extend the government 

obligations exemption to transactions in obligations 

of an agency of any State or political subdivision 

thereof. 

constraining impermissible proprietary 

trading? Is this requirement sufficiently 

clear? If not, what alternative would be 

more effective and/or clearer? Are there 

types of risk-mitigating hedging 

activities that may give rise to new and 

significant exposures that should be 

permitted under the hedging 

exemption? If so, what activities? 

Should the requirement that no 

significant exposure be introduced be 

extended for the duration of the hedging 

position? If so, why? 

Question 112. Is the requirement that 

any transaction conducted in reliance 

on the hedging exemption be subject to 

continuing review, monitoring and 

management after the transaction is 

established effective? If not, what 

alternative would be more effective? 

Question 113. Is the requirement that 

the compensation arrangements of 

persons performing risk-mitigating 

hedging activities at a banking entity be 

designed not to reward proprietary risktaking effective? If not, how should the 

requirement be changed? Are there 

other types of compensation incentives 

that should be clearly referenced as 

consistent, or inconsistent, with 

permitted risk-mitigating hedging 

activity? Are there specific and 

identifiable characteristics of 

compensation arrangements that clearly 

incentivize prohibited proprietary 

trading? 

Question 114. Is the proposed 

documentation requirement effective? If 

not, what alternative would be more 

effective? Are there certain additional 

types of hedging transactions that 

should be subject to the documentation 

requirement? If so, what transactions 

and why? Should all types of hedging 

transactions be subject to the 

documentation requirement? If so, why? 

Should banking entities be required to 

document more aspects of a particular 

transaction (e.g., all of the criteria 

applicable to §ll.5(b) of the proposed 

rule)? If so, what aspects and why? 

What burden would the proposed 

documentation requirement place on 

banking entities? How might such 

burden be reduced or eliminated in a 

manner consistent with the language 

and purpose of the statute? 

Question 115. Aside from the required 

documentation, do the substantive 

requirements of the proposed riskmitigating hedging exemption suggest 

that additional documentation would be 

required to achieve compliance with the 

proposed rule? If so, what burden would 

this additional documentation 

requirement place on banking entities? 

How might such burden be reduced or 

eliminated in a manner consistent with 

the language and purpose of the statute? 

4. Section l.6: Other Permitted Trading 

Activities 

Section ll.6 of the proposed rule 

permits a banking entity to engage in 

certain other trading activities described 

in section 13(d)(1) of the BHC Act. 

These permitted activities include 

trading in certain government 

obligations, trading on behalf of 

customers, trading by insurance 

companies, and trading outside of the 

United States by certain foreign banking 

entities. Section ll.6 of the proposed 

rule does not contain all of the statutory 

exemptions contained in section 

13(d)(1) of the BHC Act. Several of these 

exemptions appear, either by plain 

language or by implication, to be 

intended to apply only to covered fund 

activities and investments, and so the 

CFTC has not proposed to include them 

in the proposed rule’s proprietary 

trading provisions.168 Those exemptions 

are referenced in other portions of the 

proposed rule pertaining to covered 

funds. 

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the exemptions contained 

in section 13(d)(1) of the BHC Act to the 

proposed rule’s proprietary trading 

provisions. In particular, the CFTC 

requests comment on the following 

questions: 

Question 116. Is the proposed rule’s 

approach of identifying which of the 

statutory exemptions contained in 

section 13(d)(1) of the BHC Act apply to 

the proposed rule’s proprietary trading 

provisions effective and/or consistent 

with the language and purpose of the 

statute? If not, what alternative would 

be more effective and/or consistent with 

the language and purpose of the statute? 

Question 117. Are there statutory 

exemptions that should apply to the 

proposed rule’s proprietary trading 

provisions that were not included? If so, 

what exemptions and why? 

Question 118. Are there statutory 

exemptions that were included in the 

proposed rule’s proprietary trading 

provisions that should not have been 

included? If so, what exemptions and 

why? 

a. Permitted Trading in Government 

Obligations 

Section ll.6(a) of the proposed rule, 

which implements section 13(d)(1)(A) of 

the BHC Act,169 permits the purchase or 

sale of a covered financial position that 

is: (i) an obligation of the United States 

or any agency thereof;170 (ii) an 

obligation, participation, or other 

instrument of or issued by the 

Government National Mortgage 

Association, the Federal National 

Mortgage Association, the Federal Home 

Loan Mortgage Corporation, a Federal 

Home Loan Bank, the Federal 

Agricultural Mortgage Corporation or a 

Farm Credit System institution 

chartered under and subject to the 

provisions of the Farm Credit Act of 

1971 (12 U.S.C. 2001 et seq.); or (iii) an 

obligation issued by any State or any 

political subdivision thereof.171 The 

proposed rule also clarifies that these 

obligations include limited as well as 

general obligations of the relevant 

government entity. The CFTC notes that, 

consistent with the statutory language, 

the types of instruments described with 

respect to the enumerated governmentsponsored entities include not only 

obligations of such entities, but also 

participations and other instruments of 

or issued by such entity. This would 

include, for example, pass-through or 

participation certificates that are issued 

and guaranteed by one of these 

government-sponsored entities (e.g., the 

Federal National Mortgage Association 

and the Federal Home Loan Mortgage 

Corporation) in connection with their 

securitization activities. 

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the government 

obligation exemption. In particular, the 

CFTC requests comment on the 

following questions: 

Question 119. Is the proposed rule’s 

application to trading in government 

obligations sufficiently clear? Should 

such obligations expressly include, for 

example, instruments issued by third 

parties but insured or guaranteed by an 

enumerated government entity or 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
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172For example, in the case of a banking entity 

acting as investment adviser to a registered mutual 

fund, any trading by the banking entity in its 

capacity of investment adviser and on behalf of that 

fund would be permitted pursuant to §ll.6(b)(i) 

of the proposed rule, so long as the relevant criteria 

were met. 

173See 12 CFR 225.28(b)(7)(ii); 17 CFR 240.3a5– 

1(b); OCC Interpretive Letter 626 (July 7, 1993). 

174The proposed rule provides definitions of the 

terms ‘‘State insurance regulator’’ and ‘‘foreign 

insurance regulator.’’ See proposed rule 

§§ll.3(c)(4), (13). 

175The CFTC 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. 

otherwise backed by its full faith and 

credit? 

Question 120. Should the CFTC adopt 

an additional exemption for proprietary 

trading in State or municipal agency 

obligations under section 13(d)(1)(J) of 

the BHC Act? If so, how would such an 

exemption promote and protect the 

safety and soundness of banking entities 

and the financial stability of the United 

States? 

Question 121. Should the CFTC adopt 

an additional exemption for proprietary 

trading in options or other derivatives 

referencing an enumerated government 

obligation under section 13(d)(1)(J) of 

the BHC Act? For example, should the 

CFTC provide an exemption for options 

or other derivatives with respect to U.S. 

government debt obligations? If so, how 

would such an exemption promote and 

protect the safety and soundness of 

banking entities and the financial 

stability of the United States? 

Question 122. Should the CFTC adopt 

an additional exemption for proprietary 

trading in the obligations of foreign 

governments and/or international and 

multinational development banks under 

section 13(d)(1)(J) of the BHC Act? If so, 

what types of obligations should be 

exempt? How would such an exemption 

promote and protect the safety and 

soundness of banking entities and the 

financial stability of the United States? 

Question 123. Should the CFTC adopt 

an additional exemption for proprietary 

trading in any other type of government 

obligations under section 13(d)(1)(J) of 

the BHC Act? If so, how would such an 

exemption promote and protect the 

safety and soundness of banking entities 

and the financial stability of the United 

States? 

Question 124. Are the definitions of 

‘‘government security’’ and ‘‘municipal 

security’’ in sections 3(a)(42) and 

3(a)(29) of the Exchange Act helpful in 

determining the proper scope of this 

exemption? If so, please explain their 

utility and how incorporating such 

definitions into the exemption would be 

consistent with the language and 

purpose of section 13 of the BHC Act. 

b. Permitted Trading on Behalf of 

Customers 

Section 13(d)(1)(D) of the BHC Act 

permits a banking entity to purchase or 

sell a covered financial position on 

behalf of customers, notwithstanding 

the prohibition on proprietary trading. 

Section ll.6(b) of the proposed rule 

implements this section. Because the 

statute does not specifically define 

when a transaction would be conducted 

‘‘on behalf of customers,’’ the proposed 

rule identifies three categories of 

transactions that, while they may 

involve a banking entity acting as 

principal for certain purposes, appear to 

be on behalf of customers within the 

purpose and meaning of the statute. As 

proposed, only transactions meeting the 

terms of these three categories would be 

considered on behalf of customers for 

purposes of the exemption. 

Section ll.6(b)(i) of the proposed 

rule provides that a purchase or sale of 

a covered financial position is on behalf 

of customers if the transaction (i) is 

conducted by a banking entity acting as 

investment adviser, commodity trading 

advisor, trustee, or in a similar fiduciary 

capacity for a customer and for the 

account of that customer, and (ii) 

involves solely covered financial 

positions of which the banking entity’s 

customer, and not the banking entity or 

any subsidiary or affiliate of the banking 

entity, is beneficial owner (including as 

a result of having long or short exposure 

under the relevant covered financial 

position). This category is intended to 

capture a wide range of trading activity 

conducted in the context of customerdriven investment or commodity 

advisory, trust, or fiduciary services, so 

long as that activity is structured in a 

way that the customer, and not the 

banking entity providing those services, 

benefits from any gains and suffers from 

any losses on such covered financial 

positions.172 A transaction that is 

structured so as to involve a listed form 

of relationship but nonetheless allows 

gains or losses from trading activity to 

inure to the benefit or detriment of the 

banking entity would fall outside the 

scope of this category. 

Section ll.6(b)(ii) of the proposed 

rule provides that a transaction is on 

behalf of customers if the banking entity 

is acting as riskless principal. These 

type of transactions are similarly 

customer-driven and do not expose the 

banking entity to gains or losses on the 

value of the traded positions, 

notwithstanding the fact that the 

banking entity technically acts as 

principal. The CFTC notes that the 

proposed language describing riskless 

principal transactions generally mirrors 

that used in the Board’s Regulation Y, 

OCC interpretive letters, and the SEC’s 

Rule 3a5–1 under the Exchange Act.173

Section ll.6(b)(iii) of the proposed 

rule addresses trading for the separate 

account of insurance policyholders by a 

banking entity that is an insurance 

company. In particular, this part of the 

proposed rule provides that a purchase 

or sale of a covered financial position is 

on behalf of customers if: 

• The banking entity is an insurance 

company engaging in the transaction for 

a separate account; 

• The banking entity is directly 

engaged in the business of insurance 

and subject to regulation by a State 

insurance regulator or foreign insurance 

regulator;174

• The banking entity purchases or 

sells the covered financial position 

solely for a separate account established 

by the insurance company in 

connection with one or more insurance 

policies issued by that insurance 

company; 

• All profits and losses arising from 

the purchase or sale of the covered 

financial position are allocated to the 

separate account and inure to the 

benefit or detriment of the owners of the 

insurance policies supported by the 

separate account, and not the banking 

entity; and 

• The purchase or sale is conducted 

in compliance with, and subject to, the 

insurance company investment and 

other laws, regulations, and written 

guidance of the State or jurisdiction in 

which such insurance company is 

domiciled. 

This category is included within the 

exemption for transactions on behalf of 

customers because such insurancerelated transactions are generally 

customer-driven and do not expose the 

banking entity to gains or losses on the 

value of separate account assets, even 

though the banking entity may be 

treated as the owner of those assets for 

certain purposes. However, to limit the 

potential for abuse of the exemption, the 

proposed rule also includes related 

requirements designed to ensure that 

the separate account trading activity is 

subject to appropriate regulation and 

supervision under insurance laws and 

not structured so as to allow gains or 

losses from trading activity to inure to 

the benefit or detriment of the banking 

entity.175 The proposed rule defines a 

‘‘separate account’’ as an account 

established or maintained by a regulated 

insurance company subject to regulation 

by a State insurance regulator or foreign 

insurance regulator under which 


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176See proposed rule §ll.2(z). 

177See 12 U.S.C. 1851(d)(1)(F). 

178The Federal banking agencies have not 

proposed at this time to determine, as part of the 

proposed rule, that the insurance company 

investment laws, regulations, and written guidance 

of any particular State or jurisdiction are 

insufficient to protect the safety and soundness of 

the banking entity, or of the financial stability of the 

United States. The Federal banking agencies expect 

to monitor, in conjunction with the Federal 

Insurance Office established under section 502 of 

the Dodd-Frank Act, the insurance company 

investment laws, regulations, and written guidance 

of States or jurisdictions to which exempt 

transactions are subject and make such 

determinations in the future, where appropriate. 

179See proposed rule §ll.3(c)(6). 

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.176

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the exemption for trading 

on behalf of customers. In particular, the 

CFTC requests comment on the 

following questions: 

Question 125. Is the proposed rule’s 

articulation of three categories of 

transactions on behalf of customers 

effective and sufficiently clear? If not, 

what alternative would be more 

effective and/or clearer? Should any of 

the categories be eliminated? Should 

any additional categories be added? 

Please explain. 

Question 126. Is the proposed rule’s 

exemption of certain investment 

adviser, commodity trading advisor, 

trustee or similar fiduciary transactions 

effective? What other types of 

relationships are or should be captured 

by the proposed rule’s reference to 

‘‘similar fiduciary relationships,’’ and 

why? Is application of this part of the 

exemption to particular transactions 

sufficiently clear? Should any other 

specific types of fiduciary or other 

relationships be specified in the rule? If 

so, what types and why? What impact 

will the proposed rule’s implementation 

of the exemption have on the 

investment adviser, commodity trading 

advisor, trustee or similar fiduciary 

activities of banking entities? If such 

impacts are negative, how could they be 

mitigated or eliminated in a manner 

consistent with the purpose and 

language of the statute? 

Question 127. Is the proposed rule’s 

exemption of riskless principal 

transactions effective? If not, what 

alternative would be more appropriate? 

Is the description of qualifying riskless 

principal activity sufficiently clear? If 

not, how should it be clarified? Should 

the riskless principal transaction 

exemption include a requirement that 

the banking entity must purchase (or 

sell) the covered financial position as 

principal at the same price to satisfy the 

customer buy (or sell) order, exclusive 

of any explicitly disclosed markup or 

markdown, commission equivalent, or 

other fee? Why or why not? Should the 

riskless principal exemption include a 

requirement with respect to the 

timeframe in which the principal 

transaction must be allocated to a 

riskless principal or customer account? 

Why or why not? 

Question 128. Is the proposed rule’s 

exemption of trading for separate 

accounts by insurance companies 

effective? If not, what alternative would 

be more appropriate? Does the proposed 

exemption sufficiently address the 

variety of customer-driven separate 

account structures typically used? If not, 

how should it address such structures? 

Does the proposed exemption 

sufficiently address the variety of 

regulatory or supervisory regimes to 

which insurance companies may be 

subject? 

Question 129. What impact will the 

proposed rule’s implementation of the 

exemption have on the insurance 

activities of insurance companies 

affiliated with banking entities? If such 

impacts are negative, how could they be 

mitigated or eliminated in a manner 

consistent with the purpose and 

language of the statute? 

Question 130. Should the term 

‘‘customer’’ be defined for purposes of 

the exemption for transactions on behalf 

of customers? If so, how should it be 

defined? For example, would an 

appropriate definition be (i) a 

continuing relationship in which the 

banking entity provides one or more 

financial products or services prior to 

the time of the transaction, (ii) a direct 

and substantive relationship between 

the banking entity and a prospective 

customer prior to the transaction, or (iii) 

a relationship initiated by the banking 

entity to a prospective customer for 

purposes of the transaction? 

Question 131. Is the exemption for 

trading on behalf of customers in the 

proposed rule over- or under-inclusive? 

If it is under-inclusive, please discuss 

any additional activities that should 

qualify as trading on behalf of customers 

under the rule. What are the mechanics 

of the particular trading activity and 

how does it qualify as being on behalf 

of customers? Are there certain 

requirements or restrictions that should 

be placed on the activity, if permitted by 

the rule, to prevent evasion of the 

prohibition on proprietary trading? How 

would permitting the activity be 

consistent with the purpose and 

language of section 13 of the BHC Act? 

If the proposed exemption is overinclusive, please explain what aspect of 

the proposed exemption does not 

involve trading on behalf of customers 

within the language and purpose of the 

statute. 

c. Permitted Trading by a Regulated 

Insurance Company 

Section ll.6(c) of the proposed rule 

implements section 13(d)(1)(F) of the 

BHC Act,177 which permits a banking 

entity to purchase or sell a covered 

financial position if the banking entity 

is a regulated insurance company acting 

for its general account or an affiliate of 

an insurance company acting for the 

insurance company’s general account, 

subject to certain conditions. Section 

ll.6(d) of the proposed rule generally 

restates the statutory requirements of 

the exemption, which provide that: 

• The insurance company must 

directly engage in the business of 

insurance and be subject to regulation 

by a State insurance regulator or foreign 

insurance regulator; 

• The insurance company or its 

affiliate must purchase or sell the 

covered financial position solely for the 

general account of the insurance 

company; 

• The purchase or sale must be 

conducted in compliance with, and 

subject to, the insurance company 

investment laws, regulations, and 

written guidance of the State or 

jurisdiction in which such insurance 

company is domiciled; and 

• The appropriate Federal banking 

agencies, after consultation with the 

Council and the relevant insurance 

commissioners of the States, must not 

have jointly determined, after notice 

and comment, that a particular law, 

regulation, or written guidance 

described above is insufficient to protect 

the safety and soundness of the banking 

entity or of the financial stability of the 

United States.178

The proposed rule defines a ‘‘general 

account’’ as all of the assets of the 

insurance company that are not legally 

segregated and allocated to separate 

accounts under applicable State law.179

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the exemption for general 

account trading by insurance 

companies. In particular, the CFTC 

requests comment on the following 

questions: 

Question 132. Should any of the 

statutory requirements for the 

exemption be further clarified in the 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8366 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

180Section 13(d)(1)(H) of the BHC Act permits a 

banking entity to engage in proprietary trading, 

notwithstanding the prohibition on proprietary 

trading, if it is conducted by a banking entity 

pursuant to paragraph (9) or (13) of section 4(c) of 

the BHC Act and the trading occurs solely outside 

of the United States and the banking entity is not 

directly or indirectly controlled by a banking entity 

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). 

181This section’s discussion of the concept 

‘‘solely outside of the United States’’ is provided 

solely for purposes of the proposed rule’s 

implementation of section 13(d)(1)(H) of the BHC 

Act, and does not affect a banking entity’s 

obligation to comply with additional or different 

requirements under applicable securities, banking, 

or other laws. 

182Under the proposal, a ‘‘State’’ means any 

State, territory or possession of the United States, 

and the District of Columbia. See proposed rule 

§ll.2(aa). 

183Section ll.6(d)(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 applied the 

authority contained in that section solely to the 

foreign activities of U.S. banking organizations 

which, by the express terms of section 13(d)(1)(H) 

of the BHC Act, are unable to rely on the foreign 

trading exemption. 

184See 12 U.S.C. 1843(c)(9). 

185See 12 CFR 211.20 et seq. 

186The CFTC notes that the Board emphasizes 

that this clarification would be applicable solely in 

the context of section 13(d)(1) of the BHC Act. The 

application of section 4(c)(9) to foreign companies 

in other contexts is likely to involve different legal 

and policy issues and may therefore merit different 

approaches. 

187See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a); 

proposed rule §ll.6(d)(2). This difference reflects 

the fact that foreign entities subject to section 13 of 

the BHC Act, but not the BHC Act generally, are 

likely to be, in many cases, predominantly 

commercial firms. A requirement that such firms 

also demonstrate that more than half of their 

banking business is outside the United States would 

likely make the exemption unavailable to such 

firms and subject their global activities to the 

prohibition on proprietary trading, a result that the 

statute does not appear to have intended. 

proposed rule? If so, how? Should any 

additional requirements be added? If so, 

what requirements and why? 

Question 133. Does the proposed rule 

appropriately and clearly define a 

general account for these purposes? If 

not, what alternative definition would 

be more appropriate? 

Question 134. For purposes of the 

exemption, are the insurance company 

investment laws, regulations, and 

written guidance of any particular State 

or jurisdiction insufficient to protect the 

safety and soundness of the banking 

entity, or of the financial stability of the 

United States? If so, why? 

Question 135. What impact will the 

proposed rule’s implementation of the 

exemption have on the insurance 

activities of insurance companies 

affiliated with banking entities? If such 

impacts are negative, how could they be 

mitigated or eliminated in a manner 

consistent with the purpose and 

language of the statute? 

d. Permitted Trading Outside of the 

United States 

Section ll.6(d) of the proposed rule 

implements section 13(d)(1)(H) of the 

BHC Act,180 which permits certain 

foreign banking entities to engage in 

proprietary trading that occurs solely 

outside of the United States.181 This 

statutory exemption limits the 

extraterritorial application of the 

prohibition on proprietary trading to the 

foreign activities of foreign firms, while 

preserving national treatment and 

competitive equality among U.S. and 

foreign firms within the United States. 

Consistent with the statute, the 

proposed rule defines both the type of 

foreign banking entities that are eligible 

for the exemption and the 

circumstances in which proprietary 

trading by such an entity will be 

considered to have occurred solely 

outside of the United States. 

i. Foreign Banking Entities Eligible for 

the Exemption 

Section ll.6(d)(1)(i) of the proposed 

rule provides that, in order to be eligible 

for the foreign trading exemption, the 

banking entity must not be directly or 

indirectly controlled by a banking entity 

that is organized under the laws of the 

United States or of one or more States. 

This requirement limits the scope of the 

exemption to banking entities that are 

organized under foreign law and 

controlled only by entities organized 

under foreign law. Consistent with the 

statutory language, a banking entity 

organized under the laws of the United 

States or any State and the subsidiaries 

and branches of such banking entity 

(wherever organized or licensed) may 

not rely on the exemption.182 Similarly, 

a U.S. subsidiary or branch of a foreign 

banking entity would not qualify for the 

exemption. 

Section ll.6(d)(1)(ii) of the 

proposed rule incorporates the statutory 

requirement that the banking entity 

must also conduct the transaction 

pursuant to sections 4(c)(9) or 4(c)(13) of 

the BHC Act. Section ll.6(d)(2) 

clarifies when a banking entity would 

meet that requirement, the criteria for 

which vary depending on whether or 

not the banking entity is a foreign 

banking organization.183

Section 4(c)(9) of the BHC Act 

provides that the restrictions on 

interests in nonbanking organizations 

contained in that statute do not apply to 

the ownership of shares held or 

activities conducted by any company 

organized under the laws of a foreign 

country the greater part of whose 

business is conducted outside the 

United States, if the Board by regulation 

or order determines that, under the 

circumstances and subject to the 

conditions set forth in the regulation or 

order, the exemption would not be 

substantially at variance with the 

purposes of the BHC Act and would be 

in the public interest.184 The Board has 

implemented section 4(c)(9) as part of 

subpart B of the Board’s Regulation 

K,185 which specifies a number of 

conditions and requirements that a 

foreign banking organization must meet 

in order to use such authority. Such 

conditions and requirements include, 

for example, a qualifying foreign 

banking organization test that requires 

the foreign banking organization to 

demonstrate that more than half of its 

worldwide business is banking and that 

more than half of its banking business 

is outside the United States. The 

proposed rule makes clear that if a 

banking entity is a foreign banking 

organization, it will qualify for the 

foreign trading exemption if the entity is 

a qualifying foreign banking 

organization that conducts the 

transaction in compliance with subpart 

B of the Board’s Regulation K, and the 

transaction occurs solely outside of the 

United States. 

Section 13 of the BHC Act also 

applies to foreign companies that 

control a U.S. insured depository 

institution but are not currently subject 

to the BHC Act generally or to the 

Board’s Regulation K—for example, 

because the foreign company controls a 

savings association or an FDIC-insured 

industrial loan company. Accordingly, 

the proposed rule also clarifies when 

this type of foreign banking entity 

would be considered to have conducted 

a transaction ‘‘pursuant to section 

4(c)(9)’’ for purposes of the foreign 

trading exemption.186 In particular, the 

draft rule proposes that to qualify for the 

foreign trading exemption, such firms 

must meet at least two of three 

requirements that evaluate the extent to 

which the foreign entity’s business is 

conducted outside the United States, as 

measured by assets, revenues, and 

income. This test largely mirrors the 

qualifying foreign banking organization 

test that is made applicable under 

section 4(c)(9) of the BHC Act and 

§ 211.23(a) of the Board’s Regulation K, 

except that the test does not also require 

such a foreign entity to demonstrate that 

more than half of its banking business 

is outside the United States.187


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188Personnel directly involved in the transaction 

would generally not include persons performing 

purely administrative, clerical, or ministerial 

functions. 

189See proposed rule §ll.2(t). 

190See 17 CFR 230.902(k). 

191See 12 U.S.C. 1851(d)(1)(J). In addition to 

permitting the CFTC to provide additional 

exemptions from the prohibition on proprietary 

trading, section 13(d)(1)(J) also states that the CFTC 

may provide additional exemptions from the 

prohibition on investing in or sponsoring a covered 

fund, as discussed in Part III.C.5 of this 

SUPPLEMENTARY INFORMATION. 

ii. Trading Solely Outside of the United 

States 

The proposed rule also clarifies when 

a transaction will be considered to have 

occurred solely outside of the United 

States for purposes of the exemption. In 

interpreting this aspect of the statutory 

language, the proposal focuses on the 

extent to which material elements of the 

transaction occur within, or are 

conducted by personnel within, the 

United States. This focus seeks to avoid 

extraterritorial application of the 

prohibition of proprietary trading 

outside the United States while 

preserving competitive parity within 

U.S. markets. The proposed rule does 

not evaluate solely whether the risk of 

the transaction or management or 

decision-making with respect to the 

transaction rests outside the United 

States, as such an approach would 

appear to permit foreign banking 

entities to structure transactions so as to 

be ‘‘outside of the United States’’ for 

risk and booking purposes while 

engaging in transactions within U.S. 

markets that are prohibited for U.S. 

banking entities. 

In particular, §ll.6(d)(3) of the 

proposed rule provides that a 

transaction will be considered to have 

occurred solely outside of the United 

States only if four conditions are met: 

• The transaction is conducted by a 

banking entity that is not organized 

under the laws of the United States or 

of one or more States; 

• No party to the transaction is a 

resident of the United States; 

• No personnel of the banking entity 

that is directly involved in the 

transaction is physically located in the 

United States; 188 and 

• The transaction is executed wholly 

outside the United States. 

These four criteria are intended to 

ensure that a transaction executed in 

reliance on the exemption does not 

involve U.S. counterparties, U.S. trading 

personnel, U.S. execution facilities, or 

risks retained in the United States. The 

presence of any of these factors would 

appear to constitute a sufficient locus of 

activity in the U.S. marketplace so as to 

preclude availability of the exemption. 

A resident of the United States is 

defined in § ll.2(t) of the proposed 

rule, and includes: (i) Any natural 

person resident in the United States; (ii) 

any partnership, corporation or other 

business entity organized or 

incorporated under the laws of the 

United States or any State; (iii) any 

estate of which any executor or 

administrator is a resident of the United 

States; (iv) any trust of which any 

trustee, beneficiary or, if the trust is 

revocable, settlor is a resident of the 

United States; (v) any agency or branch 

of a foreign entity located in the United 

States; (vi) any discretionary or nondiscretionary account or similar account 

(other than an estate or trust) held by a 

dealer or fiduciary for the benefit or 

account of a resident of the United 

States; (vii) any discretionary account or 

similar account (other than an estate or 

trust) held by a dealer or fiduciary 

organized or incorporated in the United 

States, or (if an individual) a resident of 

the United States; or (viii) any 

partnership or corporation organized or 

incorporated under the laws of any 

foreign jurisdiction formed by or for a 

resident of the United States principally 

for the purpose of engaging in one or 

more transactions described in 

§ ll.6(d)(1) or § ll.13(c)(1) of the 

proposed rule.189 The proposed 

definition is designed to capture the 

scope of U.S. counterparties, decisionmakers and personnel that, if involved 

in the transaction, would preclude that 

transaction from being considered to 

have occurred solely outside the United 

States. The Agencies note that the 

proposed definition is similar but not 

identical to the definition of ‘‘U.S. 

person’’ for purposes of the SEC’s 

Regulation S, which governs securities 

offerings and sales outside of the United 

States that are not registered under the 

Securities Act.190

iii. Request for Comment 

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the foreign trading 

exemption. In particular, the CFTC 

requests comment on the following 

questions: 

Question 136. Is the proposed rule’s 

implementation of the foreign trading 

exemption effectively delineated? If not, 

what alternative would be more 

effective and/or clearer? 

Question 137. Are the proposed rule’s 

provisions regarding when an activity 

will be considered to have been 

conducted pursuant to section 4(c)(9) of 

the BHC Act effective and sufficiently 

clear? If not, what alternative would be 

more effective and/or clearer? Do those 

provisions effectively address the 

application of the foreign trading 

exemption to foreign banking entities 

not subject to the BHC Act generally? If 

not, how should the proposed rule 

apply the exemption? 

Question 138. Are the proposed rule’s 

provisions regarding when an activity 

will be considered to have occurred 

solely outside the United States 

effective and sufficiently clear? If not, 

what alternative would be more 

effective and/or clearer? Should any 

requirements be modified or removed? 

If so, which requirements and why? 

Should additional requirements be 

added? If so, what requirements and 

why? 

Question 139. Is the proposed rule’s 

definition of ‘‘resident of the United 

States’’ effective and sufficiently clear? 

If not, what alternative would be more 

effective and/or clearer? Is the definition 

over- or under-inclusive? If so, why? 

Should the definition more closely 

track, or incorporate by reference, the 

definition of ‘‘U.S. person’’ under the 

SEC’s Regulation S under the Securities 

Act? If so, why? 

Question 140. Does the proposed rule 

effectively define a resident of the 

United States for these purposes? If not, 

how should the definition be altered? 

Question 141. Should the CFTC use 

the authority provided in section 

13(d)(1)(J) of the BHC Act to allow U.S.- 

controlled banking entities to engage in 

proprietary trading pursuant to section 

4(c)(13) of the BHC Act outside of the 

United States under certain 

circumstances? If so, under what 

circumstances should this be permitted 

and how would such activity promote 

and protect the safety and soundness of 

banking entities and the financial 

stability of the United States? 

e. Discretionary Exemptions for 

Proprietary Trading Under Section 

13(d)(1)(J) of the BHC Act 

Section 13(d)(1)(J) of the BHC Act 

permits the CFTC to grant, by rule, other 

exemptions from the prohibition on 

proprietary trading if the CFTC 

determines that the exemption would 

promote and protect the safety and 

soundness of the banking entity and the 

financial stability of the United 

States.191 The CFTC has not, at this 

time, proposed any such discretionary 

exemptions with respect to the 

prohibition on proprietary trading. The 

CFTC requests comment as follows: 

Question 142. Should the CFTC adopt 

any exemption from the prohibition on 

proprietary trading under section 

13(d)(1)(J) of the BHC Act? If so, what 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8368 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

192Section 13(e)(1) of the BHC Act requires the 

CFTC to issue regulations regarding internal 

controls and recordkeeping to ensure compliance 

with section 13. See 12 U.S.C. 1851(e)(1). Section 

ll.20 and Appendix C of the proposed rule also 

implement section 13(e)(1) of the BHC Act. 

193See SUPPLEMENTARY INFORMATION, Part III.D. 

194See proposed rule §ll.7. 

195See proposed rule §ll.7(a). The CFTC notes 

that this $1 billion trading asset and liability 

threshold is the same standard that is used in the 

Market Risk Capital Rules for determining which 

bank holding companies and insured depository 

institutions must calculate their risk-based capital 

requirements for trading positions under those 

rules. These banking entities maintain large and 

complex portfolios of trading assets and are 

therefore the most likely to be engaged in the types 

of trading activities that will require significant 

oversight of compliance with the restrictions on 

proprietary trading. 

exemption and why? How would such 

an exemption promote and protect the 

safety and soundness of banking entities 

and the financial stability of the United 

States? 

5. Section ll.7: Reporting and 

Recordkeeping Requirements 

Applicable to Trading Activities 

Section ll.7 of the proposed rule, 

which implements in part section 

13(e)(1) of the BHC Act,192 requires 

certain banking entities to comply with 

the reporting and recordkeeping 

requirements specified in Appendix A 

of the proposed rule. In addition, 

§ ll.7 requires banking entities to 

comply with the recordkeeping 

requirements in §ll.20 of the 

proposed rule, related to the banking 

entity’s compliance program,193 as well 

as any other reporting or recordkeeping 

requirements that the CFTC may impose 

to evaluate the banking entity’s 

compliance with the proposed rule.194

Proposed Appendix A requires a 

banking entity with significant trading 

activities to furnish periodic reports to 

the CFTC regarding various quantitative 

measurements of its trading activities 

and create and retain records 

documenting the preparation and 

content of these reports. The 

measurements vary depending on the 

scope, type, and size of trading 

activities. In addition, proposed 

Appendix B contains a detailed 

commentary regarding the 

characteristics of permitted market 

making-related activities and how such 

activities may be distinguished from 

trading activities that, even if conducted 

in the context of a banking entity’s 

market-making operations, would 

constitute prohibited proprietary 

trading. 

A banking entity must comply with 

proposed Appendix A’s reporting and 

recordkeeping requirements only if it 

has, together with its affiliates and 

subsidiaries, trading assets and 

liabilities the average gross sum of 

which (on a worldwide consolidated 

basis) is, as measured as of the last day 

of each of the four prior calendar 

quarters, equal to or greater than $1 

billion.195 The CFTC has not proposed 

to extend the reporting and 

recordkeeping requirements to banking 

entities with smaller amounts of trading 

activity, as it appears that the more 

limited benefits of applying these 

requirements to such banking entities, 

whose trading activities are typically 

small, less complex, and easier to 

supervise, would not justify the burden 

associated with complying with the 

reporting and recordkeeping 

requirements. 

a. General Approach to Reporting and 

Recordkeeping Requirements 

The reporting and recordkeeping 

requirements of § ll.7 and Appendix 

A of the proposed rule are an important 

part of the proposed rule’s multi-faceted 

approach to implementing the 

prohibition on proprietary trading. 

These requirements are intended, in 

particular, to address some of the 

difficulties associated with (i) 

identifying permitted market makingrelated activities and distinguishing 

such activities from prohibited 

proprietary trading and (ii) identifying 

certain trading activities resulting in 

material exposure to high-risk assets or 

high-risk trading strategies. To do so, 

the proposed rule requires certain 

banking entities to calculate and report 

detailed quantitative measurements of 

their trading activity, by trading unit. 

These measurements will help banking 

entities and the CFTC in assessing 

whether such trading activity is 

consistent with permitted trading 

activities in scope, type and profile. The 

quantitative measurements that must be 

reported under the proposed rule are 

generally designed to reflect, and to 

provide meaningful information 

regarding, certain characteristics of 

trading activities that appear to be 

particularly useful in differentiating 

permitted market making-related 

activities from prohibited proprietary 

trading. For example, the proposed 

quantitative measurements measure the 

size and type of revenues generated, and 

the types of risks taken, by a trading 

unit. Each of these measurements 

appears to be useful in assessing 

whether a trading unit is (i) engaged in 

permitted market making-related 

activity or (ii) materially exposed to 

high-risk assets or high-risk trading 

strategies. Similarly, the proposed 

quantitative measurements also measure 

how much revenue is generated per 

such unit of risk, the volatility of a 

trading unit’s profitability, and the 

extent to which a trading unit trades 

with customers. Each of those 

characteristics appears to be useful in 

assessing whether a trading unit is 

engaged in permitted market makingrelated activity. 

However, the CFTC recognizes 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 CFTC 

proposes to use a variety of quantitative 

measurements to help identify 

transactions or activities that warrant 

more in-depth analysis or review. 

To be effective, this approach requires 

identification of useful quantitative 

measurements as well as judgment 

regarding the type of measurement 

results that suggest a further review of 

the trading unit’s activity is warranted. 

The CFTC intends to take a heuristic 

approach to implementation in this area 

that recognizes that quantitative 

measurements can only be usefully 

identified and employed after a process 

of substantial public comment, practical 

experience, and revision. In particular, 

the CFTC notes 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. Additional study and analysis 

will be required before quantitative 

measurements may be effectively 

designed and employed for that 

purpose. 

Consistent with this heuristic 

approach, the proposed rule includes a 

large number of potential quantitative 

measurements on which public 

comment is sought, many of which 

overlap to some degree in terms of their 

informational value. Not all of these 

quantitative measurements may 

ultimately be adopted, depending on 

their relative strengths, weaknesses, 

costs, and benefits. The CFTC notes that 

some of the proposed quantitative 

measurements may not be relevant to all 

types of trading activities or may 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 8369 

196Section 13(c)(2) of the BHC Act provides 

banking entities two years from the date that the 

proposed rule becomes effective (with the 

possibility of up to three, one-year extensions) to 

bring their activities, investments, and relationships 

into compliance with section 13, including the 

prohibition on proprietary trading. See 12 U.S.C. 

1851(c)(2). 

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 

CFTC has therefore requested comment 

on a large number of issues related to 

the relevance, practicability, costs, and 

benefits of the quantitative 

measurements proposed. The CFTC also 

seeks comment on whether the 

quantitative measurements described in 

the proposal may be appropriate to use 

in assessing compliance with section 13 

of the BHC Act. 

In addition to the proposed 

quantitative measurements, a banking 

entity may itself develop and implement 

other quantitative measurements in 

order to effectively monitor its covered 

trading activities for compliance with 

section 13 of the BHC Act and the 

proposed rule and to establish, 

maintain, and enforce an effective 

compliance program, as required by 

§ ll.20 of the proposed rule and 

Appendix C. The CFTC notes that the 

proposed quantitative measurements in 

Appendix A are intended to assist 

banking entities and the CFTC in 

monitoring compliance with the 

proprietary trading restrictions and, 

thus, are related to the compliance 

program requirements in §ll.20 of the 

proposed rule and proposed Appendix 

C. Nevertheless, implementation of the 

proposed quantitative measurements 

under Appendix A would not 

necessarily provide all the data 

necessary for the banking entity to 

establish an effective compliance 

program, and a banking entity may need 

to develop and implement additional 

quantitative measurements. The CFTC 

recognizes that appropriate and effective 

quantitative measurements may differ 

based on the profile of the banking 

entity’s businesses in general and, more 

specifically, of the particular trading 

unit, including types of instruments 

traded, trading activities and strategies, 

and history and experience (e.g., 

whether the trading desk is an 

established, successful market maker or 

a new entrant to a competitive market). 

In all cases, banking entities must 

ensure that they have robust measures 

in place to identify and monitor the 

risks taken in their trading activities, to 

ensure the activities are within risk 

tolerances established by the banking 

entity, and to monitor for compliance 

with the proprietary trading restrictions 

in the proposed rule. 

To the extent that data regarding 

measurements, as set forth in the 

proposed rule, are collected, the CFTC 

proposes to utilize the automatic twoyear 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 CFTC believes are 

needed to ensure that these 

measurements are as effective as 

possible.196 This heuristic, gradual 

approach to implementing reporting 

requirements for quantitative 

measurements would be intended to 

ensure that the requirements are 

formulated in a manner that maximizes 

their utility for identifying trading 

activity that warrants additional 

scrutiny in assessing compliance with 

the prohibition on proprietary trading, 

while limiting the risk that the use of 

quantitative measurements could 

inadvertently curtail permissible market 

making-related activities that provide an 

important service to market participants 

and the capital markets at large. 

In addition, the CFTC requests 

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 CFTC. The CFTC has 

not proposed specific numerical 

thresholds in the proposal because 

substantial public comment and 

analysis would be beneficial prior to 

formulating and proposing specific 

numerical thresholds. Instead, the CFTC 

intends to carefully consider public 

comments that are provided on this 

issue and to separately determine 

whether it would be appropriate to 

propose, subsequent to finalizing the 

current proposal, such numerical 

thresholds. 

The CFTC requests comment on the 

proposed approach to implementing 

reporting requirements for proprietary 

trading. In particular, the CFTC requests 

comment on the following questions: 

Question 143. Is the use of the 

proposed reporting requirements as part 

of the multi-faceted approach to 

implementing the prohibition on 

proprietary trading appropriate? Why or 

why not? 

Question 144. Is the proposed gradual 

approach to implementing reporting 

requirements effective? If not, what 

approach would be more effective? For 

example, should the CFTC defer 

reporting of quantitative measurements 

until banking entities have developed 

and refined their compliance programs 

through the supervision and 

examination process? What would be 

the costs and benefits of such an 

approach? 

Question 145. What role, if any, could 

or should the Office of Financial 

Research (‘‘OFR’’) play in receiving and 

analyzing banking entities’ reported 

quantitative measurements? Should 

reporting to the OFR be required instead 

of reporting to the CFTC, and would 

such reporting be consistent with the 

composition and purpose of OFR? In the 

alternative, should reporting to either (i) 

only the CFTC or (ii) both the CFTC and 

OFR be required? If so, why? What are 

the potential costs and benefits of 

reporting quantitative measurements to 

the OFR? Please explain. 

Question 146. Is there an alternative 

manner in which the CFTC should 

develop and propose the reporting 

requirements for quantitative 

measurements? If so, how should they 

do so? 

Question 147. Does the proposed 

approach provide sufficient time for the 

development and implementation of 

effective reporting requirements? If not, 

what alternative approach would be 

preferable? 

Question 148. Should a trading unit 

be permitted not to furnish a 

quantitative measurement otherwise 

required under Appendix A if it can 

demonstrate that the measurement is 

not, as applied to that unit, calculable 

or useful in achieving the purposes of 

the Appendix with respect to the 

trading unit’s covered trading activities? 

How might a banking entity make such 

a demonstration? 

Question 149. Is the manner in which 

the CFTC proposes to utilize the 

conformance period for review of 

collected data and refinement of the 

reporting requirements effective? If not, 

what process would be more effective? 

Question 150. Is the proposed $1 

billion trading asset and liability 

threshold, which is also currently used 

in the Market Risk Capital Rules for 

purposes of identifying which banks 

and bank holdings companies must 

comply with those rules, an appropriate 

standard for triggering the reporting and 

recordkeeping requirements of the 

proposed rule? Why or why not? If not, 

what alternative standard would be a 

better benchmark for triggering the 

reporting and recordkeeping 

requirements? 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8370 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

197As noted in Appendix A, the CFTC expects 

that this would generally be the smallest unit of 

organization used by the banking entity to structure 

and control its risk-taking activities and employees, 

and would include each unit generally understood 

to be a single ‘‘trading desk.’’ For example, if a 

banking entity has one set of employees engaged in 

market making-related activities in the equities of 

U.S. non-financial corporations, and another set of 

employees engaged in market making-related 

activities in the equities of U.S. financial 

corporations, the two sets of employees would 

appear to be part of a single trading unit if both sets 

of employees structure and control their trading 

activities together, making and executing highly 

coordinated decisions about required risk levels, 

inventory levels, sources of revenue growth and 

similar features. On the other hand, if the risk 

decisions and revenue strategies are considered and 

executed separately by the two sets of employees, 

with only loose coordination, they would appear to 

be two distinct trading units. In determining 

whether a set of employees constitute a single 

trading unit, important factors would likely include 

whether compensation is strongly linked to the 

group’s performance, whether risk levels and 

trading limits are managed and set jointly or 

separately, and whether trades are booked together 

or separately. 

198This latter prong of the definition has been 

included to ensure that the CFTC has the ability to 

require banking entities to report quantitative 

measurements in other ways to prevent a banking 

entity from organizing its trading operations so as 

to undermine the effectiveness of the reporting 

requirement. 

Question 151. What are the typical 

trading activities (e.g., market makingrelated activities) of a banking entity 

with less than $1 billion in gross trading 

assets and liabilities? How complex are 

those trading activities? 

Question 152. Should the proposed $1 

billion trading and asset liability 

threshold used for triggering the 

reporting and recordkeeping 

requirements adjust each time the 

thresholds for complying with the 

Market Risk Capital Rules adjust, or 

otherwise be adjusted over time? If not, 

how and when should the numerical 

threshold be adjusted? 

Question 153. Should all banking 

entities be required to comply with the 

reporting and recordkeeping 

requirements set forth in Appendix A in 

order to better protect against prohibited 

proprietary trading, rather than only 

those banking entities that meet the 

proposed $1 billion trading asset and 

liability threshold? Why or why not? 

Question 154. Should banking entities 

that fall under the proposed $1 billion 

trading asset and liability threshold be 

required to comply with the reporting 

and recordkeeping provisions for a pilot 

period in order to help inform judgment 

regarding the levels of quantitative 

measurements at such entities and the 

appropriate frequency and scope of 

examination by the relevant Agency for 

such banking entities? Why or why not? 

b. Proposed Appendix A—Purpose and 

Definitions 

Section I of proposed Appendix A 

describes the purpose of the appendix, 

which is to specify reporting 

requirements that are intended to assist 

banking entities that are engaged in 

significant trading activities and the 

CFTC in identifying trading activities 

that warrant further review or 

examination to verify compliance with 

the proprietary trading restrictions, 

including whether an otherwisepermitted activity under §§ll.4 

through ll.6(a) of the proposed rule is 

consistent with the requirement that 

such activity not result, directly or 

indirectly, in a material exposure by the 

banking entity to high-risk assets and 

high-risk trading strategies. In 

particular, section I provides that the 

purpose of the appendix is to assist the 

CFTC and banking entities in: 

• Better understanding and 

evaluating the scope, type, and profile 

of the banking entity’s covered trading 

activities; 

• Monitoring the banking entity’s 

covered trading activities; 

• Identifying covered trading 

activities that warrant further review or 

examination by the banking entity to 

verify compliance with the proprietary 

trading restrictions; 

• Evaluating whether the trading 

activities of trading units engaged in 

market making-related activities under 

§ ll.4(b) of the proposed rule are 

consistent with the requirements 

governing permitted market makingrelated activities; 

• Evaluating whether the trading 

activities of trading units that are 

engaged in permitted trading activity 

under §§ll.4, ll.5, or ll.6(a) of 

the proposed rule (e.g., permitted 

underwriting, market making-related 

activity, risk-mitigating hedging, or 

trading in certain government 

obligations) are consistent with the 

requirement that such activity not 

result, directly or indirectly, in a 

material exposure by the banking entity 

to high-risk assets and high-risk trading 

strategies; 

• Identifying the profile of particular 

trading activities of the banking entity, 

and the individual trading units of the 

banking entity, to help establish the 

appropriate frequency and scope of 

examination by the CFTC of such 

activities; and 

• Assessing and addressing the risks 

associated with the banking entity’s 

trading activities. 

The types of trading and market 

making-related activities in which 

banking entities engage is often highly 

complex, and any quantitative 

measurement is capable of producing 

both ‘‘false negatives’’ and ‘‘false 

positives’’ that suggest that prohibited 

proprietary trading is occurring when it 

is not, or vice versa. Recognizing this, 

section I of proposed Appendix A 

makes clear that the quantitative 

measurements that may be required to 

be reported would not be intended to 

serve as a dispositive tool for identifying 

permissible or impermissible activities. 

Section II of proposed Appendix A 

defines relevant terms used in the 

appendix. These include certain 

definitions that clarify how and when 

certain calculations must be made, as 

well as a definition of ‘‘trading unit’’ 

that governs the level of organization at 

which a banking entity must calculate 

quantitative measurements. The 

proposed definition of ‘‘trading unit’’ 

covers multiple organizational levels of 

a banking entity, including: 

• Each discrete unit engaged in the 

coordinated implementation of a 

revenue generation strategy that 

participates in the execution of any 

covered trading activity; 197

• Each organizational unit used to 

structure and control the aggregate risktaking activities and employees of one 

or more trading units described above; 

• All trading operations, collectively; 

and 

• Any other unit of organization 

specified by the CFTC with respect to a 

particular banking entity.198

The definition of ‘‘trading unit’’ is 

intended to capture multiple layers of a 

banking entity’s organization structure, 

including individual trading desks, 

intermediate divisions that oversee a 

variety of trading desks, and all trading 

operations in the aggregate. As 

described below, under the proposal, 

the quantitative measurements specified 

in section IV of proposed Appendix A 

must be calculated and reported for 

each such ‘‘trading unit.’’ Accordingly, 

the definition of trading unit is 

purposefully broad and captures 

multiple levels of organization so as to 

ensure that quantitative measurements 

provide meaningful information, at both 

a granular and aggregate level, to help 

banking entities and the CFTC evaluate 

the quantitative profile of trading 

operations in a variety of contexts. 

The CFTC expects that the scope and 

nature of trading units to which the 

quantitative measurements are applied 

would have an important impact on the 

informational content and utility of the 

resulting measurements. Applying a 

quantitative measurement to a trading 

unit at a level that aggregates a variety 

of distinct trading activities may 

obscure or ‘‘smooth’’ differences 

between distinct lines of business, asset 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 8371 

199See proposed rule Appendix A.III.A. These 

seventeen quantitative measurements are discussed 

further below. 

200See 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. 

categories and risk management 

processes in a way that renders the 

measurement relatively uninformative, 

because it does not adequately reflect 

the specific characteristics of the trading 

activities being conducted. Similarly, 

applying a quantitative measurement to 

a trading unit at a highly granular level 

could, if it captured only a narrow 

portion of activity that is conducted as 

part of a broader business strategy, 

introduce meaningless ‘‘noise’’ into the 

measure or result in a measurement that 

is idiosyncratic in nature. This highly 

granular application could render the 

measurement relatively uninformative 

because it would not accurately reflect 

the entirety of the trading activities 

being conducted. In order to address the 

potential weaknesses of applying the 

quantitative measurements at an 

aggregate and a granular level, 

respectively, the proposal requires 

reporting at both levels. The 

informational inputs required to 

calculate any particular quantitative 

measurement at either level are the 

same. Consequently, it is expected that, 

depending on the nature of the systems 

of a particular institution, there may be 

little, if any, incremental burden 

associated with calculating and 

reporting quantitative measurements at 

multiple levels. 

The CFTC requests comment on the 

proposed reporting requirements in 

Appendix A. In particular, the CFTC 

requests comment on the following 

questions: 

Question 155. Are the ways in which 

the proposed rule would make use of 

reported quantitative measurements 

effective? If not, what uses would be 

more effective? Should the proposed 

rule instead use quantitative 

measurements as a dispositive tool for 

identifying prohibited proprietary 

trading? If so, what types of quantitative 

measurements should be employed, 

what numerical amount would indicate 

impermissible proprietary trading 

activity, and why? Should the 

quantitative measurements play a less 

prominent role than proposed in 

identifying prohibited proprietary 

trading and why? 

Question 156. Are the proposed 

definitions of terms provided in 

Appendix A effective? If not, how 

should the definitions be amended? 

Question 157. Is the proposed 

definition of ‘‘trading unit’’ effective? Is 

it sufficiently clear? If not, what 

alternative definition would be more 

effective and/or clearer? Should the 

definition include more or less granular 

levels of activity? If so, what specific 

criteria should be used to determine the 

appropriate level of granularity? 

Question 158. If you are a banking 

entity, how would your trading activity 

be categorized, in terms of quantity and 

type, under the proposed definition of 

trading unit in Appendix A? For each 

trading unit type, what categories of 

quantitative measurements (e.g., riskmanagement measurements) or specific 

quantitative measurements (e.g., 

Stressed Value-at-Risk (‘‘Stress VaR’’)) 

are best suited to assist in distinguishing 

prohibited proprietary trading from 

permitted trading activity? 

Question 159. Is the proposed rule’s 

requirement that quantitative 

measurements be reported at multiple 

levels of organization, including for 

quantitative measurements historically 

reported on an aggregate basis (e.g., 

Value-at-Risk (‘‘VaR’’) or Stress VaR) 

appropriate? If not, what alternative 

would be more effective? What burdens 

are associated with such a requirement? 

How might those burdens be reduced or 

limited? Please quantify your answers, 

to the extent feasible. 

c. Proposed Appendix A—Scope of 

Required Reporting 

Part III of proposed Appendix A 

defines the scope of the reporting 

requirements. The proposed rule adopts 

a tiered approach that requires banking 

entities with the most extensive trading 

activities to report the largest number of 

quantitative measurements, while 

banking entities with smaller trading 

activities have fewer or no reporting 

requirements. This tiered approach is 

intended to reflect the heightened 

compliance risks of banking entities 

with extensive trading activities and 

limit the regulatory burden imposed on 

banking entities with relatively small or 

no trading activities, which appear to 

pose significantly less compliance risk. 

Banking Entities With Gross Trading 

Assets and Liabilities of $5 Billion or 

More 

For any banking entity that has, 

together with its affiliates and 

subsidiaries, trading assets and 

liabilities the average gross sum of 

which (on a worldwide consolidated 

basis), as measured as of the last day of 

each of the four prior calendar quarters, 

equals or exceeds $5 billion, the 

proposal would require the banking 

entity to furnish quantitative 

measurements for all trading units of the 

banking entity engaged in trading 

activity subject to §§ll.4, ll.5, or 

ll.6(a) of the proposed rule (i.e., 

permitted underwriting and market 

making-related activity, risk-mitigated 

hedging, and trading in certain 

government obligations). The scope of 

data to be furnished depends on the 

activity in which the trading unit is 

engaged. First, for the trading units of 

such a banking entity that are engaged 

in market making-related activity 

pursuant to § ll.4(b) of the proposed 

rule, proposed Appendix A requires that 

a banking entity furnish seventeen 

quantitative measurements.199 Second, 

all trading units of such a banking entity 

engaged in trading activity subject to 

§§ ll.4(a), ll.5, or ll.6(a) of the 

proposed rule would be required to 

report five quantitative measurements 

designed to measure the general risk 

and profitability of the trading unit.200

The CFTC expects that each of these 

general types of measurements will be 

useful in assessing the extent to which 

any permitted trading activity involves 

exposure to high-risk assets or high-risk 

trading strategies. These requirements 

would apply to all type of trading units 

engaged in underwriting and market 

making-related activity, risk-mitigated 

hedging, and trading in certain 

government obligations. These 

additional measurements are designed 

to help evaluate the extent to which the 

quantitative profile of a trading unit’s 

activities is consistent with permissible 

market making-related activities. 

Banking Entities With Gross Trading 

Assets and Liabilities Between $1 

Billion and $5 Billion 

For any banking entity that has, 

together with its affiliates and 

subsidiaries, trading assets and 

liabilities the average gross sum of 

which (on a worldwide consolidated 

basis), as measured as of the last day of 

each of the four prior calendar quarters, 

equals or exceeds $1 billion but is less 

than $5 billion, the proposal would 

require quantitative measurements to be 

furnished for trading units that are 

engaged in market making-related 

activity subject to §ll.4(b) of the 

proposed rule. Trading units of such 

banking entities that are engaged in 

market making-related activities must 

report eight quantitative measurements 

that are designed to help evaluate the 

extent to which the quantitative profile 

of a trading unit’s activities is consistent 

with permissible market making-related 


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8372 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

201See 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. 

activities.201 The proposal applies a 

smaller number of measurements to a 

smaller universe of trading units for this 

class of banking entities because they 

are likely to pose lesser compliance risk 

and fewer supervisory and examination 

challenges. A less burdensome reporting 

regime, coupled with other elements of 

the proposal (e.g., the compliance 

program requirement), is likely to be 

equally as effective in ensuring 

compliance with section 13 of the BHC 

Act and the proposed rule for banking 

entities with smaller trading operations. 

Frequency of Calculation and Reporting 

Section III.B of proposed Appendix A 

specifies the frequency of required 

calculation and reporting of quantitative 

measurements. Under the proposed 

rule, each required quantitative 

measurement must be calculated for 

each trading day. Required quantitative 

measurements must be reported to the 

CFTC on a monthly basis, within 30 

days of the end of the relevant calendar 

month, or on such other reporting 

schedule as the CFTC may require. 

Section III.C of proposed Appendix A 

requires 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 

CFTC to verify the accuracy of such 

measurements, for a period of 5 years. 

This would include records for each 

trade and position. 

Question 160. Is the proposed tiered 

approach to identifying which banking 

entities and trading units must comply 

with the reporting requirements 

effective? If not, what alternative would 

be more effective? Does the proposal 

strike the appropriate balance between 

the potential benefits of the reporting 

requirements for monitoring and 

assuring compliance and the potential 

costs of those reporting requirements? If 

not, how could that balance be 

improved? Should the relevant gross 

trading assets and liabilities threshold 

for any category be increased or 

reduced? If so, why? 

Question 161. Should the $1 billion 

and $5 billion gross trading assets and 

liabilities thresholds used to identify the 

extent to which a banking entity is 

required to furnish quantitative 

measurements be increased or reduced? 

If so, why? Should the thresholds be 

indexed in some way to account for 

fluctuations in capital markets activity 

over time? If so, what would be an 

appropriate method of indexation? 

Question 162. Is the proposed $5 

billion trading asset and liability 

threshold an appropriate standard for 

triggering enhanced reporting 

requirements under the proposed rule? 

Why or why not? If not, what alternative 

standard would be a better benchmark 

for triggering enhanced reporting 

requirements? 

Question 163. Should the proposed $5 

billion trading and asset liability 

threshold used for triggering enhanced 

reporting requirements under the 

proposed rule be subject to adjustment 

over time? If so, how and when should 

the numerical threshold be adjusted? 

Question 164. Is there a different 

criterion other than gross trading assets 

and liabilities that would be more 

appropriate for identifying banking 

entities that must furnish quantitative 

measurements? If so, what is the 

alternative criterion, and why would it 

be more appropriate? Are worldwide 

gross trading assets and liabilities the 

appropriate criterion for foreign-based 

banking entities? If not, what alternative 

criterion would be more appropriate, 

and why? 

Question 165. Are the quantitative 

measurements specified for the various 

types of banking entities and trading 

units effective? If not, what alternative 

set of measurements would be more 

effective? For each type of trading unit, 

does the proposal strike the appropriate 

balance between the potential benefits 

of the reporting requirements for 

monitoring and assuring compliance 

and the potential costs of those 

reporting requirements? If not, how 

could that balance be improved? 

Question 166. Should banking entities 

with gross trading assets and liabilities 

between $1 billion and $5 billion also 

be required to calculate and report some 

of the quantitative measurements 

proposed for banking entities meeting 

the $5 billion threshold for purposes of 

assessing whether the banking entity’s 

underwriting, market making, riskmitigating hedging, and trading in 

certain government obligations activities 

involve a material exposure to high-risk 

assets or high-risk trading strategies? If 

so, which quantitative measurements 

and why? If not, why not? 

Question 167. Is the proposed 

frequency of reporting effective? If not, 

what frequency would be more 

effective? Should the quantitative 

measurements be required to be 

reported quarterly, annually, or upon 

the request of the CFTC and why? 

d. Proposed Appendix A—Quantitative 

Measurements 

Section IV of proposed Appendix A 

describes, in detail, the individual 

quantitative measurements that must be 

furnished. These measurements are 

grouped into the following five broad 

categories, each of which is described in 

more detail below: 

• Risk-management measurements— 

VaR, Stress VaR, VaR Exceedance, Risk 

Factor Sensitivities, and Risk and 

Position Limits; 

• Source-of-revenue measurements— 

Comprehensive Profit and Loss, 

Portfolio Profit and Loss, Fee Income 

and Expense, Spread Profit and Loss, 

and Comprehensive Profit and Loss 

Attribution; 

• Revenues-relative-to-risk 

measurements—Volatility of 

Comprehensive Profit and Loss, 

Volatility of Portfolio Profit and Loss, 

Comprehensive Profit and Loss to 

Volatility Ratio, Portfolio Profit and 

Loss to Volatility Ratio, Unprofitable 

Trading Days based on Comprehensive 

Profit and Loss, Unprofitable Trading 

Days based on Portfolio Profit and Loss, 

Skewness of Portfolio Profit and Loss, 

and Kurtosis of Portfolio Profit and 

Loss; 

• Customer-facing activity 

measurements—Inventory Turnover, 

Inventory Aging, and Customer-facing 

Trade Ratio; and 

• Payment of fees, commissions, and 

spreads measurements—Pay-to-Receive 

Spread Ratio. 

The CFTC has proposed these 

quantitative measurements because, 

taken together, these measurements 

appear useful for understanding the 

context in which trading activities occur 

and identifying activities that may 

warrant additional scrutiny to 

determine whether these activities 

involve prohibited proprietary trading 

because the trading activity either is 

inconsistent with permitted market 

making-related activities or presents a 

material exposure to high-risk assets or 

high-risk trading strategies. As 

described below, different quantitative 

measurements are proposed to identify 

different aspects and characteristics of 

trading activity for the purpose of 

helping to identify prohibited 

proprietary trading, and the CFTC 

expects that the quantitative 

measurements will be most useful for 

this purpose when implemented and 

reviewed collectively, rather than in 

isolation. The CFTC believes that, in the 

aggregate, many banking entities already 

collect and review many of these 


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Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 8373 

measurements as part of their risk 

management activities, and expect that 

many of the quantitative measurements 

proposed would be readily computed 

and monitored at the multiple levels of 

organization that are included in 

proposed Appendix A’s definition of 

‘‘trading unit,’’ to which they would 

apply. 

The first set of quantitative 

measurements relates to risk 

management, and includes VaR, Stress 

VaR, VaR Exceedance, Risk Factor 

Sensitivities, and Risk and Position 

Limits. These measurements are widely 

used by banking entities to measure and 

manage trading risks and activities. In 

the case of VaR, Stress VaR, VaR 

Exceedance, and Risk Factor 

Sensitivities, these measures provide 

internal, model-based assessments of 

overall risk, stated in terms of large but 

plausible losses that may occur or 

changes in revenue that would be 

expected to result from movements in 

underlying risk factors. In the case of 

Risk and Position Limits, the measure 

provides an explicit assessment of 

management’s expectation of how much 

risk is required to perform permitted 

market-making and hedging activities. 

With the exception of Stress VaR, each 

of these measurements are routinely 

used to manage and control risk taking 

activities, and are also used by some 

banking entities for purposes of 

calculating regulatory capital and 

allocating capital internally. In the 

context of permitted market makingrelated activities, these risk management 

measures are useful in assessing 

whether the actual risk taken is 

consistent with the level of principal 

risk that a banking entity must retain in 

order to service the near-term demands 

of customers. Significant, abrupt or 

inconsistent changes to key risk 

management measures, such as VaR, 

that are inconsistent with prior 

experience, the experience of similarly 

situated trading units and management’s 

stated expectations for such measures 

may indicate impermissible proprietary 

trading. In addition, indicators of 

unanticipated or unusual levels of risk 

taken, such as a significant number of 

VaR Exceedance or breaches of internal 

Risk and Position Limits, may suggest 

behavior that is inconsistent with 

appropriate levels of risk and may 

warrant further scrutiny. 

The second set of quantitative 

measurements relates to the source of 

revenues, and includes Comprehensive 

Profit and Loss, Portfolio Profit and 

Loss, Fee Income, Spread Profit and 

Loss, and Comprehensive Profit and 

Loss Attribution. These measurements 

are intended to capture the extent, 

scope, and type of profits and losses 

generated by trading activities and 

provide important context for 

understanding how revenue is generated 

by trading activities. Because permitted 

market making-related activities seek to 

generate profits by providing customers 

with intermediation and related services 

while maintaining, and to the extent 

practicable, minimizing the risks 

associated with any asset or risk 

inventory required to meet customer 

demands, these revenue measurements 

would appear to provide helpful 

information to banking entities and the 

CFTC regarding whether actual 

revenues are consistent with these 

expectations. The CFTC notes that 

although banking entities already 

routinely calculate and analyze the 

extent and source of revenues derived 

from their trading activities, calculating 

the proposed source of revenue 

measurements according to the 

specifications described in proposed 

Appendix A may require banking 

entities to implement new processes to 

calculate and furnish the required data. 

The third set of measurements relates 

to realized risks and revenue relative to 

realized risks, and includes Volatility of 

Profit and Loss, Comprehensive Profit 

and Loss to Volatility Ratio and 

Portfolio Profit and Loss to Volatility 

Ratio, Unprofitable Trading Days based 

on Comprehensive Profit and Loss and 

Unprofitable Trading Days based on 

Portfolio Profit and Loss, and Skewness 

of Portfolio Profit and Loss and Kurtosis 

of Portfolio Profit and Loss. These 

measurements are intended to provide 

banking entities and the Agencies with 

ex post, data-based assessments of risk, 

as a supplement to internal, modelbased assessments of risk, and give 

further context around the riskiness of 

underlying trading activities and the 

profitability of these activities relative to 

the risks taken. Some of these 

measurements, such as the skewness 

and kurtosis measurements, are 

proposed in order to capture 

asymmetric, ‘‘fat tail’’ risks that (i) are 

not well captured by simple volatility 

measures, (ii) may not be well captured 

by internal risk measurement metrics, 

such as VaR, and (iii) can be associated 

with proprietary trading strategies that 

seek to earn short-term profits by taking 

exposures to these types of risks. The 

CFTC expects that these realized-risk 

and revenue-relative-to-realized-risk 

measurements would provide 

information useful in assessing whether 

trading activities are producing 

revenues that are consistent, in terms of 

the degree of risk that is being assumed, 

with typical market making-related 

activities. Market making and related 

activities seek to generate profitability 

primarily by generating fees, 

commissions, spreads and other forms 

of customer revenue that are relatively, 

though not completely, insensitive to 

market fluctuations and generally result 

in a high level of revenue relative to risk 

over an appropriate time frame. In 

contrast, proprietary trading strategies 

seek to generate revenue primarily 

through favorable changes in asset 

valuations. The CFTC notes that each of 

the proposed measurements relating to 

realized risks and revenues relative to 

realized risks are generally consistent 

with existing revenue, risk, and 

volatility data routinely collected by 

banking entities with large trading 

operations or are simple, standardized 

functions of such data. 

The fourth set of quantitative 

measurements relates to customer-facing 

activity measurements, and includes 

Inventory Risk Turnover, Inventory 

Aging, and Customer-facing Trade Ratio. 

These measurements are intended to 

provide banking entities and the CFTC 

with meaningful information regarding 

the extent to which trading activities are 

directed at servicing the demands of 

customers. Quantitative measurements 

such as Inventory Risk Turnover and 

Inventory Aging assess the extent to 

which size and volume of trading 

activity is aimed at servicing customer 

needs, while the Customer-facing Trade 

Ratio provides directionally useful 

information regarding the extent to 

which trading transactions are 

conducted with customers. The CFTC 

expects that these measurements will be 

useful in assessing whether permitted 

market making-related activities are 

focused on servicing customer demands. 

Although the CFTC understands that 

banking entities typically measure 

inventory aging and turnover in the 

context of cash instruments (e.g., equity 

and debt securities), they note that 

applying these measurements, as well as 

the Customer-facing Trade Ratio 

generally, would require banking 

entities to implement new processes to 

calculate and furnish the related data. 

The fifth set of quantitative 

measurements relates to the payment of 

fees, commissions, and spreads, and 

includes the Pay-to-Receive Spread 

Ratio. This measurement is intended to 

measure the extent to which trading 

activities generate revenues for 

providing intermediation services, 

rather than generate expenses paid to 

other intermediaries for such services. 

Because market making-related 

activities ultimately focus on servicing 

customer demands, they typically 

generate substantially more fees, 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8374 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

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 

CFTC expects that the proposed Pay-toReceive Spread Ratio measurement will 

be useful in assessing whether 

permitted market making-related 

activities are primarily generating, 

rather than paying, fees, spreads and 

other transactional revenues or 

expenses. A level of fees, commissions, 

and spreads paid that is inconsistent 

with prior experience, the experience of 

similarly situated trading units and 

management’s stated expectations for 

such measures could indicate 

impermissible proprietary trading. 

For each individual quantitative 

measurement, proposed Appendix A 

describes the measurement, provides 

general guidance regarding how the 

measurement should be calculated 

(where needed) and specifies the period 

over which each calculation should be 

made. The proposed quantitative 

measurements attempt to incorporate, 

wherever possible, measurements 

already used by banking entities to 

manage risks associated with their 

trading activities. Of the measurements 

proposed, the CFTC expects that a large 

majority of measurements proposed are 

either (i) already routinely calculated by 

banking entities or (ii) based solely on 

underlying data that are already 

routinely calculated by banking entities. 

However, calculating these 

measurements according to the 

specifications described in proposed 

Appendix A and at the various levels of 

organization mandated may require 

banking entities to implement new 

processes to calculate and furnish the 

required data. 

The extent of the burden associated 

with calculating and reporting 

quantitative measurements will likely 

vary depending on the particular 

measurements and differences in the 

sophistication of management 

information systems at different banking 

entities. As noted, the proposal tailors 

these data collections to the size and 

type of activity conducted by each 

banking entity in an effort to minimize 

the burden in particular on firms that 

engage in few or no trading activities 

subject to the proposed rule. 

The CFTC also has attempted to 

provide, to the extent possible, a 

standardized description and general 

method of calculating each quantitative 

measurement that, while taking into 

account the potential variation among 

trading practices and asset classes, 

would facilitate reporting of sufficiently 

uniform information across different 

banking entities so as to permit 

horizontal reviews and comparisons of 

the quantitative profile of trading units 

across firms. 

The CFTC requests comment on the 

proposed quantitative measurements. In 

particular, the CFTC requests comment 

on the following questions: 

Question 168. Are the proposed 

quantitative measurements appropriate 

in general? If not, what alternative(s) 

would be more appropriate, and why? 

Should certain quantitative 

measurements be eliminated, and if so, 

why? Should additional quantitative 

measurements be added? If so, which 

measurements and why? How would 

those additional measurements be 

described and calculated? 

Question 168.1. Should the proposed 

CFTC Rule include all of the required 

metrics? In particular, the Commission 

is interested in which metrics are most 

relevant for swaps, futures, and their 

related hedges. Please explain the 

rationale for including or excluding the 

provisions in the proposed CFTC Rule. 

Question 168.2. If the CFTC Rule 

reduces the number of required metrics, 

should both sets of covered banking 

entities described in sections III.A.(i) 

and III.A.(ii) of Appendix A be required 

to comply with the reduced number of 

required metrics? 

Question 169. How many of the 

proposed quantitative measurements do 

banking entities currently utilize? What 

are the current benefits and costs 

associated with calculating such 

quantitative measurements? Would the 

reporting and recordkeeping 

requirements proposed in Appendix A 

for such quantitative measurements 

impose any significant, additional 

benefits or costs? 

Question 170. Which of the proposed 

quantitative measurements do banking 

entities currently not utilize? What are 

the potential benefits and costs to 

calculating these quantitative 

measurements and complying with the 

proposed reporting and recordkeeping 

requirements? Please quantify your 

answers, to the extent feasible. 

Question 171. Is the scope and 

frequency of required reporting 

appropriate? If not, what alternatives 

would be more appropriate? What 

burdens would be associated with 

reporting quantitative measurements on 

that basis, and how could those burdens 

be reduced or eliminated in a manner 

consistent with the purpose and 

language of the statute? Please quantify 

your answers, to the extent feasible. 

Question 172. For each of the 

categories of quantitative measurements 

(e.g., quantitative measurements relating 

to risk management), what factors 

should be considered in order to further 

refine the proposed category of 

quantitative measurements to better 

distinguish prohibited proprietary 

trading from permitted trading activity? 

For example, should the timing of a 

calculation be considered significant in 

certain contexts (e.g., should specific 

quantitative measurements be 

calculated during the middle of a 

trading day instead of the end of the 

day)? Please quantify your answers, to 

the extent feasible. 

Question 173. In light of the size, 

scope, complexity, and risk of covered 

trading activities, do commenters 

anticipate the need to hire new staff 

with particular expertise in order to 

calculate the required quantitative 

measurements (e.g., collect data and 

make computations)? Do commenters 

anticipate the need to develop 

additional infrastructure to obtain and 

retain data necessary to compute the 

proposed quantitative measurements? 

Please explain and quantify your 

answers, to the extent feasible. 

Question 174. For each individual 

quantitative measurement that is 

proposed: 

• Is the use of the quantitative 

measurement to help distinguish 

between permitted and prohibited 

trading activities effective? If not, what 

alternative would be more effective? 

Does the quantitative measurement 

provide any additional information of 

value relative to other quantitative 

measurements proposed? 

• Is the use of the quantitative 

measurement to help determine whether 

an otherwise-permitted trading activity 

is consistent with the requirement that 

such activity must not result, directly or 

indirectly, in a material exposure by the 

banking entity to high-risk assets and 

high-risk trading strategies effective? If 

not, what alternative would be more 

effective? 

• What factors should be considered 

in order to further refine the proposed 

quantitative measurement to better 

distinguish prohibited proprietary 

trading from permitted trading activity? 

For example, should the timing of a 

calculation be considered significant in 

certain contexts (e.g., should specific 

quantitative measurements be 

calculated during the middle of a 

trading day instead of at the end of the 

day)? 

• If the quantitative measurement is 

proposed to be applied to a trading unit 


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that is engaged in activity pursuant to 

§§ ll.4(a), ll.5, or ll.6(a) of the 

proposed rule, is the quantitative 

measurement calculable in relation to 

such activity? Is the quantitative 

measurement useful for determining 

whether underwriting, risk-mitigating 

hedging, or trading in certain 

government obligations is resulting, 

directly or indirectly, in a material 

exposure by the banking entity to highrisk assets or high-risk trading 

strategies? 

• Is the description of the quantitative 

measurement sufficiently clear? What 

alternative would be more appropriate 

or clearer? Is the description of the 

quantitative measurement appropriate, 

or is it overly broad or narrow? If it is 

overly broad, what additional 

clarification is needed? Should the 

CFTC provide this additional 

clarification in the appendix’s 

description of the quantitative 

measurement? If the description is 

overly narrow, how should it be 

modified to appropriately describe the 

quantitative measurement, and why? 

• Is the general calculation guidance 

effective and sufficiently clear? If not, 

what alternative would be more 

effective or clearer? Is more or less 

specific calculation guidance necessary? 

If so, what level of specificity is needed 

to calculate the quantitative 

measurement? What are the different 

calculation options and methodologies 

that could be used to reach the desired 

level of specificity? What are the costs 

and benefits of these different options? 

If the proposed calculation guidance is 

not sufficiently specific, how should the 

calculation guidance be modified to 

reach the appropriate level of 

specificity? For example, rather than 

provide this level of specificity in 

proposed Appendix A, should the CFTC 

instead make each banking entity 

responsible for determining the best 

method of calculating the quantitative 

measurement at this level of specificity, 

based on the banking entity’s business 

and profile, which would then be 

subject to supervision, review, or 

examination by the CFTC? If the 

proposed calculation guidance is overly 

specific, why is it too specific and how 

should the guidance be modified to 

reach the appropriate level of 

specificity? 

• Is the general calculation guidance 

for the measurement consistent with 

how banking entities currently calculate 

the quantitative measurement, if they do 

so? If not, how does the proposed 

guidance differ from methodology 

currently used by banking entities? 

What is the purpose of the current 

calculation methodology used by 

banking entities? 

• What operational or logistical 

challenges might be associated with 

performing the calculation of the 

quantitative measurement and obtaining 

any necessary informational inputs? 

• Is the quantitative measurement not 

calculable for any specific type of 

trading unit? If so, what type of trading 

unit, and why is the quantitative 

measurement not calculable for that 

type of trading unit? Is there an 

alternative quantitative measurement 

that would reflect the same trading 

activity but not pose the same 

calculation difficulty? Are there 

particular challenges to documenting 

that a specific quantitative measurement 

is not calculable? 

• Is the quantitative measurement 

substantially likely to frequently 

produce false negatives or false 

positives that suggest that prohibited 

proprietary trading is occurring when it 

is not, or vice versa? If so, why? If so, 

what alternative quantitative 

measurement would better help identify 

prohibited proprietary trading? 

• Should the quantitative 

measurement better account for 

distinctions among trading activities, 

trading strategies, and asset classes? If 

so, how? For example, should the 

quantitative measurements better 

account for distinctions between trading 

activities in cash and derivatives 

markets? If so, how? Are there any other 

distinctions for which the quantitative 

measurements may need to account? If 

so, what distinctions, and why? 

• Does the quantitative measurement 

provide useful information as applied to 

all types of trading activities, or only a 

certain subset of trading activities? If it 

only provides useful information for a 

subset of trading activities, how should 

this issue be addressed? How beneficial 

is the information that the quantitative 

measurement provides for this subset of 

trading activities? Do any of the other 

quantitative measurements provide the 

same level of beneficial information for 

this subset of trading activities? Should 

the quantitative measurement be 

required to be reported for all trading 

activities, only a relevant subset of 

trading activities, or not at all? 

• Does the quantitative measurement 

provide useful information as applied to 

all asset classes, or only a certain subset 

of asset classes? If it only provides 

useful information for a subset of asset 

classes, how should this issue be 

addressed? How beneficial is the 

information the quantitative 

measurement provides for this subset of 

asset classes? Do any of the other 

quantitative measurements provide the 

same level of beneficial information for 

this subset of asset classes? Should the 

quantitative measurement be required to 

be reported for all asset classes, only a 

relevant subset of asset classes, or not at 

all? 

• Is the calculation period effective 

and sufficiently clear? If not, what 

alternative would be more effective or 

clearer? 

• How burdensome and costly would 

it be to calculate the measurement at the 

specified calculation frequency and 

calculation period? Are there any 

difficulties or costs associated with 

calculating the measurement for 

particular trading units? How significant 

are those potential costs relative to the 

potential benefits of the measurement in 

monitoring for impermissible 

proprietary trading? Are there potential 

modifications that could be made to the 

measurement that would reduce the 

burden or cost? If so, what are those 

modifications? Please quantify your 

answers, to the extent feasible. 

Question 175. In light of the size, 

scope, complexity, and risk of covered 

trading activities, are there certain types 

of quantitative measurements that will 

not be appropriate for some types of 

banking entities, desks, or levels? If so, 

would it be appropriate to require only 

certain quantitative measurements for 

such banking entities, desks, or levels? 

Question 176. How might the number 

of quantitative measurements impact 

behavior of banking entities? Is there a 

cost of requiring more quantitative 

measurements, such as the cost of 

increased uncertainty regarding the 

combined results of such quantitative 

measurements? To what extent and in 

what ways might uncertainty as to how 

the quantitative measurements are 

applied and evaluated impact behavior? 

Proposed Appendix B—Commentary 

Regarding Identification of Permitted 

Market Making-Related Activities 

Proposed Appendix B provides 

commentary that is intended to assist a 

banking entity in distinguishing 

permitted market making-related 

activities from trading activities that, 

even if conducted in the context of a 

banking entity’s market making 

operations, would constitute prohibited 

proprietary trading. As noted in Part I of 

proposed Appendix B, the commentary 

applies to all banking entities that are 

engaged in market making-related 

activities in reliance on §ll.4(b) of 

the proposed rule. Part II of proposed 

Appendix B clarifies that all defined 

terms used in Appendix B have the 

meaning given those terms in §§ll.2 

and ll.3 of the proposed rule and 

Appendix A. 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8376 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

202See proposed rule Appendix B, § III.A. The 

practices and characteristics that are described 

generally reinforce and augment the specific 

requirements that a banking entity must meet in 

order to rely on the market-making exemption 

under §ll.4(b) of the proposed rule. 

203See proposed rule Appendix B, § III.B. 

204See proposed rule Appendix B, § III.C. 

Proposed Appendix B notes, for example, that it 

may be difficult to distinguish (i) inventory 

positions that appropriately support market 

making-related activities from (ii) positions taken 

for proprietary purposes. See id. 

205For simplicity and ease of reading, the CFTC 

has used the term ‘‘customer’’ throughout the 

discussion of market making-related activity. 

However, as discussed in proposed Appendix B, a 

market maker’s ‘‘customers’’ generally vary 

depending on the asset class and market in which 

the market maker is providing intermediation 

services. In the context of market making in a 

security that is executed on an organized trading 

facility or an exchange, a ‘‘customer’’ is any person 

on behalf of whom a buy or sell order has been 

submitted by a broker-dealer or any other market 

participant. In the context of market making in a 

covered financial position in an over-the-counter 

market, a ‘‘customer’’ generally would be a market 

participant that makes use of the market maker’s 

intermediation services, either by requesting such 

services or entering into a continuing relationship 

with the market maker with respect to such 

services. In certain cases, depending on the 

conventions of the relevant market (e.g., the overthe-counter derivatives market), such a ‘‘customer’’ 

may consider itself or refer to itself more generally 

as a ‘‘counterparty.’’ 

206See proposed rule Appendix B, § III.C.1–6. 

The CFTC notes that each of these six criteria is 

directly related to the overview of market makingrelated activities provided in section III.A. of 

proposed Appendix B. 

207The proposed commentary does not 

contemplate explanatory facts and circumstances 

for the compensation incentives factor, given that 

the choice of compensation incentives provided to 

trading personnel is under the full control of the 

banking entity. 

208The CFTC also notes that, although a 

particular trading activity may not meet the 

requirements applicable to permitted market 

making-related activities, it may still be exempt 

under another available exemption. 

The commentary regarding 

identification of permitted market 

making-related activities, which is 

contained in Part III of proposed 

Appendix B, includes three principal 

components. The first component 

provides an overview of market makingrelated activities and describes, in 

detail, typical practices in which market 

makers engage and typical 

characteristics of market making-related 

activities, articulating the general 

framework within which the CFTC 

views market making-related 

activities.202 For example, the 

commentary provides that market 

making-related activities, in the context 

of a banking entity acting as principal, 

generally involve either (i) in the case of 

market making in a security that is 

executed on an organized trading 

facility or exchange, passively providing 

liquidity by submitting resting orders 

that interact with the orders of others on 

an organized trading facility or 

exchange and acting as a registered 

market maker, where such exchange or 

organized trading facility provides the 

ability to register as a market maker, or 

(ii) in other cases, providing an 

intermediation service to its customers 

by assuming the role of a counterparty 

that stands ready to buy or sell a 

position that the customer wishes to sell 

or buy. The second component of the 

commentary provides an overview of 

prohibited proprietary trading activities, 

which describes the general framework 

within which the CFTC views 

prohibited proprietary trading and 

contrasts that activity to the practices 

and characteristics of market makingrelated activities.203 The third 

component describes certain challenges 

that arise in distinguishing permitted 

market making-related activities and 

prohibited proprietary trading, 

particularly in cases in which both of 

these activities occur within the context 

of a market making operation,204 and 

proposes guidance that the CFTC would 

apply in distinguishing permitted 

market making-related activities from 

prohibited proprietary trading. This 

guidance includes six factors that would 

cause a banking entity to be considered, 

absent explanatory circumstances, to be 

engaged in prohibited proprietary 

trading, and not permitted market 

making-related activity. The six factors 

are: 

• Trading activity in which a trading 

unit retains risk in excess of the size and 

type required to provide intermediation 

services to customers; 205

• Trading activity in which a trading 

unit primarily generates revenues from 

price movements of retained principal 

positions and risks, rather than 

customer revenues; 

• Trading activity in which a trading 

unit: (i) Generates only very small or 

very large amounts of revenue per unit 

of risk taken; (ii) does not demonstrate 

consistent profitability; or (iii) 

demonstrates high earnings volatility; 

• Trading activity in which a trading 

unit either (i) does not transact through 

a trading system that interacts with 

orders of others or primarily with 

customers of the banking entity’s market 

making desk to provide liquidity 

services, or (ii) holds principal positions 

in excess of reasonably expected near 

term customer demands; 

• Trading activity in which a trading 

unit routinely pays rather than earns 

fees, commissions, or spreads; and 

• The use of compensation incentives 

for employees of a particular trading 

activity that primarily reward 

proprietary risk-taking.206

The proposed commentary makes 

clear that the enumerated factors are 

subject to certain facts and 

circumstances that may explain why a 

trading activity may meet one or more 

factors but does not involve prohibited 

proprietary trading, and provides a 

range of examples of such explanatory 

facts and circumstances.207 The CFTC 

emphasizes that these examples are not 

meant to be exhaustive, as a variety of 

other circumstances may exist to 

explain why a particular trading 

activity, even if meeting one of the 

factors, may nonetheless be a permitted 

market making-related activity.208

In addition, for each of these six 

factors, the proposed rule provides 

general guidance as to (i) the types of 

facts and circumstances on which the 

CFTC may base any determination that 

a banking entity’s trading activity met 

the relevant factor and (ii) which 

quantitative measurements, if furnished 

by a banking entity pursuant to 

Appendix A, the CFTC would use to 

help assess the extent to which a 

banking entity’s activities met the 

relevant factor. 

The CFTC requests comment on the 

proposed commentary regarding 

identification of permitted market 

making-related activities. In particular, 

the CFTC requests comment on the 

following questions: 

Question 177. Is the overview of 

permitted market making-related 

activities and prohibited proprietary 

trading proposed in Appendix B 

accurate? If not, what alternative 

overview would be more accurate? Does 

the overview appropriately account for 

differences in market making-related 

activities across different asset classes? 

If not, which type of market makingrelated activity does the overview not 

sufficiently describe or account for? 

Question 177.1. Should the proposed 

CFTC Rule include the entire Appendix 

B (e.g., description of market-making in 

liquid exchange-traded equity)? Please 

explain the rationale for including or 

excluding certain provisions of 

Appendix B in the proposed CFTC Rule. 

Question 178. Is the requirement that 

a market maker engaged in market 

making that is executed on an exchange 

or an organized trading facility must be 

a registered market maker, provided the 

relevant exchange or organized trading 

facility provides the ability to register, 

appropriate, or is it over- or underinclusive? Please discuss and provide 

detailed examples of any such markets 

where registering as a market maker is 

not feasible or should not be required 

for purposes of this rule, and 


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unregistered market makers provide 

similar services or perform similar 

functions. 

Question 179. With respect to market 

making that is executed on an exchange 

or an organized trading facility, what 

potential impact or unintended 

consequences might result from limiting 

the market making exemption to 

registered market makers when the 

relevant exchange or organized trading 

facility registers market makers? Would 

such a requirement result in any 

potential decrease in the passive 

provision of liquidity by the submission 

of resting orders? Do you anticipate that 

any such decrease would be exacerbated 

in times of market stress? If yes, please 

describe the impact on liquidity and the 

marketplace in general. Please discuss 

whether and how any potential decrease 

in liquidity could be mitigated. In 

addition, would such a requirement 

result in additional costs that would be 

borne by market participants purchasing 

and selling on an exchange or organized 

trading facility? Please identify and 

discuss any other additional costs. 

Please discuss whether and how any 

such consequences can be mitigated. 

Question 180. In addition to benefits 

discussed in the Supplementary 

Information, are there other benefits that 

would be achieved by requiring that a 

market maker be registered with respect 

to market making on an exchange or an 

organized trading facility? Is there a way 

to amplify these benefits? Could these 

benefits be realized through alternative 

means? If so, how? 

Question 181. In addition to 

registered market makers on exchanges 

or organized trading facilities, what 

other classes of liquidity providers 

exist? Are their obligations and 

activities similar to, or different than 

those of registered market makers? If so, 

how? Are the compensated in a different 

manner? 

Question 182. How much liquidity is 

provided by registered market makers 

versus other liquidity providers by asset 

class (e.g., equities, etc.) with respect to 

trading on an exchange or an organized 

trading facility? The CFTC encourages 

commenters to provide data, or studies, 

in support of comments. 

Question 183. Is there any specific 

element of market making-related 

activity that the overview does not take 

into account in its description of market 

making? If so, how should the overview 

account for this element? Are there any 

descriptions of market making-related 

activity in the overview that should not 

be considered to be market makingrelated activity? If so, why? Is there any 

specific element of prohibited 

proprietary trading activity that the 

overview does not take into account in 

its description of prohibited proprietary 

trading? If so, how should the overview 

account for this element? Are there any 

descriptions of prohibited proprietary 

trading activity in the overview that 

should not be considered to be 

prohibited proprietary trading? If so, 

why? 

Question 184. Are each of the six 

factors specified for helping to 

distinguish permitted market makingrelated activity from prohibited 

proprietary trading appropriate? If not, 

how should they be changed, and why? 

Should any factors be eliminated or 

added? If so, which ones and why? 

Could any of the proposed factors occur 

as a result of the banking entity 

engaging in one of the other permitted 

activities (e.g., underwriting, trading on 

behalf of customers)? If so, would the 

facts and circumstances that the CFTC 

proposes to consider be sufficient to 

determine and verify that the banking 

entity is not engaged in prohibited 

proprietary trading? If not, how should 

this issue be addressed? 

Question 185. Are the facts and 

circumstances that would be used to 

determine whether a banking entity’s 

activities satisfy a certain factor 

appropriate? If not, how should they be 

changed, and why? Should any be 

eliminated or added? If so, which ones, 

and why? 

Question 186. Are the identified 

quantitative measurements that the 

CFTC would use to help assess a 

particular factor appropriate? If not, 

how should they be changed, and why? 

Should any be eliminated or added? If 

so, which ones, and why? 

e. Incorporation of Numerical 

Thresholds in the Commentary 

Regarding Identification of Permitted 

Market Making-Related Activities 

As noted above, the CFTC is currently 

requesting comment on whether to 

incorporate, as part of the proposed 

rule, numerical thresholds for certain 

quantitative measurements, and if so, 

how to do so. For example, the 

proposed rule could include one or 

more numerical thresholds that, if met 

by a banking entity, would require the 

banking entity to review its trading 

activities for compliance and summarize 

that review to the CFTC. 

The primary purpose of using some 

form of threshold would be to provide 

banking entities with a clear standard 

regarding trading activity that presented 

a quantitative profile sufficiently 

questionable to warrant further review 

and explanation to the CFTC. Such 

clarity would appear to provide 

significant benefits both to banking 

entities in conducting their trading 

activities in conformance with the 

proposed rule and to the CFTC in 

monitoring trading activities and 

obtaining additional, more detailed 

information in circumstances 

warranting closer scrutiny. In addition 

to the benefits of transparency, 

thresholds would also encourage 

consistent review by banking entities 

and the CFTC of transactions, both 

within a banking entity and across all 

banking entities. The purpose of such 

thresholds would not be to serve as 

bounds of permitted conduct or as a 

comprehensive, dispositive tool for 

determining whether prohibited 

proprietary trading has occurred. 

Numerical thresholds have not been 

included in the proposed rule because 

the CFTC believes that public comment 

and further review is warranted before 

numerical thresholds and specific 

numerical amounts may be proposed. 

Instead, the CFTC requests comment on 

whether such thresholds would be 

desirable and, if so, what particular 

form such thresholds should take and 

what specific numerical thresholds 

would be appropriate. To facilitate the 

comment process, this request for 

comment includes a number of 

illustrative examples of numerical 

thresholds on which specific comment 

is sought. 

In particular, the CFTC requests 

comment on the following questions: 

Question 187. What are the potential 

benefits and costs of incorporating into 

the proposed rule one or more 

numerical thresholds for certain 

quantitative measurements that, if 

reported by a banking entity, would 

require the banking entity to review its 

trading activities for compliance and 

summarize that review to the CFTC? 

Would such thresholds provide useful 

clarity to banking entities and/or market 

participants regarding the types of 

trading activities that merit additional 

scrutiny? Should numerical thresholds 

be used for any purposes other than 

highlighting trading activities that 

should be reviewed, the results of which 

would be reported to the CFTC? If so, 

for what purpose, and how and why? 

Question 188. For which of the 

relevant quantitative measurements 

might it be appropriate and effective to 

include a numerical threshold that 

would trigger banking entity review and 

explanation? How should a numerical 

threshold be formulated, and why? 

Should a numerical threshold for a 

single quantitative measurement be 

applied individually, or should the 

threshold instead be triggered by 

exceeding some combination of 

numerical thresholds for different 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8378 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

209See 12 U.S.C. 1851(d)(2). 210Section ll.17(b) of the proposed rule defines 

the scope of material conflicts of interest which, if 

arising in connection with permitted covered fund 

activities, are prohibited. 

211See, e.g., U.S. Senate Permanent 

Subcommittee on Investigations, Wall Street and 

the Financial Crisis: Anatomy of a Financial 

Collapse (Apr. 13, 2011), available at http:// 

hsgac.senate.gov/public/lfiles/FinanciallCrisis/ 

FinancialCrisisReport.pdf. 

212See proposed rule §ll.8(b)(1). 

measurements? For any particular 

threshold, what numerical amount 

should be used, and why? How would 

such numerical amount be consistent 

with a level at which further review and 

explanation is warranted? Should the 

amount vary by asset class or other 

characteristic? If so, how? 

Question 189. For each of the 

following illustrative examples of 

potential thresholds, is the threshold 

formulated effectively? If not, what 

alternative formulation would be more 

effective? Should the threshold 

formulation vary by asset class or other 

characteristic? If so, how and why? If 

the threshold was utilized, what actual 

numerical amount should be specified, 

and why? How would such numerical 

amount be consistent with a level at 

which further review and explanation is 

warranted? Should the numerical 

amount vary by asset class or other 

characteristic? If so, how and why? 

• ‘‘If a trading unit reports an increase 

in VaR, Stress VaR, or Risk Factor 

Sensitivities greater than [ll] over a 

period of [ll] months, or such other 

threshold as the CFTC may require, the 

banking entity must (i) promptly review 

and investigate the trading unit’s 

activities to verify whether the trading 

unit is operating in compliance with the 

proprietary trading restrictions and (ii) 

report to the CFTC a summary of such 

review, including any explanatory 

circumstances.’’ 

• ‘‘If a trading unit reports an average 

Comprehensive Profit and Loss that is 

less than [ll] times greater than the 

Portfolio Profit and Loss, exclusive of 

Spread Profit and Loss, for [ll] 

consecutive months, or such other 

threshold as the CFTC may require, the 

banking entity must (i) promptly review 

and investigate the trading unit’s 

activities to verify whether the trading 

unit is operating in compliance with the 

proprietary trading restrictions and (ii) 

report to the CFTC a summary of such 

review, including any explanatory 

circumstances.’’ 

• ‘‘If a trading unit reports a 

Comprehensive Profit and Loss to 

Volatility Ratio that is less than [ll] 

times greater than that trading desk’s 

Portfolio Profit and Loss to Volatility 

Ratio over a period of [ll] months, or 

such other threshold as the CFTC may 

require, the banking entity must (i) 

promptly review and investigate the 

trading unit’s activities to verify 

whether the trading unit is operating in 

compliance with the proprietary trading 

restrictions and (ii) report to the CFTC 

a summary of such review, including 

any explanatory circumstances.’’ 

• ‘‘If a trading unit reports a number 

of Unprofitable Trading Days Based on 

Portfolio Profit and Loss that is less than 

[ll] times greater than the number of 

Unprofitable Trading Days Based on 

Comprehensive Profit and Loss for 

[ll] consecutive months, or such 

other threshold as [Agency] may 

require, the banking entity must (i) 

promptly review and investigate the 

trading unit’s activities to verify 

whether the trading unit is operating in 

compliance with the proprietary trading 

restrictions and (ii) report to [Agency] a 

summary of such review, including any 

explanatory circumstances.’’ 

• ‘‘If a trading unit reports a Pay-toReceive Spread Ratio that is less than 

[ll] over a period of [ll] months, or 

such other threshold as [Agency] may 

require, the banking entity must (i) 

promptly review and investigate the 

trading unit’s activities to verify 

whether the trading unit is operating in 

compliance with the proprietary trading 

restrictions and (ii) report to [Agency] a 

summary of such review, including any 

explanatory circumstances.’’ 

6. Section ll.8: Limitations on 

permitted trading activities 

Section ll.8 of the proposed rule 

implements section 13(d)(2) of the BHC 

Act, which places certain limitations on 

the permitted trading activities (e.g., 

permitted market making-related 

activities, risk-mitigating hedging, etc.) 

in which a banking entity may 

engage.209 Consistent with the statute, 

§ ll.8(a) of the proposed rule provides 

that no transaction, class of transactions, 

or activity is permissible under 

§§ ll.4 through ll.6 of the proposed 

rule if the transaction, class of 

transactions, or activity would: 

• Involve or result in a material 

conflict of interest between the banking 

entity and its clients, customers, or 

counterparties; 

• Result, directly or indirectly, in a 

material exposure by the banking entity 

to a high-risk asset or a high-risk trading 

strategy; or 

• Pose a threat to the safety and 

soundness of the banking entity or U.S. 

financial stability. 

The proposed rule further defines 

‘‘material conflict of interest,’’ ‘‘highrisk asset,’’ and ‘‘high-risk trading 

strategy’’ for these purposes. 

a. Scope of ‘‘Material Conflict of 

Interest’’ 

Section ll.8(b) of the proposed rule 

defines the scope of material conflicts of 

interest which, if arising in connection 

with a permitted trading activity, are 

prohibited under the proposal.210

Conflicts of interest may arise in a 

variety of circumstances related to 

permitted trading activities. For 

example, a banking entity may acquire 

substantial amounts of nonpublic 

information about the financial 

condition of a particular company or 

issuer through its lending, underwriting, 

investment advisory or other activities 

which, if improperly transmitted to and 

used in trading operations, would 

permit the banking entity to use such 

information to its customers’, clients’ or 

counterparties’ disadvantage. Similarly, 

a banking entity may conduct a 

transaction that places the banking 

entity’s own interests ahead of its 

obligations to its customers, clients or 

counterparties, or it may seek to gain by 

treating one customer involved in a 

transaction more favorably than another 

customer involved in that transaction. 

Concerns regarding conflicts of interest 

are likely to be elevated when a 

transaction is complex, highly 

structured or opaque, involves illiquid 

or hard-to-value instruments or assets, 

requires the coordination of multiple 

internal groups (such as multiple 

trading desks or affiliated entities), or 

involves a significant asymmetry of 

information or transactional data among 

participants.211 In all cases, the 

existence of a material conflict of 

interest depends on the specific facts 

and circumstances. 

To address these types of material 

conflicts of interest, §ll.8(b) of the 

proposed rule specifies that a material 

conflict of interest between a banking 

entity and its clients, customers, or 

counterparties exists if the banking 

entity engages in any transaction, class 

of transactions, or activity that would 

involve or result in the banking entity’s 

interests being materially adverse to the 

interests of its client, customer, or 

counterparty with respect to such 

transaction, class of transactions, or 

activity, unless the banking entity has 

appropriately addressed and mitigated 

the conflict of interest, where possible, 

and subject to specific requirements 

provided in the proposal, through either 

(i) timely and effective disclosure, or (ii) 

informational barriers.212 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 


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213The CFTC notes that a banking entity subject 

to Appendix C must implement a compliance 

program that includes, among other things, policies 

and procedures that explain how the banking entity 

monitors and prohibits conflicts of interest with 

clients, customers, and counterparties. Further, as 

noted in the discussion of the definition of 

‘‘material conflict of interest’’ in Part III.B.6 of this 

Supplemental Information, the discussion of that 

definition is provided solely for purposes of the 

proposed rule’s definition of material conflict of 

interest, and does not affect the scope of that term 

in other contexts or a banking entity’s obligation to 

comply with additional or different requirements 

with respect to a conflict under applicable 

securities, banking, or other laws (e.g., section 27B 

of the Securities Act, which governs conflicts of 

interest relating to certain securitizations; section 

206 of the Investment Advisers Act of 1940, which 

applies to conflicts of interest between investment 

advisers and their clients; or 12 CFR 9.12, which 

applies to conflicts of interest in the context of a 

national bank’s fiduciary activities). 

214See proposed rule §ll.8(b)(1)(A). 

215See id. 216See proposed rule §ll.8(b)(1)(B). 

217For example, information barriers have been 

used in complying with the requirement in section 

15(g) of the Exchange Act that registered brokers 

and dealers establish, maintain and enforce written 

policies and procedures reasonably designed, taking 

into consideration the nature of such broker’s or 

dealer’s business, to prevent the misuse of material, 

nonpublic information by such broker or dealer or 

any person associated with such broker or dealer. 

activity would be prohibited under the 

proposed rule, notwithstanding the fact 

that it may be otherwise permitted 

under §§ll.4 through ll.6 of the 

proposed rule.213

However, while these conflicts may 

be material for purposes of the proposed 

rule, the mere fact that the buyer and 

seller are on opposite sides of a 

transaction and have differing economic 

interests would not be deemed a 

‘‘material’’ conflict of interest with 

respect to transactions related to bona 

fide underwriting, market making, riskmitigating hedging or other permitted 

activities, assuming the activities are 

conducted in a manner that is consistent 

with the proposed rule and securities 

and banking laws and regulations. 

Section ll.8(b)(1) of the proposed 

rule describes the two requirements that 

must be met in cases where a banking 

entity addresses and mitigates a material 

conflict of interest through timely and 

effective disclosure. First, 

§ ll.8(b)(1)(i) of the proposed rule 

requires that the banking entity, prior to 

effecting the specific transaction or class 

or type of transactions, or engaging in 

the specific activity, for which a conflict 

may arise, make clear, timely, and 

effective disclosure of the conflict or 

potential conflict of interest, together 

with any other necessary 

information.214 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.215 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, 

§ ll.8(b)(1)(ii) of the proposed rule 

requires that the disclosure be made 

explicitly and effectively, and in a 

manner that provides the client, 

customer, or counterparty the 

opportunity to negate, or substantially 

mitigate, any materially adverse effect 

on the client, customer, or counterparty 

that was created or would be created by 

the conflict or potential conflict.216

The CFTC notes that, in order to 

provide the requisite opportunity for the 

client, customer or counterparty to 

negate or substantially mitigate the 

disadvantage created by the conflict, the 

disclosure would need to be provided 

sufficiently close in time to the client’s, 

customer’s, or counterparty’s decision to 

engage in the transaction or activity to 

give the client, customer, or 

counterparty an opportunity to 

meaningfully evaluate and, if necessary, 

take steps that would negate or 

substantially mitigate the conflict. 

Disclosure provided far in advance of 

the individual, class, or type of 

transaction, such that the client, 

customer, or counterparty is unlikely to 

take that disclosure into account when 

evaluating a transaction, would not 

suffice. Conversely, disclosure provided 

without a sufficient period of time for 

the client, customer, or counterparty to 

evaluate and act on the information it 

receives, or disclosure provided after 

the fact, would also not suffice under 

the proposal. The CFTC notes that the 

proposed definition would not prevent 

or require disclosure with respect to 

transactions or activities that align the 

interests of the banking entity with its 

clients, customers, or counterparties or 

that otherwise do not involve ‘‘material’’ 

conflicts of interest as discussed above. 

The proposed disclosure standard 

reflects the fact that some types of 

conflicts may be appropriately resolved 

through the disclosure of clear and 

meaningful information to the client, 

customer, or counterparty that provides 

such party with an informed 

opportunity to consider and negate or 

substantially mitigate the conflict. 

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 CFTC 

notes that the proposed disclosure 

provisions are provided solely for 

purposes of the proposed rule’s 

definition of material conflict of 

interest, and do not affect a banking 

entity’s obligation to comply with 

additional or different disclosure or 

other requirements with respect to a 

conflict under applicable securities, 

banking, or other laws (e.g., section 27B 

of the Securities Act, which governs 

conflicts of interest relating to certain 

securitizations; section 206 of the 

Investment Advisers Act of 1940, which 

governs conflicts of interest between 

investment advisers and their clients; or 

12 CFR 9.12, which applies to conflicts 

of interest in the context of a national 

bank’s fiduciary activities). 

Section ll.8(b)(2) of the proposed 

rule describes the requirements that 

must be met in cases where a banking 

entity uses information barriers that are 

reasonably designed to prevent a 

material conflict of interest from having 

a materially adverse effect on a client, 

customer or counterparty. Information 

barriers can be used to restrict the 

dissemination of information within a 

complex organization and to prevent 

material conflicts by limiting knowledge 

and coordination of specific business 

activities among units of the entity. 

Examples of information barriers 

include, but are not limited to, 

restrictions on information sharing, 

limits on types of trading, and greater 

separation between various functions of 

the firm. Information barriers may also 

require that banking entity units or 

affiliates have no common officers or 

employees. Such information barriers 

have been recognized in Federal 

securities laws and rules as a means to 

address or mitigate potential conflicts of 

interest or other inappropriate 

activities.217

In order to address and mitigate a 

conflict of interest through the use of 

the information barriers pursuant to 

§ ll.8(b)(2) of the proposed rule, a 

banking entity would be required to 

establish, maintain, and enforce 

information barriers that are 

memorialized in written policies and 

procedures, including physical 

separation of personnel, functions, or 

limitations on types of activity, that are 

reasonably designed, taking into 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8380 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

218See proposed rule §ll.8(b)(2). As part of 

maintaining and enforcing information barriers, a 

banking entity should have processes to review, 

test, and modify information barriers on a 

continuing basis. In addition, banking entities 

should have ongoing monitoring to maintain and to 

enforce information barriers, for example by 

identifying whether such barriers have not 

prevented unauthorized information sharing and 

addressing instances in which the barriers were not 

effective. This may require both remediating any 

identified breach as well as updating the 

information barriers to prevent further breaches, as 

necessary. Periodic assessment of the effectiveness 

of information barriers and periodic review of the 

written policies and procedures are also important 

to the maintenance and enforcement of effective 

information barriers and reasonably designed 

policies and procedures. Such assessments can be 

done either (i) internally by a qualified employee 

or (ii) externally by a qualified independent party. 

219See proposed rule §ll.8(b)(2). 

220 In addition, if a conflict occurs to the 

detriment of a client, customer, or counterparty 

despite an information barrier, the CFTC 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. 

221The CFTC notes 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). 

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.218

Importantly, the proposed rule also 

provides that, notwithstanding a 

banking entity’s establishment of such 

information barriers, if the banking 

entity knows or should reasonably know 

that a material conflict of interest arising 

out of a specific transaction, class or 

type of transactions, or activity may 

involve or result in a materially adverse 

effect on a client, customer, or 

counterparty, the banking entity may 

not rely on those information barriers to 

address and mitigate any conflict of 

interest. In such cases, the transaction or 

activity would be prohibited, unless the 

banking entity otherwise complies with 

the requirements of §ll.8(b)(1).219

This aspect of the proposal is intended 

to make clear that, in specific cases in 

which a banking entity has established 

an information barrier but knows or 

should reasonably know that it has 

failed or will fail to prevent a conflict 

of interest arising from a specific 

transactions or activity that 

disadvantages a client, customer, or 

counterparty, the information barrier is 

insufficient to address that conflict and 

the transaction would be prohibited, 

unless the banking entity is otherwise 

able to address and mitigate the conflict 

through timely and effective disclosure 

under the proposal.220

The CFTC notes that the proposed 

definition of material conflict of interest 

does not address instances in which a 

banking entity has made a material 

misrepresentation to its client, 

customer, or counterparty in connection 

with a transaction, class of transactions, 

or activity, as such transactions or 

activity appears to involve fraud rather 

than a conflict of interest. However, the 

CFTC notes that such 

misrepresentations are generally illegal 

under a variety of Federal and State 

regulatory schemes (e.g., the Federal 

securities laws). In addition, the CFTC 

notes that any activity involving a 

material misrepresentation to, or other 

fraudulent conduct with respect to, a 

client, customer, or counterparty would 

not be permitted under the proposed 

rule in the first instance. For example, 

a trading activity involving a material 

misrepresentation to a client, customer, 

or counterparty would fail, on its face, 

to satisfy the proposed terms of the 

underwriting or market-making 

exemption. 

b. Definition of ‘‘High-Risk Asset’’ and 

‘‘High-Risk Trading Strategy’’ 

Section ll.8(c) of the proposed rule 

defines ‘‘high-risk asset’’ and ‘‘high-risk 

trading strategy’’ for proposes of 

§ ll.8’s proposed limitations on 

permitted trading activities. Section 

ll.8(c)(1) defines a ‘‘high-risk asset’’ 

as an asset or group of assets that would, 

if held by the banking entity, 

significantly increase the likelihood that 

the banking entity would incur a 

substantial financial loss or would fail. 

Section ll.8(c)(2) defines a ‘‘high-risk 

trading strategy’’ as a trading strategy 

that would, if engaged in by the banking 

entity, significantly increase the 

likelihood that the banking entity would 

incur a substantial financial loss or 

would fail.221

c. Request for Comment 

The CFTC requests comment on the 

proposed limitations on permitted 

trading activities. In particular, the 

CFTC requests comment on the 

following questions: 

Question 190. Is the manner in which 

the proposed rule implements the 

limitations of section 13(d)(2) of the 

BHC Act effective and sufficiently clear? 

If not, what alternative would be more 

effective and/or clearer? 

Question 191. Is the proposed rule’s 

definition of material conflict of interest 

effective and sufficiently clear? If not, 

what alternative would be more 

effective and/or clearer? 

Question 192. Is the proposed 

definition of material conflict of interest 

over- or under-inclusive? If so, how 

should the definition be broader or 

narrower? Is there an alternative 

definition that would be appropriate? If 

so, what definition? Why would that 

alternative definition better define 

material conflict of interest for purposes 

of implementing section 13 of the BHC 

Act? 

Question 193. Would the proposed 

definition of material conflict of interest 

have any unintended chilling effect on 

underwriting, market making, riskmitigating hedging or other permitted 

activities? If so, what alternatives might 

limit such an effect? 

Question 194. Would the proposed 

definition of material conflict of interest 

lead to unintended consequences? If so, 

what unintended consequences and 

why? Please suggest modifications to 

the proposed definition that would 

mitigate those consequences. 

Question 195. Is it likely that the 

proposed definition of material conflict 

of interest would anticipate all future 

material conflicts of interest, 

particularly as the financial markets 

evolve and change? If not, what 

alternative definition would better 

anticipate future material conflicts of 

interest? 

Question 196. Does the proposed rule 

provide sufficient guidance for 

determining when a material conflict of 

interest exists? If not, what additional 

detail should be provided? Should the 

CFTC adopt an approach similar to that 

under the securities laws, in which a 

material conflict of interest is not 

specifically defined? 

Question 197. Are there transactions, 

classes or types of transactions, or 

activities inherent in underwriting, 

market-making, risk-mitigating hedging 

or other permitted activities that should 

not be prohibited but may be captured 

by the proposed definition of material 

conflict of interest? If so, what 

transactions and activities? Should they 

be permitted under the proposed rule? 

If so, why and under what conditions, 

if any? Conversely, are there 

transactions or activities that would be 

permitted under the proposed rule that 

should be prohibited? If so, what 

transactions and activities? Why should 

they be prohibited under the proposed 

rule? 

Question 198. Please discuss the 

inherent conflicts of interest that arise 

from bona fide underwriting, market 

making-related activity, risk-mitigating 

hedging, or any other permitted activity, 

and provide specific examples of such 

inherent conflicts. Do you believe that 

such conflicts ever result in a materially 


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adverse interest between a banking 

entity and a client, customer, or 

counterparty? How should the proposal 

address inherent conflicts that result 

from otherwise-permitted activities? 

Question 199. Is the manner in which 

the proposed rule permits the use of 

disclosure in certain cases to address 

and mitigate conflicts of interest 

appropriate? Why or why not? Should 

additional or alternative requirements 

be placed on the use of disclosure to 

address and mitigate conflicts? If so, 

what additional and alternative 

requirements, and why? Is the level of 

detail and specificity required by the 

proposed rule with respect to disclosure 

appropriate? If not, what alternative 

level of detail and specificity would be 

more appropriate? 

Question 200. Should the proposed 

rule require written disclosure to a 

client, customer, or counterparty 

regarding a material conflict of interest? 

If so, please explain why written 

disclosure should be required. Are there 

certain circumstances where written 

disclosure should be required, but 

others where oral disclosure should be 

sufficient? For example, should oral 

disclosure be permitted for transactions 

in certain fast-moving markets or 

transactions with sophisticated clients, 

customers, or counterparties? If oral 

disclosure is permitted under certain 

circumstances, should subsequent 

written disclosure be required? Please 

explain. 

Question 201. Should the proposed 

rule provide further detail regarding the 

types of conflicts of interest that cannot 

be addressed and mitigated through 

disclosure? If so, what type of additional 

detail would be helpful, and why? 

Should the proposed rule enumerate an 

exhaustive or non-exhaustive list of 

conflicts that cannot be addressed and 

mitigated through disclosure? If so, 

what conflicts should that list include, 

and why? 

Question 202. Should the proposed 

rule provide further detail regarding the 

frequency at which disclosure must be 

made? Should general disclosure be 

permitted for certain types of 

transactions, classes of transactions, or 

activities? For example, should a 

banking entity be permitted to make a 

one-time, written disclosure to a client, 

customer, or counterparty prior to 

engaging in a certain type of transaction 

or activity? Should general disclosure be 

permitted for certain types of clients, 

customers, or counterparties (e.g., 

highly sophisticated parties)? Please 

explain why specific disclosure (i.e., 

prior to each transaction, class of 

transaction, or activity) would not be 

necessary under the identified 

circumstances. Are there any clients, 

customers, or counterparties that should 

be able to waive a material conflict of 

interest under certain circumstances? If 

so, under what circumstances would a 

waiver approach be appropriate and 

consistent with the statute? Please 

explain. 

Question 203. Should the proposed 

definition of material conflict of interest 

deem certain potential conflicts of 

interest to not be material conflicts of 

interest if a banking entity establishes, 

maintains, and enforces policies and 

procedures (other than information 

barriers) reasonably designed to prevent 

transactions, classes of transactions, or 

activities that would involve or result in 

a material conflict of interest? If so, for 

what types of potential conflicts? What 

policies and procedures would be 

appropriate? How would this approach 

be consistent with the purpose and 

language of the statute? Should such 

policies and procedures only be 

considered effective if they prevent the 

banking entity from receiving an 

advantage to the disadvantage of the 

client, customer, or counterparty? 

Question 204. Are there any particular 

types of clients, customers, or 

counterparties for whom disclosure of a 

material conflict of interest should not 

be required under the proposal, 

consistent with the statute? Please 

identify the types of clients, customers, 

or counterparties for whom disclosure 

might not be necessary and explain. 

Why might disclosures be useful for 

some clients, customers, or 

counterparties, but not others? Please 

explain. What characteristics should a 

firm use in determining whether or not 

a client, customer, or counterparty 

needs a particular disclosure? 

Question 205. Are there additional 

steps that a banking entity that seeks to 

manage conflicts of interest through the 

use of disclosure should be required to 

take with regard to disclosure? If so, 

what steps? 

Question 206. Are there 

circumstances in which disclosure 

might be impracticable or ineffective? If 

so, what circumstances, and why? 

Question 207. Is the manner in which 

the proposed rule permits the use of 

information barriers to address and 

mitigate conflicts of interest 

appropriate? Why or why not? Should 

additional or alternative requirements 

be placed on the use of information 

barriers to address and mitigate 

conflicts? If so, what additional and 

alternative requirements, and why? 

Question 208. Should the proposed 

rule mandate the use of other means of 

managing potential conflicts of interest? 

If so, what specific means should be 

considered? How effective are any such 

methods as currently used? Can such 

methods be circumvented? If so, in what 

ways? 

Question 209. What burdens or costs 

might be associated with the disclosurerelated or information barrier-related 

requirements contained in the proposed 

definition of material conflict of 

interest? How might these burdens or 

costs be eliminated or reduced in a 

manner consistent with the purpose and 

language of section 13 of the BHC Act? 

Question 210. Are there specific 

transactions, classes of transactions or 

activities that should be managed 

through consent? If so, what 

transactions or activities, and why? 

What form of consent should be 

required? What level of detail should 

any such consent include? Should 

consent only apply to certain conflicts 

and not others? If so, which conflicts? 

Are there circumstances in which 

obtaining consent might be 

impracticable or ineffective? Should 

consent be limited to certain types of 

clients, customers, or counterparties? If 

so, which clients, customers, or 

counterparties? Are there certain types 

of clients, customers, or counterparties 

for whom consent would never be 

sufficient? Are there additional steps 

that a banking entity that seeks to 

manage conflicts of interest through the 

use of consent should be required to 

take? Please specify such steps. 

Question 211. What is the potential 

relationship between, and interplay of, 

the proposed rule and Section 621 of the 

Dodd-Frank Act regarding conflicts of 

interest relating to certain 

securitizations which contains a 

prohibition on material conflicts of 

interest? 

Question 212. Should the proposed 

rule provide for specific types of 

procedures that would be more effective 

in managing and mitigating conflicts of 

interest than others? Do banking entities 

currently use certain procedures that 

effectively manage and mitigate material 

conflicts of interest? If so, please 

describe such procedures and explain 

why such procedures are effective. Is 

the proposed rule consistent with such 

procedures? Why or why not? What are 

the costs and benefits of modifying your 

current procedures in response to the 

proposed rule? 

Question 213. Is the proposed rule’s 

definition of a high-risk asset effective 

and sufficiently clear? If not, what 

alternative would be more effective and/ 

or clearer? Should the proposed rule 

specify particular assets that are deemed 

high-risk per se? If so, what assets and 

why? 


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222See 12 U.S.C. 1851(a)(1)(B). 

223See proposed rule §ll.10(a). 

224The CFTC notes that this language is intended 

to prevent a banking entity from evading the 

restrictions contained in section 13(a)(1)(B) of the 

BHC Act on acquiring or retaining an ownership 

interest in a covered fund. 

225See proposed rule §ll.10(b)(1). The term 

banking entity, which is discussed above in Part 

III.A.2 of this Supplementary Information, is 

defined in §ll.2(e). 

226 12 U.S.C. 1851(h)(2). Sections 3(c)(1) and 

3(c)(7) of the Investment Company Act, in relevant 

part, provide two exclusions from the definition of 

‘‘investment company’’ for, as appropriate, (1) any 

issuer whose outstanding securities are beneficially 

owned by not more than one hundred persons and 

which is not making and does not presently 

propose to make a public offering of its securities 

(other than short-term paper), or (2) any issuer, the 

outstanding securities of which are owned 

exclusively by persons who, at the time of 

acquisition of such securities, are qualified 

purchasers, and which is not making and does not 

at that time proposes to make a public offering of 

such securities. See 15 U.S.C. 80a–3(c)(1) and (c)(7). 

227See proposed rule §ll.10(b)(1). 

228See proposed rule §ll.10(b)(1)(i). Under the 

proposed rule, if an issuer (including an issuer of 

asset-backed securities) may rely on another 

exclusion or exemption from the definition of 

‘‘investment company’’ under the Investment 

Question 214. Is the proposed rule’s 

definition of a high-risk trading strategy 

effective and sufficiently clear? If not, 

what alternative would be more 

effective and/or clearer? Should the 

proposed rule specify particular trading 

strategies that are deemed high-risk per 

se? If so, what trading strategies and 

why? 

C. Subpart C—Covered Fund Activities 

and Investments 

As noted above, except as otherwise 

permitted, section 13(a)(1)(B) of the 

BHC Act prohibits a banking entity from 

acquiring or retaining any ownership in, 

or acting as sponsor to, a covered 

fund.222 Subpart C of the proposed rule 

applies those portions of section 13 of 

the BHC Act that operate as a 

prohibition or restriction on a banking 

entity’s ability, as principal, directly or 

indirectly, to acquire or retain an 

ownership interest in, act as sponsor to, 

or have certain relationships with, a 

covered fund. Subpart C also 

implements the permitted activity and 

investment authorities provided for 

under section 13(d)(1) of the BHC Act 

related to covered fund activities and 

investments, as well as the rule of 

construction related to the sale and 

securitization of loans under section 

13(g)(2) of that Act. Additionally, 

subpart C contains a discussion of the 

internal controls, reporting and 

recordkeeping requirements applicable 

to covered fund activities and 

investments, and incorporates by 

reference the minimum compliance 

standards for banking entities contained 

in subpart D of the proposed rule, as 

well as Appendix C, to the extent 

applicable. 

1. Section ll.10: Prohibition of 

Acquisition or Retention of Ownership 

Interests in, and Certain Relationships 

With, a Covered Fund 

Section ll.10 of the proposed rule 

defines the scope of the prohibition on 

acquisition or retention of ownership 

interests in, and certain relationships 

with, a covered fund, as well as defines 

a number of key terms related to such 

prohibition. 

a. Prohibition Regarding Covered Fund 

Activities and Investments 

Section ll.10(a) of the proposed 

rule implements section 13(a)(1)(B) of 

the BHC Act and prohibits a banking 

entity from, as principal, directly or 

indirectly, acquiring or retaining an 

equity, partnership, or other ownership 

interest in, or acting as sponsor to, a 

covered fund, unless otherwise 

permitted under subpart C of the 

proposed rule.223 This prohibition 

reflects the statute’s purpose and effect 

of limiting a banking entity’s ability to 

invest in or have exposure to a covered 

fund. 

The CFTC notes that the general 

prohibition in §ll.10(a) of the 

proposed rule applies solely to a 

banking entity’s acquisition or retention 

of an ownership interest in or acting as 

sponsor to a covered fund ‘‘as principal, 

directly or indirectly.’’ 224 As such, the 

proposed rule would not prohibit the 

acquisition or retention of an ownership 

interest (including a general partner or 

membership interest) in a covered fund: 

(i) By a banking entity in good faith in 

a fiduciary capacity, except where such 

ownership interest is held under a trust 

that constitutes a company as defined in 

section (2)(b) of the BHC Act; (ii) by a 

banking entity in good faith in its 

capacity as a custodian, broker, or agent 

for an unaffiliated third party; (iii) by a 

‘‘qualified plan,’’ as that term is defined 

in section 401 of the Internal Revenue 

Code of 1956 (26 U.S.C. 401), if the 

ownership interest would be attributed 

to a banking entity solely by operation 

of section 2(g)(2) of the BHC Act; or (iv) 

by a director or employee of a banking 

entity who acquires the interest in his 

or her personal capacity and who is 

directly engaged in providing advisory 

or other services to the covered fund, 

unless the banking entity, directly or 

indirectly, extended credit for the 

purpose of enabling the director or 

employee to acquire the ownership 

interest in the fund and the credit was 

used to acquire such ownership interest 

in the fund. 

Among other things, §ll.10(b) of 

the proposed rule defines the term 

‘‘covered fund.’’ 225 This definition 

explains the universe of entities to 

which the prohibition contained in 

§ ll.10(a) applies unless the activity is 

specifically permitted under an 

available exemption contained in 

subpart C of the proposed rule. Other 

related terms, including ‘‘ownership 

interest,’’ ‘‘prime brokerage 

transaction,’’ ‘‘sponsor,’’ and ‘‘trustee,’’ 

are in turn defined in §§ll.10(b)(2) 

through ll.10(b)(6) of the proposed 

rule. 

b. ‘‘Covered Fund’’ and Related 

Definitions 

i. Definition of ‘‘Covered Fund’’ 

Section 13(h)(2) of the BHC Act 

defines the terms ‘‘hedge fund’’ and 

‘‘private equity fund’’ to mean ‘‘any 

issuer that would be an investment 

company, as defined in the [Investment 

Company Act], but for section 3(c)(1) or 

3(c)(7) of that Act,’’ or such similar 

funds as the Agencies may by rule 

determine.226 Given that the statute 

defines a ‘‘hedge fund’’ and ‘‘private 

equity fund’’ synonymously, the 

proposed rule implements this statutory 

definition by combining the terms into 

the definition of a ‘‘covered fund.’’ 227

Sections 3(c)(1) and 3(c)(7) of the 

Investment Company Act are exclusions 

from the definition of ‘‘investment 

company’’ in that Act and are 

commonly relied on by a wide variety 

of entities that would otherwise be 

covered by the broad definition of 

‘‘investment company’’ contained in 

that Act. As a result, the statutory 

definition in section 13(h)(2) of the BHC 

Act could potentially include within its 

scope many entities and corporate 

structures that would not usually be 

thought of as a ‘‘hedge fund’’ or ‘‘private 

equity fund.’’ For instance, joint 

ventures, acquisition vehicles, certain 

wholly-owned subsidiaries, and other 

widely-utilized corporate structures 

typically rely on the exclusion 

contained in section 3(c)(1) or 3(c)(7) of 

the Investment Company Act. These 

types of entities are generally not used 

to engage in investment or trading 

activities. Additionally, as noted in Part 

II.H of this Supplementary Information, 

certain securitization vehicles may be 

included in this definition. 

The proposed rule follows the scope 

of the statutory definition by covering 

an issuer only if it would be an 

investment company, as defined in the 

Investment Company Act, but for 

section 3(c)(1) or 3(c)(7) of that Act.228


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Company Act other than the exclusions contained 

in section 3(c)(1) or 3(c)(7) of that Act, it would not 

be considered a covered fund, as long as it can 

satisfy all of the conditions of an alternative 

exclusion or exemption for which it is eligible. 

229 12 U.S.C. 1851(b)(2). 

230 ‘‘Commodity pool’’ is defined in the 

Commodity Exchange Act to mean any investment 

trust, syndicate, or similar form of enterprise 

operated for the purpose of trading in commodity 

interests, including any: (i) Commodity for future 

delivery, security futures product, or swap; (ii) 

agreement, contract, or transaction described in 

section 2(c)(2)(C)(i) or 2(c)(2)(D)(i) of the 

Commodity Exchange Act; (iii) commodity option 

authorized under section 4c of the Commodity 

Exchange Act; or (iv) leverage transaction 

authorized under section 23 of the Commodity 

Exchange Act. See 7 U.S.C. 1a(10). 

231See proposed rule §ll.10(b)(1)(iii). The 

proposed rule makes clear that any issuer, as 

defined in section 2(a)(22) of the Investment 

Company Act, (15 U.S.C. 80a–2(a)(22)), that is 

organized or offered outside of the United States, 

would qualify as a covered fund if, were it 

organized or offered under the laws, or offered for 

sale or sold to a resident, of the United States or 

of one or more States, it would be either: (i) An 

investment company, as defined in the Investment 

Company Act, but for section 3(c)(1) or 3(c)(7) of 

that Act; (ii) a commodity pool; or (iii) any such 

similar fund as the appropriate Federal banking 

agencies, the SEC, and the CFTC may determine, by 

rule, as provided in section 13(b)(2) of the BHC Act. 

232See proposed rule §ll.10(b)(3). 

233See proposed rule §ll.10(b)(3)(ii). 

234See 12 U.S.C. 1851(f)(3). 

235See proposed rule §ll.10(b)(4). 

236See 12 U.S.C. 1851(h)(5). 

237See proposed rule §ll.10(b)(5). 

Additionally, the proposed rule 

incorporates the statutory application of 

the rule to ‘‘such similar funds as the 

Agencies may determine by rule as 

provided in section 13(b)(2) of the BHC 

Act.’’ 229 The CFTC has proposed to 

include as ‘‘similar funds’’ a commodity 

pool,230 as well as the foreign equivalent 

of any entity identified as a ‘‘covered 

fund.’’ 231 These entities have been 

included in the proposed rule as 

‘‘similar funds’’ given that they are 

generally managed and structured 

similar to a covered fund, except that 

they are not generally subject to the 

Federal securities laws due to the 

instruments in which they invest or the 

fact that they are not organized in the 

United States or one or more States. 

ii. Definition of ‘‘Ownership Interest’’ 

The proposed rule defines 

‘‘ownership interest’’ in order to make 

clear the scope of section 13(a)(1)(B) of 

the BHC Act and § ll.10(a)’s 

prohibition on a banking entity 

acquiring or retaining any equity, 

partnership, or other ownership interest 

in a covered fund. The definition of 

ownership interest includes a 

description of what interests constitute 

an ownership interest, as well as an 

exclusion from the definition of 

ownership interest for carried 

interest.232 The proposed rule defines 

ownership interest to mean, with 

respect to a covered fund, any equity, 

partnership, or other similar interest 

(including, without limitation, a share, 

equity security, warrant, option, general 

partnership interest, limited partnership 

interest, membership interest, trust 

certificate, or other similar interest) in a 

covered fund, whether voting or 

nonvoting, as well as any derivative of 

such interest. This definition focuses on 

the attributes of the interest and 

whether it provides a banking entity 

with economic exposure to the profits 

and losses of the covered fund, rather 

than its form. To the extent that a debt 

security or other interest of a covered 

fund exhibits substantially the same 

characteristics as an equity or other 

ownership interest (e.g., provides the 

holder with voting rights, the right or 

ability to share in the covered fund’s 

profits or losses, or the ability, directly 

or pursuant to a contract or synthetic 

interest, to earn a return based on the 

performance of the fund’s underlying 

holdings or investments), the Agencies 

could consider such instrument an 

ownership interest as an ‘‘other similar 

instrument.’’ 

Many banking entities that serve as 

investment adviser or commodity 

trading advisor to a covered fund are 

compensated for services they provide 

to the fund through receipt of so-called 

‘‘carried interest.’’ In recognition of the 

manner in which such compensation is 

traditionally provided, the proposed 

rule also clarifies that an ownership 

interest with respect to a covered fund 

does not include an interest held by a 

banking entity (or an affiliate, subsidiary 

or employee thereof) in a covered fund 

for which the banking entity (or an 

affiliate, subsidiary or employee thereof) 

serves as investment manager, 

investment adviser or commodity 

trading advisor, so long as: (i) The sole 

purpose and effect of the interest is to 

allow the banking entity (or the affiliate, 

subsidiary or employee thereof) to share 

in the profits of the covered fund as 

performance compensation for services 

provided to the covered fund by the 

banking entity (or the affiliate, 

subsidiary or employee thereof), 

provided that the banking entity (or the 

affiliate, subsidiary or employee thereof) 

may be obligated under the terms of 

such interest to return profits previously 

received; (ii) all such profit, once 

allocated, is distributed to the banking 

entity (or the affiliate, subsidiary or 

employee thereof) promptly after being 

earned or, if not so distributed, the 

reinvested profit of the banking entity 

(or the affiliate, subsidiary or employee 

thereof) does not share in the 

subsequent profits and losses of the 

covered fund; (iii) the banking entity (or 

the affiliate, subsidiary or employee 

thereof) does not provide funds to the 

covered fund in connection with 

acquiring or retaining this carried 

interest; and (iv) the interest is not 

transferable by the banking entity (or the 

affiliate, subsidiary or employee thereof) 

except to an affiliate or subsidiary.233

The proposed rule therefore permits a 

banking entity to receive an interest as 

performance compensation for services 

provided by it or one of its affiliates, 

subsidiaries, or employees to a covered 

fund, but only if the enumerated 

conditions are met. 

iii. Definition of ‘‘Prime Brokerage 

Transaction’’ 

Section 13(f)(3) of the BHC Act 

permits a banking entity to enter into a 

prime brokerage transaction with a 

covered fund in which a covered fund 

managed, organized, or sponsored by 

such banking entity (or an affiliate or 

subsidiary thereof) has taken an 

ownership interest.234 However, section 

13 of the BHC Act does not define what 

qualifies as a prime brokerage 

transaction. In order to provide clarity 

regarding the types of services and 

relationships that are permitted as a 

prime brokerage transaction, the 

proposed rule defines a ‘‘prime 

brokerage transaction’’ to mean one or 

more products or services provided by 

a banking entity to a covered fund, such 

as custody, clearance, securities 

borrowing or lending services, trade 

execution, or financing, data, 

operational, and portfolio management 

support.235

iv. Definition of ‘‘Sponsor’’ and 

‘‘Trustee’’ 

The proposed rule defines ‘‘sponsor’’ 

in the same manner as section 13(h)(5) 

of the BHC Act.236 Section ll.10(b)(5) 

of the proposed rule defines the term 

‘‘sponsor’’ as an entity that: (i) serves as 

a general partner, managing member, 

trustee, or commodity pool operator of 

a covered fund; (ii) in any manner 

selects or controls (or has employees, 

officers, or directors, or agents who 

constitute) a majority of the directors, 

trustees, or management of a covered 

fund; or (iii) shares with a covered fund, 

for the corporate, marketing, 

promotional, or other purposes, the 

same name or a variation of the same 

name.237

The definition of ‘‘sponsor’’ contained 

in section 13(h)(5) of the BHC Act 

focuses on the ability to control the 

decision-making and operational 


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238See proposed rule §ll.10(b)(6)(ii). 239See 17 CFR 229.1101(l). 

functions of the fund. In keeping with 

this focus, the proposed rule defines the 

term ‘‘trustee’’ (which is a part of the 

definition of ‘‘sponsor’’) to exclude 

trustee that does not exercise 

investment discretion with respect to a 

covered fund, including a directed 

trustee, as that term is used in section 

403(a)(1) of the Employee’s Retirement 

Income Security Act (29 U.S.C. 

1103(a)(1)). The proposed rule provides 

that a ‘‘trustee’’ includes any banking 

entity that directs a directed trustee, or 

any person who possesses authority and 

discretion to manage and control the 

assets of the covered fund.238

v. Request for Comment 

The CFTC requests comment on the 

proposed rule’s approach to defining the 

terms covered fund, ownership interest, 

and other related terms. In particular, 

the CFTC requests comment on the 

following questions: 

Question 215. Is the proposed rule’s 

approach to applying section 13 of the 

BHC Act’s restrictions related to covered 

fund activities and investments to those 

instances where a banking entity acts 

‘‘as principal or beneficial owner’’ 

effective? If not, why? What alternative 

approach might be more effective in 

light of the language and purpose of the 

statute? 

Question 216. Does the proposed rule 

effectively address the circumstances 

under which an investment by a 

director or employee of a banking entity 

in a covered fund would be attributed 

to a banking entity? If not, why? What 

alternative might be more effective? 

Question 217. Does the proposed 

rule’s definition of ‘‘covered fund’’ 

effectively implement the statute? What 

alternative definitions might be more 

effective in light of the language and 

purpose of the statute? 

Question 218. Is specific inclusion of 

commodity pools within the definition 

of ‘‘covered fund’’ effective and 

consistent with the language and 

purpose of the statute? Why or why not? 

Question 218.1. The proposed CFTC 

Rule defines a ‘‘covered fund’’ to 

include a commodity pool, as defined in 

section 1a(10) of the Commodity 

Exchange Act. Is the use of this 

definition of ‘‘commodity pools’’ too 

broad? For example, will this definition 

potentially pull in additional pools that 

may be outside the intent of the 

proposed regulations? 

Question 219. The proposed 

definition of ‘‘sponsor’’ focuses on ‘‘the 

ability to control the decision-making 

and operational functions of the fund.’’ 

In the securitization context, is this an 

appropriate manner to determine the 

identity of the sponsor? If not, what 

factors should be used to determine the 

identity of the sponsor in the 

securitization context for purposes of 

the proposed rule and why? Is the 

definition of ‘‘sponsor’’ set forth in the 

SEC’s Regulation AB239 an appropriate 

party to treat as sponsor for purposes of 

the proposed rule? Is additional 

guidance necessary with respect to how 

the proposed definition of ‘‘sponsor’’ 

should be applied to a securitization 

transaction? 

Question 220. Should the application 

of the proposed definition of ‘‘sponsor’’ 

mean that the servicer or investment 

manager in a securitization transaction 

would be considered the sponsor for 

purposes of the proposed rule? What 

impact would this interpretation of the 

proposed definition have on existing 

securitizations? 

Question 221. Should the definition 

of ‘‘covered fund’’ focus on the 

characteristics of an entity rather than 

whether it would be an investment 

company but for section 3(c)(1) or 

3(c)(7) of the Investment Company Act? 

If so, what characteristics should be 

considered and why? Would a 

definition focusing on an entity’s 

characteristics rather than its form be 

consistent with the language and 

purpose of the statute? 

Question 222. Instead of adopting a 

unified definition of ‘‘covered fund’’ for 

those entities included under section 

13(h)(2) of the BHC Act, should the 

Agencies consider having separate 

definitions for ‘‘hedge fund’’ and 

‘‘private equity fund’’? If so, which 

definitions and why? 

Question 223. Should the CFTC 

consider using the authority provided 

under section 13(d)(1)(J) of the BHC Act 

to exempt the acquisition or retention of 

an ownership interest in a covered fund 

with certain attributes or characteristics, 

including, for example: (i) A 

performance fee or allocation to an 

investment manager’s equity account 

calculated by taking into account 

income and realized and unrealized 

gains; (ii) borrowing an amount in 

excess of one-half of its total capital 

commitments or has gross notional 

exposure in excess of twice its total 

capital commitments; (iii) sells 

securities or other assets short; (iv) has 

restricted or limited investor 

redemption rights; (v) invests in public 

and non-public companies through 

privately negotiated transactions 

resulting in private ownership of the 

business; (vi) acquires the unregistered 

equity or equity-like securities of such 

companies that are illiquid as there is 

no public market and third party 

valuations are not readily available; (vii) 

requires holding those investments 

long-term; (viii) has a limited duration 

of ten years or less; or (ix) returns on 

such investments are realized and the 

proceeds of the investments are 

distributed to investors before the 

anticipated expiration of the fund’s 

duration? Which, if any, of these 

characteristics are appropriate to 

describe a hedge fund or private equity 

fund that should be considered a 

covered fund for purposes of this rule? 

Are there any other characteristics that 

would be more appropriate to describe 

a covered fund? If so, which 

characteristics and why? 

Question 224. Is specific inclusion of 

certain non-U.S. entities as a ‘‘covered 

fund’’ under §ll.10(b)(1)(iii) of the 

proposed rule necessary, or would such 

entities already be considered to be a 

‘‘covered fund’’ under §ll.10(b)(1)(i) 

of the proposed rule? If so, why? Does 

the proposed rule’s language on nonU.S. entities correctly describe those 

non-U.S. entities, if any, that should be 

included in the definition of ‘‘covered 

fund’’? Why or why not? What 

alternative language would be more 

effective? Should the CFTC define nonU.S. funds by reference to the following 

structural characteristics: whether they 

are limited in the number or type of 

investors; whether they operate without 

regard to statutory or regulatory 

requirements relating to the types of 

instruments in which they may invest or 

the degree of leverage they may incur? 

Why or why not? 

Question 225. Are there any entities 

that are captured by the proposed rule’s 

definition of ‘‘covered fund,’’ the 

inclusion of which does not appear to 

be consistent with the language and 

purpose of the statute? If so, which 

entities and why? 

Question 226. Are there any entities 

that are not captured by the proposed 

rule’s definition of ‘‘covered fund,’’ the 

exclusion of which does not appear to 

be consistent with the language and 

purpose of the statute? If so, which 

entities and why? 

Question 227. Do the proposed rule’s 

definitions of ‘‘covered fund’’ and/or 

‘‘ownership interest’’ pose unique 

concerns or challenges to issuers of 

asset-backed securities and/or 

securitization vehicles? If so, why? Do 

certain types of securitization vehicles 

(trusts, LLCs, etc.) typically issue assetbacked securities which would be 

included in the proposed definition of 

ownership interest? What would be the 

impact of the application of the 

proposed rules to these securitization 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 8385 

240See 17 CFR 229.1101(c). 

vehicles? Are certain asset classes 

(collateralized debt obligations, future 

flows, corporate debt repackages, etc.) 

more likely to be impacted by the 

proposed definition of ‘‘covered fund’’ 

because the issuer cannot rely on an 

exemption other than 3(c)(1) or 3(c)(7) 

of the Investment Company Act? 

Question 227.1. Should the proposed 

CFTC Rule cover securitization 

vehicles? Please explain the rationale 

for including or excluding securitization 

vehicles in the proposed CFTC Rule. 

Question 228. How many existing 

issuers of asset-backed securities would 

be included in the proposed definition 

of ‘‘covered fund?’’ What would be the 

legal and economic impact of the 

proposed rule on holders of assetbacked securities issued by existing 

securitization vehicles that would be 

included in the proposed definition of 

covered fund? 

Question 229. Are there entities that 

issue asset-backed securities (as defined 

in Section 3(a) of the Exchange Act) that 

should be exempted from the 

requirements of the proposed rule? How 

would such an exemption promote and 

protect the safety and soundness of the 

banking entity and the financial stability 

of the United States as required by 

section 13(d)(1)(J) of the BHC Act? 

Question 230. Since certain existing 

asset-backed securities may have a term 

that exceeds the conformance or 

extended transition periods provided for 

under section 13(c) of the BHC Act, 

should the CFTC consider using the 

authority contained in section 

13(d)(1)(J) of that Act to exclude those 

existing asset-backed securities from the 

proposed definition of ‘‘ownership 

interest’’ and/or should the rule permit 

a banking entity to acquire or retain an 

ownership interest in existing assetbacked issuers? If so, how would either 

approach be consistent with the 

language and purpose of the statute? 

Question 231. Many issuers of assetbacked securities have features and 

structures that resemble some of the 

features of hedge funds and private 

equity funds (e.g., CDOs are managed by 

an investment adviser that has the 

discretion to choose investments, 

including investments in securities). If 

the proposed definition of ‘‘covered 

fund’’ were to exempt any entity issuing 

asset-backed securities, would this 

allow for interests in hedge funds or 

private equity funds to be structured as 

asset-backed securities and circumvent 

the proposed rule? If this approach is 

taken, how should the proposal address 

this concern? 

Question 232. Are the structural 

similarities between an entity that 

issues asset-backed securities and hedge 

funds and private equity funds of 

sufficient concern that the CFTC should 

not exclude any entity that issues assetbacked securities from the definition of 

covered fund? 

Question 233. Should entities that 

rely on a separate exclusion from the 

definition of investment company other 

than sections 3(c)(1) or 3(c)(7) of the 

Investment Company Act be included in 

the definition of ‘‘covered fund’’? Why 

or why not? 

Question 234. Do the proposed rule’s 

definitions of ‘‘ownership interest’’ and 

‘‘carried interest’’ effectively implement 

the statute? What alternative definitions 

might be more appropriate in light of 

the language and purpose of the statute? 

Are there other types of instruments that 

should be included or excluded from 

the definition of ‘‘ownership interest’’? 

Does the proposed definition of 

ownership interest capture most 

interests that are typically viewed as 

ownership interests? Is the proposed 

rule’s exemption of carried interest from 

the definition of ownership interest 

with respect to a covered fund 

appropriate? Does the exemption 

adequately address existing 

compensation arrangements and the 

way in which a banking entity becomes 

entitled to carried interest? Is it 

consistent with the current tax 

treatment of these arrangements? 

Question 235. In the context of assetbacked securities, the distinction 

between debt and equity may be 

complicated (e.g., trust certificates 

issued in a residential mortgage backed 

security transaction) and the legal, 

accounting and tax treatment may differ 

for the same instrument. Is guidance 

necessary with respect to the 

application of the definition of 

ownership interest for asset-backed 

securitization transactions? 

Question 236. In many securitization 

transactions, the residual interest 

represents the ‘‘equity’’ in the 

transaction. As this often constitutes the 

portion of the securitization transaction 

with the most risk, because it may 

absorb any losses experienced by the 

underlying assets before any other 

interests issued by the securitization 

vehicle, should the CFTC instead use 

their authority under section 13(d)(1)(J) 

of the BHC Act to exempt the buying 

and selling of any ownership interest in 

a securitization vehicle that is a covered 

fund other than the residual interest? 

Question 237. For purposes of 

limiting either an exclusion for issuers 

of asset-backed securities from the 

proposed definition of ‘‘covered fund’’ 

and/or an exclusion of asset-backed 

securities from the proposed definition 

of ‘‘ownership interest,’’ what definition 

of asset-backed security most effectively 

implements the language of section 13 

of the BHC Act? Section 3(a)(77) of the 

Exchange Act and the SEC’s Regulation 

AB240 provide two possible definitions. 

Is either of these definitions sufficient, 

and if so why? If one of the definitions 

is too narrow, what additional entities/ 

securities should be included and why? 

If one of the definitions is too broad, 

what entities/securities should be 

excluded and why? Would some other 

definition of asset-backed security be 

more consistent with the language and 

purpose of section 13 of the BHC Act? 

Question 238. Are there special 

concerns raised by not including as an 

ownership interest the residual interests 

in a securitization vehicle? Should the 

CFTC instead exempt the buying and 

selling of any ownership interest in a 

securitization vehicle that is a covered 

fund other than the residual interest? 

Question 239. Should the legal form 

of a beneficial interest be a determining 

factor for deciding whether a beneficial 

interest is an ‘‘ownership interest’’? For 

example, should pass-through trust 

certificates issued as part of a 

securitization transaction be excluded 

from the definition of ‘‘ownership 

interest’’? Should the definition of 

ownership interest explicitly include 

debt instruments with equity features 

(e.g., voting rights, profit participations, 

etc.)? 

Question 240. How should the 

proposed rule address those instances in 

which both debt and equity interests are 

issued, and the debt interests receive all 

of the economic benefits and all of the 

control rights? Should the debt interests 

(other than the residual interest) be 

counted as ownership interests even 

though they are not legally ownership 

and do not receive any profit 

participation? Should the equity 

interests be counted as ownership 

interests even though the holder does 

not receive economic benefits or have 

any control rights? Should the residual 

interest be considered the only 

‘‘ownership interest’’ for purposes of the 

proposed rule? Should mezzanine 

interests that lack both control rights 

and profit participation be considered 

an ownership interest? If the mezzanine 

interests obtain control rights (because 

more senior classes have been repaid), 

should they become ‘‘ownership 

interests’’ at that time for purposes of 

the proposed rule? If both debt and 

equity interests are counted as 

ownership interests, how should 

percentages of ownership interests be 

calculated when the units of 

measurement do not match (e.g., a 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8386 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

241See proposed rule §ll.11. 

242 156 Cong. Rec. S5889 (daily ed. July 15, 2010) 

(statement of Sen. Hagan). 

243See proposed rule §§ll.11(a)—(h). 

244While section 13(d)(1)(G) of the BHC Act does 

not explicitly mention ‘‘commodity trading 

advisory services,’’ the CFTC has proposed to 

include commodity pools within the definition of 

‘‘covered fund’’ and commodity trading advisory 

services in the same way as investment advisory 

services because commodity trading advisory 

services are the functional equivalent of investment 

advisory services to commodity pools. 

245See id. at §ll.11(a)–(h). The CFTC is not 

proposing any such additional rules at this time, 

although they may do so in the future. 

246See 12 U.S.C. 1851(d)(1)(G)(i); proposed rule 

§ll.11(a). 

247See, e.g., 12 U.S.C. 1843(c)(4), (c)(8), (k),12 

CFR 225.28(b)(5) and (6), 12 CFR 225.86, 12 CFR 

225.125 (with respect to a bank holding company); 

12 U.S.C. 24 (Seventh), 92a, 12 CFR Part 9 (with 

respect to a national bank); 12 U.S.C. 1831a, 12 CFR 

Part 362 (with respect to a state nonmember bank). 

248See 12 U.S.C. 1851(d)(1)(G)(ii). 

249See proposed rule §ll.11(b). 

250See 156 Cong. Rec. at S5897 (daily ed. July 15, 

2010) (statement of Sen. Merkley). 

single trust certificate, a single residual 

certificate with no face value and 

multiple classes of currencydenominated notes)? 

Question 241. Does the proposed 

rule’s definition of ‘‘prime brokerage 

transaction’’ effectively implement the 

statute? What other types of transactions 

or services, if any, should be included 

in the definition? Should any types of 

transactions or services be excluded 

from the definition? Would an 

alternative definition be more effective, 

and if so, why? 

Question 242. Do the proposed rule’s 

definitions of ‘‘sponsor’’ and ‘‘trustee’’ 

effectively implement the statute? Is the 

exclusion of ‘‘directed trustee’’ from the 

definition of ‘‘trustee’’ appropriate? 

Question 243. Do the proposed rule’s 

other definitions in §ll.10(b) 

effectively implement the statute? What 

alternative definitions might be more 

effective in light of the language and 

purpose of the statute? Are additional 

definitions needed, and if so, what 

definition(s)? 

2. Section l.11: Permitted Organizing 

and Offering of a Covered Fund 

Section ll.11 of the proposed rule 

implements section 13(d)(1)(G) of the 

BHC Act and permits a banking entity 

to organize and offer a covered fund, 

including acting as sponsor of the fund, 

if certain criteria are met.241 This 

exemption is designed to permit a 

banking entity to be able to engage in 

certain traditional asset management 

and advisory businesses in compliance 

with section 13 of the BHC Act.242

a. Required Criteria for Permitted 

Organizing and Offering of Covered 

Funds 

Section ll.11 of the proposed rule 

provides for and describes the 

conditions that must be met in order to 

enable a banking entity to qualify for the 

exemption to organize and offer a 

covered fund.243 These conditions 

include: (i) The banking entity must 

provide bona fide trust, fiduciary, 

investment advisory, or commodity 

trading advisory services;244 (ii) the 

covered fund must be organized and 

offered only in connection with the 

provision of bona fide trust, fiduciary, 

investment advisory, or commodity 

trading advisory services and only to 

persons that are customers of such 

services of the banking entity; (iii) the 

banking entity may not acquire or retain 

an ownership interest in the covered 

fund except as permitted under subpart 

C of the proposed rule; (iv) the banking 

entity must comply with the restrictions 

governing relationships with covered 

funds under §ll.16 of the proposed 

rule; (v) the banking entity may not, 

directly or indirectly, guarantee, 

assume, or otherwise insure the 

obligations or performance of the 

covered fund or of any covered fund in 

which such covered fund invests; (vi) 

the covered fund, for corporate, 

marketing, promotional, or other 

purposes, (A) may not share the same 

name or a variation of the same name 

with the banking entity (or an affiliate 

or subsidiary thereof), and (B) may not 

use the word ‘‘bank’’ in its name; (vii) 

no director or employee of the banking 

entity may take or retain an ownership 

interest in the covered fund, except for 

any director or employee of the banking 

entity who is directly engaged in 

providing investment advisory or other 

services to the covered fund; and (viii) 

the banking entity must (A) clearly and 

conspicuously disclose, in writing, to 

any prospective and actual investor in 

the covered fund (such as through 

disclosure in the covered fund’s offering 

documents) the enumerated disclosures 

contained in § ll.11(h) of the 

proposed rule, and (B) comply with any 

additional rules of the CFTC or other 

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.245 These 

requirements are explained in detail 

below. 

i. Bona Fide Services 

Section ll.11(a) of the proposed 

rule requires that, in order to qualify for 

the exemption related to organizing and 

offering a covered fund, a banking entity 

provide bona fide trust, fiduciary, 

investment advisory, or commodity 

trading advisory services.246 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.247

Additionally, depending on the type of 

banking entity that conducts the activity 

or provides the service, variations in the 

precise services involved may occur. 

For example, a national bank and an 

SEC-registered investment adviser may 

provide substantially similar investment 

advisory services to clients, but be 

subject to different statutory and 

regulatory requirements. In recognition 

of potential variations in services and 

functional regulation, the proposed rule 

does not specify what services would 

qualify as ‘‘bona fide trust, fiduciary, 

investment advisory, or commodity 

trading advisory services’’ under 

§ ll.11(a) of the proposed rule. 

Instead, the proposed rule largely 

mirrors the statutory language of section 

13(d)(1)(G)(i) of the BHC Act and 

reflects the intention that so long as a 

banking entity provides trust, fiduciary, 

investment advisory, or commodity 

trading advisory services in compliance 

with relevant statutory and regulatory 

requirements, the requirement 

contained in § ll.11(a) of the 

proposed rule would generally be 

deemed to be satisfied. 

ii. ‘‘Customers of Such Services’’ 

Requirement 

Section 13(d)(1)(G)(ii) of the BHC Act 

requires that a banking entity organize 

and offer a covered fund ‘‘only in 

connection with’’ the provision of 

qualified services to persons that are 

customers of such services of the 

banking entity.248 Section ll.11(b) of 

the proposed rule implements the 

statute and reflects the statutory 

requirement that there are two 

independent conditions contained in 

section 13(d)(1)(G)(ii) of the BHC Act: (i) 

A covered fund must be organized and 

offered in connection with bona fide 

trust, fiduciary, investment advisory, or 

commodity trading advisory services, 

and (ii) the banking entity providing 

those services may offer the covered 

fund only to persons that are customers 

of those services of the banking 

entity.249 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.250

Section 13(d)(1)(G)(ii) of the BHC Act 

does not explicitly require that the 

customer relationship be pre-existing. 


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251The proposed rule does not change any 

requirement imposed by separate statute, 

regulation, or other law, if applicable. For instance, 

a banking entity that conducts a private placement 

of a covered fund pursuant to the SEC’s Regulation 

D pertaining to private offerings would still be 

expected to comply with the relevant requirements 

related to such offering, including the limitations 

related to the manner in which and types of persons 

to whom it may offer or sell interests in such fund. 

See 12 CFR 230.501 et seq. 

252See 12 U.S.C. 1851(d)(1)(G)(iii). 

253See, e.g., id. at 1851(d)(1)(C). 

254See proposed rule §ll.11(c). 

255 12 U.S.C. 1851(d)(1)(G)(iv); proposed rule 

§ll.11(d). 

256See SUPPLEMENTARY INFORMATION, Part III.C.7. 

257 12 U.S.C. 1851(d)(1)(G)(v); proposed rule 

§ll.11(e). 

258See 156 Cong. Rec. S5897 (daily ed. July 15, 

2010) (statement of Sen. Merkley). 

259 12 U.S.C. 1851(d)(1)(G)(vi); proposed rule 

§ll.11(f). 

260 156 Cong. Rec. S5897 (daily ed. July 15, 2010) 

(statement of Sen. Merkley). 

261Similar 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). 

262See 12 U.S.C. 1851(d)(1)(G)(vii); proposed rule 

§ll.11(g). 

Accordingly, the proposed rule provides 

that it may be established through or in 

connection with the banking entity’s 

organization and offering of a covered 

fund, so long as that fund is a 

manifestation of the provision by the 

banking entity of bona fide trust, 

fiduciary, investment advisory or 

commodity trading advisory services to 

the customer. This application of the 

customer requirements is consistent 

with the manner in which trust, 

fiduciary, investment advisory, and 

commodity trading advisory services are 

provided by banking entities. 

Historically, banking entities have 

raised capital commitments for covered 

funds from existing customers as well as 

individuals or entities that have no preexisting relationship with the banking 

entity. 

Banking entities commonly organize 

and offer funds to customers of the 

banking entity’s trust, fiduciary, and 

investment advisory or commodity 

trading advisory services as a way of 

ensuring the efficient and consistent 

provision of these services. For 

example, a person often obtains the 

investment advisory services of the 

banking entity by acquiring an interest 

in a fund organized and offered by the 

banking entity. This is distinguished 

from a fund organized and offered by a 

banking entity for the purpose of itself 

investing as principal, indirectly 

through its investment in the fund, in 

assets held by the fund. Under the 

proposed rule, a banking entity could, 

consistent with past practice, provide a 

covered fund to persons that are 

customers of such services for purposes 

of the exemption so long as the fund is 

organized and offered as a means of 

providing bona fide trust, fiduciary, 

investment advisory, or commodity 

trading advisory services to customers. 

The banking entity may not organize 

and offer a covered fund as a means of 

itself investing in the fund or assets held 

in the fund.251

The CFTC notes that a banking entity 

could, through organizing and offering a 

covered fund pursuant to the authority 

contained in § ll.11 of the proposed 

rule that itself makes investments or 

engages in trading activity, seek to 

evade the restrictions contained in 

section 13 of the BHC Act and the 

proposed rule. In order to address these 

concerns, the proposed rule provides 

that a banking entity relying on the 

authority contained in §ll.11 must 

organize and offer a covered fund 

pursuant to a credible plan or similar 

documentation outlining how the 

banking entity intends to provide 

advisory or similar services to its 

customers through organizing and 

offering such fund. 

iii. Compliance With Investment 

Limitations 

Section 13(d)(1)(G)(iii) of the BHC Act 

limits the ability of a banking entity that 

organizes and offers a covered fund to 

acquire or retain an ownership interest 

in that covered fund.252 Separately, 

other provisions of section 13 of the 

BHC Act provide independent 

exemptions which permit a banking 

entity to acquire or retain an ownership 

interest in a covered fund.253 Section 

ll.11(c) of the proposed rule 

incorporates these statutory provisions 

by prohibiting a banking entity from 

acquiring or retaining an ownership 

interest in a covered fund that it 

organizes and offers except as permitted 

under subpart C of the proposed rule.254

The limits on a banking entity’s ability 

to invest in a covered fund that it 

organizes and offers are described in 

§ ll.12 of the proposal. 

iv. Compliance With Section 13(f) of the 

BHC Act 

Section ll.11(d) of the proposed 

rule requires that the banking entity 

comply with the limitations on certain 

relationships with covered funds.255

These limitations apply in several 

contexts, and are contained in §ll.16 

of the proposed rule, discussed in detail 

below. In general, §ll.16 of the 

proposed rule prohibits certain 

transactions or relationships that would 

be covered by section 23A of the FR Act, 

and provides that any permitted 

transaction is subject to section 23B of 

the FR Act, in each instance as if such 

banking entity were a member bank and 

such covered fund were an affiliate 

thereof.256

v. No Guarantees or Insurance of Fund 

Performance 

Section ll.11(e) of the proposed 

rule prohibits the banking entity from, 

directly or indirectly, guaranteeing, 

assuming or otherwise insuring the 

obligations or performance of the 

covered fund or any covered fund in 

which such covered fund invests.257

This prong implements section 

13(d)(1)(G)(iv) of the BHC Act and is 

intended to prevent a banking entity 

from engaging in bailouts of a covered 

fund in which it has an interest.258

vi. Limitation on Name Sharing With a 

Covered Fund 

Section ll.11(f) of the proposed rule 

prohibits the covered fund from sharing 

the same name or a variation of the 

same name with the banking entity, for 

corporate, marketing, promotional, or 

other purposes.259 This section 

implements section 13(d)(1)(G)(v) of the 

BHC Act and addresses the concern that 

name-sharing could undermine market 

discipline and encourage a banking 

entity to bail out a covered fund it 

organizes and offers in order to preserve 

the entity’s reputation.260 Thus, under 

§ ll.11(f) of the proposed rule, a 

covered fund would be prohibited from 

sharing the same name or variation of 

the same name with a banking entity 

that organizes and offers or serves as 

sponsor to that fund (or an affiliate or 

subsidiary of such banking entity). A 

covered fund would also be prohibited 

under the proposed rule from using the 

word ‘‘bank’’ in its name.261

vii. Limitation on Ownership by 

Directors and Employees 

Section ll.11(g) of the proposed 

rule implements section 13(d)(1)(G)(vii) 

of the BHC Act. The provision prohibits 

any director or employee of the banking 

entity from acquiring or retaining an 

ownership interest in the covered fund, 

except for any director or employee of 

the banking entity who is directly 

engaged in providing investment 

advisory or other services to the covered 

fund.262 This allows an individual 

acting as fund manager or adviser and 

employed by a banking entity to acquire 

or retain an ownership interest in a 

covered fund that aligns the manager or 

adviser’s incentives with those of its 


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8388 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

263See 156 Cong. Rec. S5897 (daily ed. July 15, 

2010) (statement of Sen. Merkley). 

264 12 U.S.C. 1851(d)(1)(G)(viii); proposed rule 

§ll.11(h). 

265As contemplated in §ll.11(a)(8)(ii) of the 

proposed rule, to the extent that any additional 

rules are issued to ensure that losses in a covered 

fund are borne solely by the investors in the 

covered fund and not by the banking entity, a 

banking entity would be required to comply with 

those as well in order to satisfy the requirements 

of section 13(d)(1)(G)(viii) of the BHC Act. 

customers by allowing the individual to 

have ‘‘skin in the game’’ with respect to 

a covered fund for which that 

individual provides management or 

advisory services (which customers or 

clients often request).263

The CFTC recognizes that director or 

employee investments in a covered fund 

may provide an opportunity for a 

banking entity to evade the limitations 

regarding the amount or value of 

ownership interests a banking entity 

may acquire or retain in a covered fund 

or funds contained in section 13(d)(4) of 

the BHC Act and § ll.12 of the 

proposed rule. In order to address this 

concern, the proposed rule would 

generally attribute an ownership interest 

in a covered fund acquired or retained 

by a director or employee to such 

person’s employing banking entity, if 

the banking entity either extends credit 

for the purpose of allowing the director 

or employee to acquire such ownership 

interest, guarantees the director or 

employee’s purchase, or guarantees the 

director or employee against loss on the 

investment. 

viii. Disclosure Requirements 

Section ll.11(h) of the proposed 

rule requires that, in connection with 

organizing and offering a covered fund, 

the banking entity (i) clearly and 

conspicuously disclose, in writing, to 

prospective and actual investors in the 

covered fund (such as through 

disclosure in the covered fund’s offering 

documents) that ‘‘any losses in [such 

covered fund] will be borne solely by 

investors in [the covered fund] and not 

by [the banking entity and its affiliates 

or subsidiaries]; therefore, [the banking 

entity’s and its affiliates’ or 

subsidiaries’] losses in [such covered 

fund] will be limited to losses 

attributable to the ownership interests 

in the covered fund held by [the 

banking entity and its affiliates or 

subsidiaries] in their capacity as 

investors in [the covered fund],’’ and (ii) 

comply with any additional rules of the 

CFTC as provided in section 13(b)(2) of 

the BHC Act designed to ensure that 

losses in any such covered fund are 

borne solely by the investors in the 

covered fund and not by the banking 

entity.264 The proposed rule also 

provides, as an additional disclosure 

requirement related to organizing and 

offering a covered fund, that a banking 

entity clearly and conspicuously 

disclose, in writing, to any prospective 

and actual investor (such as through 

disclosure in the covered fund’s offering 

documents): (i) That such investor 

should read the fund offering 

documents before investing in the 

covered fund; (ii) that the ‘‘ownership 

interests in the covered fund are not 

insured by the FDIC, and are not 

deposits, obligations of, or endorsed or 

guaranteed in any way, by any banking 

entity’’ (unless that happens to be the 

case); and (iii) the role of the banking 

entity and its affiliates, subsidiaries, and 

employees in sponsoring or providing 

any services to the covered fund. As 

noted above, the proposed rule clarifies 

that a banking entity may satisfy the 

requirements of this prong with respect 

to a covered fund by making the 

required disclosures, in writing, in the 

covered fund’s offering documents.265

ix. Request for Comment 

The CFTC requests comment on the 

proposed rule’s approach with respect 

to implementing the exemption 

permitting banking entities to organize 

and offer a covered fund. In particular, 

the CFTC requests comment on the 

following questions: 

Question 244. Is the proposed rule’s 

approach to implementing the 

exemption for organizing and offering a 

covered fund effective? If not, what 

alternative approach would be more 

effective and why? 

Question 245. Should the approach 

include other elements? If so, what 

elements and why? Should any of the 

proposed elements be revised or 

eliminated? If so, why and how? 

Question 246. Is the proposed rule’s 

approach to implementing the scope of 

bona fide trust, fiduciary, investment 

advisory and commodity trading 

advisory services consistent with the 

statute? If not, what alternative 

approach would be more effective? 

Should the scope of such services be 

broader or, in the alternative, more 

limited? Are there specific services 

which should be included but which are 

not currently under the proposed rule? 

Question 247. Does the proposed rule 

effectively implement the ‘‘customers of 

such services’’ requirement? If not, what 

alternative approach would be more 

effective and why? Is the proposed 

rule’s approach consistent with the 

statute? Why or why not? How do 

banking entities currently sell or 

provide interests in covered funds? Do 

banking entities rely on a concept of 

‘‘customer’’ by reference to other laws or 

regulations, and if so, what laws or 

regulations? 

Question 248. Does the proposed rule 

effectively and clearly recognize the 

manner in which banking entities 

provide trust, fiduciary, investment 

advisory, or commodity trading 

advisory services to customers? If not, 

how should the proposed rule be 

modified to be more effective or clearer? 

Question 249. Should the CFTC 

consider adopting a definition of 

‘‘customer of such services’’ for 

purposes of implementing the 

exemption related to organizing and 

offering a covered fund? If so, what 

criteria should be included in such 

definition? For example, should the 

customer requirement specify that the 

relationship be pre-existing? Should the 

CFTC consider adopting an existing 

definition related to ‘‘customer’’ and if 

so, what definitions (for instance, the 

SEC’s ‘‘pre-existing, substantive 

relationship’’ concept applicable to 

private offerings under its Regulation D) 

would provide for effective 

implementation of the customer 

requirement in section 13(d)(1)(G) of the 

BHC Act? If so, why and how? How 

should the customer requirement be 

applied in the context of non-U.S. 

covered funds? Is there an equivalent 

concept used for such non-U.S. covered 

fund offerings? 

Question 250. Should the CFTC 

distinguish between direct and indirect 

customer relationships for purposes of 

implementing section 13(d)(1)(G) of the 

BHC Act? Should the rule differentiate 

between a customer relationship 

established by a customer as opposed to 

a banking entity? If so, why? 

Question 251. Does the proposed rule 

effectively implement the prohibition 

on a banking entity guaranteeing or 

insuring the obligations or performance 

of certain covered funds? If not, what 

alternative approach would be more 

effective, and why? 

Question 252. Does the proposed rule 

effectively implement the requirement 

that a banking entity comply with the 

limitation on certain relationships with 

a covered fund contained in §ll.16 of 

the proposed rule? If not, what 

alternative approach would be more 

effective, and why? 

Question 253. Does the proposed rule 

effectively implement the prohibition 

on a covered fund sharing the same 

name or variation of the same name 

with a banking entity? If not, what 

alternative approach would be more 

effective and why? Should the 

prohibition on a covered fund sharing 

the same name be limited to specific 


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Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 8389 

266See, e.g., proposed rule §§ll.12(b)(2), (c). 

267See 12 U.S.C. 1851(d)(4). 

268See proposed rule at §ll.12(a)(2)(ii). The 

process and manner in which a banking entity’s 3 

percent tier 1 capital limit is determined for 

purposes of the proposed rule is discussed in detail 

below in Part III.C.3 of this SUPPLEMENTARY

INFORMATION. 

269See 12 U.S.C. 1851(d)(4)(B). 

270See proposed rule §ll.12(b)(2). 

271Under the proposed rule, a banking entity’s 

investment in a covered fund may not result in 

more than 3 percent of the losses of the covered 

fund being allocable to the banking entity’s 

investment since the banking entity’s permitted 

investment in a covered fund may be no more than 

3 percent of the value and amount of such fund’s 

total ownership interests, and the banking entity 

may not, directly or indirectly, guarantee, assume, 

or otherwise insure the obligations or performance 

of the covered fund. See 12 U.S.C. 1851(d)(1)(G)(v); 

proposed rule §ll.11(e). 

272See proposed rule §ll.12(b)(4). 

273See proposed rule §ll.12(b)(1)(A). 

types of banking entities (e.g., insured 

depository institutions and bank 

holding companies) or only to the 

banking entity that organizes and offers 

the fund, and if so why? 

Question 254. Does the proposed rule 

effectively implement the limitation on 

director or employee investments in a 

covered fund organized and offered by 

a banking entity? If not, what alternative 

approach would be more effective and 

why? Should the agencies provide 

additional guidance on what ‘‘other 

services’’ should be included for 

purposes of satisfying §ll.11(g)? Why 

or why not? 

Question 255. Are the disclosure 

requirements related to organizing and 

offering a covered fund appropriate? If 

not, what alternative disclosure 

requirement(s) should the proposed rule 

include? Should the CFTC consider 

adoption of a model disclosure form 

related to this requirement? Does the 

timing of the proposed disclosure 

requirement adequately address 

disclosure to secondary market 

purchasers? 

3. Section ll.12: Permitted Investment 

in a Covered Fund 

Section ll.12 of the proposed rule 

describes the limited circumstances 

under which a banking entity may 

acquire or retain, as an investment, an 

ownership interest in a covered fund 

that the banking entity or one of its 

subsidiaries or affiliates organizes and 

offers. This section implements section 

13(d)(4) of the BHC Act and related 

provisions, and describes the statutory 

limits on both (i) the amount and value 

of an investment by a banking entity in 

a covered fund, and (ii) the aggregate 

value of all investments in all covered 

funds made by the banking entity. 

As described below, a banking entity 

that makes or retains an investment in 

a covered fund under § ll.12 of the 

proposed rule is generally subject to 

three principal limitations related to 

such investment. First, the banking 

entity’s investment in a covered fund 

may not represent more than 3 percent 

of the total outstanding ownership 

interests of such fund (after the 

expiration of any seeding period 

provided under the rule). Second, the 

banking entity’s investment in a covered 

fund may not result in more than 3 

percent of the losses of the covered fund 

being allocable to the banking entity’s 

investment. Third, a banking entity may 

invest no more than 3 percent of its tier 

1 capital in covered funds.266

a. Authority and Limitations on 

Permitted Investments 

Section 13(d)(4) of the BHC Act 

permits a banking entity to acquire and 

retain an ownership interest in a 

covered fund that the banking entity 

organizes and offers pursuant to section 

13(d)(1)(G), for the purposes of (i) 

establishing the covered fund and 

providing the fund with sufficient 

initial equity for investment to permit 

the fund to attract unaffiliated investors, 

or (ii) making a de minimis investment 

in the covered fund in compliance with 

applicable requirements.267 Section 

ll.12 of the proposed rule implements 

this authority and related limitations. 

Consistent with this statutory 

provision, the proposed rule requires a 

banking entity to (i) actively seek 

unaffiliated investors to ensure that the 

banking entity’s investment conforms 

with the limits of § ll.12, and (ii) 

reduce through redemption, sale, 

dilution, or other methods the aggregate 

amount and value of all ownership 

interests of the banking entity in a single 

fund held under §ll.12 to an amount 

that does not exceed 3 percent of the 

total outstanding ownership interests of 

the fund not later than 1 year after the 

date of establishment of the fund (or 

such longer period as may be provided 

by the Board) (the ‘‘per-fund 

limitation’’). Additionally, §ll.12 of 

the proposed rule implements the 

statutory requirement that the aggregate 

value of all ownership interests of the 

banking entity in all covered funds held 

as an investment not exceed 3 percent 

of the tier 1 capital of the banking entity 

(the ‘‘aggregate funds limitation’’).268

b. Permitted Investment in a Single 

Covered Fund 

Section ll.12(b) of the proposed 

rule describes the limitations and 

restrictions on a banking entity’s ability 

to make or retain an investment in a 

single covered fund. This section 

implements the requirements of section 

13(d)(4) of the BHC Act.269

Section ll.12 of the proposed rule 

describes the manner in which the 

limitations on the amount and value of 

ownership interests in a covered fund 

must be calculated, in recognition of the 

fact that a covered fund may have 

multiple classes of ownership interests 

which possess different characteristics 

or values that impact a person’s 

ownership in that fund. A banking 

entity must apply the limits to both the 

total value and amount of its investment 

in a covered fund. For purposes of 

applying these limits, the banking entity 

must calculate (without regard to 

committed funds not yet called for 

investment): (i) The value of all 

investments or capital contributions 

made with respect to any ownership 

interest by the banking entity in a 

covered fund, divided by the value of all 

investments or capital contributions 

made by all persons in that covered 

fund, and (ii) the total number of 

ownership interests held as an 

investment by the banking entity in a 

covered fund divided by the total 

number of ownership interests held by 

all persons in that covered fund.270

Therefore, under the proposed rule, 

such calculation would include as the 

numerator the amount or value of a 

banking entity’s investment in a covered 

fund, and as the denominator the 

amount or value (matched to the unit of 

measurement in the numerator) of all 

classes of ownership interests held by 

all persons in that covered fund. As 

noted above, the banking entity’s 

investment in a covered fund also may 

not result in more than 3 percent of the 

losses of the covered fund being 

allocable to the banking entity’s 

investment.271

In order to ensure that a banking 

entity calculates its investment in a 

covered fund accurately and does not 

evade the per-fund investment 

limitation, the proposed rule requires 

that the banking entity must calculate 

its investment in the same manner and 

according to the same standards utilized 

by the covered fund for determining the 

aggregate value of the fund’s assets and 

ownership interests in the covered 

fund.272

Under the proposed rule, the amount 

and value of a banking entity’s 

investment in any single covered fund 

is (i) the total amount or value held by 

the banking entity directly and through 

any entity that is controlled, directly or 

indirectly, by the banking entity,273 plus 

(ii) the pro rata amount or value of any 


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8390 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

274See proposed rule §ll.12(b)(1)(B). As noted 

above, whether or not an investment is controlled 

or noncontrolled will be determined consistent 

with the BHC Act, as implemented by the Board. 

See 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e). 

275See proposed rule §ll.12(b)(2)(B). 

276See proposed rule §ll.12(b)(3). 

277With respect to an issuer of asset-backed 

securities, depending on the transaction structure, 

such calculation may need to be made each time a 

payment is made to any holder of the issuer’s assetbacked securities. 

278The CFTC notes that while calculation of a 

banking entity’s ownership interest in a covered 

fund must be determined no less frequently than at 

the end of every quarter, it is possible that no 

change in a banking entity’s ownership interest 

(e.g., no redemptions or other changes in investor 

composition) may occur during every quarter. 

279For instance, where a banking entity acts as 

sponsor to a covered fund, in connection with the 

organizing and offering of that fund it may include 

a requirement (such as a ‘‘tag-along’’ redemption 

right) in the fund’s organizational documents in 

order to assist the banking entity in complying with 

the per-fund investment limitation. 

280As noted in the discussion regarding the perfund limitation, the proposed rule provides that, for 

purposes of determining compliance with §ll.12, 

the banking entity’s permitted investment in a 

covered fund shall be calculated in the same 

manner and according to the same standards 

utilized by the covered fund for determining the 

aggregate value of the fund’s assets and ownership 

interests. However, the value of a banking entity’s 

aggregate permitted investments in all covered 

funds shall be determined in accordance with 

applicable accounting standards. See proposed rule 

§ll.12(c)(1). 

281See 12 U.S.C. 1851(d)(4)(B)(ii)(II); proposed 

rule §ll.12(a)(2)(ii). 282See proposed rule §ll.12(c)(1). 

283See proposed rule §ll.12(c)(1)(A). 

284See proposed rule §ll.12(c)(2)(ii)(B)(2). 

285See proposed rule §ll.12(c)(2)(ii)(A). 

286See proposed rule §ll.12(c)(1)(B). 

covered fund held by any entity (other 

than certain operating entities noted 

below) that is not controlled, directly or 

indirectly, by the banking entity but in 

which the banking entity owns, 

controls, or holds with the power to 

vote more than 5 percent of the voting 

shares.274

Additionally, the proposed rule 

provides that, to the extent that a 

banking entity is contractually obligated 

to directly invest in, or is found to be 

acting in concert through knowing 

participation in a joint activity or 

parallel action toward a common goal of 

investing in, one or more investments 

with a covered fund that is organized 

and offered by the banking entity 

(whether or not pursuant to an express 

agreement), such investment shall be 

included in the calculation of a banking 

entity’s per-fund limitation.275 In this 

way, the proposed rule prevents a 

banking entity from evading the 

limitations under §ll.12 of the 

proposed rule through committed coinvestments. 

Section ll.12(b)(3) of the proposed 

rule provides that the amount and value 

of a banking entity’s investment in a 

covered fund may at no time exceed the 

3 percent limits contained in 

§ ll.12(b) of the proposed rule after 

the conclusion of any conformance 

period, if applicable.276 In cases where 

a fund calculates its value or stands 

ready to issue or redeem interests 

frequently (e.g., daily), a banking entity 

must calculate its per-fund limitation no 

less frequently than the fund performs 

such calculation or issues or redeems 

interests. In recognition of the fact that 

not every covered fund may calculate or 

determine its valuation daily (for 

instance, if it does not allow 

redemptions except infrequently or 

invests principally in illiquid assets for 

which no market price is readily 

available), the proposed rule would not 

require a daily calculation of value for 

such fund (unless a daily calculation is 

determined by the fund).277 In such 

cases, the calculation of the amount and 

value of a banking entity’s per-fund 

limitation must be made no less 

frequently than at the end of every 

quarter.278 Additionally, since a banking 

entity must organize and offer any 

covered fund in which it invests, the 

CFTC expects that such banking entity 

would closely and regularly monitor not 

only the value of such fund’s interests, 

but also any changes in the fund’s 

investors’ relative ownership 

percentages.279

c. Aggregate Permitted Investments in 

All Covered Funds and Calculation of a 

Banking Entity’s Tier 1 Capital 

In addition to a limit on investments 

in a single covered fund, section 

13(d)(4) of the BHC Act requires the 

banking entity to comply with the 

aggregate funds limitation on 

investments in all covered funds.280 As 

required under section 13(d)(4)(B)(ii)(II) 

of the BHC Act, the proposed rule 

provides that the aggregate of a banking 

entity’s ownership interests in all 

covered funds that are held under 

§ ll.12 of the proposed rule may not 

exceed 3 percent of the tier 1 capital of 

a banking entity.281 In order to maintain 

equality in application of the aggregate 

funds limitation, the proposed rule 

provides that, for purposes of 

determining compliance with §ll.12 

of the proposed rule, the aggregate of all 

of a banking entity’s investments in all 

covered funds under §ll.12 of the 

proposed rule must be valued pursuant 

to applicable accounting standards.282

This value calculation is separate and in 

addition to the required calculation of 

the value of a banking entity’s 

investment in a covered fund as part of 

determining compliance with the perfund limitation. 

Tier 1 capital is a banking law 

concept that, in the United States, is 

calculated and reported by certain 

depository institutions and bank 

holding companies in order to 

determine their compliance with 

regulatory capital standards. 

Accordingly, the proposed rule clarifies 

that for purposes of the aggregate funds 

limitation in §ll.12, a banking entity 

that is a bank, a bank holding company, 

a company that controls an insured 

depository institution that reports tier 1 

capital, or uninsured trust company that 

reports tier 1 capital (each a ‘‘reporting 

banking entity’’) must apply the 

reporting banking entity’s tier 1 capital 

as of the last day of the most recent 

calendar quarter that has ended, as 

reported to the relevant Federal banking 

agency.283

However, not all entities subject to 

section 13 of the BHC Act calculate and 

report tier 1 capital. In order to provide 

a measure of equality related to the 

aggregate funds limitation contained in 

section 13(d)(4)(B)(ii)(II) of the BHC Act 

and §ll.12(c) of the proposed rule, 

the proposed rule clarifies how the 

aggregate funds limitation shall be 

calculated for entities that are not 

required to calculate and report tier 1 

capital in order to determine 

compliance with regulatory capital 

standards. Under the proposed rule, 

with respect to any banking entity that 

is not affiliated with a reporting banking 

entity and not itself required to report 

capital in accordance with the riskbased capital rules of a Federal banking 

agency, the banking entity’s tier 1 

capital for purposes of the aggregate 

funds limitation shall be the total 

amount of shareholders’ equity of the 

top-tier entity within such organization 

as of the last day of the most recent 

calendar quarter that has ended, as 

determined under applicable accounting 

standards.284 For a banking entity that is 

not itself required to report tier 1 capital 

but is a subsidiary of a reporting 

banking entity that is a depository 

institution (e.g., a subsidiary of a 

national bank), the aggregate funds 

limitation shall be the amount of tier 1 

capital reported by such depository 

institution.285 For a banking entity that 

is not itself required to report tier 1 

capital but is a subsidiary of a reporting 

banking entity that is not a depository 

institution (e.g., a nonbank subsidiary of 

a bank holding company), the aggregate 

funds limitation shall be the amount of 

tier 1 capital reported by the top-tier 

affiliate of such banking entity that 

holds and reports tier 1 capital.286 Thus, 


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287 If the aggregate value of all investments in all 

covered funds attributable to such a depository 

institution is less than 3 percent of its tier 1 capital, 

then that amount of capital which is greater than 

the amount supporting the depository institution’s 

investments (or those held by its subsidiaries) in a 

covered fund, but less than 3 percent of the 

depository institution’s tier 1 capital, may be used 

to support an investment in a covered fund by an 

affiliated banking entity that is not itself a 

depository institution that holds and reports tier 1 

capital or controlled, directly or indirectly, by such 

a depository institution. 

288See 12 U.S.C. 1851(d)(4)(B)(iii). 

289See proposed rule §ll.12(d). 

290The CFTC notes that since this deduction from 

capital implements Section 13(d)(4)(B)(iii) of the 

BHC Act, it is being included in this proposed rule 

which deals with Section 13 of the BHC Act. 

However, the CFTC may relocate this deduction as 

part of any later revised capital rules if, in the 

future, it is determined that inclusion in such rules 

is more appropriate. 

291See 12 CFR part 208, Appendices A, E, and 

F (for a state member bank); 12 CFR part 225, 

Appendices A, E, and G (for a bank holding 

company); 12 CFR part 3, Appendices A, B, and C 

(for a national bank); 12 CFR part 325, Appendices 

A, C, and D (for a state nonmember bank); and 12 

CFR part 167, Appendix C (for a federal thrift). 

292 12 U.S.C. 1851(d)(4)(C). 

293See id. 

294As noted in Part III.C.2.a.ii of this 

SUPPLEMENTARY INFORMATION, the CFTC recognizes 

the potential for evasion of the restrictions 

contained in section 13 of the BHC Act through 

organizing and offering a covered fund pursuant to 

the authority contained in §ll.11 of the proposed 

rule. Therefore, in addition to taking action against 

a banking entity that does not actively seek 

unaffiliated investors to reduce or dilute the 

investment of the banking entity as provided under 

§ll.12(a)(2) of the proposed rule, the CFTC 

expects that if a banking entity is habitually or 

routinely seeking an extension of the one-year 

period provided under §ll.12(a)(2)(i)(B), this 

could be evidence of seeking to evade the 

restrictions contained in the proposed rule and, as 

appropriate, the CFTC may take action against such 

banking entity. 

for purposes of calculating the aggregate 

funds limitation under §ll.12(c)(2) of 

the proposed rule, the tier 1 capital for 

the different types of banking entities 

would be as follows: 

Type of banking entity Tier 1 capital for purposes of §ll.12 

Depository institution that is a reporting banking entity (or a subsidiary 

thereof).

Tier 1 capital of the depository institution as of the last day of the most 

recent calendar quarter that has ended, as reported to the relevant 

Federal banking agency. 

Bank holding company or a subsidiary thereof (other than a reporting 

banking entity).

Tier 1 capital of the bank holding company as of the last day of the 

most recent calendar quarter that has ended, as reported to the 

Board. 

Company that controls an insured depository institution and that is a 

reporting banking entity (or a subsidiary thereof other than a reporting banking entity).

Tier 1 capital of the top tier entity within such organization as of the 

last day of the most recent calendar quarter that has ended, as reported to the Board. 

Other banking entity (including an industrial loan company holding 

company, thrift holding company, or a subsidiary thereof).

Shareholders’ equity of the top-tier entity within such organization as of 

the last day of the most recent calendar quarter that has ended, 

under applicable accounting standards. 

Additionally, in the case of a depository 

institution that is itself a reporting 

banking entity and is also a subsidiary 

or affiliate of a reporting banking entity, 

the aggregate of all investments in all 

covered funds held by the depository 

institution (including investments by its 

subsidiaries) may not exceed 3 percent 

of either the tier 1 capital of the 

depository institution or of the top-tier 

reporting banking entity that controls 

such depository institution.287

d. Deduction of an Investment in a 

Covered Fund From Tier 1 Capital 

Section 12(d) of the proposed rule 

also implements the provision 

contained in section 13(d)(4)(b)(iii) of 

the BHC Act regarding the deduction of 

a banking entity’s aggregate investment 

in a covered fund held under section 

13(d)(4) of that Act from the assets and 

tangible equity of the banking entity. 

The statute also provides that the 

amount of the deduction must increase 

commensurate with the leverage of the 

underlying fund.288

Section ll.12(d) of the proposal 

requires a banking entity to deduct the 

aggregate value of its investments in 

covered funds from tier 1 capital. Since 

§ ll.12 of the proposed rule 

implements the authorities contained in 

section 13(d)(4) of the BHC Act related 

to an investment in a fund organized 

and offered by the banking entity (or an 

affiliate or subsidiary thereof), the 

deduction contained in §ll.12(d) 

applies only to those ownership 

interests held as an investment by a 

banking entity pursuant to §ll.12 of 

the proposed rule.289 For instance, a 

banking entity that acquires or retains 

an ownership interest in a covered fund 

as a permitted risk-mitigating hedge 

under §ll.13(b) of the proposed rule, 

or that acquires or retains an ownership 

interest in the course of collecting a debt 

previously contracted in good faith, 

would not be required to deduct the 

value of such ownership interest from 

its tier 1 capital.290 The deduction 

required under §ll.12(d) of the 

proposed rule must be calculated 

consistent with other like deductions 

under the applicable risk-based capital 

rules.291

e. Extension of Time To Divest an 

Ownership Interest in a Single Covered 

Fund 

Section 13(d)(4)(C) of the BHC Act 

permits the Board, upon application by 

a banking entity, to extend for up to 2 

additional years the period of time 

within which a banking entity must 

reduce its attributable ownership 

interests in a covered fund to no more 

than 3 percent of such fund’s total 

ownership interests.292 The statute 

provides the possibility of an extension 

only with respect to the per-fund 

limitation, and not to the aggregate 

funds limitation.293 Section ll.12(e) 

of the proposed rule implements this 

provision of the statute. In order to grant 

any extension, the Board must 

determine that the extension would be 

consistent with safety and soundness 

and would not be detrimental to the 

public interest.294

Section ll.12(e) of the proposed 

rule requires any banking entity that 

seeks an extension of this conformance 

period to submit a written request to the 

Board. Under the proposal, any such 

request must: (i) Be submitted in writing 

to the Board at least 90 days prior to the 

expiration of the applicable time period; 

(ii) provide the reasons why the banking 

entity believes the extension should be 

granted; and (iii) provide a detailed 

explanation of the banking entity’s plan 

for reducing or conforming its 

investment(s). 

In addition, the proposed rule 

provides that any extension request by 

a banking entity must address each of 

the following matters (to the extent they 

are relevant): (i) Whether the investment 

would—(A) involve or result in material 

conflicts of interest between the banking 

entity and its clients, customers or 

counterparties; (B) result, directly or 

indirectly, in a material exposure by the 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8392 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

295See proposed rule §ll.12(e)(1)(ii). 

296Nothing in section 13 of the BHC Act or the 

proposed rule limits or otherwise affects the 

authority that the Board, the other Federal banking 

agencies, the SEC, or the CFTC may have under 

other provisions of law. In the case of the Board, 

these authorities include, but are not limited to, 

section 8 of the Federal Deposit Insurance Act and 

section 8 of the BHC Act. See 12 U.S.C. 1818, 1847. 297See proposed rule §§ll.12(e)(iii) and (iv). 

banking entity to high-risk assets or 

high-risk trading strategies; (C) pose a 

threat to the safety and soundness of the 

banking entity; or (D) pose a threat to 

the financial stability of the United 

States; (ii) market conditions; (iii) the 

contractual terms governing the banking 

entity’s interest in the covered fund; (iv) 

the date on which the covered fund is 

expected to have attracted sufficient 

investments from investors unaffiliated 

with the banking entity to enable the 

banking entity to comply with the 

limitations in section 12(a)(2)(i)(B) of 

the proposed rule; (v) the total exposure 

of the banking entity to the investment 

and the risks that disposing of, or 

maintaining, the investment in the 

covered fund may pose to the banking 

entity or the financial stability of the 

United States; (vi) the cost to the 

banking entity of divesting or disposing 

of the investment within the applicable 

period; (vii) whether the divestiture or 

conformance of the investment would 

involve or result in a material conflict 

of interest between the banking entity 

and unaffiliated clients, customers or 

counterparties to which it owes a duty; 

(viii) the banking entity’s prior efforts to 

divest or sell interests in the covered 

fund, including activities related to the 

marketing of interests in such covered 

fund; and (ix) any other factor that the 

Board believes appropriate.295 Under 

the proposed rule, the Board would 

consider requests for an extension in 

light of all relevant facts and 

circumstances, including the factors 

described above. 

Section ll.12(e) of the proposed 

rule also would allow the Board to 

impose conditions on any extension 

granted under the proposed rule if the 

Board determines conditions are 

necessary or appropriate to protect the 

safety and soundness of banking entities 

or the financial stability of the United 

States, address material conflicts of 

interest or other unsound practices, or 

otherwise further the purposes of 

section 13 of the BHC Act and the 

proposed rule.296 In cases where the 

banking entity is primarily supervised 

by the CFTC, the Board would consult 

with the CFTC 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 

under the proposed rule.297

f. Request for Comment 

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the exemption which 

allows a banking entity to make or 

retain a permitted investment in a 

covered fund that it organizes and 

offers. In particular, the CFTC requests 

comment on the following questions: 

Question 256. Is the proposed rule’s 

approach to implementing the 

exemption that allows a banking entity 

to make or retain a permitted 

investment in a covered fund effective? 

If not, what alternative approach would 

be more effective and why? 

Question 257. Should the approach 

include other elements? If so, what 

elements and why? Should any of the 

proposed elements be revised or 

eliminated? If so, why and how? 

Question 258. Should the proposed 

rule specify at what point a covered 

fund will be considered to have been 

‘‘established’’ for purposes of 

commencing the period in which a 

banking entity may own more than 3 

percent of the total outstanding 

ownership interests in such fund? If so, 

why and how? 

Question 259. Does the proposed rule 

effectively implement the requirement 

that a banking entity comply with the 

limitations on an investment in a single 

covered fund? If not, what alternative 

approach would be more effective and 

why? 

Question 260. Does the proposed rule 

effectively implement the requirement 

that a banking entity comply with the 

limitations on the aggregate of all 

investments in all covered funds? If not, 

what alternative approach would be 

more effective and why? 

Question 261. Is the proposed rule’s 

approach to calculating a banking 

entity’s investment in a covered fund 

effective? Should the per-fund 

calculation be based on committed 

capital, rather than invested capital? 

Why or why not? Is the timing of the 

calculation of a banking entity’s 

ownership interest in a single covered 

fund appropriate? If not, why not, and 

what alternative approach would be 

more effective and why? For example, 

should the per-fund calculation be 

required on a less-frequent basis (e.g., 

monthly) for funds that compute their 

value and allow purchases and 

redemptions on a daily basis (e.g., 

daily)? Why or why not? 

Question 262. Is the proposed rule’s 

approach to parallel investments 

effective? Why or why not? Should this 

provision require a contractual 

obligation and/or knowing 

participation? Why or why not? How 

else could the proposed rule define 

parallel investments? What 

characteristics would more closely 

achieve the scope and intended 

purposes of section 13 of the BHC Act? 

Question 263. Is the proposed rule’s 

treatment of investments in a covered 

fund by employees and directors of a 

banking entity effective? If not, what 

alternative approach would be more 

effective and why? 

Question 264. Is the proposed rule’s 

approach to differentiating between 

controlled and noncontrolled 

investments in a covered fund unduly 

complex or burdensome? If so, what 

alternative approach, if any, would be 

more effective and why? 

Question 265. Is the proposed rule’s 

approach to valuing an investment in a 

covered fund according to the same 

standards utilized by the covered fund 

for determining the aggregate value of 

its assets and ownership interests 

effective? If not, what alternative 

valuation approach would be more 

effective and why? Should the rule 

specify one methodology for valuing an 

investment in a covered fund? 

Question 266. Is the proposed rule’s 

approach regarding when to require the 

calculation of a banking entity’s 

aggregate investments in all covered 

funds effective? What is the potential 

impact of calculating a banking entity’s 

aggregate investment limit under the 

proposed rule on a quarterly basis as 

opposed to solely at the time an 

investment in a covered fund is made? 

Would calculation of the aggregate 

investment limit solely at the time an 

investment in a covered fund is made be 

consistent with the language and 

purpose of the statute? Does the 

proposed rule provide sufficient 

guidance for an issuer of asset-backed 

securities about how and when to make 

such calculation? Why or why not? 

Question 267. Is the proposed rule’s 

approach to determining and calculating 

a banking entity’s relevant tier 1 capital 

limit effective? If not, what alternative 

approach would be more effective and 

why? With respect to applying the 

aggregate funds limitation to a banking 

entity that is not affiliated with an entity 

that is required to hold and report tier 

1 capital, is total shareholder equity on 

a consolidated basis as of the last day of 

the most recent calendar quarter that 

has ended an effective proxy for tier 1 

capital? If not, what alternative 

approach would be more effective and 

why? 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 8393 

298Section ll.13(a) of the proposed rule also 

implements a proposed determination by the CFTC 

under section 13(d)(1)(J) of the BHC Act that a 

banking entity may not only invest in such entities 

as provided under section 13(d)(1)(E) of the BHC 

Act, but also may sponsor an entity described in 

that paragraph and that such activity, since it 

generally would facilitate investment in small 

businesses and support the public welfare, would 

promote and protect the safety and soundness of 

banking entities and the financial stability of the 

United States. 

299 In particular, §ll.13 of the proposed rule 

does not include: (i) The exemption in section 

13(d)(1)(A) of the BHC Act for trading in certain 

permitted government obligations; (ii) the 

exemption in section 13(d)(1)(H) of the BHC Act for 

certain foreign proprietary trading activities; and 

(iii) the exemption contained in section 13(d)(1)(B) 

of the BHC Act related to underwriting and marketmaking related activities. Each of these exemptions 

appear relevant only to covered trading activities 

and not to covered fund activities. 

300Section 13(d)(1)(E) of the BHC Act permits a 

banking entity to make investments in one or more 

SBICs, investments designed primarily to promote 

the public welfare, investments of the type 

permitted under 12 U.S.C. 24 (eleventh), and 

investments that are qualified rehabilitation 

expenditures with respect to a qualified 

rehabilitated building or certified historic structure. 

See 12 U.S.C. 1851(d)(1)(E). 

Question 268. Should the proposed 

rule be modified to permit a banking 

entity to bring its investments in 

covered funds into compliance with the 

proposed rule within a reasonable 

period of time if, for example, the 

banking entity’s aggregate permitted 

investments in covered funds exceeds 3 

percent of its tier 1 capital for reasons 

unrelated to additional investments 

(e.g., a banking entity’s tier 1 capital 

decreases)? Why or why not? 

Question 269. Does the proposed rule 

effectively and appropriately implement 

the deduction from capital for an 

investment in a covered fund contained 

in section 13(d)(4)(B)(iii) of the BHC 

Act? If not, what alternative approach 

would be more effective or appropriate, 

given the statutory language of the BHC 

Act and overall structure of section 

13(d)(4), and why? What effect, if any, 

should the CFTC give to the crossreference in section 13(d)(4) to section 

13(d)(3) of the BHC Act, which provides 

the CFTC with discretion to require 

additional capital, if appropriate, to 

protect the safety and soundness of 

banking entities engaged in activities 

permitted under section 13 of the BHC 

Act? How, if at all, should a banking 

entity’s deduction of its investment in a 

covered fund be increased 

commensurate with the leverage of the 

covered fund? Should the amount of the 

deduction be proportionate to the 

leverage of the covered fund? For 

example, instead of a dollar-for-dollar 

deduction, should the deduction be set 

equal to the banking entity’s investment 

in the covered fund times the difference 

between 1 and the covered fund’s 

equity-to-assets ratio? 

Question 270. Does the proposed rule 

effectively implement the Board’s 

statutory authority to grant an extension 

of the period of time a banking entity 

may retain in excess of 3 percent of the 

ownership interests in a single covered 

fund? Are the enumerated factors that 

the Board may consider in connection 

with reviewing such an extension 

appropriate (including factors related to 

the effect of an extension of the covered 

fund), and if not, why not? Are there 

additional factors that the Board should 

consider in reviewing such a request? 

Are there specific additional conditions 

or limitations that the Board should, by 

rule, impose in connection with 

granting such an extension? If so, what 

conditions or limitations would be more 

effective? 

Question 271. Given that the statute 

does not provide for an extension of 

time for a banking entity to comply with 

the aggregate funds limitation, within 

what period of time should a banking 

entity be required to bring its 

investments into conformance with the 

aggregate funds limit? Should the 

proposed rule expressly contain a grace 

period for complying with these limits? 

Why or why not? If yes, what grace 

period would be most effective and 

why? 

Question 272. Does the proposed rule 

effectively implement the prohibition 

on a banking entity guaranteeing or 

insuring the obligations or performance 

of certain covered funds? If not, what 

alternative approach would be more 

effective and why? 

Question 273. In the context of 

securitization transactions, control and 

ownership are often completely 

separated. Is additional guidance 

necessary with respect to how control 

should be determined with respect to 

issuers of asset-backed securities for 

purposes of determining the calculation 

of the per-fund and aggregate ownership 

limitations? 

Question 274. In many securitization 

transactions, the voting rights of 

investors are extremely limited and 

management may be contractually 

delegated to a third party (because 

issuers of asset-backed securities rarely 

have a board with any authority or any 

employees). The servicer or manager has 

the ‘‘ability to control the decisionmaking and operational functions of the 

fund.’’ When calculating the per-fund 

and aggregate ownership limitations, to 

whom should the proposed rule allocate 

‘‘control’’ in this type of situation? 

Which participants in a securitization 

transaction would need to include the 

activities of an issuer of asset-backed 

securities in their calculations of perfund and aggregate ownership, and what 

is the potential impact of such 

inclusion? 

Question 275. For purposes of 

calculating the per-fund and aggregate 

ownership limitations, how should the 

proposed rule address those instances in 

which equity is issued, but the equity 

holder does not receive economic 

benefits or have any control rights? For 

instance, in order to enhance or achieve 

bankruptcy remoteness, a single 

purpose trust without an owner (i.e., an 

orphan trust) may hold all of the equity 

interests in a securitization vehicle. 

Such interests often do not have any 

meaningful economic or control rights. 

4. Section ll.13: Other Permitted 

Covered Fund Activities and 

Investments 

Section 13 of the proposed rule 

implements the statutory exemptions 

described in sections 13(d)(1)(C), (E), 

and (I) of the BHC Act that permit a 

banking entity: (i) To acquire an 

ownership interest in, or act as sponsor 

to, one or more SBICs, a public welfare 

investment, or a certain qualified 

rehabilitation expenditure; 298 (ii) to 

acquire or retain an ownership interest 

in a covered fund as a risk-mitigating 

hedging position; and (iii) in the case of 

a non-U.S. banking entity, to acquire or 

retain an ownership interest in or 

sponsor a foreign covered fund. 

Additionally, §ll.13 of the proposed 

rule implements in part the rule of 

construction related to the sale and 

securitization of loans contained in 

section 13(g)(2) of the BHC Act. Similar 

to §ll.6 of the proposed rule (which 

implements certain permitted 

proprietary trading activities), §ll.13 

contains only the statutory exemptions 

contained in section 13(d)(1) of the BHC 

Act that the CFTC has determined 

apply, either by plain language or by 

implication, to investments in or 

relationships with a covered fund.299

a. Permitted Investments in SBICs and 

Related Funds 

Section ll.13(a) of the proposed 

rule implements sections 13(d)(1)(E) 

and (J) of the BHC Act 300 and permits 

a banking entity to acquire or retain any 

ownership interest in, or act as sponsor 

to: (i) One or more SBICs, as defined in 

section 102 of the Small Business 

Investment Act of 1958 (12 U.S.C. 662); 

(ii) an investment that is designed 

primarily to promote the public welfare, 

of the type permitted under paragraph 

(11) of section 5136 of the Revised 

Statutes of the United States (12 U.S.C. 

24), including the welfare of low- and 

moderate-income communities or 

families (such as providing housing, 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8394 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

301See proposed rule §ll.13(a). 

302Pursuant to the exemption contained in 

§ll.13(a) of the proposed rule, a banking entity 

may acquire an ownership interest in, or act as 

sponsor to, a low income housing credit fund, if 

such fund qualifies as an SBIC, public welfare 

investment or qualified rehabilitation expenditure. 

303See 12 U.S.C. 1851(d)(1)(C). 

304 In order to prevent evasion of the general 

limitation that a banking entity may not acquire or 

retain more than 3 percent of the ownership 

interests in any single covered fund that such 

banking entity organizes and offers, the proposed 

rule limits a banking entity’s ability to acquire or 

retain an ownership interest in a covered fund as 

a permitted risk-mitigating hedge to those situations 

where the customer of the banking entity is not 

itself a banking entity. See proposed rule 

§ll.13(b)(1)(i)(A). 

305See proposed rule §ll.13(b). 

306See SUPPLEMENTARY INFORMATION, Part III.B.3. 

services, or jobs); and (iii) an investment 

that is a qualified rehabilitation 

expenditure with respect to a qualified 

rehabilitation building or certified 

historic structure, as such terms are 

defined in section 47 of the Internal 

Revenue Code of 1986 or a similar State 

historic tax credit program.301 Since 

section 13(d)(1)(E) of the BHC Act does 

not limit a banking entity’s investment 

to a limited partnership or other noncontrolling investment, §ll.13(a) of 

the proposed rule would permit a 

banking entity to be a shareholder, 

general partner, managing member, or 

trustee of an SBIC without regard to 

whether the interest is a controlling or 

noncontrolling interest.302

In addition to the acquisition or 

retention of an ownership interest, 

permitting a banking entity to act as 

sponsor to these types of public interest 

investments will provide valuable 

expertise and services to these types of 

entities, as well as help enable banking 

entities to provide valuable funding and 

assistance to small business and lowand moderate-income communities. 

Therefore, the Agencies believe this 

exemption would be consistent with the 

safe and sound operation of banking 

entities, and would also promote the 

financial stability of the United States. 

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the exemption for 

permitted investments in and 

relationships with SBICs and certain 

related funds. In particular, the CFTC 

requests comment on the following 

questions: 

Question 276. Is the proposed rule’s 

approach to implementing the SBIC, 

public welfare and qualified 

rehabilitation investment exemption for 

acquiring or retaining an ownership 

interest in a covered fund effective? If 

not, what alternative approach would be 

more effective? 

Question 277. Should the approach 

include other elements? If so, what 

elements and why? Should any of the 

proposed elements be revised or 

eliminated? If so, why and how? 

Question 278. Should the proposed 

rule permit a banking entity to sponsor 

an SBIC and other identified public 

interest investments? Why or why not? 

Does the CFTC’s determination under 

section 13(d)(1)(J) of the BHC Act 

regarding sponsoring of an SBIC, public 

welfare or qualified rehabilitation 

investment effectively promote and 

protect the safety and soundness of 

banking entities and the financial 

stability of the United States? If not, 

why not? 

Question 279. What would the effect 

of the proposed rule be on a banking 

entity’s ability to sponsor and syndicate 

funds supported by public welfare 

investments or low income housing tax 

credits which are utilized to assist banks 

and other insured depository 

institutions with meeting their 

Community Reinvestment Act (‘‘CRA’’) 

obligations? 

Question 280. Does the proposed rule 

unduly constrain a banking entity’s 

ability to meet the convenience and 

needs of the community through CRA or 

other public welfare investments or 

services? If so, why and how could the 

proposed rule be revised to address this 

concern? 

b. Permitted Risk-Mitigating Hedging 

Activities 

Section ll.13(b) of the proposed 

rule permits a banking entity to acquire 

and retain an ownership interest in a 

covered fund if the transaction is made 

in connection with, and related to, 

certain individual or aggregated 

positions, contracts, or other holdings of 

the banking entity and is designed to 

reduce the specific risks to the banking 

entity in connection with and related to 

such positions, contracts, or other 

holdings. This section of the proposed 

rule implements, in relevant part, 

section 13(d)(1)(C) of the BHC Act, 

which provides an exemption from the 

prohibition on acquiring or retaining an 

ownership interest in a covered fund for 

certain risk-mitigating hedging 

activities.303

Interests by a banking entity in a 

covered fund may not typically be used 

as hedges for specific positions, 

contracts, or other holdings of a banking 

entity. However, two situations where a 

banking entity may potentially acquire 

or retain an ownership interest in a 

covered fund as a hedge are (i) when 

acting as intermediary on behalf of a 

customer that is not itself a banking 

entity to facilitate the exposure by the 

customer to the profits and losses of the 

covered fund (similar to acting as a 

‘‘riskless principal’’),304 and (ii) to cover 

a compensation arrangement with an 

employee of the banking entity that 

directly provides investment advisory or 

other services to that fund. Section 

ll.13(b) of the proposed rule provides 

an exemption for banking entity to 

acquire or retain an ownership interest 

in a covered fund in these limited 

situations.305

i. Approach for Hedges Using an 

Ownership Interest in a Covered Fund 

As noted above in the discussion of 

§ ll.5 of the proposed rule, riskmitigating hedging activities present 

certain implementation challenges 

because of the potential that prohibited 

activities or investments could be 

conducted in the context of, or 

mischaracterized as, hedging 

transactions. In light of these 

complexities, the Agencies have 

proposed a multi-faceted approach to 

implementation, which is discussed in 

detail above in reference to §ll.5 of 

the proposed rule.306 As with the 

hedging exemption provided under 

§ ll.5, this multi-faceted approach is 

intended to clearly articulate the CFTC’s 

expectation regarding the scope of 

permitted hedging activities under 

§ ll.13(b) in a manner that limits 

potential abuse of the hedging 

exemption while not unduly 

constraining the important risk 

management function that is served by 

a banking entity’s hedging activities. 

However, because of the possibility that 

using an ownership interest in a covered 

fund as a hedging instrument may mask 

an intent to evade the limitations on the 

amount and value of ownership 

interests in a covered fund or funds 

under §ll.12, the proposed rule 

contains several additional 

requirements related to a banking 

entity’s ability to use an ownership 

interest in a covered fund as a hedging 

instrument. 

ii. Required Criteria for Permitted RiskMitigating Hedging Activities Involving 

a Covered Fund 

Section ll.13(b) of the proposed 

rule describes the criteria that a banking 

entity must meet in order to rely on the 

hedging exemption with respect to 

ownership interests of a covered fund. 

The majority of these requirements are 

substantially similar to those discussed 

in detail above in connection with the 

risk-mitigating hedging exemption 

contained in § ll.5 of the proposed 

rule, and include the requirements that: 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 8395 

307See proposed rule §ll.13(b). 

308See proposed rule §ll.13(b)(1)(i). 

(i) The hedge is made in connection 

with and related to individual or 

aggregated obligations or liabilities of 

the banking entity that are: (A) taken by 

the banking entity when acting as 

intermediary on behalf of a customer 

that is not itself a banking entity to 

facilitate the exposure by the customer 

to the profits and losses of the covered 

fund, or (B) directly connected to a 

compensation arrangement with an 

employee that directly provides 

investment advisory or other services to 

the covered fund; (ii) the banking entity 

has established the internal compliance 

program required by subpart D designed 

to ensure the banking entity’s 

compliance with the requirements of 

this paragraph, including reasonably 

designed written policies and 

procedures regarding the instruments, 

techniques and strategies that may be 

used for hedging, internal controls and 

monitoring procedures, and 

independent testing; (iii) the transaction 

is designed to reduce the specific risks 

to the banking entity in connection with 

and related to such obligations or 

liabilities; (iv) the acquisition or 

retention of an ownership interest in a 

covered fund: (A) Is made in accordance 

with the written policies, procedures 

and internal controls established by the 

banking entity pursuant to subpart D; 

(B) hedges or otherwise mitigates an 

exposure to a covered fund through a 

substantially similar offsetting exposure 

to the same covered fund and in the 

same amount of ownership interest in 

that covered fund that arises out of a 

transaction conducted solely to 

accommodate a specific customer 

request with respect to, or directly 

connected to its compensation 

arrangement with an employee that 

directly provides investment advisory or 

other services to, that covered fund; (C) 

does not give rise, at the inception of the 

hedge, to significant exposures that 

were not already present in individual 

or aggregated positions, contracts, or 

other holdings of a banking entity and 

are not hedged contemporaneously; and 

(D) is subject to continuing review, 

monitoring and management by the 

banking entity that: (1) Is consistent 

with its written hedging policies and 

procedures; (2) maintains a substantially 

similar offsetting exposure to the same 

amount and type of ownership interest, 

based upon the facts and circumstances 

of the underlying and hedging positions 

and the risks and liquidity of those 

positions, to the risk or risks the 

purchase or sale is intended to hedge or 

otherwise mitigate; and (3) mitigates any 

significant exposure arising out of the 

hedge after inception; and (v) the 

compensation arrangements of persons 

performing the risk-mitigating hedging 

activities are designed not to reward 

proprietary risk-taking.307

These requirements, while 

substantially similar to those contained 

in §ll.5 above, are different in several 

material aspects. First, §ll.13(b)(1)(i) 

of the proposed rule provides that any 

banking entity relying on this 

exemption may only hedge or otherwise 

mitigate one or more specific risks 

arising in connection with and related 

to the two situations enumerated in that 

section. These are risks taken by the 

banking entity when acting as 

intermediary on behalf of a customer 

that is not itself a banking entity to 

facilitate the exposure by the customer 

to the profits and losses of the covered 

fund, or directly connected to its 

compensation arrangement with an 

employee that directly provides 

investment advisory or other services to 

the covered fund.308 Second, 

§ ll.13(b)(2)(ii)(B) of the proposed 

rule requires that the acquisition or 

retention of an ownership interest in a 

covered fund hedge or otherwise 

mitigate a substantially similar 

offsetting exposure to the same covered 

fund and in the same amount of 

ownership interest in that covered fund, 

which requires greater equivalency 

between the reference asset and hedging 

instrument than the correlation required 

under §ll.5. Third, §ll.13(b)(3) of 

the proposed rule imposes a 

documentation requirement on all types 

of hedging transactions where the 

banking entity uses ownership interests 

in a covered fund as the hedging 

instrument. This requirement is broader 

than that contained in §ll.5 and is 

reflective of the limited scope of 

positions or exposures for which a 

banking entity may acquire or retain an 

ownership interest in a covered fund as 

a hedge. Specifically, for any transaction 

that a banking entity acquires or retains 

an ownership interest in a covered fund 

in reliance of the hedging exemption, 

the banking entity must document the 

risk-mitigating purposes of the 

transaction and identify the risks of the 

individual or aggregated positions, 

contracts, or other holding of the 

banking entity that the transaction is 

designed to reduce. Such 

documentation must be established at 

the time the hedging transaction is 

effected, not after the fact. This 

documentation requirement establishes 

a contemporaneous record that will 

assist the CFTC in assessing the actual 

reasons for which the position was 

established. 

iii. Request for Comment 

In addition to those questions raised 

in connection with the proposed 

implementation of the risk-mitigating 

hedging exemption under §ll.5 of the 

proposed rule, the CFTC requests 

comment on the proposed 

implementation of that same exemption 

with respect to covered fund activities. 

In particular, the CFTC requests 

comment on the following questions: 

Question 281. Is the proposed rule’s 

approach to implementing the hedging 

exemption for acquiring or retaining an 

ownership interest in a covered fund 

effective? If not, what alternative 

approach would be more effective? 

Question 282. Should the approach 

include other elements? If so, what 

elements and why? Should any of the 

proposed elements be revised or 

eliminated? If so, why and how? 

Question 283. What burden will the 

proposed approach to implementing the 

hedging exemption have on banking 

entities? How can any burden be 

minimized or eliminated in a manner 

consistent with the language and 

purpose of the statute? 

Question 284. Are the criteria 

included in §ll.13(b)’s hedging 

exemption effective? Is the application 

of each criterion to potential 

transactions sufficiently clear? Should 

any of the criteria be changed or 

eliminated? Should other requirements 

be added? 

Question 285. Is the requirement that 

an ownership interest in a covered fund 

may only be used as a hedge (i) by the 

banking entity when acting as 

intermediary on behalf of a customer 

that is not itself a banking entity to 

facilitate the exposure by the customer 

to the profits and losses of the covered 

fund, or (ii) to cover compensation 

arrangements with an employee of the 

banking entity that directly provides 

investment advisory or other services to 

that fund effective? If not, what other 

requirements would be more effective? 

Question 286. Does the proposed rule 

sufficiently articulate the types of risks 

and positions that a banking entity 

typically would utilize an ownership 

interest in a covered fund to hedge? If 

not, how should the proposal be 

changed? 

Question 287. Is the requirement that 

the hedging transaction involve a 

substantially similar offsetting exposure 

to the same covered fund and in the 

same amount of ownership interest to 

the risk or risks the transaction is 

intended to hedge or otherwise mitigate 

effective? If not, how should the 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
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309Section 13(d)(1)(I) of the BHC Act permits a 

banking entity to acquire or retain an ownership 

interest in, or have certain relationships with, a 

covered fund notwithstanding the prohibition on 

proprietary trading and restrictions on investments 

in, and relationships with, a covered fund, if: (i) 

such activity or investment is conducted by a 

banking entity pursuant to paragraph (9) or (13) of 

section 4(c) of the BHC Act; (ii) the activity occurs 

solely outside of the United States; (iii) no 

ownership interest in such fund is offered for sale 

or sold to a resident of the United States; and (iv) 

the banking entity is not directly or indirectly 

controlled by a banking entity that is organized 

under the laws of the United States or of one or 

more States. See 12 U.S.C. 1851(d)(1)(I). 

310See 156 Cong. Rec. S5897 (daily ed. July 15, 

2010) (statement of Sen. Merkley). 

311Section ll.13(c)(2) of the proposed rule only 

addresses when a transaction or activity will be 

considered to have been conducted pursuant to 

section 4(c)(9) of the BHC Act; although the statute 

also references section 4(c)(13) of the BHC Act, the 

CFTC notes that the Board has applied the authority 

contained in that section only to include certain 

foreign activities of U.S. banking organizations. The 

express language of section 13(d)(1)(I) of the BHC 

Act limits its availability to foreign banking entities 

that are not controlled by a banking entity 

organized under the laws of the United States or of 

one or more States. A foreign banking entity may 

not rely on the exemptive authority of section 

4(c)(13) and, so, that section is not addressed in the 

proposed rule. 

312See 12 U.S.C. 1843(c)(9). 

313The CFTC notes that the Board emphasizes 

that this clarification would be applicable solely in 

the context of sections 13(d)(1)(H) and (I) of the 

BHC Act. The application of section 4(c)(9) to such 

foreign companies in other contexts is likely to 

involve different legal and policy issues and may 

therefore merit different approaches. 

requirement be changed? Should some 

other level of correlation be required? 

Should the proposal specify in greater 

detail how correlation should be 

measured? If not, how could it better do 

so? 

Question 288. Is the requirement that 

the transaction not give rise, at the 

inception of the hedge, to material risks 

that are not themselves hedged in a 

contemporaneous transaction effective? 

Is the proposed materiality qualifier 

appropriate and sufficiently clear? If 

not, what alternative would be effective 

and/or clearer? 

Question 289. Is the requirement that 

any transaction conducted in reliance 

on the hedging exemption be subject to 

continuing review, monitoring and 

management after the transaction is 

established effective? If not, what 

alternative would be more effective? 

Question 290. Is the proposed 

documentation requirement effective? If 

not, what alternative would be more 

effective? What burden would the 

proposed documentation requirement 

place on covered banking entities? How 

might such burden be reduced or 

eliminated in a manner consistent with 

the language and purpose of the statute? 

c. Permitted Covered Fund Activities 

and Investments Outside of the United 

States 

Section ll.13(c) of the proposed 

rule, which implements section 

13(d)(1)(I) of the BHC Act,309 permits 

certain foreign banking entities to 

acquire or retain an ownership interest 

in, or to act as sponsor to, a covered 

fund so long as such activity occurs 

solely outside of the United States and 

the entity meets the requirements of 

sections 4(c)(9) or 4(c)(13) of the BHC 

Act. The purpose of this statutory 

exemption appears to be to limit the 

extraterritorial application of the 

statutory restrictions on covered fund 

activities to foreign firms that, in the 

course of operating outside of the 

United States, engage outside the United 

States in activities permitted under 

relevant foreign law, while preserving 

national treatment and competitive 

equality among U.S. and foreign firms 

within the United States.310 Consistent 

with this purpose, the proposed rule 

defines both the type of foreign banking 

entities that are eligible for the 

exemption and the circumstances in 

which covered fund activities or 

investments by such an entity will be 

considered to have occurred solely 

outside of the United States (including 

clarifying when an ownership interest 

will be deemed to have been offered for 

sale or sold to a resident of the United 

States). 

i. Foreign Banking Entities Eligible for 

the Exemption 

Section ll.13(c)(1)(i) of the 

proposed rule incorporates the statutory 

requirement that the banking entity not 

be, directly or indirectly, controlled by 

a banking entity that is organized under 

the laws of the United States or of one 

or more States. Consistent with the 

statutory language, banking entities 

organized under the laws of the United 

States or of one or more States, or the 

subsidiaries or branches thereof 

(wherever organized or licensed), may 

not rely on the exemption. Similarly, 

the U.S. subsidiaries or U.S. branches of 

foreign banking entities would not 

qualify for the exemption. 

Section ll.13(c)(2) clarifies when a 

banking entity would be considered to 

have met the statutory requirement that 

the banking entity conduct the activity 

pursuant to paragraphs 4(c)(9) or 

4(c)(13) of the BHC Act 311 Section 

4(c)(9) of the BHC Act generally 

provides that the restrictions on 

nonbanking activities contained in 

section 4(a) of that statute do not apply 

to the ownership of shares held or 

activities conducted by any company 

organized under the laws of a foreign 

country the greater part of whose 

business is conducted outside the 

United States, if the Board by regulation 

or order determines that, under the 

circumstances and subject to the 

conditions set forth in the regulation or 

order, the exemption would not be 

substantially at variance with the 

purposes of this Act and would be in 

the public interest.312 The CFTC notes 

that the Board has, in part, implemented 

section 4(c)(9) through subpart B of the 

Board’s Regulation K, which specifies a 

number of conditions and requirements 

that a foreign banking organization must 

meet in order to use such authority. 

Such conditions and requirements 

include, for example, a qualifying 

foreign banking organization test that 

requires the foreign banking 

organization to demonstrate that more 

than half of its worldwide business is 

banking and that more than half of its 

banking business is outside the United 

States. 

The proposed rule makes clear that a 

banking entity will qualify for the 

foreign fund exemption if the entity is 

a foreign banking organization subject to 

subpart B of the Board’s Regulation K 

and the transaction occurs solely 

outside the United States. Section 13 of 

the BHC Act also applies to foreign 

companies that are banking entities 

covered by Section 13 but are not 

currently subject either to the BHC Act 

generally or the Board’s Regulation K, 

for example, because the foreign 

company controls a savings association 

or an FDIC-insured industrial loan 

company but not a bank or branch in the 

United States. Accordingly, the 

proposed rule clarifies when such a 

foreign banking entity would be 

considered to have conducted a 

transaction or activity ‘‘pursuant to 

section 4(c)(9)’’ for purposes of the 

exemption at §ll.13(c) of the 

proposed rule.313 In particular, the 

proposed rule proposes that to qualify 

for the foreign banking entity 

exemption, such firms must meet at 

least two of three requirements that 

evaluate the extent to which the foreign 

entity’s business is conducted outside 

the United States, as measured by 

assets, revenues, and income. This test 

largely mirrors the qualifying foreign 

banking organization test that is made 

applicable under section 4(c)(9) and 

§ 211.23(a) of the Board’s Regulation K, 

except that the relevant test under 

§ ll.13(c)(2)(ii) of the proposed rule 

does not require such a foreign entity to 

demonstrate that more than half of its 


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314See 12 U.S.C. 1843(c)(9); 12 CFR 211.23(a); 

proposed rule §ll.13(c)(2). This difference 

reflects the fact that foreign entities subject to 

section 13 of the BHC Act but not the BHC Act are, 

in many cases, predominantly commercial firms. A 

requirement that a firm also demonstrate that more 

than half of its banking business is outside the 

United States would likely make the exemption 

unavailable to many such firms and subject their 

global activities to the prohibition on acquiring or 

retaining an ownership interest in, or acting as 

sponsor to, a covered fund, a result that the statute 

does not appear to have intended. 

315See proposed rule §ll.13(d). The types of 

derivatives permitted under §ll.13(d)(3) of the 

proposed rule are not meant to include a synthetic 

securitization or a securitization of derivatives, but 

rather to include those derivatives that are used to 

hedge foreign exchange or interest rate risk 

resulting from loans held by the issuer of assetbacked securities. 

business is banking conducted outside 

the United States.314

ii. Transactions and Activities Solely 

Outside of the United States 

Section ll.13(c) of the proposed 

rule also clarifies when a transaction or 

activity will be considered to have 

occurred solely outside of the United 

States for purposes of the exemption. In 

interpreting this aspect of the statutory 

language, the proposal focuses on the 

extent to which material elements of the 

transaction occur within, or are effected 

by personnel within, the United States. 

This aspect of the proposal reflects the 

apparent intent of the foreign funds 

exemption to avoid extraterritorial 

application of the restrictions on 

covered funds activities and 

investments outside the United States 

while preserving competitive parity 

within U.S. market. The proposed rule 

does not evaluate solely whether the 

risk of the transaction or activity, or 

management or decision-making with 

respect to such transaction or activity, 

rests outside the United States. Rather, 

the proposal also provides that foreign 

banking entities may not structure a 

transaction or activity so as to be 

‘‘outside of the United States’’ for risk 

and booking purposes while 

simultaneously engaging in transactions 

within U.S. markets that are prohibited 

for U.S. banking entities. 

In particular, §ll.13(c)(3) of the 

proposed rule provides that a 

transaction or activity will be 

considered to have occurred solely 

outside of the United States only if all 

of the following three conditions are 

satisfied: 

• The transaction or activity is 

conducted by a banking entity that is 

not organized under the laws of the 

United States or of one or more States; 

• No subsidiary, affiliate, or employee 

of the banking entity that is involved in 

the offer or sale of an ownership interest 

in the covered fund is incorporated or 

physically located in the United States; 

and 

• No ownership interest in such 

covered fund is offered for sale or sold 

to a resident of the United States. 

These three criteria reflect statutory 

constraints and are intended to ensure 

that a transaction or activity conducted 

in reliance on the exemption does not 

involve either investors that are 

residents of the United States or a 

relevant U.S. employee of the banking 

entity, as such involvement would 

appear to constitute a sufficient locus of 

activity in the U.S. marketplace so as to 

preclude the availability of the 

exemption. 

A resident of the United States is 

defined in § ll.2(t) of the proposed 

rule, and is described in detail in Part 

III.B.4.d of this SUPPLEMENTARY

INFORMATION. The proposed rule applies 

this definition in the context of the 

foreign covered funds exemption 

because it would appear to 

appropriately capture the scope of 

counterparties (including investors that 

are residents of the United States) or 

relevant U.S. personnel of the banking 

entity, that, if involved in the 

transaction or activity, would preclude 

such transaction or activity from being 

considered to have occurred solely 

outside the United States. Under the 

proposed rule, an employee or entity 

engaged in the offer or sale of an 

ownership interest (or booking such 

transaction) must be outside of the 

United States; however, an employee or 

entity with no customer relationship 

and involved solely in providing 

administrative services or so-called 

‘‘back office’’ functions to the fund as 

incident to the activity permitted under 

§ ll.13(c) of the proposed rule (such 

as clearing and settlement or 

maintaining and preserving records of 

the fund with respect to a transaction 

where no ownership interest is offered 

for sale or sold to a resident of the 

United States) would not be subject to 

this requirement. 

iii. Request for Comment 

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the foreign covered funds 

activity and investment exemption. In 

particular, the CFTC request comment 

on the following questions: 

Question 291. Is the proposed rule’s 

implementation of the ‘‘foreign funds’’ 

exemption effective? If not, what 

alternative would be more effective and/ 

or clearer? 

Question 292. Are the proposed rule’s 

provisions regarding when an activity 

will be considered to be conducted 

pursuant to section 4(c)(9) of the BHC 

Act effective and sufficiently clear? If 

not, what alternative would be more 

effective and/or clearer? Does it 

effectively address application of the 

foreign funds exemption to foreign 

banking entities not subject to the BHC 

Act generally? If not, how could it better 

address application of the exemption? 

Question 293. Are the proposed rule’s 

provisions regarding when a transaction 

or activity will be considered to have 

occurred solely outside the United 

States effective and sufficiently clear? If 

not, what alternative would be more 

effective and/or clearer? Should 

additional requirements be added? If so, 

what requirements and why? Should 

additional requirements be modified or 

removed? If so, what requirements and 

why or how? 

Question 294. Is the proposed 

exemption consistent with the purpose 

of the statute? Is the proposed 

exemption consistent with respect to 

national treatment for foreign banking 

organizations? Is the proposed 

exemption consistent with the concept 

of competitive equity? 

Question 295. Does the proposed rule 

effectively define a resident of the 

United States for these purposes? If not, 

how should the definition be altered? 

What definitions of resident of the 

United States are currently used by 

banking entities? Would using any one 

of these definitions reduce the burden of 

complying with section 13 of the BHC 

Act? Why or why not? 

d. Sale and Securitization of Loans 

Section ll.13(d) of the proposed 

rule permits a banking entity to acquire 

and retain an ownership interest in a 

covered fund that is an issuer of assetbacked securities, the assets or holdings 

of which are solely comprised of: (i) 

Loans; (ii) contractual rights or assets 

directly arising from those loans 

supporting the asset-backed securities; 

and (iii) interest rate or foreign exchange 

derivatives that (A) materially relate to 

the terms of such loans or contractual 

rights or assets and (B) are used for 

hedging purposes with respect to the 

securitization structure.315 The 

authority contained in this section of 

the proposed rule would therefore allow 

a banking entity to engage in the sale 

and securitization of loans by acquiring 

and retaining an ownership interest in 

certain securitization vehicles (which 

could qualify as a covered fund for 

purposes of section 13(h)(2) of the BHC 

Act and the proposed rule) that the 

banking entity organizes and offers, or 

acts as sponsor to, in excess of and 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8398 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

316See 12 U.S.C. 1851(g)(2). 

317Section 13(d)(1)(J) of the BHC Act provides the 

CFTC discretion to determine that other activities 

not specifically identified by sections 13(d)(1)(A)– 

(I) of the BHC Act are exempted from the general 

prohibitions contained in section 13(a) of that Act, 

and are thus permitted activities. In order to make 

such a determination, the CFTC must find that such 

activity or activities promote and protect the safety 

and soundness of a banking entity, as well as 

promote and protect the financial stability of the 

United States. See 12 U.S.C. 1851(d)(1)(J). 

318See 12 U.S.C. 1851(d)(1)(J). 319Section 13(d)(1)(J) of the BHC Act only 

provides the CFTC with the ability to provide 

additional exemptions from the prohibitions 

contained in section 13(a)(1) of the BHC Act. 

Section 13(f) of the BHC Act, which deals with 

relationships and transactions with a fund that is, 

directly or indirectly, organized and offered or 

sponsored by a banking entity, operates as an 

independent prohibition and set of limitations on 

the activities of banking entities. As such, §ll.14 

of the proposed rule cannot and does not provide 

any exemptions from the prohibition on 

relationships or transaction with a covered fund 

contained in section 13(f) of the BHC Act or 

§ll.16 of the proposed rule. 

320See 12 U.S.C. 1851(d)(2), (e)(1). 

321See, e.g., Bank Owned Life Insurance, 

Interagency Statement on the Purchase and Risk 

Management of Life Insurance (‘‘Interagency BOLI 

Guidance’’) (Dec. 7, 2004). 

without being subject to the limitations 

contained in § ll.12 of the proposed 

rule. Proposed §ll.13(d) is designed 

to assist in implementing section 

13(g)(2) of the BHC Act, which provides 

that nothing in section 13 of the BHC 

Act shall be construed to limit or restrict 

the ability of a banking entity or 

nonbank financial company supervised 

by the Board to sell or securitize loans 

in a manner otherwise permitted by 

law.316

The CFTC notes that the phrase 

‘‘materially relate to terms of such 

loans’’ is intended to quantitatively 

limit the derivatives permitted in a 

‘‘securitization of loans’’ under 

§ ll.13(d) of the proposed rule to 

include only those derivatives where 

the notional amount of the derivative is 

tied to the outstanding principal balance 

of the loans supporting the asset-backed 

securities of such issuer, either 

individually or in the aggregate. 

Additionally, such derivatives must be 

used solely to hedge risks that result 

from a mismatch between the loans and 

the related asset-backed securities (e.g., 

fixed rate loans with floating rate assetbacked securities, loans tied to the 

Prime Rate with LIBOR asset-backed 

securities, or Euro-denominated loans 

with Dollar-denominated asset-backed 

securities). Therefore, §ll.13(d)(3) of 

the proposed rule would not allow the 

use of a credit default swap by an issuer 

of asset-backed securities. 

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the rule of construction 

related to the sale and securitization of 

loans. In particular, the CFTC requests 

comment on the following questions: 

Question 296. Is the proposed rule’s 

implementation of the statute’s ‘‘sale 

and securitization of loans’’ rule of 

construction effective? If not, what 

alternative would be more effective and/ 

or clearer? 

Question 296.1. Should the proposed 

CFTC Rule include the securitization 

exemption in §ll.13(d)? Please 

explain the rationale for including or 

excluding the securitization exemption 

in the proposed CFTC Rule. 

Question 297. Are there other entities 

or activities that should be included in 

the proposed rule’s implementation of 

the rule of construction related to the 

sale and securitization of loans? If so, 

what entity or activity and why? 

Question 298. Is the proposed rule’s 

application of the rule of construction 

contained in section 13(g)(2) of the BHC 

Act appropriate? 

Question 299. Are the proposed rule 

and this SUPPLEMENTARY INFORMATION

sufficiently clear regarding which 

derivatives would be allowed in a 

‘‘securitization of loans’’ under 

§ ll.13(d)(3) of the proposed rule? Is 

additional guidance necessary with 

respect to the types of derivatives that 

would be included in or excluded from 

a securitization of loans for purposes of 

interpreting the rule of construction 

contained in section 13(g)(2) of the BHC 

Act? If so, what topics should the 

additional guidance discuss and why? 

Question 300. Should derivatives 

other than interest rate or foreign 

exchange derivatives be allowed in a 

‘‘securitization of loans’’ for purposes of 

interpreting the rule of construction 

contained in section 13(g)(2) of the BHC 

Act? Why or why not? What would be 

the legal and economic impact of not 

allowing the use of derivatives other 

than interest rate or foreign exchange 

derivatives in a ‘‘securitization of loans’’ 

under §ll.13(d)(3) of the proposed 

rule for existing issuers of asset-backed 

securities and for future issuers of assetbacked securities? 

Question 301. Should the CFTC 

consider providing additional guidance 

for when a transaction with 

intermediate steps constitutes one or 

more securitization transactions that 

each would be subject to the rule? For 

example, both auto lease securitizations 

and asset-backed commercial paper 

conduits typically involve intermediate 

securitizations. The asset-backed 

securities issued to investors in such 

covered funds are technically supported 

by the intermediate asset-backed 

securities. Should these kinds of 

securitizations be viewed as a single 

transaction and included within a 

securitization of loans for purposes of 

the proposed rule? Should each step be 

viewed as a separate securitization? 

5. Section ll.14: Covered Fund 

Activities and Investments Determined 

To Be Permissible 

Section ll.14 of the proposed rule, 

which implements section 13(d)(1)(J) of 

the BHC Act,317 permits a banking 

entity to engage in any covered funds 

activity that the CFTC determines 

promotes and protects the safety and 

soundness of a banking entity and the 

financial stability of the United 

States.318 Any activity authorized under 

§ ll.14 of the proposed rule must still 

comply with the prohibition and 

limitations governing relationships with 

covered funds contained in section 13(f) 

of the BHC Act, as implemented by 

§ ll.16 of this proposal.319

Additionally, like other activities 

permissible under section 13(d)(1) of the 

BHC Act and as implemented by 

subpart C of the proposed rule, activities 

found permissible under §ll.14 of the 

proposed rule and section 13(d)(1)(J) 

remain subject to other provisions of 

section 13 of the BHC Act, including the 

sections limiting conflicts of interest 

and high-risk assets or trading strategies, 

as well as the section designed to 

prevent evasion of section 13 of the BHC 

Act.320

The CFTC has proposed to permit 

three activities at this time under this 

authority. These activities involve 

acquiring or retaining an ownership 

interest in and sponsoring of (i) certain 

BOLI separate accounts; (ii) certain 

entities that, although within the 

definition of covered fund are, in fact, 

common corporate organizational 

vehicles; and (iii) a covered fund in the 

ordinary course of collecting a debt 

previously contracted in good faith or 

pursuant to and in compliance with the 

conformance or extended transition 

period provided for under the Board’s 

rules issued under section 13(c)(6) of 

the BHC Act. 

a. Investments in Certain Bank Owned 

Life Insurance Separate Accounts 

Banking entities have for many years 

invested in life insurance policies that 

cover key employees, in accordance 

with supervisory policies established by 

the Federal banking agencies.321 These 

BOLI investments are typically 

structured as investments in separate 

accounts that are excluded from the 

definition of ‘‘investment company’’ 

under the Investment Company Act by 

virtue of section 3(c)(1) or 3(c)(7) of that 


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322See 12 U.S.C. 1851(h)(2). 

323The proposed rule defines ‘‘separate account’’ 

as ‘‘an account established and maintained by an 

insurance company subject to regulation by a State 

insurance regulatory or a foreign insurance 

regulator under which income, gains, and losses, 

whether or not realized, from assets allocated to 

such account, are, in accordance with the 

applicable contract, credited to or charged against 

such account without regard to other income, gains, 

or losses of the insurance company.’’ See proposed 

rule §ll.2(z). 

324See proposed rule §ll.14(a)(1)(i)–(ii). While 

other guidance or requirements may be imposed by 

the CFTC or other Agencies for a specific banking 

entity for which it serves as the primary financial 

regulator, the CFTC notes that, at a minimum, 

investments under authority of this section must 

comply with the Interagency BOLI Guidance. This 

guidance requires, among other things, that a 

banking entity generally: (i) Not control the 

investment decisions regarding the underlying 

assets or holdings of the separate account; (ii) 

demonstrate to the satisfaction of the CFTC that the 

potential returns from the investments in such 

separate account are appropriately matched to the 

banking entity’s employee compensation or benefit 

plan obligations; and (iii) not use such separate 

account to take speculative positions or to support 

the general operations of the banking entity. 325See proposed rule §ll.14(a)(2). 

326See 156 Cong. Rec. H5226 (daily ed. June 30, 

2010) (statement of Reps. Hymes and Frank). 

327The SEC and certain banking agencies issued 

a proposed rule to implement the requirements of 

section 15G of the Exchange Act, as required under 

section 941 of the Dodd-Frank Act. See Credit Risk 

Retention, 76 FR 24090 (Apr. 29, 2011). 

328See proposed rule §ll.14(a)(2)(iii). 

Act. By virtue of reliance on these 

exclusions, these BOLI accounts would 

be covered by the definition of ‘‘hedge 

fund’’ or ‘‘private equity fund’’ in 

section 13 of the BHC Act.322

However, when made in the normal 

course, these investments do not 

involve the speculative risks intended to 

be addressed by section 13 of the BHC 

Act. Moreover, applying the 

prohibitions in section 13 to these 

investments would eliminate an 

investment that helps banking entities 

to reduce their costs of providing 

employee benefits as well as other costs. 

Section ll.14(a)(1) of the proposed 

rule permits a banking entity to acquire 

and retain these BOLI investments, as 

well as act as sponsor to a BOLI separate 

account.323 The proposal includes a 

number of conditions designed to 

ensure that BOLI investments are not 

conducted in a manner that raises the 

concerns that section 13 of the BHC Act 

is intended to address. In particular, in 

order for a banking entity to invest in or 

sponsor a BOLI separate account, the 

banking entity that purchases the 

insurance policy: (i) May not control the 

investment decisions regarding the 

underlying assets or holdings of the 

separate account; and (ii) must hold its 

ownership interests in the separate 

account in compliance with applicable 

supervisory guidance provided by the 

appropriate Federal regulatory agency 

regarding BOLI.324

The CFTC has structured this 

exemption in the proposed rule so as to 

allow a banking entity to continue to 

manage and structure its risks and 

obligations related to its employee 

compensation or benefit plan 

obligations in a manner that promotes 

and protects the safety and soundness of 

banking entities, which on an industrywide level has the concomitant effect of 

promoting and protecting the financial 

stability of the United States. 

b. Investments in Certain Other Covered 

Funds 

As noted above, the definition of 

‘‘covered fund’’ as contained in 

§ ll.10(b)(1) of the proposed rule 

potentially includes within its scope 

many entities and corporate structures 

that would not usually be thought of as 

a ‘‘hedge fund’’ or ‘‘private equity 

fund.’’ Additionally, the Dodd-Frank 

Act contains other provisions that 

permit or require a banking entity to 

acquire or retain an ownership interest 

in or act as sponsor to a covered fund 

in a manner not specifically described 

under section 13 of the BHC Act. 

Section ll.14(a)(2) of the proposed 

rule permits a banking entity to own 

certain specified entities that are often 

part of corporate structures and that, by 

themselves and without other 

extenuating circumstances or factors, do 

not raise the type of concerns which 

section 13 of the BHC Act was intended 

to address but which nevertheless may 

be captured by the definition of ‘‘hedge 

fund’’ or ‘‘private equity fund’’ in 

section 13(h)(2) of the BHC Act. 

Specifically, §ll.14(a)(2) of the 

proposed rule permits a banking entity 

to acquire or retain an ownership 

interest in or act as sponsor to (i) a joint 

venture between the banking entity and 

any other person, provided that the joint 

venture is an operating company and 

does not engage in any activity or any 

investment not permitted under the 

proposed rule; (ii) an acquisition 

vehicle, provided that the sole purpose 

and effect of such entity is to effectuate 

a transaction involving the acquisition 

or merger of one entity with or into the 

banking entity or one of its affiliates; 

and (iii) a wholly-owned subsidiary of 

the banking entity that is (A) engaged 

principally in providing bona fide 

liquidity management services 

described under §ll.3(b)(2)(iii)(C) of 

the proposed rule, and (B) carried on the 

balance sheet of the banking entity.325

The CFTC notes that these types of 

entities may meet the definition of 

covered fund contained in 

§ ll.10(b)(1) of the proposed rule (and 

as contained in section 13(h)(2) of the 

BHC Act), to the extent these entities 

rely solely on section 3(c)(1) or 3(c)(7) 

of the Investment Company Act. 

However, these types of entities do not 

engage in the type and scope of 

activities to which Congress intended 

section 13 of the BHC Act to apply.326

Additionally, without this exemption, 

many entities would be forced to alter 

their corporate structure without 

achieving any reduction in risk. 

Permitting such investments in these 

entities would thus appear to promote 

and protect the safety and soundness of 

banking entities and promote and 

protect the financial stability of the 

United States. 

Section ll.14(a)(2) of the proposed 

rule also permits a banking entity to 

comply with section 15G of the 

Exchange Act (15 U.S.C. 78o–11), added 

by section 941 of the Dodd-Frank Act, 

which requires a banking entity to 

maintain a certain minimum interest in 

certain sponsored or originated assetbacked securities.327 In order to give 

effect to this separate requirement under 

the Dodd-Frank Act, §ll.14(a)(2)(iii) 

of the proposed rule permits a banking 

entity to acquire or retain an ownership 

interest in or act as sponsor to an issuer 

of asset-backed securities, but only with 

respect to that amount or value of 

economic interest in a portion of the 

credit risk for an asset-backed security 

that is retained by a banking entity that 

is a ‘‘securitizer’’ or ‘‘originator’’ in 

compliance with the minimum 

requirements of section 15G of the 

Exchange Act (15 U.S.C. 78o–11) and 

any implementing regulations issued 

thereunder.328 The Agencies have 

structured this exemption to recognize 

that Congress imposed other 

requirements on firms that are banking 

entities under section 13 of the BHC 

Act. Additionally, permitting a banking 

entity to retain the minimum level of 

economic interest will incent banking 

entities to engage in more careful and 

prudent underwriting and evaluation of 

the risks and obligations that may 

accompany asset-backed securitizations, 

which would promote and protect the 

safety and soundness of banking entities 

and the financial stability of the United 

States. 

Section 14(a)(2) of the proposed rule 

permits a banking entity to acquire and 

retain an ownership interest in a 

covered fund that is an issuer of assetbacked securities described in § 13(d) of 

the proposed rule, the assets or holdings 

of which are solely comprised of: (i) 

Loans; (ii) contractual rights or assets 

directly arising from those loans 


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329See id. at §ll.14(a)(2)(v). 

330The CFTC notes that proposed exemption 

applies only to the covered fund-related provisions 

of the proposed rule, and not to its prohibition on 

proprietary trading. 

331See proposed rule §ll.14(b). The 

Conformance or Extended Transition period 

authorities are substantially similar to those 

proposed by the Board in its February 2011 final 

rule governing such conformance periods under 

section 13 of the BHC Act. 

supporting the asset-backed securities; 

and (iii) interest rate or foreign exchange 

derivatives that (A) materially relate to 

the terms of such loans or contractual 

rights or assets and (B) are used for 

hedging purposes with respect to the 

securitization structure. This exemption 

augments the authority regarding the 

sale and securitization of loans available 

under §ll.13(d) of the proposed rule 

(which partially implements the rule of 

construction under section 13(g)(2) of 

the BHC Act) and permits a banking 

entity to engage in the purchase, and not 

only the sale and securitization, of loans 

through authorizing the acquisition or 

retention of an ownership interest in 

such securitization vehicles that the 

banking entity does not organize and 

offer, or for which it does not act as 

sponsor, provided that the assets or 

holdings of such vehicles are solely 

comprised of the instruments or 

obligations referenced above.329

Permitting banking entities to acquire 

or retain an ownership interest in these 

loan securitizations will provide a 

deeper and richer pool of potential 

participants and a more liquid market 

for the sale of such securitizations, 

which in turn should result in increased 

availability of funds to individuals and 

small businesses, as well as provide 

greater efficiency and diversification of 

risk. The CFTC believes this exemption 

would promote and protect the safety 

and soundness of a banking entity, and 

would also promote and protect the 

financial stability of the United 

States.330

c. Acquiring or Retaining an Ownership 

Interest in or Acting a Sponsor to a 

Covered Fund Under Certain Specified 

Authorities 

Section ll.14(b) of the proposed 

rule permits a banking entity to acquire 

or retain an ownership interest in or act 

as sponsor to a covered fund in those 

instances where the ownership interest 

is acquired or retained by a banking 

entity (i) in the ordinary course of 

collecting a debt previously contracted 

in good faith, if the banking entity 

divests the ownership interest within 

applicable time periods provided for by 

the CFTC, or (ii) pursuant to and in 

compliance with the Conformance or 

Extended Transition Period authorities 

provided for under the proposed rule.331

Allowing banking entities to rely on 

these authorities for acquiring or 

retaining an ownership interest in or 

acting as sponsor to a covered fund will 

enable banking entities to manage their 

risks and structure their business in a 

manner consistent with their chosen 

corporate form and in a manner that 

otherwise complies with applicable 

laws. Thus, permitting such activities 

would promote and protect the safety 

and soundness of a banking entity, and 

would also promote and protect the 

financial stability of the United States. 

d. Request for Comment 

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the exemption related to 

activities specifically determined to be 

permissible under section 13(d)(1)(J) of 

the BHC Act. In particular, the CFTC 

requests comment on the following 

questions: 

Question 302. Is the proposed rule’s 

implementation of exemptions for 

covered fund activities and investments 

pursuant to section 13(d)(1)(J) of the 

BHC Act effective? If not, what 

alternative would be more effective and/ 

or clearer? 

Question 302.1. Should the proposed 

CFTC Rule include the additional 

exemptions listed in section 13(d)(1)(J) 

of the BHC Act in Section ll.14 (e.g., 

BOLI, certain acquisition vehicles)? 

Please explain the rationale for 

including or excluding the exemptions 

in the proposed CFTC Rule. 

Question 303. Is the proposed rule’s 

approach to utilizing section 13(d)(1)(J) 

of the BHC Act to permit a banking 

entity to acquire or retain an ownership 

interest in, or act as sponsor to, certain 

entities that would fall into the 

definition of covered fund effective? 

Why or why not? If not, what alternative 

would be more effective and why? What 

legal authority under the statute would 

permit such an alternative? 

Question 304. Are the proposed rule’s 

provisions regarding when a covered 

fund activity will be deemed to be 

permitted under authority of section 

13(d)(1)(J) of the BHC Act effective and 

sufficiently clear? If not, what 

alternative would be more effective and/ 

or clearer? 

Question 305. Do the exemptions 

provided for in §ll.14 of the 

proposed rule effectively promote and 

protect the safety and soundness of 

banking entities and the financial 

stability of the United States? If not, 

why not? 

Question 306. Are the proposed rule’s 

provisions regarding what qualifications 

must be satisfied in order to qualify for 

an exemption under §ll.14 of the 

proposed rule effective and sufficiently 

clear? If not, what alternative would be 

more effective and/or clearer? Should 

additional requirements be added? If so, 

what requirements and why? Should 

additional requirements be modified or 

removed? If so, what requirements and 

why or how? 

Question 307. Does the proposed rule 

effectively cover the scope of covered 

funds activities which the Agencies 

should specifically determine to be 

permissible under section 13(d)(1)(J) of 

the BHC Act? If not, what activity or 

activities should be permitted? For 

additional activities that should be 

permitted, on what grounds would these 

activities promote and protect the safety 

and soundness of banking entities and 

the financial stability of the United 

States? 

Question 308. Does the proposed rule 

effectively address the interplay 

between the restrictions on covered 

fund activities and investments in 

section 13 of the BHC Act and the 

requirements imposed on certain 

banking entities under section 15G of 

the Exchange Act? Why or why not? 

Question 309. Rather than permitting 

the acquisition or retentions of an 

ownership interest in, or acting as 

sponsor to, specific covered funds under 

section 13(d)(1)(J) of the BHC Act, 

should the CFTC use the authority 

provided under section 13(d)(1)(J) to 

permit investments in a covered fund 

that display certain characteristics? If 

so, what characteristics should the 

Agencies consider? How would 

investments with such characteristics 

promote and protect the safety and 

soundness of the banking entity and 

promote the financial stability of the 

United States? 

Question 310. Should venture capital 

funds be excluded from the definition of 

‘‘covered fund’’? Why or why not? If so, 

should the definition contained in rule 

203(l)–1 under the Advisers Act be 

used? Should any modification to that 

definition of venture capital fund be 

made? How would permitting a banking 

entity to invest in such a fund meet the 

standards contained in section 

13(d)(1)(J) of the BHC Act? 

Question 311. Should non-U.S. funds 

or entities be included in the definition 

of ‘‘covered fund’’? Should any non-U.S. 

funds or entities be excluded from this 

definition? Why or why not? How 

would permitting a banking entity to 

invest in such a fund meet the standards 

contained in section 13(d)(1)(J) of the 

BHC Act? 


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332Section 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). 

333See proposed rule §ll.15. 

334 12 U.S.C. 371c. 

335 12 U.S.C. 371c–1. 

336As noted above, the proposed rule implements 

the definition of ‘‘banking entity’’ in a manner that 

does not include covered funds for which a banking 

entity acts as sponsor or organizes and offers 

pursuant to section 13(d)(1)(G) of the BHC Act, or 

any covered fund in which such related covered 

fund invests. Accordingly, these covered funds (and 

any covered fund in which such covered fund 

acquired or retains a controlling investment) are not 

generally subject to the prohibitions contained in 

§ll.16 of the proposed rule. 

337Section 23A of the FR Act limits the aggregate 

amount of covered transactions by a member bank 

to no more than (i) 10 per centum of the capital 

stock and surplus of the member bank in the case 

of any affiliate, and (ii) 20 per centum of the capital 

stock and surplus of the member bank in the case 

of all affiliates. See 12 U.S.C. 371c(a). Conversely, 

section 13(f) of the BHC Act operates as a general 

prohibition on such transactions without providing 

any similar amount of permitted transactions. 

338The 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. 

339 Id. at 371c(b)(7)(C). 

340See, e.g.,12 U.S.C. 1851(d)(1)(G), (d)(4), and 

(f)(3). 

Question 312. Should so-called ‘‘loan 

funds’’ that invest principally in loans 

and not equity be excluded from the 

definition of ‘‘covered fund’’? Why or 

why not? What characteristics would be 

most effective in determining whether a 

fund invests principally in loans and 

not equity? How would permitting a 

banking entity to invest in such a fund 

meet the standards contained in section 

13(d)(1)(J) of the BHC Act? 

Question 313. Are the proposed rule’s 

proposed determinations that the 

specified covered funds activities or 

investments promote and protect the 

safety and soundness of banking entities 

and the financial stability of the United 

States appropriate? If not, how should 

the determinations be amended or 

altered? 

6. Section ll.15: Internal Controls, 

Reporting and Recordkeeping 

Requirements Applicable to Covered 

Fund Activities and Investments 

Section ll.15 of the proposed rule, 

which implements section 13(e)(1) of 

the BHC Act,332 requires a banking 

entity engaged in covered fund activities 

and investments to comply with (i) the 

internal controls, reporting, and 

recordkeeping requirements required 

under §ll.20 and Appendix C of the 

proposed rule, as applicable and (ii) 

such other reporting and recordkeeping 

requirements as the CFTC may deem 

necessary to appropriately evaluate the 

banking entity’s compliance with this 

subpart C.333 These requirements are 

discussed in detail in Part III.D of this 

SUPPLEMENTARY INFORMATION. 

7. Section ll.16: Limitations on 

Relationships With a Covered Fund 

Section 13(f) of the BHC Act generally 

prohibits a banking entity from entering 

into certain transactions with a covered 

fund that would be a covered 

transaction as defined in section 23A of 

the FR Act.334 Section ll.16 of the 

proposed rule implements this 

provision. Section ll.16(a)(2) of the 

proposed rule clarifies that, for reasons 

explained in detail below, certain 

transactions between a banking entity 

and a covered fund remain permissible. 

Section ll.16(b) of the proposed rule 

implements the statute’s requirement 

that any transaction permitted under 

section 13(f) of the BHC Act (including 

a prime brokerage transaction) between 

the banking entity and covered fund is 

subject to section 23B of the FR Act,335

which, in general, requires that the 

transaction be on market terms or on 

terms at least as favorable to the banking 

entity as a comparable transaction by 

the banking entity with an unaffiliated 

third party. 

a. General Prohibition on Certain 

Transactions and Relationships 

Section 13(f)(1) of the BHC Act 

generally prohibits a banking entity that, 

directly or indirectly, serves as 

investment manager, investment 

adviser, commodity trading adviser, or 

sponsor to a covered fund (or that 

organizes and offers a covered fund 

pursuant to section 13(d)(1)(G) of the 

BHC Act) from engaging in any 

transaction with the covered fund, or 

with any covered fund that is controlled 

by such fund, if the transaction would 

be a ‘‘covered transaction’’ as defined in 

section 23A of the FR Act, as if the 

banking entity and any affiliate thereof 

were a member bank and the covered 

fund were an affiliate thereof.336 Section 

ll.16(a)(1) of the proposed rule 

includes this prohibition. 

Consistent with the requirements of 

section 13(f)(1) of the BHC Act, 

§ ll.16(a)(1) of the proposed rule is 

more restrictive than section 23A of the 

FR Act because §ll.16(a)(1) generally 

prohibits a banking entity and any of its 

affiliates from entering into any such 

transaction, while section 23A permits 

covered transactions with affiliates so 

long as the transactions meet specified 

quantitative and qualitative 

requirements.337

b. Transactions That Would Be a 

‘‘Covered Transaction’’ 

Section 13(f) of the BHC Act applies 

to covered transactions as defined in 

section 23A of the FR Act without 

incorporating any of the provisions in 

section 23A that provide exemptions 

from the prohibitions in that section for 

certain types of covered transactions.338

Section ll.16 of the proposed rule 

adopts the same language as the statute. 

The definition of ‘‘covered transaction’’ 

contained in section 23A of the FR Act 

itself includes an explicit exemption 

from the definition of ‘‘covered 

transaction’’ for ‘‘such purchase of real 

and personal property as may be 

specifically exempted by the Board by 

order or regulation.’’ 339 Since these 

transactions are, by definition, excluded 

from the definition of ‘‘covered 

transaction,’’ any transaction that is 

specifically exempted by the Board 

pursuant to this specific authority 

would not be deemed to be a covered 

transaction as defined in section 23A of 

the FR Act. 

c. Certain Transactions and 

Relationships Permitted 

While section 13(f)(1) of the BHC Act 

operates as a general prohibition on a 

banking entity’s ability to enter into a 

transaction with a related covered fund 

that would be a covered transaction as 

defined under section 23A of the FR 

Act, other specific portions of the 

statute expressly provide for, or make 

reference to, a banking entity’s ability to 

engage in certain transactions or 

relationships with such funds.340

Section ll.16(a)(2) of the proposed 

rule implements and clarifies these 

authorities. 

i. Permitted Investments and 

Ownerships Interests 

Sectionll.16(a)(2) of the proposed 

rule clarifies that a banking entity may 

acquire or retain an ownership interest 

in a covered fund in accordance with 

the requirements of subpart C of the 


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341See proposed rule §ll.16(a)(2)(i). 

342See proposed rule §ll.16(a)(2)(ii). 

343See proposed rule §ll.10(b)(4). 

344 12 U.S.C. 371c–1. 345See proposed rule §ll.16(b). 346 12 U.S.C. 371c–1(a); 12 CFR 223.51. 347See 12 U.S.C. 1851(f)(2), (f)(3)(B); proposed 

rule §ll.16(b). 

proposed rule.341 This clarification is 

proposed in order to remove any 

ambiguity regarding whether the section 

prohibits a banking entity from 

acquiring or retaining an interest in 

securities issued by a related covered 

fund in accordance with the other 

provisions of the rule, since the 

purchase of securities of a related 

covered fund would be a covered 

transaction as defined by section 23A of 

the FR Act. There is no evidence that 

Congress intended section 13(f)(1) of the 

BHC Act to override the other 

provisions of section 13 with regard to 

the acquisition or retention of 

ownership interests specifically 

permitted by the section. Moreover, a 

contrary reading would make these 

more specific sections that permit 

covered transactions between a banking 

entity and a covered fund mere 

surplusage. 

ii. Prime Brokerage Transactions Also 

Permitted 

Section ll.16(a)(2)(ii) of the 

proposed rule implements section 

13(f)(3)(A) of the BHC Act, which 

provides that a banking entity may enter 

into any prime brokerage transaction 

with a covered fund in which a covered 

fund managed, sponsored, or advised by 

such banking entity has taken an 

ownership interest, so long as certain 

enumerated conditions are satisfied.342

The proposed rule defines ‘‘prime 

brokerage transaction’’ to mean one or 

more products or services provided by 

the banking entity to a covered fund, 

such as custody, clearance, securities 

borrowing or lending services, trade 

execution, or financing, and data, 

operational, and portfolio management 

support.343 To engage in a prime 

brokerage transaction with a covered 

fund pursuant to §ll.16(a)(2)(ii) of 

the proposed rule, a banking entity must 

be in compliance with the limitations 

set forth in §ll.11 of the proposed 

rule with respect to a covered fund 

organized and offered by such banking 

entity. In addition, as required by 

statute, the chief executive officer (or 

equivalent officer) of the banking entity 

must certify in writing annually that the 

banking entity does not, directly or 

indirectly, guarantee, assume, or 

otherwise insure the obligations or 

performance of the covered fund or of 

any covered fund in which such 

covered fund invests. Finally, the Board 

must not have determined that such 

transaction is inconsistent with the safe 

and sound operation and condition of 

the banking entity. 

d. Restrictions on Transactions With 

Any Permitted Covered Fund 

Section ll.16(b) of the proposed 

rule implements sections 13(f)(2) and 

13(f)(3)(B) of the BHC Act and applies 

section 23B of the FR Act 344 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.345 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 such 

banking entity as those prevailing at the 

time for comparable transactions with or 

involving other unaffiliated companies 

or, in the absence of comparable 

transactions, on terms and under 

circumstances, including credit 

standards, that in good faith would be 

offered to, or would apply to, 

nonaffiliated companies.346

Section ll.16(b) applies this 

requirement to transactions between a 

banking entity that serves as investment 

manager, investment adviser, 

commodity trading adviser, or sponsor 

to a covered fund and that fund and any 

other fund controlled by that fund. It 

also applies this condition to a 

permissible prime brokerage transaction 

in which a banking entity may engage 

pursuant to § ll.16(a)(2)(ii) of the 

proposed rule.347

e. Request for Comment 

The CFTC requests comment on the 

proposed rule’s approach to 

implementing the limitations on certain 

relationships with covered funds and, in 

particular, the manner in which the 

CFTC has proposed to apply a banking 

entity’s ability to make explicitly 

permitted investments for these 

purposes, as described above. In 

particular, the CFTC requests comment 

on the following questions: 

Question 314. Is the proposed rule’s 

approach to implementing the 

limitations on certain transactions with 

a covered fund effective? If not, what 

alternative approach would be more 

effective and why? 

Question 315. Should the approach 

include other elements? If so, what 

elements and why? Should any of the 

proposed elements be revised or 

eliminated? If so, why and how? 

Question 316. What types of 

transactions or relationships that 

currently exist between banking entities 

and a covered fund (or another covered 

fund in which such covered fund makes 

a controlling investment) would be 

prohibited under the proposed rule? 

What would be the effect of the 

proposed rule on banking entities’ 

ability to continue to meet the needs 

and demands of their clients? Are there 

other transactions between a banking 

entity and such covered funds that are 

not already covered but that should be 

prohibited or limited under the 

proposed rule? 

Question 317. Should the CFTC 

provide a different definition of ‘‘prime 

brokerage transaction’’ under the 

proposed rule? If so, what definition 

would be appropriate? Are there any 

transactions that should be included in 

the definition of ‘‘prime brokerage 

transaction’’? Are there transactions or 

practices provided by banking entities 

that should be excluded in order to 

mitigate the burdens of complying with 

section 13 of the BHC Act? 

Question 318. With respect to the 

CEO (or equivalent officer) certification 

required under section 13(f)(3)(A) (ii) of 

the BHC Act and § ll.16(a)(2)(ii)(B) of 

the proposed rule, what would be the 

most useful, efficient method of 

certification (e.g., a new stand-alone 

certification, a certification incorporated 

into an existing form or filing, Web site 

certification, or certification filed 

directly with the CFTC)? 

8. Section ll.17: Other Limitations on 

Permitted Covered Funds Activities 

Section ll.17 of the proposed rule 

implements section 13(d)(2) of the BHC 

Act, which places certain limitations on 

the permitted covered fund activities 

and investments in which a banking 

entity may engage. Consistent with the 

statute and §ll.8 of the proposed 

rule, §ll.17 provides that no 

transaction, class of transactions, or 

activity is permissible under §§ll.11 

through ll.16 of the proposed rule if 

the transaction, class of transactions, or 

activity would: 

• Involve or result in a material 

conflict of interest between the banking 

entity and its clients, customers, or 

counterparties; 

• Result, directly or indirectly, in a 

material exposure by the banking entity 

to a high-risk asset or a high-risk trading 

strategy; or 

• Pose a threat to the safety and 

soundness of the banking entity or the 

financial stability of the United States. 

Section ll.17 of the proposed rule 

further defines ‘‘material conflict of 

interest,’’ ‘‘high-risk assets,’’ and ‘‘highVerDate Mar<15>2010 22:12 Feb 13, 2012 Jkt 226001 PO 00000 Frm 00072 Fmt 4701 Sfmt 4702 E:\FR\FM\14FEP2.SGM 14FEP2

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348As noted in the discussion of the definition of 

‘‘material conflict of interest in Part III.B.6 of this 

Supplementary Information, the proposed 

disclosure provisions of that definition are provided 

solely for purposes of the proposed rule’s definition 

of material conflict of interest, and do not affect a 

banking entity’s obligation to comply with 

additional or different disclosure or other 

requirements with respect to a conflict under 

applicable securities, banking, or other laws (e.g., 

section 27B of the Securities Act, which governs 

conflicts of interest relating to certain 

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). 

349See 12 U.S.C. 1851(e)(1). 

350See proposed rule §ll.20. 351See proposed rule §ll.20(d). 

risk trading strategies for these 

purposes, which are identical to the 

definitions of the same terms for 

purposes of §ll.8 of the proposed 

rule related to proprietary trading, and 

are described in detail in Part III.B.6 of 

this SUPPLEMENTARY INFORMATION.348

The CFTC requests comment on the 

proposed limitations on permitted 

covered fund activities and investments, 

including with respect to the questions 

in Part III.B.6 of the Supplemental 

Information as they pertain to covered 

fund activities and investments in 

particular. 

D. Subpart D (Compliance Program 

Requirement) and Appendix C 

(Minimum Standards for Programmatic 

Compliance) 

Subpart D of the proposed rule, which 

implements section 13(e)(1) of the BHC 

Act,349 requires certain banking entities 

to develop and provide for the 

continued administration of a program 

reasonably designed to ensure and 

monitor compliance with the 

prohibitions and restrictions on covered 

trading activities and covered fund 

activities and investments set forth in 

section 13 of the BHC Act and the 

proposed rule.350 This compliance 

program requirement forms a key part of 

the proposal’s multi-faceted approach to 

implementing section 13 of the BHC 

Act, and is intended to ensure that 

banking entities establish, maintain and 

enforce compliance procedures and 

controls to prevent violation or evasion 

of the prohibitions and restrictions on 

covered trading activities and covered 

fund activities and investments. 

1. Section ll.20: Compliance Program 

Mandate 

The proposed rule adopts a tiered 

approach to implementing the 

compliance program mandate, requiring 

a banking entity engaged in covered 

trading activities or covered fund 

activities and investments to establish a 

compliance program that contains 

specific elements and, if the banking 

entity’s activities are significant, meet a 

number of minimum standards. If a 

banking entity does not engage in 

covered trading activities and covered 

fund activities and investments, it must 

ensure that its existing compliance 

policies and procedures include 

measures that are designed to prevent 

the banking entity from becoming 

engaged in such activities and making 

such investments and must develop and 

provide for the required compliance 

program under proposed §ll.20(a) of 

the proposed rule prior to engaging in 

such activities or making such 

investments, but is not otherwise 

required to meet the requirements of 

subpart D of the proposed rule.351

Section ll.20(a) of the proposed 

rule contains the core requirement that 

each banking entity engaged in covered 

trading activities or covered fund 

activities and investments must 

establish, maintain and enforce a 

program reasonably designed to ensure 

and monitor compliance with the 

prohibitions and restrictions on 

proprietary trading activities and 

covered fund activities and investments 

set forth in section 13 of the BHC Act 

and the proposed rule and that such 

program must be suitable for the size, 

scope, and complexity of activities and 

business structure of the banking entity. 

Section ll.20(b) of the proposed rule 

specifies the following six elements that 

each compliance program established 

under subpart D must provide for, at a 

minimum: 

• Internal written policies and 

procedures reasonably designed to 

document, describe, and monitor the 

covered trading activities and covered 

fund activities and investments of the 

banking entity to ensure that such 

activities and investments comply with 

section 13 of the BHC Act and the 

proposed rule; 

• A system of internal controls 

reasonably designed to monitor and 

identify potential areas of 

noncompliance with section 13 of the 

BHC Act and the proposed rule in the 

banking entity’s covered trading 

activities and covered fund activities 

and investments and to prevent the 

occurrence of activities that are 

prohibited by section 13 of the BHC Act 

and the proposed rule; 

• A management framework that 

clearly delineates responsibility and 

accountability for compliance with 

section 13 of the BHC Act and the 

proposed rule; 

• Independent testing for the 

effectiveness of the compliance 

program, conducted by qualified 

banking entity personnel or a qualified 

outside party; 

• Training for trading personnel and 

managers, as well as other appropriate 

personnel, to effectively implement and 

enforce the compliance program; and 

• Making and keeping records 

sufficient to demonstrate compliance 

with section 13 of the BHC Act and the 

proposed rule, which a banking entity 

must promptly provide to the CFTC 

upon request and retain for a period of 

no less than 5 years. 

In addition, for a banking entity with 

significant covered trading activities or 

covered fund activities and investments, 

§ ll.20(c) requires the compliance 

program established under subpart D to 

meet a number of minimum standards, 

which are specified in Appendix C of 

the proposed rule. In particular, a 

banking entity must comply with the 

minimum standards specified in 

Appendix C of the proposed rule if: 

• With respect to its covered trading 

activities, it engages in any covered 

trading activities and has, together with 

its affiliates and subsidiaries, trading 

assets and liabilities the average gross 

sum of which (on a worldwide 

consolidated basis), as measured as of 

the last day of each of the four prior 

calendar quarters, (i) is equal to or 

greater than $1 billion or (ii) equals 10 

percent or more of its total assets; and 

• With respect to its covered fund 

activities and investments, it engages in 

any covered fund activities and 

investments and either (i) has, together 

with its affiliates and subsidiaries, 

aggregate investments in one or more 

covered funds the average value of 

which is, as measured as of the last day 

of each of the four prior calendar 

quarters, equal to or greater than $1 

billion or (ii) sponsors or advises, 

together with its affiliates and 

subsidiaries, one or more covered funds 

the average total assets of which are, as 

measured as of the last day of each of 

the four prior calendar quarters, equal to 

or greater than $1 billion. 

The application of detailed minimum 

standards to these types of banking 

entities is intended to reflect the 

heightened compliance risks of large 

covered trading and large covered fund 

activities and investments and provide 

guidance to such banking entities 

regarding the minimum compliance 

measures that would be required under 

the proposed rule. 

If a banking entity does not meet the 

thresholds specified in §ll.20(c)(2), it 

need not comply with each of the 

minimum standards specified in 

Appendix C. However, the proposed 

rule would require such a banking 


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352The CFTC has 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. 

entity to establish a compliance program 

that effectively implements the six 

elements specified in §ll.20(b). 

Banking entities engaged in a relatively 

small amount of covered fund activities 

are encouraged to look to the minimum 

standards of Appendix C for guidance. 

Generally, the CFTC would expect that 

the closer a banking entity is to the 

thresholds specified in §ll.20(c)(2), 

the more its compliance program should 

generally include the specific 

requirements described in Appendix C. 

Within the bounds of subpart D and 

Appendix C, a banking entity has 

discretion to structure and manage its 

program for compliance with section 13 

of the BHC Act and the proposed rule 

in a manner that best reflects the unique 

organization and operation of the 

banking entity and its affiliates and 

subsidiaries, and is suitable taking 

account of the size, scope, and 

complexity of activities in which the 

banking entity and its affiliates and 

subsidiaries engage. 

As described above, §ll.20(d) of 

the proposed rule clarifies that, if a 

banking entity does not engage in 

covered trading activities and/or 

covered fund activities or investments, 

it will have satisfied the requirements of 

this section if its existing compliance 

policies and procedures include 

measures that are designed to prevent 

the banking entity from becoming 

engaged in such activities or making 

such investments and which require the 

banking entity to develop and provide 

for the compliance program required 

under paragraph (a) of this section prior 

to engaging in such activities or making 

such investments. 

2. Appendix C—Minimum Standards 

for Programmatic Compliance 

Appendix C of the proposed rule 

specifies a variety of minimum 

standards applicable to the compliance 

program of a banking entity with 

significant covered trading activities or 

covered fund activities and 

investments.352 Section I.A of proposed 

Appendix C sets forth the purpose of the 

required compliance program, which is 

to ensure that each banking entity 

establishes, maintains, and enforces an 

effective compliance program, 

consisting of written policies and 

procedures, internal controls, a 

management framework, independent 

testing, training, and recordkeeping, 

that: 

• Is designed to clearly document, 

describe, and monitor the covered 

trading activities and covered fund 

activities or investments and the risks of 

the banking entity related to such 

activities or investments, identify 

potential areas of noncompliance, and 

prevent activities or investments 

prohibited by, or that do not comply 

with, section 13 of the BHC Act and the 

proposed rule; 

• Specifically addresses the varying 

nature of activities or investments 

conducted by different units of the 

banking entity’s organization, including 

the size, scope, complexity, and risks of 

the individual activity or investment; 

• Subjects the effectiveness of the 

compliance program to independent 

review and testing; 

• Makes senior management and 

intermediate managers accountable for 

the effective implementation of the 

compliance program, and ensures that 

the board of directors or chief executive 

office (‘‘CEO’’) review the effectiveness 

of the compliance program; and 

• Facilitate supervision of the 

banking entity’s covered trading 

activities and covered fund activities or 

investments by the CFTC. 

A banking entity’s compliance 

program should not be developed 

through a generic, one-size-fits-all 

approach, but rather should carefully 

take into account and reflect the unique 

manner in which a banking entity 

operates, as well as the particular 

compliance risks and challenges that its 

businesses present. In light of the 

complexities presented in 

differentiating prohibited proprietary 

trading from permitted market makingrelated activities in particular, the CFTC 

expects that such a dynamic, carefullytailored approach to internal 

compliance will play an important role 

in ensuring that banking entities comply 

with section 13’s prohibitions and 

restrictions. In addition, although this 

statement of purpose appears within the 

text of proposed Appendix C, the CFTC 

notes the statement equally describes 

the general purpose of any compliance 

program required under subpart D of the 

proposed rule, regardless of whether 

proposed Appendix C specifically 

applies. 

Section I.B of proposed Appendix C 

provides for several definitions used 

throughout the appendix, including the 

definition of ‘‘trading unit’’ and ‘‘asset 

management unit’’ to which the 

minimum standards apply. The term 

‘‘trading unit’’ is defined in the same 

way as in Appendix A, as described in 

Part II.B.5 of the Supplementary 

Information, and is intended to identify 

multiple layers of a banking entity’s 

organizational structure because any 

effective compliance program will need 

to manage, limit and monitor covered 

trading activity at each such level of 

organization in order to effectively 

support compliance with the 

prohibition on proprietary trading. The 

term ‘‘asset management unit’’ is 

defined as any unit of organization of a 

banking entity that makes an investment 

in, acts as sponsor to, or has 

relationships with, a covered fund that 

the banking entity sponsors, organizes 

and offers, or in which a covered fund 

sponsored or advised by a banking 

entity invests. 

Section I.C of proposed Appendix C 

incorporates by reference the six 

elements that must be included in the 

compliance program under §ll.20 of 

the proposed rule, and section I.D 

describes the structure of a compliance 

program meeting the minimum 

standards. In particular, section I.D 

permits a banking entity to establish a 

compliance program on an enterprisewide basis to satisfy the requirements of 

§ ll.20 of the proposed rule and the 

appendix, which program could cover 

the banking entity and all of its affiliates 

and subsidiaries collectively. In order to 

do so, the program must (i) be clearly 

applicable, both by its terms and in 

operation, to all such affiliates and 

subsidiaries, (ii) specifically address the 

requirements set forth in proposed 

Appendix C, (iii) take into account and 

address the consolidated organization’s 

business structure, size, and complexity, 

as well as the particular activities, risks, 

and applicable legal requirements of 

each subsidiary and affiliate, and (iv) be 

determined through periodic 

independent testing to be effective for 

the banking entity and its affiliates and 

subsidiaries. In addition, the enterprisewide program would be subject to 

supervisory review and examination by 

any Agency vested with rulewriting 

authority under section 13 of the BHC 

Act with respect to the compliance 

program and the activities of any 

banking entity for which the Agency has 

such authority. Further, such Agency 

would have access to all records related 

to the enterprise-wide compliance 

program pertaining to any banking 

entity that is supervised by the Agency 

vested with such rulewriting authority. 

a. Internal Policies and Procedures 

Section II of proposed Appendix C 

articulates minimum standards for the 

first element of the compliance program, 

internal policies and procedures, for 

both covered trading activities and 

covered fund activities and investments. 

With respect to covered trading 

activities, the proposal would require 


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that internal policies and procedures: (i) 

Specify how the banking entity 

identifies its trading accounts; (ii) 

identify the trading activity in which 

the banking entity is engaged and how 

that activity is organized; (iii) 

thoroughly articulate the mission, 

strategy, risks, and compliance controls 

for each trading unit; (iv) include for 

each trader a mandate that describes the 

scope of his or her trading activity; (v) 

clearly articulate and document a 

comprehensive description of the risks 

associated with the trading unit’s 

activities; (vi) document a 

comprehensive explanation of how the 

mission and strategy of the trading unit, 

and its related risk levels, comply with 

the proposed rule; and (vii) require the 

banking entity to promptly address and 

remedy any violation of section 13 of 

the BHC Act and the proposed rule. 

These internal policies and procedures 

would require banking entities to have 

the data and standards to prevent 

prohibited proprietary trading and to 

identify abnormalities and 

discrepancies that may be indicative of 

prohibited proprietary trading. The 

internal policies and procedures should 

also provide the Agencies with a clear, 

comprehensive picture of a banking 

entity’s covered trading activities that 

can be effectively reviewed. With 

respect to covered fund activities and 

investments, the proposal would require 

that internal policies and procedures 

describe all covered fund activities in 

which the banking entity engages and 

the procedures used by the banking 

entity to ensure that it complies with 

the restrictions of section 13 of the BHC 

Act and the proposed rule. 

The CFTC expects that these internal 

policies and procedures will be 

regularly reviewed and updated to 

reflect changes in business practices, 

strategies, or laws and regulations, 

though frequent, unexplained changes 

to policies and procedures or other 

aspects of the compliance program— 

particularly changes to reduce their 

stringency—would warrant additional 

scrutiny from banking entity 

management, independent testing 

personnel, and CFTC examiners. 

b. Internal Controls 

Section III of proposed Appendix C 

articulates minimum standards for the 

second element of the compliance 

program, internal controls. With respect 

to covered trading activities, the 

proposal would require internal controls 

that: (i) Are reasonably designed to 

ensure that the covered trading activity 

is conducted in conformance with a 

trading unit’s authorized risks, 

instruments and products, as 

documented in the banking entity’s 

written policies and procedures; (ii) 

establish and enforce risk limits for each 

trading unit; and (iii) perform robust 

analysis and quantitative measurement 

of covered trading activity for 

conformance with section 13 of the BHC 

Act and the proposed rule. In particular, 

the banking entity must perform 

analysis and quantitative measurement 

that is reasonably designed to: (i) Ensure 

that the activity of each trading unit is 

appropriate to the mission, strategy, and 

risk of each trading unit, as documented 

in the banking entity’s internal written 

policies and procedures; (ii) monitor 

and assist in the identification of 

potential and actual prohibited trading 

activity; and (iii) prevent the occurrence 

of prohibited proprietary trading. This 

analysis and measurement should 

incorporate the quantitative 

measurements calculated and reported 

under Appendix A of the proposed rule, 

but should also include other analysis 

and measurements developed by the 

banking entity that are specifically 

tailored to the business, risks, practices, 

and strategies of its trading units. The 

Agencies expect that the thoughtful use 

of these types of quantitative tools to 

monitor the extent to which the 

activities of a trading unit are consistent 

with its stated mission, strategy, and 

risk profile may help identify, for 

banking entities and the CFTC, 

abnormalities or discrepancies in 

permitted trading activity that may be 

indicative of prohibited proprietary 

trading. In addition, these internal 

controls must provide for regular 

monitoring of the effectiveness of the 

banking entity’s compliance program 

and require the banking entity to take 

prompt action to address and remedy 

any deficiencies identified and to 

provide timely notification to the CFTC 

of any investigation and remedial action 

taken. 

With respect to covered fund 

activities and investments, the internal 

controls required under section III of 

proposed Appendix C generally focus 

on ensuring that a banking entity has 

effective controls in place to monitor its 

investments in, and relationships with, 

covered funds to ensure its compliance 

with the covered fund activity and 

investments restrictions, including 

controls that relate to implementing 

remedies in the event of a violation of 

the requirements of section 13 of the 

BHC Act and the proposed rule. 

c. Responsibility and Accountability 

Section IV of proposed Appendix C 

articulates minimum standards for the 

third element of the compliance 

program, responsibility and 

accountability. These standards focus 

on four key constituencies—the board of 

directors, the CEO, senior management, 

and managers at each trading unit and 

asset management unit level. Section IV 

makes clear that the board of directors, 

or similar corporate body, and the CEO 

are responsible for creating an 

appropriate ‘‘tone at the top’’ by setting 

an appropriate culture of compliance 

and establishing clear policies regarding 

the management of covered trading 

activities and covered fund activities 

and investments. Senior management 

must be made responsible for 

communicating and reinforcing the 

culture of compliance established by the 

board of directors and the CEO, for the 

actual implementation and enforcement 

of the approved compliance program, 

and for taking effective corrective 

action, where appropriate. Managers 

with responsibility for one or more 

trading units or asset management units 

of the banking entity that are engaged in 

covered trading activity or covered fund 

activity and investments are 

accountable for effective 

implementation and enforcement of the 

compliance program for the applicable 

trading unit or asset management unit. 

d. Independent Testing 

Section V of proposed Appendix C 

articulates minimum standards for the 

fourth element of the compliance 

program, independent testing. A 

banking entity subject to the appendix 

must ensure that its independent testing 

is conducted by a qualified independent 

party, such as the banking entity’s 

internal audit department, outside 

auditors, consultants or other qualified 

independent parties. The independent 

testing must examine both the banking 

entity’s compliance program and its 

actual compliance with the proposed 

rule. Such testing must include not only 

the general adequacy and effectiveness 

of the compliance program and 

compliance efforts, but also the 

effectiveness of each element of the 

compliance program and the banking 

entity’s compliance with each provision 

of the proposed rule. This requirement 

is intended to ensure that a banking 

entity continually reviews and assesses, 

in an objective manner, the strength of 

its compliance efforts and promptly 

identifies and remedies any weaknesses 

or matters requiring attention within the 

compliance framework. 

e. Training 

Section VI of proposed Appendix C 

articulates minimum standards for the 

fifth element of the compliance 

program, training. It proposes to require 

that a banking entity provide adequate 


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training to its trading personnel and 

managers, as well as other appropriate 

personnel, in order to effectively 

implement and enforce the compliance 

program. In particular, personnel 

engaged in covered trading activities or 

covered fund activities and investments 

should be educated with respect to 

applicable prohibitions and restrictions, 

exemptions, and compliance program 

elements to an extent sufficient to 

permit them to make informed, day-today decisions that support the banking 

entity’s compliance with the proposed 

rule and section 13 of the BHC Act. In 

particular, any personnel with 

discretionary authority to trade, in any 

amount, should be appropriately trained 

regarding the differentiation of 

prohibited proprietary trading and 

permitted trading activities and given 

detailed guidance regarding what types 

of trading activities are prohibited. 

Similarly, personnel providing 

investment management or advisory 

services, or acting as general partner, 

managing member, or trustee of a 

covered fund, should be appropriately 

trained regarding what covered fund 

activities and investments are permitted 

and prohibited. 

f. Recordkeeping 

Section VII of proposed Appendix C 

articulates minimum standards for the 

sixth element of the compliance 

program, recordkeeping. Generally, a 

banking entity must create records 

sufficient to demonstrate compliance 

and support the operation and 

effectiveness of its compliance program 

(i.e., records demonstrating the banking 

entity’s compliance with the 

requirements of section 13 of the BHC 

Act and the proposed rule, any scrutiny 

or investigation by compliance 

personnel or risk managers, and any 

remedies taken in the event of a 

violation or non-compliance), and retain 

these records for no less than five years 

in a form that allows the banking entity 

to promptly produce these records to 

the CFTC upon request. Records created 

and retained under the compliance 

program shall include trading records of 

the trading units, including trades and 

positions of each such unit. 

g. Request for Comment 

The CFTC requests comment on the 

compliance program requirement 

contained in § ll.20 of the proposed 

rule and the minimum standards 

specified in proposed Appendix C. In 

particular, the CFTC requests comment 

on the following questions: 

Question 319. Is the proposed rule’s 

inclusion of a compliance program 

requirement effective in light of the 

purpose and language of the statute? If 

not, what alternative would be more 

effective? 

Question 320. Is the proposed 

application of §ll.20’s compliance 

program requirement to all banking 

entities engaged in covered trading 

activity or covered trading investments 

and activities and the minimum 

standards of proposed Appendix C to 

only banking entities with significant 

covered trading or covered fund 

activities, effective? If not, what 

alternative would be more effective? 

Should proposed Appendix C apply to 

all banking entities? If so, why? Are the 

thresholds proposed for determining 

whether a banking entity must comply 

with proposed Appendix C appropriate? 

If not, what alternative would be more 

effective? 

Question 321. What implementation, 

operational, or other burdens or 

expenses might be associated with the 

compliance program requirement? How 

could those burdens or expenses be 

reduced or eliminated in a manner 

consistent with the purpose and 

language of the statute? 

Question 322. Do the proposed 

compliance program requirement and 

minimum standards provide sufficient 

guidance and clarity regarding how 

compliance programs should be 

structured? If not, what additional 

guidance or clarity is needed? Do the 

proposed compliance program 

requirement and minimum standards 

provide sufficient discretion to banking 

entities to structure a compliance 

program that appropriately reflects the 

unique nature of their businesses? If not, 

how could additional discretion be 

provided in a manner consistent with 

the purpose and language of the statute? 

Question 323. Are the six proposed 

elements of a required compliance 

program effective? If not, what 

alternative would be more effective? 

Should elements be added or removed? 

If so, which ones and why? 

Question 324. For each of the six 

proposed elements of a required 

compliance program for which 

minimum standards are provided in 

proposed Appendix C, are the proposed 

minimum standards effective? If not, 

what alternative would be more 

effective? Should minimum standards 

be added or removed? If so, which ones 

and why? 

Question 325. Does the requirement 

that a banking entity provide timely 

notification to the relevant Agency 

provide sufficient guidance as to what 

activities must be reported and how and 

when such reporting should be made? 

Should more specific standards be 

provided (e.g., regarding the timing of 

reporting and the types of activities that 

must be reported)? If so, what additional 

criteria should be implemented? Should 

the notification requirement be applied 

explicitly to banking entities that are not 

required to comply with the minimum 

standards specified in Appendix C 

because they are below the thresholds 

specified in §ll.20(c)(2)? Why or why 

not? 

Question 326. Are there specific 

records that banking entities should be 

required to make and keep to document 

compliance with section 13 of the BHC 

Act and the proposed rule? Please 

explain. 

Question 327. What process should 

the Agencies use in determining 

whether to require a banking entity that, 

based on its size, would not be subject 

to Appendix C to comply with all or 

portions of the appendix under section 

I.E of the proposed appendix? What 

considerations should the CFTC take 

into account in making such a 

determination? Should this requirement 

be implemented by a CFTC order, by 

authority delegated to the CFTC staff, or 

a different method? Please explain. 

Question 328. Should the proposed 

rule permit banking entities to comply 

with Appendix C of the proposed rule 

on an enterprise-wide basis? If so, why? 

What are the advantages and 

disadvantages of an enterprise-wide 

compliance program? Should the 

proposed appendix provide additional 

clarity or discretion regarding how such 

an enterprise-wide program should be 

structured? If so, how? Please include a 

discussion relating to the infrastructure 

of an enterprise-wide compliance 

program and its management. If 

enterprise-wide compliance or similar 

programs are used in other contexts, 

please describe your experience with 

such programs and how those 

experiences influence your judgment 

concerning whether or not you would 

choose an enterprise-wide compliance 

program in this context. 

Question 329. Should the proposed 

rule permit banking entities to comply 

with §ll.20(b) of the proposed rule 

on an enterprise-wide basis? If so, why? 

What are the advantages and 

disadvantages of an enterprise-wide 

compliance program for smaller banking 

entities that are not subject to Appendix 

C? Please include a discussion relating 

to the infrastructure of an enterprisewide compliance program and its 

management in the context of smaller 

banking entities. If enterprise-wide 

compliance or similar programs are 

used in other contexts, please describe 

your experience with such programs 

and how those experiences influence 

your judgment concerning whether or 


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not you would choose an enterprisewide compliance program in this 

context. Are there particular reasons 

why a enterprise-wide compliance 

program should be permitted for larger 

banking entities subject to the 

requirements of Appendix C, but not 

those that are subject to §ll.20(b) of 

the proposed rule? 

Question 330. What are the particular 

challenges that should be considered in 

connection with establishing a 

compliance program on an enterprisewide basis? How will such challenges 

be addressed? Can an enterprise-wide 

compliance program be appropriately 

tailored to each of the subsidiaries and 

affiliates of a banking entity? 

Question 331. Are there efficiencies 

that can be gained through an 

enterprise-wide compliance program? If 

so, how and what efficiencies? 

Question 332. Would the complexities 

of various types of covered trading 

activity be adequately reflected in an 

enterprise-wide compliance program? 

Question 333. Should only outside 

parties be permitted to conduct 

independent testing for the effectiveness 

of the proposed compliance program to 

satisfy certain minimum standards? If 

so, why? Under the proposal, the 

independent testing requirement may be 

satisfied by testing conducted by an 

internal audit department or a third 

party. Should the rule specify the 

minimum standards for 

‘‘independence’’ as applied to internal 

and/or external parties testing the 

effectiveness of the compliance 

program? For example, would an 

internal audit be deemed to be 

independent if none of the persons 

involved in the testing are involved 

with, or report to persons that are 

involved with, activities implicated by 

section 13 of the BHC Act? Why or why 

not? 

Question 334. Do you anticipate that 

banking entities that do not meet the 

thresholds specified in §ll.20(c) 

would voluntarily comply with the 

proposed minimum standards in 

Appendix C in order to effectively 

implement the six elements specified in 

§ ll.20(b)? Are there specific 

minimum standards that would not be 

practical or would be unattainable for a 

banking entity that does not meet the 

§ lll.20(c) thresholds? Please 

identify the minimum standard(s) and 

explain. 

Question 335. In light of the size, 

scope, complexity, and risk of covered 

trading activities, do commenters 

anticipate the need to hire new staff 

with particular expertise in order to 

establish, maintain, and enforce the 

proposed compliance program 

requirement concerning covered trading 

activities or any subset of covered 

trading activities? 

Question 336. With respect to the 

proposed requirement that training 

should occur with a frequency 

appropriate to the size and risk profile 

of the banking entity’s covered trading 

activities and covered fund activities, 

should there be a minimum requirement 

that such training shall be conducted no 

less than once every twelve (12) 

months? If so, why? 

Question 337. Should proposed rule’s 

Appendix C be revised to require a 

banking entity’s CEO to annually certify 

that the banking entity has in place 

processes to establish, maintain, 

enforce, review, test and modify the 

compliance program established 

pursuant to Appendix C in a manner 

that is reasonably designed to achieve 

compliance with section 13 of the BHC 

Act and this proposal? If so, why? If so, 

what would be the most useful, efficient 

method of certification (e.g., a new 

stand-alone certification, a certification 

incorporated into an existing form or 

filing, Web site certification, or 

certification filed directly with the 

CFTC)? Would a central data repository 

with a CEO attestation to the CFTC be 

a preferable approach? 

Question 338. Do the proposed rule 

requirements relating to establishment 

and implementation of a compliance 

program pose unique concerns or 

challenges to issuers of asset-backed 

securities that are banking entities, and 

if so, why? Are certain asset classes 

particularly impacted by the proposed 

rule requirements, and if so, how? 

Question 339. How would existing 

issuers of asset-backed securities that 

are banking entities pay for establishing 

and implementing a compliance 

program? Should existing issuers of 

asset-backed securities that cannot 

comply with the compliance program 

requirements be excluded from the 

proposed definition of ‘‘banking 

entity’’? Should such exclusion be 

limited, and if so, based on what 

factors? Are the proposed thresholds 

specified in §ll.20(c) of the proposed 

rule and/or the allowance of an 

enterprise-wide compliance program as 

set forth in Appendix C of the proposed 

rule sufficient to minimize these 

concerns for issuers of asset-backed 

securities? 

Question 340. With respect to future 

securitizations, what would be the 

impact of the establishment and 

implementation of the compliance 

program related to the provisions of the 

proposed rule as required by §ll.20 

of the proposed rule (including 

Appendix C, where applicable)? Are the 

proposed thresholds specified in 

§ ll.20(c) of the proposed rule and/or 

the allowance of an enterprise-wide 

compliance program as set forth in 

Appendix C of the proposed rule 

sufficient to minimize these concerns 

for issuers of asset-backed securities? 

Question 341. Would existing issuers 

of asset-backed securities that are 

banking entities be able to establish and 

implement a compliance program 

related to the provisions of the proposed 

rule as required by § ll.20 of the 

proposed rule (including Appendix C, 

where applicable)? If amendments to 

transactional documents are necessary, 

are there any obstacles that would make 

such amendments difficult to execute? If 

existing issuers of asset-backed 

securities cannot establish and 

implement a compliance program, what 

would be the impact on such existing 

issuers of asset-backed securities and 

the holders of securities issued by a 

non-compliant issuer of asset-backed 

securities? Is the allowance of an 

enterprise-wide compliance program as 

set forth in Appendix C of the proposed 

rule sufficient to minimize these 

concerns for issuers of asset-backed 

securities? 

Question 342. To rely on the 

exemptions for permitted underwriting, 

market making-related, and riskmitigating hedging activities, the 

proposed rule requires banking entities 

to establish the internal compliance 

program under §ll.20 and, where 

applicable, Appendix C, designed to 

ensure compliance with the 

requirements of the applicable 

exemption (e.g., policies and 

procedures, internal controls and 

monitoring procedures, etc.). Do these 

requirements in the proposed rule 

impose undue cumulative burdens, 

such that the marginal benefit of a given 

requirement is not justified by the cost 

that the requirement imposes? If so, why 

does the proposed rule impose 

cumulative burdens and what are the 

costs of those burdens? Please explain 

the circumstances under which these 

burdens may arise. Is there a way to 

reduce or eliminate such burdens or 

requirements in a manner consistent 

with the language and purpose of the 

statute? For any requirements that 

impose undue burdens, are there other 

requirements that could be substituted 

that would more efficiently ensure 

compliance with the statute? Are there 

any requirements that the proposed rule 

imposes that are particularly effective, 

and if so, how can the Agencies make 

better use of these requirements? 

Question 343. Are the six elements of 

the proposed compliance program 

requirement mutually reinforcing and 


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353See 12 U.S.C. 1851(e)(2). 

354See proposed rule §ll,21(a). The CFTC has 

proposed to include § __.21(a), in addition to the 

provisions of §ll.21(b) of the proposed rule, to 

make clear that the requirement to terminate an 

activity or, as relevant, dispose of an investment 

would be triggered where a banking entity discovers 

a violation or evasion, regardless of whether an 

Agency order has been issued. 

355See proposed rule §ll,21(b). 

356As noted above in connection with the 

conformance and extended transition periods, the 

proposed rule would not require an immediate 

application of these restrictions for any activity or 

investment entered into prior to the effective date 

of section 13 of the BHC Act (July 21, 2012). 

However, any activity or investment entered into 

after the effective date would be required to comply 

with section 13 of the BHC Act and the proposed 

rule, if adopted. See Supplemental Information Part 

III.E. 

357See Supplemental Information Part II.A. 

358See 12 U.S.C. 1851(b)(2)(A); see also Financial 

Stability Oversight Council, Study & 

Recommendations on Prohibitions on Proprietary 

Trading & Certain Relationships with Hedge Funds 

& Private Equity Funds (Jan. 2011), available at 

http://www.treasury.gov/initiatives/Documents/

Volcker%20sec%20%20619%20study%20

final%201%2018%2011%20rg.pdf. 

359This CFTC Rule is being promulgated 

exclusively under section 13 of the BHC. Therefore, 

the Commission will not be conducting a costbenefit consideration under Section 15(a) of the 

Commodity Exchange Act. However, the 

Commission will consider the responses to the 

questions posed in this section when finalizing this 

rulemaking. 

cost effective, or are there redundancies 

in the six elements? Please explain any 

redundant requirements in the policies 

and procedures, internal controls, 

management framework, independent 

testing, training, and recordkeeping 

requirements in §ll.20(b) of the 

proposed rule or proposed Appendix C. 

Why are such requirements redundant, 

and how should the redundancy be 

addressed and remedied in the rule? 

Question 344. A banking entity that 

meets the $1 billion or greater trading 

assets and liabilities threshold would be 

required under the proposed rule to 

comply with both the reporting and 

recordkeeping requirements in 

Appendix A with respect to quantitative 

measurements and the compliance 

program requirement in Appendix C. 

Are the requirements in these 

appendices mutually reinforcing and 

cost effective, or do the appendices 

impose redundant requirements on 

banking entities that meet the $1 billion 

threshold? Please explain any 

redundant requirements in the 

appendices and how such redundancy 

should be addressed and remedied in 

the rule. 

Question 345. Proposed Appendix C 

incorporates the quantitative 

measurements provided in proposed 

Appendix A in the internal controls 

requirement for banking entities that are 

engaged in covered trading activity and 

meet the $1 billion or greater trading 

assets and liabilities threshold. Do the 

requirements in proposed Appendix A 

and Appendix C impose undue 

cumulative burdens with respect to any 

elements (e.g., quantitative 

measurements), such that the marginal 

benefit of a given requirement is not 

justified by the cost that the requirement 

imposes? Please explain why the 

proposed appendices impose 

cumulative burdens, the costs of those 

burdens, and the circumstances under 

which these burdens may arise. Is there 

a way to reduce or eliminate such 

burdens or requirements in a manner 

consistent with the language and 

purpose of the statute? For any 

requirements in the appendices that 

impose undue burdens, are there other 

requirements that could be substituted 

that would more efficiently ensure 

compliance with the statute? Are there 

any requirements that the proposed 

appendices impose that are particularly 

effective, and if so, how can the CFTC 

make better use of these requirements? 

Question 346. Should the CFTC 

prescribe any specific method by which 

the board of directors or similar 

corporate body reviews and approves 

the compliance program? For example, 

should the CFTC require that: (i) A chief 

compliance officer or similar officer 

present an annual compliance report 

including, as appropriate, recommended 

actions to be taken by the banking entity 

to improve compliance or correct any 

compliance deficiencies; (ii) the board 

review any such recommendations and 

determine whether to approve them; 

and (iii) the banking entity notify the 

CFTC if the board declines to approve 

such recommendations, or approves 

different actions than those 

recommended in the compliance report? 

What are the advantages and 

disadvantages of such an approach? 

3. Section ll.21: Termination of 

Activities or Investments; Penalties for 

Violations 

Section ll.21 of the proposed rule 

implements section 13(e)(2) of the BHC 

Act, which requires the termination of 

activities or investments that violate or 

function as an evasion of section 13 of 

the Act.353 In particular, §ll.21(a) of 

the proposed rule requires any banking 

entity that engages in an activity or 

makes an investment in violation of 

section 13 of the BHC Act or the 

proposed rule or in a manner that 

functions as an evasion of the 

requirements of section 13 of the BHC 

Act or the proposed rule, including 

through an abuse of any activity or 

investment permitted under subparts B 

or C, or otherwise violates the 

restrictions and requirements of section 

13 of the BHC Act or the proposed rule, 

to terminate the activity and, as 

relevant, dispose of the investment.354

Section ll.21(b) of the proposed rule 

provides that if a relevant Agency finds 

reasonable cause to believe any banking 

entity has engaged in an activity or 

made an investment described in 

paragraph (a), the CFTC may, after due 

notice and an opportunity for hearing, 

by order, direct the banking entity to 

restrict, limit, or terminate the activity 

and, as relevant, dispose of the 

investment.355

IV. Request for Comments 

The CFTC is interested in receiving 

comments on all aspects of the proposed 

rule. 

V. The Economic Impact of the 

Proposed Rule Under Section 13 of the 

BHC Act—Request for Comment 

Section 13 of the BHC Act imposes on 

all banking entities prohibitions and 

restrictions on proprietary trading and 

certain interests in, and relationships 

with, a covered fund,356 which apply to 

banking entities whether or not the 

CFTC adopts implementing rules. In 

formulating the proposed rule to 

implement these provisions, which is 

required by statute, the CFTC has 

chosen a multi-faceted approach to 

establish a regulatory framework that 

provides for clear, robust, and effective 

implementation of the statute’s 

provisions in a consistent manner, 

while also not unduly constraining the 

ability of banking entities to engage in 

permitted activities and investments.357

The CFTC has proposed this approach 

after considering the Council’s findings 

and recommendations regarding how to 

implement section 13 of the BHC Act 

and a variety of alternatives described 

throughout this Supplemental 

Information.358 The CFTC seeks 

comment, in particular, on the potential 

costs and benefits of those aspects of the 

proposed rule that involve choices 

made, or the exercise of discretion, by 

the CFTC in implementing section 13 of 

the BHC Act.359

The CFTC recognizes that there are 

economic impacts that may arise from 

the proposed rule and its 

implementation of section 13 of the 

BHC Act and invite comment on the 

manner in which the proposed rule 

implements section 13 of the BHC Act, 

including commenters’ views on the 

potential economic impacts discussed 

in this Part of the Supplemental 


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360For example, implementation of section 

13(d)(1)(H) of the BHC Act may result in a 

competitive advantage for foreign-controlled 

banking entities over U.S.-controlled banking 

entities with respect to activities that occur solely 

outside of the United States. 

Information. In addition, the CFTC 

seeks comment on whether the 

proposed rule represents a balanced and 

effective approach to implementing 

section 13 of the BHC Act or whether 

alternative approaches to implementing 

section 13 of the BHC Act exist that 

would provide greater benefits or 

involve fewer costs, consistent with the 

statutory purpose. We also request 

comment on the potential competitive 

effects of the manner in which the 

proposed rule implements the 

statute.360

In addition to the questions posed 

throughout Part II of the Supplemental 

Information with respect to the potential 

costs and benefits of particular aspects 

of the statute and proposed rule, in 

order to assist in the analysis of the 

economic impacts associated with the 

final rule and any alternatives the CFTC 

may evaluate, the CFTC encourages 

commenters to provide quantitative 

information about the rule’s impact on 

banking entities, their clients, 

customers, and counterparties, specific 

markets or asset classes, and any other 

entities potentially affected by the 

proposed rule with respect to: 

1. The direct and indirect costs and 

benefits of compliance with section 13 

of the BHC Act, as proposed to be 

implemented; 

2. The effect of section 13 of the BHC 

Act, as proposed to be implemented, on 

competition; and 

3. Any other economic impacts of the 

proposal. 

In addition, to assist with potential 

estimates of the proposed rule’s 

quantitative impacts, we request 

specific comment on: (i) The extent to 

which banking entities currently engage 

in proprietary trading activity or 

covered funds activities or investments 

that are prohibited or restricted by the 

statute, or have otherwise divested or 

conformed such activities; and (ii) the 

potential costs and benefits or other 

quantitative impacts of various aspects 

of the proposed rule, such as the 

compliance program requirement, the 

required reporting of quantitative 

measurements, and the conditions and 

requirements for relying on the 

proposed exemptions. 

To further facilitate public comment 

on the economic effects of the manner 

in which the proposed rule implements 

the statute, the CFTC has identified 

below a number of significant aspects of 

the proposed rule and potential 

economic impacts that may result from 

section 13 of the BHC Act’s 

requirements, as proposed to be 

implemented. We seek commenters’ 

views on the likelihood of the potential 

economic impacts identified in this Part 

and whether there are additional costs, 

benefits, or other impacts that may arise 

from the proposed rule. To the extent 

that such costs, benefits, or other 

impacts are quantifiable, commenters 

are encouraged to identify, discuss, 

analyze, and supply relevant data, 

information, or statistics related to such 

costs, benefits, and other impacts and 

the quantification of such costs, 

benefits, and other impacts. In addition, 

commenters are asked to identify or 

estimate start-up, or non-recurring, costs 

separately from costs or effects they 

believe would be ongoing. 

A. Proprietary Trading Provisions 

1. Definition of Trading Account 

Section ll.3 of the proposed rule, 

which implements the statutory 

definition of ‘‘trading account,’’ 

provides a multi-pronged definition of 

that term that is intended to ensure that 

banking entities do not engage in 

‘‘hidden’’ proprietary trading by 

characterizing trading activity as being 

conducted outside a trading account. In 

addition to positions taken principally 

for the purpose of short-term resale, 

benefitting from short-term price 

movements, realizing short-term 

arbitrage profits, or hedging another 

trading account position, the proposed 

definition also includes: (i) With respect 

to a banking entity subject to the Federal 

banking agencies’ Market Risk Capital 

Rules, all positions in financial 

instruments subject to the prohibition 

on proprietary trading that are treated as 

‘‘covered positions’’ under those capital 

rules, other than certain foreign 

exchange and commodities positions; 

and (ii) all positions acquired or taken 

by certain registered securities and 

derivatives dealers (or, in the case of 

financial institutions that are 

government securities dealers, that have 

filed notice with an appropriate 

regulatory agency) in connection with 

their activities that require such 

registration or notice. Although these 

prongs of the definition are proposed to 

prevent evasion of the statutory 

requirements, we seek comment on the 

extent to which either of these two 

prongs may create a competitive 

disadvantage for certain banking entities 

vis-a`-vis competitors that are either not 

subject to section 13 of the BHC Act 

and/or competitors subject to different 

prongs of the proposed definition. 

2. Exemption for Underwriting 

Activities 

Section 13(d)(1)(B) of the BHC Act 

provides an exemption from the 

prohibition on proprietary trading for 

purchases and sales in connection with 

underwriting activities, to the extent 

that such activities are designed not to 

exceed the reasonably expected near 

term demands of clients, customers, or 

counterparties. In implementing this 

exemption in §ll.4(a) of the proposed 

rule, the CFTC has endeavored to 

establish a regime that clearly sets forth 

the requirements for relying on the 

underwriting exemption established in 

the statute to facilitate banking entities’ 

compliance with the statutory 

requirements. In considering potential 

requirements for the underwriting 

exemption, and assessing the potential 

economic impacts of each such 

requirement, the CFTC strived to 

propose an appropriate balance between 

considerations related to: (i) The 

potential for evasion of the statutory 

prohibition on proprietary trading 

through misuse of the underwriting 

exemption; and (ii) the potential costs 

that may arise from constraints on 

legitimate underwriting activities. 

The CFTC has proposed to use, 

wherever practicable, common terms 

from existing laws and regulations in 

the context of underwriting to facilitate 

market participants’ understanding and 

use of the exemption and to promote 

consistency across laws and regulations. 

Specifically, the proposed definitions of 

‘‘distribution’’ and ‘‘underwriter’’ 

established in the proposed rule largely 

mirror the definitions provided for these 

terms in the SEC’s Regulation M. 

Because the proposed rule uses a 

modified version of the Regulation M 

definition of ‘‘underwriter’’ to include 

selling group members, the proposed 

definition would permit the current 

market practice of members of the 

underwriting syndicate entering into an 

agreement with other selling group 

members to collectively distribute the 

securities, rather than requiring all 

members of a distribution to join the 

underwriting syndicate. 

In addition, the definition of 

‘‘distribution’’ from Regulation M that 

the CFTC has proposed in §ll.4(a) of 

the proposed rule is intended to ensure 

that the underwriting exemption does 

not unduly constrain banking entities 

from providing underwriting services, 

while at the same time preventing 

banking entities from relying on the 

underwriting exemption to evade the 

proposed rule and the statutory 

prohibition on proprietary trading. The 

CFTC anticipates that the proposed 


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approach to implementing the 

underwriting exemption should permit 

legitimate forms of underwriting in 

which market participants currently 

engage and, thus, should not unduly 

burden capital formation. In addition, 

the proposed rule would permit 

underwriters to continue to employ 

existing practices to stabilize a 

distribution of securities, which 

stabilization promotes confidence 

among issuers, selling security holders, 

and investors and further supports 

capital formation. 

Under the proposed rule, the 

underwriting activities of a banking 

entity must be designed to generate 

revenues primarily from fees, 

commissions, underwriting spreads or 

other income, not from appreciation in 

value of covered financial positions that 

the banking entity holds related to such 

activities or the hedging of such covered 

financial positions. This proposed 

requirement should promote investor 

confidence by ensuring that the 

activities conducted in reliance on the 

underwriting exemption are designed to 

benefit the interests of clients seeking to 

bring their securities to market, not the 

interests of the underwriters themselves. 

The proposed requirement should also 

help prevent evasion of the statutory 

prohibition on proprietary trading, as 

trading activity designed to generate 

revenues from appreciation in the value 

of positions held by the banking entity 

would be indicative of prohibited 

proprietary trading, not underwriting 

activity. We seek comment on whether 

this approach of identifying 

underwriting activity by reference to 

revenue source could also make 

underwriting less profitable to the 

extent that it precludes or discourages 

certain types of profitability for bona 

fide underwriting services. 

In addition to commenters’ views on 

the potential economic impacts 

identified above, we request comment 

on whether the proposed rule may cause 

some banking entities to choose to 

decrease the supply of underwriting 

services in response to potential costs of 

the proposed rule and whether this 

result would adversely affect 

competition among underwriters or 

have a harmful impact on capital 

formation. In addition, if banking 

entities were to pass the increased costs 

of complying with the proposed 

exemption on to issuers, selling security 

holders, or their customers, we seek 

comment on whether the effect would 

be to increase the cost of raising capital 

and whether this would harm capital 

formation to the extent that such cost 

increases were sufficient to preclude 

issuers from accessing the capital 

markets. As described above, the CFTC 

has designed the proposal to balance 

such potential costs with provisions 

intended to permit banking entities’ 

legitimate underwriting activities to 

continue as provided by the statute, 

while also establishing sufficient 

requirements to prevent evasion of the 

statutory goals through misuse of the 

underwriting exemption. 

3. Exemption for Market Making-Related 

Activities 

Section 13(d)(1)(B) of the BHC Act 

provides an exemption from the 

prohibition on proprietary trading for 

purchases and sales in connection with 

market making-related activities, to the 

extent that such activities are designed 

not to exceed the reasonably expected 

near term demands of clients, 

customers, or counterparties. In setting 

forth the requirements for eligibility for 

this exemption in §ll.4(b) of the 

proposed rule, the CFTC has 

endeavored to establish a regime that 

clearly sets forth the requirements for 

relying on the exemption for market 

making-related activity established in 

the statute to facilitate banking entities’ 

compliance with the statutory 

requirements. In considering potential 

requirements for the market-making 

exemption, and assessing the potential 

economic impacts of each such 

requirement, the CFTC tried to strike an 

appropriate balance between 

considerations related to: (i) The 

potential for evasion of the statutory 

prohibition on proprietary trading 

through misuse of the exemption for 

market making-related activity; (ii) the 

potential difficulties related to 

distinguishing market making-related 

activity from prohibited proprietary 

trading; and (iii) potential costs that 

may arise from constraints on legitimate 

market making-related activities. 

The CFTC has proposed to use, where 

practicable, terms and concepts used in 

current laws and regulations in the 

context of market making to promote 

clarity and consistency. Recognizing 

that there are differences in market 

making activities between different 

types of asset classes (e.g., liquid and 

illiquid instruments) and market 

structures (e.g., organized trading 

facilities and the over-the-counter 

markets), the CFTC has proposed to 

implement the market-making 

exemption in a manner that accounts for 

these distinctions and permits market 

making activities in different asset 

classes and market structures. 

Permitting legitimate market making in 

its different forms should promote 

market liquidity and efficiency by 

allowing banking entities to continue to 

provide customer intermediation and 

liquidity services in both liquid and 

illiquid instruments. The CFTC also 

recognizes, however, that market 

making-related activities in the over-thecounter markets or activities involving 

less liquid instruments are sometimes 

less transparent than similar activities 

on organized trading facilities or in 

liquid markets. We seek comment on 

whether, in order to comply with the 

statutory prohibition on proprietary 

trading, some banking entities may be 

inclined to abstain from some marketmaking activities in an effort to reduce 

the risk of noncompliance. We also 

request comment on whether, if banking 

entities did so, this could result in 

reduced liquidity for certain types of 

trades or for certain less liquid 

instruments. 

In addition, the proposed exemption 

permits anticipatory market making, 

block positioning, and hedging of 

market making positions under certain 

circumstances, which should further 

facilitate customer intermediation and 

market liquidity and efficiency. 

However, certain conditions are placed 

on such market making-related activities 

in the proposal in an effort to ensure 

that such activities are, in fact, market 

making-related activities, and are not 

hidden proprietary trading activities 

subject to the statutory prohibition. 

The proposal requires that the market 

making-related activities be designed to 

generate revenues primarily from fees, 

commissions, bid/ask spreads or other 

income not attributable to appreciation 

in the value of covered financial 

positions a banking entity holds in 

trading accounts or the hedging of such 

positions. This proposed requirement 

should promote investor confidence by 

helping to ensure that market making 

serves customer needs. The proposed 

requirement should also help prevent 

evasion of the statutory prohibition on 

proprietary trading, as trading activity 

designed to generate revenues from 

appreciation in the value of positions 

held by the banking entity would be 

indicative of prohibited proprietary 

trading, not market making-related 

activity. The CFTC requests comment 

on whether this approach of identifying 

market making activity by reference to 

a market making trading unit’s revenue 

source would also make market making 

activity less profitable and whether it 

would preclude or discourage certain 

types of profitability for bona fide 

market making services. Commenters 

should also address whether this 

requirement would reduce the 

willingness of some banking entities to 

continue to provide market makingrelated services and whether this could 


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361The Agencies note that, for some costs of the 

proposed rule, hour burden estimates are provided 

in Part [internal cite to PRA] of this SUPPLEMENTARY

INFORMATION for purposes of the Agencies’ 

compliance with the Paperwork Reduction Act. 

reduce liquidity, harm capital 

formation, or make market makingrelated services more expensive. The 

CFTC notes that, in order to balance the 

potential for such effects with the 

statutory purpose, the proposed rule 

does not expressly prohibit all types of 

non-client income, and recognizes that 

the precise type and source of revenues 

generated by bona fide market making 

services can and will vary depending on 

the relevant market, asset, and facts and 

circumstances. 

4. Exemption for Risk-Mitigating 

Hedging Activities 

Section 13(d)(1)(C) provides an 

exemption from the prohibition on 

proprietary trading for risk-mitigating 

hedging activities in connection with 

and related to individual or aggregated 

positions, contracts, or other holdings of 

a banking entity that are designed to 

reduce the specific risks to the banking 

entity in connection with and related to 

such positions, contracts, or other 

holdings. The proposed exemption 

requires that the hedging transaction be 

reasonably correlated to these risks that 

the transaction is intended to hedge or 

otherwise mitigate. This proposed 

requirement is intended to address the 

potential for misuse of the exemption 

where a transaction is not closely tied 

to risk mitigation, while also providing 

some flexibility in the degree of 

correlation that is required in order to 

promote consistency with the statutory 

goals and requirements. 

In addition, the proposed exemption 

requires that the hedging transaction: (i) 

Not give rise, at the inception of the 

hedge, to significant exposures that are 

not themselves hedged in a 

contemporaneous transaction; and (ii) 

be subject to continuing review, 

monitoring, and management. Together, 

these proposed requirements are 

designed to ensure that a banking entity 

does not use the hedging exemption to 

conduct prohibited proprietary trading 

in the guise of hedging activity and to 

prevent evasion of the proprietary 

trading prohibition contained in section 

13 of the BHC Act and the proposed 

rule. These proposed requirements are 

intended to ensure that an exempt 

hedging transaction will mitigate, not 

amplify, risk. Moreover, such 

requirements should further the goals of 

compliance with the statutory 

requirements and reducing banking 

entities’ risks. 

We seek comment on whether the 

proposed requirements for relying on 

the hedging exemption are more 

restrictive than necessary to implement 

the statutory language and purpose, and 

to prevent evasion of the statutory 

provisions, and whether a banking 

entity’s hedging activities could be 

unduly constrained by the proposed 

rule. Further, commenters should 

address the extent to which a banking 

entity may be unable or unwilling to 

execute certain hedges and whether, as 

a result, a banking entity could be 

limited in its means to reduce its risk. 

In addition, would banking entities be 

dissuaded from engaging in other 

permitted activities or activities outside 

the scope of the statute (e.g., long-term 

investments) if the requirements of the 

proposed hedging exemption unduly 

limits or prevents them from mitigating 

the risks associated with such activities? 

We request comment on whether a 

reduction in efficiency could result from 

a reduced ability of covered banking 

entities to transfer risks to those more 

willing to bear them. Commenters 

should also address whether the 

proposed rule would reduce a banking 

entity’s willingness to engage in 

permitted risk-mitigating hedging 

activities in order to avoid costs related 

to ensuring compliance with the 

exemption’s requirements and whether 

this would increase the banking entity’s 

risk exposure. In order to balance the 

potential for such effects with the 

statutory purpose, the proposed rule 

attempts to implement the riskmitigating hedging exemption in a 

manner that recognizes that the precise 

nature and execution of risk mitigation 

through hedging transactions can and 

will vary depending on the relevant 

market, asset, and facts and 

circumstances, while also establishing 

requirements designed to ensure that 

transactions relying on the hedging 

exemption are, in fact, hedges and not 

hidden proprietary trading prohibited 

by the statute. 

The proposed exemption would 

require documentation with respect to 

hedges established at a different level of 

organization than that responsible for 

the underlying positions or risks that are 

being hedged. This proposed 

documentation requirement is intended 

to facilitate review by banking entities 

and Agency supervisors and examiners 

in assessing whether the hedge position 

was established to hedge or otherwise 

mitigate another unit’s risks. Without 

such documentation, there could be an 

increased risk of evasion of the statute’s 

prohibition on proprietary trading, as it 

would be difficult to assess whether a 

purported hedging transaction was 

established to mitigate another level of 

organization’s risk or solely to profit 

from price appreciation of the position 

established by the purported hedge. We 

seek comment on the costs of the 

proposed documentation requirement 

for certain hedging transactions, such as 

the costs related to systems changes and 

maintenance, employee resources and 

time, and recordkeeping.361 The CFTC 

also requests comment on the extent to 

which the proposed documentation 

requirement would reduce the speed in 

which a banking entity could execute a 

hedge at a different level within the 

entity and whether this could reduce 

efficiency or result in a banking entity 

being exposed to a greater amount of 

risk. Further, we seek commenters’ 

views on whether potentially slower 

execution times could also reduce 

profitability associated with the position 

as it remains unhedged (or, 

alternatively, increase profitability, 

depending on whether the value of the 

unhedged position is increasing or 

decreasing in the market). To balance 

the potential for such consequences 

with the statutory purpose, the CFTC 

has proposed to apply the 

documentation requirement to only a 

subset of hedging transactions that pose 

the greatest compliance risk (i.e., hedges 

that are established at a different level 

of organization than that establishing or 

responsible for the underlying positions 

or risks that are being hedged). In 

addition, the CFTC expects that the 

preparation of required documentation 

would become less burdensome and 

more efficient over time as systems are 

developed and personnel become more 

accustomed to the proposed 

requirement. 

5. Compensation Related to Permitted 

Activities 

The proposed rule would require that 

the compensation arrangements of 

persons performing underwriting, 

market making-related, and riskmitigating hedging activities be 

designed not to reward proprietary risktaking. These proposed requirements are 

intended to reduce incentives for 

personnel of the banking entity to 

violate the statutory prohibition on 

proprietary trading and expose the 

banking entity to risks arising from 

prohibited proprietary trading. We 

request comment on whether the 

proposed rule’s requirements regarding 

compensation arrangements would 

reduce the banking entity’s ability to 

attract talented and experienced trading 

personnel or would harm the banking 

entity’s ability to compete with entities 

that are not subject to section 13 of the 

BHC Act and the proposed rule. In order 


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362Section 13(e)(1) of the BHC Act requires the 

CFTC to issue regulations regarding internal 

controls and recordkeeping to ensure compliance 

with section 13. See 12 U.S.C. 1851(e)(1). Section 

ll.20 and Appendix C of the proposed rule also 

implement section 13(e)(1) of the BHC Act. 

to balance the potential for such effects 

with the statutory goals, the proposed 

rule does not expressly prescribe how a 

banking entity must compensate its 

personnel or prohibit all types of 

compensation incentives related to nonclient income, but instead proposes an 

approach that leaves banking entities 

with a degree of flexibility to 

compensate their personnel as they 

deem appropriate. 

6. Exemption for Trading on Behalf of 

Customers 

Section ll.6(b) of the proposed rule 

implements section 13(d)(1)(D) of the 

BHC Act, which permits a banking 

entity, notwithstanding the prohibition 

on proprietary trading, to purchase or 

sell a covered financial position on 

behalf of customers. Because the statute 

does not define when a transaction 

would be conducted on behalf of 

customers, the proposed rule identifies 

three categories of transactions that 

would qualify under this exemption. By 

providing that only transactions meeting 

the terms of the three categories would 

be considered to be on behalf of 

customers for purposes of the 

exemption, the proposed rule addresses 

the potential for evasion of the statutory 

prohibition. At the same time, the 

proposed rule also would not permit 

banking entities to rely on the 

exemption with respect to other, 

unanticipated transactions that banking 

entities may undertake on behalf of 

customers. The CFTC seeks comment on 

whether banking entities currently 

engage in principal transactions on 

behalf of customers that are not covered 

by the proposed exemption or other 

permitted activities and whether the 

lack of an exemption in the proposed 

rule for such activities would impact 

beneficial customer facilitation, market 

liquidity, efficiency, or capital 

formation. 

7. Exemption for Trading Outside of the 

United States 

Section ll.6(d) of the proposed rule 

implements section 13(d)(1)(H) of the 

BHC Act, which permits certain foreign 

banking entities to engage in proprietary 

trading that occurs ‘‘solely outside of 

the United States.’’ The proposed 

exemption provides a number of 

specific criteria for determining when 

trading will be considered to have 

occurred solely outside of the United 

States to help prevent evasion of the 

statutory restriction. The proposed 

exemption also provides a definition of 

‘‘resident of the United States’’ that is 

similar to the SEC’s definition of ‘‘U.S. 

person’’ in Regulation S, which should 

promote consistency and understanding 

among market participants that have 

experience with the concept from the 

SEC’s Regulation S. In addition, the 

proposed exemption clarifies when a 

foreign banking entity will be 

considered to engage in such trading 

pursuant to sections 4(c)(9) and 4(c)(13) 

of the BHC Act, as required by the 

statute, including with respect to a 

foreign banking entity that is not a 

‘‘foreign banking organization’’ under 

the Board’s Regulation K. This 

implementation of section 13(d)(1)(H) of 

the BHC Act would permit certain 

foreign banking entities that are not 

‘‘qualifying foreign banking 

organizations’’ under the Board’s 

Regulation K to also rely on the 

exemption, notwithstanding the fact 

such foreign banking entities are not 

currently subject to the BHC Act 

generally or the Board’s Regulation K. 

As a result, such foreign banking 

entities should encounter fewer costs 

related to complying with the 

proprietary trading prohibitions than if 

they were unable to rely on the 

exemption in section 13(d)(1)(H) of the 

BHC Act. 

Despite the reference to section 

4(c)(13) of the BHC Act, the statute 

provides that the exemption for trading 

outside of the United States is only 

available to banking entities that are not 

directly or indirectly controlled by U.S. 

banking entities (i.e., not any U.S. 

banking entities or their foreign 

subsidiaries and affiliates). Under the 

statute, the prohibition on proprietary 

trading applies to the consolidated, 

worldwide operations of U.S. firms. As 

required by statute, the proposal 

prohibits U.S. banking entities from 

engaging in proprietary trading unless 

the requirements of one or more 

relevant exemptions (other than the 

exemption for trading by foreign 

banking entities) are satisfied. As a 

result, the statute creates a competitive 

difference between the foreign activities 

of U.S. banking entities, which must 

monitor and limit their foreign activities 

in accordance with the requirements of 

section 13 of the BHC Act, relative to 

the foreign activities of foreign-based 

banking entities, which may not be 

subject to restrictions similar to those in 

section 13 of BHC Act. The CFTC seeks 

commenters’ views on whether the 

proposed rule’s implementation of 

section 13(d)(1)(H) of the BHC Act 

imposes additional competitive 

differences, beyond those recognized 

above, and the potential economic 

impact of such competitive differences. 

8. Quantitative Measurements 

Section ll.7 of the proposed rule, 

which implements in part section 

13(e)(1) of the BHC Act,362 requires 

certain banking entities to comply with 

the reporting and recordkeeping 

requirements specified in Appendix A 

of the proposed rule. Proposed 

Appendix A requires a banking entity 

with significant trading activities to 

furnish periodic reports to the relevant 

Agency regarding various quantitative 

measurements of its trading activities 

and create and retain records 

documenting the preparation and 

content of these reports. The proposed 

measurements would vary depending 

on the scope, type, and size of trading 

activities. In addition, proposed 

Appendix B contains a detailed 

commentary regarding the 

characteristics of permitted market 

making-related activities and how such 

activities may be distinguished from 

trading activities that, even if conducted 

in the context of banking entity’s market 

making operations, would constitute 

prohibited proprietary trading. These 

proposed requirements are intended, in 

particular, to address some of the 

difficulties associated with (i) 

identifying permitted market makingrelated activities and distinguishing 

such activities from prohibited 

proprietary trading and (ii) identifying 

certain trading activities resulting in 

material exposure to high-risk assets or 

high-risk strategies. In combination, 

§ ll.7 and Appendix A of the 

proposed rule provide a quantitative 

overlay designed to help banking 

entities and the CFTC identify trading 

activities that warrant further analysis 

or review in a variety of levels and 

contexts. 

The various quantitative 

measurements that would be required to 

be reported focus on assessing banking 

entities’ risk management, sources of 

revenue, revenues in relation to risk, 

customer servicing, and fee generation. 

Aberrant patterns among the 

measurements with respect to these 

areas would warrant further review to 

determine whether trading activities 

have occurred that are proprietary in 

nature and whether such activities may 

be exposing banking entities to 

disproportionate risk. For example, 

quantitative measurements should 

provide banking entities with a useful 

starting point for assessing whether 

their trading activities are consistent 

with the proposed rule and whether 

traders are exposing the entity to 

disproportionate risks. In addition, 


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proposed Appendix A applies a 

standardized description and general 

method of calculating each quantitative 

measurement that, while taking into 

account the potential variation among 

trading practices and asset classes, is 

intended to facilitate reporting of 

sufficiently uniform information across 

different banking entities so as to permit 

horizontal reviews and comparisons of 

the quantitative profile of trading units 

across firms. This proposed approach, 

which recognizes that quantitative 

measurements must be applied with 

respect to differences within a banking 

entity’s structure, business lines, and 

trading desks, should facilitate efficient 

application within firms and efficient 

examination across firms. The proposed 

use of a suite of quantitative 

measurements for these purposes may 

also limit erroneous indications of 

potential violations or erroneous 

indications of compliance (i.e., false 

positives and false negatives), thus 

allowing banking entities and examiners 

and supervisors to focus upon the 

measurements that may be most 

relevant in identifying prohibited 

conduct. The uniformity of the 

proposed measurements across different 

types of banking entities is also 

intended to ensure that banking entities 

are calculating comparable 

measurements consistently and that 

comparable measurements are being 

evaluated consistently by the CFTC. The 

CFTC expects that as the 

implementation of quantitative 

measurements and the internal 

compliance and external oversight 

processes become more efficient over 

time, banking entities will find 

compliance efforts less burdensome. 

The CFTC seeks comment on the 

extent to which banking entities will 

incur costs associated with 

implementing, monitoring, and 

attributing financial and personnel 

resources for purposes of complying 

with the requirements of proposed 

Appendix A. Specifically, please 

discuss the extent to which banking 

entities are unlikely to currently 

calculate certain quantitative 

measurements in the manner required 

under the proposal (e.g., Spread Profit 

and Loss or Customer-facing Trade 

Ratio) and whether this may result in 

significant start-up costs associated with 

developing these measurements. Under 

the proposal, banking entities would 

also need to dedicate personnel and 

supervisory staff to review for potential 

aberrant patterns of activity that warrant 

further review, as well as maintain 

appropriate records of that review. In 

order to limit these calculation and 

surveillance costs to the greatest extent 

practicable, the CFTC has proposed 

measurements that, in many cases, are 

already calculated by many banking 

entities to measure and manage trading 

risks and activities. The costs to banking 

entities associated with calculating the 

proposed quantitative metrics should 

also be mitigated by the tiered 

application of Appendix A, which 

would require banking entities with the 

most extensive trading activities to 

report the largest number of quantitative 

measurements, while imposing fewer or 

no reporting requirements on banking 

entities with smaller trading activities. 

By limiting the application of aspects of 

Appendix A to firms with greater than 

$1 billion in trading assets and 

liabilities, and all aspects of the 

appendix only to entities with greater 

than $5 billion in trading assets and 

liabilities, the costs imposed should be 

proportional to the market reach and 

complexity of a banking entity’s trading 

activities. 

B. Covered Fund Activities 

Subpart C implements the statutory 

provisions of section 13(a)(1)(B) of the 

BHC Act, which prohibit banking 

entities from acquiring or retaining any 

equity, partnership, or other ownership 

interest in, or sponsoring, a covered 

fund, and other provisions of section 13 

of the BHC Act which provide 

exemptions from, or otherwise relate to, 

that prohibition. In implementing the 

covered funds provisions of section 13 

of the BHC Act, the CFTC has proposed 

to define and interpret several terms 

used in implementing these provisions 

and the goals of section 13. We seek 

comment on whether the proposed rule 

represents a balanced and effective 

approach to implementing the covered 

fund provisions of the statute. 

1. General Scope 

For banking entities that invest in, 

sponsor or have relationships with one 

or more covered funds, the economic 

impact of complying with the statute 

and the implementing rule will vary, 

depending on the size, scope and 

complexity of their respective business, 

operations and relationships with 

clients, customers and counterparties. 

Moreover, the types of covered funds 

advised or sponsored by an adviser, the 

types of business and other 

relationships that an adviser may 

conduct with such funds and the 

adviser’s other business activities, 

including relationships with other third 

party advised covered funds, will affect 

whether a covered fund activity would 

be subject to the statutory prohibition, 

eligible for a particular exemption or 

subject to particular internal control 

requirements as specified by the 

proposed rule. 

For example, with respect to a 

banking entity that does not ‘‘sponsor,’’ 

invest in, or otherwise provide ‘‘prime 

brokerage transactions’’ to, a ‘‘covered 

fund,’’ the statute, as implemented by 

the proposed rule, would not 

substantively restrict the banking 

entity’s activity; instead, the proposed 

rule would only require the minimum 

internal controls reasonably designed to 

prevent the entity from engaging in the 

prohibited activities. As a result, we do 

not expect that the proposed rule would 

have a significant effect on most 

banking entities, such as investment 

advisers, that are primarily engaged in 

providing bona fide trust, fiduciary, or 

advisory services to unrelated parties. 

Although such advisers may incur some 

incremental costs to develop and 

implement a compliance program 

reasonably designed to ensure that they 

do not engage in otherwise prohibited 

activities, there should be no significant 

costs associated with modifying existing 

business practices and procedures. We 

request comment on the extent to which 

such banking entities would be required 

to modify their existing business 

practices and procedures to comply 

with the proposed rule. For instance, 

would a registered investment adviser 

that only advises registered investment 

companies and that does not trade for 

its own account incur costs, benefits or 

other impacts in addition to costs to 

implement the minimum internal 

controls reasonably designed to prevent 

it from engaging in prohibited activities? 

Would an adviser that trades on behalf 

of itself incur, with respect to such 

trading activities, additional costs, 

benefits or other impacts described 

above relating to the proposed 

restrictions on proprietary trading? 

In contrast, a banking entity that seeks 

to invest in a covered fund could only 

do so in reliance on an exemption 

specified in the statute or the proposed 

rule, such as the exemption for 

organizing and offering certain covered 

funds provided in section 13(d)(1)(G), as 

implemented in §ll.11 of the 

proposed rule. Similarly, a banking 

entity that seeks to enter into ‘‘prime 

brokerage transactions’’ with a covered 

fund could only do so by meeting 

certain requirements under the 

proposed rule. Accordingly, the 

economic impact of the proposed rule 

will depend on whether an adviser’s 

activities fall within the scope of the 

terms as proposed such that the banking 

entity would be subject to the 

limitations on covered fund activities. 

To the extent that these terms or 


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8414 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

exemptions would result in more, or 

fewer, activities being captured by the 

proposed rule, what are the attendant 

costs and benefits that a covered 

banking may incur? We request 

commenters provide empirical data, or 

studies, where possible. 

Definition of Covered Fund. The 

proposed rule’s definition of ‘‘covered 

fund’’ includes hedge funds and private 

equity funds as defined by statute, but 

also identifies two types of similar 

funds—commodity pools and certain 

non-U.S. funds—that are subject to the 

covered fund restrictions and 

prohibitions of section 13 of the BHC 

Act, as implemented by the proposed 

rule. The CFTC has proposed to include 

these funds since they are generally 

managed and structured similar to a 

covered fund, but are not generally 

subject to the Federal securities laws 

due to the instruments in which they 

invest or the fact that they are not 

organized in the United States or one or 

more States. We request comment on 

whether applying the definition of 

covered fund in this way as proposed 

would increase the number of 

investment vehicles or similar entities 

that would be subject to the limitations 

under the proposed rule. Would this 

approach increase compliance costs for 

banking entities that sponsor, invest in, 

or have certain relationships with these 

types of funds? 

The proposed rule also excludes 

certain types of investments in covered 

funds, pursuant to section 13(d)(1)(J) of 

the BHC Act, which authorizes the 

CFTC to exclude from the general 

covered fund activity prohibition those 

activities that would promote the safety 

and soundness of a banking entity. 

Section ll.14 of the proposed rule 

would exclude from the prohibition, 

among other things, a banking entity’s 

investments in covered funds related to 

bank owned life insurance, certain joint 

ventures and interests in securitization 

vehicles retained in compliance with 

the minimum credit risk retention 

requirements of section 15G of the 

Exchange Act. We request comment on 

the potential economic impact of the 

proposal to exclude these types of 

investments from the general 

prohibition. For banking entities whose 

only covered fund activities are those 

described in §ll.14, what economic 

impact would be attributed to 

complying with this provision of the 

proposed rule? Would these costs and 

benefits differ from those of banking 

entities that conduct covered fund 

activities as well as engage in activities 

described in §ll.14? As described in 

the Supplementary Information, a 

banking entity that generally does not 

engage in any prohibited activities is 

only required to adopt and implement a 

compliance program reasonably 

designed to ensure that the entity does 

not engage in prohibited activities. To 

what extent will the proposed 

provisions in § __.14 increase or 

mitigate any costs, benefits or other 

impacts associated with the foregoing 

minimum internal controls 

requirement? 

Definition of Sponsor. Under the 

proposed rule, the term ‘‘sponsor’’ is 

defined by incorporating the definition 

set forth in section 13(h)(5) of the BHC 

Act, but the CFTC has proposed to 

clarify that the term trustee, as used in 

the definition of sponsor, does not 

include a trustee that does not provide 

discretionary investment services to a 

covered fund. This exception 

distinguishes a trustee providing nondiscretionary advisory services from 

trustees providing services similar to 

those associated with entities serving as 

general partner, managing member, 

commodity pool operator or investment 

adviser of a covered fund. We request 

comment on the economic impact 

associated with the proposed definition 

of ‘‘sponsor.’’ Will the economic impact 

differ depending on the scope of a 

banking entity’s covered fund activities? 

For example, a banking entity whose 

only relationship with a covered fund 

involves the provision of nondiscretionary investment services would 

not be a sponsor under the proposed 

rule. We request comment on whether 

such a banking entity would benefit 

from this exception. We also request 

comment on whether a covered fund’s 

investors and counterparties would bear 

any costs associated with a banking 

entity’s modification of its business 

practices or its relationship to the 

covered fund. 

Other Definitions. The covered fund 

provisions also define, among other 

things, ‘‘director’’ and ‘‘prime brokerage 

transaction.’’ What are the costs, 

benefits or other impacts associated 

with the way the proposed rule defines 

these terms? For example, would the 

proposed definition of ‘‘prime brokerage 

transaction’’ enable a banking entity to 

provide services to a covered fund that 

would not ordinarily be understood to 

be prime brokerage as long as it met 

certain conditions? What costs, or 

benefits, for banking entities, clients, 

customers or counterparties may be 

associated with this approach to 

defining prime brokerage transaction? 

2. Exemptions 

In implementing the covered funds 

provisions of section 13 of the BHC Act, 

the CFTC also has interpreted or defined 

terms contained in the three principal 

exemptions related to covered fund 

activities by a banking entity: (i) The 

exemption for organizing and offering 

covered funds; (ii) the exemption for 

investment in a covered fund in the case 

of risk-mitigating hedging; and (iii) the 

exemption for covered fund activities 

outside of the United States. We request 

comment generally on the potential 

impact of these statutory exemptions, as 

implemented by the proposed rule. The 

CFTC notes that there are multiple 

factors that could affect the impact of 

the statute and the proposed rule on a 

banking entity’s covered fund activities, 

including other conditions set forth in 

the statute or the proposed rule that 

could mitigate costs or enhance benefits 

associated with a particular element or 

condition of an exemption. 

Organize and Offer Exemption. 

Section ll.11 of the proposed rule 

implements the exemption set forth in 

section 13(d)(1)(G) of the BHC Act and 

generally incorporates all of the 

conditions specified in the statute. As 

required by the statute, the exemption 

for organizing and offering covered 

funds is available only to banking 

entities that provide bona fide trust, 

fiduciary, commodity trading or 

investment advisory services, which 

must meet certain requirements. As a 

result, the exemption should not 

preclude banking entities, such as 

registered advisers, registered operators, 

or other advisers, from providing trust 

or advisory services to their clients. We 

request comment on whether the 

proposed requirements of the exemption 

would result in a banking entity 

modifying its business practices or 

bearing higher costs to comply with the 

limitations and requirements applicable 

to this statutory exemption, as 

implemented by the proposed rule. 

These costs may include, for example, 

developing a credible plan that 

documents how advisory services 

would be provided to banking entity 

customers through organizing and 

offering covered funds and making the 

specified disclosures required by the 

exemption. We also request comment on 

whether the banking entity will pass 

these costs on to covered fund investors 

and counterparties. 

In implementing this statutory 

exemption, the CFTC has defined or 

clarified several key terms or 

requirements, including (i) the 

definition of ownership interest and (ii) 

the method for calculating the 3% 

ownership interest limit. The proposed 

definition of ownership interest is 

designed to describe the typical types of 

relationships through which an investor 

has exposure to the profits and losses of 


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Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 8415 

363Proposed rule §ll.10(b)(3)(i). 

a covered fund. Consistent with this 

approach, carried interest is not 

included within the proposed definition 

of ownership interest. As discussed in 

the Supplementary Information above, 

carried interest generally entitles service 

providers, such as banking entities that 

provide advisory services, to receive 

compensation for such services 

determined as a share of a covered 

fund’s profits. As a result, the proposed 

rule does not treat carried interest as an 

ownership interest, which could have 

costs and benefits. To help discern these 

costs and benefits, we request comment 

on whether this is consistent with how 

providers of advisory services view the 

receipt of such ‘‘carried interest’’ (i.e., as 

compensation for services rather than as 

an ‘‘ownership interest’’ equivalent to 

an investor’s interest that shares in a 

fund’s profits and losses). The proposed 

definition of carried interest has 

limitations designed to prevent a 

banking entity from circumscribing the 

proposed rule’s limitations on 

ownership. For instance, among other 

things, the proposed definition requires 

that the ‘‘sole purpose and effect of the 

interest is to allow banking entity * * * 

to share in the profits of the covered 

fund. 363 For banking entities receiving 

compensation that would satisfy all of 

the elements of the proposed definition, 

there should be no burden associated 

with modifying existing business 

practices. For other banking entities, 

however, the conditions specified in the 

proposed definition could result in 

more banking entities being deemed to 

hold ‘‘ownership interests’’ and hence 

subject to the limitations under the 

statute and the proposed rule, including 

the limitations on material conflicts of 

interest, high-risk trading activities and 

exposure to high-risk assets. We request 

comment on whether these banking 

entities would need to modify their 

existing practices and develop 

alternatives, and, if so, whether these 

modifications will impose costs and 

benefits. For example, costs associated 

with modifying business practices could 

include developing and implementing a 

compliance program in accordance with 

the proposed rule; benefits that may 

arise as a result of modifying business 

practices could include limiting the 

extent to which material conflicts of 

interest may arise between clients, 

customer and counterparties of banking 

entities. We also request comment on 

whether such costs, if any, are likely to 

be passed on to fund investors, clients 

and counterparties. 

As required by statute, a banking 

entity that seeks to invest in a covered 

fund under the exemption for 

organizing and offering covered funds 

could not, after the expiration of an 

initial one-year period (plus any 

applicable extensions), hold more than 

3% of the total outstanding ownership 

interests of such fund. The proposed 

rule would require that a banking entity 

calculate the per-fund limit whenever 

the covered fund calculates its value or 

permits investor investments or 

redemptions, but in no case less 

frequently than quarterly. We request 

comment on whether this approach will 

limit any additional burden associated 

with calculating the per-fund limit for 

banking entities that invest in covered 

funds that determine their value on at 

least a quarterly basis. We also request 

comment on whether such banking 

entities will incur any additional 

significant costs in determining their 

compliance with the 3% ownership 

limitation. 

Risk-mitigating Hedging Exemption. 

The proposed rule specifies an 

exemption from the general prohibition 

on covered fund activities in the case of 

risk-mitigating hedging. Similar to the 

hedging exemption in the case of 

proprietary trading (discussed above), 

the hedging exemption for covered fund 

activities specifies a number of 

conditions that are identical except for 

two conditions. In the case of the 

hedging exemption for covered fund 

activities, the hedging must generally 

‘‘offset’’ the exposure of the banking 

entity to the liabilities associated with 

(i) the facilitation of customer 

transactions or (ii) compensation 

arrangements for certain employees. 

Consistent with the statute, the 

proposed exemption would enable a 

banking entity to invest in a covered 

fund without limit if the investment is 

for risk-mitigating hedging purposes. 

We request comment on whether the 

proposed requirements will have 

benefits of furthering the goals of 

compliance with the statute and 

reducing banking entities’ risks. We also 

request comment on whether the 

proposed requirements are more 

restrictive than necessary to implement 

the statute and whether they could 

unnecessarily limit a banking entity’s 

hedging activities and ability to reduce 

risk. Commenters should also address 

whether the proposed requirements will 

dissuade banking entities from engaging 

in other permitted activities (e.g., 

organizing and offering covered funds) 

or those activities outside the scope of 

the statute to the extent that the 

exemption prevents them from 

mitigating the risks associated with such 

activities. We request comment on 

whether a reduction in efficiency could 

result from a reduced ability of covered 

banking entities to transfer risks to those 

more willing to bear them. 

Commentators should also address 

whether the proposed rule could reduce 

a banking entity’s willingness to engage 

in permitted risk-mitigating hedging 

activities in order to avoid costs related 

to ensuring compliance with the 

exemption’s requirements, and whether 

this would increase the banking entity’s 

risk exposure. 

Exemption for Covered Fund 

Activities Outside of the United States. 

Section ll.13(c) of the proposed rule 

implements section 13(d)(1)(I) of the 

BHC Act, which permits certain foreign 

banking entities to sponsor or invest in 

covered funds ‘‘solely outside of the 

United States,’’ so long as the covered 

fund is not offered or sold to a resident 

of the United States. The proposed 

exemption provides a number of 

specific criteria for determining when a 

banking entity will be considered to 

have invested or sponsored a covered 

fund solely outside of the United States. 

The proposed exemption provides a 

definition of ‘‘resident of the United 

States’’ that is similar, but not identical, 

to the SEC’s definition of ‘‘U.S. person’’ 

in Regulation S, which should promote 

consistency and understanding among 

market participants that have 

experience with the concept from the 

SEC’s Regulation S. In addition, the 

proposed exemption clarifies when a 

foreign banking entity will be 

considered to engage in such trading 

pursuant to sections 4(c)(9) and 4(c)(13) 

of the BHC Act, as required by the 

statute, including with respect to a 

foreign banking entity that is not a 

‘‘foreign banking organization’’ under 

the Board’s Regulation K. This 

implementation of section 13(d)(1)(I) of 

the BHC Act would permit certain 

foreign banking entities that are not 

‘‘qualifying foreign banking 

organizations’’ under the Board’s 

Regulation K to also rely on the 

exemption, notwithstanding the fact 

such foreign banking entities are not 

currently subject to the BHC Act 

generally or the Board’s Regulation K. 

As a result, such foreign banking 

entities should encounter fewer costs 

related to complying with the covered 

fund activity prohibitions than if they 

were unable to rely on the exemption in 

section 13(d)(1)(I) of the BHC Act. 

Despite the reference to section 

4(c)(13) of the BHC Act, the statute 

provides that the exemption for covered 

fund activities outside of the United 

States is only available to banking 

entities that are not directly or 

indirectly controlled by U.S. banking 

entities (i.e., not any U.S. banking 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
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entities or their foreign subsidiaries and 

affiliates). Under the statute, the 

prohibition and restrictions on covered 

fund activities apply to the 

consolidated, worldwide operations of 

U.S. firms. As required by statute, the 

proposal prohibits U.S. banking entities 

from investing in or sponsoring covered 

funds unless the requirements of one or 

more relevant exemptions (other than 

the exemption for trading by foreign 

banking entities) are satisfied. As a 

result, the statute creates a competitive 

difference between the foreign activities 

of U.S. banking entities, which must 

monitor and limit their foreign activities 

in accordance with the requirements of 

section 13 of the BHC Act, relative to 

the foreign activities of foreign-based 

banking entities, which may not be 

subject to restrictions similar to those in 

section 13 of the BHC Act. The CFTC 

seeks commenters’ views on whether 

the proposed rule’s implementation of 

section 13(d)(1)(I) of the BHC Act 

imposes additional competitive 

differences, beyond those discussed 

above, and the potential economic 

impact of such competitive differences. 

3. Securitizations 

The CFTC recognizes that by defining 

‘‘covered fund’’ and ‘‘banking entity’’ 

broadly, securitization vehicles may be 

affected by the restrictions and 

requirements of the proposed rule, and 

this may give rise to various economic 

effects. The CFTC preliminarily believes 

that the proposed rule should mitigate 

the impact of securitization market 

participants and investors in some nonloan asset classes (including, for 

example, banking entities that are 

participants in a securitization that may 

acquire or retain ownership interests in 

a securitization vehicle that falls within 

the definition of covered fund) by 

excluding loan securitizations from the 

restrictions on sponsoring or acquiring 

and retaining ownership interests in 

covered funds. 

Costs may be incurred to establish 

internal compliance programs to track 

compliance for any securitization 

vehicle that falls within the definition of 

banking entity. These costs may be 

minimized for future securitization 

vehicles, however, because such 

securitizations may be able both to 

incorporate any internal compliance 

program requirements into their 

documentation prior to execution and to 

minimize (or eliminate) any activities 

that may trigger greater compliance 

costs. The proposed rule should further 

minimize the costs of the internal 

compliance programs by (i) allowing for 

enterprise-wide compliance programs 

and minimal requirements for banking 

entities that do not engage in covered 

trading activities and/or covered fund 

activities or investments (each as 

described below), and (ii) allowing for 

reduced compliance program 

requirements by establishing financial 

thresholds for ‘‘significant’’ covered 

trading activities or covered fund 

activities or investments (as described 

below). 

There could be initial costs both for 

banking entities that have an ownership 

interest in a securitization vehicle and 

for other securitization participants to 

determine if a particular vehicle falls 

within the definition of covered fund. 

Additional costs could be incurred to 

the extent that banking entities divest 

their ownership interests in any 

securitization vehicle that is a covered 

fund and is not otherwise eligible for 

one of the exceptions allowed under the 

proposed rule. This divestment could 

result in selling pressure that may have 

a negative impact on the market prices 

for the vehicles that fall within the 

definition of covered fund, which in 

turn could impact all investors in those 

securitization vehicles. Additionally, 

under the proposed rule, banking 

entities would no longer be allowed to 

acquire and retain such ownership 

interests, which may result in fewer 

potential investors and reduced 

liquidity in the market for ownership 

interests in these covered funds. 

For example, the proposed rule could 

lead to significant potential market 

impacts if, with respect to an issuance 

of asset-backed securities secured by 

assets which are not loans, the market 

requires credit risk retention in excess 

of the minimum requirements to be 

adopted pursuant to Section 941 of the 

Dodd-Frank Act (i.e., the market 

believes that 5% credit risk retention is 

insufficient to address potential 

misalignment of incentives in a 

particular transaction). In such 

circumstances, the proposed rule could 

reduce potential investors’ demand for 

such securitizations and could make 

such securitizations more expensive. 

C. Limitations on Permitted Activities 

for Material Conflicts of Interest and 

High-Risk Assets and High-Risk Trading 

Strategies 

Section 13(d)(2)(A)(i) of the BHC Act 

provides that an otherwise-permitted 

activity would not qualify for a statutory 

exemption if it would involve or result 

in a material conflict of interest. The 

proposed rule’s definition of material 

conflict of interest, as discussed in more 

detail in Part II of the Supplemental 

Information, would provide flexibility 

to banking entities and their clients, 

customers, and counterparties with 

respect to how transactions are 

structured, while also establishing a 

structure to prevent banking entities 

from engaging in transactions and 

activities in reliance on a statutory 

exemption when the transaction or 

activity would have a materially adverse 

effect on the clients, customers, or 

counterparties of the banking entity. 

Specifically, the proposed definition 

would permit the use of timely and 

effective disclosure and/or information 

barriers in certain circumstances to 

address and mitigate conflicts of 

interest, while prohibiting transactions 

or activities where such a conflict of 

interest cannot be addressed or 

mitigated in the specified manner. The 

CFTC has endeavored to establish a 

workable definition that sets forth when 

a banking entity may not rely on an 

exemption because it would involve or 

result in a material conflict of interest, 

consistent with the statutory goals, to 

facilitate banking entities’ compliance 

with the statutory requirements. We 

seek comment on whether the statutory 

prohibition, as implemented by the 

proposal, may impose costs on banking 

entities or their clients, customers, or 

counterparties. For instance, by 

permitting a client, customer or 

counterparty the option of negating or 

mitigating the conflict after the banking 

entity has disclosed the conflict, would 

the banking entity incur certain costs 

related to terminating the transaction, 

providing compensation or other means 

of mitigating the conflict, or 

administrative costs associated with 

negotiating the extent of any such 

compensation or other means of 

mitigating the conflict, depending on 

the actions of the client, customer, or 

counterparty in response to the 

disclosure? 

In addition, section 13(d)(2)(A)(ii) of 

the BHC Act provides that an otherwisepermitted activity would not qualify for 

a statutory exemption if it would result, 

directly or indirectly, in a material 

exposure by the banking entity to highrisk assets or high-risk trading strategies. 

This statutory limitation, as 

implemented in the proposed rule, 

would prevent a banking entity from 

engaging in certain high-risk activity. 

The CFTC requests comment on 

whether the proposed definitions of 

high-risk asset and high-risk trading 

strategy would potentially reduce 

liquidity or create a reduction in 

efficiency for assets or markets related 

to that high-risk activity. 

D. Compliance Program 

Under §ll.20 of the proposed rule, 

all covered banking entities that are 

engaged in covered trading activities or 


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364Proposed rule §ll.20 and Appendix C 

implement section 13(e) of the BHC Act, which 

requires the Agencies to issue regulations regarding 

internal controls and recordkeeping to ensure 

compliance with section 13. 

covered fund activities or investments 

would be required to have a compliance 

program that provides for the following 

six elements, at a minimum: (i) Internal 

written policies and procedures; (ii) 

internal controls; (iii) a management 

framework; (iv) independent testing; (v) 

training; and (vi) recordkeeping. For 

those banking entities with significant 

covered trading activities or covered 

fund activities or investments under 

§ ll.20(c) of the proposed rule, 

additional standards in proposed 

Appendix C must be met with respect 

to these six elements.364 Collectively, 

the six proposed requirements would 

facilitate a banking entity’s review and 

assessment of its compliance with 

section 13 of the BHC Act and the 

proposed rule, including identifying 

potential areas of deficiency in a 

banking entity’s compliance program 

and providing the banking entity the 

opportunity to take appropriate 

corrective or disciplinary action, where 

warranted. The proposed compliance 

program would also facilitate Agency 

examination and supervision for 

compliance with the requirements of the 

statute and the proposed rule. By 

requiring that a banking entity have in 

place specific, documented elements 

(e.g., written policies and procedures 

and internal controls, recordkeeping 

requirements), the proposed rule would 

ensure that Agency examiners and 

supervisors can effectively review a 

banking entity’s activities and 

investments to assess compliance and, 

where a banking entity is not in 

compliance with the proposed rule, take 

appropriate action. 

Beyond the benefits recognized above, 

the individual elements of the proposed 

compliance program should also 

provide certain benefits. For example, 

the proposed management framework 

requirement is designed to give 

management a greater incentive to 

comply with the proposed rule and to 

ascertain that the employees they are 

responsible for overseeing are also 

complying with the proposed rule. 

Further, by establishing a management 

framework for compliance, the banking 

entity would be required to set a strong 

compliance tone at the top of the 

banking entity’s organization and signal 

to its employees that management is 

serious about compliance, which should 

foster a strong culture of compliance 

throughout the banking entity. 

Similarly, the proposed independent 

testing requirement would provide a 

third-party assessment of a banking 

entity’s compliance with the proposed 

rule, which should provide assurances 

to the banking entity, its clients, 

customers, and counterparties, and 

current or prospective investors that the 

banking entity is in compliance with the 

proposed rule. In addition, the proposed 

training requirement should help the 

various employees of a banking entity 

that have responsibilities and 

obligations under the proposed rule 

(e.g., complying with the requirements 

for permitted market making-related 

activity) understand such 

responsibilities and obligations and 

facilitate the banking entity’s 

compliance with the proposed rule. 

This proposed requirement may also 

promote market confidence by assuring 

that trading personnel, and other 

appropriate personnel of the banking 

entity, are familiar with their regulatory 

responsibilities and are complying with 

the applicable laws and regulations in 

their interactions with clients, 

customers, and counterparties. 

Because the six elements would be 

required to be established by all banking 

entities, other than those that are not 

engaged in covered trading activities or 

covered fund activities or investments, 

the proposed compliance program 

requirement should promote 

consistency across banking entities. 

However, the proposed elements are 

also intended to give a banking entity a 

degree of flexibility in establishing and 

maintaining its compliance program in 

order to address the varying nature of 

activities or investments conducted by 

different units of the banking entity’s 

organization, including the size, scope, 

complexity, and risks of the activity or 

investment. 

We seek comment on whether 

developing and providing for the 

continued administration of a 

compliance program under §ll.20 of 

the proposed rule is likely to impose 

material costs on banking entities. Costs 

related to the proposed compliance 

program requirement are likely to be 

higher for those banking entities that are 

engaged in significant covered trading 

or covered fund activities or 

investments and, as a result, are 

required to comply with the more 

detailed, specific requirements of 

proposed Appendix C. Potential costs 

related to implementation of a 

compliance program under the proposal 

include those associated with: Hiring 

additional personnel or other personnel 

modifications, new or additional 

systems (including computer hardware 

or software), developing exception 

reports, and consultation with outside 

experts (e.g., attorneys, accountants). 

The proposed compliance program 

requirement would also impose ongoing 

costs related to maintenance and 

enforcement of the compliance program 

elements, which may include those 

associated with: Ongoing system 

maintenance, surveillance (e.g., 

reviewing and monitoring exception 

reports), recordkeeping, independent 

testing, and training. For example, the 

independent testing requirement in the 

proposal may necessitate that additional 

resources be provided to the internal 

audit department of the covered banking 

entity that is a registered broker-dealer 

or security-based swap dealer, if such 

testing is conducted by a qualified 

internal tester. Alternatively, if an 

outside party is used to conduct the 

independent testing, the covered 

banking entity would incur costs 

associated with paying the qualified 

outside partys for its services. The CFTC 

does not anticipate significant costs 

related to the proposed management 

framework requirement, as banking 

entities should already have relevant 

management structures in place. 

The tiered approach with which the 

proposal applies the proposed 

compliance program requirement to 

banking entities of varying size should 

reduce the costs associated with 

developing and providing for the 

continued administration of a 

compliance program. In setting forth the 

proposed compliance program 

requirement in §ll.20 of the proposed 

rule and Appendix C, the CFTC has 

taken into consideration the size, scope, 

and complexity of a banking entity’s 

covered trading activities and covered 

fund activities and investments in 

developing requirements targeted to the 

compliance risks of large and small 

banking entities. Specifically, banking 

entities that do not meet the thresholds 

established in §ll.20(c) of the 

proposed rule would not be required to 

comply with the more detailed and 

burdensome requirements set forth in 

Appendix C. In addition, banking 

entities that do not engage in covered 

trading activities and covered fund 

activities and investments would not be 

required to establish a compliance 

program under the proposed rule, and 

therefore should incur only minimal 

costs associated with adding measures 

to their existing compliance policies 

and procedures to prevent the banking 

entity from becoming engaged in such 

activities or making such investments. 

Together, these provisions have been 

proposed in order to permit a banking 

entity to tailor its compliance program 

to its activities and investments and, 


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where possible, leverage its existing 

compliance structures, all of which 

should minimize the incremental costs 

associated with establishing a 

compliance program under the 

proposed rule. However, banking 

entities that are engaged in significant 

covered trading and covered fund 

activities and investments and thereby 

present a heightened compliance risk 

due to the size and nature of their 

activities and investments would be 

required to comply with the additional 

standards set forth in proposed 

Appendix C. 

Costs associated with the 

requirements of proposed Appendix C 

should also be reduced by aspects of the 

proposed rule that would permit a 

banking entity to establish an 

enterprise-wide compliance program 

under certain circumstances. An 

enterprise-wide compliance program 

would generally permit one compliance 

program to be established for a banking 

entity and all of its affiliates and 

subsidiaries collectively, rather than 

each legal entity being required to 

establish its own separate compliance 

program. The CFTC expects that an 

enterprise-wide compliance program 

should promote efficiencies and 

economies of scale, and reduce costs, 

associated with establishing separate 

compliance programs. 

E. Additional Request for Comment 

In addition to the requests for 

comment discussed above, we seek 

commenters’ views on the following 

additional questions related to the 

potential economic impacts of the 

proposed framework for implementing 

section 13 of the BHC Act: 

Question 348. What are the expected 

costs and benefits of complying with the 

requirements of the proposed rule? We 

seek commenters’ estimates of the 

aggregate cost or benefit that would be 

incurred or received by banking entities 

subject to section 13 of the BHC Act to 

comply. We also ask commenters to 

break out the costs or benefits of 

compliance to banking entities with 

each individual aspect of the proposed 

rule. Please provide an explanation of 

how cost or benefit estimates were 

derived. Please also identify any costs or 

benefits that would occur on a one time 

basis and costs that would recur. Would 

particular costs or benefits decrease or 

increase over time? If certain costs or 

benefits cannot be estimated, please 

discuss why such costs or benefits 

cannot be estimated. 

Question 348.1 The CFTC seeks 

comment on the proposed rule’s effects 

on market-making and liquidity, the 

costs of borrowing by businesses and 

consumers, the prices of financial 

assets, and the competitiveness of the 

United States financial services sector. 

The Commission also solicits comment 

on the benefits that will result from the 

proposed regulations and how these 

benefits compare to the costs of 

complying with the proposed 

regulations. The Commission also 

solicits comment on the CFTC’s 

assessments of the costs and benefits of 

the regulations proposed herein. 

Question 349. Please identify any 

costs or benefits that would occur on a 

one-time basis and costs or benefits that 

would recur (e.g., training and 

compliance monitoring). Please identify 

any costs or benefits that you believe 

would decrease over time. Please 

identify any costs or benefits that you 

believe may increase over time or 

remain static. 

Question 350. Are there 

circumstances in which registered 

dealers, security-based swap dealers, 

and/or swap dealers (i) hold accounts 

other than trading accounts or (ii) hold 

investment positions for activities for 

which they are required to be 

registered? If so, would including all 

such dealer positions within the trading 

account definition create competitive 

burdens as well as additional burdens 

on the operations of such dealers that 

may not be consistent with the language 

and purpose of the statute? Please 

describe how this may occur, and to 

what extent it may occur. 

Question 351. Please identify the 

ways, if any, that banking entities might 

alter the ways they currently conduct 

business as a result of the costs that 

could be incurred to comply with the 

requirements of the proposed rule. Do 

you anticipate that banking entities will 

terminate any services or products 

currently offered to clients, customers, 

or counterparties due to the proposed 

rule, if adopted? Please explain. 

Question 352. How would trading 

systems and practices used in today’s 

marketplace be impacted by the 

proposed rule? What would be the costs 

and/or benefits of such changes in 

trading practices and systems? 

Question 353. Would the proposed 

rule create any additional 

implementation or operational costs or 

benefits associated with systems 

(including computer hardware and 

software), surveillance, procedural, 

recordkeeping, or personnel 

modifications, beyond those discussed 

in the above analysis? Would smaller 

banking entities be disproportionately 

impacted by any of these additional 

implementation or operational costs? 

Question 354. We seek specific 

comments on the costs and benefits 

associated with systems changes on 

banking entities with respect to the 

proposed rule, including the type of 

systems changes necessary and 

quantification of costs associated with 

changing the systems, including both 

start-up and maintenance costs. We 

request comments on the types of jobs 

and staff that would be affected by 

systems modifications and training with 

respect to the proposed rule, the number 

of labor hours that would be required to 

accomplish these matters, and the 

compensation rates of these staff 

members. 

Question 355. Please discuss any 

human resources costs associated with 

the proposed rule, along with any 

associated overhead costs. 

Question 356. What are the benefits 

and costs associated with the 

requirements for relying on the 

underwriting exemption? What impact 

will these requirements have on capital 

formation, efficiency, competition, 

liquidity, price efficiency, if any? Please 

estimate any resulting benefits and costs 

or discuss why such benefits and costs 

cannot be estimated. What alternatives, 

if any, may be more cost-effective while 

still being consistent with the purpose 

and language of the statute? 

Question 357. What are the benefits 

and costs associated with the 

requirements for relying on the 

exemption for market-making-related 

activity, including the requirement that 

such activity be consistent with the 

commentary in Appendix B? What 

impact will these requirements have on 

liquidity, price efficiency, capital 

formation, efficiency, and competition, 

if any? Please estimate any resulting 

benefits and costs or discuss why such 

benefits and costs cannot be estimated. 

What alternatives, if any, may be more 

cost-effective while still being 

consistent with the purpose and 

language of the statute? 

Question 358. What are the benefits 

and costs associated with the 

requirements for relying on the 

exemption for risk-mitigating hedging 

activity, including the requirement that 

certain hedge transactions be 

documented? What impact will these 

requirements have on liquidity, price 

efficiency, capital formation, efficiency, 

and competition, if any? Please estimate 

any resulting benefits and costs or 

discuss why such benefits and costs 

cannot be estimated. What alternatives, 

if any, may be more cost-effective while 

still being consistent with the purpose 

and language of the statute? 

Question 359. Are there traditional 

risk management activities of banking 

entities that are not covered by the 

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mitigating hedging exemptions as 

currently proposed? What risks do 

banking entities face that go beyond 

market, counterparty/credit, currency/ 

foreign exchange, interest rate, and basis 

risk? Could the proposed construction 

of the liquidity management and riskmitigating hedging exemptions increase 

the costs of management or impede the 

ability of banking entities to effectively 

manage risk? 

Question 360. To rely on the 

exemptions from the proposed rule for 

permitted underwriting, market-makingrelated activity, and risk-mitigating 

hedging, banking entities must 

establish, maintain, and enforce a 

compliance program, including written 

policies and procedures and internal 

controls. Please discuss how the costs 

incurred, or benefits received, by 

banking entities related to initial 

implementation and ongoing 

maintenance of the compliance program 

would impact their customers and their 

businesses with respect to underwriting, 

market making, and hedging activity. 

Question 361. Please discuss benefits 

and costs related to the limitations on 

permitted activities for material 

conflicts of interest, high-risk assets and 

trading strategies, and threats to the 

safety and soundness of banking entities 

or to the financial stability of the U.S. 

in the proposed rule. Are there 

particular benefits and costs related to 

the proposed definitions of material 

conflict of interest, high-risk asset, and 

high-risk trading strategy in the 

proposed rule? Would these definitions 

have any unintended costs, such as 

creating undue burdens and limitations 

on permitted underwriting, market 

making-related, or hedging activity? 

Please explain. What alternatives, if any, 

may be more cost-effective while still 

being consistent with the purpose and 

language of the statute? 

Question 362. Please discuss the 

benefits and costs related to the 

definition of derivative in the proposed 

rule and the application of the 

restrictions on proprietary trading to 

transactions in the different types of 

derivatives covered by the definition. 

What alternatives, if any, may be more 

cost-effective while still being 

consistent with the purpose and 

language of the statute? 

Question 363. What costs and benefits 

would be associated with calculating, 

reviewing, and analyzing the proposed 

quantitative measurements? What costs 

and benefits would be associated with 

reporting the proposed quantitative 

measurements to an Agency? Please 

identify any of the proposed 

quantitative measurements that are 

already reported to an Agency and 

discuss whether the current reporting 

regime would mitigate costs associated 

with the proposed rule. With respect to 

any quantitative measurement that is 

not already reported to an Agency, what 

are the costs and benefits of beginning 

to report the measurement? Would 

banking entities have to create or 

purchase new systems or implement 

changes to existing systems in order to 

report these quantitative measurements? 

Please discuss the costs and benefits 

associated with such systems changes. 

Question 364. How much of the data 

necessary to calculate the quantitative 

measurements in Appendix A is 

currently captured, retained, and 

utilized by banking entities? If the 

applicable data is not currently used by 

banking entities, is it readily available? 

Is it possible to collect all of the data 

that is necessary for calculating the 

required measurements? Please identify 

any data that banking entities do not 

currently utilize that would need to be 

captured and retained for purposes of 

proposed Appendix A and discuss the 

costs and benefits of capturing and 

retaining such data. 

Question 365. Do the costs and 

benefits of calculating, analyzing, and 

reporting certain or all quantitative 

measurements differ between trading 

units and their trading activities, 

including trading strategies, asset 

classes, market structure, experience 

and market share, and market 

competitiveness? Are any quantitative 

measurements particularly costly to 

calculate or analyze for specific trading 

activities or, alternatively, particularly 

beneficial? If so, which quantitative 

measurement, what type of trading 

activity, and what factor(s) of that 

trading activity make the quantitative 

measurement particularly costly or 

beneficial? Please discuss how these 

costs, if any, could be mitigated or 

benefits, if any, could be enhanced. 

Question 366. The proposed 

definition of trading unit would require 

a tiered approach to calculating and 

reporting quantitative measurements, 

such that the measurements would be 

calculated and reported for different 

levels within the banking entity, with 

higher levels encompassing smaller 

units (e.g., trading desks, business lines, 

and all trading operations). What are the 

costs and benefits of calculating the 

quantitative measurements for each 

level within the definition of trading 

unit? Can the higher level calculations 

incorporate the lower level calculations 

such that the higher level calculations 

result in small, incremental costs? Why 

or why not? Are there particular costs or 

benefits associated with calculating, 

analyzing, and reporting a quantitative 

measurement at one of the levels within 

the definition of trading unit that would 

not be experienced at the other levels? 

Please explain. What are the costs, if 

any, of ‘‘noise,’’ ‘‘false positives,’’ or 

‘‘false negatives’’ with respect to the 

quantitative measurements and 

calculations at different levels? Can 

these costs be mitigated and, if so, how? 

What alternatives, if any, may be more 

cost-effective while still being 

consistent with the purpose and 

language of the statute? 

Question 367. We seek comment on 

whether the requirement that banking 

entities employ a suite of quantitative 

measurements may lead to 

redundancies and/or inefficiencies in 

the application of the measurements for 

some types of trading units within some 

banking entities. Despite the flexibility 

of Appendix A via recognition that 

quantitative measurements will be 

applied with respect to differences 

within a banking entity’s structure, 

business lines, and trading desks, we 

seek comment on whether the 

requirement of a mandatory suite of 

quantitative measurements may prove 

burdensome. For instance, is the 

application of certain quantitative 

measurements not efficient, appropriate, 

or calculable for certain asset classes or 

trading units or would the benefits of 

applying such quantitative 

measurements be negligible in relation 

to the costs of applying such 

measurements? In addition, would the 

overlay divert a banking entity from 

allocating resources toward 

quantitative—or other—measurements 

that might prove more useful and better 

tailored to its specific and unique 

trading practices? 

Question 368. What are the benefits 

and costs of the recordkeeping 

requirement in proposed Appendix A? 

Please explain and quantify, to the 

extent possible. To what extent would 

the proposed recordkeeping 

requirement impose new or additional 

costs and benefits beyond the current 

recordkeeping obligations of different 

types of banking entities (e.g., affiliated 

broker-dealers, affiliated investment 

advisers, insured depository 

institutions, etc.)? What alternatives, if 

any, may be more cost-effective while 

still being consistent with the purpose 

and language of the statute? 

Question 369. Please identify any cost 

savings that would be achieved through 

the use of an enterprise-wide 

compliance program. Alternatively, 

would you expect certain costs to 

increase when using an enterprise-wide 

compliance program? Please explain. 

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be amplified or reduced when using an 

enterprise-wide compliance program. 

Question 370. Are there tools or 

elements in the contents of the 

compliance program set forth in 

§ ll.20(b) for which the costs may be 

negligible because banking entities use 

the same or similar elements for other 

purposes (e.g., satisfying other 

regulatory requirements, risk 

management, etc.) and could utilize 

existing infrastructure for purposes of 

the proposed rule? For example, could 

existing trader mandates or an existing 

training program be expanded to meet 

the requirements of the proposed rule, 

rather than developing an entirely new 

infrastructure? Alternatively, would the 

proposed rule require redundancies or 

duplications within a banking entity’s 

infrastructure (e.g., the trader mandates 

currently used for one purpose do not 

conform to the requirements of the 

proposed rule, so a banking entity 

would have to utilize both in different 

circumstances)? Please identify and 

explain any such redundancies and how 

the rule could be modified to reduce or 

eliminate such redundancies, if 

possible. 

Question 371. How would the 

proposed rule affect compliance costs 

(e.g., personnel or system changes) or 

benefits for each category of banking 

entity: small, medium, and large? Please 

discuss any differences between the 

costs and benefits of the compliance 

program required under §ll.20(b) for 

smaller banking entities and the 

compliance program requirements of 

Appendix C for larger banking entities. 

Are the differences between these 

benefits and costs justified due to the 

differences in size and complexity of 

smaller and larger banking entities? 

Question 372. The definition of 

trading unit in proposed Appendix C 

covers different levels of a banking 

entity and, as a result, requires a tiered 

approach to establishing, maintaining, 

and enforcing the compliance program 

requirements with respect to covered 

trading activities. What are the costs and 

benefits of applying the compliance 

program requirements at several levels 

within the banking entity? To what 

extent does the ability to incorporate 

written policies and procedures of 

lower-level units by reference, rather 

than establishing separate written 

policies and procedures, mitigate the 

costs of the proposed requirements? Are 

there other ways that the proposed 

requirements could be made more costeffective for the different levels within 

the banking entity? 

Question 373. How will the proposed 

definition of ‘‘covered fund’’ affect a 

banking entity’s investment advisory 

activities, in particular activities and 

relationships with investment funds 

that would be treated as ‘‘covered 

funds’’? Please estimate any resulting 

costs or benefits or discuss why such 

costs or benefits cannot be estimated. 

Question 374. How have banking 

entities traditionally organized and 

offered covered funds? What are the 

benefits and costs associated with the 

proposed requirements for relying on 

the exception for organizing and 

offering covered funds? Please estimate 

any resulting costs or benefits or discuss 

why such costs or benefits cannot be 

estimated. 

Question 375. What are the costs and 

benefits associated with the way the 

proposed rule implements the 

‘‘customers of such services’’ 

requirement in the exception for 

organizing and offering covered funds? 

What alternative, if any, may be more 

cost-effective while still being 

consistent with the language and 

purpose of the statute? 

Question 376. Is it common for a 

banking entity to share a name with the 

covered funds that it invests in or 

sponsors? If yes, what entity in the 

banking structure typically shares a 

name with such covered funds? What 

costs and benefits will result from the 

proposed rule’s implementation of the 

name sharing requirement in exception 

for organizing and offering a covered 

fund? What alternatives, if any, may be 

more cost-effective while still being 

consistent with the purpose of the 

statute? 

Question 377. Under what 

circumstances do directors and 

employees of a banking entity invest in 

covered funds? What are the benefits 

and costs associated with the proposed 

provisions regarding director and 

employee investments in covered 

funds? What alternatives, if any, may be 

more cost-effective while still being 

consistent with the purpose of the 

statute? 

Question 378. Do banking entities 

currently invest in or sponsor SBICs and 

public welfare and qualified 

rehabilitation investments? If yes, to 

what extent? What are the benefits and 

costs associated with the proposed 

rule’s implementation of the exception 

for investment in SBICs and public 

welfare and qualified rehabilitation 

investments? 

Question 379. Do banking entities 

currently invest in or sponsor each of 

the vehicles that the proposed rule 

permits banking entities to continue to 

invest in and sponsor under section 

12(d)(1)(J) of the BHC Act? If yes, to 

what extent? What are the benefits and 

costs associated with the proposed 

rule’s implementation of these 

exceptions? 

Question 380. For banking entities 

that are affiliated investment advisers, 

are there additional costs or benefits to 

complying with section 13 of the BHC 

Act and the proposed rule? For 

example, do affiliated investment 

advisers typically maintain records that 

would enable them to demonstrate 

compliance with the 3% ownership 

limits or restrictions on transactions that 

would be subject to sections 23A and 

23B of the FR Act? 

Question 381. Would complying with 

section 13 of the BHC Act and the 

proposed rule affect an affiliated 

investment adviser’s other business 

activities (benefit or burden) that are not 

subject to restrictions on proprietary 

trading or other covered fund activities? 

For example, would advisers incur 

additional burdens to distinguish 

covered fund activities from noncovered fund activities? 

Question 382. For banking entities 

that are affiliated investment advisers, 

are there particular costs or benefits to 

complying with the portions of 

Appendix C that are applicable to each 

asset management unit of the adviser? 

Do these costs and benefits differ 

depending on whether the adviser 

complies with Appendix C individually 

or on an enterprise basis? Does the rule 

provide sufficient clarify for how 

Appendix C applies to unregistered 

affiliates of an affiliated investment 

adviser? 

Question 383. To the extent 

applicable, please address each of the 

questions above with respect to 

securitization vehicles that would be 

included in the proposed definition of 

covered fund. 

VI. Administrative Law Matters 

A. Paperwork Reduction Act Analysis; 

Request for Comment on Proposed 

Information Collection 

In accordance with section 3512 of 

the Paperwork Reduction Act of 1995 

(44 U.S.C. 3501–3521) (‘‘PRA’’), the 

CFTC 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. In conjunction with the 

Joint Release, the OCC, FDIC, and the 

Board obtained OMB control numbers. 

The information collection requirements 

contained in the Joint Release, to the 

extent they apply to banking entities 

that are not under a holding company, 

were submitted by the OCC and FDIC to 

OMB for review and approval under 

section 3506 of the PRA and section 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 8421 

365See 76 FR 68936. 

366See id. 

367See id. 

368See id. 

369See id. 

370See 76 FR 68936–38. 

371A banking organization is generally 

considered to be a small banking entity for the 

purposes of the RFA if it has assets less than or 

equal to $175 million. See also 13 CFR 

121.1302(a)(6) (noting factors that the Small 

Business Administration considers in determining 

whether an entity qualifies as a small business, 

including receipts, employees, and other measures 

of its domestic and foreign affiliates). 

1320.11 of OMB’s implementing 

regulations (5 C.F.R. § 1320).365 Under 

the Joint Release, the Board will submit 

to OMB once the final rule is published 

and the submission will include burden 

for Federal Reserve-supervised 

institutions, as well as burden for 

OCC-, FDIC-, SEC-, and CFTCsupervised institutions under a holding 

company.366 Under the Joint Release, 

the OCC or the FDIC will take burden 

for banking entities that are not under 

a holding company.367

In this CFTC Rule, the CFTC is 

proposing a separate rulemaking under 

which the CFTC would adopt the same 

substantive requirements as proposed in 

the Joint Release. Accordingly, the 

burden for CFTC-supervised institutions 

under the CFTC Rule would be the same 

as the burdens set forth and assumed by 

the Board and the OCC in the Joint 

Release.368

In the Joint Release, the proposed 

collection of information is titled 

‘‘Reporting, Recordkeeping, and 

Disclosure Requirements Associated 

with Restrictions on Proprietary Trading 

and Certain Relationships with Hedge 

Funds and Private Equity Funds.’’ The 

collection of information request 

submitted to OMB by the FDIC is titled 

‘‘Prohibitions and Restrictions on 

Proprietary Trading and Certain 

Interests In, and Relationships with, 

Hedge Funds and Private Equity 

Funds.’’ 

In the Joint Release, the Board stated 

that it would take burden for all 

institutions under a holding company, 

including, among other things, banking 

entities for which the CFTC is the 

primary financial regulatory agency, as 

defined in section 2(12)(C) of the DoddFrank Act.369

In the Joint Release, the OCC stated 

that it 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. 

The CFTC seeks comment on whether 

there are any banking entities 

supervised by the FDIC or are 

subsidiaries or affiliates of an FDICsupervised banking entity (‘‘FDIC 

supervised-entities) for which the CFTC 

will be the primary financial regulatory 

agency under section 2(12)(C) of the 

Dodd-Frank Act. The Joint Release does 

not identify any such entities. 

The CFTC will request, pursuant to 44 

U.S.C. 3509, that the director of the 

OMB designate the Board or the OCC as 

the respective collection agency for PRA 

purposes for the banking entities for 

which the CFTC is the primary financial 

regulatory agency under section 

2(12)(C). This does not affect the CFTC’s 

obligation and authority to receive and 

review the relevant information (as set 

forth in the PRA section of the Joint 

Release for all banking entities) for those 

entities.370

B. Initial Regulatory Flexibility Act 

Analysis 

The Regulatory Flexibility Act 

(‘‘RFA’’), 5 U.S.C. 601 et seq., requires 

an agency to consider whether the rules 

it proposes will have a significant 

economic impact on a substantial 

number of small entities.371 If so, the 

agency must prepare an initial and final 

regulatory flexibility analysis respecting 

the significant economic impact. 

Pursuant to section 605(b) of the RFA, 

the regulatory flexibility analysis 

otherwise required under sections 603 

and 604 of the RFA is not required if an 

agency certifies that the rule will not 

have a significant economic impact on 

a substantial number of small entities. 

The Agencies have considered the 

potential impact of the proposed rule on 

small entities in accordance with the 

RFA. The proposed rule would not 

appear to have a significant economic 

impact on small entities for several 

reasons. 

First, while the proposed rule will 

affect all banking organizations, 

including those that have been defined 

to be ‘‘small businesses’’ under the RFA, 

only certain limited requirements would 

be imposed on entities that engage in 

little or no covered trading activities or 

covered fund activities and investments. 

Significantly, the reporting and 

recordkeeping requirements of §ll.7 

and Appendix A of the proposed rule 

apply only to banking entities with 

average trading assets and liabilities on 

a consolidated, worldwide basis equal 

to or greater than $1 billion for the 

preceding year. This is a threshold that 

a small banking entity typically would 

not meet. 

Second, the scope and size of the 

compliance program requirements set 

forth in subpart D and Appendix C of 

the proposed rule would vary based on 

the size and activities of each covered 

banking entity. Only banking entities 

with average trading assets and 

liabilities on a worldwide consolidated 

basis equal to or greater than $1 billion 

or 10 percent or more of their total 

assets, or that have aggregate 

investments in, or sponsor or advise, 

covered funds with aggregate total assets 

of more than $1 billion must establish, 

maintain and enforce a full compliance 

program under the proposed rule. 

Banking entities that engage in trading 

activities or covered fund activities and 

investments under these thresholds 

must adopt, at a minimum, only the six 

core compliance requirements set forth 

in §ll.20 of the proposed rule. 

Banking entities that do not engage in 

any covered trading or fund activities, 

typical of small banking entities, must 

ensure only that their compliance 

programs include measures designed to 

prevent the entities from becoming 

engaged in covered activities unless 

they first adopt a compliance program. 

These compliance requirements would 

not appear to have a significant 

economic impact on a substantial 

number of small entities. 

For the reasons stated above, the head 

of the CFTC certifies, for the covered 

banking entities subject to the CFTC’s 

jurisdiction, that the proposed rule 

would not result in a significant 

economic impact on a substantial 

number of small entities. The CFTC 

encourages written comments regarding 

this certification, and request that 

commenters describe the nature of any 

impact on small entities and provide 

empirical data, or studies, to illustrate 

and support the extent of the impact. 

VII. CFTC: Additional Matters 

A. Commodity Pool Operators and 

Commodity Trading Advisors 

As discussed above, under the 

proposed rule, a covered banking entity 

as defined in §ll.2(j) would generally 

be subject to the substantive 

requirements contained in the CFTC 

Rule. These substantive requirements 

implement the provisions on 

proprietary trading and covered fund 

activities under section 13 of the BHC 

Act. Thus for example, a covered 

banking entity that is a registered swap 

dealer would be required to comply 

with subparts A through D of the CFTC 

Rule, including Appendices A, B and C, 

where applicable. With respect to 

covered fund activities, investments, or 

relationships set forth in subpart C and 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8422 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

372A commodity pool operator or commodity 

trading advisor would, however, be required to 

comply with the provisions that implement the 

proprietary trading restrictions set forth in subparts 

A, B and §ll.20 of subpart D of the proposed rule 

as promulgated by the CFTC, including Appendix 

C, where applicable. 

§ ll.20 of subpart D (‘‘covered fund 

restrictions’’), however, the CFTC’s 

proposed rule would require that a 

covered banking entity that is a covered 

banking entity because it is a 

commodity pool operator or commodity 

trading advisor for which the CFTC is 

the primary financial regulatory agency 

under sections 2(12)(C)(ii) and 

2(12)(C)(iii) of the Dodd-Frank Act 

comply with the covered fund 

restrictions issued by the appropriate 

Federal banking agency that regulates 

the banking entity specified in 

§ ll.2(e)(1), (2) and (3) with which the 

commodity pool operator or commodity 

trading advisor is affiliated.372 Under 

this approach, a commodity pool 

operator or commodity trading advisor 

would be required to comply with the 

rules and related guidance issued by the 

appropriate Federal banking agency. 

The CFTC would, however, retain 

enforcement authority over all activities 

of commodity pool operators or 

commodity trading advisors (i.e., both 

proprietary trading and covered fund 

restrictions). 

The covered fund restrictions of 

section 13 of the BHC Act and the 

proposed implementing rules make 

reference to or incorporate a number of 

banking law and supervision concepts 

that traditionally appear in Federal 

banking law and are interpreted and 

applied by the Federal banking 

agencies. For example, as discussed in 

greater detail in the Supplementary 

Information, the limitations on 

ownership interests in a covered fund 

set forth in the statute and the proposed 

rule generally reference the tier 1 capital 

of the affiliated insured depository 

institution or the affiliated holding 

company. Similarly, capital deductions 

under the proposed rule refer to the tier 

1 capital of the affiliated insured 

depository institution or the affiliated 

holding company. In addition, the 

covered fund restrictions of the statute 

and the proposed rule incorporate by 

reference sections 23A and 23B of the 

FR Act and are administered by the 

Federal banking agencies. These 

sections of the FR Act restrict and limit 

transactions between certain banking 

organizations and their affiliates, some 

of which are based on a percentage of 

bank capital. Further, other covered 

fund restrictions, including for example 

exemptions for investments involving 

the public welfare and bank-owned life 

insurance and the extension of time to 

divest of investments after the seeding 

period, reference other banking laws or 

regulations that are administered by the 

Federal banking agencies. 

In light of these considerations, the 

proposed CFTC Rule would require a 

commodity pool operator or commodity 

trading advisor to comply with the 

covered fund restrictions contained in 

subpart C and § .ll20 of subpart D of 

rules implementing section 13 of the 

BHC that are issued by the appropriate 

Federal banking agency that regulates 

the banking entity with which the 

commodity pool operator or commodity 

trading advisor is affiliated. Under the 

proposed approach, a commodity pool 

operator or commodity trading advisor 

complying with the CFTC Rule would 

do so by complying with the rule issued 

by the appropriate Federal banking 

agency, including any related 

interpretations or guidance regarding 

such requirements. Similarly, under the 

proposed approach, the foregoing 

determinations regarding capital or 

other banking law requirements that 

may be applicable to a commodity pool 

operator or commodity trading advisor 

would be made by the appropriate 

Federal banking agency that regulates 

the banking entity with which the 

commodity pool operator or commodity 

trading advisor is affiliated. This 

approach would mitigate the burdens of 

complying with the covered fund 

restrictions for commodity pool 

operators or commodity trading advisors 

and would avoid creating incentives for 

covered fund activities to be moved 

from a commodity pool operator or 

commodity trading advisor to a bank. 

The proposed CFTC Rule specifies 

that a commodity operator or 

commodity trading advisor must 

comply with the covered fund 

restrictions contained in subpart C and 

§ ll.20 of subpart D that are issued by 

the appropriate Federal banking agency 

that regulates the banking entity with 

which the commodity pool operator or 

commodity trading advisor is affiliated. 

Subpart C, which uses terms defined in 

subpart A, specifies the covered fund 

restrictions. Subpart D §ll.20 

requires the establishment of a 

compliance program when engaging in 

covered fund activities. A commodity 

pool operator or commodity trading 

advisor complying with subpart C and 

§ ll.20 of subpart D, as issued by the 

appropriate Federal banking agency, 

would also rely on interpretative 

guidance issued by the appropriate 

Federal banking agency with respect to 

those subparts of the proposed rule. 

Because §ll.20 of subpart D relates to 

both the prohibitions and restrictions on 

proprietary trading activity as well as 

the prohibitions and restrictions on 

covered fund activities and investments, 

a commodity pool operator or 

commodity trading advisor would be 

required to comply with the relevant 

covered fund provisions issued by the 

appropriate Federal banking agency. A 

commodity pool operator or commodity 

trading advisor, however, would be 

subject to the provisions set forth in 

subpart D of the proposed CFTC Rule, 

including §ll.20, that relate to 

covered trading activities. 

Nothing set forth in the discussion 

above, or in §ll.10(a)(2) of the 

proposed CFTC Rule, however, is 

intended, or shall be deemed, to limit 

the CFTC’s authority under any other 

provision of law, including pursuant to 

section 13 of the BHC Act. 

The CFTC requests comment on the 

its proposed approach to implementing 

section 13 of the BHC Act as it applies 

to commodity pool operators or 

commodity trading advisors with 

respect to the covered fund restrictions. 

In particular, the CFTC requests 

comment on the following: 

Question CFTC–5. Should the CFTC 

instead require commodity pool 

operators or commodity pool advisors to 

comply with the covered fund 

restrictions proposed by the CFTC, 

instead of those issued the appropriate 

Federal banking agency? If so, could this 

create incentives to move the advisory 

business between the commodity pool 

operator or commodity trading advisor 

and its affiliated bank? Are there 

benefits to this alternate approach? If so, 

please explain. 

Question CFTC–6. Are there other 

alternative approaches to the proposed 

rule that would be more effective? If yes, 

what alternatives and why? 

Question CFTC–7. Would commodity 

pool operators or commodity trading 

advisors affiliated with insured 

depository institutions benefit from the 

proposed approach? Why or why not? 

Question CFTC–8. Would a 

commodity pool operator or commodity 

trading advisor that is affiliated with 

insured depository institutions that are 

regulated by multiple Federal banking 

agencies encounter additional burdens 

in implementing the proposed 

approach? With respect to these 

commodity pool operators or 

commodity trading advisors, which 

Federal banking agency’s rules should 

be applicable to the commodity pool 

operator or commodity trading advisor? 

For example, should the commodity 

pool operator or commodity trading 

advisor be subject to the rules 

applicable to the commodity pool 

operator or commodity trading advisor’s 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
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373The text of the Proposed Common Rules 

section of the CFTC Rule is identical to the text of 

the Proposed Common Rules adopted in the Joint 

Release. See 76 FR 68944–68967. 

immediate parent that is an insured 

depository institution? 

Question CFTC–9. Is the proposed 

requirement that commodity pool 

operators or commodity trading advisors 

comply with the covered fund 

restrictions in §ll.20 issued by the 

Federal banking agency that regulates 

the banking entity specified in 

§ ll.2(e)(1), (2) and (3) of the proposed 

rule with which the commodity pool 

operator or commodity trading advisor 

is affiliated sufficiently clear? Are there 

particular compliance program 

requirements in §ll.20 with respect 

to the covered fund restrictions that 

overlap with the proprietary trading 

restrictions, such that it would be 

difficult to identify which requirements 

are related to the covered fund 

restrictions and which requirements are 

related to the proprietary trading 

restrictions? If so, which requirements 

and how should this overlap be 

addressed? Should commodity pool 

operators or commodity trading advisors 

be required to comply with §ll.20 of 

the CFTC Rule in its entirety? Why or 

why not? 

Question CFTC–10. Will the CFTC’s 

proposed approach limit the potential 

for inconsistent application of the 

proposed rules with respect to affiliates 

of entities specified in §ll.2(e)(1), (2) 

and (3)? Why or why not? 

Question CFTC–11. Will the CFTC’s 

proposed approach be effective in 

avoiding the creation of incentives for 

covered fund activities to move from a 

commodity pool operator or commodity 

trading advisor to a bank? Why or why 

not? 

Text of the Proposed Common Rules 373

(applicable to the OCC, Board, FDIC, 

and SEC under the Joint Release) 

The text of the proposed common 

rules appears below: 

PART [ ]—PROPRIETARY TRADING 

AND CERTAIN INTERESTS IN AND 

RELATIONSHIPS WITH COVERED 

FUNDS. 

Subpart A—Authority and Definitions 

Sec. 

ll.1 Authority, purpose, scope, and 

relationship to other authorities 

[Reserved]. 

ll.2 Definitions. 

Subpart B—Proprietary Trading 

ll.3 Prohibition on proprietary trading. 

ll.4 Permitted underwriting and market 

making-related activities. 

ll.5 Permitted risk-mitigating hedging 

activities. 

ll.6 Other permitted proprietary trading 

activities. 

ll.7 Reporting and recordkeeping 

requirements applicable to trading 

activities. 

ll.8 Limitations on permitted proprietary 

trading activities. 

ll.9 [Reserved] 

Subpart C—Covered Fund Activities and 

Investments 

ll.10 Prohibition on acquiring or 

retaining an ownership interest in and 

having certain relationships with a 

covered fund. 

ll.11 Permitted organizing and offering 

of a covered fund. 

ll.12 Permitted investment in a covered 

fund. 

ll.13 Other permitted covered fund 

activities and investments. 

ll.14 Covered fund activities and 

investments determined to be 

permissible. 

ll.15 Internal controls, reporting and 

recordkeeping requirements applicable 

to covered fund activities and 

investments. 

ll.16 Limitations on relationships with a 

covered fund. 

ll.17 Other limitations on permitted 

covered fund activities and investments. 

ll.18 [Reserved] 

ll.19 [Reserved] 

Subpart D—Compliance Program 

Requirement; Violations 

ll.20 Program for monitoring 

compliance; enforcement. 

ll.21 Termination of activities or 

investments; penalties for violations. 

Appendix A to Part [ ]—Reporting and 

Recordkeeping Requirements for 

Covered Trading Activities 

Appendix B to Part [ ]—Commentary 

Regarding Identification of 

Permitted Market Making-Related 

Activities 

Appendix C to Part [ ]—Minimum 

Standards for Programmatic 

Compliance 

Subpart A—Authority and Definitions 

§ll.1 Authority, purpose, scope, and 

relationship to other authorities. [Reserved] 

§ll.2 Definitions. 

Unless otherwise specified, for 

purposes of this part: 

(a) Affiliate has the same meaning as 

in section 2(k) of the BHC Act (12 U.S.C. 

1841(k)). 

(b) Applicable accounting standards 

means U.S. generally accepted 

accounting principles or such other 

accounting standards applicable to a 

covered banking entity that the [Agency] 

determines are appropriate, that the 

covered banking entity uses in the 

ordinary course of its business in 

preparing its consolidated financial 

statements. 

(c) BHC Act means the Bank Holding 

Company Act of 1956 (12 U.S.C. 1841 et 

seq.). 

(d) Bank holding company has the 

same meaning as in section 2 of the BHC 

Act (12 U.S.C. 1841). 

(e) Banking entity means: 

(1) Any insured depository 

institution; 

(2) Any company that controls an 

insured depository institution; 

(3) Any company that is treated as a 

bank holding company for purposes of 

section 8 of the International Banking 

Act of 1978 (12 U.S.C. 3106); and 

(4) Any affiliate or subsidiary of any 

entity described in paragraphs (e)(1), (2), 

or (3) of this section, other than an 

affiliate or subsidiary that is: 

(i) A covered fund that is organized, 

offered and held by a banking entity 

pursuant to § ll.11 and in accordance 

with the provisions of subpart C of this 

part, including the provisions governing 

relationships between a covered fund 

and a banking entity; or 

(ii) An entity that is controlled by a 

covered fund described in paragraph 

(e)(4)(i) of this section. 

(f) Board means the Board of 

Governors of the Federal Reserve 

System. 

(g) Buy and purchase each include 

any contract to buy, purchase, or 

otherwise acquire. For security futures 

products, such terms include any 

contract, agreement, or transaction for 

future delivery. With respect to a 

commodity future, such terms include 

any contract, agreement, or transaction 

for future delivery. With respect to a 

derivative, such terms include the 

execution, termination (prior to its 

scheduled maturity date), assignment, 

exchange, or similar transfer or 

conveyance of, or extinguishing of rights 

or obligations under, a derivative, as the 

context may require. 

(h) CFTC means the Commodity 

Futures Trading Commission. 

(i) Commodity Exchange Act means 

the Commodity Exchange Act (7 U.S.C. 

1 et seq.). 

(j) [Reserved] 

(k) Depository institution has the same 

meaning as in section 3(c) of the Federal 

Deposit Insurance Act (12 U.S.C. 

1813(c)). 

(l) (i) Derivative means: 

(A) Any swap, as that term is defined 

in section 1a(47) of the Commodity 

Exchange Act (7 U.S.C. 1a(47)), or 

security-based swap, as that term is 

defined in section 3(a)(68) of the 

Exchange Act (15 U.S.C. 78c(a)(68)), and 

as those terms are further jointly defined 

by the CFTC and SEC by joint 

regulation, interpretation, guidance, or 

other action, in consultation with the 


tkelley on DSK3SPTVN1PROD with PROPOSALS2
8424 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

Board pursuant to section 712(d) of the 

Dodd-Frank Wall Street Reform and 

Consumer Protection Act (15 U.S.C. 

8302(d)); 

(B) Any purchase or sale of a 

nonfinancial commodity for deferred 

shipment or delivery that is intended to 

be physically settled; 

(C) Any foreign exchange forward (as 

that term is defined in section 1a(24) of 

the Commodity Exchange Act (7 U.S.C. 

1a(24)) or foreign exchange swap (as 

that term is defined in section 1a(25) of 

the Commodity Exchange Act (7 U.S.C. 

1a(25)); 

(D) Any agreement, contract, or 

transaction in foreign currency 

described in section 2(c)(2)(C)(i) of the 

Commodity Exchange Act (7 U.S.C. 

2(c)(2)(C)(i)); 

(E) Any agreement, contract, or 

transactions in a commodity other than 

foreign currency described in section 

2(c)(2)(D)(i) of the Commodity Exchange 

Act (7 U.S.C. 2(c)(2)(D)(i)); and 

(F) Any transaction authorized under 

section 19 of the Commodity Exchange 

Act (7 U.S.C. 23(a) or (b)); 

(ii) A derivative does not include: 

(A) Any consumer, commercial, or 

other agreement, contract, or transaction 

that the CFTC and SEC have further 

defined by joint regulation, 

interpretation, guidance, or other action 

as not within the definition of swap, as 

that term is defined in section 1a(47) of 

the Commodity Exchange Act (7 U.S.C. 

1a(47)), or security-based swap, as that 

term is defined in section 3(a)(68) of the 

Exchange Act (15 U.S.C. 78c(a)(68)); 

(B) Any identified banking product, as 

defined in section 402(b) of the Legal 

Certainty for Bank Products Act of 2000 

(7 U.S.C. 27(b)), that is subject to section 

403(a) of that Act (7 U.S.C. 27a(a)). 

(m) Exchange Act means the 

Securities Exchange Act of 1934 (15 

U.S.C. 78a et seq.). 

(n) Federal banking agencies means 

the Board, the Office of the Comptroller 

of the Currency, and the Federal Deposit 

Insurance Corporation. 

(o) Foreign banking organization has 

the same meaning as in section 

211.21(o) of the Board’s Regulation K 

(12 CFR 211.21(o)). 

(p) Insured depository institution has 

the same meaning as in section 3(c) of 

the Federal Deposit Insurance Act (12 

U.S.C. 1813(c)), but does not include 

any insured depository institution that 

is described in section 2(c)(2)(D) of the 

BHC Act (12 U.S.C. 1841(c)(2)(D)). 

(q) Loan means any loan, lease, 

extension of credit, or secured or 

unsecured receivable. 

(r) Nonbank financial company 

supervised by the Board has the 

meaning specified in section 102 of the 

Financial Stability Act of 2010 (12 

U.S.C. 5311). 

(s) Qualifying foreign banking 

organization means a foreign banking 

organization that qualifies as such under 

section 211.23(a) of the Board’s 

Regulation K (12 CFR 211.23(a)). 

(t) Resident of the United States 

means: 

(1) Any natural person resident in the 

United States; 

(2) Any partnership, corporation or 

other business entity organized or 

incorporated under the laws of the 

United States or any State; 

(3) Any estate of which any executor 

or administrator is a resident of the 

United States; 

(4) Any trust of which any trustee, 

beneficiary or, if the trust is revocable, 

any settlor is a resident of the United 

States; 

(5) Any agency or branch of a foreign 

entity located in the United States; 

(6) Any discretionary or nondiscretionary account or similar account 

(other than an estate or trust) held by a 

dealer or fiduciary for the benefit or 

account of a resident of the United 

States; 

(7) Any discretionary account or 

similar account (other than an estate or 

trust) held by a dealer or fiduciary 

organized or incorporated in the United 

States, or (if an individual) a resident of 

the United States; or 

(8) Any person organized or 

incorporated under the laws of any 

foreign jurisdiction formed by or for a 

resident of the United States principally 

for the purpose of engaging in one or 

more transactions described in 

§ ll.6(d)(1) or § ll.13(c)(1). 

(u) SEC means the Securities and 

Exchange Commission. 

(v) Sale and sell each include any 

contract to sell or otherwise dispose of. 

For security futures products, such 

terms include any contract, agreement, 

or transaction for future delivery. With 

respect to a commodity future, such 

terms include any contract, agreement, 

or transaction for future delivery. With 

respect to a derivative, such terms 

include the execution, termination 

(prior to its scheduled maturity date), 

assignment, exchange, or similar 

transfer or conveyance of, or 

extinguishing of rights or obligations 

under, a derivative, as the context may 

require. 

(w) Security has the meaning 

specified in section 3(a)(10) of the 

Exchange Act (15 U.S.C. 78c(a)(10)). 

(x) Security future has the meaning 

specified in section 3(a)(55) of the 

Exchange Act (15 U.S.C. 78c(a)(55)). 

(y) Securities Act means the Securities 

Act of 1933 (15 U.S.C. 77a et seq.). 

(z) Separate account means an 

account established and maintained by 

an insurance company subject to 

regulation by a State insurance regulator 

or a foreign insurance regulator under 

which income, gains, and losses, 

whether or not realized, from assets 

allocated to such account, are, in 

accordance with the applicable contract, 

credited to or charged against such 

account without regard to other income, 

gains, or losses of the insurance 

company. 

(aa) State means any State, territory or 

possession of the United States, and the 

District of Columbia. 

(bb) Subsidiary has the same meaning 

as in section 2(d) of the BHC Act (12 

U.S.C. 1841(d)). 

Subpart B—Proprietary Trading 

§ll.3 Prohibition on proprietary trading. 

(a) Prohibition. Except as otherwise 

provided in this subpart, a covered 

banking entity may not engage in 

proprietary trading. 

(b) Definition of ‘‘proprietary trading’’ 

and related terms. For purposes of this 

subpart: 

(1) Proprietary trading means 

engaging as principal for the trading 

account of the covered banking entity in 

any purchase or sale of one or more 

covered financial positions. Proprietary 

trading does not include acting solely as 

agent, broker, or custodian for an 

unaffiliated third party. 

(2) Trading account. 

(i) Trading account means any 

account that is used by a covered 

banking entity to: 

(A) Acquire or take one or more 

covered financial positions principally 

for the purpose of: 

(1) Short-term resale; 

(2) Benefitting from actual or expected 

short-term price movements; 

(3) Realizing short-term arbitrage 

profits; or 

(4) Hedging one or more positions 

described in paragraphs (b)(2)(i)(A)(1), 

(2), or (3) of this section; 

(B) Acquire or take one or more 

covered financial positions, other than 

positions that are foreign exchange 

derivatives, commodity derivatives, or 

contracts of sale of a commodity for 

future delivery, that are market risk 

capital rule covered positions, if the 

covered banking entity, or any affiliate 

of the covered banking entity that is a 

bank holding company, calculates riskbased capital ratios under the market 

risk capital rule; or 

(C) Acquire or take one or more 

covered financial position for any 

purpose, if the covered banking entity 

is: 


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(1) A dealer or municipal securities 

dealer that is registered with the SEC 

under the Exchange Act, to the extent 

the position is acquired or taken in 

connection with the activities of the 

dealer or municipal securities dealer 

that require it to be registered under that 

Act; 

(2) A government securities dealer 

that is registered, or that has filed 

notice, with an appropriate regulatory 

agency (as that term is defined in 

section 3(a)(34) of the Exchange Act (15 

U.S.C. 78c(a)(34)), to the extent the 

position is acquired or taken in 

connection with the activities of the 

government securities dealer that 

require it to be registered, or to file 

notice, under that Act; 

(3) A swap dealer that is registered 

with the CFTC under the Commodity 

Exchange Act, to the extent the position 

is acquired or taken in connection with 

the activities of the swap dealer that 

require it to be registered under that 

Act; 

(4) A security-based swap dealer that 

is registered with the SEC under the 

Exchange Act, to the extent the position 

is acquired or taken in connection with 

the activities of the security-based swap 

dealer that require it to be registered 

under that Act; or 

(5) Engaged in the business of a 

dealer, swap dealer, or security-based 

swap dealer outside of the United States 

to the extent the position is acquired or 

taken in connection with the activities 

of such business. 

(ii) Rebuttable presumption for 

certain positions. An account shall be 

presumed to be a trading account if it is 

used to acquire or take a covered 

financial position, other than a covered 

financial position described in 

paragraph (b)(2)(i)(B) or (C) of this 

section, that the covered banking entity 

holds for a period of sixty days or less, 

unless the covered banking entity can 

demonstrate, based on all the facts and 

circumstances, that the covered 

financial position, either individually or 

as a category, was not acquired or taken 

principally for any of the purposes 

described in paragraph (b)(2)(i)(A) of 

this section. 

(iii) An account shall not be deemed 

a trading account for purposes of 

paragraph (b)(2)(i) of this section to the 

extent that such account is used to 

acquire or take a position in one or more 

covered financial positions: 

(A) That arise under a repurchase or 

reverse repurchase agreement pursuant 

to which the covered banking entity has 

simultaneously agreed, in writing, to 

both purchase and sell a stated asset, at 

stated prices, and on stated dates or on 

demand with the same counterparty; 

(B) That arise under a transaction in 

which the covered banking entity lends 

or borrows a security temporarily to or 

from another party pursuant to a written 

securities lending agreement under 

which the lender retains the economic 

interests of an owner of such security, 

and has the right to terminate the 

transaction and to recall the loaned 

security on terms agreed by the parties; 

(C) For the bona fide purpose of 

liquidity management and in 

accordance with a documented liquidity 

management plan of the covered 

banking entity that: 

(1) Specifically contemplates and 

authorizes the particular instrument to 

be used for liquidity management 

purposes, its profile with respect to 

market, credit and other risks, and the 

liquidity circumstances in which the 

particular instrument may or must be 

used; 

(2) Requires that any transaction 

contemplated and authorized by the 

plan be principally for the purpose of 

managing the liquidity of the covered 

banking entity, and not for the purpose 

of short-term resale, benefitting from 

actual or expected short-term price 

movements, realizing short-term 

arbitrage profits, or hedging a position 

taken for such short-term purposes; 

(3) Requires that any position taken 

for liquidity management purposes be 

highly liquid and limited to financial 

instruments the market, credit and other 

risks of which the covered banking 

entity does not expect to give rise to 

appreciable profits or losses as a result 

of short-term price movements; 

(4) Limits any position taken for 

liquidity management purposes, 

together with any other positions taken 

for such purposes, to an amount that is 

consistent with the banking entity’s 

near-term funding needs, including 

deviations from normal operations, as 

estimated and documented pursuant to 

methods specified in the plan; and 

(5) Is consistent with [Agency]’s 

supervisory requirements, guidance and 

expectations regarding liquidity 

management; or 

(D) That are acquired or taken by a 

covered banking entity that is a 

derivatives clearing organization 

registered under section 5b of the 

Commodity Exchange Act (7 U.S.C. 7a– 

1) or a clearing agency registered with 

the SEC under section 17A of the 

Exchange Act (15 U.S.C. 78q–1) in 

connection with clearing derivatives or 

securities transactions. 

(3) Covered financial position. 

(i) Covered financial position means 

any position, including any long, short, 

synthetic or other position, in: 

(A) A security, including an option on 

a security; 

(B) A derivative, including an option 

on a derivative; or 

(C) A contract of sale of a commodity 

for future delivery, or option on a 

contract of sale of a commodity for 

future delivery. 

(ii) A covered financial position does 

not include any position that is: 

(A) A loan; 

(B) A commodity; or 

(C) Foreign exchange or currency. 

(c) Definition of other terms related to 

proprietary trading. For purposes of this 

subpart: 

(1) Commodity has the same meaning 

as in section 1a(9) of the Commodity 

Exchange Act (7 U.S.C. 1a(9)), except 

that a commodity does not include any 

security; 

(2) Contract of sale of a commodity 

for future delivery means a contract of 

sale (as that term is defined in section 

1a(13) of the Commodity Exchange Act 

(7 U.S.C. 1a(13)) for future delivery (as 

that term is defined in section 1a(27) of 

the Commodity Exchange Act (7 U.S.C. 

1a(27)). 

(3) Exempted security has the same 

meaning as in section 3(a)(12)(A) of the 

Exchange Act (15 U.S.C. 78c(a)(12)(A)). 

(4) Foreign insurance regulator means 

the insurance commission, or a similar 

official or agency, of one or more 

countries other than the United States 

that is engaged in the supervision of 

insurance companies under foreign 

insurance law. 

(5) General account means, with 

respect to an insurance company, all of 

the assets of the insurance company that 

are not legally segregated and allocated 

to separate accounts under applicable 

State or foreign law. 

(6) Government securities has the 

same meaning as in section 3(a)(42) of 

the Exchange Act (15 U.S.C. 78c(a)(42)). 

(7) Market risk capital rule covered 

position means a covered position as 

that term is defined for purposes of: 

(i) In the case of a covered banking 

entity that is a bank holding company 

or insured depository institution, the 

market risk capital rule that is 

applicable to the covered banking 

entity; and 

(ii) In the case of a covered banking 

entity that is affiliated with a bank 

holding company, other than a covered 

banking entity to which a market risk 

capital rule is applicable, the market 

risk capital rule that is applicable to the 

affiliated bank holding company. 

(8) Market risk capital rule means 12 

CFR 3, Appendix B, 12 CFR 208, 

Appendix E, 12 CFR 225, Appendix E, 

and 12 CFR 325, Appendix C, as 

applicable. 


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(9) Municipal securities has the same 

meaning as in section 3(a)(29) of the 

Exchange Act (15 U.S.C. 78c(a)(29)). 

(10) Security-based swap has the 

meaning specified in section 3(a)(68) of 

the Exchange Act (15 U.S.C. 78c(a)(68)). 

(11) Swap has the meaning specified 

in section 1a(47) of the Commodity 

Exchange Act (7 U.S.C. 1a(47)). 

(12) State insurance regulator means 

the insurance commission, or a similar 

official or agency, of a State that is 

engaged in the supervision of insurance 

companies under State insurance law. 

§ll.4 Permitted underwriting and 

market making-related activities. 

(a) Underwriting activities. 

(1) Permitted underwriting activities. 

The prohibition on proprietary trading 

contained in § ll.3(a) does not apply 

to the purchase or sale of a covered 

financial position by a covered banking 

entity that is made in connection with 

the covered banking entity’s 

underwriting activities. 

(2) Requirements. For purposes of 

paragraph (a)(1) of this section, a 

purchase or sale of a covered financial 

position shall be deemed to be made in 

connection with a covered banking 

entity’s underwriting activities only if: 

(i) The covered banking entity has 

established the internal compliance 

program required by subpart D of this 

part that is designed to ensure the 

covered banking entity’s compliance 

with the requirements of paragraph 

(a)(2) of this section, including 

reasonably designed written policies 

and procedures, internal controls, and 

independent testing; 

(ii) The covered financial position is 

a security; 

(iii) The purchase or sale is effected 

solely in connection with a distribution 

of securities for which the covered 

banking entity is acting as underwriter; 

(iv) The covered banking entity is: 

(A) With respect to a purchase or sale 

effected in connection with a 

distribution of one or more covered 

financial positions that are securities, 

other than exempted securities, 

security-based swaps, commercial 

paper, bankers’ acceptances, or 

commercial bills: 

(1) A dealer that is registered with the 

SEC under section 15 of the Exchange 

Act (15 U.S.C. 78o), or a person that is 

exempt from registration or excluded 

from regulation as a dealer thereunder; 

or 

(2) Engaged in the business of a dealer 

outside of the United States and subject 

to substantive regulation of such 

business in the jurisdiction where the 

business is located; 

(B) With respect to a purchase or sale 

effected as part of a distribution of one 

or more covered financial positions that 

are municipal securities, a municipal 

securities dealer that is registered under 

section 15B of the Exchange Act (15 

U.S.C. 78o–4) or exempt from 

registration thereunder; or 

(C) With respect to a purchase or sale 

effected as part of a distribution of one 

or more covered financial positions that 

are government securities, a government 

securities dealer that is registered, or 

that has filed notice, under section 15C 

of the Exchange Act (15 U.S.C. 78o–5) 

or exempt from registration thereunder; 

(v) The underwriting activities of the 

covered banking entity with respect to 

the covered financial position are 

designed not to exceed the reasonably 

expected near term demands of clients, 

customers, or counterparties; 

(vi) The underwriting activities of the 

covered banking entity are designed to 

generate revenues primarily from fees, 

commissions, underwriting spreads or 

other income not attributable to: 

(A) Appreciation in the value of 

covered financial positions related to 

such activities; or 

(B) The hedging of covered financial 

positions related to such activities; and 

(vii) The compensation arrangements 

of persons performing underwriting 

activities are designed not to reward 

proprietary risk-taking. 

(3) Definition of distribution. For 

purposes of paragraph (a) of this section, 

a distribution of securities means an 

offering of securities, whether or not 

subject to registration under the 

Securities Act, that is distinguished 

from ordinary trading transactions by 

the magnitude of the offering and the 

presence of special selling efforts and 

selling methods. 

(4) Definition of underwriter. For 

purposes of paragraph (a) of this section, 

underwriter means: 

(i) A person who has agreed with an 

issuer of securities or selling security 

holder: 

(A) To purchase securities for 

distribution; 

(B) To engage in a distribution of 

securities for or on behalf of such issuer 

or selling security holder; or 

(C) To manage a distribution of 

securities for or on behalf of such issuer 

or selling security holder; and 

(ii) A person who has an agreement 

with another person described in 

paragraph (a)(4)(i) of this section to 

engage in a distribution of such 

securities for or on behalf of the issuer 

or selling security holder. 

(b) Market making-related activities. 

(1) Permitted market making-related 

activities. The prohibition on 

proprietary trading contained in 

§ ll.3(a) does not apply to the 

purchase or sale of a covered financial 

position by a covered banking entity 

that is made in connection with the 

covered banking entity’s market makingrelated activities. 

(2) Requirements. For purposes of 

paragraph (b)(1) of this section, a 

purchase or sale of a covered financial 

position shall be deemed to be made in 

connection with a covered banking 

entity’s market making-related activities 

only if: 

(i) The covered banking entity has 

established the internal compliance 

program required by subpart D that is 

designed to ensure the covered banking 

entity’s compliance with the 

requirements of paragraph (b)(2) of this 

section, including reasonably designed 

written policies and procedures, 

internal controls, and independent 

testing; 

(ii) The trading desk or other 

organizational unit that conducts the 

purchase or sale holds itself out as being 

willing to buy and sell, including 

through entering into long and short 

positions in, the covered financial 

position for its own account on a regular 

or continuous basis; 

(iii) The market making-related 

activities of the trading desk or other 

organizational unit that conducts the 

purchase or sale are, with respect to the 

covered financial position, designed not 

to exceed the reasonably expected near 

term demands of clients, customers, or 

counterparties; 

(iv) The covered banking entity is: 

(A) With respect to a purchase or sale 

of one or more covered financial 

positions that are securities, other than 

exempted securities, security-based 

swaps, commercial paper, bankers’ 

acceptances, or commercial bills: 

(1) A dealer that is registered with the 

SEC under section 15 of the Exchange 

Act (15 U.S.C. 78o), or a person that is 

exempt from registration or excluded 

from regulation as a dealer thereunder; 

or 

(2) Engaged in the business of a dealer 

outside of the United States and subject 

to substantive regulation of such 

business in the jurisdiction where the 

business is located; 

(B) With respect to a purchase or sale 

of one or more covered financial 

positions that are swaps: 

(1) A swap dealer that is registered 

with the CFTC under the Commodity 

Exchange Act (7 U.S.C. 1a) or a person 

that is exempt from registration 

thereunder; or 

(2) Engaged in the business of a swap 

dealer outside the United States and 

subject to substantive regulation of such 

business in the jurisdiction where the 

business is located; 


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(C) With respect to a purchase or sale 

of one or more covered financial 

positions that are security-based swaps: 

(1) A security-based swap dealer that 

is registered with the SEC under section 

15F of the Exchange Act (15 U.S.C. 78o– 

10) or a person that is exempt from 

registration thereunder; or 

(2) Engaged in the business of a 

security-based swap dealer outside of 

the United States and subject to 

substantive regulation of such business 

in the jurisdiction where the business is 

located; 

(D) With respect to a purchase or sale 

of one or more covered financial 

positions that are municipal securities, 

a municipal securities dealer that is 

registered under section 15B of the 

Exchange Act (15 U.S.C. 78o–4) or a 

person that is exempt from registration 

thereunder; or 

(E) With respect to a purchase or sale 

of one or more covered financial 

positions that are government securities, 

a government securities dealer that is 

registered, or that has filed notice, under 

section 15C of the Exchange Act (15 

U.S.C. 78o–5) or a person that is exempt 

from registration thereunder; 

(v) The market making-related 

activities of the trading desk or other 

organizational unit that conducts the 

purchase or sale are designed to 

generate revenues primarily from fees, 

commissions, bid/ask spreads or other 

income not attributable to: 

(A) Appreciation in the value of 

covered financial positions it holds in 

trading accounts; or 

(B) The hedging of covered financial 

positions it holds in trading accounts; 

(vi) The market making-related 

activities of the trading desk or other 

organizational unit that conducts the 

purchase or sale are consistent with the 

commentary provided in appendix B to 

this part; and 

(vii) The compensation arrangements 

of persons performing the market 

making-related activities are designed 

not to reward proprietary risk-taking. 

(3) Market making-related hedging. 

For purposes of paragraph (b)(1) of this 

section, a purchase or sale of a covered 

financial position shall also be deemed 

to be made in connection with a covered 

banking entity’s market making-related 

activities if: 

(i) The covered financial position is 

purchased or sold to reduce the specific 

risks to the covered banking entity in 

connection with and related to 

individual or aggregated positions, 

contracts, or other holdings acquired 

pursuant to paragraph (b) of this section; 

and 

(ii) The purchase or sale meets all of 

the requirements described in 

§ ll.5(b) and, if applicable, §ll.5(c). 

§ll.5 Permitted risk-mitigating hedging 

activities. 

(a) Permitted risk-mitigating hedging 

activities. The prohibition on 

proprietary trading contained in 

§ ll.3(a) does not apply to the 

purchase or sale of a covered financial 

position by a covered banking entity 

that is made in connection with and 

related to individual or aggregated 

positions, contracts, or other holdings of 

a covered banking entity and is 

designed to reduce the specific risks to 

the covered banking entity in 

connection with and related to such 

positions, contracts, or other holdings. 

(b) Requirements. For purposes of 

paragraph (a) of this section, a purchase 

or sale of a covered financial position 

shall be deemed to be in connection 

with and related to individual or 

aggregated positions, contracts, or other 

holdings of a covered banking entity 

and designed to reduce the specific risks 

to the covered banking entity in 

connection with and related to such 

positions, contracts, or other holdings 

only if: 

(1) The covered banking entity has 

established the internal compliance 

program required by subpart D of this 

part designed to ensure the covered 

banking entity’s compliance with the 

requirements of paragraph (b) of this 

section, including reasonably designed 

written policies and procedures 

regarding the instruments, techniques 

and strategies that may be used for 

hedging, internal controls and 

monitoring procedures, and 

independent testing; 

(2) The purchase or sale: 

(i) Is made in accordance with the 

written policies, procedures and 

internal controls established by the 

covered banking entity pursuant to 

subpart D of this part; 

(ii) Hedges or otherwise mitigates one 

or more specific risks, including market 

risk, counterparty or other credit risk, 

currency or foreign exchange risk, 

interest rate risk, basis risk, or similar 

risks, arising in connection with and 

related to individual or aggregated 

positions, contracts, or other holdings of 

a covered banking entity; 

(iii) Is reasonably correlated, based 

upon the facts and circumstances of the 

underlying and hedging positions and 

the risks and liquidity of those 

positions, to the risk or risks the 

purchase or sale is intended to hedge or 

otherwise mitigate; 

(iv) Does not give rise, at the 

inception of the hedge, to significant 

exposures that were not already present 

in the individual or aggregated 

positions, contracts, or other holdings of 

a covered banking entity and that are 

not hedged contemporaneously; 

(v) Is subject to continuing review, 

monitoring and management by the 

covered banking entity that: 

(A) Is consistent with the written 

hedging policies and procedures 

required under paragraph (b)(1) of this 

section; and 

(B) Maintains a reasonable level of 

correlation, based upon the facts and 

circumstances of the underlying and 

hedging positions and the risks and 

liquidity of those positions, to the risk 

or risks the purchase or sale is intended 

to hedge or otherwise mitigate; and 

(C) Mitigates any significant exposure 

arising out of the hedge after inception; 

and 

(vi) The compensation arrangements 

of persons performing the riskmitigating hedging activities are 

designed not to reward proprietary risktaking. 

(c) Documentation. With respect to 

any purchase, sale, or series of 

purchases or sales conducted by a 

covered banking entity pursuant to this 

§ ll.5 for risk-mitigating hedging 

purposes that is established at a level of 

organization that is different than the 

level of organization establishing or 

responsible for the positions, contracts, 

or other holdings the risks of which the 

purchase, sale, or series of purchases or 

sales are designed to reduce, the 

covered banking entity must, at a 

minimum, document, at the time the 

purchase, sale, or series of purchases or 

sales are conducted: 

(1) The risk-mitigating purpose of the 

purchase, sale, or series of purchases or 

sales; 

(2) The risks of the individual or 

aggregated positions, contracts, or other 

holdings of a covered banking entity 

that the purchase, sale, or series of 

purchases or sales are designed to 

reduce; and 

(3) The level of organization that is 

establishing the hedge. 

§ll.6 Other permitted proprietary 

trading activities. 

(a) Permitted trading in government 

obligations. 

(1) The prohibition on proprietary 

trading contained in §ll.3(a) does not 

apply to the purchase or sale by a 

covered banking entity of a covered 

financial position that is: 

(i) An obligation of the United States 

or any agency thereof; 

(ii) An obligation, participation, or 

other instrument of or issued by the 

Government National Mortgage 


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Association, the Federal National 

Mortgage Association, the Federal Home 

Loan Mortgage Corporation, a Federal 

Home Loan Bank, the Federal 

Agricultural Mortgage Corporation or a 

Farm Credit System institution 

chartered under and subject to the 

provisions of the Farm Credit Act of 

1971 (12 U.S.C. 2001 et seq.); or 

(iii) An obligation of any State or any 

political subdivision thereof. 

(2) An obligation or other instrument 

described in paragraphs (a)(1)(i), (ii) or 

(iii) of this section shall include both 

general obligations and limited 

obligations, such as revenue bonds. 

(b) Permitted trading on behalf of 

customers. (1) The prohibition on 

proprietary trading contained in 

§ ll.3(a) does not apply to the 

purchase or sale of a covered financial 

position by a covered banking entity on 

behalf of customers. 

(2) For purposes of paragraph (b)(1) of 

this section, a purchase or sale of a 

covered financial position by a covered 

banking entity shall be considered to be 

on behalf of customers if: 

(i) The purchase or sale: 

(A) Is conducted by a covered banking 

entity acting as investment adviser, 

commodity trading advisor, trustee, or 

in a similar fiduciary capacity for a 

customer; 

(B) Is conducted for the account of the 

customer; and 

(C) Involves solely covered financial 

positions of which the customer, and 

not the covered banking entity or any 

subsidiary or affiliate of the covered 

banking entity, is beneficial owner 

(including as a result of having long or 

short exposure under the relevant 

covered financial position); 

(ii) The covered banking entity is 

acting as riskless principal in a 

transaction in which the covered 

banking entity, after receiving an order 

to purchase (or sell) a covered financial 

position from a customer, purchases (or 

sells) the covered financial position for 

its own account to offset a 

contemporaneous sale to (or purchase 

from) the customer; or 

(iii) The covered banking entity is an 

insurance company that purchases or 

sells a covered financial position for a 

separate account, if: 

(A) The insurance company is directly 

engaged in the business of insurance 

and subject to regulation by a State 

insurance regulator or foreign insurance 

regulator; 

(B) The insurance company purchases 

or sells the covered financial position 

solely for a separate account established 

by the insurance company in 

connection with one or more insurance 

policies issued by that insurance 

company; 

(C) All profits and losses arising from 

the purchase or sale of a covered 

financial position are allocated to the 

separate account and inure to the 

benefit or detriment of the owners of the 

insurance policies supported by the 

separate account, and not the insurance 

company; and 

(D) The purchase or sale is conducted 

in compliance with, and subject to, the 

insurance company investment and 

other laws, regulations, and written 

guidance of the State or jurisdiction in 

which such insurance company is 

domiciled. 

(c) Permitted trading by a regulated 

insurance company. The prohibition on 

proprietary trading contained in 

§ ll.3(a) does not apply to the 

purchase or sale of a covered financial 

position by an insurance company or 

any affiliate of an insurance company if: 

(1) The insurance company is directly 

engaged in the business of insurance 

and subject to regulation by a State 

insurance regulator or foreign insurance 

regulator; 

(2) The insurance company or its 

affiliate purchases or sells the covered 

financial position solely for the general 

account of the insurance company; 

(3) The purchase or sale is conducted 

in compliance with, and subject to, the 

insurance company investment laws, 

regulations, and written guidance of the 

State or jurisdiction in which such 

insurance company is domiciled; and 

(4) The appropriate Federal banking 

agencies, after consultation with the 

Financial Stability Oversight Council 

and the relevant insurance 

commissioners of the States, have not 

jointly determined, after notice and 

comment, that a particular law, 

regulation, or written guidance 

described in paragraph (c)(3) of this 

section is insufficient to protect the 

safety and soundness of the covered 

banking entity, or of the financial 

stability of the United States. 

(d) Permitted trading outside of the 

United States. 

(1) The prohibition on proprietary 

trading contained in §ll.3(a) does not 

apply to the purchase or sale of a 

covered financial position by a covered 

banking entity if: 

(i) The covered banking entity is not 

directly or indirectly controlled by a 

banking entity that is organized under 

the laws of the United States or of one 

or more States; 

(ii) The purchase or sale is conducted 

pursuant to paragraph (9) or (13) of 

section 4(c) of the BHC Act; and 

(iii) The purchase or sale occurs 

solely outside of the United States. 

(2) A purchase or sale shall be 

deemed to be conducted pursuant to 

paragraph (9) or (13) of section 4(c) of 

the BHC Act only if: 

(i) With respect to a covered banking 

entity that is a foreign banking 

organization, the banking entity is a 

qualifying foreign banking organization 

and is conducting the purchase or sale 

in compliance with subpart B of the 

Board’s Regulation K (12 CFR 211.20 

through 211.30); or 

(ii) With respect to a covered banking 

entity that is not a foreign banking 

organization, the covered banking entity 

meets at least two of the following 

requirements: 

(A) Total assets of the covered 

banking entity held outside of the 

United States exceed total assets of the 

covered banking entity held in the 

United States; 

(B) Total revenues derived from the 

business of the covered banking entity 

outside of the United States exceed total 

revenues derived from the business of 

the covered banking entity in the United 

States; or 

(C) Total net income derived from the 

business of the covered banking entity 

outside of the United States exceeds 

total net income derived from the 

business of the covered banking entity 

in the United States. 

(3) A purchase or sale shall be 

deemed to have occurred solely outside 

of the United States only if: 

(i) The covered banking entity 

conducting the purchase or sale is not 

organized under the laws of the United 

States or of one or more States; 

(ii) No party to the purchase or sale 

is a resident of the United States; 

(iii) No personnel of the covered 

banking entity who is directly involved 

in the purchase or sale is physically 

located in the United States; and 

(iv) The purchase or sale is executed 

wholly outside of the United States. 

§ll.7 Reporting and recordkeeping 

requirements applicable to trading 

activities. 

A covered banking entity engaged in 

any proprietary trading activity 

permitted under §§ll.4 through 

ll.6 shall comply with: 

(a) The reporting and recordkeeping 

requirements described in appendix A 

to this part, if the covered banking 

entity has, together with its affiliates 

and subsidiaries, trading assets and 

liabilities the average gross sum of 

which (on a worldwide consolidated 

basis) is, as measured as of the last day 

of each of the four prior calendar 

quarters, equal to or greater than $1 

billion; 


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(b) The recordkeeping requirements 

required under §ll.20 and appendix 

C to this part, as applicable; and 

(c) Such other reporting and 

recordkeeping requirements as [Agency] 

may impose to evaluate the covered 

banking entity’s compliance with this 

subpart. 

§ll.8 Limitations on permitted 

proprietary trading activities. 

(a) No transaction, class of 

transactions, or activity may be deemed 

permissible under §§ll.4 through 

ll.6 if the transaction, class of 

transactions, or activity would: 

(1) Involve or result in a material 

conflict of interest between the covered 

banking entity and its clients, 

customers, or counterparties; 

(2) Result, directly or indirectly, in a 

material exposure by the covered 

banking entity to a high-risk asset or a 

high-risk trading strategy; or 

(3) Pose a threat to the safety and 

soundness of the covered banking entity 

or to the financial stability of the United 

States. 

(b) Definition of material conflict of 

interest. For purposes of this section, a 

material conflict of interest between a 

covered banking entity and its clients, 

customers, or counterparties exists if the 

covered banking entity engages in any 

transaction, class of transactions, or 

activity that would involve or result in 

the covered banking entity’s interests 

being materially adverse to the interests 

of its client, customer, or counterparty 

with respect to such transaction, class of 

transactions, or activity, unless: 

(1) Timely and effective disclosure 

and opportunity to negate or 

substantially mitigate. Prior to effecting 

the specific transaction or class or type 

of transactions, or engaging in the 

specific activity, for which a conflict of 

interest may arise, the covered banking 

entity: 

(i) Makes clear, timely, and effective 

disclosure of the conflict of interest, 

together with other necessary 

information, in reasonable detail and in 

a manner sufficient to permit a 

reasonable client, customer, or 

counterparty to meaningfully 

understand the conflict of interest; and 

(ii) Makes such disclosure explicitly 

and effectively, and in a manner that 

provides the client, customer, or 

counterparty the opportunity to negate, 

or substantially mitigate, any materially 

adverse effect on the client, customer, or 

counterparty created by the conflict of 

interest; or 

(2) Information barriers. The covered 

banking entity has established, 

maintained, and enforced information 

barriers that are memorialized in written 

policies and procedures, such as 

physical separation of personnel, or 

functions, or limitations on types of 

activity, that are reasonably designed, 

taking into consideration the nature of 

the covered banking entity’s business, to 

prevent the conflict of interest from 

involving or resulting in a materially 

adverse effect on a client, customer, or 

counterparty. A covered banking entity 

may not rely on such information 

barriers if, in the case of any specific 

transaction, class or type of transactions 

or activity, the banking entity knows or 

should reasonably know that, 

notwithstanding the covered banking 

entity’s establishment of information 

barriers, the conflict of interest may 

involve or result in a materially adverse 

effect on a client, customer, or 

counterparty. 

(c) Definition of high-risk asset and 

high-risk trading strategy. For purposes 

of this section: 

(1) High-risk asset means an asset or 

group of related assets that would, if 

held by a covered banking entity, 

significantly increase the likelihood that 

the covered banking entity would incur 

a substantial financial loss or would fail. 

(2) High-risk trading strategy means a 

trading strategy that would, if engaged 

in by a covered banking entity, 

significantly increase the likelihood that 

the covered banking entity would incur 

a substantial financial loss or would fail. 

Subpart C—Covered Funds Activities 

and Investments 

§ll.10 Prohibition on acquiring or 

retaining an ownership interest in and 

having certain relationships with a covered 

fund. 

(a) Prohibition. Except as otherwise 

provided in this subpart, a covered 

banking entity may not, as principal, 

directly or indirectly, acquire or retain 

any ownership interest in or sponsor a 

covered fund. 

(b) Definitions. For purposes of this 

part: 

(1) Covered fund means: 

(i) An issuer that would be an 

investment company, as defined in the 

Investment Company Act of 1940 (15 

U.S.C. 80a–1 et seq.), but for section 

3(c)(1) or 3(c)(7) of that Act (15 U.S.C. 

80a–3(c)(1) or (7)); 

(ii) A commodity pool, as defined in 

section 1a(10) of the Commodity 

Exchange Act (7 U.S.C. 1a(10)); 

(iii) Any issuer, as defined in section 

2(a)(22) of the Investment Company Act 

of 1940 (15 U.S.C. 80a–2(a)(22)), that is 

organized or offered outside of the 

United States that would be a covered 

fund as defined in paragraphs (b)(1)(i), 

(ii), or (iv) of this section, were it 

organized or offered under the laws, or 

offered to one or more residents, of the 

United States or of one or more States; 

and 

(iv) Any such similar fund as the 

appropriate Federal banking agencies, 

the SEC, and the CFTC may determine, 

by rule, as provided in section 13(b)(2) 

of the BHC Act. 

(2) Director has the same meaning as 

provided in § 215.2(d)(1) of the Board’s 

Regulation O (12 CFR 215.2(d)(1)). 

(3) Ownership interest. 

(i) Ownership interest means any 

equity, partnership, or other similar 

interest (including, without limitation, a 

share, equity security, warrant, option, 

general partnership interest, limited 

partnership interest, membership 

interest, trust certificate, or other similar 

instrument) in a covered fund, whether 

voting or nonvoting, or any derivative of 

such interest. 

(ii) Ownership interest does not 

include, with respect to a covered fund: 

(A) Carried interest. An interest held 

by a covered banking entity (or an 

affiliate, subsidiary or employee thereof) 

in a covered fund for which the covered 

banking entity (or an affiliate, subsidiary 

or employee thereof) serves as 

investment manager, investment adviser 

or commodity trading adviser, so long 

as: 

(1) The sole purpose and effect of the 

interest is to allow the covered banking 

entity (or the affiliate, subsidiary or 

employee thereof) to share in the profits 

of the covered fund as performance 

compensation for services provided to 

the covered fund by the covered 

banking entity (or the affiliate, 

subsidiary or employee thereof), 

provided that the covered banking 

entity (or the affiliate, subsidiary or 

employee thereof) may be obligated 

under the terms of such interest to 

return profits previously received; 

(2) All such profit, once allocated, is 

distributed to the covered banking 

entity (or the affiliate, subsidiary or 

employee thereof) promptly after being 

earned or, if not so distributed, the 

reinvested profit of the covered banking 

entity (or the affiliate, subsidiary or 

employee thereof) does not share in the 

subsequent profits and losses of the 

covered fund; 

(3) The covered banking entity (or the 

affiliate, subsidiary or employee thereof) 

does not provide funds to the covered 

fund in connection with acquiring or 

retaining this interest; and 

(4) The interest is not transferable by 

the covered banking entity (or the 

affiliate, subsidiary or employee thereof) 

except to another affiliate or subsidiary 

thereof. 


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(4) Prime brokerage transaction means 

one or more products or services 

provided by a covered banking entity to 

a covered fund, such as custody, 

clearance, securities borrowing or 

lending services, trade execution, or 

financing, data, operational, and 

portfolio management support. 

(5) Sponsor, with respect to a covered 

fund, means: 

(i) To serve as a general partner, 

managing member, trustee, or 

commodity pool operator of a covered 

fund; 

(ii) In any manner to select or to 

control (or to have employees, officers, 

or directors, or agents who constitute) a 

majority of the directors, trustees, or 

management of a covered fund; or 

(iii) To share with a covered fund, for 

corporate, marketing, promotional, or 

other purposes, the same name or a 

variation of the same name. 

(6) Trustee. (i) For purposes of this 

subpart, a trustee does not include a 

trustee that does not exercise 

investment discretion with respect to a 

covered fund, including a directed 

trustee, as that term is used in section 

403(a)(1) of the Employee’s Retirement 

Income Security Act (29 U.S.C. 

1103(a)(1)). 

(ii) Any covered banking entity that 

directs a person identified in paragraph 

(b)(6)(i) of this section, or that possesses 

authority and discretion to manage and 

control the assets of a covered fund for 

which such person identified in 

paragraph (b)(6)(i) of this section serves 

as trustee, shall be considered a trustee 

of such covered fund. 

§ll.11 Permitted organizing and 

offering of a covered fund. 

Section ll.10(a) does not prohibit a 

covered banking entity from, directly or 

indirectly, organizing and offering a 

covered fund, including serving as a 

general partner, managing member, 

trustee, or commodity pool operator of 

the covered fund and in any manner 

selecting or controlling (or having 

employees, officers, directors, or agents 

who constitute) a majority of the 

directors, trustees, or management of the 

covered fund, including any necessary 

expenses for the foregoing, only if: 

(a) The covered banking entity 

provides bona fide trust, fiduciary, 

investment advisory, or commodity 

trading advisory services; 

(b) The covered fund is organized and 

offered only in connection with the 

provision of bona fide trust, fiduciary, 

investment advisory, or commodity 

trading advisory services and only to 

persons that are customers of such 

services of the covered banking entity, 

pursuant to a credible plan or similar 

documentation outlining how the 

covered banking entity intends to 

provide advisory or similar services to 

its customers through organizing and 

offering such fund; 

(c) The covered banking entity does 

not acquire or retain an ownership 

interest in the covered fund except as 

permitted under this subpart; 

(d) The covered banking entity 

complies with the restrictions under 

§ ll.16 of this subpart; 

(e) The covered banking entity does 

not, directly or indirectly, guarantee, 

assume, or otherwise insure the 

obligations or performance of the 

covered fund or of any covered fund in 

which such covered fund invests; 

(f) The covered fund, for corporate, 

marketing, promotional, or other 

purposes: 

(1) Does not share the same name or 

a variation of the same name with the 

covered banking entity (or an affiliate or 

subsidiary thereof); and 

(2) Does not use the word ‘‘bank’’ in 

its name; 

(g) No director or employee of the 

covered banking entity takes or retains 

an ownership interest in the covered 

fund, except for any director or 

employee of the covered banking entity 

who is directly engaged in providing 

investment advisory or other services to 

the covered fund; and 

(h) The covered banking entity: 

(1) Clearly and conspicuously 

discloses, in writing, to any prospective 

and actual investor in the covered fund 

(such as through disclosure in the 

covered fund’s offering documents): 

(i) That ‘‘any losses in [such covered 

fund] will be borne solely by investors 

in [the covered fund] and not by [the 

covered banking entity and its affiliates 

or subsidiaries]; therefore, [the covered 

banking entity’s and its affiliates’ or 

subsidiaries’] losses in [such covered 

fund] will be limited to losses 

attributable to the ownership interests 

in the covered fund held by the [covered 

banking entity and its affiliates or 

subsidiaries] in their capacity as 

investors in the [covered fund]’’; 

(ii) That such investor should read the 

fund offering documents before 

investing in the covered fund; 

(iii) That the ‘‘ownership interests in 

the covered fund are not insured by the 

FDIC, and are not deposits, obligations 

of, or endorsed or guaranteed in any 

way, by any banking entity’’ (unless that 

happens to be the case); 

(iv) The role of the covered banking 

entity and its affiliates, subsidiaries and 

employees in sponsoring or providing 

any services to the covered fund; and 

(2) Complies with any additional 

rules of the appropriate Federal banking 

agencies, the SEC, or the CFTC, as 

provided in section 13(b)(2) of the BHC 

Act, designed to ensure that losses in 

such covered fund are borne solely by 

investors in the covered fund and not by 

the covered banking entity and its 

affiliates or subsidiaries. 

§ll.12 Permitted investment in a 

covered fund. 

(a) Authority and limitations on 

permitted investments in covered funds. 

(1) The prohibition contained in 

§ ll.10(a) does not apply with respect 

to a covered banking entity acquiring 

and retaining any ownership interest in 

a covered fund that the covered banking 

entity or an affiliate or subsidiary 

thereof organizes and offers, for the 

purposes of: 

(i) Establishment. Establishing the 

covered fund and providing the fund 

with sufficient initial equity for 

investment to permit the fund to attract 

unaffiliated investors as required by 

paragraph (a)(2)(i) of this section; or 

(ii) De minimis investment. Making 

and retaining an investment in the 

covered fund that does not exceed 3 

percent of the total outstanding 

ownership interests in the fund. 

(2) Ownership limits. 

(i) With respect to an investment in 

any covered fund pursuant to paragraph 

(a)(1)(i) of this section, the covered 

banking entity: 

(A) Must actively seek unaffiliated 

investors to reduce through redemption, 

sale, dilution, or other methods the 

aggregate amount of all ownership 

interests of the covered banking entity 

in any covered fund under §ll.12 to 

the amount permitted in paragraph 

(a)(2)(i)(B) of this section; and 

(B) May not exceed 3 percent of the 

total amount or value of outstanding 

ownership interests of the fund not later 

than 1 year after the date of 

establishment of the fund (or such 

longer period as may be provided by the 

Board pursuant to paragraph (e) of this 

section); and 

(ii) The aggregate value of all 

ownership interests of the covered 

banking entity in all covered funds 

under §ll.12 may not exceed 3 

percent of the tier 1 capital of the 

covered banking entity, as provided 

under paragraph (c) of this section. 

(b) Limitations on investments in a 

single covered fund. For purposes of 

determining whether a covered banking 

entity is in compliance with the 

limitations and restrictions on permitted 

investments in covered funds contained 

in paragraph (a) of this section, a 

covered banking entity shall calculate 

its amount and value of a permitted 


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investment in a single covered fund as 

follows: 

(1) Attribution of ownership interests 

to a covered banking entity. The amount 

and value of a banking entity’s 

permitted investment in any single 

covered fund shall include: 

(i) Controlled investments. Any 

ownership interest held under §ll.12 

by any entity that is controlled, directly 

or indirectly, by the covered banking 

entity for purposes of this part; and 

(ii) Noncontrolled investments. The 

pro rata share of any ownership interest 

held under §ll.12 by any covered 

fund that is not controlled by the 

covered banking entity but in which the 

covered banking entity owns, controls, 

or holds with the power to vote more 

than 5 percent of the voting shares. 

(2) Calculation of amount of 

ownership interests in a single covered 

fund. For purposes of determining 

whether an investment in a single 

covered fund does not exceed 3 percent 

of the total outstanding ownership 

interests of the fund under paragraph 

(a)(2)(i)(B) of this section: 

(i) The aggregate amount of all 

ownership interests of the covered 

banking entity shall be the greater of 

(without regard to committed funds not 

yet called for investment): 

(A) The value of any investment or 

capital contribution made with respect 

to all ownership interests held under 

§ ll.12 by the covered banking entity 

in the covered fund, divided by the 

value of all investments or capital 

contributions, respectively, made by all 

persons in that covered fund; or 

(B) The total number of ownership 

interests held under §ll.12 by the 

covered banking entity in a covered 

fund divided by the total number of 

ownership interests held by all persons 

in that covered fund. 

(ii) Inclusion of certain parallel 

investments. To the extent that a 

covered banking entity is contractually 

obligated to directly invest in, or is 

found to be acting in concert through 

knowing participation in a joint activity 

or parallel action toward a common goal 

of investing in, one or more investments 

with a covered fund that is organized 

and offered by the covered banking 

entity, whether or not pursuant to an 

express agreement, such investments 

shall be included in any calculation 

required under paragraph (a)(2) of this 

section. 

(3) Timing of single covered fund 

investment calculation. The aggregate 

amount of all ownership interests of a 

covered banking entity in a single 

covered fund may at no time exceed the 

limits in this paragraph after the 

conclusion of the period provided in 

paragraph (a)(2)(i)(B) of this section. 

(4) Methodology and standards for 

calculation. For purposes of 

determining the amount or value of its 

investment in a covered fund under this 

paragraph (b), a covered banking entity 

must calculate its investment in the 

same manner and according to the same 

standards utilized by the covered fund 

for determining the aggregate value of 

the fund’s assets and ownership 

interests. 

(c) Aggregate permitted investments 

in all covered funds. (1) For purposes of 

determining the aggregate value of all 

permitted investments in all covered 

funds by a covered banking entity under 

paragraph (a)(2)(ii) of this section, the 

aggregate value of all ownership 

interests held by that covered banking 

entity shall be the sum of the value of 

each investment in a covered fund held 

under §ll.12, as determined in 

accordance with applicable accounting 

standards. 

(2) Calculation of tier 1 capital. For 

purposes of determining compliance 

with paragraph (a)(2)(ii) of this section: 

(i) Entities that are required to hold 

and report tier 1 capital. If a covered 

banking entity is required to calculate 

and report tier 1 capital, the covered 

banking entity’s tier 1 capital shall be 

equal to the amount of tier 1 capital 

calculated by that covered banking 

entity as of the last day of the most 

recent calendar quarter that has ended, 

as reported to its primary financial 

regulatory agency, as defined in section 

2(12) of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act; 

and 

(ii) If a covered banking entity is not 

required to calculate and report tier 1 

capital, the covered banking entity’s tier 

1 capital shall be determined to be equal 

to: 

(A) In the case of a covered banking 

entity that is controlled, directly or 

indirectly, by a depository institution 

that calculates and reports tier 1 capital, 

the amount of tier 1 capital reported by 

such controlling depository institution 

pursuant to paragraph (c)(2)(i) of this 

section; 

(B) In the case of a covered banking 

entity that is not controlled, directly or 

indirectly, by a depository institution 

that calculates and reports tier 1 capital: 

(1) Bank holding company 

subsidiaries. If the covered banking 

entity is a subsidiary of a bank holding 

company or company that is treated as 

a bank holding company, the amount of 

tier 1 capital reported by the top-tier 

affiliate of such covered banking entity 

that calculates and reports tier 1 capital, 

pursuant to paragraph (c)(2)(i) of this 

section; and 

(2) Other holding companies and any 

subsidiary or affiliate thereof. If the 

covered banking entity is not a 

subsidiary of a bank holding company 

or a company that is treated as a bank 

holding company, the total amount of 

shareholders’ equity of the top-tier 

affiliate within such organization as of 

the last day of the most recent calendar 

quarter that has ended, as determined 

under applicable accounting standards. 

(3) A covered banking entity’s 

aggregate permitted investment in all 

covered funds shall be calculated as of 

the last day of each calendar quarter. 

(d) Capital treatment for a permitted 

investment in a covered fund. For 

purposes of calculating capital pursuant 

to the applicable capital rules, a covered 

banking entity shall deduct the 

aggregate value of all permitted 

investments in all covered funds made 

or retained by a covered banking entity 

pursuant to this section (as determined 

under paragraph (c)(1) of this section) 

from the banking entity’s tier 1 capital 

(as determined under paragraph (c)(2) of 

this section). 

(e) Extension of time to divest an 

ownership interest. (1) Upon application 

by a covered banking entity, the Board 

may extend the period of time to meet 

the requirements under paragraphs 

(a)(2)(i)(A) and (B) of this section for up 

to 2 additional years, if the Board finds 

that an extension would be consistent 

with safety and soundness and not 

detrimental to the public interest. An 

application for extension must: 

(i) Be submitted to the Board at least 

90 days prior to the expiration of the 

applicable time period; 

(ii) Provide the reasons for 

application, including information that 

addresses the factors in paragraph (e)(2) 

of this section; and 

(iii) Explain the covered banking 

entity’s plan for reducing the permitted 

investment in a covered fund through 

redemption, sale, dilution or other 

methods as required in paragraph 

(a)(2)(i) of this section. 

(2) Factors governing Board 

determinations. In reviewing any 

application under paragraph (e)(1) of 

this section, the Board may consider all 

the facts and circumstances related to 

the permitted investment in a covered 

fund, including: 

(i) Whether the investment would: 

(A) Involve or result in material 

conflicts of interest between the covered 

banking entity and its clients, customers 

or counterparties; 

(B) Result, directly or indirectly, in a 

material exposure by the covered 


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banking entity to high-risk assets or 

high-risk trading strategies; 

(C) Pose a threat to the safety and 

soundness of the covered banking 

entity; or 

(D) Pose a threat to the financial 

stability of the United States; 

(ii) Market conditions; 

(iii) The contractual terms governing 

the covered banking entity’s interest in 

the covered fund; 

(iv) The date on which the covered 

fund is expected to have attracted 

sufficient investments from investors 

unaffiliated with the covered banking 

entity to enable the covered banking 

entity to comply with the limitations in 

paragraph (a)(2)(i) of this section; 

(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 covered banking entity and 

the financial stability of the United 

States; 

(v) The cost to the covered banking 

entity of divesting or disposing of the 

investment within the applicable 

period; 

(vi) Whether the divestiture or 

conformance of the investment would 

involve or result in a material conflict 

of interest between the covered banking 

entity and unaffiliated clients, 

customers or counterparties to which it 

owes a duty; 

(vii) The covered banking entity’s 

prior efforts to reduce through 

redemption, sale, dilution, or other 

methods its ownership interests in the 

covered fund, including activities 

related to the marketing of interests in 

such covered fund; and 

(viii) Any other factor that the Board 

believes appropriate. 

(3) Consultation. In the case of a 

covered banking entity that is primarily 

regulated by another Federal banking 

agency, the SEC, or the CFTC, the Board 

will consult with such agency prior to 

approval of an application by the 

covered banking entity for an extension 

under paragraph (e)(1) of this section. 

(4) Authority to impose restrictions on 

activities or investment during any 

extension period. (i) The Board may 

impose such conditions on any 

extension approved under paragraph 

(e)(1) of this section as the Board 

determines are necessary or appropriate 

to protect the safety and soundness of 

the covered banking entity or the 

financial stability of the United States, 

address material conflicts of interest or 

other unsound banking practices, or 

otherwise further the purposes of 

section 13 of the BHC Act (12 U.S.C. 

1851) and this part. 

(ii) Consultation. In the case of a 

covered banking entity that is primarily 

regulated by another Federal banking 

agency, the SEC, or the CFTC, the Board 

will consult with such agency prior to 

imposing conditions on the approval of 

a request by the covered banking entity 

for an extension under paragraph (e)(1) 

of this section. 

§ll.13 Other permitted covered fund 

activities and investments. 

(a) Permitted investments in SBICs 

and related investments. The 

prohibition contained in §ll.10(a) 

does not apply with respect to acquiring 

or retaining an ownership interest in, or 

acting as sponsor to, a covered fund by 

a covered banking entity or an affiliate 

or subsidiary thereof: 

(1) In one or more small business 

investment companies, as defined in 

section 102 of the Small Business 

Investment Act of 1958 (15 U.S.C. 662); 

(2) That is designed primarily to 

promote the public welfare, of the type 

permitted under paragraph (11) of 

section 5136 of the Revised Statutes of 

the United States (12 U.S.C. 24), 

including the welfare of low- and 

moderate-income communities or 

families (such as providing housing, 

services, or jobs); or 

(3) That is a qualified rehabilitation 

expenditure with respect to a qualified 

rehabilitation building or certified 

historic structure, as such terms are 

defined in section 47 of the Internal 

Revenue Code of 1986 or a similar State 

historic tax credit program. 

(b) Permitted Risk-Mitigating Hedging 

Activities. 

(1) The prohibition contained in 

§ ll.10(a) does not apply with respect 

to an ownership interest in a covered 

fund by a covered banking entity, 

provided that the acquisition or 

retention of the ownership interest is: 

(i) Made in connection with and 

related to individual or aggregated 

obligations or liabilities of the covered 

banking entity that are: 

(A) Taken by the covered banking 

entity when acting as intermediary on 

behalf of a customer that is not itself a 

banking entity to facilitate the exposure 

by the customer to the profits and losses 

of the covered fund, or 

(B) Directly connected to a 

compensation arrangement with an 

employee that directly provides 

investment advisory or other services to 

the covered fund; and 

(ii) Designed to reduce the specific 

risks to the covered banking entity in 

connection with and related to such 

obligations or liabilities. 

(2) Requirements. For purposes of 

paragraph (b)(1) of this section, 

acquiring or retaining an ownership 

interest in a covered fund by a covered 

banking entity shall be a permissible 

risk-mitigating hedging activity under 

this section only if: 

(i) The covered banking entity has 

established the internal compliance 

program required by subpart D designed 

to ensure the covered banking entity’s 

compliance with the requirements of 

this paragraph (b)(2) of this section 

including reasonably designed written 

policies and procedures regarding the 

instruments, techniques and strategies 

that may be used for hedging, internal 

controls and monitoring procedures, 

and independent testing; 

(ii) The acquisition or retention of an 

ownership interest in a covered fund: 

(A) Is made in accordance with the 

written policies, procedures and 

internal controls established by the 

covered banking entity pursuant to 

subpart D of this part; 

(B) Hedges or otherwise mitigates an 

exposure to a covered fund through an 

offsetting exposure to the same covered 

fund and in the same amount of 

ownership interest in that covered fund 

that: 

(1) Arises out of a transaction 

conducted solely to accommodate a 

specific customer request with respect 

to, or 

(2) Is directly connected to its 

compensation arrangement with an 

employee that directly provides 

investment advisory or other services to, 

that covered fund; 

(C) Does not give rise, at the inception 

of the hedge, to significant exposures 

that were not already present in 

individual or aggregated positions, 

contracts, or other holdings of a covered 

banking entity and that are not hedged 

contemporaneously; and 

(D) Is subject to continuing review, 

monitoring and management by the 

covered banking entity that: 

(1) Is consistent with its written 

hedging policies and procedures; 

(2) Maintains a substantially similar 

offsetting exposure to the same amount 

and type of ownership interest, based 

upon the facts and circumstances of the 

underlying and hedging positions and 

the risks and liquidity of those 

positions, to the risk or risks the 

purchase or sale is intended to hedge or 

otherwise mitigate; and 

(3) Mitigates any significant exposure 

arising out of the hedge after inception; 

and 

(iii) The compensation arrangements 

of persons performing the riskmitigating hedging activities are 

designed not to reward proprietary risktaking. 


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(3) Documentation. With respect to 

any acquisition or retention of an 

ownership interest in a covered fund by 

a covered banking entity pursuant to 

this paragraph (b), the covered banking 

entity must document, at the time the 

transaction is conducted: 

(i) The risk-mitigating purpose of the 

acquisition or retention of an ownership 

interest in a covered fund; 

(ii) The risks of the individual or 

aggregated obligation or liability of a 

covered banking entity that the 

acquisition or retention of an ownership 

interest in a covered fund is designed to 

reduce; and 

(iii) The level of organization that is 

establishing the hedge. 

(c) Certain permitted covered fund 

activities and investments outside of the 

United States. 

(1) The prohibition contained in 

§ ll.10(a) does not apply to the 

acquisition or retention of any 

ownership interest in, or the 

sponsorship of, a covered fund by a 

covered banking entity if: 

(i) The covered banking entity is not 

directly or indirectly controlled by a 

banking entity that is organized under 

the laws of the United States or of one 

or more States; 

(ii) The activity is conducted pursuant 

to paragraph (9) or (13) of section 4(c) 

of the BHC Act; 

(iii) No ownership interest in such 

covered fund is offered for sale or sold 

to a resident of the United States; and 

(iv) The activity occurs solely outside 

of the United States. 

(2) An activity shall be considered to 

be conducted pursuant to paragraph (9) 

or (13) of section 4(c) of the BHC Act 

only if: 

(i) With respect to a covered banking 

entity that is a foreign banking 

organization, the covered banking entity 

is a qualifying foreign banking 

organization and is conducting the 

activity in compliance with subpart B of 

the Board’s Regulation K (12 CFR 211.20 

through 211.30); or 

(ii) With respect to a covered banking 

entity that is not a foreign banking 

organization, the covered banking entity 

meets at least two of the following 

requirements: 

(A) Total assets of the covered 

banking entity held outside of the 

United States exceed total assets of the 

covered banking entity held in the 

United States; 

(B) Total revenues derived from the 

business of the covered banking entity 

outside of the United States exceed total 

revenues derived from the business of 

the covered banking entity in the United 

States; or 

(C) Total net income derived from the 

business of the covered banking entity 

outside of the United States exceeds 

total net income derived from the 

business of the covered banking entity 

in the United States. 

(3) An activity shall be considered to 

have occurred solely outside of the 

United States only if: 

(i) The covered banking entity 

engaging in the activity is not organized 

under the laws of the United States or 

of one or more States; 

(ii) No subsidiary, affiliate, or 

employee of the covered banking entity 

that is involved in the offer or sale of an 

ownership interest in the covered fund 

is incorporated or physically located in 

the United States or in one or more 

States; and 

(iii) No ownership interest in such 

covered fund is offered for sale or sold 

to a resident of the United States. 

(d) Loan securitizations. The 

prohibition contained in §ll.10(a) 

does not apply with respect to the 

acquisition or retention by a covered 

banking entity of any ownership interest 

in, or acting as sponsor to, a covered 

fund that is an issuer of asset-backed 

securities, the assets or holdings of 

which are solely comprised of: 

(1) Loans; 

(2) Contractual rights or assets 

directly arising from those loans 

supporting the asset-backed securities; 

and 

(3) Interest rate or foreign exchange 

derivatives that: 

(i) Materially relate to the terms of 

such loans or contractual rights or 

assets; and 

(ii) Are used for hedging purposes 

with respect to the securitization 

structure. 

§ll.14 Covered fund activities 

determined to be permissible. 

(a) The prohibition contained in 

§ ll.10(a) does not apply to the 

acquisition or retention by a covered 

banking entity of any ownership interest 

in or acting as sponsor to: 

(1) Bank owned life insurance. A 

separate account which is used solely 

for the purpose of allowing a covered 

banking entity to purchase an insurance 

policy for which the covered banking 

entity is the beneficiary, provided that 

the covered banking entity that 

purchases the insurance policy: 

(i) Does not control the investment 

decisions regarding the underlying 

assets or holdings of the separate 

account; and 

(ii) Holds its ownership interest in the 

separate account in compliance with 

applicable supervisory guidance 

regarding bank owned life insurance. 

(2) Certain other covered funds. Any 

of the following entities that would 

otherwise qualify as a covered fund: 

(i) A joint venture between the 

covered banking entity or one of its 

affiliates and any other person, provided 

that the joint venture: 

(A) Is an operating company; and 

(B) Does not engage in any activity or 

make any investment that is prohibited 

under this part; 

(ii) An acquisition vehicle, provided 

that the sole purpose and effect of such 

entity is to effectuate a transaction 

involving the acquisition or merger of 

one entity with or into the covered 

banking entity or one of its affiliates; 

(iii) An issuer of an asset-backed 

security, but only with respect to that 

amount or value of economic interest in 

a portion of the credit risk for an assetbacked security that is retained by a 

covered banking entity that is a 

‘‘securitizer’’ or ‘‘originator’’ in 

compliance with the minimum 

requirements of section 15G of the 

Exchange Act (15 U.S.C. 78o–11) and 

any implementing regulations issued 

thereunder; 

(iv) A wholly-owned subsidiary of the 

covered banking entity that is: 

(A) Engaged principally in performing 

bona fide liquidity management 

activities described in 

§ ll.3(b)(2)(iii)(C), and 

(B) Carried on the balance sheet of the 

covered banking entity; and 

(v) A covered fund that is an issuer of 

asset-backed securities described in 

§ ll.13(d), the assets or holdings of 

which are solely comprised of: 

(A) Loans; 

(B) Contractual rights or assets 

directly arising from those loans 

supporting the asset-backed securities; 

and 

(C) Interest rate or foreign exchange 

derivatives that: 

(1) Materially relate to the terms of 

such loans or contractual rights or 

assets, and 

(2) Are used for hedging purposes 

with respect to the securitization 

structure. 

(b) The prohibition contained in 

§ ll.10(a) does not apply to the 

acquisition or retention by a covered 

banking entity of any ownership interest 

in, or acting as sponsor to, a covered 

fund, but only if such ownership 

interest is acquired or retained by a 

covered banking entity (or an affiliate or 

subsidiary thereof): 

(1) In the ordinary course of collecting 

a debt previously contracted in good 

faith, if the covered banking entity 

divests the ownership interest within 

applicable time periods provided for by 

the [Agency]; or 


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8434 Federal Register / Vol. 77, No. 30 / Tuesday, February 14, 2012 / Proposed Rules 

(2) Pursuant to and in compliance 

with the conformance or extended 

transition period authorities provided 

for in subpart E of the Board’s rules 

implementing section 13 of the BHC Act 

(12 CFR 248.30 through 248.35). 

§ll.15 Internal controls, reporting and 

recordkeeping requirements applicable to 

covered fund activities and investments. 

A covered banking entity engaged in 

any covered fund activity or making or 

holding any investment permitted under 

this subpart shall comply with: 

(a) The internal controls, reporting, 

and recordkeeping requirements 

required under §ll.20 and appendix 

C to this part, as applicable; and 

(b) Such other reporting and 

recordkeeping requirements as the 

[Agency] may deem necessary to 

appropriately evaluate the covered 

banking entity’s compliance with this 

subpart. 

§ll.16 Limitations on relationships with 

a covered fund. 

(a) Relationships with a covered fund. 

(1) Except as provided for in 

paragraph (a)(2) of this section, no 

covered banking entity that serves, 

directly or indirectly, as the investment 

manager, investment adviser, 

commodity trading advisor, or sponsor 

to a covered fund, or that organizes and 

offers a covered fund pursuant to 

§ ll.11, and no affiliate of such entity, 

may enter into a transaction with the 

covered fund, or with any other covered 

fund that is controlled by such covered 

fund, that would be a covered 

transaction as defined in section 23A of 

the Federal Reserve Act (12 U.S.C. 

371c), as if such covered banking entity 

and the affiliate thereof were a member 

bank and the covered fund were an 

affiliate thereof. 

(2) Notwithstanding paragraph (a)(1) 

of this section, a covered banking entity 

may: 

(i) Acquire and retain any ownership 

interest in a covered fund in accordance 

with the requirements of this subpart; 

and 

(ii) Enter into any prime brokerage 

transaction with any covered fund in 

which a covered fund managed, 

sponsored, or advised by such covered 

banking entity (or an affiliate or 

subsidiary thereof) has taken an 

ownership interest, if: 

(A) The covered banking entity is in 

compliance with each of the limitations 

set forth in §ll.11 with respect to a 

covered fund organized and offered by 

such covered banking entity (or an 

affiliate or subsidiary thereof); 

(B) The chief executive officer (or 

equivalent officer) of the top-tier 

affiliate of the covered banking entity 

certifies in writing annually (with a 

duty to update the certification if the 

information in the certification 

materially changes) that the covered 

banking entity does not, directly or 

indirectly, guarantee, assume, or 

otherwise insure the obligations or 

performance of the covered fund or of 

any covered fund in which such 

covered fund invests; and 

(C) The Board has not determined that 

such transaction is inconsistent with the 

safe and sound operation and condition 

of the covered banking entity. 

(b) Restrictions on transactions with 

covered funds. A covered banking entity 

that serves, directly or indirectly, as the 

investment manager, investment 

adviser, commodity trading advisor, or 

sponsor to a covered fund, or that 

organizes and offers a covered fund 

pursuant to § ll.11, shall be subject to 

section 23B of the Federal Reserve Act 

(12 U.S.C. 371c–1), as if such covered 

banking entity were a member bank and 

such covered fund were an affiliate 

thereof. 

(c) Restrictions on prime brokerage 

transactions. A prime brokerage 

transaction permitted under paragraph 

(a)(2)(ii) of this section shall be subject 

to section 23B of the Federal Reserve 

Act (12 U.S.C. 371c–1) as if the 

counterparty were an affiliate of the 

covered banking entity. 

§ll.17 Other limitations on permitted 

covered fund activities. 

(a) No transaction, class of 

transactions, or activity may be deemed 

permissible under §§ll.11 through 

ll.14 and §ll.16 if the transaction, 

class of transactions, or activity would: 

(1) Involve or result in a material 

conflict of interest between the covered 

banking entity and its clients, 

customers, or counterparties; 

(2) Result, directly or indirectly, in a 

material exposure by the covered 

banking entity to a high-risk asset or a 

high-risk trading strategy; or 

(3) Pose a threat to the safety and 

soundness of the covered banking entity 

or the financial stability of the United 

States. 

(b) Definition of material conflict of 

interest. For purposes of this section, a 

material conflict of interest between a 

covered banking entity and its clients, 

customers, or counterparties exists if the 

covered banking entity engages in any 

transaction, class of transactions, or 

activity that would involve or result in 

the covered banking entity’s interests 

being materially adverse to the interests 

of its client, customer, or counterparty 

with respect to such transaction, class of 

transactions, or activity, unless: 

(1) Timely and effective disclosure 

and opportunity to negate or 

substantially mitigate. Prior to effecting 

the specific transaction or class or type 

of transactions, or engaging in the 

specific activity, for which a conflict of 

interest may arise, the covered banking 

entity: 

(i) Makes clear, timely, and effective 

disclosure of the conflict of interest, 

together with other necessary 

information, in reasonable detail and in 

a manner sufficient to permit a 

reasonable client, customer, or 

counterparty to meaningfully 

understand the conflict of interest; and 

(ii) Makes such disclosure explicitly 

and effectively, and in a manner that 

provides the client, customer, or 

counterparty the opportunity to negate, 

or substantially mitigate, any materially 

adverse effect on the client, customer, or 

counterparty created by the conflict of 

interest; or 

(2) Information barriers. The covered 

banking entity has established, 

maintained, and enforced information 

barriers that are memorialized in written 

policies and procedures, such as 

physical separation of personnel, or 

functions, or limitations on types of 

activity, that are reasonably designed, 

taking into consideration the nature of 

the covered banking entity’s business, to 

prevent the conflict of interest from 

involving or resulting in a materially 

adverse effect on a client, customer, or 

counterparty. A covered banking entity 

may not rely on such information 

barriers if, in the case of any specific 

transaction, class or type of transactions 

or activity, the banking entity knows or 

should reasonably know that, 

notwithstanding the covered banking 

entity’s establishment of information 

barriers, the conflict of interest may 

involve or result in a materially adverse 

effect on a client, customer, or 

counterparty. 

(c) Definition of high-risk asset and 

high-risk trading strategy. For purposes 

of this section: 

(1) High-risk asset means an asset or 

group of related assets that would, if 

held by a covered banking entity, 

significantly increase the likelihood that 

the covered banking entity would incur 

a substantial financial loss or would fail. 

(2) High-risk trading strategy means a 

trading strategy that would, if engaged 

in by a covered banking entity, 

significantly increase the likelihood that 

the covered banking entity would incur 

a substantial financial loss or would fail. 


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§ll.18 [Reserved] 

§ll.19 [Reserved] 

Subpart D—Compliance Program 

Requirement; Violations 

§ll.20 Program for monitoring 

compliance; enforcement. 

(a) Program requirement. Except as 

provided in paragraph (d) of this 

section, each covered banking entity 

shall develop and provide for the 

continued administration of a program 

reasonably designed to ensure and 

monitor compliance with the 

prohibitions and restrictions on 

proprietary trading and covered fund 

activities and investments set forth in 

section 13 of the BHC Act and this part, 

and such program shall be appropriate 

for the size, scope and complexity of 

activities and business structure of the 

covered banking entity. 

(b) Contents of compliance program. 

The compliance program required by 

paragraph (a) of this section, at a 

minimum, shall include: 

(1) Internal written policies and 

procedures reasonably designed to 

document, describe, and monitor 

trading activities subject to subpart B 

and activities and investments with 

respect to a covered fund subject to 

subpart C (including those permitted 

under §§ll.4 through ll.6 or 

§§ ll.11 through ll.16) to ensure 

that such activities and investments 

comply with section 13 of the BHC Act 

and this part; 

(2) A system of internal controls 

reasonably designed to monitor and 

identify potential areas of 

noncompliance with section 13 of the 

BHC Act and this part in the covered 

banking entity’s trading activities 

subject to subpart B and activities and 

investments with respect to a covered 

fund subject to subpart C (including 

those permitted under §§ll.4 through 

ll.6 or §§ll.11 through ll.16) 

and to prevent the occurrence of 

activities or investments that are 

prohibited by section 13 of the BHC Act 

and this part; 

(3) A management framework that 

clearly delineates responsibility and 

accountability for compliance with 

section 13 of the BHC Act and this part; 

(4) Independent testing for the 

effectiveness of the compliance program 

conducted by qualified personnel of the 

covered banking entity or by a qualified 

outside party; 

(5) Training for trading personnel and 

managers, as well as other appropriate 

personnel, to effectively implement and 

enforce the compliance program; and 

(6) Making and keeping records 

sufficient to demonstrate compliance 

with section 13 of the BHC Act and this 

part, which a covered banking entity 

must promptly provide to [Agency] 

upon request and retain for a period of 

no less than 5 years. 

(c) Additional Standards. (1) In the 

case of any covered banking entity 

described in paragraph (c)(2) of this 

section, the compliance program 

required by paragraph (a) of this section 

shall also satisfy the requirements and 

other standards contained in appendix 

C to this part. 

(2) A covered banking entity is subject 

to paragraph (c)(1) of this section if: 

(i) The covered banking entity engages 

in proprietary trading and has, together 

with its affiliates and subsidiaries, 

trading assets and liabilities the average 

gross sum of which (on a worldwide 

consolidated basis), as measured as of 

the last day of each of the four prior 

calendar quarters: 

(A) Is equal to or greater than $1 

billion; or 

(B) Equals 10 percent or more of its 

total assets; 

(ii) The covered banking entity invests 

in, or has relationships with, a covered 

fund and: 

(A) The covered banking entity has, 

together with its affiliates and 

subsidiaries, aggregate investments in 

one or more covered funds, the average 

value of which is, as measured as of the 

last day of each of the four prior 

calendar quarters, equal to or greater 

than $1 billion; or 

(B) Sponsors or advises, together with 

its affiliates and subsidiaries, one or 

more covered funds, the average total 

assets of which are, as measured as of 

the last day of each of the four prior 

calendar quarters, equal to or greater 

than $1 billion; or 

(iii) [Agency] deems it appropriate. 

(d) No program required for certain 

banking entities. To the extent that a 

covered banking entity does not engage 

in activities or investments prohibited 

or restricted by subpart B or subpart C 

of this part, a covered banking entity 

will have satisfied the requirements of 

this section if its existing compliance 

policies and procedures include 

measures that are designed to prevent 

the covered banking entity from 

becoming engaged in such activities or 

making such investments and which 

require the covered banking entity to 

develop and provide for the compliance 

program required under paragraph (a) of 

this section prior to engaging in such 

activities or making such investments. 

§ll.21 Termination of activities or 

investments; penalties for violations. 

(a) Any covered banking entity that 

engages in an activity or makes an 

investment in violation of section 13 of 

the BHC Act or this part or in a manner 

that functions as an evasion of the 

requirements of section 13 of the BHC 

Act or this part, including through an 

abuse of any activity or investment 

permitted under subparts B or C of this 

part, or otherwise violates the 

restrictions and requirements of section 

13 of the BHC Act or this part, shall 

terminate the activity and, as relevant, 

dispose of the investment. 

(b) After due notice and an 

opportunity for hearing, if the [Agency] 

finds reasonable cause to believe any 

covered banking entity has engaged in 

an activity or made an investment 

described in paragraph (a) of this 

section, the [Agency] may, by order, 

direct the banking entity to restrict, 

limit, or terminate the activity and, as 

relevant, dispose of the investment. 

(c) [Reserved] 

Appendix A to Part [ ]—Reporting and 

Recordkeeping Requirements for 

Covered Trading Activities 

I. Purpose 

This appendix sets forth reporting and 

recordkeeping requirements that certain 

covered banking entities must satisfy in 

connection with the restrictions on 

proprietary trading set forth in subpart B 

(‘‘proprietary trading restrictions’’). Pursuant 

to §ll.7, this appendix generally applies to 

a covered banking entity that has, together 

with its affiliates and subsidiaries, trading 

assets and liabilities the average gross sum of 

which (on a worldwide consolidated basis) 

is, as measured as of the last day of each of 

the four prior calendar quarters, equal to or 

greater than $1 billion. These entities are 

required to (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 should be incorporated into the 

covered banking entity’s internal compliance 

program under §ll.20 and Appendix C. 

The purpose of this appendix is to assist 

covered banking entities and [Agency] in: 

(i) Better understanding and evaluating the 

scope, type, and profile of the covered 

banking entity’s trading activities; 

(ii) Monitoring the covered banking entity’s 

trading activities; 

(iii) Identifying trading activities that 

warrant further review or examination by the 

covered banking entity to verify compliance 

with the proprietary trading restrictions; 

(iv) Evaluating whether the trading 

activities of trading units engaged in market 

making-related activities subject to 

§ll.4(b) are consistent with the 

requirements governing permitted market 

making-related activities; 

(v) Evaluating whether the covered trading 

activities of trading units that are engaged in 

permitted trading activity subject to 


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1 [Agency] expects that this will generally be the 

smallest unit of organization used by the covered 

banking entity to structure and control its risktaking activities and employees, and will include 

each unit generally understood to be a single 

‘‘trading desk.’’ 

2 [Agency] expects that this will generally include 

management or reporting divisions, groups, subgroups, or other intermediate units of organization 

used by the covered banking entity to manage one 

or more discrete trading units (e.g., ‘‘North 

American Credit Trading,’’ ‘‘Global Credit Trading,’’ 

etc.). 

3For example, under section IV.B.1 of this 

appendix, a banking entity is required to report to 

[Agency] the Comprehensive Profit and Loss 

quantitative measurement, as calculated for all 

trading days in June of any year, no later than July 

30 of that year. 

§§ll.4, ll.5, or ll.6(a) (i.e., 

underwriting and market making-related 

activity, risk-mitigating hedging, or trading in 

certain government obligations) are 

consistent with the requirement that such 

activity not result, directly or indirectly, in 

a material exposure to high-risk assets or 

high-risk trading strategies; 

(vi) Identifying the profile of particular 

trading activities of the covered banking 

entity, and the individual trading units of the 

banking entity, to help establish the 

appropriate frequency and scope of 

examination by [Agency] of such activities; 

and 

(vii) Assessing and addressing the risks 

associated with the covered banking entity’s 

covered trading activities. 

The quantitative measurements that must 

be furnished pursuant to this appendix are 

not intended to serve as a dispositive tool for 

the identification of permissible or 

impermissible activities. 

In addition to the quantitative 

measurements required in this appendix, a 

covered banking entity may need to develop 

and implement other quantitative 

measurements in order to effectively monitor 

its covered trading activities for compliance 

with section 13 of the BHC Act and this part 

and to have an effective compliance program, 

as required by §ll.20 and appendix C to 

this part. The effectiveness of particular 

quantitative measurements may differ based 

on the profile of the banking entity’s 

businesses in general and, more specifically, 

of the particular trading unit, including types 

of instruments traded, trading activities and 

strategies, and history and experience (e.g., 

whether the trading desk is an established, 

successful market maker or a new entrant to 

a competitive market). In all cases, covered 

banking entities must ensure that they have 

robust measures in place to identify and 

monitor the risks taken in their trading 

activities, to ensure that the activities are 

within risk tolerances established by the 

covered banking entity, and to monitor and 

examine for compliance with the proprietary 

trading restrictions in this part. 

On an ongoing basis, covered banking 

entities should carefully monitor, review, 

and evaluate all furnished quantitative 

measurements, as well as any others that they 

choose to utilize in order to maintain 

compliance with section 13 of the BHC Act 

and this part. All measurement results that 

indicate a heightened risk of impermissible 

proprietary trading, including with respect to 

otherwise-permitted activities under 

§§ll.4 through ll.6 that result in a 

material exposure to high-risk assets or highrisk trading strategies, should be escalated 

within the banking entity for review, further 

analysis, explanation to [Agency], and 

remediation, where appropriate. Many of the 

quantitative measurements discussed in this 

appendix will also be helpful to covered 

banking entities in identifying and managing 

the risks related to their covered trading 

activities. 

II. Definitions 

The terms used in this appendix have the 

same meanings as set forth in §§ll.2 and 

ll.3. In addition, for purposes of this 

appendix, the following definitions apply: 

Covered trading activity means proprietary 

trading, as defined in paragraph (b)(1) of 

§ll.3. 

Trading unit means each of the following 

units of organization of a covered banking 

entity: 

(i) Each discrete unit that is engaged in the 

coordinated implementation of a revenuegeneration strategy and that participates in 

the execution of any covered trading 

activity; 1

(ii) Each organizational unit that is used to 

structure and control the aggregate risktaking activities and employees of one or 

more trading units described in paragraph 

(i); 2

(iii) All trading operations, collectively; 

and 

(iv) Any other unit of organization 

specified by the [Agency] with respect to a 

particular banking entity. 

Calculation period means the period of 

time for which a particular quantitative 

measurement must be calculated. 

III. Reporting and Recordkeeping of 

Quantitative Measurements 

A. Scope of Required Reporting 

General scope. The quantitative 

measurements that must be furnished by a 

covered banking entity depend on the 

aggregate size of the covered banking entity’s 

trading activities and the activities in which 

its trading units engage, as follows: 

(i) With respect to any covered banking 

entity that is engaged in any covered trading 

activity, and has trading assets and liabilities 

the average gross sum of which (on a 

worldwide consolidated basis) is, as 

measured as of the last day of each of the four 

prior calendar quarters, equal to or greater 

than $5 billion: 

(a) Each trading unit of the covered 

banking entity that is engaged in market 

making-related activities subject to 

§ll.4(b) must furnish the following 

quantitative measurements, calculated in 

accordance with this appendix: 

• Value-at-Risk and Stress VaR; 

• VaR Exceedance; 

• Risk Factor Sensitivities; 

• Risk and Position Limits; 

• Comprehensive Profit and Loss; 

• Portfolio Profit and Loss; 

• Fee Income and Expense; 

• Spread Profit and Loss; 

• Comprehensive Profit and Loss 

Attribution; 

• Pay-to-Receive Spread Ratio; 

• Unprofitable Trading Days Based on 

Comprehensive Profit and Loss and 

Unprofitable Trading Days Based on Portfolio 

Profit and Loss; 

• Skewness of Portfolio Profit and Loss 

and Kurtosis of Portfolio Profit and Loss; 

• Volatility of Comprehensive Profit and 

Loss and Volatility of Portfolio Profit and 

Loss; 

• Comprehensive Profit and Loss to 

Volatility Ratio and Portfolio Profit and Loss 

to Volatility Ratio; 

• Inventory Risk Turnover; 

• Inventory Aging; and 

• Customer-facing Trade Ratio; and 

(b) Each trading unit of the covered 

banking entity that is engaged in permitted 

trading activity subject to §§ll.4(a), ll.5, 

or ll.6(a) must furnish the following 

quantitative measurements, calculated in 

accordance with this appendix: 

• Value-at-Risk and Stress VaR; 

• Risk Factor Sensitivities; 

• Risk and Position Limits; 

• Comprehensive Profit and Loss; and 

• Comprehensive Profit and Loss 

Attribution; and 

(ii) With respect to any covered banking 

entity that is engaged in any covered trading 

activity, and has trading assets and liabilities 

the average gross sum of which (on a 

worldwide consolidated basis) is, as 

measured as of the last day of each of the four 

prior calendar quarters, equal to or greater 

than $1 billion and less than $5 billion, each 

trading unit of the covered banking entity 

that is engaged in market making-related 

activities under §ll.4(b) must furnish the 

following quantitative measurement, 

calculated in accordance with this appendix: 

• Comprehensive Profit and Loss; 

• Portfolio Profit and Loss; 

• Fee Income and Expense; 

• Spread Profit and Loss; 

• Value-at-Risk; 

• Comprehensive Profit and Loss 

Attribution; 

• Volatility of Comprehensive Profit and 

Loss and Volatility of Portfolio Profit and 

Loss; and 

• Comprehensive Profit and Loss to 

Volatility Ratio and Portfolio Profit and Loss 

to Volatility Ratio. 

B. Frequency of Required Calculation and 

Reporting 

A covered banking entity must calculate 

any applicable quantitative measurement for 

each trading day. A covered banking entity 

must report each applicable quantitative 

measurement to [Agency] on a monthly basis, 

or on any other reporting schedule requested 

by [Agency]. All quantitative measurements 

for any calendar month must be reported to 

[Agency] no later than 30 days after the end 

of that calendar month or on any other time 

basis requested by [Agency].3

C. Recordkeeping 

A covered banking entity must, for any 

quantitative measurement furnished to 

[Agency] pursuant to this appendix and 

§ll.7, create and maintain records 

documenting the preparation and content of 


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these reports, as well as such information as 

is necessary to permit [Agency] to verify the 

accuracy of such reports, for a period of 5 

years. 

IV. Quantitative Measurements 

A. Risk-Management Measurements 

1. Value-at-Risk and Stress Value-at-Risk 

Description: For purposes of this appendix, 

Value-at-Risk (‘‘VaR’’) is the commonly used 

percentile measurement of the risk of future 

financial loss in the value of a given portfolio 

over a specified period of time, based on 

current market conditions. For purposes of 

this appendix, Stress Value-at-Risk (‘‘Stress 

VaR’’) is the percentile measurement of the 

risk of future financial loss in the value of a 

given portfolio over a specified period of 

time, based on market conditions during a 

period of significant financial stress. 

General Calculation Guidance: Banking 

entities should compute and report VaR and 

Stress VaR by employing generally accepted 

standards and methods of calculation. VaR 

should reflect a loss in a trading unit that is 

expected to be exceeded less than one 

percent of the time over a one-day period. 

For those banking entities that are subject to 

regulatory capital requirements imposed by a 

Federal banking agency, VaR and Stress VaR 

should be computed and reported in a 

manner that is consistent with such 

regulatory capital requirements. In cases 

where a trading unit does not have a 

standalone VaR or Stress VaR calculation but 

is part of a larger portfolio for which a VaR 

or Stress VaR calculation is performed, a VaR 

or Stress VaR calculation that includes only 

the trading unit’s holdings should be 

performed consistent with the VaR or Stress 

VaR model and methodology used by the 

larger portfolio. 

Calculation Period: One trading day. 

2. VaR Exceedance 

Description: For purposes of this appendix, 

VaR Exceedance is the difference between 

VaR and Portfolio Profit and Loss, exclusive 

of Spread Profit and Loss, for a trading unit 

for any given calculation period. 

Calculation Period: One trading day. 

3. Risk Factor Sensitivities 

Description: For purposes of this appendix, 

Risk Factor Sensitivities are changes in a 

trading unit’s Portfolio Profit and Loss, 

exclusive of Spread Profit and Loss, that are 

expected to occur in the event of a change 

in a trading unit’s ‘‘risk factors’’ (i.e., one or 

more underlying market variables that are 

significant sources of the trading unit’s 

profitability and risk). 

General Calculation Guidance: A covered 

banking entity should report the Risk Factor 

Sensitivities that are monitored and managed 

as part of the trading unit’s overall risk 

management policy. The underlying data and 

methods used to compute a trading unit’s 

Risk Factor Sensitivities should depend on 

the specific function of the trading unit and 

the internal risk management models 

employed. The number and type of Risk 

Factor Sensitivities that are monitored and 

managed by a trading unit, and furnished to 

[Agency], should depend on the explicit risks 

assumed by the trading unit. In general, 

however, reported Risk Factor Sensitivities 

should be sufficient to account for a 

preponderance of the price variation in the 

trading unit’s holdings. 

Trading units should take into account any 

relevant factors in calculating Risk Factor 

Sensitivities, including, for example, the 

following with respect to particular asset 

classes: 

• Commodity derivative positions: 

sensitivities with respect to the related 

commodity type (e.g., precious metals, oil 

and petroleum or agricultural products), the 

maturity of the positions, volatility and/or 

correlation sensitivities (expressed in a 

manner that demonstrates any significant 

non-linearities), and the maturity profile of 

the positions; 

• Credit positions: sensitivities with 

respect to credit spread factors that are 

sufficiently granular to account for specific 

credit sectors and market segments, the 

maturity profile of the positions, and 

sensitivities to interest rates at all relevant 

maturities; 

• Credit-related derivative positions: credit 

positions sensitivities and volatility and/or 

correlation sensitivities (expressed in a 

manner that demonstrates any significant 

non-linearities), and the maturity profile of 

the positions; 

• Equity positions: sensitivity to equity 

prices and sensitivities that differentiate 

between important equity market sectors and 

segments, such as a small capitalization 

equities and international equities; 

• Equity derivative positions: equity 

position sensitivities and volatility and/or 

correlation sensitivities (expressed in a 

manner that demonstrates any significant 

non-linearities), and the maturity profile of 

the positions; 

• Foreign exchange derivative positions: 

sensitivities with respect to major currency 

pairs and maturities, sensitivity to interest 

rates at relevant maturities, and volatility 

and/or correlation sensitivities (expressed in 

a manner that demonstrates any significant 

non-linearities), as well as the maturity 

profile of the positions; and 

• Interest rate positions, including interest 

rate derivative positions: sensitivities with 

respect to major interest rate categories and 

maturities and volatility and/or correlation 

sensitivities (expressed in a manner that 

demonstrates any significant non-linearities), 

as well as the maturity profile of the 

positions. 

The methods used by a covered banking 

entity to calculate sensitivities to a common 

factor shared by multiple trading units, such 

as an equity price factor, should be applied 

consistently across its trading units so that 

the sensitivities can be compared from one 

trading unit to another. 

Calculation Period: One trading day. 

4. Risk and Position Limits 

Description: For purposes of this appendix, 

Risk and Position Limits are the constraints 

that define the amount of risk that a trading 

unit is permitted to take at a point in time, 

as defined by the covered banking entity for 

a specific trading unit. 

General Calculation Guidance: Risk and 

Position Limits should be reported in the 

format used by the covered banking entity for 

the purposes of risk management of each 

trading unit. Risk and Position Limits are 

often expressed in terms of risk measures, 

such as VaR and Risk Factor Sensitivities, but 

may also be expressed in terms of other 

observable criteria, such as net open 

positions. When criteria other than VaR or 

Risk Factor Sensitivities are used to define 

the Risk and Position Limits, both the value 

of the Risk and Position Limits and the value 

of the variables used to assess whether these 

limits have been reached should be reported. 

Calculation Period: One trading day. 

B. Source-of-Revenue Measurements 

1. Comprehensive Profit and Loss 

Description: For purposes of this appendix, 

Comprehensive Profit and Loss is the net 

profit or loss of a trading unit’s material 

sources of trading revenue, including, for 

example, dividend and interest income and 

expense, over a specific period of time. A 

trading unit’s Comprehensive Profit and Loss 

for any given calculation period should 

generally equal the sum of the trading unit’s 

Portfolio Profit and Loss and Fee Income. 

General Calculation Guidance: 

Comprehensive Profit and Loss generally 

should be computed using data on the value 

of a trading unit’s underlying holdings, the 

prices at which those holdings were bought 

and sold, and the value of any fees, 

commissions, sales credits, spreads, 

dividends, interest income and expense, or 

other sources of income from trading 

activities, whether realized or unrealized. 

Comprehensive Profit and Loss should not 

include: compensation costs or other costs 

required to operate the unit, such as 

information technology costs; or charges and 

adjustments made for internal reporting and 

management purposes, such as accounting 

reserves. 

Calculation Period: One trading day. 

2. Portfolio Profit and Loss 

Description: For purposes of this appendix, 

Portfolio Profit and Loss is a trading unit’s 

net profit or loss on its underlying holdings 

over a specific period of time, whether 

realized or unrealized. Portfolio Profit and 

Loss should generally include any increase or 

decrease in the market value of a trading 

unit’s holdings, including, for example, any 

dividend, interest income, or expense of a 

trading unit’s holdings. Portfolio Profit and 

Loss should not include direct fees, 

commissions, sales credits, or other sources 

of trading revenue that are not directly 

related to the market value of the trading 

unit’s holdings. 

General Calculation Guidance: In general, 

Portfolio Profit and Loss should be computed 

using data on a trading unit’s underlying 

holdings and the prices at which those 

holdings are marked for valuation purposes. 

Portfolio Profit and Loss should not include: 

compensation costs or other costs required to 

operate the trading unit, such as information 

technology costs; or charges and adjustments 

made for internal reporting and management 

purposes, such as accounting reserves. 

Calculation Period: One trading day. 

3. Fee Income and Expense 

Description: For purposes of this appendix, 

Fee Income and Expense generally includes 

direct fees, commissions and other distinct 


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income for services provided by or to a 

trading unit over a specific period of time. 

General Calculation Guidance: Fee Income 

and Expense should be computed using data 

on direct fees that are earned by the trading 

unit for services it provides to clients, 

customers, or counterparties, such as fees 

earned for structured transactions or sales 

commissions and credits earned for fulfilling 

a customer request, whether realized or 

unrealized, and similar fees paid by the 

trading unit to other service providers. 

Calculation Period: One trading day. 

4. Spread Profit and Loss 

Description: For purposes of this appendix, 

Spread Profit and Loss is the portion of 

Portfolio Profit and Loss that generally 

includes revenue generated by a trading unit 

from charging higher prices to buyers than 

the trading unit pays to sellers of comparable 

instruments over the same period of time 

(i.e., charging a ‘‘spread,’’ such as the bid-ask 

spread). 

General Calculation Guidance: Spread 

Profit and Loss generally should be 

computed using data on the prices at which 

comparable instruments are either bought or 

sold by the trading unit, as well as the 

turnover of these instruments. Spread Profit 

and Loss should be measured with respect to 

both the purchase and the sale of any 

position, and should include both the 

spreads that are earned by the trading unit to 

execute transactions (expressed as positive 

amounts), and the spreads that are paid by 

the trading unit to initiate transactions 

(expressed as negative amounts). Spread 

Profit and Loss should be computed by 

calculating the difference between the bid 

price or the ask price (whichever is paid or 

received) and the mid-market price. The midmarket price is the average of bid and ask. 

For some asset classes in which a trading 

unit is engaged in market making-related 

activities, bid-ask or similar spreads are 

widely disseminated, constantly updated, 

and readily available, or otherwise 

reasonably ascertainable. For purposes of 

calculating the Spread Profit and Loss 

attributable to a transaction in such asset 

classes, the trading unit should utilize the 

prevailing bid-ask or similar spread on the 

relevant position at the time the purchase or 

sale is completed. 

For other asset classes in which a trading 

unit is engaged in market making-related 

activities, bid-ask or similar spreads may not 

be widely disseminated on a consistent basis 

or otherwise reasonably ascertainable. A 

covered banking entity must identify any 

trading unit engaged in market makingrelated activities in an asset class for which 

the covered banking entity believes bid-ask 

or similar spreads are not widely 

disseminated on a consistent basis or are not 

otherwise reasonably ascertainable and must 

be able to demonstrate that bid-ask or similar 

spreads for the asset class are not reasonably 

ascertainable. In such cases, the trading unit 

should calculate the Spread Profit and Loss 

for the relevant purchase or sale of a position 

in a particular asset class by using whichever 

of the following three alternatives the 

banking entity believes more accurately 

reflects prevailing bid-ask or similar spreads 

for transactions in that asset class: 

(i) End of Day Spread Proxy: A proxy based 

on the bid-ask or similar spread that is used 

to estimate, or is otherwise implied by, the 

market price at which the trading entity 

marks (or in the case of a sale, would have 

marked) the position for accounting purposes 

at the close of business on the day it executes 

the purchase or sale (‘‘End of Day Spread 

Proxy’’); 

(ii) Historical Data Spread Proxy: A proxy 

based on historical bid-ask or similar spread 

data in similar market conditions (‘‘Historical 

Data Spread Proxy’’); or 

(iii) Any other proxy that the banking 

entity can demonstrate accurately reflects 

prevailing bid-ask or similar spreads for 

transactions in the specific asset class. 

A covered banking entity selecting any of 

these alternatives should be able to 

demonstrate that the alternative it has chosen 

most accurately reflects prevailing bid-ask or 

similar spreads for the relevant asset class. If 

a covered banking entity chooses to calculate 

Spread Profit and Loss for a particular 

trading unit using the End of Day Spread 

Proxy, then the banking entity should 

separately identify the portion of Spread 

Profit and Loss that is attributable to 

positions acquired and disposed of on the 

same trading day. If a banking entity chooses 

to calculate Spread Profit and Loss for a 

particular trading unit using the Historical 

Data Spread Proxy, the covered banking 

entity should be able to demonstrate that the 

Historical Data Proxy is appropriate and 

continually monitor market conditions and 

adjust, as necessary, the Historical Data 

Proxy to reflect any changes. 

Calculation Period: One trading day. 

5. Comprehensive Profit and Loss Attribution 

Description: For purposes of this appendix, 

Comprehensive Profit and Loss Attribution is 

an attribution analysis that divides the 

trading unit’s Comprehensive Profit and Loss 

into the separate sources of risk and revenue 

that have caused any observed variation in 

Comprehensive Profit and Loss. This 

attribution analysis should attribute 

Comprehensive Profit and Loss to specific 

market and risk factors that can be accurately 

and consistently measured over time. Any 

component of Comprehensive Profit and Loss 

that cannot be specifically identified in the 

attribution analysis should be identified as 

an unexplained portion of the 

Comprehensive Profit and Loss. 

General Calculation Guidance: The 

specific market and risk factors used by a 

trading unit in the attribution analysis should 

be tailored to the trading activities 

undertaken by the unit. These factors should 

be measured consistently over time to 

facilitate historical comparisons. The 

attribution analysis should also identify any 

significant factors that have a consistent and 

regular influence on Comprehensive Profit 

and Loss, such as Risk Factor Sensitivities 

that have a significant influence on portfolio 

income, customer spreads, bid-ask spreads, 

or commissions that are earned. Factors that 

influence Comprehensive Profit and Loss 

across different trading units should be 

measured and included in the attribution 

analysis in a comparable fashion. 

Calculation Period: One trading day. 

C. Revenue-Relative-to-Risk Measurements 

1. Volatility of Comprehensive Profit and 

Loss and Volatility of Portfolio Profit and 

Loss 

Description: For purposes of this appendix, 

Volatility of Comprehensive Profit and Loss 

generally is the standard deviation of the 

trading unit’s Comprehensive Profit and Loss 

estimated over a given calculation period. 

For purposes of this appendix, Volatility of 

Portfolio Profit and Loss generally is the 

standard deviation of the trading unit’s 

Portfolio Profit and Loss, exclusive of Spread 

Profit and Loss, estimated over a given 

calculation period. 

Calculation Period: 30 days, 60 days, and 

90 days. 

2. Comprehensive Profit and Loss to 

Volatility Ratio and Portfolio Profit and Loss 

to Volatility Ratio 

Description: For purposes of this appendix, 

Comprehensive Profit and Loss to Volatility 

Ratio is a ratio of Comprehensive Profit and 

Loss to the Volatility of Comprehensive Profit 

and Loss for a trading unit over a given 

calculation period. For purposes of this 

appendix, Portfolio Profit and Loss to 

Volatility Ratio is a ratio of Portfolio Profit 

and Loss, exclusive of Spread Profit and 

Loss, to the Volatility of Portfolio Profit and 

Loss, exclusive of Spread Profit and Loss, for 

a trading unit over a given calculation period. 

Calculation Period: 30 days, 60 days, and 

90 days. 

3. Unprofitable Trading Days Based on 

Comprehensive Profit and Loss and 

Unprofitable Trading Days Based on Portfolio 

Profit and Loss 

Description: For purposes of this appendix, 

Unprofitable Trading Days Based on 

Comprehensive Profit and Loss is the number 

or proportion of trading days on which a 

trading unit’s Comprehensive Profit and Loss 

is less than zero over a given calculation 

period. For purposes of this appendix, 

Unprofitable Trading Days Based on Portfolio 

Profit and Loss, exclusive of Spread Profit 

and Loss, is the number or proportion of 

trading days on which a trading unit’s 

Portfolio Profit and Loss, exclusive of Spread 

Profit and Loss, is less than zero over a given 

calculation period. 

Calculation Period: 30 days, 90 days, and 

360 days. 

4. Skewness of Portfolio Profit and Loss and 

Kurtosis of Portfolio Profit and Loss 

Description: Skewness of Portfolio Profit 

and Loss and Kurtosis of Portfolio Profit and 

Loss should be calculated using standard 

statistical methods with respect to Portfolio 

Profit and Loss, exclusive of Spread Profit 

and Loss. 

Calculation Period: 30 days, 60 days, and 

90 days. 

D. Customer-Facing Activity Measurements 

1. Inventory Risk Turnover 

Description: For purposes of this appendix, 

Inventory Risk Turnover is a ratio that 

measures the amount of risk associated with 

a trading unit’s inventory, as measured by 

Risk Factor Sensitivities, that is turned over 

by the trading unit over a specific period of 


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1The status of being a registered market maker is 

not, on its own, a sufficient basis for relying on the 

exemption for market making-related activity 

contained in §ll.4(b). Registration as a market 

maker generally involves filing a prescribed form 

with an exchange or organized trading facility, in 

accordance with its rules and procedures, and 

complying with the applicable requirements for 

market makers set forth in the rules of that 

exchange or organized trading facility. See, e.g., 

Nasdaq Rule 4612, New York Stock Exchange Rule 

104, CBOE Futures Exchange Rule 515, BATS 

Exchange Rule 11.5. 

2 In certain cases, depending on the conventions 

of the relevant market (e.g., the over-the-counter 

derivatives market), such a ‘‘customer’’ may 

consider itself or refer to itself more generally as a 

‘‘counterparty.’’ 

time. For each Risk Factor Sensitivity, the 

numerator of the Inventory Risk Turnover 

ratio generally should be the absolute value 

of the Risk Factor Sensitivity associated with 

each transaction over the calculation period. 

The denominator of the Inventory Risk 

Turnover ratio generally should be the value 

of each Risk Factor Sensitivity for all of the 

trading unit’s holdings at the beginning of the 

calculation period. 

General Calculation Guidance: As a 

general matter, a trading unit should measure 

and report the Inventory Risk Turnover ratio 

for each of the Risk Factor Sensitivities 

calculated and furnished for that trading 

unit. 

Calculation Period: 30 days, 60 days, and 

90 days. 

2. Inventory Aging 

Description: For purposes of this appendix, 

Inventory Aging generally describes the 

trading unit’s aggregate assets and liabilities 

and the amount of time that those assets and 

liabilities have been held for the following 

periods: 0–30 days; 30–60 days; 60–90 days; 

90–180 days; 180–360 days; and greater than 

360 days. Inventory Aging should measure 

the age profile of the trading unit’s assets and 

liabilities. 

General Calculation Guidance: In general, 

Inventory Aging should be computed using a 

trading unit’s trading activity data and 

should identify the trading unit’s aggregate 

assets and liabilities. In addition, Inventory 

Aging should include two schedules, an 

asset-aging schedule and a liability-aging 

schedule. The asset-aging schedule should 

record the value of the trading unit’s assets 

that have been held for: 0–30 days; 30–60 

days; 60–90 days; 90–180 days; 180–360 

days; and greater than 360 days. The liabilityaging schedule should record the value of the 

trading unit’s liabilities that have been held 

for: 0–30 days; 30–60 days; 60–90 days; 90– 

180 days; 180–360 days; and more than 360 

days. 

Calculation Period: 30 days, 60 days, and 

90 days. 

3. Customer-Facing Trade Ratio 

Description: For purposes of this appendix, 

the Customer-Facing Trade Ratio is a ratio 

comparing the number of transactions 

involving a counterparty that is a customer 

of the trading unit to the number of 

transactions involving a counterparty that is 

not a customer of the trading unit. For 

purposes of calculating the Customer-Facing 

Trade Ratio, a counterparty is considered to 

be a customer of the trading unit if the 

counterparty is neither (i) a counterparty to 

a transaction executed on a designated 

contract market registered under the 

Commodity Exchange Act or national 

securities exchange registered under the 

Exchange Act, nor (ii) a broker-dealer, swap 

dealer, security-based swap dealer, any other 

entity engaged in market making-related 

activities, or any affiliate thereof. A brokerdealer, swap dealer, or security-based swap 

dealer, any other entity engaged in market 

making-related activities, or any affiliate 

thereof may be considered a customer of the 

trading unit for these purposes if the covered 

banking entity treats that entity as a customer 

and has documented how and why the entity 

is treated as such. 

Calculation Period: 30 days, 60 days, and 

90 days. 

E. Payment of Fees, Commissions, and 

Spreads Measurement 

1. Pay-to-Receive Spread Ratio 

Description: For purposes of this appendix, 

the Pay-to-Receive Spread Ratio is a ratio 

comparing the amount of Spread Profit and 

Loss and Fee Income that is earned by a 

trading unit to the amount of Spread Profit 

and Loss and Fee Income that is paid by the 

trading unit. 

General Calculation Guidance: The Pay-toReceive Spread Ratio will depend on the 

amount of Spread Profit and Loss and Fee 

Income that is earned by the trading unit for 

facilitating buy and sell orders and the 

amount of Spread Profit and Loss that is paid 

by a trading unit as it initiates buy and sell 

orders. The Pay-to-Receive Spread Ratio 

generally should be computed using the 

calculation of Spread Profit and Loss 

described in this appendix, except that 

spread paid should include the aggregate 

Spread Profit and Loss of all transactions 

producing a negative Spread Profit and Loss, 

and spread received should include the 

aggregate Spread Profit and Loss of all 

transactions producing a positive Spread 

Profit and Loss. 

Calculation Period: One trading day. 

Appendix B to Part [ ]—Commentary 

Regarding Identification of Permitted 

Market Making-Related Activities 

I. Purpose 

This appendix provides commentary 

describing the features of permitted market 

making-related activities and distinctions 

between permitted market making-related 

activities and prohibited proprietary trading. 

The appendix applies to all covered banking 

entities that are engaged in market makingrelated activities in reliance on §ll.4(b). 

The following commentary must be 

incorporated into the covered banking 

entity’s internal compliance program under 

§ll.20, as applicable. 

II. Definitions 

The terms used in this appendix have the 

same meanings as those set forth in §§ll.2 

and ll.3 and appendix A to this part. 

III. Commentary 

Section 13 of the BHC Act and §ll.3 

prohibit any covered banking entity from 

engaging in proprietary trading, which is 

generally defined as engaging as principal for 

the trading account of the covered banking 

entity in any transaction to purchase or sell 

a covered financial position. However, 

section 13(d)(1)(B) of the BHC Act and 

§ll.4(b) permit a covered banking entity to 

engage in proprietary trading that would 

otherwise be prohibited if the activity is 

conducted in connection with the covered 

banking entity’s market making-related 

activities, to the extent that such activities 

are designed not to exceed the reasonably 

expected near term demands of clients, 

customers, and counterparties. This 

commentary is intended to assist covered 

banking entities in identifying permitted 

market making-related activities and 

distinguishing such activities from trading 

activities that, even if conducted in the 

context of the covered banking entity’s 

market making operations, would constitute 

prohibited proprietary trading. 

A. Overview of Market Making-Related 

Activities 

In the context of trading activities in which 

a covered banking entity acts as principal, 

market making-related activities generally 

involve the covered banking entity either (i) 

in the case of market making in a security 

that is executed on an organized trading 

facility or exchange, passively providing 

liquidity by submitting resting orders that 

interact with the orders of others on an 

organized trading facility or exchange and 

acting as a registered market maker, where 

such exchange or organized trading facility 

provides the ability to register as a market 

maker,1 or (ii) in other cases, providing an 

intermediation service to its customers by 

assuming the role of a counterparty that 

stands ready to buy or sell a position that the 

customer wishes to sell or buy. A market 

maker’s ‘‘customers’’ generally vary 

depending on the asset class and market in 

which the market maker is providing 

intermediation services. In the context of 

market making in a security that is executed 

on an organized trading facility or an 

exchange, a ‘‘customer’’ is any person on 

behalf of whom a buy or sell order has been 

submitted by a broker-dealer or any other 

market participant. In the context of market 

making in a covered financial position in an 

over-the-counter market, a ‘‘customer’’ 

generally would be a market participant that 

makes use of the market’s maker 

intermediation services, either by requesting 

such services or entering into a continuing 

relationship with the market maker with 

respect to such services.2

The primary purpose of market makingrelated activities is to intermediate between 

buyers and sellers of similar positions, for 

which service market makers are 

compensated, resulting in more liquid 

markets and less volatile prices. The purpose 

of such activities is not to earn profits as a 

result of movements in the price of positions 

and risks acquired or retained; rather, a 

market maker generally manages and limits 

the extent to which it is exposed to 

movements in the price of principal positions 

and risks that it acquires or retains, or in the 

price of one or more material elements of 

those positions. To the extent that it can, a 


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market maker will eliminate some or all of 

the price risks to which it is exposed. 

However, in some cases, the risks posed by 

one or more positions may be sufficiently 

complex or specific that the risk cannot be 

fully hedged. In other cases, although it may 

be possible to hedge the risks posed by one 

or more positions, the cost of doing so may 

be so high as to effectively make market 

making in those positions uneconomic if 

complete hedges were acquired. In such 

cases, in order to provide effective 

intermediation services, market makers are 

required to retain at least some risk for at 

least some period of time with respect to 

price movements of retained principal 

positions and risks. The size and type of risk 

that must be retained in such cases may vary 

widely depending on the type and size of the 

positions, the liquidity of the specific market, 

and the market’s structure. As the liquidity 

of positions increases, the frequency with 

which a market maker must take or retain 

risk in order to make a market in those 

positions generally decreases. 

The profitability of market making-related 

activities relies on forms of revenues that 

reflect the value of the intermediation 

services that are provided to the market 

maker’s customers. These revenues typically 

take the form of explicit fees and 

commissions or, in markets where no such 

fees or commission are charged, a bid-ask or 

similar spread that is generated by charging 

higher prices to buyers than is paid to sellers 

of comparable instruments. In the case of a 

derivative contract, these revenues reflect the 

difference between the cost of entering into 

the derivative contract and the cost of 

hedging incremental, residual risks arising 

from the contract. These types of ‘‘customer 

revenues’’ provide the primary source of a 

market maker’s profitability. Typically, a 

market maker holds at least some risk with 

respect to price movements of retained 

principal positions and risks. As a result, the 

market maker also incurs losses or generates 

profits as price movements actually occur, 

but such losses or profits are incidental to 

customer revenues and significantly limited 

by the banking entity’s hedging activities. 

Customer revenues, not revenues from price 

movements, predominate. The appropriate 

proportion of ‘‘customer revenues’’ to profits 

and losses resulting from price movements of 

retained principal positions and risks varies 

depending on the type of positions involved, 

the typical fees, commissions, and spreads 

payable for transactions in those positions, 

and the risks of those positions. As a general 

matter, the proportion of ‘‘customer 

revenues’’ generated when making a market 

in certain positions increases as the fees, 

commissions, or spreads payable for those 

positions increase, the volatility of those 

positions’ prices decrease, and the prices for 

those positions are less transparent. 

Because a market maker’s business model 

entails managing and limiting the extent to 

which it is exposed to movements in the 

prices of retained principal positions and 

risks while generating customer revenues 

that are earned, regardless of movements in 

the price of retained principal positions and 

risks, a market maker typically generates 

significant revenue relative to the risks that 

it retains. Accordingly, a market maker will 

typically demonstrate consistent profitability 

and low earnings volatility under normal 

market conditions. The appropriate extent to 

which a market maker will demonstrate 

consistent profitability and low earnings 

volatility varies depending on the type of 

positions involved, the liquidity of the 

positions, the price transparency of the 

positions, and the volatility of the positions’ 

prices. As a general matter, consistent 

profitability will decrease and earnings 

volatility will increase as the liquidity of the 

positions decrease, the volatility of the 

positions’ prices increase, and the prices for 

the positions are less transparent. 

As the primary purpose of market makingrelated activities is to provide intermediation 

services to its customers, market makers 

focus their activities on servicing customer 

demands and typically only engage in 

transactions with non-customers to the extent 

that these transactions directly facilitate or 

support customer transactions. In particular, 

a market maker generally only transacts with 

non-customers to the extent necessary to 

hedge or otherwise manage the risks of its 

market making-related activities, including 

managing its risk with respect to movements 

of the price of retained principal positions 

and risks, to acquire positions in amounts 

consistent with reasonably expected near 

term demand of its customers, or to sell 

positions acquired from its customers. The 

appropriate proportion of a market maker’s 

transactions that are with customers versus 

non-customers varies depending on the type 

of positions involved and the extent to which 

the positions are typically hedged in noncustomer transactions. In the case of a 

derivatives market maker that engages in 

dynamic hedging, the number of noncustomer transactions significantly 

outweighs the number of customer 

transactions, as the derivatives market maker 

must constantly enter into transactions to 

appropriately manage its retained principal 

positions and risks as market prices for the 

positions and risks move and additional 

transactions with customers change the risk 

profile of the market makers retained 

principal positions. 

Because a market maker generates revenues 

primarily by transacting with, and providing 

intermediation services to, customers, a 

market maker typically engages in 

transactions that earn fees, commissions, or 

spreads as payment for its services. 

Transactions in which the market maker pays 

fees, commissions, or spreads—i.e., where it 

pays another market maker for providing it 

with liquidity services–are much less 

frequent, although in some cases obtaining 

liquidity services from another market maker 

and paying fees, commissions, or spreads 

may be necessary to prudently manage its 

risk with respect to price movements of 

retained principal positions and risks. The 

appropriate proportion of a market maker’s 

transactions that earn, rather than pay, fees, 

commissions or spreads varies depending on 

the type of positions involved, the liquidity 

of the positions, and the extent to which 

market trends increase the volatility of its 

risk with respect to price movements of 

retained principal positions and risks. As a 

general matter, the proportion of a market 

maker’s transactions that earn rather than pay 

fees, commissions or spreads decreases as the 

liquidity of the positions decreases, and the 

extent to which the price volatility of 

retained principal positions and risks 

increases. 

Finally, because the primary purpose of 

market making-related activities is to provide 

intermediation services to its customers, a 

market maker does not provide compensation 

incentives to its personnel that primarily 

reward proprietary risk-taking. Although a 

market maker may take into account 

revenues resulting from movements in the 

price of retained principal positions and risks 

to the extent that such revenues reflect the 

effectiveness with which personnel have 

effectively managed the risk of movements in 

the price of retained principal positions and 

risks, a market maker that provides 

compensation incentives relating to revenues 

generally does so through incentives that 

primarily reward customer revenues and 

effective customer service. 

B. Overview of Prohibited Proprietary 

Trading Activities 

Like permitted market making-related 

activities, prohibited proprietary trading 

involves the taking of principal positions by 

a covered banking entity. Unlike permitted 

market making-related activities, the purpose 

of prohibited proprietary trading is to 

generate profits as a result of, or otherwise 

benefit from, changes in the price of 

positions and risks taken. Whereas a market 

maker attempts to eliminate some or all of 

the price risks inherent in its retained 

principal positions and risks by hedging or 

otherwise managing those risks in a 

reasonable period of time after positions are 

acquired or risks arise, a proprietary trader 

seeks to capitalize on those risks, and 

generally only hedges or manages a portion 

of those risks when doing so would improve 

the potential profitability of the risk it 

retains. A proprietary trader does not have 

‘‘customers’’ because a proprietary trader 

simply seeks to obtain the best price and 

execution in purchasing or selling its 

proprietary positions. A proprietary trader 

generates few if any fees, commissions, or 

spreads from its trading activities because it 

is not providing an intermediation service to 

any customer or other third party. Instead, a 

proprietary trader is likely to pay fees, 

commissions, or spreads to other market 

makers when obtaining their liquidity 

services is beneficial to execution of its 

trading strategy. Because a proprietary trader 

seeks to generate profits from changes in the 

price of positions taken, a proprietary trader 

typically provides compensation incentives 

to its personnel that primarily reward 

successful proprietary risk taking. 

C. Distinguishing Permitted Market MakingRelated Activities From Prohibited 

Proprietary Trading 

Because both permitted market makingrelated activities and prohibited proprietary 

trading involve the taking of principal 

positions, certain challenges arise in 

distinguishing permitted market makingrelated activities and prohibited proprietary 


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trading, particularly in cases where both of 

these activities occur in the context of a 

market making operation. Particularly during 

periods of significant market disruption, it 

may be difficult to distinguish between 

retained principal positions and risks that 

appropriately support market making-related 

activities and positions taken, or positions or 

risks not hedged, for proprietary purposes. 

In connection with these challenges, 

[Agency] will apply the following factors in 

distinguishing permitted market makingrelated activities from trading activities that, 

even if conducted in the context of the 

covered banking entity’s market making 

operations, would constitute prohibited 

proprietary trading. The particular types of 

trading activity described in this appendix 

may involve the aggregate trading activities 

of a single trading unit, a significant number 

or series of transactions occurring at one or 

more trading units, or a single significant 

transaction, among other potential scenarios. 

In addition to meeting the terms of this 

appendix, any transaction or activity for 

which a covered banking entity intends to 

rely on the market making exemption in 

§ll.4(b) must also satisfy all the 

requirements specified in §ll.4(b), as well 

as the other applicable requirements and 

conditions of this part. 

1. Risk Management 

Absent explanatory facts and 

circumstances, particular trading activity in 

which a trading unit retains risk in excess of 

the size and type required to provide 

intermediation services to customers will be 

considered to be prohibited proprietary 

trading, and not permitted market makingrelated activity. 

[Agency] will base a determination of 

whether a trading unit retains risk in excess 

of the size and type required for these 

purposes on all available facts and 

circumstances, including a comparison of 

retained principal risk to: the amount of risk 

that is generally required to execute a 

particular market making function; hedging 

options that are available in the market and 

permissible under the covered banking 

entity’s hedging policy at the time the 

particular trading activity occurred; the 

trading unit’s prior levels of retained risk and 

its hedging practices with respect to similar 

positions; and the levels of retained risk and 

the hedging practices of other trading units 

with respect to similar positions. 

To help assess the extent to which a 

trading unit’s risks are potentially being 

retained in excess of amounts required to 

provide intermediation services to customers, 

[Agency] will utilize the VaR and Stress VaR, 

VaR Exceedance, and Risk Factor 

Sensitivities quantitative measurements, as 

applicable, among other risks measurements 

described in Appendix A and any other 

relevant factor. This assessment will focus 

primarily on the risk measurements relative 

to: the risk required for conducting market 

making-related activities, and any significant 

changes in the risk over time and across 

similarly-situated trading units and banking 

entities. 

Explanatory facts and circumstances might 

include, among other things, market-wide 

changes in risk, changes in the specific 

composition of market making-related 

activities, temporary market disruptions, or 

other market changes that result in 

previously-used hedging or other risk 

management techniques no longer being 

possible or cost-effective. 

2. Source of Revenues 

Absent explanatory facts and 

circumstances, particular trading activity in 

which a trading unit primarily generates 

revenues from price movements of retained 

principal positions and risks, rather than 

customer revenues, will be considered to be 

prohibited proprietary trading, and not 

permitted market making-related activity. 

[Agency] will base a determination of 

whether a trading activity primarily generates 

revenues from price movements of retained 

principal positions and risks, rather than 

customer revenues, on all available facts and 

circumstances, including: an evaluation of 

the revenues derived from price movements 

of retained principal positions and risks 

relative to its customer revenues; and a 

comparison of these revenue figures to the 

trading unit’s prior revenues with respect to 

similar positions, and the revenues of other 

covered banking entities’ trading units with 

respect to similar positions. 

To help assess the extent to which a 

trading unit’s revenues are potentially 

derived from movements in the price of 

retained principal positions and risks, 

[Agency] will utilize the Comprehensive 

Profit and Loss, Portfolio Profit and Loss, Fee 

Income and Expense, and Spread Profit and 

Loss quantitative measurements, as 

applicable, both individually and in 

combination with one another (e.g., by 

comparing the ratio of Spread Profit and Loss 

to Portfolio Profit and Loss), and any other 

relevant factor. 

Explanatory facts and circumstances might 

include, among other things: general upward 

or downward price trends in the broader 

markets in which the trading unit is making 

a market, provided revenues from price 

movements in retained principal positions 

and risks are consistent; sudden market 

disruptions or other changes causing 

significant, unanticipated alterations in the 

price of retained principal positions and 

risks; sudden and/or temporary changes in 

the market (e.g., narrowing of bid/ask 

spreads) that cause significant, unanticipated 

reductions in customer revenues; or efforts to 

expand or contract a trading unit’s market 

share. 

3. Revenues Relative to Risk 

Absent explanatory facts and 

circumstances, particular trading activity will 

be considered to be prohibited proprietary 

trading, and not permitted market makingrelated activity, if the trading unit: generates 

only very small or very large amounts of 

revenue per unit of risk taken; does not 

demonstrate consistent profitability; or 

demonstrates high earnings volatility. 

[Agency] will base such a determination on 

all available facts and circumstances, 

including: an evaluation of the amount of 

revenue per unit of risk taken, earnings 

volatility, profitability, exposure to risks, and 

overall level of risk taking for the particular 

trading activities; and a comparison of these 

figures to the trading unit’s prior results with 

respect to similar positions, and the results 

of other covered banking entities’ trading 

units with respect to similar positions. 

To help assess the riskiness of revenues 

and the amount of revenue per unit of risk 

taken, [Agency] will utilize the Volatility of 

Comprehensive Profit and Loss and Volatility 

of Portfolio Profit and Loss, Comprehensive 

Profit and Loss to Volatility Ratio and 

Portfolio Profit and Loss to Volatility Ratio, 

and Comprehensive Profit and Loss 

Attribution quantitative measurements, as 

applicable, and any other relevant factor. 

To help assess the extent to which a 

trading unit demonstrates consistent 

profitability, [Agency] will utilize the 

Unprofitable Trading Days Based on 

Comprehensive Profit and Loss and 

Unprofitable Trading Days Based on Portfolio 

Profit and Loss quantitative measurements, 

as applicable, and any other relevant factor. 

To help assess the extent to which a 

trading unit is exposed to outsized risk, 

[Agency] will utilize the Skewness of 

Portfolio Profit and Loss and Kurtosis of 

Profit and Loss quantitative measurements, 

as applicable, and any other relevant factor. 

Explanatory facts and circumstances might 

include, among other things: market 

disruptions or other changes causing 

significant, unanticipated increases in a 

trading unit’s risk with respect to movements 

in the price of retained principal positions 

and risks; market disruptions or other 

changes causing significant, unanticipated 

increases in the volatility of positions in 

which the trading unit makes a market; 

sudden and/or temporary changes in the 

market (e.g., narrowing of bid-ask spreads) 

that cause significant, unanticipated 

reductions in customer revenues and 

decrease overall profitability; or efforts to 

expand or contract a trading unit’s market 

share. 

4. Customer-Facing Activity 

Absent explanatory facts and 

circumstances, particular trading activity will 

be considered to be prohibited proprietary 

trading, and not permitted market makingrelated activity, if the trading unit: does not 

transact through a trading system that 

interacts with orders of others or primarily 

with customers of the banking entity’s market 

making desk to provide liquidity services; or 

retains principal positions and risks in excess 

of reasonably expected near term customer 

demands. 

[Agency] will base such a determination on 

all available facts and circumstances, 

including, among other things: an evaluation 

of the extent to which a trading unit’s 

transactions are with customers versus noncustomers and the frequency with which the 

trading unit’s retained principal positions 

and risks turn over; and a comparison of 

these figures to the trading unit’s prior results 

with respect to similar positions and market 

situations, and the results of other covered 

banking entities’ trading units with respect to 

similar positions. 

To help assess the extent to which a 

trading unit’s transactions are with customers 

versus non-customers, [Agency] will utilize 

the Customer-Facing Trade Ratio quantitative 

measurement, as applicable, and any other 


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1 [Agency] expects that this will generally be the 

smallest unit of organization used by the covered 

banking entity to structure and control its risktaking activities and employees, and will include 

each unit generally understood to be a single 

‘‘trading desk.’’ 

2 [Agency] expects that this will generally include 

management or reporting divisions, groups, subgroups, or other intermediate units of organization 

used by the covered banking entity to manage one 

or more discrete trading units (e.g.,‘‘North 

American Credit Trading,’’ ‘‘Global Credit Trading,’’ 

etc.). 

relevant factor. To help assess the frequency 

with which the trading unit’s retained 

principal positions and risks turn over, 

[Agency] will utilize the Inventory Risk 

Turnover and Inventory Aging quantitative 

measurements, as applicable, and any other 

relevant factor. 

With respect to a particular trading activity 

in which a trading unit either does not 

transact through a trading system that 

interacts with orders of others or primarily 

with customers of the banking entity’s market 

making desk to provide liquidity services, 

explanatory facts and circumstances might 

include, among other things: sudden market 

disruptions or other changes causing 

significant increases in a trading unit’s 

hedging transactions with non-customers; or 

substantial intermediary trading required to 

satisfy customer demands and hedging 

management. With respect to particular 

trading activity in which a trading unit 

retains principal positions and risks in excess 

of reasonably expected near term customer 

demands, explanatory facts and 

circumstances might include, among other 

things: sudden market disruptions or other 

changes causing a significant reduction in 

actual customer demand relative to expected 

customer demand; documented and 

reasonable expectations for temporary 

increases in customer demand in the near 

term; and sudden market disruptions or other 

changes causing a significant reduction in the 

value of retained principal positions and 

risks, such that it would be imprudent for the 

trading unit to dispose of the positions in the 

near term. 

5. Payment of Fees, Commissions, and 

Spreads 

Absent explanatory facts and 

circumstances, particular trading activity in 

which a trading unit routinely pays rather 

than earns fees, commissions, or spreads will 

be considered to be prohibited proprietary 

trading, and not permitted market makingrelated activity. 

[Agency] will base such a determination on 

all available facts and circumstances, 

including, among other things: an evaluation 

of the frequency with which the trading unit 

pay fees, commissions, or spreads and the 

relative amount of fees, commissions, or 

spreads that is paid versus earned; and a 

comparison of these figures to the trading 

unit’s prior results with respect to similar 

positions, and the results of other covered 

banking entities’ trading units with respect to 

similar positions. 

To help assess the extent to which a 

trading unit is paying versus earning fees, 

commissions, and spreads, [Agency] will 

utilize the Pay-to-Receive Spread Ratio 

quantitative measurement, as applicable, and 

any other relevant factor. 

Explanatory facts and circumstances might 

include, among other things, sudden market 

disruptions or other changes causing 

significant, increases in a trading unit’s 

hedging transactions with non-customers for 

which it must pay fees, commissions, or 

spreads, sudden, unanticipated customer 

demand for liquidity that requires the trading 

unit itself to pay fees, commissions, or 

spreads to other market makers for liquidity 

services to obtain the inventory needed to 

meet that customer demand, or significant, 

unanticipated reductions in fees, 

commissions, or spreads earned by the 

trading unit. Explanatory facts and 

circumstances might also include a trading 

unit’s efforts to expand or contract its market 

share. 

6. Compensation Incentives 

Absent explanatory facts and 

circumstances, the trading activity of a 

trading unit that provides compensation 

incentives to employees that primarily 

reward proprietary risk taking will be 

considered to be prohibited proprietary 

trading, and not permitted market makingrelated activity. 

[Agency] will base such a determination on 

all available facts and circumstances, 

including, among other things, an evaluation 

of: the extent to which compensation 

incentives are provided to trading unit 

personnel that reward revenues from 

movements in the price of retained principal 

positions and risks; the extent to which 

compensation incentives are provided to 

trading unit personnel that reward customer 

revenues; and the compensation incentives 

provided by other covered banking entities to 

similarly-situated personnel. 

Appendix C to Part [ ]—Minimum 

Standards for Programmatic Compliance 

I. Overview 

A. Purpose 

This appendix sets forth the minimum 

standards with respect to the establishment, 

maintenance, and enforcement by banking 

entities of internal compliance programs for 

ensuring and monitoring compliance with 

the prohibitions and restrictions on 

proprietary trading and covered fund 

activities or investments set forth in section 

13 of the BHC Act and this part. 

This appendix requires that banking 

entities establish, maintain, and enforce an 

effective compliance program, consisting of 

written policies and procedures, internal 

controls, a management framework, 

independent testing, training, and 

recordkeeping, that: 

• Is reasonably designed to clearly 

document, describe, and monitor the covered 

trading and covered fund activities or 

investments and the risks of the covered 

banking entity related to such activities or 

investments, identify potential areas of 

noncompliance, and prevent activities or 

investments prohibited by, or that do not 

comply with, section 13 of the BHC Act and 

this part; 

• Specifically addresses the varying nature 

of activities or investments conducted by 

different units of the covered banking entity’s 

organization, including the size, scope, 

complexity, and risks of the individual 

activities or investments; 

• Subjects the effectiveness of the 

compliance program to independent review 

and testing; 

• Makes senior management and 

intermediate managers accountable for the 

effective implementation of the compliance 

program, and ensures that the board of 

directors and CEO review the effectiveness of 

the compliance program; and 

• Facilitates supervision and examination 

of the covered banking entity’s covered 

trading and covered fund activities or 

investments by the Agencies. 

B. Definitions 

The terms used in this Appendix have the 

same meanings as set forth in §§ll.2, 

ll.3, and ll.10. In addition, for purposes 

of this appendix, the following definitions 

apply: 

Asset management unit means any unit of 

organization of a covered banking entity that 

makes investments in, or acts as sponsor to, 

covered funds, or has relationships with 

covered funds, that the covered banking 

entity (or an affiliate of subsidiary thereof) 

has sponsored, organized and offered, or in 

which a covered fund sponsored or advised 

by the covered banking entity invests. 

Compliance program means the internal 

compliance program established by a covered 

banking entity in accordance with §ll.20 

and this appendix. 

Covered fund activity or investment means 

sponsoring any covered fund or making 

investments in, or otherwise having 

relationships with, any covered fund for 

which the covered banking entity (or an 

affiliate or subsidiary thereof) acts as sponsor 

or organizes and offers. 

Covered fund restrictions means the 

restrictions on covered fund activities or 

investments set forth in subpart C. 

Covered trading activity means proprietary 

trading, as defined in §ll.3(b)(1). 

Trading unit means each of the following 

units of organization of a covered banking 

entity: 

(i) Each discrete unit that is engaged in the 

coordinated implementation of a revenuegeneration strategy and that participates in 

the execution of any covered trading 

activity; 1

(ii) Each organizational unit that is used to 

structure and control the aggregate risktaking activities and employees of one or 

more trading units described in paragraph 

(i); 2

(iii) All trading operations, collectively; 

and 

(iv) Any other unit of organization 

specified by the [Agency] with respect to a 

particular banking entity. 

C. Required Elements 

Section ll.20 requires that covered 

banking entities establish, maintain, and 

enforce a compliance program reasonably 

designed to ensure and monitor compliance 

with the prohibitions and restrictions on 

proprietary trading and covered fund 

activities or investments that effectively 


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3These policies and procedures must be updated 

with a frequency sufficient for the covered banking 

entity to adequately control the applicable trading 

unit for purposes of this part. 

implements, at a minimum, the six elements 

required under paragraph (b) of §ll.20. 

D. Compliance Program Structure 

Each covered banking entity subject to 

§ll.20(c) must be governed by a 

compliance program meeting the 

requirements of this appendix. A covered 

banking entity may establish a compliance 

program on an enterprise-wide basis to 

satisfy the requirements of §ll.20 and this 

appendix with respect to the covered banking 

entity and all of its affiliates and subsidiaries 

collectively, provided that: the program is 

clearly applicable, both by its terms and in 

operation, to all such affiliates and 

subsidiaries; the program specifically 

addresses the requirements set forth in this 

appendix; the program takes into account 

and addresses the consolidated 

organization’s business structure, size, and 

complexity, as well as the particular 

activities, risks, and applicable legal 

requirements of each subsidiary and affiliate; 

and the program is determined through 

periodic independent testing to be effective 

for the covered banking entity and all of its 

subsidiaries and affiliates. An enterprisewide program established pursuant to this 

Appendix will be subject to supervisory 

review and examination by any Agency 

vested with rulewriting authority under 

section 13 of the BHC Act with respect to the 

compliance program and the activities or 

investments of any banking entity for which 

the Agency has such authority. Further, such 

Agency will have access to all records related 

to the enterprise-wide compliance program 

pertaining to any banking entity that is 

supervised by the Agency vested with such 

rulewriting authority. 

E. Applicability 

This appendix applies only to covered 

banking entities described in §ll.20(c)(2). 

In addition, [Agency] may require any 

covered banking entity to comply with all or 

portions of this appendix if [Agency] deems 

it appropriate for purposes the covered 

banking entity’s compliance with this part. 

Nothing in this appendix limits the 

authority of [Agency] under any other 

provision of law or regulation to take 

supervisory, examination, or enforcement 

action, including action to address unsafe or 

unsound practices or conditions, deficient 

capital levels, or violations of law. 

II. Internal Policies and Procedures 

A. Covered Trading Activities 

A covered banking entity must establish, 

maintain, and enforce written policies and 

procedures reasonably designed to 

document, describe, and monitor the covered 

banking entity’s covered trading activities 

and the risks taken in these activities, as 

follows:3

Identification of trading account: The 

covered banking entity’s policies and 

procedures must specify how the banking 

entity evaluates the covered financial 

positions it acquires or takes and determines 

which of its accounts are trading accounts for 

purposes of subpart B. 

Identification of trading units and 

organization structure: The covered banking 

entity’s written policies and procedures must 

identify and document each trading unit 

within the organization and map each trading 

unit to the division, business line, or other 

organizational structure that the covered 

banking entity uses to manage or oversee the 

trading unit’s activities. 

Description of missions and strategies: The 

covered banking entity’s written policies and 

procedures for each trading unit must clearly 

articulate and document a comprehensive 

description of the mission (i.e., the nature of 

the business conducted) and strategy (i.e., 

business model for the generation of 

revenues) of the trading unit, and include a 

description of: 

• How revenues are intended to be 

generated by the trading unit; 

• The activities that the trading unit is 

authorized to conduct, including authorized 

instruments and products and authorized 

hedging strategies and instruments; 

• The expected holding period of, and the 

market risk associated with, covered 

financial positions in its trading account; 

• The types of clients, customers, and 

counterparties with whom trading is 

conducted by the trading unit; 

• How the trading unit, if engaged in 

market making-related activity under 

§l.4(b) of this part, identifies its customers 

for purposes of computing the CustomerFacing Trade Ratio, if applicable, including 

documentation explaining when, how, and 

why a broker-dealer, swap dealer, securitybased swap dealer, any other entity engaged 

in market making-related activities, or any 

affiliate thereof is considered to be a 

customer of the trading unit for those 

purposes; and 

• The compensation structure of the 

employees associated with the trading unit. 

Trader mandates: The covered banking 

entity must establish, maintain, document, 

and enforce trader mandates for each trading 

unit. At a minimum, trader mandates must: 

• Clearly inform each trader of the 

prohibitions and requirements set forth in 

section 13 of the BHC Act and this part and 

his or her responsibilities for compliance 

with such requirements; 

• Set forth appropriate parameters for each 

trader engaged in covered trading activities, 

including: 

Æ The conditions for relying on the 

applicable exemptions in §§ll.4 through 

ll.6; 

Æ The financial contracts, products, and 

underlying assets that the trader is permitted 

to trade pursuant to the covered banking 

entity’s internal controls; 

Æ The risk limits of the trader’s trading 

unit, and the types and levels of risk that may 

be taken; and 

Æ The applicable trading unit’s hedging 

policy. 

Description of risks and risk management 

processes: The written policies and 

procedures for each trading unit must clearly 

articulate and document a comprehensive 

description of the risks associated with the 

trading unit. Such descriptions must include, 

at a minimum, the following elements: 

• A description of the supervisory and risk 

management structure governing the trading 

units, including a description of processes for 

initial and senior-level review of new 

products and new strategies; 

• A description of the types of risks that 

may be taken to implement the mission and 

strategy of the trading unit, including an 

enumeration of material risks resulting from 

the activities in which the trading unit is 

engaged (including but not limited to all 

significant price risks, such as basis, 

volatility and correlation risks, as well as any 

significant counterparty credit risk associated 

with the trading activity); 

• An articulation of the amount of risk 

allocated by the covered banking entity to 

such trading unit to implement the 

documented mission and strategy of the 

trading unit; 

• An explanation of how the risks 

allocated to such trading unit will be 

measured; and 

• An explanation of why the allocated risk 

levels are appropriate to the mission and 

strategy of the trading unit. 

Hedging policies and procedures. The 

covered banking entity must establish, 

maintain, and enforce policies and 

procedures for all of its trading units 

regarding the use of risk-mitigating hedging 

instruments and strategies. At a minimum, 

these hedging policies and procedures must 

articulate the following: 

• The manner in which the covered 

banking entity will determine that the risks 

generated by each trading unit have been 

properly and effectively hedged; 

• The instruments, techniques and 

strategies the covered entity will use to hedge 

the risk of the positions or portfolios; 

• The level of the organization at which 

hedging activity and management will occur; 

• The manner in which hedging strategies 

will be monitored; 

• The risk management processes used to 

control unhedged or residual risks; and 

• The independent testing of hedging 

techniques and strategies. 

Explanation of compliance. The covered 

banking entity’s written policies and 

procedures must clearly articulate and 

document a comprehensive explanation of 

how the mission and strategy of each trading 

unit, and its related risk levels, comply with 

this part. Such explanation must: 

• Identify which portions of the risk-taking 

activity of the trading unit would or would 

not constitute covered trading activity; 

• Identify activities of the trading unit that 

will be conducted in reliance on exemptions 

contained in §§ll.4 through ll.6, 

including an explanation of: 

Æ How and where the activity occurs; and 

Æ Which exemption is being relied on and 

how the activity meets the specific 

requirements for reliance on the applicable 

exemption. 

• Describe how the covered banking entity 

monitors for and prohibits potential or actual 

material exposure to high-risk assets or highrisk trading strategies presented by each 

trading unit, which must take into account 

potential or actual exposure to: 


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Æ Assets whose values cannot be 

externally priced or, where valuation is 

reliant on pricing models, whose model 

inputs cannot be externally validated; 

Æ Assets whose changes in values cannot 

be adequately mitigated by effective hedging; 

Æ New products with rapid growth, 

including those that do not have a market 

history; 

Æ Assets or strategies that include 

significant embedded leverage; 

Æ Assets or strategies that have 

demonstrated significant historical volatility; 

Æ Assets or strategies for which the 

application of capital and liquidity standards 

would not adequately account for the risk; 

and 

Æ Assets or strategies that result in large 

and significant concentrations to sectors, risk 

factors, or counterparties; 

• Explain how each trading unit will 

comply with the reporting and recordkeeping 

requirements of §ll.7 and Appendix A ; 

• Describe how the covered banking entity 

monitors for and prohibits potential or actual 

material conflicts of interest between the 

covered banking entity and its clients, 

customers, or counterparties present in each 

trading unit; and 

• Describe how the covered banking entity 

monitors for and prohibits potential or actual 

transactions or activities that may threaten 

the safety and soundness of the covered 

banking entity. 

Remediation of violations. The covered 

banking entity’s written policies and 

procedures must require the covered banking 

entity to promptly document, address and 

remedy any violation of section 13 of the 

BHC Act or this part, and document all 

proposed and actual remediation efforts. 

Further, such policies and procedures must 

include specific procedures that are 

reasonably designed to implement and 

monitor any required remediation and that 

assess the extent to which any violation 

indicates that modification to the covered 

banking entity’s compliance program is 

warranted. 

With respect to any trading unit that is 

either used by the covered banking entity to 

structure and control the aggregate risktaking activities and employees of one or 

more other trading units, or comprised of the 

entire trading operation of the covered 

banking entity, the description of missions 

and strategies, description of risks and risk 

management processes, and explanation of 

compliance for such trading units may 

incorporate by reference the policies and 

procedures of the underlying trading units 

that the trading unit oversees and manages in 

the aggregate. 

B. Covered Fund Activities or Investments 

A covered banking entity must establish, 

maintain, and enforce written policies and 

procedures that are reasonably designed to 

document, describe, and monitor the covered 

banking entity’s covered fund activities or 

investments and the risks taken in these 

activities or investments, as follows. 

Identification of covered funds: The 

covered banking entity’s policies and 

procedures must specify how the covered 

banking entity identifies covered funds that 

the covered banking entity sponsors, 

organizes and offers, or in which covered 

banking entity invests. 

Identification of asset management units 

and organization structure: The covered 

banking entity’s written policies and 

procedures must identify and document each 

asset management unit within the 

organization and map each asset management 

unit to the division, business line, or other 

organizational structure that the covered 

banking entity uses to manage or oversee the 

asset management unit’s activities or 

investments. 

Description of sponsorship activities 

related to covered funds: The covered 

banking entity’s written policies and 

procedures for each asset management unit 

must clearly articulate and document a 

comprehensive description of the mission 

(i.e., the nature of the business conducted) 

and strategy (i.e., business model for the 

generation of revenues) of the asset 

management unit related to its sponsorship 

or organizing and offering of covered funds, 

including a description of how such 

activities comply with this part and, in 

particular: 

• The activities that the asset management 

unit is authorized to conduct, including the 

nature of any trust, fiduciary, investment 

advisory, or commodity trading advisory 

services offered to customers of the covered 

banking entity; 

• The types of customers to whom the 

asset management unit provides such 

services and to whom ownership interests in 

covered funds are sold; 

• The extent of any co-investment 

activities of the covered banking entity 

(including its directors or employees) in 

covered funds offered to such customers; and 

• How the asset management unit 

complies with the requirements of subpart C. 

Description of investment activities of 

covered funds: The covered banking entity’s 

written policies and procedures for each 

asset management unit must clearly 

articulate and document a comprehensive 

description of the mission (i.e., the nature of 

the business conducted) and strategy (i.e., 

business model for the generation of 

revenues) of the asset management unit 

related to its investments in covered funds, 

including a description of how such 

activities comply with this part and, in 

particular: 

• The asset management unit’s practices 

with respect to seed capital investments in 

covered funds, including how the asset 

management unit reduces its investments in 

covered funds to amounts that are permitted 

de minimis investments within the required 

period of time; 

• The asset management unit’s practices 

with respect to co-investments in covered 

funds, including certain parallel investments 

as identified in §ll.12; 

• How the asset management unit 

complies with the requirements of §ll.12 

with respect to individual and aggregate 

investments in covered funds; 

• With respect to other permitted covered 

fund activities or investment, how the asset 

management unit complies with the 

requirements of §§ll.13 and ll.14; 

• How the asset management unit 

complies with the limitations on 

relationships with a covered fund under 

§ll.16; 

• How the covered banking entity 

monitors for and prohibits potential or actual 

material conflicts of interest between the 

covered banking entity and its clients, 

customers, or counterparties related to the 

asset management unit; 

• How the covered banking entity 

monitors for and prohibits potential or actual 

transactions or activities that may threaten 

the safety and soundness of the covered 

banking entity related to the asset 

management unit; and 

• How the covered banking entity 

monitors for and prohibits potential or actual 

material exposure to high-risk assets or highrisk trading strategies presented by each asset 

management unit. 

Remediation of violations. The covered 

banking entity’s written policies and 

procedures must require the covered banking 

entity to promptly document, address and 

remedy any violation of section 13 of the 

BHC Act or this part, and document all 

proposed and actual remediation efforts. 

Further, such policies and procedures must 

include specific procedures that are designed 

to implement, monitor, and enforce any 

required remediation and that assess the 

extent to which any violation indicates that 

modification to the covered banking entity’s 

compliance program is warranted. 

III. Internal Controls 

A. Covered Trading Activities 

A covered banking entity must establish, 

maintain, and enforce written internal 

controls that are reasonably designed to 

ensure that the trading activity of each 

trading unit is appropriate and consistent 

with the description of mission, strategy, and 

risk mitigation for each trading unit 

contained in its written policies and 

procedures. These written internal controls 

must also be reasonably designed and 

established to effectively monitor and 

identify for further analysis any covered 

trading activity that may indicate potential 

violations of section 13 of the BHC Act and 

this part and to prevent actual violations of 

section 13 of the BHC Act and this part. 

Further, the internal controls must describe 

procedures for remedying violations of 

section 13 of the BHC Act and this part. The 

written internal controls must include, at a 

minimum, the following. 

Authorized risks, instruments, and 

products. The covered banking entity must 

implement and enforce internal controls for 

each trading unit that are reasonably 

designed to ensure that trading activity is 

conducted in conformance with the trading 

unit’s authorized risks, instruments, and 

products, as documented in the covered 

banking entity’s written policies and 

procedures and trader mandates. At a 

minimum, these internal controls must 

monitor and govern: 

• The types and levels of risks that may be 

taken by each trading unit, consistent with 

the covered banking entity’s written policies 

and procedures; 

• The type of hedging instruments used, 

hedging strategies employed, and the amount 


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of risk effectively hedged, consistent with the 

covered banking entity’s written policies and 

procedures; and 

• The financial contracts, products and 

underlying assets that the trading unit may 

trade, consistent with covered banking 

entity’s written policies and procedures. 

Risk limits. The covered banking entity 

must establish and enforce risk limits 

appropriate for each trading unit, which shall 

include limits based on probabilistic and 

non-probabilistic measures of potential loss 

(e.g., Value-at-Risk and notional exposure, 

respectively), measured under normal and 

stress market conditions. 

Analysis and quantitative measurements. 

The covered banking entity must perform 

robust analysis and quantitative 

measurement of its covered trading activities 

that is reasonably designed to ensure that the 

trading activity of each trading unit is 

consistent with its mission, strategy and risk 

management process, as documented in the 

covered banking entity’s written policies and 

procedures; monitor and assist in the 

identification of potential and actual 

prohibited proprietary trading activity; and 

prevent the occurrence of prohibited 

proprietary trading. In addition to the 

quantitative measurements reported by the 

covered banking entity to [Agency] pursuant 

to appendix A to this part, each covered 

banking entity must develop and implement, 

to the extent necessary to facilitate 

compliance with this part, additional 

quantitative measurements specifically 

tailored to the particular risks, practices, and 

strategies of its trading units. The covered 

banking entity’s analysis and quantitative 

measurement must incorporate the 

quantitative measurements reported by the 

covered banking entity to [Agency] pursuant 

to appendix A to this part and include, at 

minimum, the following: 

• Internal controls and written policies 

and procedures reasonably designed to 

ensure the accuracy and integrity of 

quantitative measurements; 

• Ongoing, timely monitoring and review 

of calculated quantitative measurements; 

• Heightened review of a quantitative 

measurement when such quantitative 

measurement raises any question regarding 

compliance with section 13 of the BHC Act 

and this part, which shall include in-depth 

analysis, appropriate escalation procedures, 

and documentation related to the review, 

including the establishment of numerical 

thresholds for each trading unit for purposes 

of triggering such heightened review; and 

• Immediate review and compliance 

investigation of the trading unit’s activities, 

escalation to senior management with 

oversight responsibilities for the applicable 

trading unit, timely notification to [Agency], 

appropriate remedial action (e.g., divesting of 

impermissible positions, cessation of 

impermissible activity, disciplinary actions), 

and documentation of the investigation 

findings and remedial action taken when the 

quantitative measurement, considered 

together with the facts and circumstances, 

suggests a reasonable likelihood that the 

trading unit has violated any part of section 

13 of the BHC Act and this part. 

Surveillance of compliance program 

effectiveness. The covered banking entity 

must regularly monitor the effectiveness of 

its compliance program and take prompt 

action to address and remedy any 

deficiencies identified. Any actions taken to 

remedy deficiencies and violations shall be 

documented and maintained as a record of 

the banking entity. 

B. Covered Fund Activities 

A covered banking entity must establish, 

maintain, and enforce internal controls that 

are reasonably designed to ensure that the 

covered fund activities or investments of its 

asset management units are appropriate and 

consistent with the description of the asset 

management unit’s mission, strategy, and risk 

management process contained in the 

covered banking entity’s written policies and 

procedures. The internal controls must, at a 

minimum, be designed to ensure that the 

covered banking entity complies with the 

requirements of §ll.11 for any covered 

fund in which it invests, acts as sponsor, or 

organizes and offers, as well as the following: 

Monitoring investments in a covered fund. 

The covered banking entity must implement 

and enforce internal controls in a way that 

monitors and limits the covered banking 

entity’s individual and aggregate investments 

in covered funds. At a minimum, the covered 

banking entity shall establish, maintain, and 

enforce internal controls reasonably designed 

to ensure that such investments are in 

compliance with section 13 of the BHC Act 

and this part at all times, including: 

• Monitoring the amount and timing of 

seed capital investments for compliance with 

the limitations (including but not limited to 

the redemption, sale or disposition 

requirements of §ll.12); 

• Calculating the individual and aggregate 

levels of ownership interests in covered 

funds required by §ll.12; 

• Describing procedures for remedying 

violations of section 13 of the BHC Act and 

this part; 

• Attributing the appropriate instruments 

to the individual and aggregate ownership 

interest calculations above; and 

• Making the appropriate required 

disclosures, in writing, to prospective and 

actual investors in any covered fund 

organized and offered or sponsored by the 

covered banking entity, as provided under 

§ll.11(h). 

Monitoring relationships with a covered 

fund. The covered banking entity must 

implement and enforce internal controls in a 

way that monitors and limits the covered 

banking entity’s sponsorship of, and 

relationships with, covered funds. At a 

minimum, the covered banking entity shall 

establish, maintain, and enforce internal 

controls reasonably designed to ensure that 

such activities and relationships are in 

compliance with section 13 of the BHC Act 

and this part at all times, including 

monitoring for and preventing any 

relationship or transaction between the 

covered banking entity and a covered fund 

that is prohibited under §ll.16. 

Surveillance of compliance program 

effectiveness. The covered banking entity 

must regularly monitor the effectiveness of 

its compliance program and take prompt 

action to address and remedy any 

deficiencies identified. Any actions taken to 

remedy deficiencies and violations shall be 

documented and maintained as a record of 

the covered banking entity. 

IV. Responsibility and Accountability for the 

Compliance Program 

A covered banking entity must establish, 

maintain, and enforce a management 

framework to manage its business and 

employees with a view to preventing 

violations of section 13 of the BHC Act and 

this part. A covered banking entity must have 

an appropriate management framework 

reasonably designed to ensure that: 

appropriate personnel are made responsible 

and accountable for the effective 

implementation and enforcement of the 

compliance program; a clear reporting line 

with a chain of responsibility is delineated; 

and the board of directors, or similar 

corporate body, and CEO reviews and 

approves the compliance program. This 

management framework must include, at a 

minimum: 

Corporate governance. The covered 

banking entity must ensure that its 

compliance program is reduced to writing, 

approved by the board of directors or similar 

corporate body, and noted in the minutes. 

Trader mandates. The covered banking 

entity must establish, maintain, and enforce 

the trader mandates required by this 

appendix to clearly inform each trader within 

a trading unit of his or her responsibilities for 

compliance with section 13 of the BHC Act 

and this part. 

Management procedures. The covered 

banking entity must establish, maintain, and 

enforce management procedures that are 

reasonably designed to achieve compliance 

with section 13 of the BHC Act and this part, 

which, at a minimum, provide for: 

• The designation of at least one person 

with authority to carry out the management 

responsibilities of the covered banking entity 

for each trading unit; 

• Written procedures addressing the 

management of the activities of the covered 

banking entity that are reasonably designed 

to achieve compliance with section 13 of the 

BHC Act and this part, including: 

Æ Procedures for the review by a manager 

of activities of the trading unit and the 

quantitative measurements pursuant to 

appendix A and any other quantitative 

measurements developed and tailored to the 

particular risks, practices, and strategies of 

the covered banking entity’s trading units; 

Æ A description of the management 

system, including the titles, qualifications, 

and locations of managers and the specific 

responsibilities of each person with respect 

to the covered banking entity’s trading units; 

and 

Æ Procedures for determining 

compensation arrangements for traders 

engaged in underwriting or market makingrelated activities under §ll.4 or riskmitigating hedging activities under §ll.5 

so that such compensation arrangements are 

designed not to reward proprietary risk 

taking. 

Business line managers. Managers with 

responsibility for one or more trading units 

or asset management units of the covered 


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4Such corrective action may include, among 

other things divesture of the position, cessation of 

the activity, or disciplinary measures. 

banking entity engaged in covered trading 

activities or covered fund activities or 

investments are accountable for the effective 

implementation and enforcement of the 

compliance program with respect to the 

applicable trading unit or asset management 

unit. 

Senior management. Senior management is 

responsible for communicating and 

reinforcing the culture of compliance with 

section 13 of the BHC Act and this part, as 

established by the board of directors or 

similar corporate body, and implementing 

and enforcing the approved compliance 

program. Senior management must also 

ensure that effective corrective action is 

taken when failures in compliance with 

section 13 of the BHC Act and this part are 

identified.4 Senior management and control 

personnel charged with overseeing 

compliance with section 13 of the BHC Act 

and this part should report to the board, or 

an appropriate committee thereof, on the 

effectiveness of the compliance program and 

compliance matters with a frequency 

appropriate to the size, scope, and risk 

profile of the covered banking entity’s 

covered trading activities and covered fund 

activities or investments, which shall be at 

least once every twelve months. 

Board of directors, or similar corporate 

body, and CEO. The board of directors, or 

similar corporate body, and CEO are 

responsible for setting an appropriate culture 

of compliance with this part and establishing 

clear policies regarding the management of 

covered trading activities and covered fund 

activities or investments in compliance with 

section 13 of the BHC Act and this part. The 

board of directors or similar corporate body 

must ensure that senior management is fully 

capable, qualified, and properly motivated to 

manage compliance with this part in light of 

the organization’s business activities. The 

board of directors or similar corporate body 

must also ensure that senior management has 

established appropriate incentives to support 

compliance with this part, including the 

implementation of a compliance program 

meeting the requirements of this appendix 

into management goals and compensation 

structures across the covered banking entity. 

V. Independent Testing 

A covered banking entity must ensure that 

independent testing is conducted by a 

qualified independent party, such as the 

covered banking entity’s internal audit 

department, outside auditors, consultants, or 

other qualified independent parties, 

regarding the effectiveness of the covered 

banking entity’s compliance program 

established pursuant to this appendix and 

§ll.20 and the covered banking entity’s 

compliance with this part. A banking entity 

must take appropriate action to remedy any 

concerns identified by the independent 

testing (e.g., remedying deficiencies in its 

written policies and procedures and internal 

controls, etc.). 

The required independent testing must 

occur with a frequency appropriate to the 

size, scope, and risk profile of the covered 

banking entity’s covered trading and covered 

fund activities or investments, which shall be 

no less than once every twelve months. This 

independent testing must include an 

evaluation of: 

• The overall adequacy and effectiveness 

of the covered banking entity’s compliance 

program, including an analysis of the extent 

to which the program contains all the 

required elements of this appendix; 

• The effectiveness of the covered banking 

entity’s written policies and procedures; 

• The effectiveness of the covered banking 

entity’s internal controls, including an 

analysis and documentation of instances in 

which such internal controls have been 

breached, and how such breaches were 

addressed and resolved; and 

• The effectiveness of the covered banking 

entity’s management procedures. 

VI. Training 

Covered banking entities must provide 

adequate training to trading personnel and 

managers of the covered banking entity, as 

well as other appropriate personnel, as 

determined by the covered banking entity, in 

order to effectively implement and enforce 

the compliance program. This training 

should occur with a frequency appropriate to 

the size and the risk profile of the covered 

banking entity’s covered trading activities 

and covered fund activities or investments. 

The training may be conducted by internal 

personnel or independent parties deemed 

appropriate by the covered banking entity 

based on its size and risk profile. 

VII. Recordkeeping 

Covered banking entities must create and 

retain records sufficient to demonstrate 

compliance and support the operations and 

effectiveness of the compliance program. A 

covered banking entity must retain these 

records for a period that is no less than 5 

years in a form that allows it to promptly 

produce such records to [Agency] on request. 

END OF COMMON RULE 

[END OF COMMON TEXT] 

Adoption of the Common Rule Text 

The proposed adoption of the 

common rules set forth above by the 

CFTC, which are identical to the 

common rules adopted by the OCC, 

Board, FDIC, and SEC in the Joint 

Release, is modified by CFTC-specific 

text, as set forth below: 

List of Subjects in 17 CFR Part 75 

Commodity pool operators, 

Commodity trading advisors, Futures 

commission merchants, Reporting and 

recordkeeping requirements, Swaps, 

Futures. 

Authority and Issuance 

For the reasons set forth in the 

Supplementary Information, the 

Commodity Futures Trading 

Commission proposes to amend 17 CFR 

Chapter I as follows: 

PART 75—PROPRIETARY TRADING 

AND RELATIONSHIPS WITH COVERED 

FUNDS 

1. The authority citation for part 75 is 

added to read as follows: 

Authority: 12 U.S.C. 1851. 

2. Part 75 is added as set forth at the 

end of the Common Preamble. 

3. Part 75 is amended by: 

a. Removing ‘‘[Agency]’’ wherever it 

appears and adding in its place ‘‘CFTC’’; 

and 

b. Removing ‘‘[The Agency]’’ 

wherever it appears and adding in its 

place ‘‘The CFTC.’’ 

4. Section 75.1 is added to read as 

follows: 

§ 75.1 Authority, purpose, scope, and 

relationship to other authorities. 

(a) Authority. This part is issued by 

the CFTC 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 commodity pool operators, 

registered commodity trading advisors, 

registered swap dealers, and registered 

major swap participants, among others 

identified in section 2(12)(C) of the 

Dodd-Frank Wall Street Reform and 

Consumer Protection Act of 2010 (12 

U.S.C. 5301(12)(C)). This part 

implements section 13 of the Bank 

Holding Company Act by defining terms 

used in the statute and related terms, 

establishing prohibitions and 

restrictions on proprietary trading and 

investments in or relationships with 

covered funds, and explaining the 

statute’s requirements. 

(c) Scope. This part implements 

section 13 of the Bank Holding 

Company Act with respect to covered 

banking entities described in § 75.2(j). 

This part takes effect on July 21, 2012. 

(d) Relationship to other authorities. 

Except as otherwise provided in under 

section 13 of the BHC Act, and 

notwithstanding any other provision of 

law, the prohibitions and restrictions 

under section 13 of BHC Act shall apply 

to the activities of a covered banking 

entity, even if such activities are 

authorized for a covered banking entity 

under other applicable provisions of 

law. 

5. Paragraph (j) of § 75.2 is added to 

read as follows: 

§ 75.2 Definitions. 

* * * * * 


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(j) Covered banking entity means any 

entity described in paragraph (e) of this 

section for which the CFTC is the 

primary financial regulatory agency, as 

defined in section 2(12)(C) of the DoddFrank Wall Street Reform and Consumer 

Protection Act of 2010 (12 U.S.C. 

5301(12)(C)). 

* * * * * 

6. Section 75.10(a) is revised to read 

as follows: 

§ 75.10 Prohibition on acquiring or 

retaining an ownership interest in and 

having certain relationships with a covered 

fund. 

* * * * * 

(a)(1) General Prohibition. Except as 

otherwise provided in this subpart, a 

covered banking entity may not, as 

principal, directly or indirectly, acquire 

or retain any ownership interest in or 

sponsor a covered fund. 

(2) Commodity Pool Operators and 

Commodity Trading Advisors. A 

covered banking entity that is a covered 

banking entity because it is a 

commodity pool operator or commodity 

trading advisor identified in sections 

2(12)(C)(ii) or 2(12)(C)(iii) of the DoddFrank Wall Street Reform and Consumer 

Protection Act of 2010 shall comply 

with the restrictions on covered fund 

activities or investments set forth in 

subpart C and §ll.20 of subpart D 

issued by the agency identified in 

section 3(q) of the Federal Deposit 

Insurance Act (12 U.S.C. 1813(q)) that 

regulates the banking entity described in 

§ 75.2 (e)(1), (2) or (3) with which the 

commodity pool operator or commodity 

trading advisor is affiliated. 

Note to paragraph (a): Nothing set 

forth in paragraph (a)(2) of this section 

shall limit the CFTC’s authority under 

any other provision of law, including 

pursuant to section 13 of the Bank 

Holding Company Act. 

* * * * * 

Issued on January 11, 2012 in Washington, 

DC. 

David A. Stawick, 

Secretary of the Commission. 

Appendices to Prohibitions and 

Restrictions on Proprietary Trading 

and Certain Interest In and 

Relationships With, Hedge Funds and 

Covered Funds. Commission Voting 

Summary and Statements of 

Commissioners 

Note: The following appendices will not 

appear in the Code of Federal Regulations. 

Appendix 1—Commission Voting Summary 

On this matter, Chairman Gensler and 

Commissioners Chilton and Wetjen voted in 

the affirmative; Commissioners Sommers and 

O’Malia voted in the negative. 

Appendix 2—Statement of Chairman Gary 

Gensler 

I support the proposed rule implementing 

the ‘‘Volcker Rule’’ requirements in the 

Dodd-Frank Wall Street Reform and 

Consumer Protection Act (Dodd-Frank Act). 

Dodd-Frank amended the Banking Holding 

Company Act to provide the Commodity 

Futures Trading Commission with authority 

to implement Volcker Rule requirements for 

the entities for which we are the primary 

financial regulator. 

Today’s proposal mirrors the joint rule 

proposed in October by the Board of 

Governors of the Federal Reserve System, the 

Federal Deposit Insurance Corporation, the 

Office of the Comptroller of the Currency, 

and the Securities and Exchange 

Commission. 

Consistent with the joint proposed rule, 

this proposal prohibits certain banking 

entities from engaging in proprietary trading. 

The proposal permits, as Congress 

prescribed, market-making and riskmitigating hedging. 

I look forward to receiving comments from 

market participants and the public on the 

proposed rule. 

[FR Doc. 2012–935 Filed 2–13–12; 8:45 am] 

BILLING CODE 6351–01–P 


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